1. 1 Measuring Product Costs CHAPTER 2 Managerial Accounting 11E Maher/Stickney/Weil © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. PowerPointPresentation by PowerPoint Presentation by LuAnn Bean Professor of Accounting Florida Institute of Technology

2. 2 CHAPTER GOAL This chapter shows how the accounting system records and reports the flow of costs in organizations to answer questions such as these:  To determine product/service cost  To compare cost with management’s expectations ☼☼

3. 3 DIRECT MATERIALS: Definition Can be easily traced directly to a product. LO 1

4. 4 DIRECT LABOR: Definition Is labor of workers who transform materials into a finished product. LO 1

5. 5 MANUFACTURING OVERHEAD: Definition Includes all other costs of transforming the materials to a finished product. LO 1

6. 6 How are materials, labor not directly traceable to a product categorized? All costs, including materials and labor, not directly traceable to a product are categorized as Manufacturing Overhead. LO 1

7. 7 RESPONSIBILITY CENTER: Definition Is any organizational unit with its own manager or managers. LO 2

8. 8 Responsibility center (department) Records costs & assigns to products Direct materials Direct labor Overhead Management compares costs to standards LO 2

9. 9 ACCOUNTING SYSTEM PURPOSES 1)To record costs by responsibility for performance evaluation and control. 2)To assign manufacturing costs to units produced for product costing. LO 3

10. 10 BASIC COST FLOW EQUATION LO 3 Beginning + Transfers = Transfers + Ending Balance In Out Balance BB + TI = TO + EB* *Recall from financial accounting: Beginning Balance + Additions - Withdrawals = Ending Balance

11. 11 COMPARING NORMAL and ACTUAL COSTING  Normal costing advantages  Smoothes seasonal and other fluctuations that don’t relate directly to activity levels  More timely than actual because of estimating process LO 4

12. 12 USING NORMAL COSTING  Select a cost driver (allocation base) to apply overhead  Estimate dollar amount of overhead and level of activity for period  Compute predetermined (normal) overhead rate  Apply overhead to production LO 4

13. 13 EXAMPLE Plantimum Builders manually assembles small modular homes. Using prior year data, Plantimum estimated variable manufacturing overhead at $100,000, 50,000 direct labor hours, and $50,000 fixed manufacturing overhead. What is Plantimum’s variable overhead rate? LO 4 $100,000 / 50,000 dlh = $2.00 per direct labor hour $ 50,000 / 50,000 dlh = $1.00 per direct labor hour What is Plantimum’s fixed overhead rate?

14. 14 EXAMPLE Actual direct labor hours for the month was 4,500. How much variable overhead did Plantimum charge to production for the month? LO 4 4,500 dlh X $2.00 per direct labor hour = $9,000 4,500 dlh X $1.00 per direct labor hour = $4,500 How much fixed overhead did Plantimum charge to production for the month?

15. 15 COST SYSTEMS  An effective cost system must have  Decision focus: meets needs of decision makers  Different costs for different purposes  Variable costing for decision making  Full absorption for financial reporting  Cost-benefit test: benefits from cost system must exceed its costs LO 5

16. 16 COST SYSTEMS: Examples  Job costing  For custom production jobs  Users: accounting and consulting firms, health care organizations  Process costing  For standardized production  Users: drink makers (e.g., Coca Cola, etc.)  Operation costing  A hybrid of job and process combined  Users: Levi Strauss, Dell LO 5

17. 17 PLANTIMUM PRODUCTION Plantimum produced 3 modular homes during the month. Plantimum wonders whether they should use job order costing or process costing? What do you think? Continued LO 6

18. 18 PLANTIMUM PRODUCTION COSTS: Using Job Order Jobs Direct Labor Direct Materials Overhead ($3/dlh) Total Cost Job #1001$ 8,000$20,800$1,200$30,000 Job #10026,00018,10090025,000 Job #10035,00011,25075017,000 $19,000$50,150$2,850$72,000 LO 6 Continued

19. 19 PLANTIMUM PRODUCT COSTING: Using Process LO 6 Unit costs = Total manufacturing costs / Units produced (DL + DM + Overhead) / 3 ($19,000 + $50,150 + $2,850) / 3 Average unit cost is $24,000 per modular house Continued

20. 20 COMPARING COST SYSTEMS Nature of Production Costing System Used Heterogeneous Units Each Unit Large Job Costing Homogeneous Units Many Small Units Continuous Process Process Costing LO 7

21. 21 FLOW OF COSTS: A Service Company Example LO 8 An accounting or consulting service firm collects costs by job or client and uses an accounting method similar to that used in manufacturing. The flow of costs accounted for include: Materials and overhead costs are transferred into Work-in- Process accounts for each job. Work-in-Process costs are transferred to Cost of Services Billed.

22. 22 FLOW OF COSTS REPORTING The income statement reports: Revenue -Cost of services billed = Gross Margin -Expenses (e.g., unbilled direct labor, underapplied overhead, marketing expenses) = Operating Profit LO 8

23. 23 CHARACTERISTICS OF JIT: (Just- in-Time Inventory) JIT inventory methods attempt to obtain materials just in time for production or sale  Reduces/eliminates inventory and carrying costs  Leads to immediate correction of defective units  Helps expose production problems  Relies on high-quality materials, production  Charges all costs directly to cost of goods sold LO 10

24. 24 What happens to inventory leftover after costs are charged to cost of goods sold in a JIT system? Cost of leftover inventory is “backflushed,” i.e., taken out of cost of goods sold and put into finished goods inventory. LO 10

25. 25 What are equivalent units? Equivalent units (E.U.) represent the translation of partially completed work into equivalent whole units. LO 11

26. 26 1.Summarize the Flow of Physical Units 2.Compute Equivalent Units (For example, two units, each 50 percent complete, represent one equivalent unit.) 3.Summarize Costs to Be Accounted For 4.Compute Unit Costs for the Current Period 5.Compute the Cost of Goods Completed and Transferred Out of Work-in-Process and the Cost of Ending Work-in-Process Inventory LO 11 The five steps required to compute product costs, the cost of ending Work-in- Process Inventory, and the cost of finished goods using equivalent units are:

27. 27 Costs flow from basic records of materials purchases, labor costs, and overhead costs to Work-in-Process Inventory accounts that show the cost of ongoing work. When products are complete, they and their costs are transferred to Finished Goods Inventory. When sold, the cost of the products is transferred out of Finished Goods Inventory to Cost of Goods Sold. Costs flow from basic records of materials purchases, labor costs, and overhead costs to Work-in-Process Inventory accounts that show the cost of ongoing work. When products are complete, they and their costs are transferred to Finished Goods Inventory. When sold, the cost of the products is transferred out of Finished Goods Inventory to Cost of Goods Sold.

28. 28 End of CHAPTER 2