Overview of Cost and Management

Accounting and cost classification

Part one by Kibrysfaw

G
1
 Introduction
Accounting systems take economic events and transactions, such as
sales and materials purchases, and process the data into information
helpful to managers, sales representatives, production supervisors,
and others.
Processing any economic transaction means collecting, categorizing,
For example,
summarizing, and analyzing
Costs are collected .
by category, such as materials, labor, and
shipping.
 These costs are then summarized to determine total costs by month,
quarter, or year.
Managerial accounting—measures, analyzes, and reports financial
 The results are analyzed to evaluate how costs have changed relative
and nonfinancial information to help managers make decisions to fulfill
to revenues from
organizational one period to the next.
goals.
Managerial accounting need not be IFRS/GAAP compliant.
Financial accounting—focus on reporting to external users
primarily investors & creditors 2
Major Differences Between Financial and Managerial Accounting

Managerial Accounting Financial Accounting

Communicate financial
Purpose Decision making by Mgt
position to outsiders
Primary
Internal managers External users
Users
Focus/
Future-oriented Past-oriented
Emphasis
Do not have to follow IFRS/GAAP compliant;
Rules
IFRS/GAAP; cost vs. benefit CPA audited
Ultra current to very long Historical monthly, quarterly
Time Span
time horizons reports
Detailednes
Detail /specific General
s
Focal point Various segments of a business . Business entity as a whole
3
 Cont’d
Cost accounting deals with accumulating cost of manufacturing a product
and other functional processes and identifying these costs with units
produced or some other cost object to enable the determination of profit.
Cost accounting provides information for both financial accounting and
management accounting.
Basic Cost Terminology & classification
• Cost—sacrificed resource to achieve a specific objective.
• Actual cost—a cost that has occurred.
• Budgeted cost—a predicted cost.
• Cost object—is defined as anything in which a separate measurement of
costs is desired.
 Costs as defined above, refers to economic resources sacrificed or
give up to acquire goods and services that is all disbursement of
cash or the commitment to pay cash in the future for the purpose
4
of
 Basic Cost Terminology & classification
 When the benefits are used up, the cost becomes an
expense. All costs initially, represent assets to the enterprise. As
the assets are used in generating revenues, the cost of the assets
must be recognized as expenses in order to match revenues and
Cost accumulation—a
expenses properly in thecollection
process ofofdetermining
cost data the
in an
netorganized
income of
manner.
the period.
Cost assignment—a general term that includes assigning
accumulated costs to a cost object. This includes:
Tracing involves Assigning accumulated direct costs (costs
with a direct relationship with the cost object) to the cost
object and
Allocating involves assigning indirect accumulated (costs
 Cost Classification
acturing costs non-manufacturing costs
Manufacturing costs - are costs incurred in manufacturing
(production) of goods
 Cost incurred around the factory and can be
direct orcosts
Non - manufacturing indirect
- are costs incurred in selling of
 Direct
production (goods) labor cost, Direct
and administering material Cost, Factory
the Business.
overhead
Also known cost as general administrative and
Direct and Indirectselling
Costs expenses
Direct costs can be conveniently and economically
traced (tracked) to a cost object
 DMC , DLC.
Indirect costs cannot be conveniently or economically traced
(tracked) to a cost object.
Instead of being traced, these costs are allocated to a cost object
 Assigning Costs to a Cost Object

Factors Affecting Direct/Indirect Cost Class

Direct Costs Indirect
Parts Costs Cost materiality
Assembly line Electricity
Rent Availability of information-
wages
Property gathering technology
taxes
 3. Cost Classification in Relation to Cost Behavior

Variable costs—changes in total in proportion to changes in the

related level of activity or volume.

Fixed costs—remain unchanged in total regardless of changes in

the related level of activity or volume.
Variable costs are constant on a per-unit basis. If a product
Costs
takes are fixed or of
5 pounds variable onlyeach,
materials with respect
it staystothe
a specific
same peractivity
unit
or a given time
regardless period.
if one, ten, or a thousand units are produced.
Fixed costs change inversely with the level of production.
As more units are produced, the same fixed cost is spread over
more and more units, reducing the cost per unit.
 Cost Behavior Summarized
TotalTotal
Dollars
Dollars Cost
CostPer Unit
per Unit

Change
Change
Variable Costs
inin proportion
proportion with with
output Unchanged in
Variable More output
Costs
output = More cost relation to output
More output =
More cost Chselyinversely
Change with output with
More output = lower cost
Fixed Costs Unchanged in relation to output outputper unit
Fixed Costs Unchanged in relation to More output = lower
output cost
per unit
 Cost driver—a variable that causally affects costs over a given time
span. For example,
 Mile driven for transport cost, Length of time of call for telephone
cost, Metric cube of water consumed for water cost & Unit sold
for cost of goods sold
 Relevant range—the band of normal activity level (or volume) in
which there is a specific relationship between the level of activity (or
volume) and a given cost
 Relevant Range Visualized

