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Chapter 12Lecture NotesChapter theme: Making decisions is one of the basic functions of a manager. To be successful in decision making, managers must be able to perform differential analysis, which focuses on identifying the costs andbenefits that differ between alternatives. The purpose of this chapter is to develop these skills by illustrating their use in a wide range of decision-making situations.Learning Objective 1: Identify relevant and irrelevant costs and benefits in a decision.I. Decision making: six key conceptsA. Key concept #1i. Every decision involves choosing from among atleast two alternatives. Therefore, the first step indecision-making is to define the alternatives beingconsidered .B. Key concept #2i. Once you have defined the alternatives, you needto identify the criteria for choosing among them.1. Relevant costs and relevant benefits shouldbe considered when making decisions.2. Irrelevant costs and irrelevant benefitsshould be ignored when making decisions.i.The key to effective decision making is differential analysis—focusing on the future costs and benefits that differ between the alternatives. Everything else is irrelevant and should be ignored.1.A future cost that differs between any twoalternatives is known as a differential cost.Differential costs are always relevant costs. 2.Future revenue that differs between any twoalternatives is known as differential revenue.3.An incremental cost is an increase in costbetween two alternatives.4.An avoidable cost is a cost that can beeliminated by choosing one alternative overanother.D.Key concept #4i.Sunk costs are always irrelevant when choosingamong alternatives.1.A sunk cost is a cost that has already beenincurred and cannot be changed regardless ofwhat a manager decides to do.E.Key concept #5i.Future costs and benefits that do not differbetween alternatives are irrelevant to thedecision-making process.i. Opportunity costs also need to be considered when making decisions.1. An opportunity cost is the potential benefitthat is given up when one alternative is selectedover another.II. Identifying relevant costs and benefitsA. An examplei. Assume the following information with respect to Cynthia, a Boston student who is consideringvisiting her friend in New York. Cynthia is tryingto decide whether it would be less expensive todrive or take the train to New York.1. She has assembled the following informationwith respect to her automobile.2. She has also gathered the additionalinformation as shown to aid in her decision.3. Which costs are relevant to her decision?a. The cost of the car is irrelevant to thedecision because it is a sunk cost.b. The annual cost of auto insurance isirrelevant because it does not differbetween alternatives.c. The cost of the gasoline is relevant becauseit is avoidable if she takes the train.d. The cost of maintenance and repairs is relevant because in the long-run these costs depend upon miles driven.e. The parking fee at school is irrelevant because it is not a differential cost.f. The decline in resale value is relevant due to the additional miles driven.g. The round trip train fare is relevant because it is avoidable if she drives her car.h. Relaxing on the train is relevant , but difficult to quantify.i. The kennel cost is irrelevant because it is not a differential cost.j. The cost of parking in New York is relevant because it is avoidable if she takes the train.k. The benefits of having a car in New York and the problem of finding a parking space are both relevant , but difficult to quantify. 4. From a financial standpoint, Cynthia would be better off taking the train .III.Decision analysis: the total cost and differential costapproachesA. An examplei. Assume the following information for a company considering a new labor-saving machine that rents for $3,000 per year . Notice:1. The total approach requires constructing twocontribution format income statements – onefor each alternative.2. The difference between the two income statements of $12,000 equals the differential benefits shown at the bottom of the right-hand column.3. The most efficient means of analyzing thisdecision is to use the differential approach toisolate the relevant costs and benefits as shown.ii.Using the differential approach is desirable for two reasons :1. Only rarely will enough information be available to prepare detailed income statementsfor both alternatives.2. Mingling irrelevant costs with relevant costsmay cause confusion and distract attentionaway from the information that is really critical.segmentsLearning Objective 2: Prepare an analysis showing whether a product line or other business segment should be added or dropped.A. One of the most important decisions managers make is whether to add or drop a business segment .i. Ultimately, a decision to drop an old segment oradd a new one is going to hinge primarily on itsfinancial impact. To assess this impact it isnecessary to carefully analyze the costs.B. Lovell Company – an examplei. Assume that Lovell Company’s digital watch line has not reported a profit for several years;accordingly, Lovell is considering whether to keep or drop this product line.1.To determine how dropping this line will affect the profits of the company, Lovell willcompare the contribution margin that would be lost to the costs that would be avoided if the line was to be dropped.ii. Assume a segmented income statement for the digital watches line is as shown. Also, assume the following:1. An investigation has revealed that the fixed general factory overhead and fixed generaladministrative expenses will not be affected by dropping the digital watch line.2. The equipment used to manufacture digitalwatches has no resale value or alternative use . iii. A contribution margin approach reveals that the contribution margin lost ($300,000) exceeds the fixed costs avoided ($260,000) by $40,000.Therefore, Lovell should retain the digital watch segment.iv. C omparative income statements can also be prepared to help make the decision.1. These income statements show that if thedigital watch line is dropped, the company loses $300,000 in contribution margin. 