solution manual management accounting

Solution Manual: Management Accounting

Management Accounting Intermediate (Universiteit van Amsterdam)

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Instructors Manual

Management and Cost Accounting

Fifth edition

Alnoor Bhimani

Charles T. Horngren Srikant M. Datar Madhav V. Rajan

Farah Ahamed

For further instructor material please visit:

www.pearsoned.co.uk/bhimani

ISBN: 978-0-273-75986-7 Pearson Education Limited 2012 Lecturers adopting the main text are permitted to download and photocopy the manual as required.


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ISBN: 978-0-273-75986-7

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3 Pearson Education Limited 2012

Contents

Chapters Pages

Part I Management and cost accounting fundamentals 1. The accountants role in the organisation 6 2. An introduction to cost terms and purposes 15 3. Job-costing systems 28 4. Process-costing systems 42 5. Cost allocation 66 6. Cost allocation: joint-cost situations 81 7. Income effects of alternative stock-costing methods 98

Part II Accounting Information for decision making 8. Costvolumeprofit relationships 114 9. Determining how costs behave 131 10. Relevant information for decision making 144 11. Activity-based costing 155 12. Pricing, target costing and customer profitability analysis 166 13. Capital investment decisions 179

Part III Planning and budgetary control systems 14. Motivation, budgets and responsibility accounting 200 15. Flexible budgets, variances and management control: I 213 16. Flexible budgets, variances and management control: II 230 17. Measuring yield, mix and quantity effects 248

Part IV Management control systems and performance issues 18. Control systems and transfer pricing 268 19. Control systems and performance measurement 281

Part V Quality, time and the strategic management of costs 20. Quality and throughput concerns in managing costs 298 21. Accounting for just-in-time systems 309 22. Strategic management accounting and emerging issues 326

Guide to case study solutions 334



Preface

This manual is intended to assist lecturers discussion of assignments and lecture topics. Points to stress and teaching tips are provided for each chapter to give broad guidance on relevant issues or potential areas of difficulty to students. Solutions are offered for end-of-chapter assessment material in the text. Case notes prepared (in most cases) by the case writer to all cases included in the text are also provided. The assistance of Pauline Gleadle, Laurence Habib, Imran Malik, Rishi Zaveri and Marvish Shami with reviewing and checking many of the problems and their solutions is gratefully acknowledged.

A. Bhimani

C. Horngren

S. Datar

M. Rajan

F. Ahamed



PART I

MANAGEMENT AND COST ACCOUNTING FUNDAMENTALS



C H A P T E R 1

The accountants role in the organisation

Teaching tips and points to stress

Modern management accounting

While the accounting system provides information (e.g. product costs, downtime) for management decisions, cost management refers to active use of this information to plan and control costs. Cost management requires managers to actively seek ways to reduce costs. Much cost management occurs well before the accounting system recognises costs. (The product design stage often offers more cost management opportunities than controlling manufacturing operations.) Cost management is integrated throughout the text.

To reinforce the value-chain concept, ask a student to illustrate activities/costs in each function in the context of his/her work experience.

Students are often confused about the difference between R&D and Design. The distinctions are not always clear-cut, but R&D is basic research and idea generation, whereas design turns those ideas into reality. Design encompasses development of prototype products and the manufacturing process by which the products are produced.

Elements of management control

Planning and control are distinct activities, but they go hand in hand. To maximise the benefits from planning (e.g. budgeting), the manager should use that plan as a benchmark for controlling (i.e. assessing the effectiveness and efficiency of implementation). Conversely, it is difficult to control activities without a plan or budget.

To help students understand how accounting numbers can affect employees behaviour and hence firms performance, ask questions, such as if a materials procurement officers annual bonus depends on the difference between budgeted price and actual price paid, how will the officer behave? The officer may be tempted to purchase cheap, perhaps low-quality materials that may not be delivered on a reliable, timely basis; he or she may refuse to order materials for rush orders if there will be an extra delivery charge, etc.

Although it is difficult to quantify the costs and benefits of accounting systems, a decision about the system will be made. The question is whether costs and benefits are considered implicitly (as part of a gut feeling) or explicitly, where effects of different estimates can be examined.

Product cost information permeates all three functions. In the scorekeeping function, accountants accumulate product cost information for both external and internal reportings. Product cost information can help identify cost management opportunities (i.e. attention directing) and it is used in make-or-buy decisions, where managers compare the cost of making the product or component with the cost of buying it from an external supplier (i.e. problem solving).


Bhimani, Horngren, Datar and Rajan, Management and Cost Accounting, 5th Edition, Instructors Manual


Costs, benefits and context

The best information system depends on both technical and human aspects of the specific situation. This is a major difference between financial accounting, where firms generally need to comply with external reporting requirements where they exist, and management accounting, where choices are based on an explicit or implicit costbenefit analysis. Management accounting students must do more than memorising rules. They must evaluate the situation and context, decide which technique or information system is most appropriate and implement it.

Themes in the design of management accounting systems

Customer satisfaction is the dominant theme. All other themes are directed toward attracting and retaining profitable customers who remain satisfied.

These themes can also be applied to functions within a business. For example, management accountants (MAs) must satisfy their customers (managers) by satisfying key success factors. MAs must provide high-quality information on a timely basis for a reasonable cost. MAs can develop innovative formats and analyses to facilitate management decisions. They should provide information regarding all elements of the value chain and must prepare information for internal decisions as well as external financial reporting. MAs should continually strive to provide better quality information, faster, at a lower cost.

Solutions to review questions

1.1 The five broad purposes are:

Purpose 1: Formulating overall strategies and long-range plans.

Purpose 2: Resource allocation decisions such as product and customer emphasis and pricing.

Purpose 3: Cost planning and cost control of operations and activities.

Purpose 4: Performance measurement and evaluation of people.

Purpose 5: Meeting external regulatory and legal reporting requirements where they exist.

1.2 Management accounting measures and reports financial as well as other types of information that may be useful to managers in fulfilling the goals of the organisation.

Financial accounting focuses on external reporting that is guided by generally accepted accounting principles.

1.3 The business functions in the value chain are:

Research and development the generation of, and experimentation with, ideas related to new products, services or processes.

Design of products, services and processes the detailed planning and engineering of products, services or processes.

Production the coordination and assembly of resources to produce a product or deliver a service.




Marketing the process by which individuals or groups (a) learn about and value the attributes of products or services and (b) purchase those products or services.

Distribution the mechanism by which products or services are delivered to a customer.

Customer service the support activities provided to the customers. 1.4 Cost management refers to actions that managers undertake to satisfy customers while

continuously reducing and controlling costs.

1.5 A successful accountant requires general business skills (such as understanding the strategy of an organisation) and people skills (such as motivating other team members) as well as technical skills (such as computer knowledge).

1.6 Yes. Drucker is advocating that accountants do more than scorekeeping, which is often interpreted as being a bobby on the beat or a watchdog. It is also essential that accountants emphasise their attention-directing and problem-solving functions.

1.7 The new accountant could reply in one or more of several ways:

a Demonstrate to the plant manager how he or she could make better decisions, if the plant accountant was viewed as a resource rather than a dead weight.

In a related way, the plant accountant could show how the plant managers time and resources could be saved by viewing the new plant accountant as a team member.

b Demonstrate to the plant manager a good knowledge of technical aspects at the plant. This approach may involve doing background reading. It certainly will involve spending much time on the plant floor speaking to plant personnel.

c Show the plant managers examples of the new plant accountants past successes in working with line managers in other plants. Examples could include

assistance in preparing the budget, assistance in analysing problem situations and assistance in submitting capital budget requests.

d Seek assistance from the corporate accountant to highlight to the plant manager the importance of many tasks undertaken by the new plant accountant. This approach is a last resort but may be necessary in some cases.

