CHAPTER 18: ADDITIONAL ASPECTS OF PRODUCT

COSTING SYTEMS
Job Order Costing
- Collects costs for each physically identifiable job
or unit of product as it move through the
production process, regardless of the
accounting period in which the work is done.
- Each job is given an identification number, and
its costs are collected on a job cost record.
- Costs are recorded as the job moves through
the various steps in the production process.
Process Costing
- Collects costs for all of the products worked on
during an accounting period and determines
unit costs by averaging the total cost over the
total number of units worked.
Traditional: single cost driver
Activity Based Costing (ABC): multiple cost driver
Direct Material Cost
- May be priced solely at its purchase or invoice
cost, or some or all of the following materialrelated costs may be added: inward freight,
inspection costs, moving costs, purchasing
department costs, and interest and space
charges associated with holding material in
inventory.

If the amount of overhead cost absorbed by

products exceeds the amount actually
incurred, overhead is said to be
overabsorbed.
If the amount is less, overhead costs are
underabsorbed.
Traditional vs. ABC
Direct Materials
Direct Labor
Factory
Overhead

Traditional
AP*AQ
AR*AQ
AQ*FOHR
(Factory
Overhead Rate)

ABC
AP*AQ
AR*AQ
AQ*Cost Driver
Rate per activity

**Total activity depends on how a company produces. If

the company is dependent on machine, machine hours
should be considered unless otherwise stated. If the
company is dependent on direct labor, direct labor
hours should be considered unless otherwise stated.

**Total activity depends on where that certain activity

is dependent. Each activity has its own cost driver rate.

*Indirect costs are allocated to products by means of an

overhead rate.

CHAPTER 19: STANDARD COSTS, VARIABLE COSTING

SYSTEMS, QUALITY COSTS, AND JOINT COSTS

Predetermined overhead rates

- Established in advance usually once a year
- Advantages:
1. Overhead rates computed monthly would
not be affected by peculiar conditions.
2. It permits product costs to be calculated
more promptly.
3. Calculation of an overhead rate once a year
requires less effort than going through the
same calculation every month.
Flexible overhead budget
- Shows what overhead costs are expected at
various volumes (Since some overhead cost
elements are fixed and other are semi-variable,
total overhead costs will be different at each
volume level)
o When a predetermined overhead rate is used, the
amount of overhead costs allocated to products in a
given month is likely to differ from the amount
actually incurred.

Standard vs Budgeted
Standard Cost
Measure of how
much an item
should be
Used to describe
what the cost of
one
unit
of
product

Budgeted Cots
Predetermined
Used to describe
what the total cost
of many units or of
a time should be

Standard Costing & Actual Costing

Standard
Direct Material
Standard Price x
Standard
Quantity
Direct Labor
Standard Rate x
Standard
Quantity
Factory
Standard FOHR x

Actual
Actual Price x
Actual Quantity
Actual Rate x
Actual Quantity
Actual FOHR x

Overhead

Standard
Quantity

Actual Quantity

If actual costs are higher than standard costs,

the variance is said to be unfavorable.
If actual costs are below standard, the variance
is a favorable variance.

Variable Costing System

Variable production costs
o includes Direct Material, Direct Labor, Variable
Overhead (VOH) (a.k.a inventoriable product
costs)
o Fixed overhead (FOH) costs treated as expenses
during the period it was incurred (period costs)
o direct costing system
o based on either actual or standard costs
o used by a very small minority of companies in
their routine management accounting systems
o difficult to identify the variable costs
Comparison of Absorption and Variable Costing
Advantages:
1. No FOH costs are charged to individual units.
No OH rate for the fixed component of OH
costs.
It requires an estimate standard volume.
2. OH Variance:
o OH Spending Variance:
Actual OH Costs - Budget OH Costs
o OH Volume Variance:
Actual Production Volume - Standard
Production Volume
The OH variance in a variable costing system is
purely a spending variance.
3. It separates variable and fixed production costs.
(It is good because variable costs are on a perunit basis and fixed costs are on a total-costper-period basis)
4. Reported monthly income is related directly to
the month's sales volume.
The following relationship will always hold:
1. Period Sales Volume = Production Volume (Qty)
Both full costing and variable costing
will have same income.
2. Period Sales Volume > Production Volume (Qty)
Full costing reports a lower income.
3. Period Sales Volume < Production Volume (Qty)
Full costing reports a higher income.

Quality Costing
Quality Costs / Cost of quality:
o any costs in excess of those that would have
been incurred if a good were manufactured or a
service provided exactly right the first time
o cost of NOT creating a quality product or service
o categorized into four groups:
1. Prevention Costs:
associated with preventing defects and
other quality problems
2. Quality appraisal (or detection) costs
include inspection, testing, and other
activities designed to find problems
before a good is delivered
3. Internal failure costs
include scrap, rework and other
activities to "make things right" before a
good is delivered
4. External failure costs
costs of making things right when a
quality problem has occurred after the
product has been delivered to the
customer
includes refund, warranty costs,
product liability costs, and the cost of
repeating a service that was not
performed properly the first time
Joint Products and By-Products
o difficult costing problems
Joint-Product Costing
two or more dissimilar products that
are produced from a single batch of raw
material or by single production process
split-off point: raw material is treated
as a single unit up to a certain point
problem is to find some reasonable
basis for allocating to each of the joint
products the costs incurred up to the
split-off point; same as allocating
indirect costs to cost centers
Sales Value Method
o allocating in proportion to sales value of the
end products minus the separate processing
and marketing costs estimated to be incurred
for each end product beyond the split-off point
Weight Method
o joint costs are divided in proportion to the
weight of the joint material in the several end
products

