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CostandCostClassifications|Types|ManagerialAccounting
AccountingExplained
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CostandCostClassifications
Costisasacrificeofresourcestoobtainabenefitoranyotherresource.Forexampleinproductionofa
car,wesacrificematerial,electricity,thevalueofmachine'slife(depreciation),andlaborwagesetc.Thus
theseareourcosts.
Costsareusuallyclassifiedasfollows:
ProductCostsVs.PeriodCosts
Productcostsarecostsassignedtothemanufactureofproductsandrecognizedforfinancialreporting
whensold.Theyincludedirectmaterials,directlabor,factorywages,factorydepreciation,etc.
Periodcostsareontheotherhandareallcostsotherthanproductcosts.Theyincludemarketingcosts
andadministrativecosts,etc.
BreakupofProductCosts
Theproductcostsarefurtherclassifiedinto:
Directmaterials:Representsthecostofthematerialsthatcanbeidentifieddirectlywiththe
productatreasonablecost.Forexample,costofpaperinnewspaperprinting,costof
Directlabor:Representsthecostofthelabortimespentonthatproduct,forexamplecostof
thetimespentbyapetroleumengineeronanoilrig,etc.
Manufacturingoverhead:Representsallproductioncostsexceptthosefordirectlaborand
directmaterials,forexamplethecostofanaccountant'stimeinanorganization,depreciationon
equipment,electricity,fuel,etc.
Theproductcoststhatcanbespecificallyidentifiedwitheachunitofaproductarecalleddirectproduct
costs.Whereasthosewhichcannotbetracedtoaspecificunitareindirectproductcosts.Thusdirect
materialcostanddirectlaborcostaredirectproductcostswhereasmanufacturingoverheadcostis
indirectproductcost.
PrimeCostsVs.ConversionCosts
Primecostsarethesumofalldirectcostssuchasdirectmaterials,directlaborandanyotherdirectcosts.
Conversioncostsareallcostsincurredtoconverttherawmaterialstofinishedproductsandtheyequal
thesumofdirectlabor,otherdirectcosts(otherthanmaterials)andmanufacturingoverheads.
CostClassificationDiagram
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CostandCostClassifications|Types|ManagerialAccounting
FixedCostsVs.VariableCosts
Fixedcostsarecostswhichremainconstantwithinacertainlevelofoutputorsales.Thiscertainlimit
wherefixedcostsremainconstantregardlessofthelevelofactivityiscalledrelevantrange.Forexample,
depreciationonfixedassets,etc.
Variablecostsarecostswhichchangewithachangeinthelevelofactivity.Examplesincludedirect
materials,directlabor,etc.
SunkCostsVs.OpportunityCosts
Thecostsdiscussedsofararehistoricalcostswhichmeanstheyhavebeenincurredinpastandcannot
beavoidedbyourcurrentdecisions.Relevantinthisregardisanothercostclassification,calledsunk
costs.Sunkcostsarethosecoststhathavebeenirreversiblyincurredorcommittedtheymayalsobe
termedunrecoverablecosts.
Incontrasttosunkcostsareopportunitycostswhicharecostsofapotentialbenefitforegone.For
exampletheopportunitycostofgoingonapicnicisthemoneythatyouwouldhaveearnedinthattime.
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
ProductandPeriodCosts
DirectandIndirectCosts
PrimeandConversionCosts
RelevantvsIrrelevantCosts
CostAccountingSystems
CostAllocation
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CostandCostClassifications|Types|ManagerialAccounting
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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CostAccountingSystems|ManagerialAccounting
AccountingExplained
Home>ManagerialAccounting>CostSystems
CostAccountingSystems
Acostaccountingsystem(alsocalledproductcostingsystemorcostingsystem)isaframeworkusedby
firmstoestimatethecostoftheirproductsforprofitabilityanalysis,inventoryvaluationandcostcontrol.
Estimatingtheaccuratecostofproductsiscriticalforprofitableoperations.Afirmmustknowwhich
productsareprofitableandwhichonesarenot,andthiscanbeascertainedonlywhenithasestimated
thecorrectcostoftheproduct.Further,aproductcostingsystemhelpsinestimatingtheclosingvalueof
materialsinventory,workinprogressandfinishedgoodsinventoryforthepurposeoffinancialstatement
preparation.
Therearetwomaincostaccountingsystems:thejobordercostingandtheprocesscosting.
Jobordercostingisacostaccountingsystemthataccumulatesmanufacturingcostsseparatelyfor
eachjob.Itisappropriateforfirmsthatareengagedinproductionofuniqueproductsandspecialorders.
Forexample,itisthecostingaccountingsystemmostappropriateforaneventmanagementcompany,a
nichefurnitureproducer,aproducerofveryhighcostairsurveillancesystem,etc.
Processcostingisacostaccountingsystemthataccumulatesmanufacturingcostsseparatelyforeach
process.Itisappropriateforproductswhoseproductionisaprocessinvolvingdifferentdepartmentsand
costsflowfromonedepartmenttoanother.Forexample,itisthecostaccountingsystemusedbyoil
refineries,chemicalproducers,etc.
Therearesituationswhenafirmusesacombinationoffeaturesofbothjobordercostingandprocess
costing,inwhatiscalledhybridcostaccountingsystem.
Inacostaccountingsystem,costallocationiscarriedoutbasedoneithertraditionalcostingsystemor
activitybasedcostingsystem.
Traditionalcostingsystemcalculatesasingleoverheadrateandappliesittoeachjoborineach
department.
Activitybasedcostingontheotherhand,involvescalculationofactivityrateandapplicationof
overheadcoststoproductsbasedontheirrespectiveactivityusage.
Basedonwhetherthefixedmanufacturingoverheadsarechargedtoproductsornot,costaccounting
systemshavetwovariations:variablecostingandabsorptioncosting.Variablecostingallocatesonly
variablemanufacturingoverheadstoinventories,whileabsorptioncostingallocatesbothvariableand
fixedmanufacturingoverheadstoproducts.Variablecostingcalculatescontributionmargin,while
absorptioncostingcalculatestherelevantgrossprofit.
