Product Costing

A. Cost Classification
1. Period Costs--period costs include all those costs that are not
associated with the manufacturing of a product and are expensed when
they are incurred
2. Product Costs--product costs include all those costs that are
associated with the manufacturing of a product and are expensed when
the product is sold
a. Direct Materials--direct materials includes the cost of materials
that can be traced directly to the products manufactured
b. Direct Labor--direct labor includes the cost of labor that can be
traced directly to the products manufactured
c. Manufacturing Overhead--manufacturing overhead includes all other
product costs that cannot be traced directly to the products
manufactured
1) Indirect Materials--indirect materials includes the cost of
insignificant materials that can be traced directly to the
products manufactured (such as nails, glue, solder, etc.) and
the cost of materials that cannot be traced directly to the
products manufactured yet are necessary to manufacture the
products (such as lubricants for the machinery, polishing and
cleaning materials, repair parts, light bulbs, etc.)
2) Indirect Labor--indirect labor includes the cost of labor that
cannot be traced directly to the products manufactured yet are
necessary for the factory to operate (such as supervisors,
maintenance workers, inventory storekeepers, etc.)
3) Other Overhead--other overhead includes all those other costs
incurred to keep the factory operating (such as depreciation,
taxes, and insurance on the factory and equipment, utility
costs, etc.)

B. Inventory Accounts
1. Materials Inventory--materials inventory includes the cost of materials
that have not yet been added to production
2. Work in Process Inventory--work in process inventory includes the
product costs incurred on products on which production activities have
been started but not yet completed
a. Factory Labor--factory labor is used to accumulate factory labor
costs until they can be associated with the products manufactured
b. Manufacturing Overhead
1) Manufacturing Overhead--manufacturing overhead is used to
accumulate the product costs that cannot be traced directly to
the products manufactured until they can be associated with the
products manufactured
2) Applied Manufacturing Overhead--applied manufacturing overhead
is used to record the manufacturing overhead costs allocated to

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 the products manufactured
3. Finished Goods Inventory--finished goods inventory includes the product
costs incurred on products on which production activities have been
completed but not yet sold
4. Cost of Goods Sold--cost of goods sold includes the product costs
incurred on which products on which production activities have been
completed and sold

C. Cost Flows
1. Purchase of Materials--the cost of materials purchased is recorded in
the materials inventory account
2. Usage of Materials--the cost of materials that can be traced directly
to the products manufactured are transferred from the materials
inventory account to the work in process inventory account, and the
cost of materials that cannot be traced directly to the products
manufactured are transferred from the materials inventory account to
the manufacturing overhead account
3. Incurrence of Factory Labor Costs--the cost of factory labor is
recorded in the factory labor account
4. Allocation of Factory Labor Costs--the cost of factory labor that can
be traced directly to the products manufactured are recorded in the
work in process inventory account, and the cost of factory labor that
cannot be traced directly to the products manufactured are recorded in
the manufacturing overhead account
5. Incurrence of Other Overhead Costs--the cost of other overhead costs
are recorded in the manufacturing overhead account
6. Overhead Application--manufacturing overhead costs are transferred to
the work in process inventory account by assigning manufacturing
overhead costs to the products manufactured using a cost allocation
basis that can be directly related to the products manufactured (such
as direct labor hours, machine hours, direct labor cost, etc.)
a. Pre-determined Overhead Rate--the cost allocation basis to assign
manufacturing overhead costs to the products manufactured is
determined at the beginning of the accounting period to even out
cyclical changes in overhead costs or production
7. Completion of Production--the product costs incurred on products on
which production activities have been completed are transferred from
the work in process inventory account to the finished goods inventory
account
8. Sale of Product--the product costs incurred on products which have been
sold are transferred from the finished goods inventory account to the
cost of goods sold account
9. Over/underapplied Overhead--any difference between actual manufacturing
overhead costs and applied manufacturing overhead costs are written off
as an adjustment to cost of goods sold as long as the difference is not
material

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D. Cost of Goods Manufactured--the cost of goods sold section in the income
statement will include a cost of goods manufactured section (that replaces
the net purchases figure for a merchandising company) that will consist of
the beginning inventory of work in process plus manufacturing costs added
to production during the current period less the ending inventory of work
in process

