Product Costing in Service and Manufacturing Entities Chapter 11

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-2 Introduction Financial Accounting Product costs are used to value inventory and to compute cost of goods sold. Managerial Accounting Product costs are used for planning, control, directing, and management decision making.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-3 The Product Manufacturing Overhead Direct Labour Direct Material Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-4 Direct Material Example: Steel used to manufacture the automobile. Example: Steel used to manufacture the automobile. Raw material that is used to make, and can be conveniently traced, to the finished product.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-5 Cost of salaries, wages, and fringe benefits for personnel who work directly on manufactured products. Direct Labour Example: Wages paid to an automobile assembly worker. Example: Wages paid to an automobile assembly worker.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-6 All other manufacturing costs Manufacturing Overhead Materials used to support the production process. Examples: lubricants and cleaning supplies used in an automobile assembly plant. Indirect Labour Indirect Material Other Costs

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-7 All other manufacturing costs Manufacturing Overhead Cost of personnel who do not work directly on the product. Examples: maintenance workers, janitors and security guards. Indirect Labour Indirect Material Other Costs

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-8 All other manufacturing costs Manufacturing Overhead Examples: depreciation on plant and equipment, property taxes, insurance, utilities, overtime premium, and unavoidable idle time. Indirect Labour Indirect Material Other Costs

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 11-9 Manufacturing Cost Flow Materials waiting to be processed. Partially complete products – material to which some labour and/or overhead has been added. Completed products awaiting sale. Raw Materials Finished Goods Work-in-Process

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow Cost of Purchases Materials Used Labour Overhead Cost of Goods Sold Balance Sheet Income Statement Raw Materials Total Mfg. Costs Incurred Ending Inventory Cost of Goods Mfd. Ending Inventory Work-in- Process Finished Goods

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cost Flow in Service Companies Hotels AttorneysBanks Hospitals Service Companies Public Accountants Insurance Firms Airlines Plumbing Companies

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Service companies do not have work-in-process and finished goods inventory accounts wherein costs are stored before being transferred to a cost of goods sold account. Cost Flow in Service Companies

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Let’s examine the cost flows in a manufacturing company. We will use T-accounts and start with materials. Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Work in Process Raw Materials Mfg. Overhead Material Purchases Manufacturing Cost Flow Direct Material Indirect Material

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Next let’s add labour costs and applied manufacturing overhead to the job-order cost flows. Are you with me? Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Direct Labour Indirect Material Overhead Applied to Work in Process If actual and applied manufacturing overhead are not equal, a year-end adjustment is required. We will look at the procedure to accomplish this later. Indirect Labour Direct Labour Overhea d Applied Indirect Labour Wages Payable Work in Process Mfg. Overhead Manufacturing Cost Flow Direct Material

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Now let’s complete the goods and sell them. Still with me? Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cost of Goods Mfd. Finished Goods Cost of Goods Sold Cost of Goods Mfd. Cost of Goods Sold Work in Process Direct Material Direct Labour Overhea d Applied Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Let’s look at the January transactions of Ventra Manufacturing company. Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra pays $26,500 cash to purchase raw materials. Raw Materials  26,500 Cash Bal. 64,500  26,500 Bal. 500

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra places $1,100 of raw materials into production in the process of making jewelry boxes. Raw Materials  1,100 Work-in-Process Bal. 0  26,500 Bal. 500  1,100

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra pays $2,000 cash to purchase production supplies. Production Supplies  26,500 Cash Bal. 64,500  2,000

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra pays production workers $1,400 cash.  26,500 Cash Bal. 64,500  2,000  1,100 Work-in-Process Bal. 0  1,400

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra applies $1,680 of estimated manufacturing overhead costs at the end of the month of January. Applied Manufacturing Overhead Actual  1,100 Work-in-Process  1,400  1,680 Bal. 0 Applied overhead = 500 boxes × $3.36 per box