Costs may be classified as:

• Direct/Indirect, Direct and variable
and Direct and fixed
• Variable/Fixed Indirect and variable
Indirect and fixed
Overview of Cost and Management
Accounting and cost classification

Part Two by
Kibrysfaw G
12
 Types of Firms
Manufacturing-sector companies purchase materials and
components and convert them into finished products.
Merchandising-sector companies purchase and then sell
tangible products without changing their basic form.
Service-sector companies provide services (intangible
products). Types of Manufacturing Inventories

Direct materials—resources in-stock and available for use

Work-in-process (or progress)—products started but not yet

completed, often abbreviated as WIP

 IV. Accounting Distinction Between Costs
Inventoriable costs—product manufacturing costs. These
costs are capitalized as assets (inventory) until they are sold
and transferred to Cost of Goods Sold. Also known as:
Product cost or Manufacturing cost.
Period costs—have no future value and are expensed in the
Types of Inventoriable costs
period incurred.
Also known as product costs
 Direct materials—acquisition costs of all materials that will
become part of the cost object.
 Direct labor—compensation of all manufacturing labor that
can be traced to the cost object.
 Indirect manufacturing—factory costs that are not traceable
to the product in an economically feasible way.
It includes: Indirect materials, Indirect manufacturing labor,
V. Cost classification by relationship to production
Prime cost is a term referring to all direct manufacturing
costs (materials and labor).
Conversion cost is a term referring to direct labor and
indirect manufacturing costs.
V. Cost classification by management influence: -
Overtime labor costs are considered part of indirect overhead
• costs.
Controllable costs are subject to significant influence by a particular manager with
in the time period under consideration.

• Uncontrollable costs are those costs over which a give manager does not have a
significant influence.

VI. Cost classification by decision significance: -

• Relevant cost is future costs that differ with the various decision alternatives.

• Irrelevant costs are generally excluded from analysis

Manufacturing Income
Balance sheet
costs statement
Unused Raw material inventory
Direct used Sold
materia WIP inventoryFinished good Cost good sold
inventory
l cost
Direct d
labor te
c a
cost l l o
a
Factory
overrea
d cost Selling costs
Non
Administrative
manufacturing Costs
costs
 Manufacturing Cost Flows
The Cost of Goods Manufactured and the Cost of Goods Sold
section of the Income Statement are accounting representations
of the actual flow of costs through a production system.
• Note the importance of inventory accounts in the following
accounting reports, and in the cost flow chart .
Schedule 1: Cost of Direct Material Used
Beginning materials inventory Xxx
Add: purchase in the period Xxx
Direct material available for use Xxx
Less: ending direct material inventory Xxx
Direct Material Used Xxx
Schedule 2: Cost of Goods Manufactured
Cost of direct material used Xxx
Add: Direct labor cost Xxx
Manufacturing overhead cost Xxx
Manufacturing Costs incurred in current period Xxx
Add: Work in process at the beginning Xxx
Total cost incurred to account for Xxx
Less : work in process ending Xxx
Schedule 3 : The Schedule of costs of Goods Sold
Finished goods beginning Xxx
Add: cost of goods Manufactured Xxx
Cost of goods available for sale Xxx
Less: finished goods ending Xxx
Cost of goods sold Xxx

Schedule 4: Income statement

Revenues Xxx
Cost of goods sold Xxx
Gross profit Xxx
Operating expense Xxx
Operating income Xxx
 Example: Assume the following data for Cellular Products. The account balances (in thousands) are for 2011.