By-product costing
By-product:
a secondary product whose total sales
value is relatively minor in comparison
with the sales value of the main product
usually costed so that zero profit is
recorded; all costs are attributed to the
main product

Total standard direct cost for an accounting period = SQ

* SP * number of units produced during the period

Accuracy of Costs
Judgment Calls
1. Capital, product, and period costs
knowing how to classify as a capital
cost, a product cost, or a period cost
2. Measurement of direct costs
3. Distinction between direct and indirect costs
4. Alternative allocation methods
5. Choice of an activity measure
6. Estimate of volume
7. Definition of cost center
significantly influences amount of OH
allocated to a product

DM Cost Variance: difference between standard cost

and actual cost
2-way variance:

Tendencies towards Uniformity

Because of the factors above, no one can actually
measure precisely the actual amount of resources used
in producing a good or service when indirect costs are
involved.
Cost System Design Choices
With the increasing diversity of organizations' activities
and production technologies, the questions must be
answered several times, once for each segment of an
organization's operations.
CHAPTER 20: PRODUCTION COSTS VARIANCE
ANALYSIS
Variances
Variance:
o difference between two numbers, one
represents the measured performance (actual)
and the other, performance standard (budget,
standard)
Variance Analysis:
o decomposition of variance into the individual
factors that caused the variance
Direct Material and Labor Variances
Direct Material Variances
Standard direct material cost of one unit of product =
Quantity of material needed to produce one unit of
output * Price paid per unit of material (SQ*SP)

Actual direct material cost of one unit of product =

Actual quantity of material used to produce one unit of
output * Actual price paid per unit of material (AQ*AP)
Total actual direct cost for an accounting period = Q * P
* actual number of units produced during the period

Actual
AP * AQ

SP * AQ

Price Variance

Standard
SP * SQ

Quantity Variance

Total Material Variance

3-way variance (Anthonys method; either both are
favorable or both are not):
Actual
AP * AQ

AP * SQ

Quantity Variance

Standard
SP * SQ

Price Variance

Or:
Direct Material Price Variance = (AP-SP) x SQ
Direct Material Quantity Variance = (AQ-SQ) x SP
Joint Variance = (AP-SP) (AQ-SQ)
Direct Labor Variances
o same as direct material variances
Standard direct labor cost of one unit of product =
Standard labor input time needed to produce one unit
of output * Standard rate paid per unit of time (SQ*SR)
Total standard direct labor for an accounting period =
SQ * SR * number of units produced during the period
Actual direct labor cost of one unit of product = Actual
labor input time needed to produce one unit of output
* Actual rate paid per unit of time (AQ*AR)
Total actual direct labor for an accounting period = AQ *
AR * number of units produced during the period
DL Variance: difference between standard cost and
actual cost

Standard
SR * SQ

SR * AQ

AP(R) > SP(R)

AQ > SQ

Price

2-way variance:
Actual
AR * AQ

Price Variance

Quantity

Quantity Variance

Total Labor Variance

Quantity Variance

Actual cost < Standard Cost: favorable*

Actual cost > Standard Cost: unfavorable
*Favorable does not really mean that performance was
good; it means actual costs were lower than standard
costs. In fact, lower costs may be a problem because it
might be the result of using materials of lower quality
Geometric Depiction of Variance Analysis:
S

Price

Quantity
S

Price

AP(R) < SP(R)

AQ > SQ

Quantity
Overhead Variance

Price Variance

Or:
Direct Material Price Variance = (AR-SP) x SQ
Direct Material Quantity Variance = (AR-SQ) x SP
Joint Variance = (AR-SP) (AQ-SQ)

AP(R) < SP(R)

AQ > SQ

Price

AP(R) < SP(R)

AQ < SQ

3-way variance (Anthonys method; either both are

favorable or both are not):
Actual
Standard
AR * AQ
AR * SQ
SR * SQ

Quantity
Joint Variance
o When both variances are unfavorable or
favorable
o AP > SP, AQ > SQ; AP < SP, AQ < SQ

R = average OH cost per unit at the standard volume

TFOHC = total fixed OH cost
UVOHC = unit variable OH cost
S = number of units
Production Volume Variance
o Standard volume is usually the volume
expected during the course of the year, which is
used to calculate the predetermined OH rate.
Spending Variance
o equal to the budgeted OH costs for the period's
actual level of volume minus the period's actual
OH costs
o Flexible budget line: shows expected
relationship between volume and actual
overhead costs; based on production volume no sales volume
o Absorption line: shows the relationship
between production volume and the credit to
the Overhead clearing account; based on
production volume - no sales volume
Calculation of OH Variances
o Net OH Variance: Absorbed costs - Actual
Costs; Volume Variance + Spending Variance
o Volume Variance: Absorbed costs - Budgeted
costs; based on the period's actual production
volume
o Spending Variance: Budgeted costs - Actual
costs

Absorbed OH
AOHR * AQ

Budgeted OH
BVOHR*AQ +
BFOH

Volume Variance

Actual OH
SP * SQ

Spending Variance

Net OH Variance
Use of the OH Variance
The manager cannot reasonably claim had the spending
variance is cause by a difference between the standard
and the actual volumes.