CHAPTER 11 Product Costing in Service and Manufacturing

CHAPTER 11 Product Costing in Service and Manufacturing Entities

11 -2 Chapter Opening Financial Accounting Managerial Accounting Product costs are used to value inventory and to compute cost of goods sold. Product costs are used for planning, control, directing, and management decision making. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -3 Learning Objective To describe the nature and treatment of product cost information for manufacturing and service companies LO 1 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

Cost Flow in Manufacturing Companies Raw Materials Work-in-Process (WIP) Finished Goods Mc. Graw-Hill/Irwin Materials waiting to be processed. Partially complete products – material to which some labor and/or overhead has been added. Completed products awaiting sale. The Mc. Graw-Hill Companies, Inc. 2008 11 -4

Cost Flow in Manufacturing Companies Raw Materials Cost of Purchases Ending Inventory Mc. Graw-Hill/Irwin Balance Sheet Work-in. Process Finished Goods Income Statement • Materials Used • Labor • Overhead Total Mfg. Costs Incurred Cost of Goods Mfd. Ending Inventory 11 -5 Cost of Goods Sold The Mc. Graw-Hill Companies, Inc. 2008

Cost Flow in Service Companies Public Accountants Airlines Insurance Firms Hospitals Service Companies Attorneys Banks Plumbing Companies Hotels Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -6

Cost Flow in Service Companies Service companies do not have work-in-process and finished goods inventory accounts where costs are stored before being transferred to a cost of goods sold account. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -7

11 -8 Learning Objective To demonstrate the flow of materials and labor costs for a manufacturing company LO 2 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -9 Manufacturing Cost Flow Direct Labor Direct Material Manufacturing Overhead The Product Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -10 Direct Labor Cost of wages and fringe benefits for personnel who work directly on manufactured products. Example: Wages paid to an automobile assembly worker. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -11 Direct Material Raw material that is used to make, and can be conveniently traced, to the finished product. Example: Steel used to manufacture the automobile. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -12 Manufacturing Overhead All other manufacturing costs Indirect Material Indirect Labor Other Costs Materials used to support the production process. Examples: Lubricants and cleaning supplies used in an automobile assembly plant. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -13 Manufacturing Overhead All other manufacturing costs Indirect Material Indirect Labor Other Costs Cost of personnel who do not work directly on the product. Examples: Maintenance workers, janitors and security guards. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -14 Manufacturing Overhead All other manufacturing costs Indirect Material Indirect Labor Other Costs Examples: Depreciation on plant and equipment, property taxes, insurance, utilities, overtime premium, and unavoidable idle time. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -15 Manufacturing Cost Flow Let’s examine the cost flows in a manufacturing company. We will use T-accounts and start with materials. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -16 Manufacturing Cost Flow Raw Materials • Material • Direct Purchases Material • Indirect Material Work-in-Process • Direct Material Mfg. Overhead • Indirect Material Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -17 Manufacturing Cost Flow Next let’s add labor costs and applied manufacturing overhead to the job-order cost flows. Are you with me? Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -18 Manufacturing Cost Flow Wages Payable • Direct Labor • Indirect Labor Mfg. Overhead • Indirect • Overhead Material Applied to Work in • Indirect Process Labor Mc. Graw-Hill/Irwin Work-in-Process • Direct Material • Direct Labor • Overhead Applied If actual and applied manufacturing overhead are not equal, a year-end adjustment is required. We will look at the procedure to accomplish this later. The Mc. Graw-Hill Companies, Inc. 2008

11 -19 Manufacturing Cost Flow Now let’s complete the goods and sell them. Still with me? Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -20 Manufacturing Cost Flow Work-in-Process • Direct • Cost of Material Goods Mfd. • Direct Labor • Overhead Applied Finished Goods • Cost of Goods Mfd. • Cost of Goods Sold Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -21 Manufacturing Cost Flow Let’s look at the January transactions of Ventra Manufacturing Company. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -22 Manufacturing Cost Flow Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -23 Manufacturing Cost Flow Ventra pays $26, 500 cash to purchase raw materials. Cash Bal. 64, 500 26, 500 Mc. Graw-Hill/Irwin Raw Materials Bal. 500 26, 500 The Mc. Graw-Hill Companies, Inc. 2008

11 -24 Manufacturing Cost Flow Ventra places $1, 100 of raw materials into production in the process of making jewelry boxes. Raw Materials Bal. 500 26, 500 Mc. Graw-Hill/Irwin 1, 100 Work-in-Process Bal. 0 1, 100 The Mc. Graw-Hill Companies, Inc. 2008

11 -25 Manufacturing Cost Flow Ventra pays $2, 000 cash to purchase production supplies. Cash Bal. 64, 500 26, 500 2, 000 Mc. Graw-Hill/Irwin Production Supplies 2, 000 The Mc. Graw-Hill Companies, Inc. 2008

11 -26 Manufacturing Cost Flow Ventra pays production workers $1, 400 cash. Cash Bal. 64, 500 26, 500 2, 000 1, 400 Mc. Graw-Hill/Irwin Work-in-Process Bal. 0 1, 100 1, 400 The Mc. Graw-Hill Companies, Inc. 2008