Direct materials inventory Jan. 1, 2011 $ 11,000

Direct materials inventory Dec. 31, 2011 8,000
Finished goods inventory Jan. 1, 2011 22,000
Finished goods inventory Dec. 31, 2011 18,000
Work-in-process inventory Jan. 1, 2011 6,000
Work-in-process inventory Dec. 31, 2011 7,000
Direct manufacturing labor 9,000
Manufacturing overhead costs 20,000
Direct materials purchased 73,000
Revenues 210,000
R & D costs, design costs, marketing costs, 70,000
distribution
Required: costs,
Compute cost and
of goods customer-service
manufactured costs
& prepare an income statement.
 Cost of Goods Manufactured
PANEL A: COST OF GOODS MANUFACTURED
Cellular Products
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
Direct materials:
Beginning inventory, January 1, 2011 $11,000
Purchases of direct materials $73,000
Cost of direct materials available for use $84,000
Ending inventory, December 31, 2011 $8,000
Direct materials used $76,000
Direct manufacturing labor $9,000
Manufacturing overhead costs $20,000
Manufacturing cost incurred during 2011 $105,000
Beginning work-in-progress inventory, January 1, 2011 $6,000
Total manufacturing costs to account for $111,000
Ending work-in-progress inventory, December 31, 2011 $7,000
Cost of goods manufactured (to income Statement) $104,000
Multiple-Step Income Statement
PANEL B: INCOME STATEMENT
Cellular Products
Income Statement
For the Year Ended December 31, 2011 (in thousands)
Revenues $210,000
Costs of goods sold:
Beginning finished goods inventory, January 1, 2011 $22,000
Costs of goods manufactured $104,000
Costs of goods available for sale $126,000
Ending finished goods inventory, December 31, 2011 $18,000
Cost of goods sold $108,000
Gross margin (or gross profit) $102,000
Operating costs
R&D, design, mktg., dist., & cust.-service cost $70,000
Total operating costs $70,000
Operating income $32,000
cost & management Chapter 3
accounting product costing

Part one job order By Kibrysfaw G.

 Building Block Concepts of Costing Systems
• Several key points from prior chapters:
• Cost objects—including services, projects, departments,
customers, products, and so on
• Direct costs and tracing—materials and labor
• Indirect costs and allocation—overhead
• Cost pool—A cost pool is a grouping of individual indirect
cost items. Cost pools are often organized in conjunction with
cost-allocation bases.
• Cost-allocation base—a cost driver is used as a basis upon
which to build a systematic method of distributing indirect costs.
• For example, let’s say that direct labor hours cause indirect
costs to change. Accordingly, direct labor hours will be used to
distribute or allocate costs among objects based on their usage
of that cost driver. 24
 Costing Systems
• Job-costing—system accounting for distinct cost objects
called jobs. Each job may be different from the next, and
consumes different resources.
Example: Computer repair jobs, aircraft, advertising etc.
• Process-costing—system accounting for mass production of
identical or similar products.
• Example: Oil refining, beverage production, orange juice etc.
• Operational costing system: In reality, few actual production
processes perfectly match either a job order costing system or a
process costing system. Thus, the typical product costing system
combines parts of both job order costing and process costing to
create a hybrid system designed specifically for an organizations
particular production process. 25
 Cont…

Job costing: Uses one work in

process inventory account to
summaries the cost of all jobs
Process costing: Uses average
order
costing system .
26
Job order costing DL
DM
DM DL Cost FOH
Cost
Cost Cost FOH

Job no .1 Job no . 2

Process costing WIP (Cutting

Cost of Direct
material used dept).
Direct labor cost WIP
incurred Assembly
Allocated dept.
overaed cost WIP Finished
good CGS
Finishing
dept inventory
 Seven-Step Job Costing
1. Identify the job that is the 4. Match indirect costs to
chosen cost object. their respective cost-
2. Identify the direct costs of allocation base(s).
the job.
3. Select the cost-allocation
5. Calculate
base(s)antooverhead allocation rate
use for allocating
Budgeted Manufacturing
indirect
Budgetedcosts to the job
Overhead Costs
Manufacturing =
Budgeted Total Quantity of Cost-
Overhead Rate
Allocation Base
6. Allocate overhead costs to the job:
Budgeted Allocation Rate x Actual Base
Activity For the Job
7. Compute total job costs by
adding all direct and indirect 28
 Cont’d

Sample cost record/cost sheet

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.

29
 Journal Entries
Journal entries are made at each step of the production process.
The purpose is to have the accounting system closely reflect the
actual state of the business, its inventories, and its production
processes.
All product costs are accumulated in the work-in-process
control account.
1 Direct materials used 2. Direct labor incurred 3.
Factory overhead allocated or applied
Actual
Purchaseindirect costs on
of materials (overhead)
credit: are accumulated in the
manufacturing overhead control account XX
Materials Control
Accounts Payable Control
XX
Requisition of direct and indirect materials (OH) into
Work-in-Process Control
production: (DMS) xxx
Manufacturing Overhead Control (IMS) xxx
Materials Control 30
 Journal Entries
Incurred direct and indirect (OH) labor wages
Work-in-Process Control (DMLCS) xxx
Manufacturing Overhead Control (IMLCS) xxx
Cash Control xxxx
Incurring or recording of various actual indirect costs:
Manufacturing Overhead Control xxxx
Various Accounts xxxx
Allocation or application of indirect costs (overhead) to the work-in-
process account is based on a predetermined overhead rate.
Work-in-Process Control X
Manufacturing Overhead Allocated X
 Note: Actual overhead costs are never posted directly into
work-in-process. 31
 Journal Entries
Products are completed and transferred out of
production in preparation for being sold.
Finished Goods Control X
ProductsWork-in-Process Control on credit.
are sold to customers X
Accounts Receivable Control X
Sales
The associated costs are transferred to an
expense (cost) account.
Cost of Goods Sold Y
Finished Goods Control Y

32
 Job order costing
• Actual costing—allocates:
• Indirect costs based on the actual indirect-cost rates times the
actual activity consumption.

