Somali Regional State

MANAGEMENT AND PUBLIC SERVICE COLLE

COLLAGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

COST ACCOUNTING & MANAGEMENT-I (ACFN3030)

Prepared by:
ACCOUNTING & FINANCE DEPARTMENT INSRUCTORS
I
CHAPTER ONE
Introduction to cost and management accounting
This introductory chapter of the course explains the intertwining roles of managers and
management accountants in choosing an organization’s strategy, and in planning and controlling
its operations. Its main purpose is to emphasize the management accountant’s role in providing
information for managers. In addition to this, the chapter will brief you about the different cost
terms, concepts and their classifications.
The work of managers focuses on (1) planning, which includes setting objectives and outlining
how to attain these objectives; and (2) control, which includes the steps to take to ensure that
objectives are realized. To carry out these planning and control responsibilities, managers need
information about the organization. From an accounting point of view, this information often
relates to the costs of organization.
Managers as internal users of information use the outputs of accounting system:
a) To administer each operational/functional areas for which they are responsible, and,
b) To coordinate those operations/functions within the framework of the organization as a
whole. In general, the current course (Cost and Management Accounting-I) and the continuing
part of it that you will take after a semester (Cost and Management Accounting-II) elucidate in
detail how accounting assists managers while undertaking the above tasks. Financial Accounting,
Management Accounting, and Cost Accounting Financial accounting and management
accounting have different goals. As many of you know, financial accounting focuses on
reporting to external parties such as investors, government agencies, banks, and suppliers. It
measures and record business transactions and provides financial statements that are based on
generally accepted accounting principles (GAAP). The most important way that financial
accounting information affects managers’ decisions and actions is through compensation, which
is often, in part, based on numbers in financial statements.
Management accounting measures analyzes, and reports financial and nonfinancial information
that helps managers make decisions to fulfill the goals of an organization.
Managers use management accounting information to develop, communicate, and implement
strategy. They also use management accounting information to coordinate product design,
production, and marketing decisions and to evaluate performance. Management accounting
information and reports do not have to follow set principles or rules.
The key questions are always
(1) how will this information help managers do their jobs better, and
(2) Do the benefits of producing this information exceed the costs?
Note, however, that reports such as balance sheets, income statements, and statements of cash
flows are common to both management accounting and financial accounting.
Cost accounting provides information for management accounting and financial accounting.
Cost accounting measures, analyzes, and reports financial and nonfinancial information relating
to the costs of acquiring or using resources in an organization. For example, calculating the cost
of a product is a cost accounting function that answers financial accounting’s inventory-valuation
needs and management accounting’s decision-making needs (such as deciding how to price
products and choosing which products to promote). Modern cost accounting takes the
perspective that collecting cost information is a function of the management decisions being
made. Thus, the distinction between management accounting and cost accounting is not so clear
cut, and we often use these terms interchangeably in the book. We frequently hear business
people use the term. Unfortunately, that cost management t term has no uniform definition. We
use to describe the approaches and activity cost management es of managers to use resources to
increase value to customers and to achieve organizational goals. Cost management decisions
include decisions such as whether to enter new markets, implement new organizational
processes, and change product designs.
Information from accounting systems helps managers to manage costs, but the information and
the accounting systems themselves are not cost management. Cost management has a broad
focus and is not only about reduction in costs.
CHAPTER TWO
COST TERMINOLOGY AND CLSSIFICATION
2.1 Cost terminologies
Many accounting reports contain several cost terminologies. A good understanding of the
different cost terminology is essential at least for the following two reasons.
 It enables accounting information users to best use the information provided.
 Uses of common terminology avoids confusion and misunderstanding
The following are some of the terms used in cost accounting
Costs, Expenses and losses: Accountants usually define cost as resource scarified or forgone to
achieve a specific objective. It refers to an out lay or expenditure of money to acquire goods and
services in the course of generating revenue. For instance purchase of raw martial represent a
cost as the raw material is used to produce finished goods that generate revenue when sold.
How ever some disbursements are not costs .For example, the payment of dividend is
disbursement but it does not help to generate revenue, hence it is not a cost.
All costs initially represent an asset. As the asset is used in generating revenue, the amount
consumed becomes an expense. There for expense is an expired cost. The cost of asset used
should then be recognized as expense to properly match revenue and expense in the process of
determining the income of the organization over a given period. For instance, insurance premium
paid in advance to serve the coming period are initially recognized as asset, but as time passes
on, the asset is continually converted in to an expenses. Another example may be a motor vehicle
bought for uses for the coming five years is an asset when initially purchased. How ever, as the
asset is used up in the process of generating revenue, the cost gradually becomes an expense.
Thus, expense are expired costs or costs used up in the course of generating revenue.
Some times a firm may incur a cost that produces neither immediate nor future benefit. This is
called a loss. For example damage caused by fir or flood on property held is a loss.
Cost object: is anything for which a separate measurement of cost is desired. In manufacturing
company, the cost object is the unit of finished goods produced.
Cost accumulation and cost assignment: A costing system typically account for costs in two
basic stages, accumulation followed by assignment. Cost accumulation is the collection of cost
data in some organized means of accounting system and cost assignment is a general term that
encompass both (1) tracing accumulated cost that have direct relationship to the cost object and
(2) allocating accumulated costs that have an indirect relationship to a cost object. For example,
a publisher that purchase paper rolls for printing magazines collect the cost of paper bought and
used in any one month to obtain the total monthly cost of paper used. Beyond accumulating
costs, the cost accountant assign cost to the different magazines the publisher publishes to help
decision making
Cost driver: is any factor that affects total cost. That is a change in the cost driver will cause a
change in the level of the cost of a related cost object. Example
 Mile driven for transport cost
 Length of time of call for telephone cost
 Meter cub of water consumed for water cost
 Unite sold for cost of goods sold

Cost management: is the set of actions that a manager takes to satisfy customers while
continuously reducing and controlling cost. Cost reduction efforts frequently focus on two key
areas
 Doing only value added activities, that is, those activities that customers perceive as
adding value to the product or service they purchase
 Efficiently managing the use of the cost drivers in the value added activities.

2.2 Classification of cost

Cost may be classified in different ways from different point of view. The same cost may be
included in several or in all of the following classification.
1. Time period point of view
From time period point of view cost are classified in to historical cost and budgeted cost.
Historical cost are costs incurred in the past period where as Budgeted costs are costs expected to
be incurred in the future period. For example, the 8000-birr cost of a computer acquired in 2005
is a historical cost in the financial statement of 2006. However, the 10,000 birr cost to acquire a
new computer in 2007 to replace the existing one is a future cost.
2. Management function point of view
From management function point of view costs are classified in to:
 Manufacturing cost: includes costs from the acquisition of raw material through
production until the product can be turned over to the marketing division to be sold
(material, labor & manufacturing overhead costs)
 Selling cost: are costs associated with marketing and selling a product. They include all
costs incurred by the marketing division from the time the manufacturing process is
completed until the product is delivered to customers. These costs include advertising,
promotion, transport and warehouse cost.
 Administrative cost: are costs associated with the management of the Company and
include expenditures for accounting, legal and administrative activity.

3. Business function (value chain) point of view

Value chain refers to the sequence of business functions in which usefulness is added to the
product or service of a company
From business function point of view cost is classified as follows
 Research and development cost
 Product design cost
 Production cost
 Marketing cost
 Distribution cost
 Customer service cost
4. Generally accepted accounting treatment point of view
The alternatives in accounting for cost are to expense it or to capitalize it.
 Costs that are expensed in the period in which they are incurred are called non
capitalized costs or periodic cost. These costs possess no future benefit and are
generally associated with a non-manufacturing area such as advertising, distribution,
sales commission etc.
 Capitalized costs are costs incurred to manufacture a product (product cost) or to
acquire long term assets. These costs are recorded as an as asset at the beginning and
expensed periodically.
 5. Cost assignment point of view.
From this point of view costs are classified as direct cost and Indirect cost.
Direct costs are costs that are directly traceable to the product. Example:
 direct material cost
 Direct labor cost
Indirect cost (manufacturing overhead or factory overhead): are costs which are not
directly traceaced to the product but allocated to it using some criteria. Example:
 Cost of electricity
 Depreciation of equipment
 Indirect labor
 Indirect material
 Cost of different utilities
 Cost of repair and maintenance
 Insurance for the plant

6. Decision making point of view

A decision involves making a choice among alternative courses of actions.
From decision making point of view costs are divided as relevant and irrelevant costs.
Relevant cost is useful for decision making where as irrelevant costs are not uses full for decision
making .Relevant cost is usually future cost which change among alternative courses of actions,
and irrelevant cost is past or sunk cost which was already incurred.
7. Management influence point of view
Management influence refers to the ability of a manager to control a particular cost.
A cost which is under the control of a given manager is controllable cost where as a cost which is
beyond the control of a given manager is uncontrollable.
Controllability of a cost depends on the level of management and time period. All costs are
controllable by someone at some level in the organization if the time period is longer enough.
 8. Cost behavior point of view
From their behavior point of view, costs are divided in to fixed cost and Variable cost
Fixed cost is a cost which remains constant with in a given relevant range regardless of change in
output level, whereas variable cost is a cost which change when units produced change .Usually,
material and labor cost are variable without put, where as some manufacturing overhead cost
such as depreciation are fixed in nature regardless of change in output.
Total cost is sum of variable cost and fixed cost

TC = VC + FC

Average cost = Total cost

No. units produced

Average Variable cost = Variable cost

Out put
Average V.Cost = Average Total cost – Average Fixed Cost

Cost Concept Average Total

Fixed AFC=TFC/Q TFC=AFC*Q
Variable AVC=TVC/Q TVC=AVC*Q
Total ATC= TC/Q TC= ATC*Q
Example 1: Student association has hired a musical group for graduation party. The fixed cost
of hiring a band for the party is birr 4000.The hall in which the graduation ceremony is
celebrated can afford up to 2000 attendee It has been determined that the cost of refreshment
consumed by each person attending the party will be birr 8.
Required: a) Fill the following table using the information provided.

No of Total Average Total Variable Total cost Total average

attendee fixed cost fixed cost cost cost
500 4000 8000/500 500*8=4000 8000
1000
1500
2000
b) Draw the graph of FC, VC and TC
c) Draw the graph of Average FC, Average VC and Average TC
d) What happen to the fixed cost if the number of attendee is 3000?

9. Commitment to cost expenditure

Commitment to a cost expenditure focused on fixed cost as opposed to variable cost and
budgeted cost as opposed to historical cost. Budgeted fixed cost can be classified as committed
cost and discretionary cost.
 Committed cost: is one that is an inevitable consequence of a previous commitment. For
example Property tax on ware house budgeted for the coming year is an example of
committeemen cost because it results from decision to construct the ware house last time.
 Discretionary cost (programmed or managed cost): is one in which the amount or
time of incurrence is a matter of choice.
These are non recurring costs for which a finale commitment has not yet been made and
that can be postponed to future period or canceled entirely.
10. Other cost classification
 Marginal cost: is cost incurred to manufacture one more product.
 Out of pocket cost: is cash expenditure associated with a particular decision alternative.
  Opportunity cost: is the cost of an opportunity for gone when one course of action is
chosen over another. Opportunity cost is not an out of pocket cost but represents an
opportunity associated with each of the alternatives that are rejected.
2.3 Manufacturing cost
There are three types of inventories in manufacturing. These are
 Direct material inventory: are raw materials in stock and waiting to be used in
manufacturing process.
 Work in process inventory: are goods partially processed but not yet completed. They
are also called work in progress (WIP).
 Finished goods inventory: are goods fully completed but not yet sold.
In manufacturing enterprises production costs are grouped in to three categories.
 Direct material costs: are costs of raw material that can be physically identified with or
traced to the finished product. It is distinguished from indirect material by the ability to
identify it economically with a finished product and is included as an element of indirect
material cost. For example cost of paper used in printing newspaper is direct material cost
for the newspaper, however, paper used in beer factory to stamp around a bottle of beer is
probably be classified as indirect material cost because it is significant part of the finished
product (Bottles of beers).
 Direct labor cost: includes The cost of employee who work directly on the product and
whose efforts can economically be traced to particular unit of finished product
 Manufacturing overhead (factory over head or indirect manufacturing cost): are all
manufacturing costs that cannot be individually traced to the finished product but
allocated to it using some criteria. Example:
 Indirect material (Nail, sand paper, screw, glue)
 Indirect labor (supervisor’s salary)
 Electricity and utilities
 Plant rent
 Plant insurance
 Depreciation
 Salary of plant manager
 Prime cost and conversion costs are two other terms used to describe production cost.
 Prime cost: are the most important or significant costs traceable to unit of finished
product. They include direct material and direct labor cost.

