Principles of MANAGEMENT

ACCOUNTING

Prof. Dr. Xavier Gabriëls

(Xavier.Gabriels@uantwerpen.be)

1
 Classes 4 & 5

Cost calculation problems in a

manufacturing environment
principles
- Service department cost allocation
- By-product and joint product costing
- BOM and factory ledger
- Job order costing
- Process costing 2
 Service Department Cost
Allocation
First Stage Allocations
Service Service department costs are allocated
to production departments.
Department
(Cafeteria) Production
Department
Service (Machining)
The
Department
Product
(Accounting) Production
Department
Service (Assembly)
Department
(Personnel) 3
 Service Department Cost
Allocation (2)
Service
Department
(Cafeteria) Production
Department
Service (Machining)
The
Department
Product
(Accounting) Production
Department
Service (Assembly)
Second Stage Allocations
Departmentdepartment overhead costs, plus allocated service
Production
(Personnel)
department costs, are applied to products using
departmental predetermined overhead rates. 4
 Selecting Allocation Bases

Personnel: Typical Custodial:

Number of Allocation Square
employees footage
Bases
Receiving: Cafeteria:
Units Number of
handled employees

Security: Accounting: Power:

Square Staff Kilowatt
footage hours hours 5
 Interdepartmental Services
Service
Department Production
(Cafeteria) Department
(Machining)

POWER DEPARTMENT

Production
Service Department
Department (Assembly)
(Custodial)
6
 Interdepartmental Services (2)

Problem
Allocating costs when service departments
provide services to each other

Solutions
Direct Method
Stepwise Method
7
 Direct Method

Service Production
Cost of services Department Department
between service (Cafeteria) (Machining)
departments are
ignored and all
costs are
allocated directly
to production Service Production
departments. Department Department
(Custodial) (Assembly)

8
 Direct Method: Example
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Number of employees 15 10 20 30
Square feet occupied 5.000 2.000 25.000 50.000

Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied

9
 Direct Method: Example (2)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 144.000 ?
Custodial allocation ? ? ?
Total after allocation $ 0

20
$360.000 × = $144.000
20 + 30

Allocation base: Number of employees

10
 Direct Method: Example (3)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 144.000 216.000
Custodial allocation ? ? ?
Total after allocation $ 0

30
$360.000 × = $216.000
20 + 30

Allocation base: Number of employees 11

 Direct Method: Example (4)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 144.000 216.000
Custodial allocation (90.000) 30.000 ?
Total after allocation $ 0 $ 0 $ 574.000

25.000
$90.000 × = $30.000
25.000 + 50.000

Allocation base: Square feet occupied

12
 Direct Method: Example (5)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 144.000 216.000
Custodial allocation (90.000) 30.000 60.000
Total after allocation $ 0 $ 0 $ 574.000 $ 976.000

50.000
$90.000 × = $60.000
25.000 + 50.000

Allocation base: Square feet occupied

13
 Stepwise Method

Service department
costs are allocated
Service Production
to other service Department Department
departments and (Cafeteria) (Machining)
to production
departments, usually
starting with the
service department
that serves the Service Production
largest number of Department Department
other service (Custodial) (Assembly)
departments.

14
 Stepwise Method (2)

Service Production
Department Department
Once a service
(Cafeteria) (Machining)
department’s costs
are allocated,
other service
departments’ costs
are not allocated
back to it. Service Production
Department Department
(Custodial) (Assembly)

15
 Stepwise Method (3)

Service Production
Department Department
Custodial will (Cafeteria) (Machining)
have a new
total to allocate
to production
departments: its
own costs plus
those costs Service Production
allocated from Department Department
the cafeteria. (Custodial) (Assembly)

16
 Stepwise Method: Example

We will use the same data used in the direct method example.

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Number of employees 15 10 20 30
Square feet occupied 5.000 2.000 25.000 50.000

Service Dpt. Relative share Highest

relative
Cafeteria => Custodial 10/60 = 1/6
share =>
Custodial => Cafeteria 5.000/80.000 = 1/16
allocate first
17
 Stepwise Method: Example (2)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 60.000 ? ?
Custodial allocation ? ? ?
Total after allocation $ 0

10
$360.000 × = $60.000
10 + 20 + 30

Allocation base: Number of employees

18
 Stepwise Method: Example (3)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 60.000 120.000 ?
Custodial allocation ? ? ?
Total after allocation $ 0

20
$360.000 × = $120.000
10 + 20 + 30

Allocation base: Number of employees

19
 Stepwise Method: Example (4)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 60.000 120.000 180.000
Custodial allocation ? ? ?
Total after allocation $ 0

30
$360.000 × = $180.000
10 + 20 + 30

Allocation base: Number of employees 20

 Stepwise Method: Example (5)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 60.000 120.000 180.000
Custodial allocation (150.000) ? ?
Total after allocation $ 0 $ 0

New total = $90.000 original custodial cost

plus $60.000 allocated from the cafeteria.

