Overview of Cost and Management Accounting and cost

classification

Part one by course instructor

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, summarizing, and
analyzing
For .
example,
 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.
 The results are analyzed to evaluate how costs have changed relative to revenues from
one period toaccounting—measures,
Managerial the next. analyzes, and reports financial and nonfinancial
information to help managers make decisions to fulfill organizational goals.
Managerial accounting need not be IFRS/GAAP compliant.
Financial accounting—focus on reporting to external users primarily investors &
creditors
Financial statements must be based on IFRS/GAAP 2
Major Differences Between Financial and Managerial Accounting
Managerial Accounting Financial Accounting

Communicate financial position to

Purpose Decision making by Mgt
outsiders
Primary Users Internal managers External users
Focus/
Future-oriented Past-oriented
Emphasis
Do not have to follow IFRS/GAAP; IFRS/GAAP compliant;
Rules
cost vs. benefit CPA audited
Ultra current to very long
Time Span Historical monthly, quarterly reports
time horizons
Detailedness Detail /specific General
Focal point for Various segments of a business entity . Business entity as a whole

Frequency When ever needed; may not be on a Periodical on a regular basis 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 of generating revenues. So cost is incurred on benefits4 to be
 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
expenses properly in the process of determining the net income of the period.
Cost accumulation—a collection of cost data in an organized manner.
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 with an indirect
relationship with a cost object) to the cost object
 Cost Classification
Manufacturing costs non-manufacturing costs
Manufacturing costs - are costs incurred in manufacturing (production) of goods
 Cost incurred around the factory and can be direct or
indirect
 Direct
Non - manufacturing costs labor cost, Direct
- are costs incurredmaterial Cost,
in selling Factory overhead
of production (goods)
and administering thecost
Business.
 Also known as general administrative and selling expenses
2. Direct and Indirect Costs
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 in a rational and
 Assigning Costs to a Cost Object

Factors Affecting Direct/Indirect Cost Classificat

Direct Costs Indirect Costs
Parts Electricity Cost materiality
Assembly line Rent
Property Availability of information-gathering
wages
taxes technology
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 takes 5 pounds of
Costs are fixed
materials each, or variable
it stays the only
samewith respect
per unit to a specific
regardless if one,activity
ten, or aorthousand
a given units
time
period.
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 inproportion
in proportionwith withoutput
output Unchanged in relation to
VariableCosts
Variable
Costs More
More output output
= More cost = More output
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 output More output = lower 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
 For example, fixed costs are considered fixed only within the relevant range.
 Relevant Range Visualized

Costs may be classified as:

• Direct/Indirect, and Direct and variable
• Variable/Fixed Direct and 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 period incurred.
Types of Inventoriable costs
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, & Other
 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
Balance sheet Income statement
costs
Unused Raw material inventory
Direct used Sold
material WIP inventory Finished good Cost good sold
inventory
cost
Direct t ed
a
labor cost
l l oc
a
Factory
overread
cost Selling costs

Non manufacturing Administrative

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, distribution costs, and 70,000
customer-service costs
Required: Compute cost of goods manufactured & 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 product
accounting 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 order
Process costing: Uses average costing
system .
26
Job order costing
DM DL Cost
DM DL Cost Cost FOH
Cost FOH

Job no .1 Job no . 2

Process costing WIP (Cutting

Cost of Direct
material used dept).
Direct labor cost
incurred WIP Assembly
Allocated overaed dept.
cost Finished good
WIP Finishing CGS
dept inventory
 Seven-Step Job Costing
1. Identify the job that is the chosen 4. Match indirect costs to their
cost object. respective cost-allocation base(s).
2. Identify the direct costs of the job.
3. Select the cost-allocation base(s) to
use for allocating indirect costs to
5.the
Calculate
job an overhead allocation rate
Budgeted Budgeted Manufacturing 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 costs together. 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 indirect
Purchase costs (overhead)
of materials on credit: are accumulated in the manufacturing overhead
control accountControl
Materials XX
Accounts Payable Control
XX
Requisition of direct and indirect materials (OH) into production:
Work-in-Process Control (DMS) xxx
Manufacturing Overhead Control (IMS) xxx
30
Materials Control xxx
 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
Work-in-Process
Products are Control
sold to customers on credit. 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 estimated (budgeted)
• Actual costs will almost never equal budgeted costs. Accordingly, an imbalance situation
overhead applied to production through the work-in-process account.
exists between the two overhead accounts.
• 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 rates for
2017.
B. During June the job cost record for job No. 205, contained 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 overhead under actual
36
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 overhead costs are equal. Therefore, there will be no under or
Budgeted Manufacturing Cost and End of period adjustment
over allocation of manufacturing overhead cost under actual costing methods.