Prime cost = Direct material cost + Direct labor cost

 Conversion costs are those required to convert raw material in to finished product and
consists of direct labor and manufacturing and manufacturing overhead cost.

Conversion cost = Direct labor cost + Manufacturing overhead cost

2.4 Financial statement for manufacturing company

In order to prepare financial statement for manufacturing company, the following schedules are
necessary

Schedule1: cost of direct material used

Beginning direct material inventory XX

Purchase in The month XX
Direct material available for use XX
Ending direct material inventory (XX)
Direct material cost used XX

Schedule 2: cost of goods manufactured

Direct material used cost----------------------- XX

Direct labor cost ------------------------------- XX
Manufacturing overhead cost -----------------XX
Cost incurred in current period ----------------XX
Add: Work in process beginning -------------- XX
Total cost incurred to date ----------------------XX
Less: work in process ending ------------------XX
 Cost of goods manufactured --------------------XX

Schedule 3: cost of goods sold

Finished goods beginning --------------------- XX

Cost of goods manufactured ------------------- XX
Cost of goods available for sale ----------------XX
Less: Finished goods ending ------------------- XX
Cost of goods sold --------------------------------XX
Schedule 4: Income statement for manufacturing company

Revenues XX
Cost of goods sold XX
Gross profit XX
Operating expense (XX)
Operating income XX

Example2: Consider the following account balance for ABC manufacturing company in the year
2004.
Beginning Balance End Balance
Direct material inventory $22,000 $26,000
WIP inventory 21,000 20,000
Finished goods inventory 18,000 23,000
Purchase of direct material 75,000
Direct labor cost 25,000
Indirect labor cost 15,000
Plant insurance 4,000
Insurance- administrative 5,000
Depreciation - plant building and equipment 9,000
Depreciation - administrative building 3,000
Repair and maintenance – factory equipment 4,000
Marketing, distribution and customer service cost 93,000
General and administrative cost 29,000
Required
a) Calculate cost of direct material used
b) Calculate cost of goods manufactured
c) Calculate cost of goods sold
d) If revenue for the year is $300, 000, prepare income statement for the Company.
Example 3: A fire destroyed XYZ manufacturing company completely on January 29, 2004.
Fortunately certain accounting records were kept in another building. It revealed the following
for the period from january1, 2004 to January 29, 2004.
Direct material purchased $160,000
WIP January1 34,000
Direct material january1, 2004 16,000
Finished goods january1, 2004 30,000
MOH cost 40% of conversion cost
Revenue 500,000
Direct labor cost 180,000
Prime cost 294,000
Gross profit based on sales 20%
Cost of goods available for sale 450,000
Requirements
a. Direct material destroyed
b. Cost of goods manufactured
c. Finished goods destroyed
d. WIP destroyed
Assignment
Problem 1: The cost department of Randall manufacturing company collected the following
cost data for financial statement presentation for the year ended on December31, 2005.
Inventories January1,2005 December31,2005
Direct material $34,500 $49,300
Work in process $ 81,500 $42,000
 Units of Finished goods 300unit 420 units
Cost of Finished goods $48,600 ?
Additional information.
 Sales during the year are 3,880 units at $220 per unit
 Direct material purchased ------- $364,000
 Prime cost -------------- $511,700
 MOH cost -------------------- 48% of conversion cost
 Operating expense ---------------- 50%of gross profit
 All units in the ending finished goods inventory are from current period production.
Requirements:
Compute the following based on the above information.
1. Cost of direct material used
2. Units of goods manufactured
3. Cost of goods manufactured
4. Cost of goods sold
5. Operating income

Problem 2: The following selected data are for ABC plastic company for the month of January
2004.
Work in process inventory January 1, 2004 $200.000
Direct material inventory January 1, 2004 90,000
Direct material purchased in January 360,000
Direct material used in January 375,000
Variable manufacturing overhead cost 250,000
Total manufacturing overhead cost 480,000
Total manufacturing cost incurred in January 1,600.000
Cost of goods manufactured 1,650,000
Cost of goods sold in January 1,700,000
Finished goods inventory January 1, 2004 125,000
Gross profit for January 150,000
Operating income for January 50,000
Requirements: For the month of January calculate the following
a) Direct material inventory on January 31, 2004
b) Fixed manufacturing overhead cost for January
c) Direct manufacturing labor cost for January
d) Work in process inventory on January31, 2004
e) Goods available for sale in January
f) Finished goods inventory January 31, 2004
g) Sales revenue
h) Operating expenses
i) Prime cost
j) Conversion cost
Problem 3: Ato Alemu was graduated from Teferi Mekonnen School ten years ago. He was
working in ABC Company for the last seven years under different positions. 15 months ago he
started his own furniture factory called JIMER office and House hold furniture. After 3
months since he started operation, he learnt that maintaining an accounting record is essential.
He thought he know how to establish an accounting system, maintain an accounting record and
prepare financial statements by virtue of his high school book keeping. He prepared the
following income statement at the end of the current year sene30, 1998
JIMER Office and House hold furniture
Income statement
For the year ended sene 30, 1998
Sales Br.135,000
Cost of goods sold
Beginning inventory
 Direct material 9,000
 Work in process 3.000
 Finished goods 12,000
Direct material purchase 30,000
 Direct labor 45,000
Rent 14,000
Light, heat, and power 5,000
Telephone 1,500
Depreciation 4,000
Indirect labor 6,000
Marketing and administrative 9,000
Insurance 8,000
Miscellaneous MOH cost 2,000
Miscellaneous marketing and adm. 1,800
Total 143,100
Net loss 8,100

The following additional information is available

The ending inventory of direct material, work in process and finished goods is birr 3,000, 4,500
and 15,000 respectively. The following costs should be allocated

Manufacturing periodic
Rent 60% 40%
Light, heat and 70% 30%
power
Telephone 70% 30%
Insurance 60% 40%
Depreciation 80% 20%
He worried why the loss comes; he doubted his capacity of accountancy, and asked you to help
him prepare the income statement as new.
Problem 4: Supply the missing data for each of the following companies
A B C D
Unit produced 45,000 unit 60,000 unit K 75,000 unit
Total cost E $450,000 $240,000 N
Fixed cost $157,500 H $90,000 O
Fixed cost per unit F $1.2 $9 P
Variable cost per unit $16.5 I L $11.1
Total cost per unit G J M $15.3

Problem 5: Supply the missing data for each company listed below:
W X Y Z
Sales $300,000 D 390,000 660,000
DM Beginning 27,000 30,000 21,000 J
DM purchased 42,000 45,000 48,000 63,000
DM ending A 24,000 27,000 24,000
Direct labor 75,000 E 51,000 95,500
MOH cost 60,000 54,000 76,500 95,500
WIP beginning 57,000 18,000 G 36,000
WIP ending 48,000 24,000 45,000 30,000
FG beginning 60,000 F 51,000 48,000
FG ending 69,000 33,000 H 54,000
Cost of goods B 126,000 210,000 K
manufactured
Cost of goods sold C 132,000 I 300,000
Gross margin 129,000 144,000 162,000 L

Problem 6: Han plc is nine month old since established to manufacture different parts of a
manual irrigation pump. The company owners failed to maintain a formal accounting record for
the nine months of operation with the presumption that the volume of activity is small and can
thus be effectively administered by them. Lately, they have discovered the importance of
maintaining an accounting rescored. Assume that the firm hires you and your first duty is to
prepare a six month income statement covering the period from January1, to june30. The
company management is capable of supplying actual data on some items but the rest are
estimates. You are given the following actual data.
1 Sales for the first six month is Br.240, 000
2. Inventory january1.
Direct material --------------- 12,000
Work in process -------------- 8,800
Finished goods ---------------- 28,500
3. The gross margin is fairly estimated at 40% of sales, and direct labor is estimated to be one
third of conversion cost and one fourth of prime cost.
4. The period cost is totally estimated at 54,000 and marketing cost is estimated to be 40%.
5. A physical count of all inventories made as of june30 reveals the following.
Direct material --------------- 9,000
Work in process -------------- 7,500
Finished goods ---------------- 52,000

Required
1. Calculate the cost of goods sold
2. Calculate the cost goods manufactured
3. Calculate the direct labor cost
4. Calculate the direct material cost
5. Calculate the direct MOH cost
 CHAPTER THREE
MANUFACTURING OVERHEAD COST ALLOCATIONS
3.1 Introduction
Costs that are related to a particular cost object but cannot traced to it in an economically feasible
way are called manufacturing overhead cost or indirect cost The term cost allocation describes
assigning indirect cost to The chosen cost object.
Purposes of cost allocation
 To provide information for economic decision
o Pricing decision
o Make or buy decision
 To motivate managers and employees
 To justify cost or compute reimbursement
 To measure income and asset for reporting
The allocation of one particular cost need not satisfy all purposes simultaneously. Different costs
are appropriate for different purpose
3.2 Criteria for guiding cost allocation decisions
1. Cause and effect criteria
Using this criterion, managers identify the variable that causes a resource to be consumed. For
example managers may use hours of testing as a variable when allocating the cost of quality test
area to products? Cost allocation based on cause and effect criteria are likely to be the most
credible to operating personnel
2. Benefit received: using this criteria manager identifies the beneficiary of the output of the cost
object.
The cost of the cost object is allocated among the beneficiaries in proportion to the benefit each
received. Consider corporate wide advertising programs that promote the general image of the
corporation rather than any individual product. The cost of this program may be allocated on the
basis of individual revenue; the higher the revenue, the higher the divisions allocated cost of the
advertising program. The rationale behind this allocation is that division with higher revenue has
apparently benefited from the advertising more than divisions with lower revenue and, therefore
ought to be allocated more of the advertising costs.
3. Fairness or equity: This criterion is often cited in government contracts when cost allocations
are the basis of establishing a price satisfactory to the government and its suppliers. Cost
allocation here is viewed as a reasonable or fair means of establishing a selling price in the mind
of the contract ring parties. For most allocation decision, fairness is difficult to achieve objective
rather than an operational criterion.
4. Ability to bear: This criteria advocates allocating costs in proportion to the cost objects ability
to bear cost allocated to income.
An example is the allocation of corporate executive salaries on the basis of division operating
income. The presumption is that the more profitable division have a greater ability to absorb
corporate headquarters cost

3.3 Allocating Cost from One Department to Another

Most manufacturing business organizations have one or more production and service giving
departments.
Service (support) departments: are departments which are not involved in the direct production
of goods but which gives support to the production departments.
Production (operating) departments: are those which directly participate in the production of
goods. The cost incurred in support departments should be collected and allocated to production
departments .The cost incurred in production department and the cost allocated from other
service departments is added together and finally allocated to products manufactured.
Allocating cost of one service department to two or more production departments
There are two ways of allocating indirect cost from service giving department to other operating
department
 Single rate cost allocation method: Collects all costs in one cost pool and allocate using
a single cost allocation base. cost pool is a grouping of individual cost items
 Dual rate cost allocation method: In this method costs are first classified in to fixed and
variable cost sub pools and different allocation rate for each sub pools is calculated. And
then, the fixed cost is allocated using the budgeted allocation base and variable cost is
allocated using the actual allocation base.
Example 1: A computer manufacturing company has two operating departments (micro
computer division and peripheral equipment division) and one support giving division called
central computer department. The central computer department gives computer and information
services for both operating divisions. The following data apply to the coming budget year.
Service provided by central computer division is expressed in terms of hours
Fixed cost in the central computer department ---------------------- ---br.300, 000 per year
Budgeted variable cost per hour --------------------------------------------- br.200
Budgeted usage in hour
 Microcomputer division---------------------- 800 hour
 Peripheral division ----------------------------- 400 hour
Total ---------------------------------------1200hours
Assume the micro computer division actually uses 900 hours and the equipment peripheral
division uses 300 during the year.
Allocate the cost of central computer department to the two operating department
a) Using single rate method
b) Using dual rate method
Example 2: Allocate only the fixed cost in example one above (br.300, 000) using the actual
hours used given below
A. 800 hrs by computer division and 400 hrs by peripheral equipment division
B. 800 hrs by computer division and 700 hrs by peripheral equipment division
C. 800 hrs by computer division and 200 hrs by peripheral equipment division

3.4 Allocating cost of two or more support giving department to production departments
Allocation of cost of support departments create special problem when they provide reciprocal
support to each other as well as to operating departments
There are three methods of allocating the cost of two or more service department to production
departments
1. Direct method
 Is the most widely used method because of its simplicity
 This method allocates each service department cost directly to the operating departments.
Ignores the inter service department cost allocation.
2. Step down allocation method
 Allows for partial recognition of the service rendered by support department to other
departments
 Under this method, once a support department cost has been allocated to another support
department, no reciprocal support department cost allocation the first one.
3. Reciprocal allocation method:
 Allocates cost by explicitly including the mutual service provided among all service
department
 This method enables us to incorporate inter department relation fully in to support
department cost allocation.
 Theoretically this method is the best method to allocate cost
 It can be repeated distribution method and linear equation method.

