class 2 optional product costs and job-order costing

Manufacturing Business

Product Costs

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Direct MaterialsThe material out of which the product is made. Wood for a bookcase, metal for an oven.

Manufacturing OverheadThe infrastructure needed to support the skilled craftspeople. Supervisors, maintenance people, machines, rent, electricity, etc.

Direct LaborThe wages paid to the skilled craftspeople who form the direct materials into the final product.

Cost Flows

Step 1. Raw materials are purchased and stored in the raw materials inventory warehouse.

Step 2. Raw materials are moved to the factory floor. All material on the factory floor is referred to as work-in-process inventory.

Step 3. On the factory floor, employees combine materials with their labor to produce finished products. This work is supported by the infrastructure, or overhead, of the factory.

Step 4. The finished products are moved to the finished goods inventory warehouse and stored until sold.

Cost Flows

Raw Materials Inventory ------------------------------------------------------------------ Purchases IN | to WIP OUT ------------------------------------------------------------------ |

Manufacturing Overhead ------------------------------------------------------------------ Actual IN | Applied OUT ------------------------------------------------------------------ |

Work-in-Process Inventory ------------------------------------------------------------------ Direct materials | Cost of Goods Direct labor | Manufactured Manufacturing Overhead | OUT ------------------------------------------------------------------ |

Finished Goods Inventory ------------------------------------------------------------------ from WIP IN | Cost of | Goods Sold | OUT ------------------------------------------------------------------ |

Product and Period Costs

Product CostsCosts incurred INSIDE the production facility

Period CostsCosts incurred OUTSIDE the production facility

Product and Period Costs

The Factory

ProductPeriod

Examples

Product Costs

• Cost of the raw materials used in production• Wages of factory employees• Salaries of the vice president of manufacturing and

the plant manager• Utility bills to heat and light the factory building• Depreciation or rent on the factory building• Wages of maintenance personnel and custodians

who work in the factory

Examples

Period Costs

• Wages and salaries of individuals working in the administrative offices

• Costs of electricity, heat, and other expenses for the administrative offices

• Advertising costs• Salaries and commissions paid to salespeople• Interest expense

Question: How about PROPERTY TAXES … product cost or period cost?

Job-Order Costing

Step 1. Identify a specific product or project

Step 2. Specifically trace the costs of direct materials and direct labor to the product or project.

Step 3. Allocate an appropriate amount of overhead costs to the product or project.

Job #117

Job-Order CostingAccounting Cost Flows for Job #117

Manufacturing Overhead Rate

QUESTION: We just paid $6,450 rent for the factory building this month. How much of that should be assigned to the cost of production of Job #117?

Oh, and how much of the cost of the plant manager salary should be assigned to Job #117?

And how about the wages of the maintenance people for the month?

And the depreciation on the tools?

SIMPLE INSIGHT: More overhead costs are created by jobs that involve• more direct labor work time and/or• more machine hour time.

So, assign (or apply) overhead costs based on• direct labor hours and/or• machine hours.

Overhead Applied to Job #117

One Mahogany Table

Job Cost Sheet

Manufacturing Cost Journal Entries

Purchase of Raw Materials

Use of DIRECT Materials

Use of INDIRECT Materials

Use of DIRECT Labor

Use of INDIRECT Labor

ACTUAL Manufacturing Overhead

Manufacturing Cost Journal EntriesAPPLIED Manufacturing Overhead

Transfer of Goods Completed

Sale of Goods to Customer

Job-Order Costing

Accounting Cost Flows

Accounting for

Manufacturing Overhead

Step 1. Before the year begins, estimate• manufacturing overhead for the year, • allocation activity level for the year (labor or machine hours), and• compute the predetermined overhead rate.

Step 2. During the year, record actual manufacturing overhead as debits to the manufacturing overhead account.

Step 3. During the year, record applied manufacturing overhead as credits to the manufacturing overhead account and debits to the work-in-process account.

Step 4. At the end of the year, compare actual and applied overhead balances; close out the difference.

Accounting for

Manufacturing Overhead ------------------------------------------------------------------ Actual IN | Applied OUT ------------------------------------------------------------------ ?Under-applied? |?Over-applied?