1.8 A customer-driven management accountant function would

a approach its customers (such as managers in different parts of the value chain) to determine how it can facilitate those managers making better decisions, and

b solicit regular and systematic feedback from those customers about its performance.

1.9 Yes, management accountants have customers just as companies have customers who purchase their products or services. Management accountants provide information and advice to many line and staff people in the organisation and to various external parties. It is essential that they provide information and advice that line and staff customers and external parties view as timely and relevant.




1.10 Five themes that affect the way managers operate and have prompted developments in management accounting are the following:

Customer satisfaction is priority one Key success factors (cost, quality, time, and innovative products and services) Total value-chain analysis Continuous improvement Dual external/internal focus.

Solutions to exercises

1.13 Value chain and classification of costs, computer company. (15 min)

Cost item Value-chain business function

a Production

b Distribution

c Design

d Research and development

E Customer service

F Design (or research and development)

G Marketing

H Production

1.14 Value chain and classification of costs, pharmaceutical company. (15 min)

Cost item Value-chain business function

a Design

b Marketing

c Customer service

d Research and development

e Marketing

f Production

g Marketing

h Distribution




1.15 Uses of feedback. (10 min)

Item Use of feedback

a 2

b 6

c 4

d 3

e 5

f 1

1.16 Scorekeeping, attention directing and problem solving. (15 min)

Because the accountant's duties are often not sharply defined, some of these answers might be challenged.

Activity Function

a Scorekeeping

b Attention directing

c Scorekeeping

d Problem solving

e Attention directing

f Attention directing

g Problem solving

h Scorekeeping, depending on the extent of the report

i This question is intentionally vague. The give-and-take of the budgetary process usually encompasses all three functions, but it emphasises scorekeeping the least. The main function is attention directing, but problem solving is also involved.

j Problem solving

1.17 Scorekeeping, attention directing and problem solving. (15 min)

The accountants duties are often not sharply defined, so some of these answers might be challenged.

Activity Function

a Attention directing

b Problem solving

c Scorekeeping




Activity Function

d Scorekeeping

e Scorekeeping

f Attention directing

g Problem solving

h Scorekeeping

i Problem solving

j Attention directing

1.18 Changes in management and changes in management accounting. (15 min)

Change in management accounting

Key theme in newly evolving management approach

a Total value-chain analysis

b Key success factors (quality) or total value-chain analysis

c Dual external/internal focus

d Continuous improvement

e Customer satisfaction is priority one

1.19 Planning and control, feedback. (1520 min)

1 Planning is choosing goals, predicting results under various ways of achieving those goals and then deciding how to attain the desired goals. One goal of the European Starting News (ESN) is to increase operating income. Increasing revenues is potentially one way to achieve this if the increase in revenues exceeds any associated increase in costs. ESN expects daily circulation to increase from 250,000 per day in April to 400,000 per day in May. This budgeted circulation gain is expected to increase newspaper revenues from 5,250,000 in April to a budgeted 6,200,000 in May.

Control covers both the actions that implement the planning decision and the performance evaluation of the personnel and operations. At ESN, the price drop would be announced to its sales force and probably to customers. Requirement 2 illustrates a performance report for May 2003.

2. Actual results Budgeted amounts Variance

Newspapers sold 13,600,000 12,400,000 1,200,000 fav

Price per paper 0.50 0.50 0.00 fav

Newspaper revenue 6,800,000 6,200,000 600,000 fav




3 Based on the 600,000 favourable variance for circulation revenue, Saunier might take the following actions:

a Change predictions. ESN underestimated the daily circulation gain by 40,000 copies per day. It might examine the procedures it uses to estimate the response of circulation to price changes.

b Change operations. ESN might now change its advertising rates to reflect that circulation in May is 76% above that of April. This gives advertisers a much larger audience they can reach with each advertisement in the ESN.

1.20 Professional ethics and reporting divisional performance. (1015 min)

1 Devalloiss ethical responsibilities are well summarised in Ethical Guidelines. Areas of ethical responsibility include

competence, confidentiality, integrity and objectivity. The key area related to Devalloiss current dilemma is integrity. Devallois should refuse to book the 200,000 of sales until the goods are shipped. Both financial accounting and management accounting principles maintain that the sales are not complete until the title is transferred to the buyer.

2 Devallois should refuse to follow Clments orders. If Clment persists, the incident should be reported to the corporate accountant. Support for line management should be wholehearted, but it should not require unethical conduct.

1.21 Responsibility for analysis of performance. (2030 min)

This problem raises plenty of thought-provoking questions. Unfortunately, there are no pat answers. The generalisations about these relationships are difficult to formulate.

1 Apparently, the accountants performance-analysis staff have not won the confidence or respect of Hedby and other line officers. Hedby regards these accountants as interlopers who are unqualified for their analytical tasks on two counts: (a) the task is Hedbys, not the accountants and (b) Hedby understands his own problems best. It is unlikely that the accountants performance-analysis staff have maintained a day-to-day relationship with line personnel in Division C.

2 Nedregotten should point out that her performance-analysis staff are doing the work in order to enable Hedby to better concentrate on his other work. The detached analyses by her staff should help Hedby better understand and improve his own performance.

Furthermore, Nedgrotten should point out that Hedby would need his own divisional accounting staff in order to prepare the necessary analysis of performance, if Hedbys group did not support him. More uniform reporting formats and procedures and more objective appraisals could potentially occur if the performance-analysis staff remain as part of the corporate accountants group.




3 Two approaches within the existing organisation reporting relationships are the following:

a Placing higher priority on having her performance-analysis staff view the division personnel as important customers and actively seeking out ways to increase customer satisfaction.

b Encouraging greater use of teams in which division personnel and corporate control personnel are members. Hopefully, mutual respect will increase by this close interaction.

A more extreme approach would be to change the organisations reporting relationships and staff assignments. For example, each division manager could have his or her own performance-analysis staff member as part of the plant accountants group.

1.23 Planning and control decisions: Internet company. (30 min)

1. Planning decisions at WebNews.co.uk focus on organisational goals, predicting results under various alternative ways of achieving those goals and then deciding on how to attain the desired goals. For example, WebNews.co.uk could have the objective of revenue growth to gain critical mass or it could have the objective of increasing operating income. Many Internet companies in their formative years make revenue growth (and subscriber growth) their primary goal.

Control focuses on (a) deciding on and taking actions that implement the planning decisions and (b) deciding on performance evaluation and the related feedback that will help future decision making.

2. Planning decisions

a Decision to raise monthly subscription fee.

c Decision to upgrade content of online services.

e Decision to decrease monthly subscription fee.

Control decisions

b Decision to inform existing subscribers about the rate of increase an implementation part of control decisions.

d Demotion of VP of Marketing performance evaluation and feedback aspect of control decisions.

1.24 Problem solving, scorekeeping and attention directing: Internet company. (30 min)

1. Problem solving comparative analysis for decision making.

Scorekeeping accumulating data and reporting reliable results to all levels of management.

Attention directing helping managers to properly focus their attention.




2 a and e Decisions to change subscription fee.

Problem solving report outlining expected revenues from subscribers and advertising with different monthly fee amounts.

Scorekeeping report with monthly subscribers and their revenues in prior months.

Attention directing report showing the change in the number of subscribers of Internet companies at the time they change their monthly fees.

b Decision in June 2005 to inform existing subscribers about rate increase in July.

Problem solving report showing the cost of different ways of informing subscribers of the rate increase.

Scorekeeping report showing how many subscribers immediately paid the new subscription fee when past fee increases occurred.

Attention directing report showing the number of subscribers to the service that have not logged on for two months or more.

c Decision to upgrade the content of online services.

Problem solving report showing the expected cost of alternative ways to upgrade content.

Scorekeeping labour cost tracking of software developers who work on content.