Example 3: An engine manufacturing company has two operating departments and two support
departments
Support department Operating department
Plant maintenance (PM) Machinating (M)
Information system (IS) Assembly (A)
Costs are accumulated in each department for planning and control purpose. For inventory
costing, however, the support department cost must be allocated to the operating departments.
The data for our example is given below
Support department Operating department
PM IS M A
Budgeted MOH cost $600,000 $116,000 $400,000 $200,000
Before allocation
Service provide by
Plant maintenance hr - 1600hrs 2400hrs 4000hrs
Information system hr 200hrs - 1600hrs 200hrs
Requirements: Using the single rate, allocate the support department cost under each of the
following methods
a) Direct method
 b) Step down method
c) Reciprocal method

Example 4: East-African Bottling Company has three service departments that support the production area.
Outlined below is the budgeted support and production departments’ spending for the upcoming year?

Budgeted Spending
Support Departments:
Receiving (R1) ---------------------------------------- Br. 250,000
Repair (R2) --------------------------------------------- 450,000
Tools (T) --------------------------------------------- 100,000
Production Departments:
Assembly (A) ---------------------------------------- 720,000
Machining (M) --------------------------------------- 450,000
Bottling (B) ------------------------------------------ 120,000
Use of services by other departments follows:
Usage proportions used by internal customers
Support departments Production departments
Receiving Repair Tools Assembly Machining Bottling
Service to be
Provided by:
Receiving - 0.40 0.10 0.20 0.20 0.10
Repair 0.10 - 0.15 0.20 0.30 0.25
Tools 0.05 0.15 - 0.30 0.30 0.20
Required:
(1) Allocate support department costs to production departments using the following methods:
(a) Direct method
(b) Step-down/ Sequential method
(c) Reciprocal method
(2) Present the total costs of each production department after the cost allocation under each of
the above three methods
Example 5: XYZ Company has three service departments that support the production area. Outlined below
is the budgeted support and production departments’ spending for the upcoming year?

Particulars Production Service departments

departments
A B Maintenance Power Personnel
Overheads 120000 150000 20000 48000 40000
before
allocation
Allocation basis:
Maintenance 80 20 - 40 20
hour
KWH 4 16 2 - 2
consumed
No of 60 30 30 18 -
employees

Required:
(1) Allocate support department costs to production departments using the following methods:
(a) Direct method
(b) Step-down/ Sequential method
(c) Reciprocal method (repeated distribution method)
(2) Present the total costs of each production department after the cost allocation under each of
the above three methods

Example 5: ABC Production Company manufactures components for radio and television satellites using two
service departments and two production departments. The inter-departmental relationship and estimated
overhead costs are given below.
Particulars Production Service departments
departments
Moulding Assembly Maintenance Scheduling
Overheads 378000 276000 750000 400000
before
allocation
Allocation basis:
Maintenance 40% 50% - 10%
Scheduling 50% 30% 20% -

Required:
(1) Allocate support department costs to production departments using the following methods:
(a) Direct method
(b) Step-down/ Sequential method
(c) Reciprocal method (repeated distribution and linear equation methods)
(2) Present the total costs of each production department after the cost allocation under each of
the above three methods

1.5 Allocating common cost

Common costs are costs which are shared by two or more activities .Common cost are incurred
for common purpose
There are two methods of allocating common costs .These are
 Stand alone method and
 Incremental method
Example 5: Almaz Abdi is a graduate of AA University in MA in Accounting and finance. She
was invited by Mekele University for an interview. The round trip from Mekele to AA and back
to AA costs Birr 400.A week before she left to Mekele, she was again invited by Bahir Dar
University for another interview. The round trip from AA to Bahir Dar and back to AA costs Birr
240. Hence instead of making both journey separately, she want to combine them. I.e. AA -
Mekele- Bahir Dar-Addis Abeba .
This combined journey will cost Birr 300. This cost is a Common cost for both employers i.e.
Mekele University and Bahir Dar University. Hence it has to be allocated to both universities.
Required: Allocate the 300 birr cost to the two universities using
1. Standalone method
2. Incremental method first to Mekele and then to Bahir Dar
3. Incremental method first to Bahir Dar and then to Mekele
Assignment
Problem 1 : Rensselar Corporation is developing department overhead rates based on direct
labor hours for its two production department. Etching and Finishing. The Etching department
employees 20 people and the Finishing department employees 80 people. Each person in the two
department works 2000 hours per year. The production related overhead cost for Etching
department is budgeted at $320,000 and $480,000 for finishing department. Two service
department, maintenance and computing directly support the two production departments. The
service departments have budgeted cost of $48,000 and $250,000 respectively. The production
department overhead rates cannot be determined until the service department costs are allocated.
The following schedule reflects the use of the maintenance department and computing
departments output by various department
Using departments
Service department Maintenance Computing Etching Finishing
Maintenance (hours) 0 1000 1000 8000
Computing (minutes) 240,000 0 840,000 120,000
Required: Calculate the overhead rates per direct labor for the Etching and Finishing department
after allocating manufacturing overhead cost in the service departments using
1. Direct method
2. Step down method
3. Reciprocal method
Problem 2: Meridian Instrument Company manufactures construction machineries. The
company has two production departments: Molding and Assembly. There are three service
departments: Maintenance, personnel and computer Aided design (CAD).
The usage of these service departments output and their budgeted cost during 2006 are as
follows
Provider of service
User department personnel Maintenance CAD
Personnel - 500 500
Maintenance 500 - 1000
CAD 500 500 -
Molding 4000 3000 2000
Assembly 5000 4000 1500
Total 10,000 8,000 5,000
Total budgeted cost in service dept. $250,000 $230,000 $350,000
Requirements: Allocate service department cost to production department using
1. Direct method
2. Step down method
3. Reciprocal method
 CHAPTER FOUR
JOB ORDER COSTING SYSTEM
4.1 Introduction
The first stage in cost accounting is to ascertain the cost of the product offered or the services
provided. In order to do the same, it is necessary to follow a particular method of ascertaining the
cost. The methods of costing are applied in various business units to ascertain the cost of product
or service offered. Different methods of costing are required to be used in different types of
businesses. For example, costing methods used in a manufacturing business will differ from the
methods used in a business that is offering services. Even in a manufacturing business, some
business units may have production in a continuous process, i.e. output of a process is an input of
the subsequent process and so on, while in some businesses production is done according to the
requirements of customers and hence each job is different from the other one. Different methods
of costing are used to suit these diverse requirements. These methods of costing are discussed in
detail in this chapter.
Building-Block Concepts of Costing Systems
Cost object—anything for which a measurement of costs is desired—for example, a product,
such as an iMac computer, or a service, such as the cost of repairing an iMac computer.
2. Direct costs of a cost object—costs related to a particular cost object that can be traced to that
cost object in an economically feasible (cost-effective) way—for example the cost of purchasing
the main computer board or the cost of parts used to make an iMac computer.
3. Indirect costs of a cost object—costs related to a particular cost object that cannot be traced to
that cost object in an economically feasible (cost-effective) way—for example, the costs of
supervisors who oversee multiple products, one of which is the iMac, or the rent paid for the
repair facility that repairs many different Apple computer products besides the iMac. Indirect
costs are allocated to the cost object using a costallocation method.
Recall that cost assignment is a general term for assigning costs, whether direct or indirect, to a
cost object. Cost tracing is a specific term for assigning direct costs; cost allocation
4. Cost pool. A cost pool is a grouping of individual indirect cost items. Cost pools can range
from broad, such as all manufacturing-plant costs, to narrow, such as the costs of operating
metal-cutting machines. Cost pools are often organized in conjunction with cost-allocation bases.
5. Cost-allocation base. How should a company allocate costs to operate metal-cutting machines
among different products? One way to allocate costs is based on the number of machine-hours
used to produce different products. The cost-allocation base (number of machine-hours) is a
systematic way to link an indirect cost or group of indirect costs (operating costs of all metal-
cutting machines) to cost objects (different products). For example, if indirect costs of operating
metal-cutting machines is
$500,000 based on running these machines for 10,000 hours, the cost allocation rate is $500,000
÷ 10,000 hours = $50 per machine-hour, where machine-hours is the cost allocation base. If a
product uses 800 machine-hours, it will be allocated $40,000, $50 per machine-hour _ 800
machine-hours. The ideal cost-allocation base is the cost driver of the indirect costs, because
there is a cause-and-effect relationship between the cost allocation base and the indirect costs. A
cost-allocation base can be either financial (such as direct labor costs) or nonfinancial (such as
the number of machine-hours). When the cost object is a job, product, or customer, the cost-
allocation base is also called a cost-application base.
Job Costing: Evaluation and Implementation
Five-Step Decision-Making Process
1. Identify the problems and uncertainties. The decision of whether and how much to bid for
the WPP job depends on how management resolves two critical uncertainties: what it will cost to
complete the job and the prices that its competitors are likely to bid.
2. Obtain information. Robinson’s managers first evaluate whether doing the WPP job is
consistent with the company’s strategy. Do they want to do more of these kinds of jobs? Is this
an attractive segment of the market? Will Robinson be able to develop a competitive advantage
over its competitors and satisfy customers? Robinson’s managers conclude that the WPP job fits
well with the company’s strategy.
Robinson’s managers study the drawings and engineering specifications provided by WPP and
decide on technical details of the machine. They compare the specifications of this machine to
similar machines they have made in the past, identify competitors who might bid on the job, and
gather information on what these bids might be.
3. Make predictions about the future. Robinson’s managers estimate the cost of direct
materials, direct manufacturing labor, and overhead for the WPP job. They also consider
qualitative factors and risk factors and think through any biases they might have. For example,
do engineers and employees working on the WPP job have the necessary skills and technical
competence? Would they find the experience valuable and challenging? How accurate are the
cost estimates, and what is the likelihood of cost overruns? What biases do Robinson’s managers
have to be careful about?
4. Make decisions by choosing among alternatives. Robinson bids $15,000 for the WPP job.
This bid is based on a manufacturing cost estimate of $10,000 and a markup of
50% over manufacturing cost. The $15,000 price takes into account likely bids by competitors,
the technical and business risks, and qualitative factors. Robinson’s managers are very confident
that they have obtained the best possible information in reaching their decision.
5. Implement the decision, evaluate performance, and learn. Robinson wins the bid for the
WPP job. As Robinson works on the WPP job, it keeps careful track of all the costs it has
incurred (which are detailed later in this chapter).
Time Period Used to Compute Indirect-Cost Rates
There are two reasons for using longer periods, such as a year, to calculate indirect cost rates.
1. The numerator reason (indirect-cost pool).
The shorter the period, the greater the influence of seasonal patterns on the amount of costs. For
example, if indirect-cost rates were calculated each month, costs of heating (included in the
numerator) would be charged to production only during the winter months. An annual period
incorporates the effects of all four seasons into a single, annual indirect-cost rate.
Levels of total indirect costs are also affected by non seasonal erratic costs.
Examples of non seasonal erratic costs include costs incurred in a particular month that benefit
operations during future months, such as costs of repairs and maintenance of equipment, and
costs of vacation and holiday pay. If monthly indirect-cost rates were calculated, jobs done in a
month with high, non seasonal erratic costs would be charged with these costs. Pooling all
indirect costs together over the course of a full year and calculating a single annual indirect-cost
rate helps smooth some of the erratic bumps in costs associated with shorter periods.
2. The denominator reason (quantity of the cost-allocation base). Another reason for longer
periods is to avoid spreading monthly fixed indirect costs over fluctuating levels of monthly
output and fluctuating quantities of the cost-allocation base. Consider the following example.
Normal Costing
The difficulty of calculating actual indirect-cost rates on a weekly or monthly basis means
managers cannot calculate the actual costs of jobs as they are completed.
However, managers, including those at Robinson, want a close approximation of the costs of
various jobs regularly during the year, not just at the end of the fiscal year. Managers want to
know manufacturing costs (and other costs, such as marketing costs) for ongoing uses, including
pricing jobs, monitoring and managing costs, evaluating the success of the job, learning about
what worked and what didn’t, bidding on new jobs, and preparing interim financial statements.
Because of the need for immediate access to job costs, few companies wait to allocate overhead
costs until year-end when the actual manufacturing overhead is finally known. Instead, a
predetermined or budgeted indirect-cost rate is calculated for each cost pool at the beginning of a
fiscal year, and overhead costs are allocated to jobs as work progresses. For the numerator and
denominator reasons already described, the budgeted indirect-cost rate for each cost pool is
computed as follows:
Budgeted indirect cost rate =
Budgeted annual indirect costs
Budgeted annual quantity of the cost-allocation base