StillfurtherrefinementtocostingaccountingsystemsincludeJITcosting,backflushcosting.
WrittenbyObaidullahJan,ACA,CFA
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CostAccountingSystems|ManagerialAccounting
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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CostAllocation|Concepts|Examples
AccountingExplained
Home>ManagerialAccounting>CostAllocation
CostAllocation
Costallocation(alsocalledcostassignment)istheprocessoffindingcostofdifferentcostobjectssuchas
aproject,adepartment,abranch,acustomer,etc.Itinvolvesidentifyingthecostobject,identifyingand
accumulatingthecoststhatareincurredandassigningthemtothecostobjectonsomereasonablebasis.
Costallocationisimportantbecauseittheprocessthroughwhichcostsincurredinproducingacertain
productorrenderingacertainserviceiscalculated.Ifcostsarenotaccuratelycalculated,abusiness
mightneverknowwhichproductsaremakingmoneyandwhichonesarelosingmoney.Ifcostare
misallocated,abusinessmaybechargingwrongpricetoitscustomersand/oritmightbewasting
resourcesonproductsthatarewronglycategorizedasprofitable.
Mechanism
Typicalcostallocationmechanisminvolves:
Identifyingtheobjecttowhichthecostshavetobeassigned,
Accumulatingthecostsindifferentpools,
Identifyingthemostappropriatebasis/methodforallocatingthecost
Costobject
Costobjectisanitemforwhichabusinessneedtoseparatelyestimatecost.
Examplesofcostobjectincludeabranch,aproductline,aserviceline,acustomer,adepartment,a
brand,aproject,etc.
Costpool
Costpoolistheaccountheadinwhichcostsareaccumulatedforfurtherassignmenttocostobjects.
Examplesofcostpoolsincludefactoryrent,insurance,machinemaintenancecost,factoryfuel,etc.
Selectionofcostpooldependsonthecostallocationbaseused.Forexampleifacompanyusesjustone
allocationbasesaydirectlaborhours,itmightuseabroadcostpoolsuchasfixedmanufacturing
overheads.However,ifitusesmorespecificcostallocationbases,forexamplelaborhours,machine
hours,etc.itmightdefinenarrowercostpools.
Costdriver
Costdriverisanyvariablethatdrivessomecost.Ifincreaseordecreaseinavariablecausesanincrease
ordecreaseisacostthatvariableisacostdriverforthatcost.
Examplesofcostdriverinclude:
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CostAllocation|Concepts|Examples
NumberofpaymentsprocessedcanbeagoodcostdriverforsalariesofAccountsPayablesection
ofaccountingdepartment,
Numberofpurchaseorderscanbeagoodcostdriverforcostofpurchasingdepartment,
Numberofinvoicessentcanbeagoodcostdriverforcostofbillingdepartment,
Numberofunitsshippedcanbeagoodcostdriverforcostofdistributiondepartment,etc.
Whiledirectcostsareeasilytracedtocostobjects,indirectcostsareallocatedusingsomesystematic
approach.
Costallocationbase
Costallocationbaseisthevariablethatisusedforallocating/assigningcostsindifferentcostpoolsto
differentcostobjects.Agoodcostallocationbaseissomethingwhichisanappropriatecostdriverfora
particularcostpool.
Example
T2Fisauniversitycafownedanoperatedbyastudent.Whileithasplansforexpansionitcurrently
offerstwoproducts:(a)tea&coffeeand(b)shakes.Itemploys2people:Mr.A,wholooksaftertea&
coffeeandMr.Bwhopreparesandservesshakes&desserts.
Itscostsforthefirstquarterareasfollows:
Mr.Asalary
16,000
Mr.Bsalary
12,000
Rent
10,000
Electricity
8,000
Directmaterialsconsumedinmakingtea&coffee
7,000
Directrawmaterialsforshakes
6,000
Musicrentalspaid
800
Internet&wifisubscription
500
Magazines
400
Totalteaandcoffeesalesandshakessaleswere$50,000&$60,000respectively.Numberofcustomers
whoorderedteaorcoffeewere10,000whilethoseorderingshakeswere8,000.
Theownerisinterestedinfindingoutwhichproductperformedbetter.
Solution
SalariesofMr.A&Banddirectmaterialsconsumedaredirectcostswhichdonotneedanyallocation.
Theyaretraceddirectlytotheproducts.Therestofthecostsareindirectcostsandneedsomebasisfor
allocation.
Costobjectsinthissituationaretheproducts:hotbeverages(i.e.tea&coffee)&shakes.Costpools
includerent,electricity,music,internetandwifisubscriptionandmagazines.
Appropriatecostdriversfortheindirectcostsareasfollows:
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Rent
CostAllocation|Concepts|Examples
10,000
Electricity
8,000
Numberofcustomers
Unitedconsumedbyeachproduct
Musicrentalspaid
800
Numberofcustomers
Internet&wifisubscription
500
Numberofcustomers
Magazines
400
Numberofcustomers
19,700
Sincenumberofcustomersisagoodcostdriverforalmostallthecosts,thecostscanbeaccumulated
togethertoformonecostpoolcalledmanufacturingoverheads.Thiswouldsimplythecostallocation.
Totalmanufacturingoverheadsforthefirstquarterare$19,700.Totalnumberofcustomerswhoordered
eitherproductare18,000.Thisgivesusacostallocationbaseof$1.1percustomer($19,700/18,000).
Adetailedcostassignmentisasfollows:
Tea&Coffee
Shakes
50,000
60,000
16,000
12,000
7,000
6,000
Manufacturingoverheadsallocated
11,000
8,800
Totalcosts
34,000
26,800
Profitearned
16,000
33,200
Revenue
Costs:
Salaries
Directmaterials
ManufacturingoverheadsallocatedtoTea&Cofee=$1.110,000
ManufacturingoverheadsallocatedtoShakes=$1.18,000
WrittenbyIrfanullahJan
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
CostAllocation
ServiceDept.CostAllocation
RepeatedDistributionMethod
SimultaneousEquationMethod
SpecificOrderofClosingMethod
DirectAllocationMethod
JointCostAllocationMethods
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
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CostAllocation|Concepts|Examples
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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JobOrderCosting|Steps|JournalEntries|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>JobOrderCosting
JobOrderCosting
Jobordercostingisacostaccountingsysteminwhichdirectcostsaretracedandindirectcostsare
allocatedtouniqueanddistinctjobsinsteadofdepartments.Itisappropriateforbusinessesthatprovide
nonuniformcustomizedproductsandservices.