Attention directing report on cost overruns relative to budget for ongoing content upgrades.

d Demotion of VP of Marketing

Problem solving budgeted cost of marketing department with alternative management teams.

Scorekeeping report showing breakdown of subscribers into renewals and new subscribers.

Attention directing report highlighting subscriber growth and rates of competing Internet news services.



C H A P T E R 2

An introduction to cost terms and purposes


Costs in general

Cost assignment is a general term for attaching either direct or indirect costs to cost objects. The distinction between direct and indirect costs is important because direct costs are directly traced to the cost object, whereas indirect costs are often pooled and then allocated to the cost object with less precision. Management, therefore, has more confidence in the accuracy of direct costs. The text uses the term cost tracing to refer specifically to assigning direct costs to cost objects. Cost allocation is reserved for assigning indirect costs to cost objects.

Cost objects include (1) activities or processes; (2) outputs of processes, such as products, services and projects; (3) parts of the organisation (e.g. departments or programmes) and (4) customers. Information on costs associated with these cost objects facilitates decisions such as (1) which manufacturing process is most economical, (2) what price should be charged for the service, (3) which department uses its resources most efficiently and (4) which customers contribute most to the companys profits. There is more to cost accounting than product costing.

Direct costs and indirect costs

Students have trouble with the distinctions between direct/indirect costs and cost tracing/cost allocation. Familiar examples can help. Public accounting firms directly trace direct professional labour costs to each audit engagement (through time sheets). In contrast, rent on the firms office and depreciation on its computers cannot be traced to individual engagements. These are indirect costs that must be allocated to the different engagements. Allocation of indirect costs is a difficult but important topic that is covered in more detail in later chapters.

Example: Is photocopying a direct or an indirect cost with respect to department cost objects? In the past, it was difficult to keep track of the amount of copying done by different departments. Moreover, there was generally less copying. Photocopying was typically considered an indirect cost because it was often an immaterial amount and hard to trace. Today, businesses are making more photocopies than ever before. Counters inserted into copiers (copy keys) easily keep track of the number of copies made by each user. Because copying costs are now higher and easier to trace, they are more often directly traced. (An additional benefit of the counters is that they may induce employees to make fewer copies because the number of copies is now more observable.)

Cost drivers and cost management

Cost management occurs when managers actively strive to reduce costs. Two major avenues for cost management are focusing on value-added activities (and eliminating non-value-added activities such as stock handling) and reducing consumption of cost drivers in value-added activities. Reduced consumption of cost drivers reduces costs only if managers actively squeeze




costs down. As more managers do their own word processing, typing by secretaries declines. But unless management reduces the number of secretaries in response to the reduced workload, secretarial costs will not reduce.

Two types of cost behaviour pattern: variable costs and fixed costs

The distinction between variable costs (VCs) and fixed costs (FCs) is necessary to address basic questions such as how much manufacturing costs change if the level of output increases by 5%. For example, many fast-food restaurants guarantee workers only an hour or two of work per shift. If sales are less than expected, workers can be dismissed for the shift after their guaranteed hour (or two). In this case, direct-labour cost varies directly with output (sales). In contrast, many government workers are salaried and cannot be dismissed except under extreme circumstances. Here, direct-labour costs for a government department are relatively fixed.

Students are often confused about when VCs are variable and when FCs are fixed. Variable costs vary in total and FCs are fixed in total. However, VCs per unit are consistent and FCs per unit decline as more units are produced.

Total costs and unit costs

Students often treat unitised fixed costs as if they were variable costs, forgetting that fixed costs are fixed in total. They attempt to calculate total costs by multiplying the cost per unit by the number of units. Because of this misleading nature of unitised fixed costs, it is better to base projections and comparisons on total costs. When estimating total costs, students should consider variable costs as an amount per unit and fixed costs as a lump sum total amount.

Financial statements and cost terminology

The basic concepts of assigning costs to cost objects (and using this information for planning and control) apply to service, merchandising and manufacturing companies. Students find it easier to grasp the basic concepts by starting with service companies, which are the simplest as they have no stocks. Merchandisers add the complications of purchases and stocks. The final step is manufacturers, which are more difficult due to the complexities of cost of good manufactured (CGM), and the three types of stock.


2.1 A cost object is anything for which a separate measurement of costs is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, a department and a programme.

2.2 Costs are not direct or indirect in isolation. A cost object (such as a product, service or project) must be specified.

Direct costs of a cost object are those costs that are related to the particular cost object and that can be traced to it in an economically feasible (cost-effective) way.




Indirect costs of a cost object are those costs that are related to the particular cost object but cannot be traced to it in an economically feasible (cost-effective) way.

Assume that the cost object is a Macintosh computer product. Apple assembles multiple products in each of its plants. The computer screen is a direct cost of the Macintosh. In contrast, the salary of the security guard at the plant where the Macintosh is assembled would be an indirect cost of the Macintosh.

2.3 Consider a supervisors salary in a maintenance department of a telephone company. If the cost object is the department, the salary is a direct cost. If the cost object is a telephone call by a customer, the salary is an indirect cost.

2.4 Factors affecting the classification of a cost as direct or indirect include

1 the materiality of the cost in question

2 available information-gathering technology

3 design of operations

4 contractual arrangements.

2.5 A cost driver is any factor that affects total costs. Examples include:

Business function Example of cost driver

Research and development Number of research projects

Design Number of products in design

Production Number of units produced

Marketing Number of advertisements run

Distribution Number of items distributed

Customer service Number of service calls

2.6 The relevant range is the range of the cost driver in which a specific relationship between cost and driver is valid. This concept enables the use of linear cost functions when examining costvolumeprofit (CVP) relationships as long as the volume levels are within that relevant range.

2.7 A unit cost is calculated by dividing some total cost (the numerator) by some number of units (the denominator). In many cases the numerator will include a fixed cost that will not change despite changes in the number of units to be assembled. It is erroneous in those cases to multiply the unit cost by volume changes to predict changes in total costs at different volume levels.

2.8 Descriptions of the three sectors are:

Service-sector companies provide services or intangible products to their customers for example, legal advice or an audit. These companies do not have any stock of intangible products at the end of an accounting period.

Merchandising-sector companies provide tangible products they have previously purchased in the same basic form from suppliers. Merchandise purchased from suppliers but not sold at the end of an accounting period is held as stock.




Manufacturing-sector companies provide tangible products that have been converted to a different form from the products purchased from suppliers. At the end of an accounting period, stock of a manufacturer can include direct materials, work in progress and finished goods.

Thus, manufacturing and merchandising companies have stock while service companies do not. Manufacturing companies have direct materials, work in progress and finished goods stock, whereas merchandising companies have only goods purchased for resale stock (merchandise stock).

2.9 The three major categories of the stockable costs of a manufactured product are:

1 direct materials costs

2 direct manufacturing labour costs

3 indirect manufacturing costs.

2.10 Direct materials costs are the acquisition costs of all materials that eventually become part of the cost object (say, units finished or in progress) and that can be traced to that cost object in an economically feasible way. Acquisition costs of direct materials include freight-in (inward delivery) charges, sales taxes and customs duties. Direct manufacturing labour costs include the compensation of all manufacturing labour that is specifically identified with the cost object (say, units finished or in progress) and that can be traced to the cost object in an economically feasible way. Examples include wages and fringe benefits paid to machine operators and assembly-line workers.

Indirect manufacturing costs are all manufacturing costs considered to be part of the cost object (say, units finished or in progress), but that cannot be individually traced to that cost object in an economically feasible way. Examples include power supplies, indirect materials, indirect manufacturing labour, plant rent, plant insurance, property taxes on plants, plant depreciation and the compensation of plant managers.