Using budgeted indirect-cost rates gives rise to normal costing.

Normal costing is a costing system that (1) traces direct costs to a cost object by using the actual
direct-cost rates times the actual quantities of the direct-cost inputs and
(2) Allocates indirect costs based on the budgeted indirect-cost rates times the actual quantities
of the cost-allocation bases. This approach is commonly used by companies in the
manufacturing, merchandising, and service sectors.
Actual Costing
Both actual costing and normal costing trace direct costs to jobs in the same way because source
documents identify the actual quantities and actual rates of direct materials and direct
manufacturing labor for a job as the work is being done. The only difference between costing a
job with normal costing and actual costing is that normal costing uses budgeted indirect-cost
rates, whereas actual costing uses actual indirect-cost rates calculated annually at the end of the
year.
Actual manufacturing overhead rate = Actual annual manufacturing overhead costs
 Actual annual quantity of the cost-allocation base
Manufacturing overhead costs allocated to the job =Actual manufacturing overhead rate * Actual
quantity of direct manufacturing labor-hours
Actual Costing Normal Costing
Direct Costs Actual direct-cost rates _ Actual direct-cost rates *
actual quantities of direct-cost inputs actual quantities of direct-
cost inputs
Indirect Costs Actual indirect-cost rates * Budgeted indirect-cost
rates *
actual quantities of cost-allocation bases actual quantities of cost-
allocation bases
4.2 Methods of Costing
As mentioned in the above paragraph, the methods of costing are used to ascertain the cost of
product or service offered by a business organization. There are two principle methods of
costing. These methods are as follows
Job Costing
Process Costing
Other methods of costing are the variations of these two principle methods. The variations of
these methods of costing are as follows.
Job Costing: Batch Costing, Contract Costing, Multiple Costing.
Process Costing: Unit or Single Output Costing, Operating Costing, Operation Costing
Companies frequently adopt one of the two costing systems to assign costs to products or
services .
Job order costing system: is a type of cost system that provides for a separate record of the cost
of each particular quantity of product that passes through the factory
Job order costing system is commonly used by companies with products that are unique
and divisible. In this system, costs are assigned to a distinct unit, batch or lot of product or
service. Job is a task for which resources are expended in bringing a distinct product or
service to market.
Job Costing: This method of costing is used in Job Order Industries where the production is as
per the requirements of the customer. In Job Order industries, the production is not on
continuous basis; rather it is only when order from customers is received and that too as per the
specifications of the customers. Consequently, each job can be different from the other one.
Method used in such type of business organizations is the Job Costing or Job Order Costing. The
objective of this method of costing is to work out the cost of each job by preparing the Job Cost
Sheet. A job may be a product, unit, batch, sales order, project, contract, service, specific
program or any other cost objective that is distinguishable clearly and unique in terms of
materials and other services used. The cost of completed job will be the materials used for the
job, the direct labor employed for the same and the production overheads and other overheads if
any charged to the job. The following are the features of job costing.
 It is a specific order costing
 A job is carried out or a product is produced is produced to meet the specific
requirements of the order
 Job costing enables a business to ascertain the cost of a job on the basis of which
quotation for the job may be given.
 While computing the cost, direct costs are charged to the job directly as they are
traceable to the job.
 Indirect expenses i.e. overheads are charged to the job on some suitable basis.
 Each job completed may be different from other jobs and hence it is difficult to have
standardization of controls and therefore more detailed supervision and control is
necessary.
 At the end of the accounting period, work in progress may or may not exist.

Examples of business that use job order costing includes:

 construction companies
 Furniture manufacturers
 printing firms
 Repair shops
 Service giving organization.
 Garages etc
 4.3 Methodology used in Job Costing
As discussed above, the objective of job costing is to ascertain the cost of a job that is produced
as per the requirements of the customers. Hence it is necessary to identify the costs associated
with the job and present it in the form of job cost sheet for showing various types of costs.
Various costs are recorded in the following manner.
Direct Material Costs: Material used during the production process of a job and identified with
the job is the direct material. The cost of such material consumed is the direct material cost.
Direct material cost is identifiable with the job and is charged directly. The source document for
ascertaining this cost is the material requisition slip from which the quantity of material
consumed can be worked out. Cost of the same can be worked out according to any method of
pricing of the issues like first in first out, last in first out or average method as per the policy of
the organization. The actual material cost can be compared with standard cost to find out any
variations between the two. However, as each job may be different from the other,
standardization is difficult but efforts can be made for the same.
Direct Labor Cost: This cost is also identifiable with a particular job and can be worked out with
the help of ‘Job Time Tickets’ which is a record of time spent by a worker on a particular job.
The ‘job time ticket’ has the record of starting time and completion time of the job and the time
required for the job can be worked out easily from the same. Calculation of wages can be done
by multiplying the time spent by the hourly rate. Here also standards can be set for the time as
well as the rate so that comparison between the standard cost and actual cost can be very useful.
Direct Expenses: Direct expenses are chargeable directly to the concerned job. The invoices or
any other document can be marked with the number of job and thus the amount of direct
expenses can be ascertained.

Overheads: This is really a challenging task as the overheads are all indirect expenses incurred
for the job. Because of their nature, overheads cannot be identified with the job and so they are
apportioned to a particular job on some suitable basis. Pre determined rates of absorption of
overheads are generally used for charging the overheads. This is done on the basis of the
budgeted data. If the predetermined rates are used, under/over absorption of overheads is
inevitable and hence rectification of the same becomes necessary.
Work in Progress: On the completion of a job, the total cost is worked out by adding the
overhead expenses in the direct cost. In other word, the overheads are added to the prime cost.
The cost sheet is then marked as ‘completed’ and proper entries are made in the finished goods
ledger. If a job remains incomplete at the end of an accounting period, the total cost incurred on
the same becomes the cost of work in progress. The work in progress at the end of the
accounting period becomes the closing work in progress and the same becomes the opening work
in progress at the beginning of the next accounting period. A separate account for work in
progress is maintained.
General Approach to Job Costing
Step 1: Identify the Job That Is the Chosen Cost Object.
The cost object in the Robinson Company example is Job WPP 298, manufacturing a paper-
making machine for Western Pulp and Paper (WPP) in 2011. Robinson’s managers and
management accountants gather information to cost jobs through source documents. A source
document is an original record (such as a labor time card on which an employee’s work hours
are recorded) that supports journal entries in an accounting system. The main source document
for Job WPP 298 is a job-cost record. 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.
Step 2: Identify the Direct Costs of the Job. Robinson identifies two direct-manufacturing
cost categories: direct materials and direct manufacturing labor.
Direct materials: On the basis of the engineering specifications and drawings provided by WPP,
a manufacturing engineer orders materials from the storeroom. The order is placed using a basic
source document called a materials-requisition record, which contains information about the cost
of direct materials used on a specific job and in a specific department
Direct manufacturing labor: The accounting for direct manufacturing labor is similar to the
accounting described for direct materials. The source document for direct manufacturing labor is
a labor-time sheet, which contains information about the amount of labor time used for a
specific job in a specific department.

Step 3: Select the Cost-Allocation Bases to Use for Allocating Indirect Costs to the Job.
Indirect manufacturing costs are costs that are necessary to do a job but that cannot be traced to a
specific job. It would be impossible to complete a job without incurring indirect costs such as
supervision, manufacturing engineering, utilities, and repairs. Because these costs cannot be
traced to a specific job, they must be allocated to all jobs in a systematic way. Different jobs
require different quantities of indirect resources. The objective is to allocate the costs of indirect
resources in a systematic way to their related jobs. Companies often use multiple cost-allocation
bases to allocate indirect costs because different indirect costs have different cost drivers.
Step 4: Identify the Indirect Costs Associated with Each Cost-Allocation Base. Because
Robinson believes that a single cost-allocation base—direct manufacturing labor-hours— can be
used to allocate indirect manufacturing costs to jobs, Robinson creates a single cost pool called
manufacturing overhead costs. This pool represents all indirect costs of the Manufacturing
Department that are difficult to trace directly to individual jobs.
Step 5: Compute the Rate per Unit of Each Cost-Allocation Base Used to Allocate
Indirect Costs to the Job. For each cost pool, the budgeted indirect-cost rate is calculated by
dividing budgeted total indirect costs in the pool (determined in Step 4) by the budgeted total
quantity of the cost-allocation base (determined in Step 3). Budgeted indirect cost rate =
Budgeted annual indirect costs
Budgeted annual quantity of the cost-allocation base

Step 6: Compute the Indirect Costs Allocated to the Job. The indirect costs of a job are
calculated by multiplying the actual quantity of each different allocation base (one allocation
base for each cost pool) associated with the job by the budgeted indirect cost rate of each
allocation base (computed in Step 5).
Step 7: Compute the Total Cost of the Job by Adding All Direct and Indirect Costs
Assigned to the Job

4.4 Advantages of Job Costing

The following are the advantages of job costing.
 Accurate information is available regarding the cost of the job completed and the profits
generated from the same.
 Proper records are maintained regarding the material, labor and overheads so that a
costing system is built up
  Useful cost data is generated from the point of view of management for proper control
and analysis.
 Performance analysis with other jobs is possible by comparing the data of various jobs.
However it should be remembered that each job completed may be different from the
other.
 If standard costing system is in use, the actual cost of job can be compared with the
standard to find out any deviation between the two.
 Some jobs are priced on the basis of cost plus basis. In such cases, a profit margin is
added in the cost of the job. In such situation, a customer will be willing to pay the price
if the cost data is reliable. Job costing helps in maintaining this reliability and the data
made available becomes credible.
4.5 Limitations of Job Costing
Job costing suffers from certain limitations.
These are as follows.
 It is said that it is too time consuming and requires detailed record keeping. This makes
the method more expensive.
 Record keeping for different jobs may prove complicated.
 Inefficiencies of the organization may be charged to a job though it may not be
responsible for the same.
In spite of the above limitations, it can be said that job costing is an extremely useful method for
computation of the cost of a job. The limitation of time consuming can be removed by
computerization and this can also reduce the complexity of the record keeping.

4.6 Source of documents for job order costing

Source documents are the original record that supports journal entries in accounting system. The
key source document in job order costing system is job cost sheet (job cost record) this document
records and accumulates all the cost (Direct material, direct labor and MOH cost) assigned to a
specific job.

