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A Typical Costing System Accounts For Cost by Doing Two Main Tasks

The document discusses the main tasks of a typical costing system, which includes accumulating costs by classification and assigning costs to cost objects by tracing direct costs and allocating indirect costs. It also covers cost flows and allocation methods, including plant-wide and departmental overhead rates, as well as issues related to cost allocation and absorption costing. The goal of absorption costing is to ensure all overhead costs are covered by revenue, though it has limitations related to accuracy of estimates and selection of cost allocation bases.

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56 views19 pages

A Typical Costing System Accounts For Cost by Doing Two Main Tasks

The document discusses the main tasks of a typical costing system, which includes accumulating costs by classification and assigning costs to cost objects by tracing direct costs and allocating indirect costs. It also covers cost flows and allocation methods, including plant-wide and departmental overhead rates, as well as issues related to cost allocation and absorption costing. The goal of absorption costing is to ensure all overhead costs are covered by revenue, though it has limitations related to accuracy of estimates and selection of cost allocation bases.

Uploaded by

vdhien
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Main tasks of costing system

 A typical costing system accounts for cost by


doing two main tasks
 Accumulation of costs by some “natural”
classification such as: material, labor, advertising
(cost items)
 Assignment of costs to cost objects by
 Tracing direct costs to cost objects
 Allocating indirect costs to cost objects
Assigning resource costs to production
cost centers
 All cost systems start by assigning resource
expenses to cost centers, then to cost objects
 The assignment of resource expenses may in
terms of actual or budgeted expenses
 Organizations typically have two types of
departments
 Production departments
 Service/support departments
Traditional two-stage costing system
Support
departments

Production
centers

Traceable costs
Cost objects
Overhead costs
 Product costing perspective
 indirect manufacturing costs, or
 all indirect costs
 Responsibility centre perspective
 indirect costs of responsibility centres
Manufacturing overhead
 All manufacturing costs, other than direct
material and direct labour costs
 Production costs which cannot be traced to
individual products
 Support (or service) departments
 Indirect materials
 Indirect labour
Manufacturing cost flow
Work in Process
Materials
Direct materials

Indirect materials
Finished goods COGS
MO

applied

Labor

Indirect labor
Direct labor
Cost allocation
 Allocation is the process of assigning a
resource cost to a cost object when a direct
measure does not exist from the quantity of the
resource consumed by the object
 Indirect (overhead) costs are often pooled up
into cost pools before allocated to cost objects
via cost drivers
Cost pool and cost drivers
 Cost pool is a grouping individual cost items
 Cost driver (allocation base) is any factor that
affects total costs
 a causal factor in the incurrence of costs
 A change in level of cost driver will cause a
change in the level of total cost of a related cost
object
Allocating overhead costs to products
 Application rates are calculated in the formula
as follow
Estimated total overhead
($$$/unit of cost driver)
Estimated volume of cost driver

 Approaches to allocating overhead costs to


products
 Plant-wide (blanket) approach
 Departmental overhead rates
Plant-wide approach
 Plant-wide approach
 All manufacturing overhead costs form a single
cost pool and one overhead rate is calculated for
the entire production plant
 Procedure
 step 1 - identify the overhead cost driver
 step 2 - calculate an overhead rate per unit of cost
driver
 step 3 - apply manufacturing overhead costs to
products using a predetermined overhead rate
Departmental overhead rates
 Separate manufacturing overhead rates are
calculated for each production department,
using different cost drivers
 Procedure
 step 1 - identify the overhead cost driver in each
department
 step 2 - calculate an overhead rate used in each
department
 step 3 - apply manufacturing overhead costs to
products in each department using departmental
predetermined overhead rate
Practice
 Illustration 4 – question 1
Service department cost allocations
 Two-stage cost allocation process
 Overhead costs allocated to production
departments, by
 tracing and allocating all manufacturing overhead costs
to production and support departments
 reassigning all support department costs to production
departments (centers)
 Separate manufacturing overhead rates are calculated
for each production department, using different cost
drivers
 Allocate (apportion) overhead costs of production
centers to products
Practice
 B Smart Ltd. Question (in workbook)
Six-step approach to costing
 Identify cost objects
 Identify direct costs
 Identify indirect-cost pools
 Select cost-allocation base for each indirect
cost pool
 Develop the rate per unit of the cost-allocation
base used to allocate indirect costs
 Assign costs to the cost objects
Cost allocation issues
 Which costs should be included in the indirect
cost (to a cost object)?
 How many cost pools should be used?
 Which allocation base (cost driver) should be
used for each of cost pools when allocating
indirect costs
Absorption costing
 Principle aim of absorption costing is to
attempt to ensure that all overhead costs are
covered by revenue received => full costing
 The central issue in absorption costing is to
decide the amount of overheads absorbed by
each product/job
 Overhead absorption is the process of sharing
out the overheads among jobs/products
Overhead absorption
OVERHEADS

Production departments Service departments


Machine Paint Assembly Water Power
department department department
Dept. Dept.

Overhead charged
to each product/job

Product costs
Absorption costing - limitations
 The accuracy of the predetermined overheads
 Selection of bases of apportionment of service
department costs
 The absorption rates are predetermined based
on estimated amount of overhead and volume
of cost drivers which can be different from the
actual amount

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