E. Assigning Costs to Units

1. Job Order Costing
a. Characteristics—individual jobs are produced to the customer’s
specifications
b. Computation--a job order costing system accumulates manufacturing
costs for each job separately through the use of subsidiary ledger
t-accounts
1) Illustration--on January 1 no jobs were in process, during the
year Job #1, Job #2, and Job #3 were started; materials were
purchased at a cost of $100,000; materials with a cost of
$75,000 were used of which $70,000 was direct materials
($10,000 on Job #1, $40,000 on Job #2, and $20,000 on Job #3);
labor costs of $250,000 were incurred of which $220,000 was
direct labor ($80,000 on Job #1, $75,000 on Job #2, and $65,000
on Job #3); other manufacturing overhead costs of $72,800 were
incurred; manufacturing overhead is applied to production on
the basis of direct labor cost; estimated manufacturing
overhead for the year was $100,000 and estimated direct labor
cost for the year was $200,000; Job #2 and Job #3 were
completed; Job #3 was sold for $200,000
Overhead Rate = 100,000 / 200,000 = 50% x direct labor cost

Job #1 = 10,000 + 80,000 + 50% x 80,000 = 130,000

Job #2 = 40,000 + 75,000 + 50% x 75,000 = 152,500
Job #3 = 20,000 + 65,000 + 50% x 65,000 = 117,500

Materials 100,000
Cash 100,000

Work in Process 70,000

Manufacturing Overhead 5,000
Materials 75,000

Factory Labor 250,000

Cash 250,000

Work in Process 220,000

Manufacturing Overhead 30,000
Factory Labor 250,000

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 Manufacturing Overhead 72,800
Cash, Etc. 72,800

Work in Process 110,000

(50% x 220,000)
Applied Manufacturing Overhead 110,000

Finished Goods 270,000

(152,500 + 117,500)
Work in Process 270,000

Cash 200,000
Sales 200,000

Cost of Goods Sold 117,500

Finished Goods 117,500

Applied Manufacturing Overhead 110,000

Manufacturing Overhead 107,800
Cost of Goods Sold 2,200

Sales 200,000
Cost of Goods Sold:
Work in Process Inventory, 1/1 ---
Direct Materials 70,000
Direct Labor 220,000
Applied Overhead 110,000 400,000
400,000
Work in Process Inventory, 1/31 130,000
Cost of Goods Manufactured 270,000
Finished Goods Inventory, 1/1 _ --- _
Goods Available for Sale 270,000
Finished Goods Inventory, 1/31 152,500
117,500
Overapplied Overhead ( 2,200) 115,300
Gross Profit _84,700

2. Process Costing
a. Characteristics--identical units are produced through a continuous
manufacturing process
b. Computation--a process costing system accumulates manufacturing
costs for a period of time and computes an average manufacturing
cost for the units produced during the period of time
1) Steps
a) Physical Flow of the Units--the physical flow of the units
identifies the units to be accounted for (the units in
beginning inventory at the start of the current period plus

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 the units started during the current period) and the units
accounted for (the units completed during the current
period plus the units in ending inventory at the end of the
current period)
b) Equivalent Units of Production--equivalent units of
production, the common denominator for completed units and
partially completed units, are computed by multiplying the
units accounted for by their percentage of completion for
each category of costs
c) Costs To Be Accounted For--the total costs to be accounted
for (the cost of the units in beginning inventory at the
start of the current period plus the costs added to
production during the current period) are identified for
each category of costs
d) Cost Per Equivalent Unit--costs per equivalent unit of
production are computed for each category of costs by
dividing the costs to be accounted for by the total
equivalent units of production
e) Costs Accounted For--the total costs to be accounted for
are allocated for each category of costs to the units
accounted for by multiplying the equivalent units of
production by the cost per equivalent unit of production
2) Methods--a weighted-average method or a FIFO method may be used
to compute the cost of the units produced
a) Weighted-average--the weighted-average method computes an
average cost that is a weighted average of the cost from
the beginning inventory and the cost from the current
period
I) Steps
A) Physical Flow of the Units--in identifying the
units accounted for, the weighted-average method
does not keep the beginning inventory units
separate from the units that were started and
completed during the current period
B) Equivalent Units of Production--in computing
equivalent units of production, the weighted-
average method does not keep the percentage of
completion performed in the prior period separate
from the percentage of completion performed in the
current period
C) Costs To Be Accounted For--in identifying the costs
to be accounted for, the weighted-average method
does not keep the costs of the units in beginning
inventory at the start of the current period
separate from the costs added to production during
the current period
D) Cost Per Equivalent Unit--in computing costs per