Job order cost sheet

Customer Name--------- Job order No.----------------
Product---------------- Date started---------------
Quantity----------------- Date completed --------------
Direct material Direct labor Factory overhead
Date Type Amount Date Hours Amount Date Amount

Source documents also exist for individual items in a job

Material requisition record: is used to record material used on a specific job
Material requisition record
Record No.----------------- Date --------------------------
Job No.----------------------
number description Quantity Unit cost Total cost
1 XX1 100 $4 $400
2 ZZ4 20 10 200
3 YY5 70 5 350
Labor time record (Employee time ticket or time card): is used to record the time labor used
on a specific job
Labor time Record Employee No.-------------
Record No. ----------- job No. --------------------
Employee-----------
Classification code----------
Time started Time stopped Hours worked Hourly rate Total cost
2:00 6:00 4 $10 $40
2:30 5:30 3 $15 45
4.7 Accounting procedures for job order costing
Job order costing system requires a subsidiary ledger for each job order and general ledger
(controlling account) for the total amount. Entries in subsidiary ledger will be made
frequently and summarized in control account in weekly or monthly interval.
Major Accounting procedures in job order costing system
 Receiving job order and purchase of raw materials
 Transferring raw material to work in process
 Recording labor to work in process.
 Recording actual manufacturing over head cost incurred
 Allocating manufacturing over head cost to work in process
 Transferring finished goods to work in process
 Transferring finished goods to customers.

Manufacturing over head cost is incurred for the benefit of all jobs produced during a period
and can not be related to any particular job. As manufacturing over head costs are incurred,
they are accumulated as manufacturing overhead control account.
Some manufacturing costs such as utility will not be known until the end of the period.
Hence, rather than holding a finished good job until all costs can be attributed to it, it is
necessary to develop a method of allocating manufacturing over head cost to the job
completed. This is called normal costing .In normal costing direct material and direct labor
costs are directly traced to the job completed but MOH cost is allocated to it using budgeted
rate and actual allocation base.
To determine budgeted rate:
 Estimate manufacturing over head cost for the year.
 Choose allocation base such as labor hour, direct labor cost or machine hour.
 Estimate the allocation base for the year
 Calculate the budgeted rate using the formula
Budgeted rate = Budgeted MOH cost
Budgeted allocation base
Explanations of Transactions
We next look at a summary of Robinson Company’s transactions for February 2011 and the
corresponding journal entries for those transactions.
1. Purchases of materials (direct and indirect) on credit, $89,000
2. Usage of direct materials, $81,000, and indirect materials, $4,000
Materials Control------------------------------------------------ 89,000
Accounts Payable Control------------------------------------------------- 89,000
Work-in-Process Control --------------------------------------81,000
Manufacturing Overhead Control --------------------------------------------4,000
Materials Control -------------------------------------------------------------------85,000
3. Manufacturing payroll for February: direct labor, $39,000, and indirect labor, $15,000, paid in
cash
Work-in-Process Control -------------------------------------------39,000
Manufacturing Overhead Control--------------------------------- 15,000
Cash Control -----------------------------------------------------------------------------54,000
4. Other manufacturing overhead costs incurred during February, $75,000, consisting of
supervision and engineering salaries, $44,000 (paid in cash); plant utilities, repairs, and
insurance, $13,000 (paid in cash); and plant depreciation, $18,000
Manufacturing Overhead Control -----------------------------------------------75,000
Cash Control ---------------------------------------------------------------------------------57,000
Accumulated Depreciation Control --------------------------------------------------------18,000
5. Allocation of manufacturing overhead to jobs, $80,000
Work-in-Process Control-------------------------------- 80,000
Manufacturing Overhead Allocated---------------------------- 80,000

Under normal costing, manufacturing overhead allocated—also called manufacturing

overhead applied—is the amount of manufacturing overhead costs allocated to individual jobs
based on the budgeted rate multiplied by actual quantity used of the allocation base. Keep in
mind the distinct difference between transactions 4 and 5. In transaction 4, all actual overhead
costs incurred throughout the month are added (debited) to the Manufacturing Overhead Control
account. These costs are not debited to Work-in-Process Control because, unlike direct costs,
they cannot be traced to individual jobs. Manufacturing overhead costs are added (debited) to
individual jobs and to Work-in-Process Control only when manufacturing overhead costs are
allocated in Transaction 5. At the time these costs are allocated, Manufacturing
Overhead Control is, in effect, decreased (credited) via its contra account, Manufacturing
Overhead Allocated. Recall that under normal costing, the budgeted manufacturing overhead rate
of $40 per direct manufacturing labor-hour is calculated at the beginning of the year on the basis
of predictions of annual manufacturing overhead costs and the annual quantity of the cost-
allocation base. Almost certainly, the overhead allocated will differ from the actual overhead
incurred. In a later section, we discuss what to do with this difference.
6. Completion and transfer of individual jobs to finished goods, $188,800
7. Cost of goods sold, $180,000
8. Marketing costs for February, $45,000, and customer service costs for February, $15,000, paid
in cash
Finished Goods Control ------------------------188,800
Work-in-Process Control ---------------------------------188,800
9. Sales revenues, all on credit, $270,000
Underallocated and Overallocated Direct Costs

Underallocated indirect costs occur when the allocated amount of indirect costs in an
accounting period is less than the actual (incurred) amount. Overallocated indirect costs occur
when the allocated amount of indirect costs in an accounting period is greater than the actual
(incurred) amount.
Underallocated (overallocated) indirect costs are also called underapplied (overapplied)
indirect costs and underabsorbed (overabsorbed) indirect costs.
Consider the manufacturing overhead cost pool at Robinson Company. There are two indirect-
cost accounts in the general ledger that have to do with manufacturing overhead:
1. Manufacturing Overhead Control, the record of the actual costs in all the individual overhead
categories (such as indirect materials, indirect manufacturing labor, supervision, engineering,
utilities, and plant depreciation)
2. Manufacturing Overhead Allocated, the record of the manufacturing overhead allocated to
individual jobs on the basis of the budgeted rate multiplied by actual direct manufacturing labor-
hours
At the end of the year, the overhead accounts show the following amounts.
Underallocated (overallocated) indirect costs = Actual indirect costs incurred - Indirect costs
allocated
The $1,080,000 credit balance in Manufacturing Overhead Allocated results from multiplying
the 27,000 actual direct manufacturing labor-hours worked on all jobs in 2011 by the budgeted
rate of $40 per direct manufacturing labor-hour.
The $135,000 ($1,215,000 – $1,080,000) difference (a net debit) is an underallocated amount
because actual manufacturing overhead costs are greater than the allocated amount. This
difference arises from two reasons related to the computation of the
$40 budgeted hourly rate:
1. Numerator reason (indirect-cost pool). Actual manufacturing overhead costs of $1,215,000
are greater than the budgeted amount of $1,120,000.
2. Denominator reason (quantity of allocation base). Actual direct manufacturing laborhours
of 27,000 are fewer than the budgeted 28,000 hours.
There are three main approaches to accounting for the $135,000 underallocated manufacturing
overhead caused by Robinson underestimating manufacturing overhead costs and overestimating
the quantity of the cost-allocation base: (1) adjusted allocation-rate approach, (2) proration
approach, and (3) write-off to cost of goods sold approach
Adjusted Allocation-Rate Approach
The adjusted allocation-rate approach restates all overhead entries in the general ledger and
subsidiary ledgers using actual cost rates rather than budgeted cost rates.
First, the actual manufacturing overhead rate is computed at the end of the fiscal year.
Then, the manufacturing overhead costs allocated to every job during the year are recomputed
using the actual manufacturing overhead rate (rather than the budgeted manufacturing overhead
rate). Finally, end-of-year closing entries are made. The result is that at year-end, every job-cost
record and finished goods record—as well as the ending Work-in-Process Control, Finished
Goods Control, and Cost of Goods
Sold accounts—represent actual manufacturing overhead costs incurred.
The widespread adoption of computerized accounting systems has greatly reduced the cost of
using the adjusted allocation-rate approach. In our Robinson example, the actual manufacturing
overhead ($1,215,000) exceeds the manufacturing overhead allocated ($1,080,000) by 12.5%
[($1,215,000 – $1,080,000) ÷ $1,080,000]. At year-end,
Robinson could increase the manufacturing overhead allocated to each job in 2011 by
12.5% using a single software command. The command would adjust both the subsidiary ledgers
and the general ledger.
Consider the Western Pulp and Paper machine job, WPP 298. Under normal costing, the
manufacturing overhead allocated to the job is $3,520 (the budgeted rate of $40 per direct
manufacturing labor-hour _ 88 hours). Increasing the manufacturing overhead allocated by
12.5%, or $440 ($3,520 _ 0.125), means the adjusted amount of manufacturing overhead
allocated to Job WPP 298 equals $3,960 ($3,520 + $440). Note from page 110 that using actual
costing, manufacturing overhead allocated to this job is $3,960 (the actual rate of $45 per direct
manufacturing labor-hour _ 88 hours). Making this adjustment under normal costing for each job
in the subsidiary ledgers ensures that all $1,215,000 of manufacturing overhead is allocated to
jobs.
The adjusted allocation-rate approach yields the benefits of both the timeliness and convenience
of normal costing during the year and the allocation of actual manufacturing overhead costs at
year-end. Each individual job-cost record and the end-of-year account balances for inventories
and cost of goods sold are adjusted to actual costs. After-the-fact analysis of actual profitability
of individual jobs provides managers with accurate and useful insights for future decisions about
job pricing, which jobs to emphasize, and ways to manage job costs.

Proration Approach
Proration spreads underallocated overhead or overallocated overhead among ending work-in-
process inventory, finished goods inventory, and cost of goods sold. Materials inventory is not
included in this proration, because no manufacturing overhead costs have been allocated to it. In
our Robinson example, end-of-year proration is made to the ending balances in Work-in-Process
Control, Finished Goods Control, and Cost of
Goods Sold. Assume the following actual results for Robinson Company in 2011:
Account Account Balance (Before Proration) Allocated
Manufacturing

Overhead
Included in Each
Account Balance
(Before Proration)
Work-in-process control $50,000 16,200
Finished goods control 75,000 31,320
Cost of goods sold 2,375,000 $1,032,480
Total $2,500,000
1,080,000

How should Robinson prorate the underallocated $135,000 of manufacturing overhead at the end
of 2011? Robinson prorates underallocated or overallocated amounts on the basis of the total
amount of manufacturing overhead allocated in 2011 (before proration) in the ending balances of
Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold. The $135,000
underallocated overhead is prorated over the three affected accounts inproportion to the total
amount of manufacturing overhead allocated (before proration) in column 2 of the following
table, resulting in the ending balances (after proration) in column 5 at actual costs.
Example 1: The following budgeted data is given for XYZ Textile factory for the year 2004.
Estimated MOH cost --------------------------- $450,000
Estimated No of shirts produced -------------- 200,000
Estimated Dm cost for the year ---------------- $300,000
Estimated DL cost --------------------------------- $900,000
Estimated DL hours -------------------------------- 300,000 hours
Estimated machine hours -------------------------- 90,000 hours
Compute the predetermined MOH based on the following allocation base.
1. Physical out put method
2. Direct material cost base
3. Direct labor cost base
4. Direct labor hours base
 5. Machine hours base
Assuming all information in above and the following additional information
Actual data for job201 is given below
Actual shirts completed for job 201 --- 2,000 shirts
Actual DM used -------------------------- $30,000
Actual DL cost ----------------------------- $20,000
Actual Dl hours ---------------------------- 400 hours
Actual machine hours ------------------------ 240 hours
Determine the total cost of Job 201 under each of the five bases of allocation
Example 2: A corporation uses job order cost system. The factory overhead rate estimated for
the year 2001 was $8 per DL hour; the inventory account had the following balances on
December 31.
Raw material -------------------- $7,000
WIP (job201) ------------------ 6,500
FG (Job 209) --------------------- 7,000
During December, The following events occurred
1. Material purchased on account $18,000
2. Direct materials and factory supplies were issued as follows
 Job211 -------------------- $4,500
 Job 212 -------------------- 5,300
 Job 213------------------- 6200
 Indirect material -------- 1800
3. The December direct labor cost were
 Job210 ------------------- 150 hrs@$6per hour
 Job211 ------------------- 400 hrs@$6per hour
 Job212 ------------------- 350 hrs@$6per hour
 Job213 ------------------- 100 hrs@$6per hour
4. Factory indirect labor for December was $2,400
5. Other overhead cost incurred during December
 Utility paid in cash ------------------- $2,500
 Factory depreciation ------------- 1000
  Repair and maintenance ----------- 500
 Total $4,000
6. Job 210,211 and 212 were completed and transferred to FG
7. Job 209 and 211 were sold on account for 120% of cost
Required
1. Journalize the above transactions
2. Determine the under or over applied overhead

Example 3: Robinson manufacturing company uses a job order costing system. Its job order
costing system has two direct costs (DM and DL) and one indirect cost category
On January 1, 2004, the following inventories are available
 Raw material --------------- $10,000
 WIP -------------------------- $5,000
 Finished goods ------------- 15,000
Robinson budgeted the 2004 manufacturing overhead to be $1,280,000 and the budget quantity
of machine hours (allocation base) are 16,000 machine hours.