21
 Stepwise Method: Example (6)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 60.000 120.000 180.000
Custodial allocation (150.000) 50.000 ?
Total after allocation $ 0 $ 0 $ 570.000

25.000
$150.000 × = $50.000
25.000 + 50.000

Allocation base: Square feet occupied

22
 Stepwise Method: Example (7)
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Cafeteria allocation (360.000) 60.000 120.000 180.000
Custodial allocation (150.000) 50.000 100.000
Total after allocation $ 0 $ 0 $ 570.000 $ 980.000

50.000
$150.000 × = $100.000
25.000 + 50.000

Allocation base: Square feet occupied

23
 Comparison of Methods

Totals after allocation

Machining Assembly
Method Department Department
Direct $ 574.000 $ 976.000
Stepwise 570.000 980.000

24
 Reciprocal Method

Production-
Service dept.
Costs of service department
departments are (Machining)
(Cafeteria)
allocated to both
the other service
departments and
production
departments. Service Production-
Department dept.
(Custodial) (Assembly)

25
 Reciprocal Method: Example

Service Dpt. Production Dept.

Cafeteria Custodial Machining Assembly
Dept. Costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
# employees 15 10 20 30
# square feet 5.000 2.000 25.000 50.000

Service Dpt. Relative share

Cafeteria => Custodial 10/60 = 1/6
Custodial => Cafeteria 5.000/80.000 = 1/16
26
Reciprocal Method: Example (2)

System of equations :
Cafeteria (A) = 1/16 B + 360.000
Custodial (B) = 1/6 A + 90.000
⇔
Cafeteria (A) = 369.473,70
Custodial (B) = 151.579

27
 Reciprocal Method: Example (3)

Cafeteria Custodial Machining Assembly

Dept. Costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Allocation Cafeteria (369.474) 61.579 123.158 184.737
Allocation Custodial 9.474 ? ? ?
Total after allocation ? ? ? ?

30
$369.474 = $184.737
× 20 + 30 +
10
Allocation base: Number of employees 28
 Reciprocal Method: Example (4)

Service Dpt. Production Dpt.

Cafeteria Custodial Machining Assembly
Dept. Costs
before allocation $ 360.000 $ 90.000 $ 400.000 $ 700.000
Allocation Cafeteria (369.474) 61.579 123.158 184.737
Allocation Custodial 9.474 (151.579) 47.368 94.737
Totaal na verdeling $ 0 $ 0 $ 570.526 $ 979.474

50.000
$151.579 × = $94.737
5.000 + 25.000 + 50.000

Allocation base : # square feet 29

Comparison of Methods
Totals after allocation
Method Machining Assembly
Direct $ 574.000 $ 976.000
Step 570.000 980.000
Reciprocal 570.526 979.474

30
 Joint Product Processes
A number of products are produced
from a single raw material input.
Product 1

Single Input Product 2

Product 3 31
 Joint Product Processes (2)
Concept: in some industries, a number of products are
produced from a single raw material input.
Key terms:
 Joint products – products resulting from a process with a
common input.
 Split-off point – the stage of processing where joint products are
separated.
 Joint cost – costs of processing joint products prior to the split-
off point.
 Final product – ready for sale without further processing.

 Intermediate product – requires further processing before sale.

32
Joint Product Cost Allocation

Consider the following

example of an oil
refinery.
We will assume only
two products,
gasoline and oil.

33
 Joint Product Cost Allocation (2)
Joint
Product
Separate Final
Costs Oil
Processing Sale

Joint Separate
Joint Production
Input Processing Costs
Process

Gasoline Separate Final

Processing Sale

Split-Off Separate
Point Processing Costs
34
 Joint Cost Allocation Methods
Physical Monetary
measure method measure method

Joint costs are

Joint costs are
allocated based on a
allocated based on
proportional measure
the relative values
(weight, volume, etc.) of
of the products at the
the joint products at the
split-off point.
split-off point.

35
Joint Cost Allocation Methods (2)

Let’s look at an example

illustrating the joint cost
allocation methods.

36
 Physical Measure Method

The physical measure method may be used when

Output product prices are highly volatile.
Many additional processes occur between the split-off point
and the first point of marketability.
Market prices are unavailable for products such as on cost-
plus contracts.

37
 Physical Measure Method (2)
Joint
Costs Oil 240.000 gallons

Common
Joint Production
Input Process

Gasoline 360.000 gallons

Split-Off
Point 38
 Physical Measure Method (3)
Joint conversion
cost = $225.000 Oil 240.000 gallons

Common
Joint material Production
cost = $275.000 Process

Gasoline 360.000 gallons

Split-Off
Point 39
 Physical Measure Method (4)

Product
Oil Gasoline Total
Output quantities in gallons 240.000 360.000 600.000
Proportionate share:
?
?
Allocated joint costs:
?
?

40
 Physical Measure Method (5)

Product
Oil Gasoline Total
Output quantities in gallons 240.000 360.000 600.000
Proportionate share:
240.000 ÷ 600.000 40%
360.000 ÷ 600.000 60%
Allocated joint costs:
?
?

