Chapter 16

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					   Chapter 16
Cost Concepts and
 Cost Allocation
Learning Objectives:
Cost Classifications
Product Costs
Manufacturing Inventory Accounts and
    Cost Flows
How much does it cost?
Types of Businesses
Financial Reporting of Costs
Overhead Cost Allocation: Traditional
    and ABC Approaches
Types of Businesses
      Figure 6

      Merchandising   or

 Cost traceability: direct and indirect
 Cost behavior: fixed or variable
 Marketing value: value or nonvalue adding
 Financial reporting: product or period
Cost Classifications

 Cost Traceability                 Costs                             Value-Adding                   Financial
                                  Behavior                            Attributes                    Reporting

                          Fixed                             Value-            Nonvalue-   Product          Period
Direct         Indirect                  Variable
                                                            Adding             Adding
Cost Classifications:

Marketing Value                        Financial Reporting      Cost Behavior

 Value Adding        Period Costs         Product Costs          Variable
 Non-Value Adding     Expenses             Inventoriable         Fixed

                    Direct Materials      Direct Labor          Overhead
                                                              Indirect Costs

                       Prime Costs         Conversion Costs     Conversion Costs
                                           Prime Costs

                  In-Class Exercise SE1
    Product Costs and Inventory Accounts
                           Figure 5
   Materials Inventory
       Materials Purchased
       Materials Used in Production
   Work in Process Inventory
       Current Manufacturing Costs:
        DM, DL, OH used
       Cost of Goods Manufactured
   Finished Goods Inventory
       Cost of Goods
       Cost of Goods Available for Sale
                                           Exercise is E5.
       Cost of Goods Sold
Financial Statement and the
Reporting of Costs
   Service Organizations
    Do not have inventory accounts
   Retail or Merchandise Organizations
    Only on inventory account
    Use of Cost of Good Sold
    Cost of Good Sold = Beg. Inv. + Purchases - End.
   Manufacturing Organizations
    Keeps three inventory accounts
      1.     Material Inventory
      2.     Work In Process Inventory
      3.     Finished Goods Inventory
Inventory Accounts in
Manufacturing Organizations
 Materials
    The purchasing department is responsible for
     purchasing direct and indirect materials need. When
     the materials arrived, direct materials cost is moved to
     Work in Process Inventory.
 Work in Process
    Cost of direct materials, direct labor, and
     manufacturing overhead are accumulated in this
 Finished Good Inventory
    As the product is completed its cost moves from the
     work in process inventory to the Finished Good
     Inventory. When the product is sold, its cost will move
     to Cost of Good Sold.
Manufacturing Cost Flow
       Direct Materials                   Work in Process
     Inventory Account                   Inventory Account

Balance 12/31/x3: Used during
          $10,000 20x4:              Balance 12/31/x3: Completed
Total direct               $25,000             $ 2,000 during 20x4:
materials                                                        $30,000
purchased                            Direct materials
during 20x4:                         used during 20x4:
           20,000                               25,000
                                     Direct labor 20x4:
Balance                                         12,000
12/31/x4:                            Manufacturing
            $5,000                   overhead 20x4:

                                     Balance 12/31/x4
Manufacturing Cost Flow
                                         Work in Process
       Factory Payroll
                                        Inventory Account

Direct labor      20x4:             Balance 12/31x3: Completed
earned during             $12,000             $ 2,000 during 20x4:
20x4:                                                           $30,000
          $12,000                   Direct materials
                                    used during 20x4:
                                    Direct labor 20x4:
Balance                             Manufacturing
12/31/x4:                           overhead 20x4:
            $0                                   6,000

                                    Balance 12/31/x4
Manufacturing Cost Flow
Manufacturing Overhead                    Work in Process
   Control Account                       Inventory Account