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 equivalent unit of production, the weighted-average
method divides the total costs to be accounted for
by the total equivalent units of production
E) Costs Accounted For--in allocating the total costs
to be accounted for to the units accounted for, the
weighted-average method does not keep the cost of
the units in beginning inventory at the start of
the current period separate from the costs added to
production during the current period
II) Illustrations
A) On January 1, 0 units were in process at a cost of
materials of $0 and a cost of conversion costs of
$0, during January 12,500 units were started,
during January materials costs of $230,000 and
conversion costs of $430,050 were added to
production, during January 10,000 units were
completed, on January 31, 2,500 units were in
process--60% complete in regards to materials and
70% complete in regards to conversion costs
Beginning Inventory ---
Units Started 12,500
12,500

_ Equivalent Units _
Conversion
_ Materials _ Costs _
Units Completed 10,000 10,000 10,000
Ending Inventory 2,500 1,500 1,750
_ _ (60% x 2,500) (70% x 2,500)
12,500 11,500 11,750

Beginning Inventory Costs --- --- ---

Current Costs 660,050 230,000 430,050
660,050 230,000 430,050

Cost Per Unit 20.00 36.60

(230,000 / 11,500) (430,050 / 11,750)

Units Completed 566,000 200,000 366,000

(20.00 x 10,000) (36.60 x 10,000)
Ending Inventory 94,050 30,000 64,050
_ _ (20.00 x 1,500) (36.60 x 1,750)
660,500 230,000 430,050

B) On February 1, 2,500 units were in process--60%

complete in regards to materials and 70% complete
in regards to conversion costs--at a cost of

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 materials of $30,000 and a cost of conversion costs
of $64,050, during February 13,100 units were
started, during February materials costs of
$283,500 and conversion costs of $428,750 were
added to production, during February 13,600 units
were completed, on February 28, 2,000 units were in
process--70% complete in regards to materials and
20% complete in regards to conversion costs
Beginning Inventory 2,500
Units Started 13,100
15,600

_ Equivalent Units _
Conversion
_ Materials _ Costs _
Units Completed 13,600 13,600 13,600
Ending Inventory 2,000 1,400 400
_ _ (70% x 2,000) (20% x 2,000)
15,600 15,000 14,000
Beginning Inventory Costs 94,050 30,000 64,050
Current Costs 712,250 283,500 428,750
806,300 313,500 492,800

Cost Per Unit 20.90 35.20

(313,500 / 15,000) (492,800 / 14,000)

Units Completed 762,960 284,240 478,720

(20.90 x 13,600) (35.20 x 13,600)
Ending Inventory 43,340 29,260 14,080
_ _ (20.90 x 1,400) (35.20 x 800)
806,300 313,500 492,800

b) FIFO--the first-in first-out method computes an average

cost that is separate for the current period from the
beginning inventory
I) Steps
A) Physical Flow of the Units--in identifying the
units accounted for, the first-in first-out method
keeps the beginning inventory units separate from
the units that were started and completed during
the current period
B) Equivalent Units of Production--in computing
equivalent units of production, the first-in first-
out method keeps the percentage of completion
performed in the prior period separate from the
percentage of completion performed in the current
period

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 C) Costs To Be Accounted For--in identifying the costs
to be accounted for, the first-in first-out method
keeps the costs of the units in beginning inventory
at the start of the current period separate from
the costs added to production during the current
period
D) Cost Per Equivalent Unit--in computing costs per
equivalent unit of production, the first-in first-
out method divides the current costs to be
accounted for by the current equivalent units of
production
E) Costs Accounted For--in allocating the total costs
to be accounted for to the units accounted for, the
first-in first-out method keeps the cost of the
units in beginning inventory at the start of the
current period separate from the costs added to
production during the current period
II) Illustrations
A) On January 1, 0 units were in process at a cost of
materials of $0 and a cost of conversion costs of
$0, during January 12,500 units were started,
during January materials costs of $230,000 and
conversion costs of $430,050 were added to
production, during January 10,000 units were
completed, on January 31, 2,500 units were in
process--60% complete in regards to materials and
70% complete in regards to conversion costs
Beginning Inventory ---
Units Started 12,500
12,500