41
 Physical Measure Method (6)
Product
Oil Gasoline Total
Output quantities in gallons 240.000 360.000 600.000
Proportionate share:
240.000 ÷ 600.000 40%
360.000 ÷ 600.000 60%
Allocated joint costs:
$500.000 × 40% $ 200.000
$500.000 × 60% $ 300.000

$275.000 joint material cost plus

$225.000 joint conversion cost 42
 Monetary Measure Method
Net Realizable Value
If products require further processing beyond
the split-off point before they are marketable,
it may be necessary to estimate the net
realizable value (NRV) at the split-off point.
Final Added
NRV = Sales – Processing
Value Costs

43
 Monetary Measure Method
Net Realizable Value (2)
Intermediate Final
Joint products products
Costs Oil
Separate Final
Processing Sale

Common Separate
Joint
Production Processing Costs
Input
Process

Separate Final
Gasoline
Processing Sale

Split-Off Separate
Point Processing Costs 44
 Monetary Measure Method
Net Realizable Value (3)
Joint conversion Sales
cost = $225.000 Separate Value
Oil Processing $500.000

Common Separate
Joint material Processing Costs
Production
cost = $275.000 Process $200,000

Sales
Separate Value
Gasoline
Processing $1.200.000

Split-Off Separate
Point Processing Costs
$500.000
45
 Monetary Measure Method
Net Realizable Value (4)
Product
Oil Gasoline Total
Sales value $ 500.000 $ 1.200.000 $ 1.700.000
Less additional processing costs ? ? ?
Estimated NRV at split-off point ? ? ?
Proportionate share:
?
?
Allocated joint costs:
?
?

46
 Monetary Measure Method
Net Realizable Value (5)
Product
Oil Gasoline Total
Sales value $ 500.000 $ 1.200.000 $ 1.700.000
Less additional processing costs 200.000 500.000 700.000
Estimated NRV at split-off point $ 300.000 $ 700.000 $ 1.000.000
Proportionate share:
?
?
Allocated joint costs:
?
?

47
 Monetary Measure Method
Net Realizable Value (6)
Product
Oil Gasoline Total
Sales value $ 500.000 $ 1.200.000 $ 1.700.000
Less additional processing costs 200.000 500.000 700.000
Estimated NRV at split-off point $ 300.000 $ 700.000 $ 1.000.000
Proportionate share:
$300.000 ÷ $1.000.000 30%
$700.000 ÷ $1.000.000 70%
Allocated joint costs:
?
?

48
 Monetary Measure Method
Net Realizable Value (7)
Product
Oil Gasoline Total
Sales value $ 500.000 $ 1.200.000 $ 1.700.000
Less additional processing costs 200.000 500.000 700.000
Estimated NRV at split-off point $ 300.000 $ 700.000 $ 1.000.000
Proportionate share:
$300.000 ÷ $1.000.000 30%
$700.000 ÷ $1.000.000 70%
Allocated joint costs:
$500.000 × 30% $ 150.000
$500.000 × 70% $350.000

49
 Choosing Among Joint Cost
Allocation Methods
The mere fact that joint
costs are common
between different Impossible to use
products means . . . cause-effect
basis

Therefore, any attempt

at allocating those . . . Can be
“joint” costs, by arbitrary
definition, . . .

50
 By-Products
Joint
Costs Major
Product

Joint
Joint Production Major
Input Process Product

Relatively low
value or quantity
By-products
when compared to
major products
Split-Off
Point
51
 Distinguishing between Main and
By-Products

MAIN PRODUCT
a joint output that
generates a significant
portion of of the net
realizable value

BY-PRODUCTS
outputs from a joint
process that are minor Do not allocate joint costs
in quantity and/or NRV to by-products
when compared to the
main products

52
 Accounting for By-Products

Two commonly used methods of

accounting for by-products are . . .

Net Realizable Value Approach

By-product NRV is deducted from joint
production costs before allocation.
Realized Value Approach
By-product NRV is treated as other
revenue.

53
 Basics of Accounting for By-Products
 Example:

Main Product 100.000 litres @ €35,00

- year 1: 60.000 litre
- year 2: 40.000 litre

Common Costs
€ 1.500.000 4.000 litres @ €15,60
By-product
- year 1: 3.000 litre
- year 2: 1.000 litre
54
 Basics of Accounting for By-Products
(2)
Method 1-A: Deduct net realizable value (NRV) related to
the sale of the by-products from the cost of the main
product
Common cost: 1.500.000
- NRV By-products: - 62.400 By-product total litres* price
= 1.437.600 Main product year 1 litres

=> 1.437.600/100.000 = 14,376 => Year 1: 14,376 x 60.000 = 862.560

Main product total litres

Year 1 Year 2
Turnover 2.100.000 1.400.000
Cost of Goods Sold (COGS) 862.560 575.040
Result 1.237.440 824.960
55
 Basics of Accounting for By-Products
(3)
Method 1-B: Deduct net realizable value (NRV) related to
the sale of the by-products from the cost of the sold main
products
Common cost Main product total litres

Common cost: 1.500.000/100.000 = 15

=> COGS Main Product year 1 = 15 x 60.000 = 900.000
Main product year 1 litres

Year 1 Year 2
Turnover (Common Cost * Production)- By product Turnover
2.100.000 1.400.000
Cost of Goods Sold (COGS) 853.200 584.400
Main Product Common Cost * Production
900.000 600.000
- By-product By product Turnover 46.800 15.600
Result 1.246.800 815.600
56
 Basics of Accounting for By-Products
(4)

Method 2: The NRV of the by-product treated as other

revenue

Used because Year 1 Year 2

by-product Turnover main product 2.100.000 1.400.000
NRVs are
Turnover by-product 46.800 15.600
small and
effects on Total turnover 2.146.800 1.415.600
income Costs of Goods Sold (COGS) 900.000 600.000
are Result 1.246.800 815.600
immaterial
57
 Disposal of Scrap And Waste
By-Product Scrap and Waste

Sales value Cost of further

exceeds cost of processing
further exceeds sales
processing value

Sold as by-product
Dispose of
Look for new
legally at or products
minimum cost 58
 BOM and factory ledger
 A Bill of Materials (BOM) defines the complete set
of physical elements required to manufacture a
product.