Accounting for

Why does the Overhead Rateneed to be estimated

at the start of the year?

On January 1, customers appear (hopefully), and you need to give them cost quotes immediately … or else they will go to your competitors.

PREDETERMINEDOverhead Rate

ACTUAL Manufacturing Overhead

Manufacturing Overhead Account

Question: What kind of account is the Manufacturing Overhead account … asset, liability, revenue, or expense?

Answer: None of the above. It is a TEMPORARY HOLDING TANK for overhead costs.

Manufacturing Cost Journal EntriesAPPLIED Manufacturing Overhead

UNDER-Applied

Two questions• What business problem is caused by this $750 UNDER-applied

overhead?• What do we do with the Manufacturing Overhead account, in terms of

debits and credits, at the end of the year?

Manufacturing Overhead ---------------------------------------- ACTUAL |APPLIED | 15,224 | 20,800 26,376 | 10,450 | 9,600 ---------------------------------------- 41,600 | 40,850 ---------------------------------------- Ending Balance 750 | (UNDER-applied)

UNDER-Applied

Business Problem• We didn’t apply enough overhead to each job during the year.• Our computed costs were too low; perhaps the prices we

charged our customers were too low.• If our customers don’t pay for the overhead, then WE have to

pay for the overhead.

Closing Journal Entry

Cost of Goods Sold 750Manufacturing Overhead 750

OVER-Applied

Two questions• What business problem is caused by this $1,250 OVER-applied

overhead?• What do we do with the Manufacturing Overhead account, in terms of

debits and credits, at the end of the year?

Manufacturing Overhead ---------------------------------------- ACTUAL |APPLIED | 15,224 | 20,800 26,376 | 10,450 | 11,600 ---------------------------------------- 41,600 | 42,850 ---------------------------------------- Ending Balance | 1,250 (OVER-applied)

OVER-Applied

Business Problem• We applied TOO MUCH overhead to each job during the year.• Our computed costs were too high; perhaps the prices we quoted

to our customers were too high.• We have driven away some customers with our high prices.

Manufacturing Overhead 1,250Cost of Goods Sold 1,250

Accounting for

Step 1. Before the year begins, estimate• manufacturing overhead for the year, • allocation activity level for the year (labor or machine hours), and• compute the predetermined overhead rate.

Step 2. During the year, record actual manufacturing overhead as debits to the manufacturing overhead account.

Step 3. During the year, record applied manufacturing overhead as credits to the manufacturing overhead account and debits to the work-in-process account.

Step 4. At the end of the year, compare actual and applied overhead balances; close out the difference.

Cost Flows

T-Account

Work-in-Process Inventory

Work-in-Process Inventory ------------------------------------------------------------------ Beginning Inventory | Direct materials | Cost of Goods Direct labor | Manufactured Manufacturing Overhead | OUT (applied!!!) | ------------------------------------------------------------------ Ending Inventory |

Cost of Goods Manufactured

Cost of Goods Manufactured• The aggregate lifetime cost of the inventory

completed this period.• WARNING: Some of these costs were incurred in

prior periods.

Cost of Goods Manufacturedis NOT the amount ofcost occurred in the factorythis period.

Schedule ofCost of Goods Manufactured

T-Account Detective Work

Raw Materials Inventory

T-Account Detective WorkWork-in-Process

Inventory

T-Account Detective WorkFinished Goods

Inventory

Cost of Goods Sold Adjustment

Under- or Over-Applied Overhead

Closing Journal EntryManufacturing Overhead 6,000

Cost of Goods Sold 6,000

Manufacturing Overhead ---------------------------------------- ACTUAL |APPLIED | 168,000 | 174,000 ---------------------------------------- Ending Balance | 6,000 (OVER-applied)

Under- or Over-Applied Overhead

ADJUSTED Cost of Goods Sold

Manufacturing Overhead 6,000Cost of Goods Sold 6,000

Schedule of

Cost of Goods Manufactured

class 2 optional product costs and job-order costing

factory floor

overhead costs

costs of direct materials

cost of production

factory buildingdepreciation

period coststhe factory

property taxes product

final product

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