chapter 5 fundamentals of product & service costing

Chapter 5Chapter 5

Fundamentals of Product & Service Fundamentals of Product & Service CostingCosting

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Learning ObjectivesLearning Objectives

2. Explain how cost allocation is used in a cost management system.

3. Explain how a basic product costing system works.

4. Understand how overhead cost is allocated to products.

5. Explain the operation of a two-stage allocation system for product costing.

6. Describe the three basic types of product costing systems: job order, process and operations.

1. Explain the fundamental themes underlying the design of cost systems.

5-3Cost Cost SystemSystem

Oriented to the needs of the decision makers

Keys to a good cost system

Designed so that benefits exceed costs

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Cost System ObjectiveL.O. 1 Explain the fundamental themes underlying the design of cost systems.

The cost system accumulates and reports costs about processes, products, and services.

Provide information about costs relevant for decision making.

5-5Why Calculate the Cost of a Why Calculate the Cost of a Product?Product?

What is the cost of inventory?

What is the cost of goods sold?

What should we sell?At what sales price?

For Decision Making

5-6

Designing a Cost SystemDesigning a Cost System

Cost-benefit

Focus

Different information for different purposes

Test

Financia

l the past

Managerial

the future

Decision making

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Cost AllocationCost AllocationL.O. 2 Explain how cost allocation is used in a cost management system.

$ Direct materials

$ Direct labor

$ Overhead

Product A Product B

Traced Directly

Allocated using Direct labor $

DM DL OH

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The Inventory The Inventory AccountsAccounts

Balance SheetBalance Sheet

Raw Materials

Raw Materials Available for Production

=

Beg. Inventory+Purchases

Raw Materials Transferred to WIP

-

Work-In-ProcessBeg. Inventory

Direct Materials Transferred from Raw Materials

+

Manufacturing Overhead

+

Cost of Goods Completed and Transferred to Finished Goods

-

Ending Inventory=

Finished GoodsBeg. InventoryCost of Goods Completed and Transferred from WIP

+

Goods Available for Sale

=

Cost of Goods Sold

-

Ending Inventory

=

To the income statement

Ending Inventory

=

Total Manufacturing Costs

=

Direct Labor

+

Raw Materials Transferred to WIP

-

Cost of Goods Completed and Transferred to Finished Goods

-

5-9A Product Costing System at A Product Costing System at WorkWork

Beginning Balance

Transfers In

Transfers Out

Ending Balance

L.O. 3 Explain how a basic product costing system works.

How costs and units move through inventories.

BB

TI

TO EB

BB TI TO EB

True for

Raw Materials

Work-In-ProcessFinished Goods

RM

WIPFG

BB TI TO EB

5-10Product Costing System Product Costing System ContinuedContinuedHow costs and units move through inventories.

RM

BB Purchases

DM to WIP

EB

FG

BB Transfers from WIP

Cost of goods sold

EB

WIP BB

DMTransfers to FG

EB

IM to OH

DL

OH

To income statement

5-11Product Costing System Product Costing System ContinuedContinued

Baxter PaintApril WIP

Inventory

0 100,000 gallons

100,000 gallons

0

Units – gallons of paint

FG

BB TI TO EB

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Costs

DM

DL

OH

$400,000

$100,000

$500,000

$1,000,000

$1,000,000

$0$0

A Product Costing System at A Product Costing System at WorkWork

Baxter PaintApril WIP

Inventory

FGCost per gallon

$1,000,000100,000

$10 per gallon

BB TI TO EB

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What are the costs?

Work-In-Process Work-In-Process CostsCosts

Where are the costs at the end of the period?

DM

DL

OH

$400,000$100,000$500,000$1,000,000

$0$1,000,000

$0

FG

Let’s rewrite the basic cost flow model

BB TI TO EB

5-14Costing with Ending WIP Costing with Ending WIP InventoryInventory

Baxter PaintMay WIP

Units

0 110,000 gallons

90,000 gallons

20,000 gallonsThese gallons are half finished.

FG

BB TI TO EB

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Equivalent UnitsEquivalent UnitsEnding WIP Inventory

20,000 gallons

½ finished

Equivalent to

10,000 gallons finished

20,000

.5

How do we cost Baxter’s 20,000 gallons of paint that are only half finished?

Total equivalent units

90,000

10,000

100,000

To FG

Ending WIP

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DM

DL

OH

$390,000

$100,000

$500,000

$990,000

? ?$0

Costs

Costing a Product Costing a Product ContinuedContinued

Baxter PaintMay WIP

FG

What is the cost of the 90,000 gallons transferred to FG and the 20,000 gallons still in WIP?