• Normal Costing—allocates:
• Indirect costs based on the budgeted indirect-cost rates times the
actual activity consumption.

• Both methods Assign direct costs to a cost object the same

way: by using actual direct-cost rates times actual consumption.

33
 Accounting for Overhead
• Recall that two different overhead accounts were used in the
preceding journal entries:
• Manufacturing overhead control was debited for the actual
overhead costs incurred.
• Manufacturing overhead allocated was credited for
• Actual costs will almost never equal budgeted costs. Accordingly, an
estimated (budgeted) overhead applied to production through the
imbalance situation exists between the two overhead accounts.
•
work-in-process account.
If Overhead Control > Overhead Allocated, this is called Under allocated
Overhead
• If Overhead Control < Overhead Allocated, this is called Overallocated
Overhead

34
 Accounting for Overhead
• This difference will be eliminated in the end-of-period
adjusting entry process, using one of three possible methods.
• The choice of method should be based on such issues as
materiality, consistency, and industry practice.
• .Proration approach—the difference is allocated between cost
of goods sold, work-in-process, and finished goods based on
their relative sizes.

• Write-off approach—the difference is simply written off to cost

of goods sold.

35
 Example:
• XYZ product uses a job-costing system with two direct cost categories (direct
materials and direct manufacturing Labour) and one manufacturing overhead cost
pool. XYZ allocates manufacturing overhead cost using direct manufacturing Labour
costs. Xyz provides the following information:
Required:
A.Compute the actual and
budgeted
manufacturing overhead
B. During June the job cost record for job rates
No. 205,
for contained
2017. the following
information:

 Compute the cost of job No 205 using (i) actual costing and (ii) Normal costing
c) At the end of 2017, Compute the under- or over allocated manufacturing
overhead under normal costing why is there no under- or over-allocated
36
overhead under actual costing?
Con'd

37
 Cont’d
C. Computation of under or over allocated manufacturing overhead
under normal costing at the end of 2017:

• Reasons for no under or over allocated overhead under actual costing:

Under actual costing method, allocation of manufacturing overhead
costs is based on actual manufacturing overhead rates. Consequently,
the actual manufacturing overheads and allocated manufacturing
Budgeted Manufacturing Cost and End of period adjustment
overhead costs are equal. Therefore, there will be no under or over
allocation of manufacturing overhead cost under actual costing
Example:
methods. Suppose that AB-Manufacturing company produces two
products X and Y. Assume that the total actual overhead costs incurred
by the company and the total overhead costs applied by the company
during the year 2002 were $19,400 and $19,000 respectively. The
current period before adjustment balance of work-in-Process, finished
38
 Budgeted Manufacturing Cost and End of period adjustment

.The under applied overhead balance = $19,400- $19,000 = $400

• The company can prorate the balance of $400 among the three accounts
as follows.
• Total year end overhead balances of the three accounts (before
Thus, the amount allocated to
adjustment) = $9,000 + $3,000 + $6,000 = $18,000
each account
Work-in process should
= $9,000 be:
Finished goods inventory = $3,000
× $400 = $200 × $400 = $66.67
Cost of goods sold = $6,000 $18,000
×$18,000
$400 = $133.33 The entry for this case should be:
8,000
WIP inventory…… 200
FGI inventory …….. 66.67
CGS ……………………. 133.33
MOH overhead
…………………. 400 39
 Cont’d
 If manufacturing overhead had been overallocated, the Work-in-Process
Control, Finished Goods Control, and Cost of Goods Sold accounts would
be decreased (credited) instead of increased (debited).

of goods sold approach

• As in the case of most companies, the over or under applied
overhead costs may be closed into cost of goods sold.