Total              20x4:             Balance 12/31/x3: Completed
manufacturing              $ 6,000              $2,000 during 20x4:
overhead                                                         $30,000
incurred during                      Direct materials
20x4:                                used during 20x4:
         $ 6,000                                25,000
                                     Direct labor 20x4:
Balance                              Manufacturing
12/31/03:                            overhead 20x4:
            $0                                    6,000

                                     Balance 12/31/x4
Manufacturing Cost Flow
       Work in Process
      Inventory Account
                                            Finished Goods
                                             Inventory Account

Balance 212/31/x3: Completed
                                      Balance 12/31/x3: Sold during 20x4:
           $2,000 during 20x4:
                            $30,000            $6,000            $24,000
Direct materials
used during 20x4:
           25,000                     during 20x4:
Direct labor 20x4:                              30,000
overhead 20x4:                        Balance
Balance 12/31/x4
 Manufacturing Cost Flow
      Finished Goods                         Cost of Goods Sold
     Inventory Account                            Account

Balance 12/31x3:      Sold during 20x4:   Sold during
         $6,000                $24,000    20x4:
during 20x4:

Group Exercise
The balance in the Work in Process Inventory account on April
1 was $31,600, and the balance on April 30 was $22,600.
Costs incurred during the month were as follows:
Direct materials                        41,250
Direct Labor                            17,300
Manufacturing Overhead                  32,600

What was the amount transfer to Finished Goods Inventory
account during April?
WIP Beginning Inventory       $31,600
Less Ending Inventory         22,600
Completed                      9,000
Direct Materials              41,250
Direct Labor                  17,300
Manufacturing OH              32,600
To Finished Goods Inventory   $101,150
Team Work
 Solve   SE3
Financial Reporting, Income
 Nomatter the type of organization the
 income statement is report as:
 Less Cost of Good Sold
 = Gross Margin
 Less Expenses
 = Operating Income
                 In-Class Exercise SE2
Statement of Goods
   Step 1: Compute the cost of direct materials
    used during the accounting period.
       Beginning Balance + DM purchase - Ending DM Balance

EI: Direct Materials Used:
       Materials Inventory, Dec.31, 2005            $100,000
       Direct Materials Purchase                     200,000
       Cost of Direct Materials available for use    300,000
       Less materials inventory, Dec. 31, 2006        50,000
        Cost of direct materials used               $250,000
Calculating Unit Cost-
The cost per unit of a product is found by
  adding all its cost and dividing it by the
  number of units produced.
In manufacturing, for example, it will include:
  Materials                    $1,000
  Labor                        $2,000
  Overhead                     $5,000
Total Cost                     $8,000
# of Units Produced       10,000

Unit Cost (10,000/ $8,000) $1.2

                      In-Class Exercise SE8
Statement of Goods
   Step 2: Calculate total manufacturing cot for the
    period: Direct Materials Used + Direct Labor +Manufacturing

EI: Manufacturing Cost:
        Direct Materials Used (from step 1)   $250,000

        Direct Labor                           120,000
        Manufacturing Overhead                  60,000

        Total manufacturing cost              $430,000
Statement of Goods
   Step 3: Determine total cost of goods manufactured
    for the period. Total Manufacturing Cost + Beginning
    WIP - Ending WIP

EI: Cost of Goods Manufactured:
        Total manufacturing cost (from step 2)          $430,000

        Add WIP Dec. 31, 2005                             20,000
        Total cost of work in process during the year    450,000
        Less WIP Dec. 31, 2006                           150,000
        Cost of Goods Manufacturing                     $300,000
Team Work
 Solve   E4
                                                  Ron Company
                                     Statement of Cost of Goods Manufactured
                                            For the Month of August

Direct materials used

 Materials Inventory, beginning                                                 $48,600

 Direct Materials purchased                                                     139,000

 Cost of direct materials available for use                                    $187,600

 Less materials inventory, ending                                                50,100

Cost of direct materials used                                                              $137,500

Direct labor costs (3,400 hours x $8.75)                                                     29,750


 Utilities                                                                 $67,000.00

