Product and Service Costing Overhead Application and JobOrder

Product and Service Costing: Overhead Application and Job-Order System Prepared by Douglas Cloud Pepperdine University 4 -1

Objectives 1. Differentiate. After the cost accounting studying this systems of service and chapter, manufacturing firms and of you should unique and standardized products. be able to: 2. Discuss the interrelationship of cost accumulation, cost measurement, and cost assignment. 3. Compute a predetermined overhead rate, and use the rate to assign overhead to production. 4 -2

Objectives 4. Explain the difference between job-order and process costing, and identify the source documents used in job-order costing. 5. Describe the cost flows associated with joborder costing, and prepare the journal entries. 6. Explain why multiple overhead rates may be preferred to a single, plantwide rate. 4 -3

Continuum of Services and Manufactured Products Pure Service Bungee jumping Manufactured Product Beauty Salon Restaurant Software Automobiles Cereals 4 -4

Features of Service Firms and Their Interface with the Cost Management System Feature Relationship to Business Impact on Cost Management System Intangibility Services cannot be stored. There are no inventory accounts. Services cannot be There is a strong ethical protected through patents. code. Services cannot readily be displayed or communicated. Prices are difficult to set. Costs must be related to entire organization. 4 -5

Features of Service Firms and Their Interface with the Cost Management System Feature Relationship to Business Inseparability Consumer is involved in production. Impact on Cost Management System Cost are accounted for by customer type. Other customers are involved in production. Centralized mass production of services is difficult Systems must be generated to encourage consistent quality. 4 -6

Features of Service Firms and Their Interface with the Cost Management System Feature Relationship to Business Heterogeneity Standardization and quality control are difficult. Impact on Cost Management System A strong systems approach is needed. Productivity measurement is ongoing. TQM is critical. 4 -7

Features of Service Firms and Their Interface with the Cost Management System Feature Perishability Relationship to Business Impact on Cost Management System Service benefit expire There are no inventories. quickly. Service may be repeated There needs to be a often for one customer. standardized system to handle repeat customers. 4 -8

Relationship of Cost Accumulation, Cost Measurement, and Cost Assignment Cost Accumulation Record Costs: Purchase materials Cost Measurement Classify Costs: Direct Materials Assemblers’ payroll Finishers’ payroll Cost Assignment Assign to Cost Objects: Product 1 Direct Labor Supervisors’ Payroll Depreciation Utilities Property taxes Product 2 Overhead Landscaping 4 -9

Cost Accumulation Cost accumulation refers to the recognition and recording of costs. The cost accountant needs to develop source documents, which keep track of costs as they occur. A source document describes a transaction. Data from these source documents can then be recorded in a database. Well-designed source documents can supply information in a flexible way. 4 -10

Cost Measurement Cost measurement refers to classifying the cost. There are two commonly used ways to measure the costs associated with production: actual costing and normal costing. An actual cost system uses actual costs for direct materials, direct labor, and overhead to determine unit cost. Normal costing systems measure overhead costs on a predetermined basis and use actual costs for direct materials and direct labor. 4 -11

Example: Prime Costs Rubber stops are made for cellos. The cost of rubber is $0. 30 per ounce and two ounces are required per stop. The price of labor is $8 per hour and it takes. 10 hour to make a stop. Thus, one stop should cost $1. 40 calculated as follows: $0. 30 x 2 = $0. 60 $8. 00 x. 10 = 0. 80 $1. 40 4 -12

Example: Using Actual Overhead Actual overhead Actual units produced Per-unit overhead April June August $20, 000 $40, 000 160, 000 $0. 50 $1. 00 $0. 25 Actual overhead/ Actual production 4 -13

Overhead Application A Normal Costing View A predetermined overhead rate is calculated using the following formula: Budgeted annual overhead Overhead rate = Budgeted annual activity level Continuing with the cello example: Overhead rate = $90, 000 225, 000 = $0. 40 4 -14

Overhead Application 1. Units produced 2. Direct labor hours Estimated Overhead Activity Driver 3. Direct labor dollars 4. Machine hours 5. Direct materials 4 -15

Data on Engine Housing Cost of operating lathe Total units produced Total machine hours used Number of housings Time on lathe Operating cost assigned using unit produced Operating cost assigned using machine hours $80, 000 20, 000 12, 500 Simple Complicated 10, 000 0. 25 MHr 1 MHr $4. 00 $1. 60 $6. 40 4 -16

Choosing the Activity Level Expected activity level is simply the production level the firm expects to attain for the coming year. Normal activity level is the average activity usage that a firm experiences in the long term (normal volume is computed over more than one year). Theoretical activity level is the absolute maximum production activity of a manufacturing firm. Practical activity level is the maximum output that can be realized if everything operates efficiently. 4 -17

Basic Concept of Overhead Application In attempting to understand the concept of applied overhead, there are two points that should be emphasized. 1. Applied overhead is the basis for computing per-unit overhead cost. 2. Applied overhead is rarely equal to a period’s actual overhead. Applied overhead = Overhead rate x Applied production activity 4 -18