Jobordercostingisoneofthetwomaincostaccountingsystems,theotherbeingtheprocesscostingin
whichcostsaretracedandallocatedfirsttodifferentprocessescarriedoutindifferentdepartmentsand
thentoproductsandservices.Manycompaniesusecostingsystemsthatareablendoffeaturesofboth
jobordercostingandprocesscostingsystems.
Companiesthatusejobordercosting
Someofthecompaniesthatusejobordercostinginclude:
Accounting,consultingandlegalfirms
Architects
Manufacturersofshipsandairplanes
Bookpublishers
Movieproducers
Thenatureoftheirworkissuchthattheyareinterestedinfindingprofitabilityofdifferentjobsandhence
theyaccumulatecostswithreferencetodifferentjobslikeauditengagement,consultingprojects,books,
movies,etc.
Stepsinjobordercostingprocess
Inajobordercostingsystem,jobsareaccountedforusingthejobordercostsheet.Theprocessinvolves
thefollowingsteps:
1. Identificationofthejob
2. Tracingdirectcoststothejob
3. Identifyingtheindirectcostsi.e.manufacturingoverheadsandfindingthecostallocationbasefor
eachcost.
4. Applyingtheindirectcoststothejobusingthepredeterminedallocationrate.
5. Findingtotalcostbysummingupallthecostcomponents.
6. Closingtheunder/overappliedmanufacturingoverheadstocostofgoodssold/incomestatement.
7. Calculatingrevenueandprofit.
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JobOrderCosting|Steps|JournalEntries|Example
Journalentries:example
DynamicSystemsInc.(DS)receivedanordertomanufactureacustomizedairplanefortheofficialuseof
thepresidentofPakistan.DSwillchargeanamountequaltothecostoftheairplaneplusa30%profit
marginoncosttothegovernmentofPakistan.ThejobcodeisPK03.
Sincethemanufactureoftheairplaneisaoneoffproject,jobordercostingisthemostappropriatecost
accumulationsystem.LetusposttherequiredjournalentriesintheDScostingsystem.
1.DSpurchasedrawmaterials(suchasaluminum,fiber,etc.)atacostof$4million.
Materialinventory
$4,000,000
Accountspayable
$4,000,000
2.$2.8millionworthofrawmaterialswereusedintheprojectasdirectmaterials.
WorkinprocessPK03
$2,800,000
Inventories
$2,800,000
3.$0.4millionworthofrawmaterialswereusedasindirectmaterials.
Manufacturingoverheads
$400,000
Inventories
$400,000
4.Totaldirectlaborhoursconsumedonthejobcost$3million.Theamountisalreadypaid.
WorkinprocessPK03
$3,000,000
Cash
$3,000,000
5.Indirectlaborhoursrelevanttotheprojectcost$1million.
Manufacturingoverheads
$1,000,000
Cash
$1,000,000
6.Otherindirectcostsyettobepaidwere$2.5million.
Manufacturingoverheads
$2,500,000
Accountspayable
$2,500,000
7.Manufacturingoverheadsarechargedtojobsat100%ofdirectlaborcosti.e.$3,000,000.
WorkinprocessPK03
Manufacturingoverheads
$3,000,000
$3,000,000
8.ThecostofPK03istransferredfromworkinprogresstofinishedgoodsonitscompletionattotalcostof
$8,800,000(=directmaterialscostof$2,800,000plusdirectlaborcostof$3,000,000andapplied
manufacturingoverheadsof$3,000,000).
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JobOrderCosting|Steps|JournalEntries|Example
Finishedgoods
$8,800,000
WorkinprocessPK03
$8,800,000
9.Revenueisrecordedat$11,440,000[=$8,800,0001.3].
Accountsreceivable
$11,440,000
Revenue
$11,440,000
10.Actualmanufacturingoverheadsare$3,900,000(=indirectmaterialsof$400,000plusindirectlabor
of$1,000,000andotheroverheadsof$2,500,000).Appliedmanufacturingoverheadsare$3,000,000.
The$900,000worthofmanufacturingoverheadsunderappliedistakentothecostofgoodssoldor
incomestatement.
Costofgoodssold
Manufacturingoverheads
$900,000
$900,000
ProfitonPK03is$1,700,000(=revenueof$11,440,000minusfinishedgoodsof$8,800,000andunder
appliedoverheadsadjustmentof$900,000).
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingExplained
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JobOrderCosting|Steps|JournalEntries|Example
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ProcessCosting|Steps|JournalEntries|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>ProcessCosting
ProcessCosting
Processcostingisacostaccountingsysteminwhichdirectcostsaretracedandindirectcostsare
allocatedtoprocessescarriedoutindifferentdepartments.Thecostoffinishedgoodsisthencomputed
basedonaveragecostaccumulatedattheendofthelastdepartment.
Unlikejobordercosting,whichisanotherwidelyusedcostingsystem,processcostingaveragesoutcosts
overalldepartmentsandvaluesthefinishedproductsandclosingworkinprocess,ifany,usingeitherthe
firstinfirstout(FIFO)orweightedaverageconvention.
Companiesthatuseprocesscosting
Processcostingisappropriateforcompaniesthatproducestandardizedproductsinlargequantities.Since
theproductsareverysimilarinnature,differentdepartmentsspecializeindifferentprocesses.Insuch
situation,itismoreefficienttoaccumulatecostsattheprocess/departmentlevelandhencethename.
Examplesincludeoilrefineries,paintandchemicalmanufacturers,fastmovingconsumergoods(FMCG)
producers,etc.