 A factory ledger is a group of accounts used to

record factory-related transactions and to keep
track of various manufacturing costs such as
direct materials, direct labour, and factory
overhead costs.

59
Materials Requisition Form
RoseCo Materials Requisition Form

Requisition No. X7 - 6890 Date 3-4-X2

Job No. A - 143
Department B3

Description Quantity Unit Cost Total Cost

2 x 4, 12 feet 12 $ 3.00 $ 36.00
1 x 6, 12 feet 20 4.00 80.00
$ 116.00

Authorized
Signature
Will E. Delite

60
 BOM

 The bill of materials lists all parts (items) with their (technical)
specifications.

61
Job-Order Cost Accounting
RoseCo Job-Cost Record
Job Number A - 143 Date Initiated 3-4-X2
Date Completed
Department B3
Item Wooden cargo crate
A materials requisition
Units Completed

Direct Materials Direct Laborform Manufacturing

is used toOverhead
Req. No. Amount Ticket
authorize the Rate
Hours Amount Hours
use of
Amount

materials on a job.
Cost Summary Units Shipped
Product Costs Amount Date Number Balance
Direct Materials Let’s see one
Direct Labor
Manufacturing Overhead
Total Cost
Unit Cost

62
 Materials Requisition Form
RoseCo Materials Requisition Form

Requisition No. X7 - 6890 Date 3-4-X2 Cost of material

Job No. A - 143 is charged to job
Department B3
A-143.
Description Quantity Unit Cost Total Cost
2 x 4, 12 feet 12 $ 3.00 $ 36.00
1 x 6, 12 feet 20 4.00 80.00
$ 116.00
Type, quantity, and
total cost of material
charged to job A-143.
Authorized
The materials requisition
form is the
Will E.
Signature source document for
Delite
recording material usage in the accounting records.
63
Job-Order Cost Accounting
RoseCo Job-Cost Record
Job Number A - 143 Date Initiated 3-4-X2
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116

Cost Summary Units Shipped

Product Costs Amount Date Number Balance
Direct Materials $ 116
Direct Labor
Manufacturing Overhead
Total Cost
Unit Cost

64
Production vs. non-production
costs
 Production or manufacturing costs are costs that
are made in order to produce a product or deliver
a service: raw material, labour, indirect
 Non-production costs relate to general
administrative expenses as well as pre- (R&D)
and post-production (distribution, …) costs
=> are treated as period costs and are not
included in inventory valuation

65
 Types of Product-Costing Systems
Process Job-Order
Costing Costing

 Used for production of small,

identical, low cost items.
 Mass produced in automated
continuous production process.
 Costs cannot be directly traced to
each unit of product.
66
 Types of Product-Costing Systems
(2)
Process Job-Order
Costing Costing

 Used for production of large,

unique, high-cost items.
 Built to order rather than mass
produced.
 Many costs can be directly traced
to each job.
67
 Types of Product-Costing Systems
(3)
Process Job-Order
Costing Costing

 Job-shop operations
 Products manufactured in very
low volumes or one at a time.
 Batch-production operations
 Multiple products in batches of
relatively small quantity.
68
 Types of Product-Costing Systems
(4)
Process Job-Order
Costing Costing

 Typical job-order cost applications:

 Special-order printing
 Building construction
 Also used in service industry
 Hospitals
 Law firms
69
 Accumulating Costs in a
Job-Order Costing System
Charge direct material and direct
labour to each job as incurred.
Direct Materials
Job No. 1 Special
documents
Direct Labour
Job No. 2 are used to
track costs
for each job.
Manufacturing Job No. 3
Overhead
Apply overhead to each job
using a predetermined rate. 70
 Manufacturing Overhead Costs
Overhead is applied to jobs using a predetermined overhead rate
(POHR) based on estimates made at the beginning of the accountin
period.

Budgeted manufacturing overhead cost

POHR =
Budgeted amount of cost driver (or activity base)

Overhead applied = POHR × Actual activity

Based on estimates, and Actual amount of the allocation

determined before the base, such as direct labour hours,
period begins incurred during the period
71
 Overhead Application Example

RoseCo applies overhead based on direct-

labour hours. Total estimated overhead for the
year is $640.000. Total estimated labour cost is
$1.400.000 and total estimated labour hours are
160.000.
What is RoseCo’s predetermined overhead rate?