Prime costs are all direct manufacturing costs. In the two-part classification of manufacturing costs, prime costs would comprise direct materials costs. In the three-part classification, prime costs would comprise direct materials costs and direct manufacturing labour costs.

Conversion costs are all manufacturing costs other than direct materials costs.


2.11 Total costs and unit costs. (10 min)

1 Total cost, 40,000. Unit cost per person, 40,000 500 = 80.00.

2 Total cost, 40,000. Unit cost per person, 40,000 2000 = 20.00.

3 The main lesson of this problem is to alert the student early in the course to the desirability of thinking in terms of total costs rather than unit costs wherever feasible. Changes in the number of cost driver units will affect total variable costs but not total fixed costs. In our example, it would be perilous to use either the 80.00 or the 20.00 unit cost to predict the total cost, because the total costs are not affected by the attendance. Instead, the student association should use the 40,000 total cost. Obviously, if the musical group agreed to work for, say 40.00 per person, such a unit variable cost could be used to predict the total cost.




2.13 Total costs and unit costs. (10 min)

1 Unit cost = Total costs Number of units.

Total costs () Number of units Unit cost ()

a 60,000 200 300

b 60,000 250 240

c 60,000 300 200

2 The unit-cost figures per passenger calculated in requirement 1 should play no role in predicting the total air-flight costs to be paid next month. Weltferien pays Saxon-Air on a per round-trip flight basis, but not on a per passenger basis. Hence, the cost driver for next month is the number of round-trip flights and not the number of passengers.

2.14 Classification of costs, service sector. (1520 min)

Cost object: Each individual focus group.

Cost variability: With respect to changes in the number of focus groups.

There may be some debate over classifications of individual items. Debate is more likely as regards cost variability.

Cost item D or I V or F

A D V

B I F

C I Va

D I F

E D V

F I F

G D V

H I Vb

a Some students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost if Presta-Servios has a flat monthly charge for a line, irrespective of the amount of usage. b Petrol costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes and detailed records may be required to examine how costs vary with changes in one of the many purposes served.




2.15 Classification of costs, merchandising sector. (1520 min)

Cost object: Film section of store.

Cost variability: With respect to changes in the number of films sold, assumptions may be made over classifications of individual items. This is mainly in relation to cost variability. Whether DVDs and videos cost the same is another matter.

Cost item D or I V or F A I F B I V C D V D D F E I F F I V G I F H D V

2.16 Cost drivers and the value chain. (15 [AQ1]min)

1 Business function area Representative cost driver A Research and development Number of patents filed with government agency B Design of

products/processes Hours spent designing cars

C Production Hours assembly line in operation D Marketing Minutes of television advertising time E Distribution Number of cars shipped F Customer service Number of calls to free customer services

2 Business function area Representative cost driver

A Research and development Hours of design and testing work Number of new models in development B Design of products/processes Number of focus groups on alternative

models and designs Hours of engineering and retooling C Production Number of units coming off assembly line Number of models manufactured D Marketing Number of promotion packages mailed Number of sales E Distribution Number of cars shipped overseas Number of cars delivered to showrooms F Customer service Number of cars recalled Number of personnel on free customer

phone lines




2.17 Calculating cost of goods manufactured and cost of goods sold. (2025 min)

Schedule of cost of goods manufactured for the year ended 31 December 2011 (in million)

m m Direct materials used 13.05 Direct manufacturing labour costs 15.10 Indirect manufacturing costs: Property tax on plant building 0.45 Plant utilities 2.56 Depreciation of plant building 1.35 Depreciation of plant equipment 1.65 Plant repairs and maintenance 2.40 Indirect manufacturing labour costs 3.45 Indirect materials used 1.65 Miscellaneous plant overhead 0.60 14.10 Manufacturing costs incurred during 2011 32.25 Add opening work in progress stock, 1 January 2011 3.00 Total manufacturing costs to account for 35.25 Deduct closing work in progress stock, 31 December 2011 3.90 Cost of goods manufactured 31.35

Schedule of cost of goods sold for the year ended 31 December 2011 (in million) m Opening finished goods, 1 January 2011 4.05 Cost of goods manufactured (above) 31.35 Cost of goods available for sale 35.40 Closing finished goods, 31 December 2011 5.10 Cost of goods sold 30.30

2.18 Income statement and schedule of cost of goods manufactured. (2530 min)

Howell Ltd Income Statement for the Year Ended 31 December 2011

(in millions)

m m Revenues 950 Cost of goods sold: Opening finished goods, 1 January 2011 70 Cost of goods manufactured (below) 645 Cost of goods available for sale 715

Closing finished goods, 31 December 2011 55 660 Gross margin 290 Marketing, distribution and customer-service costs 240 Operating income 50




Howell Ltd

Schedule of cost of goods manufactured for the year ended 31 December 2011 (in millions)

Direct materials costs: Opening stock, 1 January 2011 15 Purchases of direct materials 325 Cost of direct materials available for use 340 Closing stock, 31 December 2011 20 Direct materials used 320 Direct manufacturing labour costs 100 Indirect manufacturing costs: Indirect manufacturing labour 60 Plant supplies used 10 Plant utilities 30 Depreciation plant, building and equipment 80 Plant supervisory salaries 5 Miscellaneous plant overhead 35 220 Manufacturing costs incurred during 2011 640 Add opening work in progress stock, 1 January 2011 10 Total manufacturing costs to account for 650 Deduct closing work in progress, 31 December 2011 5 Cost of goods manufactured 645

2.19 Interpretation of statements. (2025 min)

1 The schedule in 2.18 can become a schedule of cost of goods manufactured and sold simply by including the opening and closing finished goods stock figures in the supporting schedule, rather than directly in the body of the income statement. Note that the term cost of goods manufactured refers to the cost of goods brought to completion (finished) during the accounting period, whether they were started before or during the current accounting period. Some of the manufacturing costs incurred are held back as costs of the closing work in progress; similarly, the costs of the opening work in progress stock become a part of the cost of goods manufactured for 2005.

2 The sales managers salary would be charged as a marketing cost as incurred by both manufacturing and merchandising companies. It is basically an operating cost that appears below the gross margin line on an income statement. In contrast, an assemblers wages would be assigned to the products worked on. Thus, the wages cost would be charged to work in progress and would not be expensed until the product is transferred from finished goods stock to cost of goods sold as the product is sold.

3 The directindirect distinction can be resolved only with respect to a particular cost object. For example, in defence contracting, the cost object may be defined as a contract. Then, a plant supervisors salary may be charged directly and wholly to that single contract.




4 Direct materials used = 320,000,000 1,000,000 units = 320 per unit.

Depreciation = 80,000,000 1,000,000 units = 80 per unit.

5 Direct materials unit cost would be unchanged at 320. Depreciation unit cost would be 80,000,000 1,200,000 = 66.67 per unit. Total direct materials costs would rise by 20% to 384,000,000, whereas total depreciation would be unaffected at 80,000,000.

6 Unit costs are averages and they must be interpreted with caution. The 320 direct materials unit cost is valid for predicting total costs because direct materials is a variable cost; total direct materials costs indeed change as output levels change. However, fixed costs like depreciation must be interpreted quite differently from variable costs. A common error in cost analysis is to regard all unit costs as one as if all the total costs to which they are related are variable costs. Changes in output levels (the denominator) will affect total variable costs, but not total fixed costs. Graphs of the two costs may clarify this point; it is safer to think in terms of total costs than in terms of unit costs.