Stepsinprocesscosting
Processcostinginvolvespreparingaprocesscostsheetusingthefollowingsteps:
1. Preparingthequantityscheduletoaccountforthenumberofunits.
2. Findingthepercentageofcompletionofunitsinclosingworkinprocessandcalculatingequivalent
unitsusingFIFOorweightedaverageconvention,whicheverisrelevant.
3. Accumulatingcostsbroughtforwardfrompreviousdepartment,ifany,andcostsincurredincurrent
department,includingmanufacturingoverheads.
4. Findingcostperequivalentunit.
5. Valuingunitstransferredtofinishedgoodsandunitsinclosingworkinprocessatthecostper
equivalentunitandtheirrelevantpercentageofcompletion.
Journalentries
InternationalChemicals(IC)isengagedinpreparationofaffordablequalitypaintsbyexploitingeconomies
ofscale.Ithasfourdepartments:pigmentdispersing,letdown,testingandcanning.Letuspostsome
hypotheticaljournalentriesforIC'sprocesscosting.
1.Assume$10,000worthofpigmentsandresinsareintroducedinpigmentdispersingdepartmentas
directmaterials.
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ProcessCosting|Steps|JournalEntries|Example
WorkinProcesspigmentdispersing
$10,000
Rawmaterials
$10,000
2.50hoursofdirectlabor@$25perhourareused.
WorkinProcesspigmentdispersing
$1,250
Payroll/wagespayable
$1,250
3.Manufacturingoverheadsareallocatedtoeachdepartmentat$500perdirectlaborhourworked.
WorkinProcesspigmentdispersing
$25,000
ManufacturingOverheads
$25,000
4.Actualmanufacturingoverheadsare$24,250.
ManufacturingOverheads
$24,250
Payables/Cash
$24,250
5.Totalcostofpigmentdispersingdepartmentwhichcomestobe$36,250($10,000+$1,250+
$25,000),istransferredtoletdowndepartment.
WorkinProcessletdown
WIPpigmentdispersing
$36,250
$36,250
6.Totalcostofpigmentdispersingdepartmentaredebitedtoworkinprocessaccountforletdown
departmentusingschemeofjournalentriesgivenfrom14andtheaccumulatedcostisthentransferred
totestingdepartmentandsoontillthefinishedgoodsaretransferredoutfromcanningdepartmentto
finishedgoodsaccount.
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
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ProcessCosting|Steps|JournalEntries|Example
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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ProcessCostingFIFOMethod|Steps|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>ProcessCostingFIFOMethod
ProcessCostingFIFOMethod
UndertheFIFOmethodofprocesscosting,costsaretransferredtonextdepartmentandultimatelyto
finishedgoodsintheorderinwhichtheyenteredthecurrentdepartmenti.e.costsenteringfirstare
transferredfirstandhencethenameFIFOfirstinfirstout.
Unliketheweightedaveragemethod,theFIFOmethoddoesnotinvolveanyaveragingoutofthetotal
costsincurredduringaperiod.Itmovesthecostofbeginningworkinprocess(includingthecosts
incurredincurrentperiod)straighttocostofunitstransferredoutanddistributesthecostsaddedduring
theperiodfirsttothecostofunitstransferredoutandtheresttothecostofunitsintheendingworkin
process.
FIFOmethodinvolvesfollowingsteps,majorityofwhicharethesameasinweightedaveragemethod:
Preparingthequantityschedule:i.e.reconcilingunitsinthebeginningworkinprocess,units
added/startedduringtheperiod,unitstransferredoutandunitsinendingWIP.
BringingforwardthecostofendingWIPoflastperiodascostofbeginningworkinprocessofthe
currentperiod.
BringingforwardthepercentageofcompletionoftheendingWIPoflastperiod.
Findingthecostsbroughtforwardfrompreviousdepartmentandcostaddedinthecurrent
departmentunderdifferentheads:directmaterialsandconversioncosts.
Findingunitsstarted/addedandcompletedduringthecurrentperiod.
Findingtotalequivalentunits.
Findingcostperequivalentunitforeachcostcomponent.
AllocatingthecostbetweenunitstransferredoutandendingWIP.
Example
Letususethesameexampleasinthearticleonprocesscostingunderweightedaveragemethod.
PrepareacostofproductionreportforthepackagingdepartmentofCompanyABCforthemonthof
December2013underFIFOmethodofprocesscosting.Importantinformationisreproducedhere.
20,000unitsinworkinprocessasat1December:$20,000ofdirectmaterialsand$40,000of
conversioncosts(i.e.$10,000directlaborand$30,000manufacturingoverheads).100%ofthe
directmaterialscostand40%oftheconversioncosthavebeenincurredinlastperiodonthese
units.
200,000unitstransferredinfromproductiondepartmentduringthemonth:atatotalcostof
$555,000.
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ProcessCostingFIFOMethod|Steps|Example
Costsaddedincluded:directmaterialsof$22,000andconversioncostsof$20,000.
180,000unitstransferredtofinishedgoods.
40,000unitsinworkinprocessasat31December:100%completeastocoststransferredin,
80%completeastomaterialsand50%completeastoconversioncosts.
Solution
Thefirststepisthepreparationofquantityschedule.
Asat1December
20,000
Transferredin
200,000
Unitstobeaccountedfor
220,000
Transferredoutfromunitsfrom1December
20,000
Unitsbothstartedandcompletedduringthecurrentperiod
160,000
Unitstransferredout
180,000
Asat31December
40,000
Unitsaccountedfor
220,000
Now,calculatetheequivalentunits:
Transferred
Direct
Conversion
in
Materials
Costs
UnitsinbeginningWIP(A)
20,000
20,000
%ofcompletionofbeginningWIPinpreviousperiod(B)
0%
100%
40%
%ofbeginningWIPcompletedthisperiod[C=100%B]
100%
0%
60%
12,000
160,000
160,000
160,000
40,000
40,000
40,000
100%
80%
50%
40,000
32,000
20,000
200,000
192,000
192,000
EquivalentunitsinbeginningWIP[D=AC]
Unitsbothstartedandcompletedincurrentperiod(E)
UnitsofendingWIP(F)
PercentageofcompletionofendingWIP(G)
EquivalentunitsinendingWIP(H=FG)
Totalequivalentunits(D+E+H)
Next,findcostperequivalentunit.