The following transaction occurs during the month of January

1. Purchase of material (direct and indirect), $89,000 on account
2. Raw material sent to manufacturing plant floor is $85,000 out of which $4000 is
indirect material
3. Manufacturing labor wages liability incurred is $54,000 out of which $15,000 is
indirect
4. The actual machine hours used in the period were 1000 machine hours. The
manufacturing over head is allocated using this actual machine hour.
5. Additional manufacturing over head cost incurred during the month is $75,000.this
cost consists of utility and repairs, $23, 000, insurance expired $2,000, depreciation
expense $50,000.

6. Cost of finished goods of eight individual jobs completed and transferred out is
$188,800.
 7. Finished goods costing $180,000 was sold for $300,000 on cash.
Required:
a) Journalize the above transactions
b) Post using T-account
c) Compute the under or over applied MOH cost
d) Close the amount using direct write off to cost of goods sold
4.4 Under and over applied manufacturing over head cost
Manufacturing over head cost that is applied to the job produced during the year using
predetermined over head rate are recorded in manufacturing over head applied account. Actual
manufacturing over head cost incurred in a period are recorded in manufacturing over head
control account
Generally, the amount recorded in manufacturing overhead applied during the year will differ
from the amount recorded in manufacturing over head control account.
This means that manufacturing over head will be either under applied or over applied

If manufacturing overhead applied account is greater than manufacturing overhead control

account it is said to be over applied
If manufacturing overhead applied account is less than manufacturing overhead control account
it is said to be under applied
There are four methods to adjust for under or over applied manufacturing over head cost
 Adjusted allocation rate approach: In this approach you restate all entries in The
ledger by using actual cost rates rather than budgeted rates
 Close to cost of goods sold account
 Prorate to total end balance of finished goods, work in process and cost of goods sold.
 Prorate to manufacturing over head cost amount allocated in The end balance of
finished goods, work in process and cost of goods sold

Example 4: ABC Company uses normal costing with single manufacturing overhead cost
pool and machine hours as the cost allocation base .the followings data are for 2004.
 Budgeted manufacturing overhead -------------------- $4,800,000
 Overhead allocation base ----------------------------- machine hours
  Budgeted machine hours ------------------------------ 80,000
 Actual manufacturing over head incurred ----------$4,900,000
 Actual machine hours -----------------------------------75,000
Machine hour’s data and the ending balance (before peroration of under or over applied
MOH cost) are as follows.
Actual machine hours End of year balance
Cost of goods sold 60,000 $8,000,000
Finished goods 11,000 1,250,000
Work in process 4,000 750,000

Required
1. Compute the budgeted manufacturing overhead rate for 2004.
2. Compute the under or over applied MOH cost
3. Close the amount using
a) Direct write of to cost of goods sold
b) Prorate based on ending balance of WIP, CGS and FG
c) Prorate based on the allocated MOH cost amount in the ending balance of
WIP, CGS and FG

Assignment
Problem 1: Medford incorporated provided the following data for January 2004.
Materials and supplies
Inventory, January1 ----------------------- $10,000
Purchase on account ------------------------ 30,000
Labor
Accrued January 1--------------------------- $3,000
Paid during January (ignore payroll taxes) 25,000
Factory over head costs
Supplies (issued from material) -------------- 1,500
Indirect labor --------------------------------- 3,500
Depreciation -------------------------------------- 1,000
Other factory overhead cost ------------------- 14,200

Job1 Job2 Job3 Total

WIP January 1 $1,000 $1,000
Job costs during January
Direct material 4,000 6,000 5,000 15,000
Direct labor 4,000 8,000 7,000 20,000
Applied factory overhead 5,000 8,000 7,000 20,000
 Job1was started in December, finished during January and sold to customer for $21,000
cash in January
 Job2 is started in January and not yet finished.
 Job3 is started in January, finished during January and now is in the finished goods
warehouse awaiting sale
Required:
1. Journalize the above transactions using subsidiary ledger and controlling account
2. Calculate the under or over applied MOH cost

Problem 2: XYZ Company uses a job order costing system. Its job costing system has two direct
cost categories (Direct material and Direct labor) and one indirect cost category ( MOH cost
allocated at budgeted rate of $60 per machine hour in 2004)
The following transaction occurred in January 2004.
a) Purchase of raw material on account for $300,000.
b) Direct material of $280,000 and indirect material of $20,000 was used in the production
process.
c) Direct labor cost of $180,000 and indirect of $60,000 was incurred in the month.
d) The actual machine hours used to complete the job was 4,200 machine hours. The MOH
cost is allocated using this actual machine hour.
e) Miscellaneous MOH cost actually incurred by department were $160,000
f) Cost of finished goods completed and transferred out was $588,000
g) Finished goods costing $584,000 was sold for $800,000 on cash
Requirements
1. Journalize the transactions for the month of January2004, identifying each by letter
2. Calculate the under or over applied MOH cost
3. Give the year end adjusting entry closing the over or under applied MOH cost to cost good
sold.
4. If the year end balance of before peroration for three accounts is given below
 Cost of goods sold-------- $584,000
 Work in process ----------- 6,000
 Finished goods ------------ 10,000
Prorate the over or under applied MOH cost to the three accounts based on their end balance
and give the adjusting entry.
 CHAPTER 5
PROCESS COSTING SYSTEM
5.1 Introduction
In one of the previous chapters we have discussed some of the methods of costing like, Job,
Batch, and Contract costing. The methods of costing basically aim at finding out the cost of a
product or service, which is offered by the organization. Process Costing is also a method of
costing which is used in those industries where the production is in continuous process, i.e. the
output of one process becomes the input of the subsequent process and so on. Examples of such
industries are, paint works, chemical plants, food manufacturing, oil refining, paper mill, textile
mills, sugar factories, fruit canning, dairy and so on. In such industries, the input is put in the
first process and the output of each process becomes the input of the subsequent process till the
final product emerges from the last process. This method is employed where it is not possible to
trace the items of prime cost [which consists of all direct costs] to a particular order because its
identity is lost in the continuous production. Thus it is not possible to compute the cost of say,
200 liters of oil or 200 kg of sugar produced as thousands of liters of oil or thousands of kg of
sugar is manufactured at the same time. We can get the cost per liter or kg by dividing the total
cost by the total production produced during that period. The features and intricacies of process
costing are discussed in the subsequent paragraphs.

5.2 Features of Process Costing

We have discussed in the previous paragraph that process costing is employed in continuous
production industries where the flow of production is in a sequence and the output of one process
becomes the input of the subsequent one. The objective of process costing is to find out the cost
of each process by identifying the direct costs with the particular process and apportioning the
indirect costs i.e. overheads to each process on some suitable basis. The units coming out the
process as the finished output are uniform in all the respects and hence the cost per unit is
computed by dividing the total cost by the total production units. In case, some units are
incomplete at the end of a particular period, equivalent units are worked out of such incomplete
units and then the cost per unit is computed. The features of process costing are:
1. The production is in continuous flow and is uniform. All units coming out as finished
products are uniform with each other in all respects.
 2. The product is manufactured in a continuous flow and hence individual units lose their
identity.
3. The unit cost is obtained by dividing the total cost for a particular period by the total
output. This is the average cost of the product units.
4. Cost per process is ascertained and cost of each process is transferred to the subsequent
process until the finished product emerges.
5. In a particular process normal and abnormal losses emerge. Normal loss is a loss, which
is inevitable in any process and thus cannot be avoided or controlled. Any loss, which, is
over and above, the normal loss is called as abnormal loss and is to be accounted for
separately. For example, if 1000 units are put in Process 1 and it is anticipated that there
will be a normal loss of 1% in the process, the output expected is 1,000 – 1% of 1,000
that is 990. If actual production is 980, there is an abnormal loss of 10 units. On the other
hand if the production is 995, there is an abnormal gain of 5 units. Abnormal gain and
abnormal loss are to be accounted for in the process cost accounts.
6. Sometimes each process may be treated as profit center and so while transferring the cost
from one process to another, a percentage of profit is added in the cost of that process.
This is known as inter process profit and needs to be accounted for in the process cost
accounts.
7. Though the cost per unit is computed by dividing the total cost by the number of units,
there can be a problem on incomplete units at the end of a particular accounting period.
In such cases equivalent units have to be worked out for computing the cost per unit.
5.3 Preparing Process Cost Accounts
1) As explained above, the objective of process costing is to work out the cost of each process,
transfer the same to the subsequent process and finally ascertain the total cost of production.
Therefore it is necessary to charge various costs to each process. For this, the factory is divided
into distinct processes or operations and an account is kept of each process to which all the costs
are debited. The following are the various elements of cost, which are shown in the process
accounts.
Materials: Raw materials required for each process is drawn from stores against material
requisitions. Proper procedure like preparing and authorizing the requisition, pricing of the
issues, return of materials to the stores, transfer of material from one process to another should
be followed while issuing the materials. Cost of materials consumed should be computed as per
the method employed for pricing of the issues and the cost should be debited to the process
account.
Labor: Wages paid to workers and supervisory staff should be charged to the particular process
if they can be identified with it. If workers work on two or more processes, proper allocation
should be made according to some basis like time spent on each process.
Direct Expenses: If expenses are identifiable with a particular process, they should be charged to
that process. For example, cost of electricity, depreciation may be charged directly to a process if
they are identifiable with it.
Overheads: By nature, overheads are indirect expenses and hence cannot be identifi ed with a
particular process. These expenses can be apportioned on some suitable basis and charged to the
process.
2) Important aspects an Process Accounts: While preparing process cost accounts, some
important aspects are to be taken into consideration. These aspects are given below.
Normal Loss: Normal loss is a loss, which is inevitable in any process. Thus if the input is 100,
the output may be 95 if the normal loss is anticipated as 5%. Accounting treatment of normal
loss is explained and illustrated in the subsequent paragraphs.
Abnormal Loss/Abnormal Gain: If the actual output is less than the normal output [Normal
output = Input – Normal Loss], the difference between the two is the abnormal loss. On the other
hand if the actual output is more than the normal output, the difference between the two is
abnormal gain. Thus in the example given above, the normal output is 95 which is 100 – 5% of
100 as the normal loss. If the actual output is 93 units, 2 units will be abnormal loss and if the
actual output is 97 units, 2 units will be abnormal gain. Abnormal loss/gain is to be treated
differently and is illustrated subsequently.
Inter Process Profits: Sometimes, while transferring the cost of one process to the subsequent
one, some percentage of profit is added in it. This is called as inter process profits. This is done
when a process is treated as profit center. In such cases, unrealized profit is to be computed and
shown separately. This is also illustrated separately.
Process costing system: is used for manufacturing processes which produce a single product or
single mix of products continuously for an extended period of time. In this system, the cost of a
product or service is obtained by using broad averages to assign costs to mass of similar units
produced for general sale and not for any specific customers
Companies that use process costing system are:
 Cement factories
 Petroleum refineries
 Flour companies
 Beer factories
 Textile factories
 Beverage companies

Difference between job order costing and process costing system.