40
Overview of Cost and Management
Accounting and cost classification

Part Two by
Kibrysfaw G
41
 Types of Firms
Manufacturing-sector companies purchase materials and
components and convert them into finished products.
Merchandising-sector companies purchase and then sell
tangible products without changing their basic form.
Service-sector companies provide services (intangible
products). Types of Manufacturing Inventories

Direct materials—resources in-stock and available for use

Work-in-process (or progress)—products started but not yet

completed, often abbreviated as WIP

 IV. Accounting Distinction Between Costs
Inventoriable costs—product manufacturing costs. These
costs are capitalized as assets (inventory) until they are sold
and transferred to Cost of Goods Sold. Also known as:
Product cost or Manufacturing cost.
Period costs—have no future value and are expensed in the
Types of Inventoriable costs
period incurred.
Also known as product costs
 Direct materials—acquisition costs of all materials that will
become part of the cost object.
 Direct labor—compensation of all manufacturing labor that
can be traced to the cost object.
 Indirect manufacturing—factory costs that are not traceable
to the product in an economically feasible way.
It includes: Indirect materials, Indirect manufacturing labor,
V. Cost classification by relationship to production
Prime cost is a term referring to all direct manufacturing
costs (materials and labor).
Conversion cost is a term referring to direct labor and
indirect manufacturing costs.
V. Cost classification by management influence: -
Overtime labor costs are considered part of indirect overhead
• costs.
Controllable costs are subject to significant influence by a particular manager with
in the time period under consideration.

• Uncontrollable costs are those costs over which a give manager does not have a
significant influence.

VI. Cost classification by decision significance: -

• Relevant cost is future costs that differ with the various decision alternatives.

• Irrelevant costs are generally excluded from analysis

Manufacturing Income
Balance sheet
costs statement
Unused Raw material inventory
Direct used Sold
materia WIP inventoryFinished good Cost good sold
inventory
l cost
Direct d
labor te
c a
cost l l o
a
Factory
overrea
d cost Selling costs
Non
Administrative
manufacturing Costs
costs
 Manufacturing Cost Flows
The Cost of Goods Manufactured and the Cost of Goods Sold
section of the Income Statement are accounting representations
of the actual flow of costs through a production system.
• Note the importance of inventory accounts in the following
accounting reports, and in the cost flow chart .
Schedule 1: Cost of Direct Material Used
Beginning materials inventory Xxx
Add: purchase in the period Xxx
Direct material available for use Xxx
Less: ending direct material inventory Xxx
Direct Material Used Xxx
Schedule 2: Cost of Goods Manufactured
Cost of direct material used Xxx
Add: Direct labor cost Xxx
Manufacturing overhead cost Xxx
Manufacturing Costs incurred in current period Xxx
Add: Work in process at the beginning Xxx
Total cost incurred to account for Xxx
Less : work in process ending Xxx
Schedule 3 : The Schedule of costs of Goods Sold
Finished goods beginning Xxx
Add: cost of goods Manufactured Xxx
Cost of goods available for sale Xxx
Less: finished goods ending Xxx
Cost of goods sold Xxx

Schedule 4: Income statement

Revenues Xxx
Cost of goods sold Xxx
Gross profit Xxx
Operating expense Xxx
Operating income Xxx
 Example: Assume the following data for Cellular Products. The account balances (in thousands) are for 2011.

Direct materials inventory Jan. 1, 2011 $ 11,000

Direct materials inventory Dec. 31, 2011 8,000
Finished goods inventory Jan. 1, 2011 22,000
Finished goods inventory Dec. 31, 2011 18,000
Work-in-process inventory Jan. 1, 2011 6,000
Work-in-process inventory Dec. 31, 2011 7,000
Direct manufacturing labor 9,000
Manufacturing overhead costs 20,000
Direct materials purchased 73,000
Revenues 210,000
R & D costs, design costs, marketing costs, 70,000
distribution
Required: costs,
Compute cost and
of goods customer-service
manufactured costs
& prepare an income statement.
 Cost of Goods Manufactured
PANEL A: COST OF GOODS MANUFACTURED
Cellular Products
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
Direct materials:
Beginning inventory, January 1, 2011 $11,000
Purchases of direct materials $73,000
Cost of direct materials available for use $84,000
Ending inventory, December 31, 2011 $8,000
Direct materials used $76,000
Direct manufacturing labor $9,000
Manufacturing overhead costs $20,000
Manufacturing cost incurred during 2011 $105,000
Beginning work-in-progress inventory, January 1, 2011 $6,000
Total manufacturing costs to account for $111,000
Ending work-in-progress inventory, December 31, 2011 $7,000
Cost of goods manufactured (to income Statement) $104,000
Multiple-Step Income Statement
PANEL B: INCOME STATEMENT
Cellular Products
Income Statement
For the Year Ended December 31, 2011 (in thousands)
Revenues $210,000
Costs of goods sold:
Beginning finished goods inventory, January 1, 2011 $22,000
Costs of goods manufactured $104,000
Costs of goods available for sale $126,000
Ending finished goods inventory, December 31, 2011 $18,000
Cost of goods sold $108,000
Gross margin (or gross profit) $102,000
Operating costs
R&D, design, mktg., dist., & cust.-service cost $70,000
Total operating costs $70,000
Operating income $32,000
cost & management Chapter 3
accounting product costing

Part one job order By Kibrysfaw G.