Costs(I)
Totalequivalentunits(J)
Costperequivalentunit(I/J)
Transferred
Direct
Conversion
in
Materials
Costs
$555,000
$22,000
$20,000
200,000
192,000
192,000
$2.775
$0.1146
$0.1042
Total
$597,000
$2.993
Weneedtofindthecostofunitstransferredout.SinceweareusingFIFOmethod,wefirstincludethe
entirebeginningWIPinthecostofunitstransferredoutandthenincludeunitsstarted/addedduringthe
period.
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ProcessCostingFIFOMethod|Steps|Example
CostofbeginningWIPbroughtforwardfromlastperiod(K)
$60,000
Transferredincosts[(100%100%)*20,000*2.775](L)
Directmaterials[(100%100%)*20,000*0.1146](M)
Conversioncosts[(100%40%)*20,000*0.1042](N)
$1,250
CostincurredonbeginningWIPincurrentperiod(O=L+M+N)
$1,250
BeginningWIP(P=K+O)
$61,250
Costofunitsstartedandcompletedincurrentperiod(2.993*160,000)(Q) $479,000
Costofunitstransferredout(P+Q)
$540,250
Costofunitsinendingworkinprocesscomesfromunitsaddedduringtheperiod:
Transferred
Direct
Conversion
in
Materials
Costs
Total
Unitsasat31December(R)
40,000
40,000
40,000
40,000
Costperequivalentunit(S)
$2.775
$0.1146
$0.1042
$2.993
100%
80%
50%
$111,000
$3,667
$2,083
Percentageofcompletion(T)
Totalcost(RST)
$116,750
Itcanalsobecalculatedusingtheshortcutformulagivenbelow
CostofendingWIP=
CostofBeginningWIP+CostsTransferredin+CostsAddedinCurrentDepartmentCostsTransferred
out
ValueofendingWIPbasedonthisformulais:
CostofendingWIP=$60,000+$555,0000+$42,000$540,250=116,750
Wecansummarizethecostmovementusingthecostschedulegivenbelow:
Costtobeaccountedfor
Accountedforas
BeginningWIP
Costtransferredin
60000
555000
Transferredout
540,250
ClosingWIP
116,750
Total
657,000
Costadded
Materials
22000
Conversion
20000
42000
Total
657000
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
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ProcessCostingFIFOMethod|Steps|Example
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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ProcessCostingWeightedAverageMethod|Steps|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>ProcessCostingWeightedAverageMethod
ProcessCostingWeightedAverageMethod
Processcostingsystemisusedforstandardizedproductionprocesses.Wheneveraprocesscostsheetis
preparedforadepartment,thedepartmentmostlikelyhassomeunfinishedunitseitherinitsbeginning
workinprocess,closingworkinprocessorboth.Insuchasituation,itisimportanttodetermineacost
flowassumption,i.e.toagreeontheorderinwhichcostsaretransferredouttothenextdepartment.
Therearetwocostflowassumptions:firstinfirstout(FIFO)andweightedaverage.
Intheweightedaveragemethodofprocesscosting,thecostsareaveragedoutandevenlyappliedtoboth
unitstransferredoutandunitsinclosingworkinprocess.UnlikeFIFOmethod,whichassumescosts
introducedfirstintoadepartmentaretransferredoutfirst,weightedaveragemethoddoesnotassume
anyspecificorder.
Processcostingunderweightedaveragemethodinvolvesthefollowingsteps:
1. Preparingthequantityschedule:i.e.findingunitsinthebeginningworkinprocessfortheperiod,
unitsstartedorunitstransferredinfrompriordepartments,unitstransferredouttonext
departmentorunitsoffinishedgoods,andunitsinclosingworkinprocess.
2. Bringingforwardthecostofunitsinthebeginningworkinprocessfromlastperiod.Thecostshould
bebrokenupintoallitscomponents:directmaterialsandconversioncosts(=directlaborand
manufacturingoverheads).
3. Findingthecostsaddedinthecurrentdepartmentunderdifferentheads:directmaterials,direct
laborandmanufacturingoverheads.
4. Findingtotalcosttobeaccountedforundereachheadi.e.directmaterials,directlaborand
manufacturingoverheads.Thiswouldinvolveaddingthecostincludedintheopeningworkin
processonaccountofdirectmaterials,directlaborandmanufacturingoverheadstothe
correspondingamountsaddedduringtheperiodonaccountoftherelevantcostcomponent.
5. Findingtotalequivalentunits.
6. Findingcostperequivalentunitforeachcostcomponentbydividingthetotalcostforthecost
componentbytotalequivalentunitsfortherelevantcostcomponent.
7. Allocatingthecostbetweentheunitstransferredoutandunitsincludedintheclosingworkin
process.
Example
Letusprepareaprocesscostsheetunderweightedaveragemethodusingthefollowingdatafor
CompanyABC'spackagingdepartmentforthemonthofDecember2013.
20,000unitsinworkinprocessasat1December:$20,000directmaterialsand$40,000for
conversioncosts(i.e.$10,000directlaborand$30,000manufacturingoverheads)
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ProcessCostingWeightedAverageMethod|Steps|Example
200,000unitstransferredinfromproductiondepartmentduringthemonth:atatotalcostof
$555,000.
Costsaddedincluded:directmaterialsof$22,000andconversioncostsof$20,000.
180,000unitstransferredtofinishedgoods
40,000unitsinworkinprocessasat31December:100%completeastocoststransferredin,
80%completeastomaterialsand50%completeastoconversioncosts.
Solution
Letuspreparethequantityschedule.
Asat1December
20,000
Transferredin
200,000
Unitstobeaccountedfor
220,000
Transferredout
180,000
Asat31December
40,000
Unitsaccountedfor
220,000
Next,calculatetheequivalentunits.