Base of comparison Job order costing Process costing
Type of product Diversified, heterogeneous Homogeneous products
and unique products produced continuously
Cost accumulation By job for a specified By department or cost center
number of units for a specified period of time
Cost per unit Cost accumulated by job, Cost accumulated by cost
divided by units in job centers divided by equivalent
unit of production during a
period of time
Reporting By job By cost center or department

Most companies have costing system that are neither pure job costing nor pure process costing,
rather they combine elements of both job costing and process costing.

Example 1: Global defense inc. manufactures thousands of components for missiles and
military equipment. We will focuses on the production of one of these components;DG-
19.The process costing system for DG-19 has a single direct cost category (DM) and a single
indirect cost category (conversion cost).Each DG-19 unit passes through two departments,
The assembly department and testing department. Every effort is made to ensure that all DG-
19 units are identical and meet asset of demanding performance specification. Direct material
is added at the beginning of the process in assembly department Additional direct material is
added at the end of the process in testing department when DG_19 component is completed.
Conversion cost is added evenly during both processes. When the testing department finishes
work on each DG-19 componenent, it is immediately transferred to finished goods.
Required: Summarize diagrammatically the above facts

We will use the manufacture of the DG-19 component to illustrate three cases.
Case 1: Process costing with no beginning or ending work in process inventory of DG-19,
that is, all units are started and fully completed by the end of the accounting period. This case
illustrates the basic averaging of cost idea that is a key feature of process costing
Example2: No beginning and ending WIP
On January 1, 2004, there were no beginnings WIP of DG-19 in the assembly department.
During january2004, Global defense started and completed assembly of DG-19 and
transferred out to testing department 400 units.
Physical unit for January 2004
 WIP beginning------------- 0 unit
 Started during January ------- 400 unit
 Completed and transferred --- 400 unit
 WIP ending ------------------ 0 unit
Total cost for January
 DM cost added during January -------$32,000
 Conversion cost added --------------- 24,000
 Total assembly department cost --------56,000
Required: Calculate the average unit cost in the assembly department

Case 2: Process costing with no beginning work in process inventory but an ending work in
process inventory of DG-19, that is some unit of DG-19 started during the accounting period,
is incomplete at the end of the period.
We use 5 steps to compute the unit cost (Average cost in each department)
Step1: summarize the flow of physical units
Physical unit express the physical flow of production. It is a measure of the units of
production that have been started and that may or mat not be completed. It does not consider
the degree of completion.
Physical flow
Beginning WIP -------------------------- XX
Units started ----------------------------- XX
To account -------------------------------XX
Ending WIP-------------------------------XX
Units completed -------------------------XX
Accounted for --------------------------- XX

Step-2: compute output in terms of equivalent units (EU)

Equivalent units measure output in terms of the physical quantity of each of the input (factor
of production) that has been consumed when producing the units. Equivalent units are
computed using physical units. It disregard dollar amount. Equivalent unit of each major
category of production inputs is calculated:
Equivalent unit = physical unit * percentage of completion
Step 3: compute equivalent unite cost
Cost per EU= Production cost
Equivalent
Step4: summarize total cost to account for.
Step 5: Assign total cost to units completed and units in ending WIP.
Example 3: No beginning WIP but some ending WIP
In february2004, Global Defense places another 400 unit of DG-19 in to the assembly
process. Because all units placed in production in January were completely assembled, there
is no beginning WIP on february1, some customers order is late, so not all units started in
February were 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 2004
are:
  Physical unit for february2004:
 WIP beginning(february1) -------------------------- 0 unit
 Started during February ----------------------------- 400 unit
 Completed and transferred out ----------------------175 unit
 WIP ending ( February 29) --------------------------225 unit
 DM (100%complete)
 CC(60%complete)
 Total cost for February:
 DM cost added during February --------------- $32,000
 CC cost added during February ---------------- 18600
 Total assembly department --------------------- 50,600
Required:
a) Summarize the flow of physical unit
b) Compute out put in terms of equivalent unit
c) Compute equivalent unit cost
d) Summarize total cost to account for
e) Assign total cost to units completed and to unit in ending WIP
f) Record the required journal entry

Case 3: Process costing with both beginning and ending work in process inventory of DG-19.
In addition to the five steps used in process costing, we use the two inventory costing methods.
These are:
1. Weighted average method (WA)
 calculate the equivalent unit of cost of all work done to date regardless of the
accounting period it was done
 It merges equivalent unit in beginning WIP with equivalent unit of work done in
the current period.
2. First in first out(FIFO) method:
o Work done on WIP beginning before the current period is kept separate from
work done in the current period.
 o Cost incurred in the current period and units produced in the current period are
used to calculate cost per equivalent unit of work done in the current period

Example4: Some beginning WIP and some ending WIP

At the beginning of March 2004, Global defense had 225 units of partially assembled DG-19 in
the assembly department. It started production of another 275 units in March 2004; data for
assembly department for March are:
Physical units for March 2004
 WIP beginning------------------------------------ 225 unit
DM (100%complete)
CC (60% complete)
 Started during March ---------------------------- 275 unit
 Completed and transferred out -------------------- 400 unit
 WIP ending ----------------------------------------- 100 units
DM 9100%complete)
CC (50%complete)
Total cost for March:
WIP beginning
DM -------------------------$18,000
CC---------------------------- 8,100 ----------$26,100
DM added during March ---------------------------- 19,800
CC added during March ------------------------------ 16,380
Total cost to account for ------------------------------ $62,280
Requirements: using WA &FIFO
a) Summarize the flow of physical unit
b) Compute out put in terms of equivalent unit
c) Compute equivalent unit cost
d) Summarize total cost to account for
e) Assign total cost to units completed and to unit in ending WIP
f) Compare the result under WA &FIFO
g) Record the required journal entry
Transferred in costs in processing costing.
 Many process costing systems have two or more department or processes in the
production cycle.
 Transferred in cost (also called previous department cost) are the cost incurred in
previous department that are carried for ward as the product cost when it moves to a
subsequent process in the production cycle.
 Transferred in cost are treated as if they are a separate type of direct material added at the
beginning of the process.

Example 5: Transferred in cost in process costing

The assembly department of Global defense transfers DG-19 units to its testing department. Here
the units receive additional direct material such as crating and other packing material to prepare
the units for shipment at the end of the process. Conversion costs are added evenly during the
process. As units are completed in testing department, they are immediately transferred to
finished goods
Physical units
WIP beginning ----------------------------- 240 units
TIC (100% complete)
DM (0% complete)
CC (62.5% complete)
Transferred in during April -------------- 400 unit
Completed during April ------------------------- 440 unit
WIP ending ---------------------------------------200 units
TIC (100% complete)
DM (0% complete)
CC (80% complete
Cost for testing department in April
WIP beginning
TIC-------------------------------------- $33,600
DM --------------------------------------- 0
 CC --------------------------------- 18,000
Transferred in during April
WA (Ex3) --------------------------------------- $52,000
FIFO EX3) ------------------------------------- 52,480
Direct material cost added during April --------- 13,200
Conversion cost during April ----------------------- 48,600

Requirements: using WA &FIFO

a) Summarize the flow of physical unit
b) Compute out put in terms of equivalent unit
c) Compute equivalent unit cost
d) Summarize total cost to account for
e) Assign total cost to units completed and to unit in ending WIP
f) Compare the result under WA &FIFO
g) Record the required journal entry
Accounting for Spoilage
Spoilages (Defective): are units of production whether fully or partially completed that don’t
meet the standard required by customers for good units and that are discarded or sold for reduced
price. Example, Defective shirts, shoes, electronic devices.
Types of spoilage
Normal spoilage: is spoilage inherent in a particular production process that arises even under
efficient operating condition. Depending on the production process, management decides the
spoilage it considers normal.
Cost of normal spoilage is typically included as a component of cost of good unit’s manufactured
because good units cannot be made with out also making some units that are spoiled.
Abnormal spoilage: is spoilage that would not arise under efficient operating condition. It is not
inherent in a particular production process. It arises because of machine break down and
operators’ error. Abnormal spoilage is usually avoidable or controllable. Abnormal spoilage cost
is recorded separately and treated as loss of the current year.
Example 6: spoilage using WA and FIFO
ABC Company manufactures a wooden recycling container in its forming department. Direct
materials for this product are added at the beginning of the production cycle. Conversion costs
are added evenly during production. Some units of this product are spoiled as result of defects,
which are detected only up on inspection of finished units. Normally spoiled units are 10% of the
good units completed. That is for 10 good units produced; there is one unit of normal spoilage.
Summery data for July 2003 are:
Physical units for July 2003
WIP beginning ------------------------------------ 1,500 units
DM (100% complete)
CC (60% complete)
Started during July --------------------------- 8,500 unit
Completed and transferred out ---------------- 7,000 unit
WIP ending ------------------------------------- 2,000 units
DM (100% complete)
CC (50% complete)
Total cost for July
WIP beginning
DM --------------------------------- $12,000
CC ----------------------------------- 9,000 -------------- $21,000
Dm cost added during July ------------------------------------------- 76,500
CC cost added during July -------------------------------------------- 89,100
Total cost to account for --------------------------------------------- 189,600
Requirements: using WA &FIFO
a) Identify units of both normal and abnormal spoilage
b) Summarize the flow of physical unit
c) Compute out put in terms of equivalent unit
d) Compute equivalent unit cost
e) Summarize total cost to account for
f) Assign total cost to units completed and to unit in ending WIP
g) Compare the result under WA &FIFO
h) Record the required journal entry
 Job order costing system and spoilage
The concept of spoilage is the same under both job order costing system and process costing.
How ever in Job order costing system, Normal spoilage may be attributable to a specific job or
common to all jobs.
Example18: ABC Furniture Company manufactures and sells house hold and office furniture
During the current fiscal year 10 units become spoiled. The cost of spoiled units is Br.10, 000.
Give the journal entries for the following separate cases
1. If the spoiled units are normal and attributable to specific job and they can be sold at
$4,500

2. If the spoiled units are normal and common to all jobs and they can be sold at $4,500
3. If the spoiled units are abnormal and they can be sold at $4,500

Job order costing system and Rework

Reworks: are units of production that don’t meet the standard required by customers for
finished units that are subsequently repaired and sold as acceptable finished unit.
In job order costing system, like spoilage, they are divided as normal rework attributable to a
specific job, normal rework common to all jobs and abnormal rework.
Example 7: ABC manufacturing company manufactures and sells house holds and office
furniture. Suppose 20 defective units were found at the point of inspection and the following
additional costs are incurred to rework them and sell at normal price.