2.20 Finding unknown balances. (2025 min)

Let G = given, I = inferred. Step 1: Use gross margin formula Case 1 Case 2 Revenues 32,000G 31,800G Cost of goods sold A 20,700I 20,000G Gross margin 11,300G C 11,800I Step 2: Use schedule of cost of goods manufactured formula Case 1 Case 2 Direct materials used 8,000G 2,000G Direct manufacturing labour costs 3,000G 5,000G Indirect manufacturing costs 7,000G D 6,500I Manufacturing costs incurred 18,000I 23,500I Add opening work in progress, 1 January 0G 800G Total manufacturing costs to account for 18,000I 24,300I Deduct closing work in progress, 31 December 0G 3,000G Cost of goods manufactured 18,000I 21,300I

Step 3: Use cost of goods sold formula Case 1 Case 2 Opening finished goods stock, 1 January 4,000G 4,000G Cost of goods manufactured 18,000I 21,300I Cost of goods available for sale 22,000I 25,300I Closing finished goods stock, 31 December B 1,300I 5,300G Cost of goods sold 20,700I 20,000G

For case 1, do steps 1, 2 and 3 in order.

For case 2, do steps 1, 3 and then 2.




2.21 Fire loss, computing stock costs. (3040 min)

1 50,000 2 28,000 3 62,000

This problem is not as easy as it first appears. These answers are obtained by working from the known figures to the unknowns in the schedule below. The basic relationships between categories of costs are:

Prime costs (given) = 294,000

Direct materials used = 294,000

Direct manufacturing labour costs = 294,000 180,000 = 114,000

Conversion costs = Direct manufacturing labour costs 0.6 180,000 0.6 = 300,000

Indirect manufacturing costs = 300,000 180,000 = 120,000

(or 0.40 = 300,000)

Schedule of Calculations

Direct materials, 1 January 2011 16,000

Direct materials purchased 160,000

Direct materials available for use 176,000

Direct materials, 26 February 2011 3 = 62,000

Direct materials used (294,000 180,000) 114,000

Direct manufacturing labour costs 180,000

Prime costs 294,000

Indirect manufacturing costs 120,000

Manufacturing costs incurred during the current period 414,000

Add work in progress, 1 January 2011 34,000

Manufacturing costs to account for 448,000

Deduct work in progress, 26 February 2011 2 = 28,000

Cost of goods manufactured 420,000

Add finished goods, 1 January 2011 30,000

Cost of goods available for sale (given) 450,000

Deduct finished goods, 26 February 2011 1 = 50,000

Cost of goods sold (80% of 500,000) 400,000

2.22 Comprehensive problem on unit costs, product costs. (30 min)

1 If 2 kg of direct materials are used to make each unit of finished product, 100,000 units 2 kg or 200,000 kg were used at l0.70 per kg of direct materials (140,000 200,000 kg). Therefore, the closing stock of direct materials is 2000 kg 0.70 = 1,400.




2 Manufacturing costs for 100,000 units Variable Fixed Total

Direct materials costs 140,000 140,000

Direct manufacturing labour costs 30,000 30,000

Plant energy costs 5,000 5,000

Indirect manufacturing labour costs 10,000 16,000 26,000

Other indirect manufacturing costs 8,000 24,000 32,000

Cost of goods manufactured 193,000 40,000 233,000

Average unit manufacturing cost: 233,000 100,000 units

= 2.33 per unit

Finished goods stock in units: 20,970 (given) = 2.33 per unit

= 9000 units

3 Units sold in 2011 = Opening stock + Production Closing stock = 0 + 100,000 9000 = 91,000 units

Selling price per unit in 2011 = 436,800 91,000

= 4.80 per unit

4 Revenues (91,000 units sold 4.80) 436,800 Cost of units sold: Opening finished goods, 1 January 2011 0 Cost of goods manufactured 233,000 Cost of goods available for sale 233,000 Closing finished goods, 31 December 2011 20,970 212,030 Gross margin 224,770

Operating costs: Marketing, distribution and customer-service costs 162,850 Administrative costs 50,000 212,850 Operating income 11,920

Note: Although not required, the full set of unit variable costs are:

Direct materials costs 1.40 Direct manufacturing labour costs 0.30 Plant energy costs 0.05 per unit manufactured Indirect manufacturing labour costs 0.10 Other direct manufacturing costs 0.08 Marketing, distribution and customer-service costs 1.35 per unit sold




2.25 Revenue and cost recording and classifications, ethics. (2530 min)

1 Concerns include:

a Total payments made by Aran Sweaters do not appear to be adequately described. Elements of total compensation appear to be:

12 million payment to ONeil in Achill Island 4.8 million payment to ONeil subsidiary in Switzerland Assistance with life insurance plans for ONeil executives at rates much

more favourable than those available in Achill Island.

One possible motivation for restricting the payment in Achill Island to 12 million is to avoid showing higher profits in Achill Island. A second motivation could be that the Swiss subsidiary is siphoning off revenues to ONeil senior executives that should be paid to ONeil. This could arise if the ONeil Swiss subsidiary is owned by the senior executives of ONeil rather than being a 100% subsidiary of ONeil.

The assistance with the insurance plans is in the grey area. If ONeil is willing to accept a lower price in return for Aran Sweaters assisting with the insurance plans, it may be a judicious economic decision by Aran Sweaters. Aran Sweaters is not hurt economically in this scenario. The concern is whether Aran Sweaters is assisting the senior executives to divert de facto payments to themselves.

b Product design costs of Aran Sweaters include 4.8 million for own product design. It is stated that the director of product design views it as an off-statement item that historically he has neither responsibility for nor any say about and that to his knowledge, ONeil uses only Aran Sweaters designs with either zero or minimal changes. It may be that the 4.8 million payment is a hidden payment made to avoid Achill Island taxation. However, the result is incorrect classification of product design costs at Aran Sweaters.

c ONeil receives from Aran Sweaters the margin between 16.8 million (12 million + 4.8 million) and the 3 million payment for wool, i.e. 13.8 million. Note that Aran Sweaters can assist ONeil to meet the 25% ratio of domestic labour costs to total costs. Charging 6.00 million for wool and receiving 19.8 million for sweaters will result in the same 13.8 million margin, but will mean ONeil will not meet the 25% test as total costs will now be 13 million instead of 10 million. Aran Sweaters has to ensure it takes an arms length in its approach to supply contracts and purchase contracts or else it may be accused by the Achill Island government of assisting ONeil to avoid local taxes.

Note: Some students will ask whether ONeil should be able to classify labour fringe benefits as a domestic labour cost. This is not Sheridans domain given that she is controller of Aran Sweaters. Her concern with the Achill Island tax rebate is whether Aran Sweaters is being pressured to adjust its billing amounts to facilitate ONeil to have a ratio of domestic labour costs to total costs exceeding 25%. If you want to discuss this issue, point out that labour-fringe benefits are typically an integral part of labour costs. Hence, if they can be traced, ONeil is justified in including them in domestic labour costs.




2 There are a variety of ethical issues relating primarily to competence and integrity that Sheridan faces:

a Is Aran Sweaters assisting ONeil to avoid income taxes in Achill Island either:

by funnelling 4.8 million to a Swiss company rather than to ONeil in Achill Island or

by understating both the 3 million wool supply cost and the 16.8 total revenue amount?

b Is Aran Sweaters assisting senior executives of ONeil to enrich themselves at the expense of the shareholders of ONeil?

c Are the accounting records of Aran Sweaters properly reflecting the underlying activities?

3 Steps Sheridan could take include:

a Seeking further information on why the 4.8 million payment is being made to the Swiss subsidiary. This should be done first internally and then by speaking to ONeil executives.

b Ensure product design costs at Aran Sweaters reflect actual product design work. So-called off-statement items should be eliminated if no adequate explanation can be given for them.

c Ensure Aran Sweaters personnel follow any company guidelines about supply relations or customer relations. There is nothing inherently wrong with assisting ONeil negotiate a better insurance package for its executives. The concern is whether developing a too cosy relationship will lead to more questionable practices being overlooked.