Transferred
Direct
Conversion
in
Materials
Costs
180,000
180,000
180,000
Unitsasat31December(B)
40,000
40,000
40,000
Percentageofcompletion(C)
100%
80%
50%
40,000
32,000
20,000
220,000
212,000
200,000
Transferredout(A)
Equivalentunitsasat31Dec(D=BC)
Totalequivalentunits(A+D)
Next,calculatethecostperequivalentunit.
Transferred
Direct
Conversion
in
Materials
Costs
$0
$20,000
$40,000
$60,000
Addedduringthemonth
$555,000
$22,000
$20,000
$597,000
Coststobeaccountedfor
$555,000
$42,000
$60,000
$657,000
220,000
212,000
200,000
$2.52
$0.20
$0.30
Asat1December
Totalequivalentunits
Costperequivalentunit
Total
$3.02
Now,weneedtofindthecostofunitstransferredout.Itequals$543,600[=$3.02180,000].
Wealsoneedthefigureforcostofworkinprocessasat31December.Itcanbecalculatedasshownin
thetablebelow.
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ProcessCostingWeightedAverageMethod|Steps|Example
Transferred
Direct
Conversion
in
Materials
Costs
Unitsasat31December(A)
Total
40,000
40,000
40,000
40,000
Costperequivalentunit(B)
$2.52
$0.20
$0.30
$3.02
Percentageofcompletion(C)
100%
80%
50%
100,909
6,340
6,000
Totalcost(ABC)
113,249
SincecostofopeningWIPpluscostaddedmustequalcosttransferredoutandcostinclosingWIP,the
costofclosingWIPcanbecalculatedusingasshortcutformulagivenbelow:
CostofclosingWIP=CoststobeAccountedforCostsTransferredOut
Inthisexample,itturnsoutafigureof$113,400(totalcosttobeaccountedforof$657,000minus
coststransferredoutof$543,600).Theminordifferenceisduetoroundingoff.
Thefinalprocesscostsheetshouldlooklikeasfollows:
CompanyABC
PackagingDepartment
CostofProductionReport
Dec13
QUANTITYSCHEDULE
Asat1December
20,000
Transferredin
200,000
Unitstobeaccountedfor
220,000
Transferredout
180,000
Asat31December
40,000
Unitsaccountedfor
220,000
COSTSCHEDULE
Directmaterials
20,000
Conversioncosts
40,000
Asat1December(A)
60,000
Coststransferredin(B)
555,000
Directmaterials
22,000
Conversioncosts
20,000
Costsadded(C)
42,000
Totalcoststobeaccountedfor(A+B+C)
657,000
Transferredtofinishedgoods(D)
543,751
Coststransferredin
100,909
Directmaterials
6,340
Conversioncosts
6,000
Asat31December(E)
113,249
Totalcostsaccountedfor(D+E)
657,000
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
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ProcessCostingWeightedAverageMethod|Steps|Example
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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EquivalentUnitsFIFOMethod|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>EquivalentUnitsFIFOMethod
EquivalentUnitsFIFOMethod
EquivalentunitsunderFIFOmethodarethenumberoffinishedunitsthatcouldhavebeenpreparedina
processduringaperiodhadtherebeennounfinishedunits,eitherinopeningWIPorclosingWIP.
UndertheFIFOcostflowassumption,itisassumedthatthecoststhatenterfirstinthedepartmentexit
first.Theconsequenceofthisassumptionisthatthecostofunitstransferredoutfirstincludesthecostof
openingWIPandthenthecostofunitsaddedduringtheperiod.ThecostofopeningWIPiscarried
directlytotheunitstransferredout.Equivalentunitsarerelevantonlyforcostsincurredduringthe
period:whichincludescostsincurredoncompletingtheopeningWIP(i.e.theunfinishedpart),cost
incurredonunitsstarted/addedandtransferredoutandcostincurredonunitsinclosingworkinprocess.
Formula
EquivalentunitsunderFIFOmethodarecalculatedusingthefollowingformula:
Equivalentunitsforeachcostcomponent=(100%A)B+C+DE
Where,
A=percentageofcompletionattheendoflastperiod
B=unitsinopeningworkinprocess
C=unitsadded/startedandtransferredout
D=percentageofcompletionofunitsinclosingworkinprocess
E=unitsinclosingworkinprocess
Example
CalculateequivalentunitsunderFIFOmethodusingthedatagivenbelow:
Unitsinopeningworkinprocess
10,000
Unitsadded
190,000
Unitstransferredout
195,000
Unitsinclosingworkinprocess
5,000
PercentageofcompletionofopeningWIPdirectmaterials
80%
PercentageofcompletionofopeningWIPconversioncosts
40%
PercentageofcompletionofclosingWIPdirectmaterials
PercentageofcompletionofclosingWIPconversioncosts
100%
60%
Solution
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1/3
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EquivalentUnitsFIFOMethod|Example
DirectMaterials
ConversionCosts
10,000
10,000
%ofcompletionofbeginningWIPinpreviousperiod(B)
80%
40%
%ofbeginningWIPcompletedthisperiod[C=100%B]
20%
60%
2,000
6,000
185,000
185,000
UnitsclosingWIP(E)
5,000
5,000
%ofcompletionofclosingWIP(F)
100%
60%
EquivalentunitsinclosingWIP(G=EF)
5,000
3,000
192,000
194,000
UnitsinbeginningWIP(A)
EquivalentunitsinbeginningWIP[D=AC]
Unitsstartedandcompletedincurrentperiod
Totalequivalentunits
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
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EquivalentUnitsFIFOMethod|Example
AccountingEx
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EquivalentUnitsWeightedAverageMethod|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>EquivalentUnitsWeightedAverageMethod
EquivalentUnitsWeightedAverageMethod
Equivalentunitsarethenumberoffinishedunitsthatwouldhavebeenpreparedhadtherebeenno
partiallycompletedunitsinaprocess.