Basic Concept of Overhead Application Measures of Activity Level Number of Units Expected Normal Consumer Demand. Oriented Measures of Activity Level Time 4 -19

Basic Concept of Overhead Application Measures of Activity Level Number of Units Theoretical Normal Productive Capability Measures of Activity Level Time 4 -20

Suncalc, Inc. Example Suncalc, Inc. produces two unique, solar-powered products: a pocket calculator and a currency translator. The following estimated and actual data for 2004: Budgeted overhead Normal activity (DLH) Actual overhead $360, 000 120, 000 100, 000 $320, 000 4 -21

Suncalc, Inc. Example The firm bases it predetermined overhead rate on normal activity measured in direct labor hours: Budgeted overhead Predetermined = overhead rate Normal activity $360, 000 = 120, 000 DLH = $3 per DLH 4 -22

Suncalc, Inc. Example Using the overhead rate, applied overhead for 2004 is: Applied overhead = Overhead rate x Actual activity usage = $3 per DLH x 100, 000 DLH = $300, 000 4 -23

Suncalc, Inc. Example Forty percent of the actual direct labor hours worked were used to produce 80, 000 units of the pocket calculator and the remaining 60 percent was used to produced 90, 000 units of the currency translator. Units produced Direct labor hours Overhead applied to production ($3 x DLH) Overhead per unit Pocket Calculators 80, 000 40, 000 Currency Translator 90, 000 60, 000 $120, 000 $1. 50 $180, 000 $2. 00 4 -24

Underapplied and Overapplied Overhead The difference between actual overhead and applied overhead is called overhead variance. If actual overhead is greater than applied overhead, then the variance is called underapplied overhead. If applied overhead is greater than actual overhead, the variance is called overapplied overhead. 4 -25

Disposition of Overhead Variances The overhead variance is disposed of in one of two ways. 1. All overhead variance is allocated to cost of goods sold. 2. The overhead variance is allocated among work in process, finished goods, and cost of goods sold. 4 -26

Disposition of Overhead Variances Suncalc’s accounts had the following applied overhead balances for the end of 2004: Work-in. Process Inventory, $60, 000; Finished Goods Inventory, $90, 000; Cost of Goods Sold, $150, 000. Suncale had $20, 000 of underapplied overhead. The amount is allocated as follows: Work-in-Process Inventory: $60, 000/$300, 000 x $20, 000 = $4, 000 Finished Goods Inventory: $90, 000/$300, 000 x $20, 000 = $6, 000 Cost of Goods Sold: $150, 000/$300, 000 x $20, 000 = $10, 000 4 -27

A Job-Order Cost Sheet Job Number Date Ordered Date Completed Date Shipped For Benson Company Item Description Valves Quantity Completed 100 Direct Materials Requisition Number 12 18 Direct Labor 16 April 2, 2004 April 24, 2004 April 25, 2004 Overhead Ticket Amount Number Hours Rate Amount $300 450 $750 Direct materials Direct labor Overhead 68 72 $750 118 180 8 10 $6 7 $ 48 70 $118 Total cost $1, 048 Unit cost $10. 48 8 10 $10 10 $ 80 100 $180 4 -28

Material Requisition Form Date Department Job Number Material Requisition Number 678 April 8, 2004 Grinding 62 Description Quantity Casing 100 Authorized Signature Cost/Unit $3 Total Cost $300 Jim Lawson 4 -29

Job Time Ticket Employee Number 45 Name Ann Wilson Date April 12, 2004 Start Time Stop Time Total Time Hourly Rate 8: 00 10: 00 11: 00 12: 00 6: 00 Authorized Signature 2 1 1 5 Job Time Ticket Number 68 Amount $6 6 $12 6 6 30 Job Number 16 17 16 16 Jim Lawson Department Supervisor 4 -30

Accounting for Overhead Actual overhead costs are never assigned directly to jobs. Overhead is applied using a predetermined overhead rate. $900, 000 Estimated Overhead rate = Estimated Direct 90, 000 DLH Labor Hours = $10 per direct labor hour 4 -31

All Signs Company 1 Materials Inventory 2 500 00 The receiving report and the invoice are Accounts Payable used to record the receipt of the merchandise and to control the payment. 2 500 00 1. Direct materials costing $2, 500 were purchased on account. 4 -32

All Signs Company 2 Work in Process 1 500 00 The receiving report and the invoice are Materials Inventory used to record the receipt of the merchandise and to control the payment. 1 500 00 2. Direct materials costing $1, 500 were requisitioned for use in production. 4 -33

All Signs Company Job 101 Materials Req. No. 1 2 3 Job 102 Materials Amount $ 300 200 500 $1, 000 Req. No. 4 5 3 Amount $250 $500 4 -34

All Signs Company 3 Work-in-Process Inventory 850 00 The receiving report and the invoice are Wages Payable used to record the receipt of the merchandise and to control the payment. 850 00 3. Direct labor costing $850 was recognized. 4 -35

