Chapter 3 Organizational Cost Flows Cost Accounting Traditions and Innovations Barfield, Raiborn, Kinney

Learning Objectives (1 of 2) List the cost classifications Describe the conversion process in service and manufacturing companies Explain assumptions about cost behavior Analyze mixed costs –high-low method –least squares regression analysis

Learning Objectives (2 of 2) List product cost categories Allocate overhead costs Describe the cause and treatment of underapplied and overapplied overhead Prepare Statements of Cost of Goods Manufactured and Sold

Cost Monetary measure of resources given up to attain an objective (such as acquiring a good or service)

Cost Categories Time of incidence Reaction to changes in activity Classification on the financial statements Impact on decision making

Cost Categories Time of incidence –Historical –Budgeted

Cost Categories Time of incidence Reaction to changes in activity –Variable –Fixed –Mixed –Step

Cost Categories Time of incidence Reaction to changes in activity Classification on the financial statements –Unexpired –Expired –Product –Period

Product Costs Direct material –Part of a product Direct labor –Labor used to manufacture a product or perform a service Overhead –Indirect production cost

Period Costs Selling and administrative costs Distribution costs –Cost to warehouse, transport, and/or deliver a product or service –Major impact on managerial decision making

Purchase raw materials or supplies Input Product or Service Output Conversion Process Change Inputs into Outputs CONVERSION

Low Degree of Conversion Department stores Gas stations Jewelry stores Travel agencies

Moderate Degree of Conversion Florists Meat markets Oil-change businesses

High Degree of Conversion Manufacturing Construction Agriculture Architecture Auditing Mining Printing Restaurants

Service Company S ignificant amount of labor Tangible or intangible output Purchase supplies Use supplies, labor, overhead to provide service Sell to customer Input Output

Retail Company P urchase finished goods Resell to customers Purchase products for resale Warehouse and/or display Sell to customer Input Output

Manufacturer Significant amount of labor and machinery T angible output Purchase raw materials and supplies Finished product Sell to customer Input Output Production Center add labor and overhead

Cost Accumulation in a Manufacturing Company Materials Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Balance Sheet Income Statement

Fixed Cost Variable Cost Cost Reaction to Changes in Activity Unit Total $ Units $ $ $ Within the relevant range

Step Cost Mixed Cost Cost Reaction to Changes in Activity $ $ Units fixed Within the relevant range variable

Determining Cost Behavior Cost Predictor –Activity accompanied by consistent, observable changes in a cost item –Predicts but may not cause the cost to change Cost Driver –Activity that has a direct cause-effect relationship on cost –Directly causes the cost to change

Separating Mixed Costs y = a + bX y = total cost a = fixed portion of total cost b = variable cost X = activity base to which y is related Use formula for a straight line

Separating Mixed Costs High-Low Method –Actual cost observations –Considers only two data points highest and lowest levels of activity –Outliers should be disregarded when analyzing mixed costs

Cost Volume High Low 10,000 2,000 $25,000 9,000 Difference8,000$16,000 = $2/unit Variable cost per unit $16,000 8,000 25,000 = a + (2)(10,000) a = 5,000Fixed cost Y = 5, X Using the High Low Method

Product Cost Cost object - anything to which costs are attached or related Direct cost - traceable to a cost object Indirect cost - not conveniently or practically traceable to a cost object –treated as overhead

Product Cost - Direct Direct Material –Distinctly and conveniently traced to cost object Direct Labor –to manufacture a product or perform a service –includes wages paid to direct labor employees, production bonuses, payroll taxes –may include holiday and vacation pay, insurance, retirement benefits

Product Cost - Indirect Overhead - indirect production costs –Fringe benefits, if cannot be easily traced to product –Overtime, if due to random scheduling –Cost of quality

Product Cost Behavior Direct MaterialVariable Direct LaborVariable OverheadVariable, fixed, mixed

Overhead Cost Allocation Assign indirect costs to one or more cost objects To determine full cost (GAAP) To motivate management To compare alternative courses of action for planning, controlling, and decision making Allocation process should be rational and systematic

Allocating Overhead Actual Cost System Product Cost Direct Materials Direct Labor Overhead Cost Used Actual

Allocating Overhead Actual Cost System The Actual Cost System is not timely All costs must be known before calculating product cost

Allocating Overhead Actual vs. Normal Product Cost Direct Materials Direct Labor Overhead Actual Cost System Actual Normal Cost System Actual Predetermined Overhead Rate

Predetermined Overhead Rate Allows overhead to be assigned during the period Compensates for fluctuations –that are not related to activity level –in activity level that do not affect fixed overhead

Predetermined Overhead Rate Total budgeted overhead Activity level (Volume) A budgeted, constant charge per unit of activity used to assign overhead to production or services

Predetermined Overhead Rate Total budgeted overhead Activity level (Volume) $500, ,000 machine hours = $5 per machine hour

The Activity Level (The Denominator) Relationship between the overhead cost and the activity –production volume –direct labor hours –direct labor cost –machine hours

Overhead Account (Combined) Actual Overhead Applied Overhead Record actual overhead Variable Overhead15,000 Fixed Overhead10,000 Various Accounts25,000 Variable 15,000 Fixed 10,000 Recording and Applying Overhead

Overhead Account (Combined) Actual Overhead Applied Overhead Applying overhead Work in Process23,000 Variable Overhead12,000 Fixed Overhead11,000 Variable 15,000 Fixed 10,000 Variable 12,000 Fixed 11,000 Recording and Applying Overhead

Overhead Account (Combined) Actual Overhead Applied Overhead Variable 15,000 Fixed 10,000 25,000 Variable 12,000 Fixed 11,000 23,000 Recording and Applying Overhead Overhead is underapplied $25,000 of overhead was incurred Only $23,000 was applied to Work in Process

Disposing of Overhead Differences Immaterial –Cost of Goods Sold Material –Work in Process –Finished Goods –Cost of Goods Sold

Alternative Capacity Level Capacity measure of volume or some other activity base Alternative measures: –Theoretical –Practical –Normal –Expected

Flow of Product Costs Raw Materials Inventory Accounts Payable Work in Process Inventory Raw Materials Inventory Work in Process Inventory Salaries/Wages Payable

Flow of Product Costs Fixed Overhead Control (actual) Salaries/Wages Payable Variable Overhead Control (actual) Utilities Payable Work in Process Inventory Variable Overhead Control (applied) Fixed Overhead Control (applied)

Flow of Product Costs Finished Goods Inventory Work in Process Inventory Accounts Receivable Sales Cost of Goods Sold Finished Goods Inventory

Statement of Cost of Goods Manufactured Beginning work in processxxxx –Raw materials used xxx –Direct laborxxx –Variable overheadxxx –Fixed overheadxxx Current period manufacturing costsxxxx Total costs to account forxxxx Ending work in process Cost of goods manufactured xxxx

Statement of Cost of Goods Manufactured Raw Materials Used Beginning raw materialsxxx Purchases of raw materialsxxx Raw materials availablexxx Ending raw materials Total raw materials usedxxx To Statement of Cost of Goods Manufactured

Schedule of Cost of Goods Sold Beginning Finished Goodxxxx Cost of Goods Manufacturedxxxx Cost of Goods Available for Salexxxx Ending Finished Goodsxxxx Cost of Goods Soldxxxx From Schedule of Cost of Goods Manufactured

Questions What is the difference in the conversion process for a service company and a manufacturing company? In a normal cost system, how are overhead costs allocated to products and services? How is cost of goods manufactured calculated?