Theconceptofequivalentunitsisapplicabletoprocesscosting.Sinceprocessesarecontinuous,whena
costofproductionreportisprepared,theunfinishedunitsintheopeningworkinprocessorclosingwork
inprocessareassignedanestimatedpercentageofcompletion.Basedonthispercentageofcompletion,
numberofequivalentsunitsiscalculatedinordertofindcostpercompletedunit.
Formula
Thecalculationofequivalentunitsdependsonthecostflowassumptionusedi.e.thecalculationis
differentforfirstinfirstoutandweightedaverage.Intheweightedaveragemethod,totalequivalent
unitsfortheprocessforaperiodarecalculatedusingthefollowingformula.
Totalequivalentunitsforacostcomponent=A+BC
Where
A=unitstransferredouttothenextdepartment/finishedgoods
B=unitsinclosingworkinprocess
C=percentageofcompletionwithrespecttotherelevantcostcomponent
Example
Calculatetotalequivalentsunitsusingthefollowinginformation.
Unitsinopeningworkinprocess
10,000
Unitsadded
190,000
Unitstransferredout
195,000
Unitsinclosingworkinprocess
5,000
%ofcompletionofclosingWIPdirectmaterials
100%
%ofcompletionofclosingWIPconversioncosts
60%
Solution
Totalequivalentunitsdirectmaterials=190,000+5,000100%=195,000
Totalequivalentunitsconversioncosts=190,000+5,00060%=193,000
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
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EquivalentUnitsWeightedAverageMethod|Example
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
AccountingEx
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ActivityBasedCosting|Steps|Example
AccountingExplained
Home>ManagerialAccounting>CostSystems>ActivityBasedCosting
ActivityBasedCosting
Activitybasedcostingisamethodofassigningindirectcoststoproductsandserviceswhichinvolves
findingcostofeachactivityinvolvedintheproductionprocessandassigningcoststoeachproductbased
onitsconsumptionofeachactivity.
Activitybasedcostingismorerefinedapproachtocostingproductsandservicesthanthetraditional
costingmethod.Itinvolvesthefollowingsteps:
Identificationofactivitiesinvolvedintheproductionprocess
Classificationofeachactivityaccordingtothecosthierarchy(i.e.intounitlevel,batchlevel,
productlevelandfacilitylevel)
Identificationandaccumulationoftotalcostsofeachactivity
Identificationofthemostappropriatecostdriverforeachactivity
Calculationoftotalunitsofthecostdriverrelevanttoeachactivity
Calculationoftheactivityratei.e.thecostofeachactivityperunitofitsrelevantcostdriver
Applicationofthecostofeachactivitytoproductsbasedonitsactivityusagebytheproduct.
CostHierarchy
Thefirststepinactivitybasedcostinginvolvesidentifyingactivitiesandclassifyingthemaccordingtothe
costhierarchy.Costhierarchyisaframeworkthatclassifiesactivitiesbasedtheeaseatwhichtheyare
traceabletoaproduct.Thelevelsare(a)unitlevel,(b)batchlevel,(c)productlevel,and(d)facilitylevel.
Unitlevelactivitiesareactivitiesthatareperformedoneachunitofproduct.Batchlevelactivitiesare
activitiesthatareperformedwheneverabatchoftheproductisproduced.Productlevelactivitiesare
activitiesthatarecarriedoutseparatelyforeachproduct.Facilitylevelactivitiesareactivitiesthatare
carriedoutattheplantlevel.Theunitlevelactivitiesaremosteasilytraceabletoproductswhilefacility
levelactivitiesareleasttraceable.
Example
AlexErwinstartedInterwood,anichefurniturebrand,10yearsago.Heranthebusinessasasole
proprietorship.Whilehehas50skilledcarpentersand5salesmenonhispayroll,hehasbeentakingcare
oftheaccountingbyhimself.Now,heintendstooffer40%oftheownershiptopublicinnextcouple
years,andiswillingtomakechangesandhashiredyouasthemanagementaccountanttoorganizeand
improvetheaccountingsystems.
Interwood'stotalbudgetedmanufacturingoverheadscostforthecurrentyearis$5,404,639and
budgetedtotallaborhoursare20,000.Alexappliedtraditionalcostingmethodduringallofthe10years
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ActivityBasedCosting|Steps|Example
period,andbasedthepredeterminedoverheadrateontotallaborhours.
Interwood'ssofarangeincludesthe2set,3setand6setoptions.PlatinumInteriorsrecentlyplacedan
orderfor150unitsofthe6settype.Theorderisexpectedtobedeliveredin1monthtime.Sinceitisa
customizedorder,Platinumwillbebilledatcostplus25%.
Youarenotafanoftraditionalproductcostingsystem.Youbelievethatthebenefitsofactivitybased
costingsystemexceedsitscosts,soyousatdownwithAaronMason,thechiefengineer,toidentifythe
activitieswhichthefirmundertakesinitssofadivision.Next,youcalculatedthetotalcostthatgoesinto
eachactivity,identifiedthecostdriverthatismostrelevanttoeachactivityandcalculatedtheactivity
rate.Theresultsaresummarizedbelow:
Activity
A(in$)
RelevantCostDriver
C=A/B(in$)
Productionofcomponents
2,313,132
Machinehours
25,000
93
Assemblyofcomponents
1,231,312
Numberoflaborhours
20,000
62
Packaging
213,123
Units
5,000
43
Shipping
231,230
Units
5,000
46
Setupcosts
34,243
Designing
123,132
Producttesting
24,234
Rent
Numberofsetups
Designerhours
Testinghours
1,234,233
Laborcost
240
143
1,000
123
500
$1,645,644
48
75%
Oncetheorderwasreadyforpackaging,Aarongaveyouasummaryoftotalcostincurredanda
statementofactivitiesperformed(alsocalledthebillofactivities)asshownbelow:
OrderNo:15X2013
Customer:PlatinumInteriors
Units:150
Type:6unit
Amountsin$
Costofdirectmaterials
25,000
Costofpurchasedcomponents
35,000
Laborcost
15,600
Activity
RelevantCostDriver
ActivityUsage
Productionofcomponents
Machinehours
320
Assemblyofcomponents
Numberoflaborhours
250
Packaging
Units
150
Shipping
Units
150
Numberofsetups
15
Designerhours
70
Setupcosts
Designing
TestingTestinghours
Rent
22
Laborcost
4500
PartA
Calculatethetotalcostoftheorderandtheinvoicevalueoftheorderbasedontraditionalcosting
system.