11 -27 Learning Objective To assign estimated overhead costs to inventory and cost of goods sold LO 3 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -28 Flow of Overhead Costs Using a predetermined rate makes it possible to estimate total job costs sooner. $ Actual overhead for the period is not known until the end of the period. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -29 Flow of Overhead Costs A predetermined overhead rate (POHR), used to apply overhead to products, is determined before the period begins. POHR = Mc. Graw-Hill/Irwin Estimated total manufacturing overhead cost for the period Estimated total units in the allocation base for the period $40, 320 12, 000 jewelry boxes = $3. 36 per box The Mc. Graw-Hill Companies, Inc. 2008

11 -30 Flow of Overhead Costs Based on estimates, and determined before the period begins. Overhead applied = POHR × Actual activity Actual amount of the allocation base such as units produced, direct labor hours, or machine hours. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -31 Manufacturing Cost Flow Ventra applies $1, 680 of estimated manufacturing overhead costs at the end of the month of January. Manufacturing Overhead Work-in-Process Actual Applied Bal. 0 1, 680 1, 100 1, 400 1, 680 Applied overhead = 500 boxes × $3. 36 per box = $1, 680 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -32 Learning Objective To account for completion and sale of products LO 4 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -33 Manufacturing Cost Flow Ventra transfers the total cost of 500 jewelry boxes from work-in-process to finished goods. Work-in-Process 100 boxes @ $8. 36 Bal. 0 Finished Goods 1, 100 4, 180 1, 400 1, 680 Bal. 836 4, 180 Unit cost = $4, 180 ÷ 500 boxes = $8. 36 per box Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -34 Manufacturing Cost Flow Ventra recognizes cost of goods sold for 400 jewelry boxes sold to customers. Finished Goods Bal. 836 3, 344 Cost of Goods Sold 3, 344 4, 180 400 boxes @ $8. 36 per box = $3, 344 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -35 Manufacturing Cost Flow Ventra recognizes $5, 600 of sales revenue for the cash sale of 400 boxes. Cash Bal. 64, 500 26, 500 5, 600 2, 000 1, 400 Revenue 5, 600 400 boxes @ $14. 00 per box = $5, 600 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -36 Manufacturing Cost Flow Ventra pays $1, 200 cash for actual manufacturing overhead costs including indirect labor, utilities, rent, etc. Cash Bal. 64, 500 26, 500 5, 600 2, 000 1, 400 1, 200 Mc. Graw-Hill/Irwin Manufacturing Overhead Actual Applied 1, 200 1, 680 The Mc. Graw-Hill Companies, Inc. 2008

11 -37 Manufacturing Cost Flow Ventra pays $1, 200 cash for actual manufacturing overhead costs including indirect labor, utilities, rent, etc. Manufacturing overhead is $480 overapplied at the end of January. Any difference between actual and applied overhead remaining at year end will be closed to cost of goods sold. Mc. Graw-Hill/Irwin Manufacturing Overhead Actual Applied 1, 200 1, 680 The Mc. Graw-Hill Companies, Inc. 2008

11 -38 Manufacturing Cost Flow At the end of the year, Ventra has the following account balances: Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -39 Manufacturing Cost Flow Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -40 Manufacturing Cost Flow Supplies: $2, 000 purchased, $1, 700 used. See Cost of Goods Manufactured and Sold Schedule Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -41 Manufacturing Cost Flow Explanation of Manufacturing Overhead balance follows. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

Analyzing Underapplied Overhead Manufacturing overhead is $3, 752 underapplied. Manufacturing Overhead Actual 43, 400 Applied 39, 648 3, 752 11, 800 boxes manufactured × $3. 36 POHR Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -42

Analyzing Underapplied Overhead 11 -43 Manufacturing overhead is $3, 752 underapplied. Manufacturing Overhead Actual 43, 400 Applied 39, 648 3, 752 Underapplied overhead is closed to Cost of Goods Sold leaving a zero balance in the overhead account. Mc. Graw-Hill/Irwin Cost of Goods Sold 83, 600 3, 752 87, 352 10, 000 boxes @ $8. 36 The Mc. Graw-Hill Companies, Inc. 2008

Analyzing Underapplied Overhead Actual Overhead Incurred Overhead Budget Overhead Applied $43, 400 $40, 320 $39, 648 Spending variance $3, 080 unfavorable Volume variance $672 unfavorable Total variance is $3, 752 unfavorable, the amount of underapplied overhead. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -44

11 -45 Learning Objective To prepare a schedule of cost of goods manufactured and sold LO 5 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

Schedule of Cost of Goods Manufactured and Sold Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -46

Schedule of Cost of Goods Manufactured and Sold Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -47

Schedule of Cost of Goods Manufactured and Sold Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -48

Schedule of Cost of Goods Manufactured and Sold Reported in the current assets section of the balance sheet. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -49

11 -50 Learning Objective To prepare financial statements for a manufacturing company LO 6 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -51 Financial Statements Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -52 Financial Statements Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -53 Financial Statements Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -54 Financial Statements From Schedule of Cost of Goods Manufactured and Sold Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -55 Learning Objective To distinguish between absorption and variable costing LO 7 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

Motive to Overproduce Absorption Costing Hokai Company incurs the following costs to produce 2, 000 units of inventory: Let’s see what happens to costs if Hokai increases production. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -56

Motive to Overproduce Absorption Costing Now let’s compute income at the three levels of production if Hokai sells 2, 000 units. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -57

Motive to Overproduce Absorption Costing Internally, many companies use variable costing to motivate managers to increase profitability without motivating them to overproduce. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008 11 -58

11 -59 Variable Costing Net income is not affected by production increases. Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008

11 -60 End of Chapter 11 Mc. Graw-Hill/Irwin The Mc. Graw-Hill Companies, Inc. 2008