 Building Block Concepts of Costing Systems
• Several key points from prior chapters:
• Cost objects—including services, projects, departments,
customers, products, and so on
• Direct costs and tracing—materials and labor
• Indirect costs and allocation—overhead
• Cost pool—A cost pool is a grouping of individual indirect
cost items. Cost pools are often organized in conjunction with
cost-allocation bases.
• Cost-allocation base—a cost driver is used as a basis upon
which to build a systematic method of distributing indirect costs.
• For example, let’s say that direct labor hours cause indirect
costs to change. Accordingly, direct labor hours will be used to
distribute or allocate costs among objects based on their usage
of that cost driver. 53
 Costing Systems
• Job-costing—system accounting for distinct cost objects
called jobs. Each job may be different from the next, and
consumes different resources.
Example: Computer repair jobs, aircraft, advertising etc.
• Process-costing—system accounting for mass production of
identical or similar products.
• Example: Oil refining, beverage production, orange juice etc.
• Operational costing system: In reality, few actual production
processes perfectly match either a job order costing system or a
process costing system. Thus, the typical product costing system
combines parts of both job order costing and process costing to
create a hybrid system designed specifically for an organizations
particular production process. 54
 Cont…

Job costing: Uses one work in

process inventory account to
summaries the cost of all jobs
Process costing: Uses average
order
costing system .
55
Job order costing DL
DM
DM DL Cost FOH
Cost
Cost Cost FOH

Job no .1 Job no . 2

Process costing WIP (Cutting

Cost of Direct
material used dept).
Direct labor cost WIP
incurred Assembly
Allocated dept.
overaed cost WIP Finished
good CGS
Finishing
dept inventory
 Seven-Step Job Costing
1. Identify the job that is the 4. Match indirect costs to
chosen cost object. their respective cost-
2. Identify the direct costs of allocation base(s).
the job.
3. Select the cost-allocation
5. Calculate
base(s)antooverhead allocation rate
use for allocating
Budgeted Manufacturing
indirect
Budgetedcosts to the job
Overhead Costs
Manufacturing =
Budgeted Total Quantity of Cost-
Overhead Rate
Allocation Base
6. Allocate overhead costs to the job:
Budgeted Allocation Rate x Actual Base
Activity For the Job
7. Compute total job costs by
adding all direct and indirect 57
 Cont’d

Sample cost record/cost sheet

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.

58
 Journal Entries
Journal entries are made at each step of the production process.
The purpose is to have the accounting system closely reflect the
actual state of the business, its inventories, and its production
processes.
All product costs are accumulated in the work-in-process
control account.
1 Direct materials used 2. Direct labor incurred 3.
Factory overhead allocated or applied
Actual
Purchaseindirect costs on
of materials (overhead)
credit: are accumulated in the
manufacturing overhead control account XX
Materials Control
Accounts Payable Control
XX
Requisition of direct and indirect materials (OH) into
Work-in-Process Control
production: (DMS) xxx
Manufacturing Overhead Control (IMS) xxx
Materials Control 59
 Journal Entries
Incurred direct and indirect (OH) labor wages
Work-in-Process Control (DMLCS) xxx
Manufacturing Overhead Control (IMLCS) xxx
Cash Control xxxx
Incurring or recording of various actual indirect costs:
Manufacturing Overhead Control xxxx
Various Accounts xxxx
Allocation or application of indirect costs (overhead) to the work-in-
process account is based on a predetermined overhead rate.
Work-in-Process Control X
Manufacturing Overhead Allocated X
 Note: Actual overhead costs are never posted directly into
work-in-process. 60
 Journal Entries
Products are completed and transferred out of
production in preparation for being sold.
Finished Goods Control X
ProductsWork-in-Process Control on credit.
are sold to customers X
Accounts Receivable Control X
Sales
The associated costs are transferred to an
expense (cost) account.
Cost of Goods Sold Y
Finished Goods Control Y

61
 Job order costing
• Actual costing—allocates:
• Indirect costs based on the actual indirect-cost rates times the
actual activity consumption.

• Normal Costing—allocates:
• Indirect costs based on the budgeted indirect-cost rates times the
actual activity consumption.

• Both methods Assign direct costs to a cost object the same

way: by using actual direct-cost rates times actual consumption.