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ActivityBasedCosting|Steps|Example
Solution
Inthetraditionalcostingsystem,costequalsmaterialscostpluslaborcostplusmanufacturingoverheads
chargedatthepredeterminedoverheadrate.
Thepredeterminedoverheadratebasedondirectlaborhours=$5,404,639/20,000=$270perlabor
hour
Theactualnumberoflaborhoursspentontheorderis250.Oncewehavethisdata,wecanestimatethe
manufacturingoverheadsandthetotalcostasfollows:
Directmaterials
25,000
Purchasedcomponents
35,000
Laborcost
15,600
Manufacturingoverheads($270250)
67,500
Totalcostundertraditionalproductcostingsystem
143,100
Platinumisbilledatcostplus25%,sotheamountofsalestobebookedwouldamountto$178,875(=
$143,1001.25).
PartB
Youknowactivitybasedcostingisamorerefinedapproach.Now,sinceyouhaveallthedataneeded,
calculatetheordercostusingactivitybasedcosting.
Solution
Inactivitybasedcosting,directmaterialscost,costofpurchasedcomponentsandlaborcostremainsthe
sameasintraditionalproductcosting.However,thevalueofmanufacturingoverheadsassignedismore
accuratelyestimated.Thefollowingworksheetestimatesthemanufacturingoverheadsthatshouldbe
assignedtotheorderofPlatinumInteriors:
(A)
(B)
(AB)
ActivityRate
ActivityUsage
ActivityCostAssigned
Productionofcomponents
93
320
29,760
Assemblyofcomponents
62
250
15,500
Packaging
43
150
6,450
Shipping
46
150
6,900
Setupcosts
143
15
2,145
Designing
123
70
8,610
48
22
1,056
75%
15,600
11,700
Activity
Producttesting
Rent
82,121
Totalcostoftheorderishence:
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3/5
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ActivityBasedCosting|Steps|Example
US$
Directmaterials
25,000
Purchasedcomponents
35,000
Laborcost
15,600
Manufacturingoverheads
82,121
Totalcostunderactivitybasedcosting
157,721
Basedonthemoreaccurateestimationoftheordercost,theinvoiceshouldberaisedat$197,150
(=$157,7211.25)insteadof$178,875calculatedundertraditionalproductcostingsystem.
Theexamplehighlightstheimportanceofcorrectestimationoftheproductcostandtheusefulnessof
activitybasedcostinginachievingthatgoal.
WrittenbyObaidullahJan,ACA,CFA
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
JobOrderCosting
JobCostSheet
ProcessCosting
ProcessCostingAVCO
EquivalentUnitsAVCO
ProcessCostingFIFO
EquivalentUnitsFIFO
ActivityBasedCosting
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
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ActivityBasedCosting|Steps|Example
AccountingEx
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CostVolumeProfitAnalysis|BasicConcepts|ManagerialAccounting
AccountingExplained
Home>ManagerialAccounting>CVPAnalysis
CostVolumeProfitAnalysis
CostVolumeProfit(CVP)analysisisamanagerialaccountingtechniquethatisconcernedwiththeeffect
ofsalesvolumeandproductcostsonoperatingprofitofabusiness.Itdealswithhowoperatingprofitis
affectedbychangesinvariablecosts,fixedcosts,sellingpriceperunitandthesalesmixoftwoormore
differentproducts.
CVPanalysishasfollowingassumptions:
1. Allcostcanbecategorizedasvariableorfixed.
2. Salespriceperunit,variablecostperunitandtotalfixedcostareconstant.
3. Allunitsproducedaresold.
Wheretheprobleminvolvesmixedcosts,theymustbesplitintotheirfixedandvariablecomponentby
HighLowMethod,ScatterPlotMethodorRegressionMethod.
CVPAnalysisFormula
ThebasicformulausedinCVPAnalysisisderivedfromprofitequation:
px=vx+FC+Profit
Intheaboveformula,
pispriceperunit
visvariablecostperunit
xaretotalnumberofunitsproducedandsoldand
FCistotalfixedcost
Besidestheaboveformula,CVPanalysisalsomakesuseoffollowingconcepts:
ContributionMargin(CM)
ContributionMargin(CM)isequaltothedifferencebetweentotalsales(S)andtotalvariablecostor,in
otherwords,itistheamountbywhichsalesexceedtotalvariablecosts(VC).Inordertomakeprofitthe
contributionmarginofabusinessmustexceeditstotalfixedcosts.Inshort:
CM=SVC
UnitContributionMargin(UnitCM)
ContributionMargincanalsobecalculatedperunitwhichiscalledUnitContributionMargin.Itisthe
excessofsalespriceperunit(p)overvariablecostperunit(v).Thus:
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CostVolumeProfitAnalysis|BasicConcepts|ManagerialAccounting
UnitCM=pv
ContributionMarginRatio(CMRatio)
ContributionMarginRatioiscalculatedbydividingcontributionmarginbytotalsalesorunitCMbyprice
perunit.
WrittenbyIrfanullahJan
ManagerialAccounting
ManagerialAccountingIntro
CostClassifications
CostAccountingSystems
CostAllocation
CostBehaviorAnalysis
CostVolumeProfitAnalysis
BEPEquationMethod
BEPContributionMethod
SalesMixBreakevenPoint
ContributionMargin
TargetIncomeSales
MarginofSafety
DegreeofOperatingLeverage
AbsorptionCosting
TargetCosting
CostplusPricing
VariableCosting
RelevantCosting
CapitalBudgeting
MasterBudget
InventoryManagement
StandardCosting
PerformanceMeasurement
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CostVolumeProfitAnalysis|BasicConcepts|ManagerialAccounting
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