All Signs Company Job 101 Materials Job 102 Ticket 1 2 3 Materials Hours Rate Ticket 15 20 4 25 5 60 Amount Hours $10 10 15 10 10 25 Rate $150 200 $10 250 10 $600 Amount $150 100 $250 4 -36

All Signs Company 4 Work-in-Process Inventory 340 00 The receiving report and the invoice are Overhead Control used to record the receipt of the merchandise and to control the payment. 340 00 4. Overhead was applied to production at the rate of $4 per direct labor hour. A total of 85 direct labor hours were worked. 4 -37

All Signs Company 5 Overhead Control 415 00 The receiving report and the invoice are Lease Payable used to record the receipt of the Utilities Payable merchandise and to control the payment. Accumulated Depr. --Equipment Wages Payable 200 00 50 00 100 00 65 00 5. Actual overhead costs of $415 were incurred: lease, $200; utilities, $50; depreciation, $100; accrued wages, $65. 4 -38

All Signs Company 6 Finished Goods Inventory 1 840 00 The receiving report and the invoice are Work-in-Process Inventory used to record the receipt of the merchandise and to control the payment. 1 840 00 6. Job 101, with a total cost of $1, 840, are completed and transferred to finished goods. 4 -39

Job Number 101 Date Ordered Jan. 1, 2004 Date Completed Jan. 2, 2004 Date Shipped Jan. 15, 2004 All Signs Company For Housing Development Item Description Street Signs Quantity Completed 20 Materials Requisition Number 1 2 3 $1, 000 Direct Labor Overhead Ticket Amount Number Hours Rate Amount $300 200 500 Direct materials Direct labor Overhead 1 2 3 $1, 000 $600 $240 15 20 25 $10 10 10 $600 $150 200 250 Total cost $1, 840 Unit cost $92 15 20 25 $4 4 4 $240 $ 60 80 100 4 -40

All Signs Company a. Cost of Goods Sold 1 840 00 The receiving report and the invoice are Finished Goods Inventory used to record the receipt of the merchandise and to control the payment. b. Accounts Receivable 1 840 00 2 760 00 Sales Revenue 2 760 00 7. Sold Job 101 for $2, 760. 4 -41

All Signs Company 8 Cost of Goods Sold 75 00 The receiving report and the invoice are Overhead Control used to record the receipt of the merchandise and to control the payment. 75 00 8. Underapplied overhead was closed to cost of goods sold. 4 -42

All Signs Company Schedule of Cost of Goods Manufactured For the Month Ended January 31, 2004 Direct materials: Beginning direct materials inventory $ 0 Purchases of direct materials 2, 500 Total direct materials available for use $2, 500 Ending direct materials 1, 000 Total direct materials used Direct labor Manufacturing Overhead: Lease $ 200 Utilities 50 Depreciation 100 Indirect labor 65 $ 415 Continued $1, 500 850 4 -43

Less: Underapplied overhead Overhead applied Current manufacturing costs Add: Beginning work in process Total manufacturing cost Less: Ending work in process Cost of goods manufactured $ 415 75 340 $2, 690 -1, 050 $1, 840 4 -44

All Signs Company Statement of Cost of Goods Sold For the Month Ended January 31, 2004 Beginning finished goods inventory Cost of goods manufactured Cost of goods available for sale Less: Ending finished goods inventory Normal cost of goods sold Add: Underapplied overhead Adjusted cost of goods sold $ 0 1, 840 $1, 840 75 $1, 915 4 -45

All Signs Company Income Statement For the Month Ended January 31, 2004 Sales Less: Cost of goods sold Gross margin Less selling and administrative expenses: Selling expenses Administrative expenses Operating income $2, 760 1, 915 $ 845 $200 550 750 $ 95 4 -46

SINGLE VERSUS MULTIPLE OVERHEAD RATES Department A Department B Overhead costs $60, 000 Direct labor hours 15, 000 Machine hours 5, 000 Total $180, 000 $240, 000 5, 000 20, 000 15, 00 20, 000 Department A is labor-intensive and Department B is machine-intensive. 4 -47

SINGLE VERSUS MULTIPLE OVERHEAD RATES Job 23 Department A Department B Total Prime costs $5, 000 $0 $5, 000 Job 24 Direct labor hours Department 500 0 A Department B 500 Total Machine hour 1 0 1 Prime costs $0 $5, 000 Units produced 1, 000 0 1, 000 Direct labor hours 0 1 1 Machine hours 0 500 Units produced 0 1, 000 4 -48

SINGLE VERSUS MULTIPLE OVERHEAD RATES Overhead cost Cost driver Department overhead rate Overhead applied to Job #23 Overhead applied to Job #24 Department A Department B $60, 000 $180, 000 15, 000 DLH 15, 000 MHr $4/DLH $12/MHr $2, 000 --- $6, 000 4 -49

End of Chapter 4 -50

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