Example: 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
goods inventory and cost of goods sold accounts were $9,000,$3,000 and $6,000 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 adjustment) = $9,000 +
$3,000 + $6,000 = $18,000
Thus, the amount allocated to each account
should
Work-in process be:
= $9,000 × $400 Finished goods inventory = $3,000 × $400
= $200 = $66.67
Cost of goods sold = $18,000
$6,000 × $400 = $18,000
$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 period incurred.
Types of Inventoriable costs
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, & Other
 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
Balance sheet Income statement
costs
Unused Raw material inventory
Direct used Sold
material WIP inventory Finished good Cost good sold
inventory
cost
Direct t ed
a
labor cost
l l oc
a
Factory
overread
cost Selling costs

Non manufacturing Administrative

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, distribution costs, and 70,000
customer-service costs
Required: Compute cost of goods manufactured & 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 product
accounting 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 order
Process costing: Uses average costing
system .
55
Job order costing
DM DL Cost
DM DL Cost Cost FOH
Cost FOH

Job no .1 Job no . 2

Process costing WIP (Cutting

Cost of Direct
material used dept).
Direct labor cost
incurred WIP Assembly
Allocated overaed dept.
cost Finished good
WIP Finishing CGS
dept inventory
 Seven-Step Job Costing
1. Identify the job that is the chosen 4. Match indirect costs to their
cost object. respective cost-allocation base(s).
2. Identify the direct costs of the job.
3. Select the cost-allocation base(s) to
use for allocating indirect costs to
5.the
Calculate
job an overhead allocation rate
Budgeted Budgeted Manufacturing 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 costs together. 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 indirect
Purchase costs (overhead)
of materials on credit: are accumulated in the manufacturing overhead
control accountControl
Materials XX
Accounts Payable Control
XX
Requisition of direct and indirect materials (OH) into production:
Work-in-Process Control (DMS) xxx
Manufacturing Overhead Control (IMS) xxx
59
Materials Control xxx
 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
Work-in-Process
Products are Control
sold to customers on credit. 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 estimated (budgeted)
• Actual costs will almost never equal Allocated costs. Accordingly, an imbalance situation
overhead applied to production through the work-in-process account.
exists between the two overhead accounts.
• 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 rates for
2017.
B. During June the job cost record for job No. 205, contained 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 overhead under actual
65
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 overhead costs are equal. Therefore, there will be no under or
Budgeted Manufacturing Cost and End of period adjustment
over allocation of manufacturing overhead cost under actual costing methods.

Example: 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
goods inventory and cost of goods sold accounts were $9,000,$3,000 and $6,000 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 adjustment) = $9,000 +
$3,000 + $6,000 = $18,000
Thus, the amount allocated to each account
should
Work-in process be:
= $9,000 × $400 Finished goods inventory = $3,000 × $400
= $200 = $66.67
Cost of goods sold = $18,000
$6,000 × $400 = $18,000
$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 Accounting
- Ievenly during the process
Conversion costs are added
Assembly Transfe Testing Transfe Finished good
department r Department r 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 similar
of a product or service units of a product or service
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 identical or
 similar units
Each unit receives the same 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 process. 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 costs
accounting are added
of process equally
costing canalong the production
be analysed by threeprocess.
different
cases:
Case 1: Process costing with zero beginning and ending work in
process
Case 2: Process costing with zero beginning work in process but some ending
Casein1:process
work Process costing with zero beginning and ending work in
Case
process3: Process costing with some beginning and some ending work
in All
process
units are started and fully completed within the
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, each similar to the other, made in a
month.
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
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 delivered directly to the assembly department. Using amounts from
the above tables, summary journal entries for February are as follows:
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 Accounting
- Ievenly during the process
Conversion costs are added
Assembly Transfe Testing Transfe Finished good
department r Department r 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 amounts for cost of
units completed and for ending work in process when the unit cost of inputs
changes from one period to the next.
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
of the process, and to incomplete units in still-in-process.
 Weighted-average costs is the total of all costs in 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 to stat and complete new units, and
lastly to units in ending work-in-process inventory.
 Distinctive feature of FIFO process-costing method is that work done on
beginning inventory is kept separate from work done in the current
period

89
Steps 1 and 2, Illustrated

90
Steps 3, 4, and 5, Illustrated

91