Where is the $990,000?

BB TI TO EB

5-17Costing a Product Costing a Product ContinuedContinuedCost Flow Diagram Product Costing at Baxter

PaintsDM DL OH

$390,000

$100,000

$500,000

FG WIP

$891,000

$99,000

90,000 gallons(90%

)

10,000 gallons(10%

)

Equivalent Gallons

Total $990,000

100,000

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Costing Multiple ProductsCosting Multiple Products

Skis Snowboards

TotalUnits

Costs 75,000 15,000 90,000Direct Material

100,000

22,500 122,500

Direct Labor

Sammy’s Skis and Boards

500 150 650Units produced

4,000

900 4,900Direct labor hours 2,00

0450 2,450Machine hours

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Costing Multiple ProductsCosting Multiple Products

Cost Pools

Cost Objects

Direct Materials

Direct Labor

Skis

Snowboards

Direct Direct

$75,000

$15,000

$100,000

$22,500

$90,000 $122,500

5-20Predetermined Overhead Predetermined Overhead RatesRates

POHR is the cost per unit of the allocation base used to charge overhead to products.

OH is indirect. Where do indirect costs belong?

With the skis?

Or with the boards?

Indirect costs are allocated using a predetermined overhead rate. POHR

L.O. 4 Understand how overhead cost is allocated to products.

POHR $

Base

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Predetermined Overhead Rates Predetermined Overhead Rates ContinuedContinued

What activity drives the overhead costs?

POHREstimated overhead $

Estimated allocation base

What are the estimated costs?

We need to cost products during the period.

We don’t know the exact amount of indirect costs until the end of the period.

Why use estimates?

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Sammy’s Skis and BoardsSammy’s Skis and Boards

Estimated Overhead Costs

$98,000

POHR$98,000

4,900$20 / DLH

4,000 900 4,900Direct Labor hours

Skis

Snowboards

Total

5-23Allocating OH to the Allocating OH to the ProductsProducts

Cost Pool

Cost Allocation Rule

Cost Objects

OH

Skis

Snowboards

Direct Labor Hours $20 / DLH

$98,000

$80,000

$18,0004,000DL

H

$20 900DLH $20

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Sammy’s Skis and BoardsSammy’s Skis and Boards

Units produced 500 150 650

Direct Labor hours

4,000 900 4,900

Direct Material

$75,000

$15,000

$90,000

Direct Labor 100,000

22,500 122,500OH @ $20/DLH 80,00

018,000 98,00

0

Costs

Skis

Snowboards

TotalUnits

Total $255,000

$55,500

$310,500

Cost per unit $510 $370

5-25Two-Stage Allocation Two-Stage Allocation SystemsSystems

Cost Pool Overhead

Intermediate Cost Pools

Cost Allocation Rule

Labor-related Machine-related

Direct Labor Hours

Machine Hours

$98,000

$73,500

$24,500

L.O. 5 Explain the operation of a two-stage allocation system for product costing.

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$18,000

$80,000

Two-Stage Allocation Systems Two-Stage Allocation Systems ContinuedContinued

Intermediate Cost Pools

Cost Allocation

Labor-related Machine-related

Direct Labor Hours

Machine Hours

$73,500

$24,500

Cost Objects Skis Snowboards

$15/DLH $10/MH

$60,000

$13,500

DL

$20,000

$4,500MH

2,4504,900

Allocated Overhead

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Sammy’s Skis and BoardsSammy’s Skis and Boards

Direct Material

$75,000

$15,000

$90,000

Direct Labor 100,000

22,500 122,500OH @ $15/DLH 60,00

013,500 73,50

0

Costs

Skis

Snowboards

Total

Total $255,000

$55,500

$310,500

Cost per unit $510 $370

OH @ $10/MH 20,000

4,500 24,500

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Product Costing SystemsProduct Costing Systems

Job Costing

Process Costing

An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods.

An accounting system used when identical units are produced through a series of uniform production steps.

L.O. 6 Describe the three basic types of product costing systems: job order, process, and operations.

Custom Homes

Movies

Services

Cornflakes

Facial Tissues

Paint

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Product Costing SystemsProduct Costing Systems

Job Costing Process Costing

An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods.

An accounting system used when identical units are produced through a series of uniform production steps.

Operation Costing

A hybrid costing system often used in manufacturing of goods that have some common characteristics plus some individual characteristics.

Automobiles

Computers

Clothing

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Chapter 5