 Supervision                                                                   41,000.00

 Indirect materials                                                            54,000.00

 Depreciation                                                                   5,000.00

 Insurance                                                                      3,000.00

 Miscellaneous                                                                 66,000.00

 Total manufacturing overhead costs                                                          38,350

Total manufacturing costs                                                                  $205,600

Add work in process inventory, beginning                                                     54,250

Total cost of work in process during the year                                              $259,850

Less work in process inventory, ending                                                       48,400

Cost of goods manufactured                                                                 $211,450
Elements of Cost
    The three elements of product cost are:
    1.   Direct Materials (Materials directly related to the product)
    2.   Direct Labor (Employees who worked in manufacturing the
    3.   Manufacturing Overhead                 (All other cost including: Indirect
         materials, Indirect Labor, and other supplies)

    Prime Cost
        Primary cost of a product, Direct Materials and
         Direct Labor
    Conversion cost
        The cost of converting a unit of production into a
         finished good, Direct materials and Manufacture
                          In-Class Exercise SE5
Costing Methods -
Actual Costing Method
 Uses  the know cost of materials, labor,
   and overhead.
EI: Manufacturing 3,000 candy bars costing the following:

   Direct Materials $540 / 3,000 = .18 each bar
   Direct Labor     $420 / 3,000 = .14
   Overhead         $421 / 3,000 = .08
   Total Production Cost per bar = $.40
Costing Methods -
Normal Costing Method
 Uses   the know cost of materials, labor,
   and estimates overhead cost using a
EI: Overhead rate is based on 60% of direct labor.
Manufacturing 3,000 candy bars costing the following:
   Direct Materials $540 / 3,000 =             .18 each bar
   Direct Labor     $420 / 3,000 =             .14
   Overhead         $420 x 60% = 252 / 3,000 = .08 (rounded)
   Total Production Cost per bar =             $.40
Costing Methods -
Standard Costing Method
 Uses   predetermined rates for materials,
   labor, and overhead.
Manufacturing 3,000 candy bars costing the following:
   Direct Materials     =        .18 each bar
   Direct Labor         =       .14
   Overhead             =       .09
Total Production Cost per bar = $.44

                              In-class Exercise SE6
Cost Allocation
A   cost object is a:
  product

  process

  department

  activity

that the organization wishes to cost.
Cost Allocation
A cost pool is the collection of indirect
 cost assigned to a cost object. EI:
 Machine hours, Units produced, etc.
A cost driver is an activity that causes
 the cost pool to increase in amount as
 the cost driver increases.
Allocation of
Manufacturing Overhead
The allocation of manufacturing
 overhead requires the following:
     The pooling of manufacturing overhead costs that
      are affected by a common activity.

     The selection of a cost driver whose activity level
      causes a change in the cost pool.

                      In-Class SE7
Key Question:
How much does it cost?

 What should   be included?
 Unit cost of a product or service:

               Total costs
             Units produced
Overhead Cost Allocation:
Traditional and ABC Approaches to Applying Overhead

     Traditional                 ABC
     One overhead account          Overhead divided into
     One plant wide rate            Activities
                                    Many activity rates
     All Budgeted Overhead
      divided by Estimated          Budgeted Activity Cost
                                     Pool divided by
      Cost Driver i.e. DL$,DLH
                                     Estimated Cost Driver
  Predetermined Rate:
                                 Predetermined Rate:
  Estimated Overhead
                                 Estimated Cost Pool
  Estimated Cost Driver
                                 Estimated Cost Driver
Team Work
   Exercise SE 8      Exercise SE 9
   SE 8                                SE9

Predetermine OH Rate =               Overhead Cost Applies =          $4
   Total Estimated Overhead Cost         per direct labor hour
   Total Estimated Service Request                               x   $1,200
                                         Service request             $4,800
    =     $18,290
          3,100 service request

    = $5.90 per service request
     E14, P1 and P3

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