72
 Overhead Application Example (2)

Budgeted manufacturing overhead cost

POHR =
Budgeted amount of cost driver (or activity base)

$640.000
POHR =
160.000 direct-labour hours (DLH)

POHR = $4,00 per DLH

For each direct labour hour worked on a
job, $4,00 of factory overhead will be
applied to the job.
73
 Overapplied and Underapplied
Manufacturing Overhead

Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . Allocation of Goods Sold

UNDERAPPLIED INCREASE INCREASE

Work in Process Cost of Goods Sold
(Applied OH is less Finished Goods
than actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASE

Work in Process Cost of Goods Sold
(Applied OH is greater Finished Goods
than actual OH) Cost of Goods Sold

74
Process-
Costing
Systems

75
 Comparison of Job-Order Costing
and Process Costing
Process Job-order
Costing Costing

 Used for production of small,

identical, low cost items.
 Mass produced in automated
continuous production process.
 Costs cannot be directly traced to
each unit of product. 76
Comparison of Job-Order Costing
and Process Costing (2)
Process Job-order
Costing Costing

Typical process cost applications:

 Petrochemical refinery
 Paint manufacturer
 Paper mill

77
 Comparison of Job-Order Costing
and Process Costing (3)
Job-order costing Process costing
 Costs accumulated by the  Costs accumulated by
department or process.
job.
 Work in process has a
 Work in process has a job- production report for each batch
cost sheet for each job. of products.

 Many unique, high cost  A few identical, low cost

products.
jobs.
 Units continuously produced for
 Jobs built to customer inventory in automated process.
order.

78
 Process Costing
Direct
Materials Direct labour costs
Dollar Amount

are usually small

Manufacturing in comparison to
Overhead
other product
costs in process
Direct
cost systems.
Labour
(high level of
automation)
Type of Product Cost

79
 Process Costing (2)
Direct Materials
Direct labour costs
Dollar Amount

Conversion are usually small

in comparison to
other product
costs in process
cost systems.
(high level of
automation)
Type of Product Cost
So, direct labour and manufacturing overhead are often
combined into one product cost called conversion.
80
 Process Costing: The Basics

Costs will be accumulated by process. They will

not be traced to individual units of product.

Direct Materials Conversion Costs

Raw material directly Labour and overhead

traceable to the process. directly traceable to the
process.
81
Schematic approach

Inventory
Production Work in progress
INPUTS
Stadium 1
Transfer semi-finished
products

Inventory
Work in progress
Production
INPUTS Finished product
Stadium 2
Sale of finished product

82
 Comparing Job Costing
and Process Costing
Work in process
Direct contains individual jobs
Materials in a
job cost system.
Finished
Direct Labour Jobs
Goods

Manufacturing Cost of
Overhead Goods
Sold
83
 Comparing Job Costing
and Process Costing (2)
Work in process
contains homogenous
Direct products in a process
Materials cost system.

Direct Labour Finished

& Overhead
Products Goods
(Conversion)

Cost of
Goods
Sold
84
 Equivalent Units: A Key Concept

 Costs are accumulated for a period of time

for products in work-in-process inventory.
 Products in work-in-process inventory at
the beginning and end of the period are
only partially complete.
 Equivalent units is a concept expressing
these partially completed products as a
smaller number of fully completed
products.
85
Equivalent Units Example
Two one-half completed products are
equivalent to one completed product.

+ = l

So, 10.000 units 70 percent complete

are equivalent to 7.000 complete units.

86
 Equivalent Units: Question 1
For the current period, Jones started 15.000
units and completed 10.000 units, leaving
5.000 units in process 30 percent complete.
How many equivalent units of production did
Jones have for the period?
a. 10.000
b. 11.500
c. 13.500
d. 15.000
87
 Equivalent Units: Question 1

For the current period, Jones started 15.000

units and completed 10.000 units, leaving
5.000 units in process 30 percent complete.
How many equivalent units of production did
Jones have for the period?
a. 10.000
10.000 units + (5.000 units ×
b. 11.500 0,30)
c. 13.500 = 11.500 equivalent units
d. 15.000
88
 Calculating and Using Equivalent
Units of Production
To calculate the cost per
equivalent unit for the period:

Cost per Costs for the period

equivalent = Equivalent units for the period
unit

89
 Equivalent Units: Question 2

If Jones incurred $27.600 in

production costs for the 11.500
equivalent units. What was Jones’s cost
per equivalent unit for the period?
a. $1,84
b. $2,40
c. $2,76
d. $2,90
90
 Equivalent Units: Question 2
If Jones incurred $27.600 in
production costs for the 11.500
equivalent units. What was Jones’s cost
per equivalent unit for the period?
a. $1,84
$27.600 ÷ 11.500 equivalent units
b. $2,40
= $2,40 per equivalent unit
c. $2,76
d. $2,90
91
 Assigning Costs to Products –
The Five-step Process
 Summarize the flow of physical units (number of
units completed and number of units remaining in
process).
 Compute the number of equivalent units produced.
 Summarize the total costs to be accounted for (costs
in beginning work in process inventory and the costs
incurred in the current period).
 Compute costs per equivalent unit.
 Assign unit costs from  to units completed and to
units in ending work-in-process inventory.