C H A P T E R 3

Job-costing systems


Building block concept of costing systems

Emphasise that students must master the building block concept of costing systems. This concept is equally applicable to service, merchandising and manufacturing sectors.

It is relatively easy to determine accurate costs for a company with only a few services/products. However, many companies have increased the diversity of their product lines over the past 30 years. These different products/services use differential amounts of common resources (e.g. electricity) and this makes it harder to determine accurate costs. This is one reason for companies renewed interest in their costing systems.

Job-costing and process-costing systems

To focus on the big picture, emphasise that management accounting provides information for:

1 Planning and control management accounting systems accumulate costs by department to compare with budgeted costs for performance evaluation.

2 Product/service costing just as financial accounting requires many choices in determining income, management accounting requires many choices to determine the costs of services and products.

Job costing in service organisations using actual costing

Why do service firms need costs of individual jobs? Not for costing stock, because there is none. Rather, service firms use job-cost information for cost management, profitability analysis and pricing. Accurate cost information is especially important in public accounting firms where competition is fierce.

Normal costing

Normal costing arose because managers did not want to wait for cost information until actual indirect-cost rates are calculated at year-end. The only difference between actual costing and normal costing is that normal costing uses a budgeted OH rate all other elements of costing are at actual rates and quantities.




Job costing in manufacturing

Emphasise that Chapter 3 explains how manufacturing costs are attached to products. The cost to manufacture a product is necessary for external reporting (e.g. stock and CGS) and internal decisions (e.g. pricing). Concepts introduced here provide a foundation for subsequent topics including relevant costs and pricing, cost allocation, progress costing, flexible budgets and variance, analysis and operations and backflush costing.

Budgeted indirect costs and end-of-period adjustments

Underallocated MOH (UAO) and overallocated MOH (OAO) arise for two reasons: (1) the numerator reason, actual MOH costs budgeted MOH costs and/or (2) the denominator reason, actual quantity of the allocation base consumed budgeted quantity. In the Wallace Co. example, budgeted MOH is 1,280,000, whereas actual MOH is 1,200,000, so the numerator reason leads to 80,000 OAO (budgeted costs actual costs). However, actual MHs (the allocation base) were only 12,500 rather than the budgeted 16,000 MH. The denominator reason leads to (16,000 MH 12,500 MH 80/MH budgeted MOH rate) = 280,000 UAO. The net effect is 280,000 UAO 80,000 OAO = 200,000 UAO.

The adjusted allocation rate approach to under- or overallocated MOH corrects account balances to what they would have been, had accountants had a crystal ball and forecasted MOH cost and quantity of the allocation base perfectly. The feasibility of implementing the adjusted rate approach increases as information progressing costs decline.

Proration based on the total amount of indirect costs allocated (method 1) corrects WIP, FG and CGS control closing balances to what they would have been under actual costing, yielding the same closing balances as the adjusted allocation rate approach. The difference is that the adjusted allocation rate method also corrects the individual jobs, whereas proration method 1 corrects only the control account closing balances.

It is conceptually preferable to prorate on the basis of the amount of MOH allocated embedded in each accounts EB (method 1). This yields the EB that would have been obtained had the correct (i.e. actual) MOH rate been used. However, many companies that prorate UAO/OAO do so via the EB method (method 2) because the EB of WIP, FG and CGS are readily available. In contrast, the amount of MOH allocated embedded in EB may be more difficult to obtain.


3.1 Cost pool a grouping of individual cost items.

Cost tracing the assigning of direct costs to the chosen cost object.

Cost allocation the assigning of indirect costs to the chosen cost object.

Cost allocation base a factor that is the common denominator for systematically linking an indirect cost or a group of indirect costs to a cost object.

3.2 No. For most service-sector companies, labour is the single largest cost category. For example, labour costs comprise over 70% of the total costs of many law firms.




3.3 In a job-costing system, costs are assigned to a distinct unit, batch or lot of a product or service. In a progress-costing system, the cost of a product or service is obtained by using broad averages to assign costs to masses of similar units.

3.4 An advertising campaign for Pepsi is likely to be very specific to that individual client. Job costing enables all the specific aspects of each job to be identified. In contrast, the progressing of cheque account withdrawals is similar for many customers. Here, progress costing can be used to compute the cost of each cheque account withdrawal.

3.5 Actual costing and normal costing differ in their use of actual or budgeted direct- or indirect-cost rates.

3.6 The two major goals of a job-costing system are (i) to assist in the cost management of departments and (ii) to determine the cost of individual jobs.

3.7 A cost allocation base is a factor that is the common denominator for systematically linking an indirect cost or a group of indirect costs to a cost object.

The role of a manufacturing overhead allocation base is to systematically link manufacturing overhead costs to cost objects such as products, projects or customers.

3.8 Under- or overallocation of indirect (overhead) costs can arise because of (a) the numerator reason the actual overhead costs differ from the budgeted overhead costs and (b) the denominator reason the actual quantity used of the allocation base differs from that of the budgeted quantity.

3.9 Alternative ways to make end-of-period adjustments for under- or overallocated overhead are:

a Proration based on the total amount of indirect costs allocated (before proration) in the closing balances of work in progress, finished goods and cost of goods sold.

b Proration based on total closing balances (before proration) in work in progress, finished goods and cost of goods sold.

c Year-end write-off to cost of goods sold.

3.10 The adjusted allocation rate approach results in the most accurate record of individual job costs. It also gives the same closing balances of work in progress, finished goods and cost of goods sold that would have been reported had an actual indirect-cost rate been used. Proration approaches do not make any adjustment to individual job-cost records. Companies wanting an accurate record of job costs for pricing purposes, product profitability purposes and evaluating the performance of managers of those jobs will prefer the adjusted allocation rate approach.





3.12 Computing direct-cost rates, consulting firm. (1520 min)

1 and 2

(a) Average salary + average fringe benefits ()

(b) Billable time for clients

(c) Total time

(d) = (a) (b) Rate per billable hour ()

(e) = (a) (c) Rate per total hour ()

Director 200,000 1,600 2,000 125.00 100

Partner 150,000 1,600 2,000 93.75 75

Associate 80,000 1,600 2,000 50.00 40

Assistant 50,000 1,600 2,000 31.25 25

3 The difference between requirements 1 and 2 is the denominator. Using only billable time as the denominator results in the hours associated with vacation, sick leave and professional development being built into the direct-cost rate for professional labour.

Including vacation, sick leave and professional development in the denominator results in part of the total labour compensation not being assigned to jobs as part of the professional labour cost. In most cases, where this approach is used, the costs associated with vacation, sick leave and professional development are included in the indirect costs assigned to jobs.

3.13 Accounting for manufacturing overhead. (15 min)

1 Budgeted manufacturing overhead rate 7,000,000 200,000 = 35 per machine-hour

2 Work in progress control 6,825,000 Manufacturing overhead allocated 6,825,000 (195,000 machine-hours 35 = 6,825,000)

3 6,825,000 6,800,000 = 25,000 overallocated, an insignificant amount Manufacturing overhead allocated 6,825,000 Manufacturing department overhead control 6,800,000 Cost of goods sold 25,000

3.14 Proration of overhead. (20 min)

1 Budgeted manufacturing overhead rate is 4,800,000 80,000 = 60 per machine-hour.

2 Manufacturing overhead underallocated = manufacturing overhead incurred manufacturing overhead allocated

= 4,900,000 4,500,000*

= 400,000

* 60 75,000 actual machine-hours = 4,500,000.