62
 Accounting for Overhead
• Recall that two different overhead accounts were used in the
preceding journal entries:
• Manufacturing overhead control was debited for the actual
overhead costs incurred.
• Manufacturing overhead allocated was credited for
• Actual costs will almost never equal Allocated costs. Accordingly, an
estimated (budgeted) overhead applied to production through the
imbalance situation exists between the two overhead accounts.
•
work-in-process account.
If Overhead Control > Overhead Allocated, this is called Under allocated
Overhead
• If Overhead Control < Overhead Allocated, this is called Overallocated
Overhead

63
 Accounting for Overhead
• This difference will be eliminated in the end-of-period
adjusting entry process, using one of three possible methods.
• The choice of method should be based on such issues as
materiality, consistency, and industry practice.
• .Proration approach—the difference is allocated between cost
of goods sold, work-in-process, and finished goods based on
their relative sizes.

• Write-off approach—the difference is simply written off to cost

of goods sold.

64
 Example:
• XYZ product uses a job-costing system with two direct cost categories (direct
materials and direct manufacturing Labour) and one manufacturing overhead cost
pool. XYZ allocates manufacturing overhead cost using direct manufacturing Labour
costs. Xyz provides the following information:
Required:
A.Compute the actual and
budgeted
manufacturing overhead
B. During June the job cost record for job rates
No. 205,
for contained
2017. the following
information:

 Compute the cost of job No 205 using (i) actual costing and (ii) Normal costing
c) At the end of 2017, Compute the under- or over allocated manufacturing
overhead under normal costing why is there no under- or over-allocated
65
overhead under actual costing?
Con'd

66
 Cont’d
C. Computation of under or over allocated manufacturing overhead
under normal costing at the end of 2017:

• Reasons for no under or over allocated overhead under actual costing:

Under actual costing method, allocation of manufacturing overhead
costs is based on actual manufacturing overhead rates. Consequently,
the actual manufacturing overheads and allocated manufacturing
Budgeted Manufacturing Cost and End of period adjustment
overhead costs are equal. Therefore, there will be no under or over
allocation of manufacturing overhead cost under actual costing
Example:
methods. Suppose that AB-Manufacturing company produces two
products X and Y. Assume that the total actual overhead costs incurred
by the company and the total overhead costs applied by the company
during the year 2002 were $19,400 and $19,000 respectively. The
current period before adjustment balance of work-in-Process, finished
67
 Budgeted Manufacturing Cost and End of period adjustment

.The under applied overhead balance = $19,400- $19,000 = $400

• The company can prorate the balance of $400 among the three accounts
as follows.
• Total year end overhead balances of the three accounts (before
Thus, the amount allocated to
adjustment) = $9,000 + $3,000 + $6,000 = $18,000
each account
Work-in process should
= $9,000 be:
Finished goods inventory = $3,000
× $400 = $200 × $400 = $66.67
Cost of goods sold = $6,000 $18,000
×$18,000
$400 = $133.33 The entry for this case should be:
8,000
WIP inventory…… 200
FGI inventory …….. 66.67
CGS ……………………. 133.33
MOH overhead
…………………. 400 68
 Cont’d
 If manufacturing overhead had been overallocated, the Work-in-Process
Control, Finished Goods Control, and Cost of Goods Sold accounts would
be decreased (credited) instead of increased (debited).

of goods sold approach

• As in the case of most companies, the over or under applied
overhead costs may be closed into cost of goods sold.

69
 Cost and management
ConversionAccounting - I during
costs are added evenly the
Assembly Transf process
Testing Finished
Transf
Departmen good
department er er
t inventory

Direct materials are added at the beaning of the

process
Process costing System –
Part I
By Kibrysfaw Geetahun
 Job versus Process Costing
Job-Costing Systems Process-Costing Systems
Distinct, identifiable units Masses of identical or sim
of a product or service units of a product or servi
Examples: Custom-made Examples:
machines, houses Food, chemical processing

 Process costing is a system where the unit cost of a

product or service is obtained by assigning total costs
 to many
Each unitidentical
receives or
thesimilar
same units
or similar amounts of direct
materials costs, direct labor costs, and manufacturing
overhead
 Unit costs
.
are computed by dividing total costs incurred
by the number of units of output from the production 71
 Process-Costing Assumptions
Direct materials are added at the beginning of the
production process, or at the start of work in a
subsequent department down the assembly line.
Conversion
The accountingcosts are costing
of process addedcan
equally along
be analysed by the
production
three process.
different cases:
Case 1: Process costing with zero beginning and ending
work in process
Case 2: Process costing with zero beginning work in process
Case
but 1: ending
some Process
workcosting
in processwith zero beginning and
Case
ending3: Process
work incosting
process with some beginning and some
ending
 work
All units in started
are process and fully completed within
72
 Process-Costing (case 1)
Example: On January 1, 2012, there was no beginning inventory of SG
units in the assembly department. During the month of January, Pacific
Electronics started, completely assembled, and transferred out to the
testing department 400 units.