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Estimated total manufacturing overhead cost for the year Estimated total units in the allocation base for the year POHR = A predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. The Flow of Overhead Costs $40,320 12,000 jewelry boxes POHR = = $3.36 per box

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Overhead applied = POHR × Actual activity Actual amount of the allocation base such as units produced, direct labour hours, or machine hours. Based on estimates, and determined before the period begins. The Flow of Overhead Costs

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Using a predetermined rate makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until the end of the period. $ The Flow of Overhead Costs

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra transfers the total cost of 500 jewelery boxes from work-in-process to finished goods. Finished Goods  1,100 Work-in-Process  1,400  1,680 Bal. 0  4,180 Bal. 836  4, $8.36 Unit cost = $4,180 ÷ 500 boxes = $8.36 per box

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventra recognizes cost of goods sold expense for 400 jewelry boxes sold to customers. Finished Goods  4,180 Bal. 836 Cost of Goods Sold  3, $8.36 per box = $3,344

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventura recognizes $5,600 of sales revenue for 400 boxes sold. Revenue  5, $14.00 per box = $5,600  26,500 Cash Bal. 64,500  2,000  1,400  5,600

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventura pays $1,200 cash for actual manufacturing overhead costs including indirect labour, utilities, rent, etc.  26,500 Cash Bal. 64,500  2,000  1,400  5,600 Applied Manufacturing Overhead Actual  1,680  1,200

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow  Ventura pays $1,200 cash for actual manufacturing overhead costs including indirect labour, utilities, rent, etc.  26,500 Cash Bal. 64,500  2,000  1,400  5,600 Applied Manufacturing Overhead Actual  1,680  1,200 Manufacturing overhead is $480 overapplied at the end of January. If a difference between actual and applied overhead exists at year end, the amount will be closed to cost of goods sold.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow At the end of the year, Ventra has the following account balances:

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow Supplies: $2,000 purchased, $1,700 used. See Cost of Goods Manufactured and Sold Schedule

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow Explanation of Manufacturing Overhead balance follows.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow Applied Manufacturing Overhead Actual 39,64843,400 3,752 Manufacturing overhead is $3,752 underapplied. 11,800 boxes manufactured × $3.36 POHR

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow Applied Manufacturing Overhead Actual 39,64843,400 3,752 Manufacturing overhead is $3,752 underapplied. Cost of Goods Sold 83,600 10,000 $8.36 3,752 Underapplied overhead is closed to Cost of Goods Sold leaving a zero balance in the overhead account. 87,352

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Analyzing the Underapplied Overhead Spending variance $3,080 unfavorable $43,400$40,320$39,648 Volume variance $672 unfavorable Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Total variance is $3,752 unfavorable, the amount of underapplied overhead.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Manufacturing Cost Flow Let’s prepare a Schedule of Cost of Goods Manufactured and Sold for Ventra.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Preparing a Cost of Goods Manufactured and Sold Schedule

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Preparing a Cost of Goods Manufactured and Sold Schedule

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Preparing a Cost of Goods Manufactured and Sold Schedule Reported in the current assets section of the balance sheet.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Let’s look at the Income Statement for Ventra. Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Let’s look at the Balance Sheet for Ventra. Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Let’s look at the Cash Flow Statement for Ventra. Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Financial Statements

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Let’s compare absorption and variable costing. The Motive to Overproduce – Absorption Costing

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada The Motive to Overproduce – Absorption Costing Reeve Manufacturing Company incurs the following costs to produce 2,000 units of inventory: Let’s see what happens to costs if Reeve increases production.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Now let’s compute income at the three level of production if Reeve sells 2,000 units. The Motive to Overproduce – Absorption Costing

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada The Motive to Overproduce – Absorption Costing Internally, many companies use variable costing to motivate managers to increase profitability without motivating them to overproduce.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Variable Costing Net income is not affected by production increases.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada End of Chapter 11