CHAPTER 2: PRODUCT COSTING

SYSTEMS
I. JOB COSTING
 A job represents the goods manufactured/services
provided to fill a particular order
 In job order costing, the costs of direct materials, direct
labour + overhead are accumulated separately for each
job
 If a job contains multiple units of a product, unit costs are
determined by dividing the total costs charged to the job
by the number of units manufactured
 Job order costing is typically used by companies that
tailor their goods/services to the specific needs of
individual customers. Eg. construction companies use job
order costing b/c each construction project is unique
 Overhead costs are allocated to products using an
estimated overhead rate:
 Total overhead costs + total units produced are not known
until the end of the year
 Not all products consume an equal amount of overhead
 An expected amount of overhead per product helps
managers decide whether too much overhead is being used
 The rate expresses an expected relationship b/w
overhead costs + some activity base related to the
production process (direct labour hours, machine
hours..)
 The rate is determined that the beginning of the period +
based on estimated amounts; ie. estimated overhead
costs/estimated units in the activity base
Example:
 AB company creates individualized computer software
programs for other companies. At the beginning of 2015,
AB management estimated:
 Estimated total overhead costs of 2015: $360,000
 Estimated total direct hours of 2015: 30,000 hours
 Estimated total lines of code of 2015: 1,000,000 lines
 If AB uses direct labour hour as allocation base, the
overhead rate is $12 per direct labour hour, ie. for 1
direct labour hour, overhead cost is $12
 If AB uses lines of code as allocation basis, the
overhead rate is $0.36 per line
 Allocation basis must be a significant driver of overhead
costs, ie. allocation basis must be a causal factor in the
incurrence of overhead costs. An increase in allocation
basis must cause a proportional increase in the actual
overhead costs incurred
 Historically, direct labour hours were the primary driver
of overhead costs.
 As factories become more automated, machine hours,
computer time, setup time… become a better matching
of overhead costs + activities
 A separate job cost sheet is prepared for each job +
used to accumulate all manufacturing costs charged to
the job
 Once the job is finished, the job cost sheet indicates the
costs of the finished goods + provides the information to
calculate unit costs
 Direct manufacturing costs (direct materials + direct
labour) are recorded on the job cost sheet as quickly as
these costs can be traced to the job.
 Simultaneously, overheads are applied using an
overhead rate.
 Exhibit 17-1 p. 765 on job cost sheet
 Accounting for direct materials:
DR Work in Process (WIP)
CR Materials Inventory
 Accounting for direct labour: Time card can be used for
each worker, recording the number of hours worked for
each job, the employee’s rate of pay + the direct labour
cost charged to each job. At the end of each month:
DR WIP
CR Direct labour
Accounting for manufacturing overheads:
 Manufacturing overhead account is debited for the actual
amount of overhead costs incurred during the period
 Overhead is an indirect cost + cannot be traced
conveniently to specific job  a predetermined overhead
rate is used to assign overhead costs to WIP:
DR WIP
CR Manufacturing overhead
Over or under allocation:
 Under allocation occurs when actual overhead cots are
more than overhead allocated
 Over allocation occurs when actual overhead costs are
less than overhead allocated
 At the year end, if the difference is not material, it will be
closed directly to Cost of Goods Sold (COGS). If it is
material, it should be allocated to WIP, Finished Goods
Inventory, + COGS accounts
 Exercise 4.19, 4.20 p.138 Horngren (2015)
 Accounting for completed job:
DR Finished Goods Inventory
CR WIP
 When sales of finished gods occurred:

(a) DR Receivables
(a) CR Sales
(b) DR COGS
(b) CR Finished Goods Inventory
II. PROCESS COSTING
 Many companies produce a continuous stream of
identical units, such as bottles of beer, gallons of
gasoline… When identical products are produced in
a continuous stream, there are no distinct jobs
 Process costing is a method for accumulating direct
+ indirect costs of a production process + averaging
those costs over the identical units produced by
that process
Job order costing Process costing
Product characteristics: Product characteristics:
•Tend to be unique •Are identical
•Use different amounts of •Use identical amounts of
direct materials direct materials
•Use different amounts of •Use identical amounts of
direct labour direct labour
•Are typically low volume •Are high volume
•Are often customer-ordered •Are created with repetitive
operations
 Process costing serves 2 purposes:
 It measures the cost of goods produced on both a total + unit
basis  used in valuing inventories + COGS
 It provides management with information about the unit-cost
of performing each step in the production process  useful
to valuate the efficiency of production departments + draw
attention to potential cost savings
 Exhibit 18-3 p. 808: Physical flows + cost flows in
Process costing
 A separate WIP account is used to measure the costs
incurred in each production process. Costs flow through
these accounts in sequence: just as the units move from
one process to the next
 Each WIP account is charged (debited) for the materials
used, direct labour + overheads that relate to that
process
 Cost flow from one process to the next: units in
production pass from one process to the next  their
costs are transferred from one WIP a/c to the next:
DR WIP – Assembly dept: 200,000
CR WIP – Cutting dept: 200,000
 The output of the cutting dept is a form of direct
materials charged to the Assembly department
 In process costing, unfinished units are stated in terms of
equivalent unit.
 An equivalent unit is a percentage measure of a
completed unit’s resource requirements present in a
partially finished unit.
 30 unfinished units with 80% complete with respect to
conversion requirement (direct labour + overhead):
conversion to make 30 units 80% complete is equivalent
to the conversion to make 24 units 100% complete (30
units*80%)
 Unfinished units consume materials in the same amount
as the finished units
 EXAMPLE of cost per equivalent unit:
 CONSIDER THE ASSEMBLY DEPARTMENT: ON MARCH 1,
1000 UNITS 30% COMPLETE WERE IN PROCESS. DURING
MARCH, 10,000 UNITS WERE TRANSFERRED FROM
CUTTING DEPT. ON MARCH 31, 3,000 UNITS 80%
COMPLETE WERE IN PROCESS. % COMPLETE WITH
RESPECT TO CONVERSION COSTS

Beginning WIP (1000 units, completion 30%) $ 27,500

Cut materials transferred from upstream process (10,000 units) 200,000
Trim materials added in March 44,000
Direct labour incurred in March 105,000
Overhead incurred in March 147,500
Ending balance (3000 units, completion 80%)
Total 524,000
COST PER EQUIVALENT UNIT ($49)
Materials Additional Conversion
transferred in materials
Costs of March $200,000 $44,000 $252,500
Equivalent units 10,000 11,000 1000*0.7+7000+3000*0.8
= 10,100
Cost per 20 4 25
equivalent unit
 Ending balance = 3000*(20+4+0.8*25) = 132,000
 Cost of FG = 524,000 – 132,00 = 392,000

DR WIP – Packaging dept

CR WIP – Assembly dept
 Exercise 17.19, 17.24 p. 698 of Horngren (2015)

 Brief exercises 18.6, 18.7, 18.7 p. 824

 Exercise 18.6 p. 826; 18.7 p. 827

 Exercise 18.9 p. 827; 18.10 p. 828; 18.11 p. 829

EVALUATING DEPARTMENT EFFICIENCY
 In evaluating the efficiency of a production department,
managers should consider only those costs incurred as
a result of that department’s activities
 Managers can calculate the per-unit cost of the
materials, direct labour, + overhead incurred within
each department. This detailed cost information help
identify quickly the cause of any change in a product’s
total unit cost