92
Equivalent Units of Production –
Weighted-Average Method
The weighted-average method . . .
 Makes no distinction between work done in the pr
period and work done in the current period.
 Blends together units and costs from the prior
period and the current period.

The FIFO method is a more

complex method and is
rarely used in practice.

93
 Start inventory: Weighted-Average
method
 Calculation # equivalent units (Eq. un.) Finished Product
(FP):
Starting Inventory (SI) + started – Ending Inventory (EI)
= # finished (1)
Total cost FP Eq. Work In Total Eq. Cost/Eq. un.
un. Progress (WIP) un.
EI Eq. un.
Transfer cost Completion ∑
Material cost SI + current percentage x # ∑
(1) (look when Total cost/
period Total Eq. un.
material is added)
Conversion ∑
cost
= ∑ (2)
 Cost finished product = (1) x (2)
 Cost EI = # Eq. un. EI x cost/Eq. un.
94
 Start inventory: FIFO
FIFO Total cost FP Eq. un. (5) WIP EI Eq. un. Total Eq. Cost/Eq. un.
un.
Transfer cost Completion ∑
# Finished - percentage*
Material cost ONLY cost (Completion # ∑
Total cost/
current percentage (look when
Total Eq. un.
period !!! SI * material is
Conversion cost ∑
# SI) added)

 Cost finished product =

∑ cost SI (transfer/mat/conv) +
respective # Eq. un. (5) * respective cost/Eq. un.
 Cost EI = # Eq. un. EI x respective cost/Eq. un.
95
 Example
 The NV Playback produces DVD-players.
 The starting inventory is about 10 items which are finished
for 40 % (material cost €139 & conversion cost €273).
 During March, the production of 100 DVD-players was
started, of which 80 items are finished. There are 20 items
of work in progress which are finished for 60%. The
material is inserted at the start of the production stadium.
The cost of materials in March is around €1.500, the
conversion costs are €1.104.

96
Example (2)

STADIUM 1

Material

SI EI
10 20
START items items TRANSFER
100
items 0% 40% 60% 100%

97
Example (3)
 Weighted-Average method:

 Add cost of the SI (material and conversion) to

the material cost and the conversion cost of
the period.

98
 Example (4)

FP
Weighted- Equivalent EI WIP Total Cost price
Cost
average units (Eq. Eq. un. Eq. un. / Eq. un.
un.)
1.500 + 10 + 100 20 110 14,9
Material 139 = – 20 =
1.639 90
1.104 + 90 12 102 13,5
Conversion 273 =
1.377
Σ Weighted-Average 28,4
99
 Example (5)

 Cost price finished goods =

90 items x €28,4 = €2.556
 Cost price end inventory (EI; work in
progress) = 20 items x €14,9 + 12 items x
€13,5 =
€298 + €162 = €460

100
Example (6)
 FIFO:

 Cost SI only taken in the finished goods

 Add cost SI (material and conversion)
separately to the cost of the finished products

101
 Example (7)
FP EI WIP Total Cost price
FIFO Cost
Eq. un. Eq. un. Eq. un. / Eq. un.
1.500 90 – 10 = 20 100 15
Material 80
1.104 90 – (40% x 12 98 11,26
Conversion 10) = 86

FIFO

102
 Example (8)

 Cost price finished products =

Σ cost SI + 80 items x €15 + 86 items x €11,26 =
€139 + €273 + 1.200 + 968,36 = €2.580,36

 Cost price end inventory (EI; WIP) =

20 items x €15 + 12 items x €11,26 =
€300 + €135,12 = €435,12

103
Rejected products
 Quality inspection:
 (Semi) finished products
 During the production process
 Cost price of rejected products:
 Cost of production?
 At the account of finished products?
 At the account of goods in process/partly finished
goods?
 Period cost?
104
Definitions and implications for
cost calculation
 Normal rejected products:
 % of rejected goods that can be considered as normal
for the production process.
 PCP at the account of approved products
 Abnormal rejected products:
 Amount of rejected goods above the normal %
 PCP at the account of P/L
 Point of inspection
 Position in the production process (degree of
finalization) at which the quality control occurs.
 Is EI WIP / SI WIP before or after the point of
inspection?
105
Example (1)
 Louisa Vuittoni is a producer of leather handbags.
This luxurious product offers top quality towards
the client. The production process develops in
two stages. In the first stage the leather is dyed.
In the second stage the dyed leather is
transformed into a handbag. The quality control
occurs at the end of the second stage, before the
product exits the factory. Normally, 5% of the
finished goods are rejected. These products are
destroyed.
106
Example (2)
 Data of October 2006 stage 2:
 Value of production in stage 1: €50.000,00
 Production started in stage 2: 1.000 pieces
 Cost of material stage 2: €20.000,00
 Processing costs stage 2: €10.000,00
 Materials are added to the production process at 20% completion.
 No stock of goods in process
 Point of inspection is located at the end of the production process
 60 products are rejected because of errors
 The accepted products are being sold at €200,00 per handbag.