_ Equivalent Units _
Conversion
_ Materials _ Costs _
Beginning Inventory --- --- ---
Units Started and
Completed 10,000 10,000 10,000
Ending Inventory 2,500 1,500 1,750
_ _ (60% x 2,500) (70% x 2,500)
12,500 11,500 11,750

Beginning Inventory Costs --- --- ---

Current Costs 660,050 230,000 430,050
660,050 230,000 430,050

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Cost Per Unit 20.00 36.60
(230,000 / 11,500) (430,050 / 11,750)

Beginning Inventory --- --- ---

Units Started and
Completed 566,000 200,000 366,000
(20.00 x 10,000) (36.60 x 10,000)
Ending Inventory 94,050 30,000 64,050
_ _ (20.00 x 1,500) (36.60 x 1,750)
660,500 230,000 430,050

B) On February 1, 2,500 units were in process--60%

complete in regards to materials and 70% complete
in regards to conversion costs--at a cost of
materials of $30,000 and a cost of conversion costs
of $64,050, during February 13,100 units were
started, during February materials costs of
$283,500 and conversion costs of $428,750 were
added to production, during February 13,600 units
were completed, on February 28, 2,000 units were in
process--70% complete in regards to materials and
20% complete in regards to conversion costs
Beginning Inventory 2,500
Units Started 13,100
15,600

_ Equivalent Units _
Conversion
_ Materials _ Costs _
Beginning Inventory 2,500 1,000 750
(40% x 2,500) (30% x 2,500)
Units Started and
Completed 11,100 11,100 11,100
Ending Inventory 2,000 1,400 400
_ _ (70% x 2,000) (20% x 2,000)
15,600 13,500 12,250

Beginning Inventory Costs 94,050 30,000 64,050

Current Costs 712,250 283,500 428,750
806,300 313,500 492,800

Cost Per Unit 21.00 35.00

(283,500 / 13,500) (428,750 / 12,250)

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 Beginning Inventory 141,300 30,000 64,050
(20.00 x 1,500) (36.60 x 1,750)
21,000 26,250
(21.00 x 1,000) (35.00 x 750)
Units Started and
Completed 621,600 233,100 388,500
(21.00 x 11,100) (35.00 x 11,100)
Ending Inventory 43,400 29,400 14,000
_ _ (21.00 x 1,400) (35.00 x 400)
806,300 313,500 492,800

c. Special Considerations
1) Transferred-in Costs--the costs of the units transferred from
one department into another department are treated as an
additional materials cost of the second department
a) Weighted-average--in computing equivalent units of
production and cost per equivalent unit of production and
in allocating the total cost to be accounted for to the
units accounted for, the weighted-average method does not
keep the beginning inventory units separate from the units
that were started and completed during the current period
I) Illustration--on February 1, 2,000 units were in
process--30% complete in regards to materials and 20%
complete in regards to conversion costs--at a
transferred-in cost of $44,800, a cost of materials of
$7,020, and a cost of conversion costs of $3,220,
during February 16,000 units were transferred-in,
during February transferred-in costs of $351,200,
materials costs of $144,180, and conversion costs of
$191,180 were added to production, during February
15,000 units were completed, on February 28, 3,000
units were in process--60% complete in regards to
materials and 40% complete in regards to conversion
costs
Beginning Inventory 2,000
Units Started 16,000
18,000

_ Equivalent Units _ _
Transferred-in Conversion
_ Costs _ _ Materials _ Costs _
Units Completed 15,000 15,000 15,000 15,000
Ending Inventory 3,000 3,000 1,800 1,200
_ _ (100% x 3,000) (60% x 3,000) (40% x 3,000)
18,000 18,000 16,800 16,200

Beginning Inventory Costs 55,040 44,800 7,020 3,220

Current Costs 686,560 351,200 144,180 191,180
741,600 396,000 151,200 194,400

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Cost Per Unit 22.00 9.00 12.00
(396,000 / 18,000) (151,200 / 16,800) (194,400 / 16,200)