Direct material ------------------ Br.1050

Direct labor cost ----------------- 950
MOH cost ---------------------------- 650
Required: Record the journal entry under each of the following cases
1. If the rework is normal rework attributable to specific job
2. If the rework is normal rework common to all jobs
3. If the rework is normal rework.
 Job order costing system and scraps
Scrapes: are materials left over when making a product .They have low sales value compared
with the sales value of the main products. Example, short lengths from wood working operations,
frayed cloth etc.
The are two accounting methods with regard to the timing of recognition of scrape in the
accounting record. These are the production method and the sales method.
1. Recognizing scrap at the time of production
The value of scrape may be recognized at the time of production
 When the amount of scrape is huge and scrapes needs proper accounting.
 When the time between production and sales is long and scrape material is to be stored in
ware house.
Example 8: ABC furniture company produce and sell house hold and office furniture. The value
of a wood shaving created (scrap) when lumber is processed is recorded at the time of
production. The value of this scrap on a specific balance sheet date was $3,000
1. Record the value of scrap on the date of production if it is attributable to a specific
job
2. Record the value of scrap on the date of production if it is common to all jobs
3. Record the sale of $2000 of scraps if it is attributable to a specific job
4. Record the sale of $2,000 of scraps if it is common to all jobs
5. Assume a scrape of$1000 is reused in the production process, record the journal
entry
2. Recognizing scrape at the time of sales.
This method is used when the sales value of the scrape is immaterial and the time between
production and sell is too short.
Example 22: Assuming the above Br.3000 scrape is immaterial and is to be recored using the
sales method
a. Give the journal entry for the sales of Br2000 scrape, if it attributable to a specific
job.
b. Give the journal entry for the sales of Br2000 scrape, if it is common to all jobs.
Assignment
Problem 1: ABC Electronics Company has two departments to manufacture computers,
Assembly and testing departments. First component parts are assembled in assembly department
and then transferred out to testing department. Direct materials are added some where in between
the assembly process but conversion costs are added evenly through out the assembly process.
The company uses process costing system. The following data are for the month of January for
assembly department.
Physical units Direct material Conversion cost
Beginning WIP 400 $2,484,000 $464,000
Started in the month 2,500
Completed units 2,300
Cost added during the month 16,100,000 6,960,000

Additional information
 There are 200 spoiled units 50% of which is abnormal
 Degree of completion –Beginning WIP
 Direct material (90% complete)
 Conversion cost (40% complete)
 Degree of completion –Ending WIP
 Direct material (60% complete)
 Conversion cost (30% complete)
Requirements: Under FIFO method
a) Summarize the flow of physical units
b) Compute equivalent unit in terms of each cost
c) Compute cost per equivalent unit
d) Assign the cost to units completed and WIP ending
e) Pass the necessary journal entries
Problem 2: The following data pertain to Milan tire and Rubber Company for the month of May.
WIP may1 (units) ?
Units started during may 60,000
Total units to account for 75,000
Units completed and transferred out ?
WIP may 31 ( in units) 10,000
Total equivalent units: Direct material 75,000
Total equivalent units: Conversion cost ?
WIP may 1:Direct material Br 135,000
WIP may 1:Conversion cost ?
Cost incurred during may: Direct material ?
Cost incurred during may: Conversion cost Br 832,250
WIP may1;Total cost Br 172,500
Cost per equivalent: Direct material Br 9.4
Cost per equivalent: Conversion ?
Total cost per equivalent unit Br 21.65

Additional information
 Direct material and conversion activities occurs uniformly through out the process
 Milan uses weighted average process costing
 The may 1 WIP was 100% complete for direct material and 20% complete for conversion
cost
Required:
Prepare production report for the month of May, the report should show
1. Units to account for ,units accounted for and percentage of completion
2. Equivalent unit of production
3. Total cost to account for
4. Cost per equivalent
5. Cost of completed and transferred out and cost of ending WIP inventory.
 CHAPTER 6
JIONT PRODUCT AND BY PRODUCTS

Meaning of terms
 Joint product: are products which are processed and manufactured in the same
processes

o Raw milk: cream & liquid skim

o Coal: Ammonia, coke, Gas, Benzene, tare
o Petroleum: crude oil, gas, raw LPG
o Salt: Hydrogen, chlorine, caustic soda
 Joint cost is the cost of a single process that yields multiple products (joint products)
simultaneously.
 Split off point is the junction in the process when one or more products in a joint
setting become separately identified.
 Separable cost is costs incurred beyond the spilt off point to further process each joint
product separately.
 Main product is a joint product having high sales value
 Byproduct s are joint products having low sales value compared to the main product
Approaches to allocating joint cost
The benefit received criteria is used to allocate joint cost to the joint products.
There are four methods of allocating joint cost. These are:
 Physical measure method: allocates joint cost on the bases of their relative
proportion at the split off point using a common physical measure such as weight or
volume
 Sales value at split off point method: allocates joint cost on the bases of the relative
sales value at the split off point of each product.
 Estimated neat realizable value method: allocates joint cost on the basis of there
relative estimated net realizable value.
Net realizable value= final sales value – separable cost
  Constant gross margin percentage neat realizable value method: allocates joint
cost in such away that the over all gross margin percentage is identical for all the
individual products
Steps to use this method
1. Compute the over all gross margin percentage for all sales value
2. Use this gross margin percentage to find gross margin of each product
3. Deduct separable cost from cost of goods available for sale
Among the four methods, the sales value at split of method is better when sales value data are
available because of the following reasons
 It does not require information after split off point
 Availability of meaningful basis to allocate joint cost to products
 Simplicity to compute

 It measures the value of joint product immediately at the end of the joint process
Example1: Farmers’ dairy purchases raw milk from individual farmers and process it up to
the split off point, where two products (cream and liquid skim) are obtained. The two
products are sold to an independent company, which markets and distribute them to super
markets and other retail outlets.

110 gallon of raw milk yields 100 gallon of good product with 10-gallon shrinkage.

Products Gallons produced sales

Cream 25 gallons 20 gallons at $8 per gallon
Liquid skim 75 gallons 30 gallons at $4 per gallon

Cost of purchasing 110 gallons of raw milk and processing it up to split of point to yield 25
gallon of cream and 75 gallon of liquid skim is $400.
Requirements:
I. Show the process diagrammatically
II. Allocate the joint cost using physical measure method and prepare partial income
statement.
 III. Allocate the joint cost using sales value at split off method and prepare partial income
statement.
Example2: Assume the same situation as in example one except that both cream and liquid
skim can be processed further.
Additional information:
 25 gallons of cream are further processed to yield 20 gallons of butter cream at
additional processing separable cost of $280.
 Butter cream is sold for $25 per gallon
 75 gallons of liquid skim are further processed to yield 50 gallons of condensed milk
at additional processing separable cost of $520.
 Condensed milk is sold for $22 per gallon
 Sales during The accounting period were 12 gallons of butter cream and 45 gallons of
condensed milk.

Requirements:
I. Show the process diagrammatically
II. Allocate the joint cost using ENRV method and prepare partial income
statement.
III. Allocate the joint cost using constant GM method and prepare partial income
statement.
IV. Prepare income statement without allocating the joint cost (no allocation of the
joint cost)

Irrelevance of joint cost for sell or process further decision making

The decision to sell at the split of point or process further should be based on incremental
operating income attainable beyond the split of point. The joint cost incurred up to the split of
point is irrelevant for such decision.

Example3: Do farmers dairy sell at the split of point or process further the two products in
example two above? Make analysis
 Accounting for by products
By products are joint products that have low sales value compared to the main product. There are
two accounting methods for by products
 Production method: recognize by products in the financial statement at the time
production is completed as a cost reduction.
 Sales method: recognizes by products in the financial statement at the time when the
byproduct is sold as a separate income
Example 4: A company is engaged in processing meat from slaughter house. One of its
department cuts lump shoulder and generates two products
 Shoulder meat (The main product) ---sold for Br 60 per pack
 Hock meat (The by product) ---------sold for Br 4 per pack
Both products are sold at the split off point with out further processing .Data for this department
in July 2004 is as follows
Beg. Inventory production sales End. inventory
Shoulder meat(in pack) 0 500 400 100
Hock meat( in pack) 0 100 30 70

The total manufacturing cost of the products were Br25, 000

Requirements
I. Show the process using diagram
II. What is the gross profit under the two methods
III. What is the inventory amount to be reported in balance sheet under each method
IV. Which method do you recommend for the company

Assignment
Problem 1: Chicago Company operates a simple chemical process to convert a single material in
to three separate products referred to as X, Y and Z. All the three products are separated
simultaneously at single split off point.
All the three products can be sold at split of point but X and Y can also be further processed with
out loss in units to super X and super Y respectively
The table below presents operating budget for Chicago Company for the year 2007
products Units produced Units sold Selling price Further Selling price per
(in tones) (In tones) at split off point processing tone after further
per tone cost processed
X 300 180 $150 $10,000 $200
Y 420 340 100 $25,000 150
Z 480 400 70 - -
The total joint cost incurred to process the three products up to the split off point for the year was
$40,000 .There were no beginning inventory of product X, Y and Z.

Requirements
a) Allocate the joint cost to the three products using
1. Physical measure method
2. sales value at split of method
3. Neat realizable value method
4. constant gross margin- NRV method
b) Prepare income statement for the three products under each of the above method
c) Should product X and Y be sold at split off point or processed further? .Make analysis

Chapter seven
Income effect of alternative inventory costing system
The three main production costs are direct material cost, direct labor cost and manufacturing
overhead cost. Most of the time ,direct material cost ,direct labor cost and some manufacturing
over head cost are variable in nature where as some manufacturing over head cost such as
depreciation, plant insurance are fixed in amount.

Inventory cost methods

There are three types of inventory costing methods
1. Absorption (Full costing): is the traditional method of inventory costing where all
production costs i.e. both variable and fixed costs are assigned to inventory cost.
2. Direct (Variable or marginal costing) is a method of inventory costing in which all
variable production costs are included as inventor able costs. All fixed manufacturing
costs are excluded from inventor able cost.
3. Through put (Super variable) costing: is a costing method that treats all costs except those
related to variable direct material as expense. The only inventor able cost is direct
material cost

Income statement under alternative costing system

The measurement of net income under the three costing method differs. The difference result
from the amount of fixed manufactured over head cost. In general, the income measurements
under the three methods will differ when production and sales amount differs.
 If production is equal to sales, the operating income under absorption costing is the
same as operating income under direct costing
 If production is greater than sales, the operating income under absorption costing is
greater than operating income under direct costing
 If production is less than sales, the operating income under absorption costing is less
than operating income under direct costing

Format of Absorption costing income statement

Sales ----------------------------- XX
Cost of goods sold
Direct material ---------- xx
Direct labor ------------ xx
Variable MOH ---------- xx
Fixed MOH -------------- xx XX
Gross profit ----------------------- XX
Variable operating expense --------xx
Fixed operating expense ----------- xx
 Operating income ------------------- XX

Format of direct costing income statement

Sales revenue ----------------------- XX
Variable cost
Direct material -------------- xx
Direct labor ---------------- xx
Variable MOH ---------------xx
Variable expense ------------ xx XX
Contribution margin ------------------ XX
Fixed MOH cost ---------------------- XX
Fixed operating expense ---------------XX
Operating income ----------------------- XX

Format of through put costing income statement

Sales revenue ------------------------ XX
Direct material cost ------------------XX
Through put contribution ---------- XX
Direct labor cost ----------- xx
Variable MOH cost -------- xx
Fixed MOH cost ------------ xx
Variable operating expense --xx
Fixed operating expense ------xx XX
Operating income ------------------------XX

Comparison between the three costing systems

Items of comparison Absorption costing Direct costing Through put costing
Direct material Product cost Product cost Product cost
Direct labor Product cost Product cost periodic cost
Variable MOH Product cost Product cost periodic cost
Fixed MOH Product cost periodic cost periodic cost
Variable Op.Exp. periodic cost periodic cost periodic cost
Fixed Op. Exp. periodic cost periodic cost periodic cost
GAAP Acceptable Not Acceptable Not Acceptable
Usefulness For external report For internal report For internal report
Performance eval. Not useful useful useful
Terms used Gross profit Contribution margin Through put cont.
If Sales= prod. ,NI Equal Equal Equal
If Sales < prod., NI Higher medium lower
If Sales >prod., NI lower medium Higher

Example1: NASCAR motors assemble and sell motor vehicles. It uses an actual costing system
in which unit cost is calculated on monthly basis. Data relating to April and may of 2005 are
given in the table below.

April May
Unit data
 Beginning inventory 0 unit 150 unit
 Production 500 unit 400 unit
 Sales 350 unit 520 unit
Variable cost per unit
 Direct material $6,700 $6,700
 Direct labor 1,500 1,500
 MOH cost 1,800 1,800
 Marketing 3,000 3,000
Fixed cost data
 MOH cost $2,000,000 $2,000,000
 Marketing 600,000 600,000
Selling price of each motor vehicle is Br24, 000
Requirements:
a) Calculate the inventor able cost producing each unit under
1. Absorption costing
2. Direct costing
3. Through put costing
b) Present income statement for the two months under
4. Absorption costing
5. Direct costing
6. Through put costing
4. Explain the difference between absorption costing income and direct costing income

Assignment
Problem 1: The following information relates to the operation of Sanfransisco Company for the
year 2004.
Selling price $20
Units produced 10,000
Unit sold 8,000
Total DM cost $40,000
Total DL cost $20,000
Total VMOH cost $60,000
Total FMOH cost $25,000
V. marketing expense $4,500
F.marketing expense $25,000

Requirement: prepare income statement using

1. Absorption costing
2. Direct costing
3. Through put costing