Three manufacturing costs

Direct material cost:

Consist of all those material that can be identified with a
specific product. Example: wood used in manufacturing of a table.

Direct labor cost :

Consist of all those cost that can be specifically traced or
identified with a particular product. Example: wages of workers
working on that table.

Overhead (indirect) cost:

overhead refers to the cost pool used to accumulate all
indirect manufacturing costs. Indirect costs are allocated to the cost
object using of cost allocation method. Example: heat, light and
power for the factory, rent on factory building, property taxes on
factory building, and all kind of depreciation.
Factory Overhead
Overhead consists of many individual cost items. These are costs that
cant be measured or traced for a specific product. Factory overhead
costs are both fixed and variable. The factory overhead controlling
account is debited when costs are incurred and credited when factory
overhead is applied to various job orders. i.e indirect material and
labor, utility costs, depreciation of equipment and salaries of factory
administrative personnel.
Plant-wide (blanket) overhead
rates
The most simplistic traditional costing system assigns
indirect costs to cost objects using a single overhead rate for
the organization as a whole. The terms blanket overhead
rate or plant-wide rate are used to describe a single
overhead rate that is established for the organization as a
whole.
Job Order Costing
A job is a production run for a specific product. A relatively small
number of units generally comprise a job. Job order costing
system record actual and estimated production costs in the
formal accounting system leading to manufacturing statements.
Construction firms use a variation of job order costing. Some
overhead is applied to each job so that the contractor can recoup
its general production costs which apply to all jobs but which are
not traceable to any specific job.
Benefits of job costing
1. You will know on an ongoing basis which projects are profitable
and which ones arent.
2. You will be able to get paid on a timely basis as you complete
the job.
3. You can avoid committing resources to projects.
If you manufacture products:
1. You will know what it cost to make each item
2. You will be able to set selling prices that cover your costs and
earn a fair profit
3. You will know what product lines to expand because theyre
profitable, and what product line to drop because theyre
unprofitable.
General approach to job
costing
1. Identify the job that is chosen cost object
The cost object can be chosen through the job cost record.
Companies keep a job cost record for every specific job. A job
cost record, also called a job cost sheet records and
accumulates all the costs assigned to a specific job, starting
when work begins.
2. Identify the Direct costs of the job:
Robinson identified two direct manufacturing cost categories,
direct material and direct manufacturing labour. Example can
be seen for the direct costs for the specific job.

3. Select the cost allocation bases to use for

allocating indirect cost to the job.
Indirect costs cant be allocated to a specific product. It will
be impossible to complete a job without incurring indirect
cost such as supervision, manufacturing engineering, utilities
and repairs. Multiple cost allocation bases are used to allocate
a indirect cost because different indirect cost have different
cost drivers. Example : depreciation or repair of machines is
closely related to machine hours so machine hours can be
used as a cost driver.
 4. Identify the indirect cost associated with each
cost allocation base.
Now that the allocation bases has been identified, all indirect
cost are now identified for that allocation base. In our
example from the Robinson company they use indirect
manufacturing costs to machinery hours used.

5. Compute the rate per unit of each cost allocation

base used to allocate indirect costs to the job.
Actual manufacturing overhead costs
Actual manufacturing overhead rate =
Actual total quantity of cost allocation base

$1215000
Actual manufacturing overhead rate =
27000 direct manufacturing labor hours

= $45 per direct manufacturing labor hour

6. Compute the indirect costs allocated to the job.

Indirect cost allocated to a job=

actual quantity of each different allocation base x indirect
cost rate of each allocation base

7. Compute the total cost of the job by adding all

direct and indirect costs assigned to the job.

Total cost= Direct cost + Indirect cost

 JOB-COST RECORD
JOB NO: WPP 298 CUSTOMER: Western Pulp and Paper
Date Started: Feb. 3, 2006 Date Completed: Feb. 28, 2006

DIRECT MATERIALS
Date Materials Quantity Unit Total
Received Requisition No. Part No. Used Cost Costs
Feb. 3, 2006 2006: 198 MB 468-A 8 $ 14 $ 112
Feb. 3, 2006 2006: 199 TB 267-F 12 63 756


Total $4,606
DIRECT MANUFACTURING LABOR
Period Labor-Time Employee Hours Hourly Total
Covered Record No. No. Used Rate Costs
Feb. 3-9, 2006 LT 232 551-87-3076 25 $ 18 $ 450
Feb. 3-9, 2006 LT 247 287-31-4671 5 19 95


Total $1,579
MANUFACTURING OVERHEAD
Cost pool Allocation-Base Allocation- Total
Date Category Allocation-Base Units Used Base Rate Costs
Dec. 31, 2006 Manufacturing Direct Manufacturing 88 hours $ 45 $ 3,960
Labor-Hours