(a)

Account End-of-year balance (before proration) ()

Proration of 400,000 underallocated manufacturing overhead ()

Balance (after proration) ()

Work in progress 750,000 0 750,000

Finished goods 1,250,000 0 1,250,000

Cost of goods sold 8,000,000 400,000 8,400,000

Total 10,000,000 400,000 10,400,000

(b)


Proration of 400,000 underallocated manufacturing overhead ()


Work in progress 750,000 (7.5%) 0.075 400,000 = 30,000 780,000

Finished goods 1,250,000 (12.5%) 0.125 400,000 = 50,000 1,300,000

Cost of goods sold

8,000,000 (80.0%) 0.800 400,000 = 320,000 8,320,000

Total 10,000,000 (100.0%) 400,000 10,400,000

(c)


Allocated overhead component of end-of-year balance (before proration) ()

Proration of 400,000 underallocated manufacturing overhead


Work in progress 750,000 240,000 (5.33%) 0.0533 400,000 = 21,320 771,320

Finished goods 1,250,000 660,000 (14.67%) 0.1467 400,000 = 58,680 1,308,680

Cost of goods sold 8,000,000 3,600,000 (80.00%) 0.8000 400,000 = 320,000 8,320,000

Total 10,000,000 450,000,000 (100.00%) 400,000 10,400,000

3 Alternative (c) is theoretically preferred to (a) and (b). Alternative (c) yields the same closing balances in work in progress, finished goods and cost of goods sold that would have been reported had actual indirect-cost rates been used. The chapter also discusses an adjusted allocation rate approach that results in the same closing balances as does alternative (c). This approach operates via a restatement of all the individual jobs worked on during the year rather than a restatement of closing balances.

3.15 Job costing with single direct-cost category, single indirect-cost pool and law firm. (1520 min)

1 Pricing decisions at Tricheur are heavily influenced by reported cost numbers. Suppose Tricheur is bidding against Andrault & Maque for a client with a job similar to that of Morges-Guyre. If the costing system overstates the costs of these jobs, Tricheur may bid too high and fail to be hired by the client. If the costing system understates the costs of these jobs, Tricheur may bid low, be hired by the client and then lose money in handling the case.




2 Panel A of Solution Exhibit 3.15 at the end of this question presents an overview of the single direct/single indirect (SD/SI) costing approach.

3

Morges-Guyre ()

Verrerie de Lausanne () Total ()

Direct professional labour, 70 104; 96

7,280 6,720 14,000

Indirect costs allocated, 105 104; 96

10,920 10,080 21,000

Total costs to be billed 18,200 16,800 35,000

Solution Exhibit 3.15

Alternative job-costing approaches for Tricheur.

3.16 Job costing; fill in the blanks. (2030 min)

1. Key to filling in the unknowns on the Pablo Caf job is to follow Exhibit 3.4. Actual costing Normal costing

Direct job costs 3,850 (55 70) 3,850 (55 70)

Indirect job costs 2,660 (38 70) 2,800 (40 70)

Total job costs 6,510 6,650




The road map to calculate these amounts is (g = given):

3,850 (55g 70g) 3,850 (55g 70g)

2,660g (38 70g) 2,800 (40 70g)

Budgeted indirect-cost rate (NC) = 2,800 70 = 40 per hour

2,800 (40 70) same as for indirect job costs for normal costing

Direct job costs (AC) = 3,850 (55g 70g)

Direct job costs (NC) = 3,850 (55 70g) same as for direct job costs for actual costing.

Indirect job costs (AC) = 38.00 (2,660g 70g)

2 From requirement 1, we have calculated:

Actual rate () Budgeted rate ()

Direct-cost rate 55 60

Indirect-cost rate 38 40

Hence, the unknowns for Eldorado for 20072008 are:

Actual amounts for 20072008

Budgeted amounts for 20072008

Consulting labour compensation () 1,155,002 1,080,000

Consulting labour-hours (hour) 21,000 18,000

Consulting support costs () 798,000 720,000

The road map to compute these amounts is:

1,155,000 1,080,000

21,000 hours 18,000g hours

798,000g 720,0004

Consulting labour-hours (A) = 798,000g

Consulting labour compensation (A) = 1,155,000 (55 21,000)

Consulting labour compensation (B) = 1,080,000 (60 18,000g)

Consulting support costs (B) = 720,000 (40 18,000g)




An overview of the Eldorado job-costing system is:

3.18 Job costing, journal entries. (30 min)

1 An overview of the product costing system is:




2 1 Materials control 800 Accounts payable control 800 2 Work in progress control 710 Materials control 710 3 Manufacturing overhead control 100 Materials control 100 4 Work in progress control 1,300 Manufacturing overhead control 900 Wages payable control 2,200 5 Manufacturing overhead control 400 Accumulated buildings and manufacturing equipment 400 6 Manufacturing overhead control 550 Miscellaneous accounts 550 7 Work in progress control 2,080 Manufacturing overhead allocated (1.60 1,300 = 2,080) 2,080 8 Finished goods control 4,120 Work in progress control 4,120 9 Accounts receivable control (or cash) 8,000 Revenues 8,000 10 Cost of goods Sold 4,020 Finished goods Control 4,020 11 Manufacturing overhead allocated 2,080 Manufacturing overhead control 1,950 Cost of goods sold 130

3 Materials control

Bal. 31/12/09 100 2 Issues 710 1 Purchase 800 3 Issues 100 Bal. 31/12/10 90

Work in progress control

Bal. 31/12/09 60 8 Goods completed 4,120 2 Direct materials 710 4 Direct manuf. labour 1,300

7 Manuf. overhead allocated 2,080

4,150 Bal. 31/12/10 30

Finished goods control Bal. 31/12/09 500 10 Goods sold 4,020




8 Goods completed 4,120 Bal. 31/12/10 600

Cost of goods sold

10 Goods sold 4,020 11 Adjust for over-allocation 130

Bal. 31/12/10 3,890

Manufacturing overhead control 3 Supplies 100 11 To close 1,950 4 Indirect manuf. labour 900 5 Depreciation 400 6 Miscellaneous 550 1,950 Bal. 0

Manufacturing overhead allocated 11 2,080 7 2,080 Bal. 0

3.19 Job costing, journal entries and source documents. (20 min)

The analysis of source documents and subsidiary ledgers follows:

1 a Approved invoice b Credit. Materials record, received column

2 a Materials requisition record b Debit. Job-cost records

Debit. Materials record, issued column

3 a Materials requisition record b Debit. Department overhead cost records, appropriate column

Credit. Materials record, issued column

4 a Summary of time records or daily time analysis. This summary is sometimes called a labour cost distribution summary.

b Debit. Job-cost records debit. Department overhead cost records, appropriate columns for various classes of indirect labour

5 a Special authorisation from the responsible accounting officer b Debit. Department overhead cost records, appropriate columns

6 a Various approved invoices and special authorisations b Debit. Department overhead cost records, appropriate columns

7 a Use of an authorised budgeted manufacturing overhead rate b Debit. Job-cost record




8 a Completed job-cost records

b Debit. Finished goods records

Credit. Job-cost record

9 a Approved sales invoice

b Debit. Customers accounts (or cash)

Credit. Sales ledger, if any

10 a Costed sales invoice

b Credit. Finished goods records

11 a Special authorisation from the responsible accounting officer

b Subsidiary records are generally not used for these entries

3.21 Job costing, accounting for manufacturing overhead, budgeted rates. (2530 min.)

1 An overview of the product-costing system is:

Budgeted manufacturing overhead divided by allocation base:

a Machining overhead:

1,800,000 = 36 per machine-hour50,000

b Assembly overhead:

3,600,000 = 180% of direct labour costs2,000,000




2 Machining overhead, 2,000 hours 36 = 72,000

Assembly overhead, 180% of 15,000 = 27,000

Total manufacturing overhead allocated = 99,000

3 Machining Assembly

Actual manufacturing overhead 2,100,000 3,700,000

Manufacturing overhead allocated,

55,000 36 = 1,980,000

Underallocated (Overallocated) 120,000 (260,000)

3.22 Overview of general-ledger relationships. (3040 min)

1 and 3 An effective approach to this problem is to draw T-accounts and insert all the known figures. Then, working with T-account relationships, solve for the unknown figures (here coded by the letter X for opening stock figures and Y for closing stock figures).