Required: Compute the cost per unit from the above details.
73
 Cont’d
• Solution:

• Case 1 shows that in a process-costing system, average unit

costs are calculated by dividing total costs in a given accounting
period by total units produced in that period. Because each unit
is identical, we assume all units receive the same amount of
direct material costs and conversion costs.
• Case 1 applies whenever a company produces a homogeneous
product or service but has no incomplete units when each
accounting period ends, which is a common situation in service-
sector organizations.
• For example, a bank can adopt this process-costing approach to
compute the unit cost of processing 100,000 customer deposits,
74
Case 2: Process Costing with Zero Beginning and
Some Ending Work-in-Process Inventory
• Example: In February 2012, Pacific Electronics places another
400 units of SG into production. Because all units placed into
production in January were completely assembled, there is no
beginning inventory of partially completed units in the assembly
department on February 1. Some customers order late, so not all
units started in February are completed by the end of the month.
Only 175 units are completed and transferred to the testing
department. Data for the assembly department for February 2012
are as follows: 75
 Cont…

Five-Step Process-Costing Allocation

1. Summarize the flow of physical units of output.
 Where did physical units come from? Where did they go?
2. Compute output in terms of equivalent units.
3. Summarize total costs to account for .
4. Compute cost per equivalent unit.
76
5. Assign total costs to units completed and to units in ending work-in-process .
Steps 1 and 2 Illustrated

77
Steps 3, 4, and 5, Illustrated

78
Journal Entries
Journal entries in process-costing systems are similar to the
entries made in job-costing systems with respect to direct
materials and conversion costs.
The main difference is that, in process costing, there is one Work
in Process account for each process.
In our example, there are accounts for Work in Process—
Assembly and Work in Process—Testing. Pacific Electronics
purchases direct materials as needed. These materials are
79
 Journal Entries:
1. Work in process-Assembly 32,000
Accounts Payable control 32,000
(To record direct materials purchased and used in production during
February)

2. Work in Process-Assembly 18,600

Various Accounts 18,600
(To record Assembly department conversion costs for February)

3. Work in process-Testing 24,500

Work in process-Assembly 24,500
(To record cost of goods completed and transferred from Assembly to
testing during February) 80
 Cost and management
ConversionAccounting - I during
costs are added evenly the
Assembly Transf process
Testing Finished
Transf
Departmen good
department er er
t inventory

Direct materials are added at the beaning of the

process
Process costing System –
Part II
By Kibrysfaw Geetahun
Case 3: Process Costing with Some Beginning and Some
Ending Work-in-Process Inventory
Example: At the beginning of March 2012, Pacific
Electronics had 225 partially assembled SG- units in the
assembly department. It started production of another
275 units in March. Data for the assembly department for
March are as follows:

83
 Cont’d…
Pacific Electronics now has incomplete units in both
beginning work-in-process inventory and ending work-in-
process inventory for March 2012.
We can still use the five steps described earlier to calculate
(1) cost of units completed and transferred out and (2) cost
of ending work in process.
To assign costs to each of these categories, however, we
first need to choose an inventory-valuation method.
We next describe the five-step approach for two important
methods—the weighted-average method and the first-in,
first-out method.
These different valuation methods produce different 84
 Weighted-Average Process-Costing Method
Calculates cost per equivalent unit of all work
done to date (regardless of the accounting period in
which it was done).
Assigns this cost to equivalent units completed
and transferred out
Weighted-average costs of thetotal
is the process, and in
of all costs to
incomplete units in still-in-process.
the work-in-process account divided by the total
equivalent units of work done to date.
The beginning balance of the work-in-process
account (work done in a prior period) is blended
in with current period costs.
85
Steps 1 and 2 Illustrated

86
Steps 3, 4, and 5 Illustrated

87
 Journal Entries
1. Work in process-Assembly 19,800
Accounts Payable control 19,800
(To record direct materials purchased and used in production during
March)
2. Work in Process-Assembly 16,380
Various Accounts 16,380

(To record Assembly department conversion costs for March)

3. Work in process-Testing 52,000
Work in process-Assembly 52,000
(To record cost of goods completed and transferred from Assembly to
testing during March)

88
 First-in, First-Out Process-Costing Method
Assigns the cost of the previous accounting period’s
equivalent units in beginning work-in-process inventory
to the first units completed and transferred out of the
process.
Assigns the cost of equivalent units worked on during the
current period first to complete beginning inventory, next
 Distinctive feature of FIFO process-costing method is
to stat and complete new units, and lastly to units in
that work
ending done on beginning
work-in-process inventory is kept separate
inventory.
from work done in the current period

89
Steps 1 and 2, Illustrated

90
Steps 3, 4, and 5, Illustrated

91