Total $ 3,960
TOTAL MANUFACTURING COST OF JOB $ 10,145
 MATERIALS-REQUISITION RECORD

Materials-Requisition Record No: 2006: 198

Job No.: WPP 298 Date: Feb. 3, 2006
Part Part Unit Total
No. Description Quantity Cost Cost
Metal
MB 468-A Brackets 8 $14 $112

Issued By:B. Clyde Date: Feb. 3, 2006

Received By: L. Daley Date: Feb. 3, 2006
Panel 1

Job Number: J4369 Date: July 6, 2000

Customer: Michigan Motors
Product: Automobile engine valves (Valve #L181)
Engineering Design Number: JDR-103
Number of Units: 1,500

Panel 2

Material
Requisition
Number Description Quantity Rate Amount
47624 Bar steel 720 lbs $11.50 $8,280.00
Stock 3
A35161 Subassemblies 290 units 38.00 $11,020.00

Total direct materials cost

$19,300.00
Panel 3

Dates Number Hours Rate Amount

8/2, 8/3, 8/4, 8/5 M16 24 $28.00 $672.00
8/2, 8/3, 8/4, 8/5 M18, M19, M20 64 26.00 1,664.00
8/6, 8/7, 8/8, 8/9, 8/10 A25, A26, A27 120 18.00 2,160.00
8/6, 8/7, 8/8, 8/9, 8/10 A32, A34, A35 60 17.00 1,020.00
Total direct labor cost 268 $5,516.00

Panel 4

Support Cost Amount

117 Machine hours @ $40 per hour $ 4,680.00
268 Direct labor hours @ 36 per hour 9,648.00

Total overhead cost $14,328.00

 Concept of Costing System

Cost Assignment

Direct Cost Tracing

costs

Cost
Object

Indirect Cost Allocation

costs
Assigning direct and indirect costs
A cost allocation is the process of assigning costs when a direct measure
does not exist for the quantity of resources consumed by a particular cost
object. Example: consider an activity such as receiving incoming materials.
Assuming that the depreciation of the machine is strongly related to the
number of hours machine was used. The basis that is used to allocate costs
to cost objects is called an allocation base or cost driver.
Two types of systems can be used to assign indirect costs to cost objects.
They are traditional costing system and activity-based-costing(ABC)
systems.
 Cost Allocations and Cost Tracing

Cost tracing
Direct
costs

Traditional
costing Cost
systems
objects
Indirect Cost allocations
costs
ABC
systems
 Traditional Costing Systems

Overhead cost accounts

(for each individual category of expenses)

First stage
allocations

Cost Cost Cost

center center center
1 2 N
(Normally (Normally (Normally
departments) departments) departments)
Second stage
allocations
(Direct labour or
machine hour)

Direct Cost objects (Products, services and customers)

cost
An illustration of the three-stage
process for a traditional costing system
Applying the three-stage allocation process requires the
following four steps:

1.Assigning all manufacturing overheads to production and service

cost centres;
2.Reallocating the cost assigned to service cost centres to
production cost centres;
3.Computing separate overhead rates for each production cost
centre;
4.Assigning cost centre overheads to products or other chosen cost
objects.
Traditional Costing System
Levels of Sophistication
Simplistic systems

Inexpensive to operate
Extensive use of
arbitrary cost allocations
Low levels of accuracy
High cost of errors
 Service
dept
S1 S2 S3 S4

Conceptual
view of the
Producing
separate
DM
DL
FO
DM
DL
FO
DM
DL
FO
dept
department
overhead
rates

Cost Cost Cost Cost Cost Cost

objects objects objects objects objects objects
Stage 1 : Assigning all manufacturing overhead
to production and service departments.

Common cost are allocated to all the departments. Some cost can be
directly related such as salary of the engineer working in the service
quality department, however other need to be allocated using an
allocation base.

Cost Basis of allocation

Property taxes, lighting and heating Area

Employee-related expenditure:
works management, works canteen, payroll office Number of employees

Depreciation and insurance of plant and machinery Value of items of plant and
machinery
Stage 2 :Reallocating the cost assigned to service
cost centers to production cost centers.
the next step is to reallocate the costs that have been assigned to service cost
centres to production cost centres. Service departments or support department
are those departments that exist to provide services of various kinds of other
units within the organization. For example, the costs of the cafeteria can be
reallocated to the production cost center by using number of workers in the
factory as the allocation base.

There are three methods in reallocating the cost from service to production
departments.

1.DIRECT METHOD
2.STEP METHOD
3.ALGEBRIC METHOD
Diagram of 3 diff, Service department Producing department
allocation methods
X A
Part 1
Direct method

Y B

X A
Part 2
Step method
Y B

X A
Part 3
Algebraic
method

Y B
Stage 3: Assigning cost center overheads to
products or other chosen cost objects.

