Managerial Accounting- 4

Prince Doliya
Review the Last Class
 Use this to Prepare a cost Sheet

Cost Sheet Total Cost of Production Per Unit

Direct materials consumed:

ADD Direct employee (labour) cost
ADD Direct expenses

Prime Cost
ADD Factory Overhead

Cost of Production
ADD Opening Stock of finished Goods
Less Clsoing Stock of Finished Goods

Cost of Goods Sold

Add Admin Overhead

Add Administrative Overheads (General) xxx

Add Add: Marketing Overheads :

Add Selling Overheads xxx

Add Distribution Overheads xxx

Cost of Sales
 1 Direct materials consumed: Total Cost (`)

Opening Stock of Raw Material xxx

Add: Additions/ Purchases xxx

Less: Closing stock of Raw Material xxx

Direct employee (labour) cost xxx

Direct expenses xxx

Prime Cost

Add: Works/ Factory Overheads xxx

Gross Works Cost (4+5) xxx

Add: Opening Work in Process xxx

Less: Closing Work in Process (xxx)

Works/ Factory Cost (6+7-8) xxx

Add: Quality Control Cost xxx

Add: Research and Development Cost xxx

12. Add: Administrative Overheads (relating to production activity)

13. Less: Credit for Recoveries/Scrap/By-Products/misc. income

14. Add: Packing cost (primary) xxx

15. Cost of Production (9+10+11+12-13+14) xxx (----)

16. Add: Opening stock of finished goods xxx

17. Less: Closing stock of finished goods (xxx)

18. Cost of Goods Sold (15+16-17) xxx

19. Add: Administrative Overheads (General) xxx

20. Add: Marketing Overheads :

Selling Overheads xxx

Distribution Overheads xxx

21. Cost of Sales (18+19+20) xxx

Connect with Financial Accounting
Product and Period Costs
• Product Costs
• Costs assigned to goods produced (i.e. direct materials,
direct labor, and manufacturing overhead)
• Included in inventory until goods sold
• Period Costs
• Costs identified with accounting periods (i.e selling and
administrative expenses)
• Expensed in period incurred
Relationships Among Cost Categories
Test Your Knowledge
 Test Your Knowledge 1

Which of the following is not a product cost?

a. Depreciation on manufacturing
equipment
b.Indirect materials
c. Insurance on manufacturing equipment
d.Bonuses compensation to the company
president

Answer:
d. Bonuses compensation to the company president
(administrative expense)
 Test Your Knowledge 2

Which of the following is a period cost?

a.Raw materials costs
b.Manufacturing plant maintenance
c. Depreciation on plant equipment
d.Depreciation on salespersons’ laptops

Answer:
d. Depreciation on salespersons’ laptops (selling
expense)
 Test Your Knowledge 3

Which of the following is a direct materials cost?

a. Steel for a ship builder
b. Postage and supplies in the mailroom
c. Factory rent
d. Wages for production line workers

Answer:
a. Steel for a ship builder
 Example
The following information has been obtained from the records of ABC Corporation for the period from June 1 to June
30.

June 1 Jun-30

Cost of raw materials 60,000 50,000

Cost of work-in-process 12,000 15,000
Cost of stock of finished goods 90,000 1,10,000
Purchase of raw materials during June 2020 4,80,000
Wages paid 2,40,000
Factory overheads 1,00,000
Administration overheads (related to production) 50,000
Selling & distribution overheads 25,000
Sales 10,00,000

PREPARE a statement giving the following information

(a) Raw materials consumed; (b) Prime cost; (c) Factory cost; (d) Cost of goods sold; and (e) Net profit.
 Product Cost in Financial Reporting/Decision
Making
• Manufacturing companies use product costs to prepare financial
statements and for managerial decisions
• Often the cost information needed is different for the two purposes
• Decision making relies on incremental analysis – an analysis of the revenues and expenses that
will actually increase or decrease as a result of the decision
• You will need to separate the variable and fixed costs to do an incremental analysis
 Flow of Product Costs

Slide 2-14 Learning objective 3: Describe the flow of product costs in a manufacturing firm’s accounts
 Flow of Product Costs in Accounts
1. Purchased materials
2. Requisitioned direct and indirect materials
3. Incurred and paid for direct and indirect labor
4. Incurred and paid other overhead costs
5. Overhead applied
6. Completed goods transferred to finished goods inventory
7. Finished goods sold

Raw Materials Cash Overhead

1. Materials
1. Materials 2. Materials 2. Indirect materials 5. Applied overhead
purchased
purchased used 3. Indirect labor
3. Total labor
4. Other overhead
4. Other
overhead
Work in Process Finished Goods COGS
2. Direct materials 6. Goods 6. Goods 7. Goods sold 7. Goods sold
3. Direct labor finished finished
5. Applied overhead
Income Statement Presentation of Product Costs
Income Statement Presentation of Product Costs
Job Order versus Process Costing