Materials control X 15,000 (1) 70,000 Purchases 85,000 100,000 70,000

Y 30,000

Work in progress control X 10,000 (4) 305,000 (1) DM 70,000 (2) DL 150,000 (3) Overhead 90,000 310,000

320,000 305,000 (a) 5,000 (c) 3,000 Y 23,000

Finished goods control X 20,000 (5) 300,000 (4) 305,000 325,000 300,000

Y 25,000




Cost of goods sold (5) 300,000 (d) 6,000

Manufacturing department overhead control 85,000 (d) 87,000 (a) 1,000

(b) 1,000

Manufacturing overhead allocated (d) 93,000 (3) 90,000 (c) 3,000

Manufacturing overhead cost rate = 90,000 150,000 = 60%

Wages payable control (a) 6,000

Various accounts (b) 1,000

2 Adjusting and closing entries: a Work in progress control 5,000 Manufacturing Department overhead control 1,000

Wages payable control 6,000 To recognise payroll costs b Manufacturing Department overhead control 1,000

Various accounts 1,000 To recognise miscellaneous manufacturing overhead

c Work in progress control 3,000 Manufacturing overhead allocated 3,000

To allocate manufacturing overhead

Note: Students tend to forget entry (c) entirely. Stress that a budgeted overhead allocation rate is used consistently throughout the year. This point is a major feature of this problem.

d Manufacturing overhead allocated 93,000 Manufacturing Department overhead control 87,000

To close manufacturing overhead accounts and overallocated overhead to cost of goods sold




An overview of the product-costing system is:

3 See the answer to 1



C H A P T E R 4

Process-costing systems


Illustrating process costing

Before discussing process costing, it is helpful to review the mechanics of WA and first-in, first-out (FIFO) cost flow assumptions in a simple financial accounting context:

Opening stock 200 units @ 1

Purchases 100 units @ 3

What is the cost/unit of 250 units sold?

Weighted average:

200 @ 1 = 200

100 @ 3 = 300

300 500 500/300 = 1.67/unit

FIFO: We first sell the 200 units of opening stock which are costed at 1 each. The next 50 units are from current purchases, costed at 3 each. WA mingles the opening stock with the current cost layers while FIFO keeps the layers distinct. These cost flow assumptions work the same way in process costing.

Case 1

Without WIP, process costing is quite straightforward because the cost/unit simply equals total costs/total units. When there are no partially complete units, no EU calculations are needed. Ask students what kinds of firms would be likely to fit Case 1 (process costing with no WIP stock): firms with highly perishable stock (e.g. many food processors, milk processors, newspaper publishers, etc.), financial service firms that must process transactions daily (e.g. bank deposits or withdrawals), firms that have adopted virtually no WIP stock. What kinds of firms would not meet the criteria for Case 1? Those for whom the nature of the business dictates large WIP stock (e.g. wineries, textiles).

Case 2

The second case adds the complication of closing WIP. Remind students that the overall goal is to calculate manufacturing cost/unit:

=Total manufacturing cost

number of units




Partially completed closing WIP complicates this calculation. The four-step procedure shows how to use EU to adjust for incomplete units.

Suggest that students draw timelines of the production processes for process-costing problems to clarify what costs will have to be added to this period to complete the units. The February timeline for defence is: Assembly Testing

DM 60% DM Added Added

Closing WIP

Use this timeline to explain the logic behind the EU calculations. In assembly, production begins with DMs that are assembled. As soon as the units begin production, they are 100% complete as to materials. The closing WIP is 60% of the way through Assembly at the end of February. It already contains all its DM but has only 60% of the conversion costs. Thus, closing WIP is at different stages of completion with respect to the different inputs.

The timeline makes it clear that the closing WIP will be completed during March by adding the remaining 40% of the conversion costs to complete the units.

The accuracy of the product costs hinges critically on the accuracy of the percentage of completion estimation, especially when the WIP is large (e.g. wineries).

Students are often confused about when a separate EU calculation is necessary. Emphasise that whenever a factor of production is added at a different stage in the production process, a separate EU computation is required. In the Euro-Dfense illustration, suppose steel is added at the beginning of the Assembly process and electronics are added two-thirds of the way through Assembly, closing WIP that is 60% complete would have steel but not electronics. We need separate EU calculations for steel and electronics of DM. (Many students erroneously believe that the number of EU should be the same for all DM.)

For simplicity, the examples assume that all conversion costs (labour, material handling, utilities, etc.) are incurred uniformly throughout the process. That is, a unit that is 70% complete has incurred 70% of the labour, material handling and utility costs. Extension to multiple cost categories (that are incurred in different patterns throughout the production process) would simply involve calculating separate EU and costs for each indirect cost category.

Case 3

The percentage completion is the percentage complete at that point of time. If opening stock was 40% complete, 40% of the work was completed last period. The remaining 60% will be done in the current period to complete the units. Conversely, if closing stock is 40% complete, the closing stock will be done next period. As the problems become more complex, timelines become more helpful. Consider the following timeline for the Euro-Dfense illustrations March data:




Assembly Testing 40% 60% DM Opening WIP DM Added Added S&C Closing WIP

The timeline shows that during March, Euro-Dfense finished the opening WIP by adding the remaining 40% of the CC (all DM were added to the opening WIP during February). They started and completed units, adding 100% of both DM and CC. Finally, they started closing WIP by getting these units 40% of the way through the Assembly process. These closing WIP units have all their DM and 40% of their CC. In April, Euro-Dfense will finish these units by adding the remaining 60% of the CC.

Comparison of weighted-average and FIFO methods

In the Euro-Dfense example, the unit cost declines over time. This is consistent with the continuous improvement theme highlighted in Chapter 1. It should be clear to students from their financial accounting courses that when costs are declining, FIFO yields the lowest stock valuation (because the latest, lowest cost units are still in closing stock) and the highest CGS.

Transferred-in costs in process costing

Students have trouble with transfers-in. In the Euro-Dfense example, units cannot begin Testing until they are completely assembled. These transferred-in (TI) Assembly Department costs act like DM, which are added at the very beginning of the Testing process. A timeline helps students understand the process.

Assembly Testing 62.5% 80% DM DM Added Added Opening stock S&C Closing stock

During the current period, the testing process at Euro-Dfense will:

Finish the

Opening stock (0% TI, 37.5% CC, 100% DM) S&C (100% of TI, CC and DM)

Start the

Closing stock (100% TI, 80% CC 0% DM)





4.1 Industries using process costing in their manufacturing area include chemical processing, oil refining, pharmaceutical, plastics, brick and tile manufacturing, semiconductor chips, beverages and breakfast cereals.

4.2 Process-costing systems separate costs into cost categories according to the timing of when costs are introduced into the process. Often, only two cost classifications, direct materials and conversion costs, are necessary. Direct materials are frequently added at one point in time, often the start or the end of the process, and all conversion costs are added at about the same time, but in a pattern different from direct materials costs.

4.3 The accuracy of the estimates of completion depends on the care and skill of the estimator and the nature of the process. Aircraft blades may differ substantially in the finishing that is necessary to obtain a final product. The amount of work may not always be easy to ascertain in advance.

4.4 The weighted-average process-costing method assigns the average equivalent unit cost of all work done to date (regardless of when it was done) to equivalent units completed and transferred out, and to equivalent units in closing stock.

4.5 FIFO calculations are distinctive because they assign the cost of the earliest equivalent units available (starting with equivalent units in opening work-in-progress stock) to units completed and transferred out, and the cost of the most recent equivalent units worke

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