In the final step is to allocated the overheads to products passing through the
production centers. Volume base allocation is used to assign the overhead
costs to the products. Example, number of units produced, number of
machine hours used.
 The annual costs for the Enterprise Company which has three
production centres (two machine centres and one assembly centre)
and two service centres (materials procurement and general factory
support) are as follows:
() ()

Indirect wages and supervision

Machine cenres: X 1 000 000
Y 1 000 000
Assembly 1 500 000
Materials procurement 1 100 000
General factory support 1 480 000 6 080 000
Indirect materials
Machine centres: X 500 000
Y 805 000
Assembly 105 000
Materials procurement 0
General factory support 10 000 1 420 000
Lighting and heating 500 000
Property taxes 1 000 000
Insurance of machinery 150 000
Depreciation of machinery 1 500 000
Insurance of buildings 250 000
Salaries of works management 800 000 4 200 000
11 700 000
 The following information is also available:

Book Area Number Direct

Value of Occupied Of Labour Machine
Machinery (sq. metres) employees hours hours
()

Machine shop: X 8 000 000 10 000 300 1 000 000 2 000 000
Y 5 000 000 5 000 200 1 000 000 1 000 000
Assembly 1 000 000 15 000 300 2 000 000
Stores 500 000 15 000 100
Maintenance 500 000 5 000 100
15 000 000 50 000 1000

Details of total material issues to the production centres are as follows:

()
Machine shop X 4 000 000
Machine shop Y 3 000 000
Assembly 1 000 000
8 000 000
OVERHEAD ANALYSIS SHEET Production centres Service centres
Machine Machine Materials General
Item of Basis of Total Assembly
centre X centre Y procurement factory support
expenditure allocation () ()
() () () ()
Indirect wage and Direct 6 080 000 1 000 000 1 000 000 1 500 000 1 100 000 1 480 000
supervision
Indirect materials Direct 1 420 000 500 000 805 000 105 000 10 000
Lighting and Area 500 000 100 000 50 000 150 000 150 000 50 000
heating
Property taxes Area 1 000 000 200 000 100 000 300 000 300 000 100 000
Insurance of Book
machinery value of
machinery 150 000 80 000 50 000 10 000 5 000 5 000
Depreciation of Book
machinery value of
machinery 1 500 000 800 000 500 000 100 000 50 000 50 000
Insurance of Area 250 000 50 000 25 000 75 000 75 000 25 000
buildings
Salaries of works Number of
management employees 800 000 240 000 160 000 240 000 80 000 80 000
(1) 11 700 000 2 970 000 2 690 000 2 480 000 1 760 000 1 800 000
Reallocation of
service centre
costs
Materials Value of
procurement materials
issued 880 000 660 000 220 000 1 760 000
General factory Direct
support labour
hours 450 000 450 000 900 000 1 800 000
(2) 11 700 000 4 300 000 3 800 000 3 600 000
Machine hours and direct
labour hours 2 000 000 1 000 000 2 000 000
Machine hour overhead rate 2.15 3.80
Direct labour hour overhead rate 1.80
Reallocation of
Service centre
costs
Materials Value of
procurement materials
issued 880 000 660 000 220 000 1 760 000
General factory Direct
support labour
hours 450 000 450 000 900 000 1 800 000
(2) 11 700 000 4 300 000 3 800 000 3 600 000
Machine hours and direct
labour hours 2 000 000 1 000 000 2 000 000
Machine hour overhead rate 2.15 3.80
Direct labour hour overhead rate 1.80
 cost centre overheads

cost centre direct labour hours or machine hours

4 300 000
Machine centre X = = 2.15 per machine hour
2 000 000 machine hours

3 800 000
Machine centre Y = = 3.80 per machine hour
1 000 000 machine hours
3 600 000
Assembly department = = 1.80 per direct labour hour
2 000 000 direct labour hours
Product A
Direct costs (100 units x 100) 10 000
Overhead allocations
Machine center A (100 units x 5 machine hours x 2.15) 1 075
Machine center B (100 units x 10 machine hours x 3.80) 3 800
Assembly (100 units x 10 direct labour hours x 1.80) 1 800
Total cost 16 675
Cost per unit (16 675/100 units) = 166.75

Product B
Direct costs (200 units x 200) 40 000
Overhead allocations
Machine center A (200 units x 10 machine hours x 2.15) 4 300
Machine center B (200 units x 20 machine hours x 3.80) 15 200
Assembly (200 units x 20 direct labour hours x 1.80) 7 200
Total cost 66 700
Cost per unit (66 700/200 units) = 333.50