• Job Order Costing

• Companies produce goods to a customer’s unique specifications
• Cost of job accumulated on job cost sheet
• Process Costing
• Companies produce large quantities of identical items
• Cost accumulated by each operation
• Unit cost of items determined dividing costs of production by number of
units produced
Relating Product Costs to Jobs

Learning objective 5: Explain the relation between the cost of jobs and
Slide 2-20the Work in Process Inventory, Finished Goods Inventory, and Cost of
Goods Sold accounts
 Job Order Costing System
• Job order costing begins when a company decides to produce a specific
product
• A job cost sheet accumulates the cost of the item or items and contains
detailed information on the three categories of product costs
• Direct materials
• Direct labor
• Manufacturing overhead
• The next slide shows an example of a job cost sheet

Slide Learning
2-21 objective 6: Describe how direct material, direct labor, and
manufacturing overhead are assigned to jobs
Job Cost Sheet
 Job Costs – Direct Materials
• A materials requisition form is used to request the release of materials
from a company’s storage area
• Removal of materials from storage for use on a specific job decreases
Raw Materials and increases Work in Process Inventory
• The next slide illustrates the journal entry and general ledger postings
assuming $60,000 of materials are issued to specific jobs

Slide 2-23
Job Costs – Direct Materials
Requisition of raw materials for use on a specific job
 Job Costs – Direct Labor

• Workers in a company that uses a job-order costing system fill out time
tickets to keep track of the amount of time spent on each job

• Incurring direct labor costs increases Work in Process Inventory and

increases Wages Payable
• The next slide illustrates the journal entry and general ledger postings
assuming $10,000 of direct labor cost is incurred
Job Costs – Direct Labor
Cost of direct labor related to a particular job

Slide 2-26 Learning objective 6: Describe how direct material, direct labor, and
manufacturing overhead are assigned to jobs
 Job Costs –
Manufacturing Overhead

• Apply manufacturing overhead to jobs

• Choose an allocation base, for example direct labor hours or direct labor cost

• Calculate overhead allocation rate

• Estimated overhead divided by estimated quantity of the allocation base

• Use rate to apply overhead to jobs based on actual quantity of base used
Overhead Allocation Rates

• Overhead is made up of cost items indirectly related to jobs produced

• Need to develop means of assigning overhead to jobs

• The rate is calculated as overhead cost divided by allocation base
• A company had $50,000 of overhead cost and used 10,000 labor hours
• Their rate is $50,000 / 10,000 = $5 per labor hour
Overhead Allocation Bases
• Choices of allocation bases include:
• Direct labor hours
• Direct labor cost
• Machine hours
• Direct material cost, among others
• Jobs with greater quantities of an allocation base will receive larger
allocations of overhead
• The allocation base used should be strongly associated with overhead
cost
 Test Your Knowledge 7
Lollah Mfg Company expects annual mfg. overhead to be $800,000, 50,000 direct labor
hours costing $1,600,000 and machine run time of 25,000 hours. Calculate overhead
allocation rates based on direct labor hours, direct labor cost, and machine time.
Overhead allocation rate based on direct labor hours
$800,000 / 50,000 = $16 per direct labor hour

Overhead allocation rate based on direct labor cost

$800,000 / $1,600,000 = 50% of direct labor cost

Overhead allocation rate based on machine time

$800,000 / 25,000 = $32 per machine hour
 Predetermined Overhead Rates
• Companies can develop rates using actual overhead and quantities of the
base
• Most do not do this because actual costs are not known until the end of the period
• Overhead rates are typically based on estimates of overhead cost and the
base
• Overhead rates calculated this way are called predetermined overhead rates
Overapplied Overhead
Manufacturing Overhead
Actual overhead Overhead costs
costs incurred applied to jobs

Ending Balance

• If applied overhead is greater than actual overhead, overhead

is overapplied
• Overapplied overhead is eliminated at the end of the period
as follows:
• If a small amount, debit Manufacturing Overhead and credit
Cost of Goods Sold
• If relatively large amount, apportion and close to Work in
Process, Finished Goods and COGS
Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rate is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
SlideInventory,
Finished Goods 2-32 and Cost of Goods Sold
Underapplied Overhead
Manufacturing Overhead
Actual overhead Overhead costs
costs incurred applied to jobs

Ending Balance

• If actual overhead is greater than applied overhead, overhead

is underapplied
• Underapplied overhead is eliminated at the end of the period
as follows:
• If a small amount, debit Cost of Goods Sold and credit
Manufacturing Overhead
• If a relatively large amount, apportion and close to Work in
Process, Finished Goods and COGS

Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rateSlide 2-33
is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold
Activity Based Costing (ABC)
• Most firms use a single overhead rate
• Activity Based Costing (ABC) assigns overhead costs to products
using a number of allocation bases
• The major activities which create overhead costs are identified and
grouped (pools)
• Multiple rates calculated by dividing each pool by its corresponding
activity (driver)
 Test Your Knowledge 8

Overapplied overhead is:

a. Overhead applied to production greater than
actual overhead
b. Overhead in excess of standard overhead
c. Equal to the predetermined overhead rate
d. Overhead in excess of the amount in the
previous period

Answer:
a. Overhead applied to production greater than actual
overhead

Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rateSlide 2-35
is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold
 Test Your Knowledge 9
Actual overhead was $1,500.000. The
predetermined overhead rate was $17 per direct
labor hour, and there were 100,000 direct labor
hours. Overhead was:
a. Underapplied by $200,000
b. Overapplied by $200,000
c. Underapplied by $20,000
d. Overapplied by $20,000

Answer:
b. Applied overhead = 100,000 X $17 = $1,700,000. Actual
minus applied = 1,500,000 – 1,700,000 = 200,000
overapplied

Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rateSlide 2-36
is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold
Eliminating Overapplied or
Underapplied Overhead
• Suppose a company had $50,000 of actual overhead
and applied $48,000
• Overhead is underapplied by $2,000
• The journal entry to close manufacturing overhead

Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rateSlide 2-37
is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold
Eliminating Overapplied or
Underapplied Overhead
• The amount of under- or overapplied overhead should be
apportioned among Work in Process, Finished Goods and
Cost of Goods Sold
• Accomplished based on relative costs in the accounts
• The company from the previous slide has Work in Process
of $10,000, Finished Goods $10,000 and Cost of Goods Sold
$20,000
• Rate is 2,000 / (10,000 + 10,000 + 20,000) = $0.05 per dollar
in the account

Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rateSlide 2-38
is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold
Eliminating Overapplied or
Underapplied Overhead
• The amount applied to each account is:
• Work in Process $10,000 * 0.05 = $500
• Finished Goods $10,000 * 0.05 = $500
• Cost of Goods Sold $20,000 * 0.05 = $1,000
• The journal entry to close manufacturing overhead

Learning objective 8: Explain why the difference between actual overhead and overhead allocated to jobs
using a predetermined rateSlide 2-39
is closed to Cost of Goods Sold or is apportioned among Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold
Job-Order Costing for Service Companies
• Service companies use the same process
• Allocate costs incurred to jobs
• Use predetermined rate to apply overhead to jobs
• Examples
• Hospitals
• Repair Shops
• Consulting Firms

Slide 2-40objective 9: Explain how service companies can use job order costing to
Learning
calculate the cost of services provided to customers
Service Company Example
• ICMS has a contract with VOIP Communications
• Contract is for $4.2 million per year or $350,000 per month
• ICMS needs to determine the cost of providing services to VOIP
• The details follow on the next slide

Slide 2-41
Job-Order Cost for Call Center
Customer Profitability
• Is VOIP a profitable customer?
• Cost of the job is $337,108.05
• Monthly revenue is $350,000
• Profit from the job is $12,891.95
• Markup is only 3.8%, which is lower than the company’s goal of 30%
• This information is useful the next time the contract is up for negotiation,
especially if VOIP presses for price concessions!

Slide 2-43objective 9: Explain how service companies can use job order costing to
Learning
calculate the cost of services provided to customers
 Modern Manufacturing Practices
▪ Just-in-Time Production (JIT)
▪ Minimize raw materials and work in
process inventories
▪ Develop flexible, balanced production
that is flexible and allows for smooth,
rapid flow of materials
▪ Concentrate on improving quality
▪ Implications for over- and underapplied
overhead
▪ Work in Process and Finished Goods
Inventories are very small
▪ Close difference into Cost of Goods Sold

Slide 2-44 Learning objective 10: Discuss modern manufacturing practices

and how they affect product costing
 Modern Manufacturing Practices
▪ Computer-Controlled Manufacturing
▪ Use computers (including robots) to
control equipment and achieve flexible
and accurate production process
▪ Lean Manufacturing
▪ Similar to JIT
▪ JIT focus is inventory management
▪ Lean focus is elimination of waste
▪ Total Quality Management (TQM)
▪ Ensure products are of highest quality
▪ Production processes are efficient

Slide 2-45 Learning objective 10: Discuss modern manufacturing practices

and how they affect product costing
Decision Making / Incremental Analysis
• The incremental profit of the job is $4,894.10, which
is the $37,021 the customer will pay minus the
incremental cost of $32,126.90
• Turning the job down would hurt financial
performance
• The incremental revenues are higher than the incremental
costs
Full and Incremental Cost

Slide 2-47 Learning objective 10: Discuss modern manufacturing practices

and how they affect product costing