107
 Example (3)

STAGE 2
Point of inspection
Material

START
1.000
pieces 20 % 100 %
Rejected: 60 pieces
Accepted: 940 pieces
108
 Example (4)

Approved Normal Abnormal EI Total

Costs € CP/Eq. un.
FP rejection rejection WIP Eq. un.
Transfer
940 50 10 0 1.000 50,00
50.000
Material
940 50 10 0 1.000 20,00
20.000
Conversion
940 50 10 0 1.000 10,00
10.000

Σ 80.000 Σ 80,00

109
Example (5)
 Valuation:
Normally rejected products
50 x 80,00 = 4.000,00
Abnormally rejected products
10 x 80,00 = 800,00
Finished product (accepted)
940 x 80,00 = 75.200,00
 Cost division of rejected products:
Normal rejected goods => to FP:
75.200,00 + 4.000,00 = 79.200,00
Abnormally rejected products => as a periodical cost to
P/L 110
Partly finished goods in stock (1)
 The EI WIP is before the point of inspection:
EI WIP Point of inspection

The cost of normal rejected production is being

allocated towards finished products.
 The EI WIP is after the point of inspection:
Point of inspection EI WIP

The cost of normal rejected production is divided over

finished products and WIP.
111
Partly finished goods in stock (2)
 The SI WIP is before the point of inspection
SI WIP Point of inspection

SI finished goods in this period can be rejected

Assign cost of rejected goods to this period
 The SI WIP is after the point of inspection
Point of inspection SI WIP

The SI finished goods has already been inspected in the

previous period
No costs assigned to the current period 112
Partly finished goods in stock (3)
 Weighted-Average
 The costs of the SI are being assimilated in the finished
goods and EI WIP on the basis of the Weighted-
Average.
 Cost of rejected goods are distributed over finished
products and EI WIP (if EI is after inspection).
 FIFO
 De costs of SI are assimilated in de cost price of
finished goods.
 Cost of rejected products are distributed over:

Started + finished SI (and EI WIP) if SI is before

inspection
Started (and EI WIP) if SI is after inspection 113
Extensive example A (1)
 Data October stage 2:
 Materials are added to the production process at 20%
completion.
 1000 pieces are started
 A SI WIP of 200, 40% completed
 Value SI = 9.500 (transfer) + 5.000 (material) + 700
(conversion) = €15.200
 An EI WIP of 300, 60% completed
 40 pieces are rejected (normal)
 Point of inspection is at 50% of the production process.
114
Extensive example A (2)

40 pieces rejected

Materials
Point of inspection
START
Finished
1.000
? products
pieces 20% SI 50% EI
200 pieces 300 pieces
40% 60%

115
 Extensive example A (3)

FP Rejected EI WIP Total CP/Eq.un.

Costs €
Eq. un. Eq. un. Eq. un. Eq. un. €
T 50.000
860 40 300 1.200 49,58
+ 9.500
M 20.000
860 40 300 1.200 20,83
+ 5.000
C 10.000
860 20 180 1.060 10,09
+ 700

Σ 95.200 Weighted-average Σ 80,50

116
Extensive example A (4)
 Valuation:
Rejected products
(40 x 49,58) + (40 x 20,83) + (20 x 10,09) =
3.018,55
Finished product (approved)
860 x 80,50 = 69.239,47
EI WIP (approved)
(300 x 49,58) + (300 x 20,83) + (180 x 10,09) =
22.941,98
117
Extensive example A (5)
 Distributing costs over rejected products
(860/1.160) x 3.018,55 = 2.237,89 to FP
(300/1.160) x 3.018,55 = 780,66 to EI
WIP
 Total cost price (incl. rejected products)
FP 69.239,47 + 2.237,89 = 71.477,36
EI WIP 22.941,98 + 780,66 = 23.722,64

118
 Extensive example A (6)

FP Rejected EI WIP Total CP/Eq.un.

Costs €
Eq. un. Eq. un. Eq. un. Eq. un. €
860
T 50.000 40 300 1.000 50,00
-200
860
M 20.000 40 300 1.000 20,00
-200
860
C 10.000 20 180 980 10,20
-80

Σ 80.000 FIFO Σ 80,20

119
Extensive example A (7)
 Valuation:
Rejected products
(40 x 50,00) + (40 x 20,00) + (20 x 10,20) =
3.004,08
Finished product (approved)
(660 x 50,00) + (660 x 20,00) + (780 x 10,20) =
54.159,18
EI WIP (approved)
(300 x 50,00) + (300 x 20,00) + (180 x 10,20) =
22.836,73 120
Extensive example A (8)
 Distribution of cost over rejected products
(860/1.160) x 3.004,08 = 2.227,16 to FP
(300/1.160) x 3.004,08 = 776,92 to EI WIP
 Total cost price (incl. rejected products)
FP 54.159,18 + 2.227,16 + 15.200 (SI)
= 71.586,34
EI WIP 22.836,73 + 776,92
= 23.613,65
121
Extensive example B (1)
 Data October stage 2:
 Materials are added to the production process at 20%
completion.
 1000 pieces are started
 A SI WIP of 200, 60% completed
 Value SI = 9.500 (transfer) + 5.000 (material) + 700
(conversion) = €15.200
 A EI WIP of 300, 80% completion
 40 pieces are rejected (normal)
 Point of inspection is at 50% of the production process.
122
Extensive example B (2)