Units Completed 645,000 330,000 135,000 180,000

(22.00 x 15,000) (9.00 x 15,000) (12.00 x 15,000)
Ending Inventory 96,600 66,000 16,200 14,400
_ _ (22.00 x 3,000) (22.00 x 1,800) (12.00 x 1,200)
741,600 396,000 151,200 194,400

b) FIFO--in computing equivalent units of production and cost

per equivalent unit of production and in allocating the
total cost to be accounted for to the units accounted for,
the first-in first-out method keeps the beginning inventory
units separate from the units that were started and
completed during the current period
I) Illustration--on February 1, 2,000 units were in
process--30% complete in regards to materials and 20%
complete in regards to conversion costs--at a
transferred-in cost of $44,800, a cost of materials of
$7,020, and a cost of conversion costs of $3,220,
during February 16,000 units were transferred-in,
during February transferred-in costs of $351,200,
materials costs of $144,180, and conversion costs of
$191,180 were added to production, during February
15,000 units were completed, on February 28, 3,000
units were in process--60% complete in regards to
materials and 40% complete in regards to conversion
costs
Beginning Inventory 2,000
Units Started 16,000
18,000

_ Equivalent Units _ _
Transferred-in Conversion
_ Costs _ _ Materials _ Costs _
Beginning Inventory 2,000 --- 1,400 1,600
(0% x 2,000) (70% x 2,000) (80% x 2,000)
Units Completed 13,000 13,000 13,000 13,000
Ending Inventory 3,000 3,000 1,800 1,200
_ _ (100% x 3,000) (60% x 3,000) (40% x 3,000)
18,000 16,000 16,200 15,800

Beginning Inventory Costs 55,040 44,800 7,020 3,220

Current Costs 686,560 351,200 144,180 191,180
741,600 396,000 151,200 194,400

Cost Per Unit 21.95 8.90 12.10

(351,200 / 16,000) (144,180 / 16,200) (191,180 / 15,800)

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Beginning Inventory 86,860 44,800 7,020 3,220
--- 12,460 19,360
(21.95 x 0) (8.90 x 1,400) (12.10 x 1,600)
Units Completed 558,350 285,350 115,700 157,300
(21.95 x 13,000) (8.90 x 13,000) (12.10 x 13,000)
Ending Inventory 96,390 65,850 16,020 14,520
_ _ (21.95 x 3,000) (8.90 x 1,800) (12.10 x 1,200)
741,600 396,000 151,200 194,400

2) Operation Costing--operation costing is a hybrid costing system

used in manufacturing goods that have some common
characteristics and some individual characteristics, such as
the manufacturing of clothes or automobiles
a) Computation--the costs with common characteristics are
allocated to the units manufactured using a process costing
calculation and the costs with individual characteristics
are allocated to the units produced using a job order
costing system
b) Illustration--a corporation manufactures two brands of
men’s suits; the expensive brand is made with fine wool;
the inexpensive brand is made with cheaper wool; 400
expensive suits were manufactured with a materials cost of
$20,000; 600 inexpensive suits were manufactured with a
materials cost of $15,000; conversion costs of $40,000 were
incurred in manufacturing the expensive suits and the
inexpensive suits
Expensive Suits = 20,000 + 400 x 40,000 / (400 + 600) =
36,000
Inexpensive Suits = 15,000 + 600 x 40 = 39,000
The per unit cost of the expensive suits is $90
(36,000 / 400). The per unit cost of the
inexpensive suits is $65 (39,000 / 600).

3) Backflushing--in a just-in-time manufacturing system

theoretically there are no inventories; therefore,
manufacturing costs are recorded directly in the cost of goods
sold account
a) Computation--the cost of any units that are not completed
at the end of the accounting period need to be transferred
from cost of goods sold account to the work in process
inventory account
b) Illustration--on January 1, 0 units were in process at a
cost of materials of $0 and a cost of conversion costs of
$0; during January 10,000 units were started; during
January materials costs of $50,000 and conversion costs of
$97,000 were added to production; during January 9,000
units were completed; on January 31, 1,000 units were in
process--100% complete in regards to materials and 70%
complete in regards to conversion costs

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Equivalent Units:
Materials = 100% x 9,000 + 100% x 1,000 = 10,000
Conversion Costs = 100% x 9,000 + 70% x 1,000 =
9,700

Cost per Unit:

Materials = 50,000 / 10,000 = 5.00
Conversion Costs = 97,000 / 9,700 = 10.00

Cost of Goods Sold = 50,000 + 97,000 – 1,000 x 5.00 –

700 x 10.00 = 135,000
Work in Process = 5,000 + 7,000 = 12,000

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