Module 17

Highlights relating to Product Costing

Inventory Costs in Various Organizations

As inventories are sold or used, they are matched against expenses.

Product and Period Costs

All costs are broken into product costs or period costs for product costing purposes.

Product Costs
All production costs necessary to get products ready to sell

Period Costs
All costs other than product costs

Costs are classified based on whether or not they are related to the production process.

Three Product Cost Components

Selecting a Cost Driver

Cost drivers are used to assign overhead costs Overhead cost per unit flaws
Units requiring extensive manufacturing activity have too little cost assigned Units requiring little manufacturing activity have too much cost assigned

Use an overhead application cost driver other than number of units of production.

Using Predetermined Overhead Rates

Established at beginning of year Can use different cost drivers

Predicted total direct labor hours Predicted total machine hours

Calculating the predetermined rate using direct labor hours

Predicted total direct labor hours for the year
The predetermined overhead rate uses predicted amounts as actual amounts are unknown.

Predicted total manufacturing overhead cost for the year

Using Predetermined Overhead Rates

Applying overhead to products

Added to product costs as direct labor hours are incurred Actual direct labor hours
Predicted manufacturing overhead rate per direct labor hour

Manufacturing overhead = assigned to Work-in-Process inventory

Predetermined Overhead Rate Example

Harmonic predicted a 2011 activity level of 40,000 direct labor hours with manufacturing overhead totaling $128,000.
Predetermined overhead rate =
Predicted total manufacturing overhead cost for the year Predicted total direct labor hours for the year

$128,000 40,000 direct labor hours

$3.20 per direct = labor hour

Applying Overhead Example

If Harmonic uses 2,200 direct labor hours in January, how much is applied overhead?
Manufacturing overhead = assigned to Work-in-Process inventory Actual direct labor hours Predicted manufacturing overhead rate per direct labor hour

= 2,200 $3.20 per direct labor hour = $7,040

The monthly variations between actual and applied overhead will likely occur.

Basic Production Cost Flows

Cost of Goods Manufactured

For

internal reporting purposes Summarizes the cost of goods completed for the period
Current manufacturing costs Cost of materials placed in production Raw materials, beginning of month Purchases Total available Raw materials, end of month Direct labor Manufacturing overhead applied Work in process, beginning of month Total costs in process Work in process, end of month Cost of goods manufactured $14,000. 45,000. 59,000. (25,000)

$34,000. 17,400. 24,650.

$76,050. 18,000. 94,050. (13,000) $81,050.

Income Statement

One line item differs on the income statement for a manufacturing company as compared to a merchandiser

Manufacturers have no purchases of finished goods inventory Manufacturers add cost of goods manufactured instead of purchases

Assume selling and administrative costs are $43,000.

Sales revenue Cost of goods sold Finished goods inventory, beginning of month Cost of goods manufactured Total goods available for sale Finished goods inventory, end of month Gross profit Selling and administrative expenses Net income

$148,000. $15,000. 81,050. 96,050. (32,680)

63,370. 84,630. (43,000) $ 41,630.

Over and Under Applied Overhead

Exists because the amount of overhead applied is likely not the same amount as the overhead incurred Balance in Manufacturing Overhead at end of period is the over or underapplied amount Must be eliminated at year end Transfer to cost of goods sold

Allow Because most of the manufacturing overhead should already be in cost of goods sold

Over and Under Applied Overhead Example

The cost flow example used earlier has an ending credit balance of $450 in Manufacturing Overhead.
Manufacturing Overhead Beg.bal 15,000 24,650 (3) 2,100 (4) 600 (4) 2,300 (4) 4,200 450
(5)

Overapplied

More overhead was applied than actually incurred, so Cost of Goods Sold must be decreased by $450.

Service Costing

The assignment of costs to services performed Uses job costing concepts Many companies regard service costs as expenses rather than product costs No formal procedures for reporting service costs on financial statements

Process Costing

Used when products are produced in a continuous manufacturing environment Production has no distinct beginning and end Determining the cost of a single unit

Equal to total product costs assigned to a process or department during a period divided by the number of units produced during the period

Examples
Coca-Cola 12 ounce cans Boxes of Cheerios

Cost of Production Report

Key document in organizing and accounting for costs in a process costing environment
A cost of production report contains
Summary of units in process Equivalent units in process Total costs to be accounted for

and cost per equivalent unit Accounting for total cost

Equivalent Completed Units

Refers to the number of completed units that is equal, in terms of production effort, to a given number of partially completed units Example: Assume 90 units in the ending inventory are 40 percent complete. Equivalent units = 90 units in ending inventory x 0.40 = 36
If all efforts were put forth to starting and completing units, 36 full units could have been completed instead of 90 partial units.

Cost of Production Report Example

Dog Divine manufactures bags of dog food using process costing. The following information is supplied:
Units
Units in process, beginning of period (80% converted) Units started Completed and transferred to finished goods Units in process, end of period (30% converted) 5,600 23,000 25,400 3,200

Production Costs
Work-in-process, beginning materials cost beginning conversion costs Current manufacturing costs: Raw materials transferred to processing Direct labor for the period Overhead applied for the period $22,400 10,080

32,000 6,500 4,200

Cost of Production Report Example

Summary of Units in Process Section
Of the total units in process, 25,400 were completed, while the remaining 3,200 were still in process at month end.
Summary of units in process 5,600. Beginning 23,000. Units started 28,600. In process Completed (25,400) 3,200. Ending

Material is incurred primarily at beginning of process. Conversion costs are incurred throughout the process.
Equivalent units for conversion costs: 3,200 30% = 960
Equivalent units in process Units completed Plus equivalent units in ending inventory Equivalent units in process Materials Conversion 25,400 25,400 3,200 960 28,600 26,360

Cost of Production Report Example

Calculations of the disposition of the total costs in process during the period divided between units completed and units still in process at month end
Total Cost to Be Accounted For Beginning work in process Current cost Total cost in process Equivalent units in process Cost per equivalent unit in process Accounting for total costs Transferred out (25,400 $2.69) Ending work-in-process Materials (3,200 $1.90) Conversion (960 $0.79) Total cost accounted for *
*Difference due to rounding

Materials Conversion $22,400 $10,080 32,000 10,700 54,400 20,780 28,600 26,360 $ 1.90 $ 0.79

Total $32,480 42,700 $75,180 $ 2.69

$68,326 $6,080 758

6,838 $75,164