40 pieces rejected

Materials

Point of inspection
START
Finished
1.000
? pieces
pieces 20% 50% SI EI
200 pieces 300 pieces
60% 80%

123
 Extensive example B (3)
FP Rejected EI WIP Total CP/Eq.un.
Costs €
Eq. un. Eq. un. Eq. un. Eq. un. €

860
T 50.000 40 300 1.000 50,00
-200

860
M 20.000 40 300 1.000 20,00
-200

860
C 10.000 20 240 1.000 10,00
-120

Σ 80.000 FIFO Σ 80,00

124
Extensive example B (4)
 Valuation:
Rejected products
(40 x 50,00) + (40 x 20,00) + (20 x 10,0) =
3.000,00
Finished products (approved)
(660 x 50,00) + (660 x 20,00) + (740 x 10,00) =
53.600,00
EI WIP (approved)
(300 x 50,00) + (300 x 20,00) + (240 x 10,00) =
23.400,00 125
Extensive example B (5)
 Distribution costs over rejected products
[(860-200)/(860-200+300)] x 3.000,00
= 2.062,50 to FP
[(300)/(860-200+300)] x 3.000,00
= 937,50 to EI WIP
 Total cost price (incl. rejected products)
FP 53.600,00 + 2.062,50 + 15.200 (SI)
= 70.862,50
EI WIP 23.400,00 + 937,50
= 24.337,50 126
Management decisions and control
tools

- Direct costing vs. Full costing

- Variance analysis
- Relevant costs and special decisions
- Limited resources
- Pricing decisions 127
Full Costing

A system of accounting for costs in which

both fixed and variable production
costs are considered product costs.
Fixed
Costs
Product
Variable
Costs

128
Full Costing (2)
 Absorption costing
 Full cost:
The total amount of resources, measured in monetary
terms, sacrificed to achieve a particular objective.
 Applications:
 Stock valuation
 Long-term pricing
 Budgeting

129
Direct Costing

A system of cost accounting that only

assigns the variable cost of production
to products.
Fixed
Costs
Product
Variable
Costs

130
Direct Costing (2)
 Choice of the allocation key for indirect
costs is often easier because of the variable
nature
 Choice of the cost calculation method
influences the reported result via the
inventory changes

131
 Full and Direct Costing

Direct
Full Costing Costing

Direct materials
Direct labor Product costs
Product costs Variable mfg. overhead

Fixed mfg. overhead

Period costs
Period costs Selling & Admin. exp.

132
 Full and Direct Costing (2)
Direct
Full Costing Costing

Direct materials
Direct labor Product costs
Product costs Variable mfg. overhead

Fixed mfg. overhead

Period costs
Period costs Selling & Admin. exp.

The difference between Full and Direct

costing is the treatment of fixed manufacturing overhead.
133
Example (1)
 Material  Depreciation
 Meal white bread 1.000  Bakery 500
 Meal whole meal br. 900  Baking oven 300
 Shop 700
 Secondary prod. 500
 Delivery van 500
 Direct labour
 Various
White bread 1.000
Energy oven 400


 Whole meal br. 1.000  Others 300
 Indirect labour  Production data
 Shop assistant 800  White bread 5.000
 Driver 800  Whole meal br. 4.000
 Selling price
 White bread 1,00
 Whole meal br. 1,20134
 Example (2)
TOTAL COST White bread Whole meal bread
Direct material cost 1.000,00 900,00
Direct labour cost 1.000,00 1.000,00
Indirect costs (4.800/9.000)x5.000 (4.800/9.000)x4.000
= 2.666,67 = 2.133,33
Total cost series 4.666,67 4.033,33
Total cost per bread 0,93 1,03
Turnover 5.000,00 4.800,00
Result per series 333,33 766,67
Result period 1.100,00
135
 Example (3)
FULL PRODUCTION COST White bread Whole meal bread
Direct material cost 1.000,00 900,00
Direct labour cost 1.000,00 1.000,00
Indirect production cost (1.700/9.000)x5.000 (1.700/9.000)x4.000
= 944,44 = 755,55
Full production cost series 2.944,44 2.655,55
Full PC per bread 0,59 0,66
Turnover 5.000,00 4.800,00
Gross result per series 2.055,56 2.144,45

136
 Example (4)
Total gross result 4.200,00
Period cost 3.100,00
Result period 1.100,00

Only the production costs are taken into account when calculating the cost
and thus only these costs are taken into account in the calculation of the
cost of the sold products and the value of the inventory.

137
 Example (5)
DIRECT White bread Whole meal bread
PRODUCTION COST
Direct material cost 1.000,00 900,00
Direct labour cost 1.000,00 1.000,00
Variable indirect (900/9.000)x5.000 (900/9.000)x4.000
production cost = 500,00 = 400,00
Direct production cost 2.500,00 2.300,00
series
Direct PC per bread 0,50 0,58
Turnover 5.000,00 4.800,00
Gross result per series 2.500,00 2.500,00
138
 Example (6)

Total gross result 5.000,00

Period cost
- fixed mfg overhead 800,00
- non-production cost 3.100,00
Result period 1.100,00

Only the variable production cost are taken into account when calculating the
cost and thus only these costs are taken into account in the calculation of the
cost of the sold products and the value of the inventory.

139