2. The general factory overhead ($60,000) would be the same under both alternatives, so it is irrelevant . 3.The salary of the product line manager ($90,000) would disappear, so it isrelevant tothe decision.4. The depreciation ($50,000) is a sunk cost. Also, remember that the equipment has no resalevalue or alternative use, so the equipment and the depreciation expense associated with it are irrelevant to the decision.5. The complete comparative income statements reveal that Lovell would earn $40,000 ofadditional profit by retaining the digital watch line.v. Lovell’s allocated fixed costs can distort the keep/drop decision.1. Lovell’s managers may ask “why keep the digital watch segment when its segmentedincome statement shows a $100,000 loss ?”2. The answer lies in the way common fixed costs are allocated to products.a. Including unavoidable common fixed costs in the segmented income statement makes the digital watch product line appear to beunprofitable, when in fact dropping theproduct line would decrease the company’soverall net operating income.V. Make or buy decisionsLearning Objective 3: Prepare a make or buy analysis.A. Key terms and strategic aspects i. When a company is involved in more than one activity in the entire value chain, it is vertically integrated . 1. A decision to carry out one of the activities inthe value chain internally , rather than to buy externally from a supplier, is called a make or buy decision .Helpful Hint: Some critics charge that managers have habitually based make or buy decisions on per unit data without determining which costs are relevant and which are not. Since the per unit costs typically includeallocated common fixed costs, they overstate the costs of producing internally. This creates a bias in favor of outsourcing production.ii.Vertical integration provides certain advantages:1.An integrated company may be able to ensure a smoother flow of parts and materials for production than a nonintegrated company.2.Some companies feel that they can controlquality better by producing their own partsand materials.3.Integrated companies realize profits from theparts and materials that they choose to makeinstead of buy.iii.T he primary disadvantage of vertical integration is that a company may fail to take advantage ofsuppliers who can create an economies of scaleadvantage by pooling demand from numerouscompanies.1.While the economies of scale factor can beappealing, a company must be careful to retaincontrol over activities that are essential tomaintaining its competitive position.B.Essex Company – an examplei.Assume that Essex Company currentlymanufactures part 4A with a unit product cost asshown.1.Also, assume the following information asshown with respect to part 4A. Given theseadditional assumptions, should Essex stopmaking part 4A and buy it from an outsidesupplier?ii. The avoidable costs associated with making part 4A include direct materials ($180,000), direct labor ($100,000), variable overhead ($20,000), and the supervisor’s salary ($40,000). Notice: 1. The depreciation of special equipment is irrelevant. The cost incurred to buy the equipment is a sunk cost; the depreciation simply spreads this sunk cost over the equipment’s useful life. Furthermore, the equipment has no resale value. Thus, the special equipment and its associated depreciation expense are irrelevant to the decision. 2. The allocated general factory overhead represents allocated costs common to all items produced in the factory and would continueunchanged even if Part 4A was purchased from an outside supplier. Thus, the general factory overhead is also irrelevant to the decision.iii. T he financial advantage of making the part is $160,000 less than the cost of buying the part, thereby suggesting that Essex should continue to make the part .C.Opportunity costi.Opportunity costs are not recorded in the organization’s general ledger because they do not represent actual dollar outlays.Rather, theyrepresent economic benefits that are forgone as aresult of pursuing some course of action.ii.In the Essex Company example that we justcompleted, if the space now being used to producePart 4A would otherwise be idle, then thecompany should continue to make its own partsand the supplier’s offer should be rejected. Idlespace that has no alternative use has anopportunity cost of zero.1.If the space to make Part 4A had an alternativeuse, the opportunity cost would have beenequal to the segment margin that could havebeen derived from the best alternative use ofthe space.VI.Special order decisionsLearning objective 4: Prepare an analysis showingwhether a special order should be accepted.A.Key terms and conceptsi. A special order is a one-time order that is notconsidered part of the company’s normal ongoingbusiness.ii. When analyzing a special order, only the incremental costs and benefits are relevant. Since the existing fixed manufacturing overhead costs would not be affected by the order, they are not relevant.Helpful Hint: Emphasize the incremental concept in the decision-making process. If a company accepts aspecial order to produce an item without carefullydetermining existing capacity, it might have to cut into regular production. The effects of lost sales fromongoing products might be devastating.B. Jet Inc. – an examplei. Assume the following information with respect to a special order opportunity for Jet Inc. Should Jet accept the offer ? ii. A contribution format income statement for Jet Inc.’s normal sales of 5,000 units is as shown.iii. I f Jet accepts the special order, the incrementalrevenue of $30,000 will exceed the incrementalcosts of $24,000 by $6,000. This suggests that Jetshould accept the order. Notice:1. This answer assumes that the fixed costs areunavoidable and that variable marketing costsmust be incurred on the special order.Quick Check – special order decision makingVII.Volume trade-off decisionsLearning Objective 5: Determine the most profitableuse of a constrained resource.A.Key terms and conceptspanies are forced to make volume trade-offdecisions when they do not have enough capacityto produce all of the products and sales volumesdemanded by their customers.1.In these situations, companies must trade off,or sacrifice production of some products infavor of others in an effort to maximizeprofits.ii.When a limited resource of some type restricts the company’s ability to satisfy demand, the companyis said to have a constraint. The machine orprocess that is limiting overall output is called thebottleneck—it is the constraint.Helpful Hint: A production process can be thought ofas a chain; each link in the chain represents a step inthe process. A chain is only as strong as its weakest link.Likewise, the capacity of a production process isdetermined by its weakest link, which is the constraint.To increase the strength of a chain, its weakest linkmust be strengthened. To increase the output of theentire process, the output of the constraint must beincreased. Strengthening the stronger links has noeffect on the strength of the entire chain. The moral isto identify the constraint and concentrate managementattention on effectively increasing its capacity.54iii.F ixed costs are usually unaffected in these situations, so the product mix that maximizes the company’s total contribution margin shouldordinarily be selected.iv.A company should not necessarily promote those products that have the highest unit contributionmargins. Rather, total contribution margin will bemaximized by promoting those products oraccepting those orders that providethe highest contribution margin in relation to theconstraining resource.B.Ensign Company – an examplei.Assume that Ensign Company produces twoproducts and selected data are as shown. Inaddition assume that:1.Machine A1 is the constraint.2.There is excess capacity on all other machines.3.Machine A1 has a capacity of 2,400 minutesper week.4.Ensign is trying to decide if it should focus itsefforts on product 1 or 2.Quick Check – constrained resource calculationsii.As suggested by the answer to the Quick Check question, Ensign should emphasize product 2 because it generates a contribution margin of $30 per minute of the constrained resource relative to $24per minute for product 1.iii.E nsign can maximize its contribution margin by first producing product 2 to meet customer demand and then usingany remaining capacity to produce product 1. The calculations would beperformed as follows:1.Satisfying the weekly demand of 2,200 unitsfor product 2 would consume 1,100 minutes ofavailable capacity on machine A1.2.This implies that 1,300 constraint minuteswould still be available to satisfy demand forproduct 1.3.Since each unit of product 1 requires oneminute of A1 machine time, Ensign couldproduce 1,300 units of product 1 with itsremaining capacity.4.This mix of production (e.g., 2,200 units ofproduct 2 and 1,300 units of product 1) wouldyield a total contribution margin of $64,200. Learning Objective 6: Determine the value of obtaining more of the constrained resource.i.How much should Ensign be willing to pay for anadditional minute of A1 machine time?1. Because the additional machine time would beused to make more units of Product 1, Ensignshould be willing to pay up to $24 per minute.This amount equals the contribution margin perminute of machine time that would be earnedproducing more units of Product 1.Quick Check – constrained resource calculationsC.Managing constraintsi.It is often possible for a manager to increase thecapacity of a bottleneck, which is called relaxing(or elevating) the constraint, in numerous wayssuch as:1.Working overtime on the bottleneck.2.Subcontracting some of the processing thatwould be done at the bottleneck.3.Investing in additional machines at thebottleneck.4.Shifting workers from non-bottleneckprocesses to the bottleneck.5.Focusing business process improvementefforts on the bottleneck.6.Reducing defective units processed throughthe bottleneck.VIII. Joint product costs and sell or process further decisionsLearning Objective 7: Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. A. Key terms/conceptsi. In some industries, a number of end products areproduced from a single raw material input. Whentwo or more products are produced from acommon input these products are known as jointproducts . The split-off point is the point in themanufacturing process at which the joint productscan be recognized as separate products.1. For example, in the petroleum refiningindustry a large number of products areextracted from crude oil, including gasoline, jetfuel, home heating oil, lubricants, asphalt, andvarious organic chemicals.ii. The term joint cost is used to describe costsincurred up to the split-off point. Joint costs arecommon costs incurred to simultaneously producea variety of end products.1. Joint costs are traditionally allocated among different products at the split-off point. A typical approach is to allocate joint costs according to the relative sales value of the end products.2. Although allocation is needed for some purposes such as balance sheet inventory valuation, allocations of this kind are very dangerous for decision making.B. Sell or process further decisionsi. Joint costs are irrelevant in decisions regarding what to do with a product from the split-off point forward. Therefore, these costs should not be allocated to end products for decision-making purposes.ii.With respect to sell or process further decisions, itis profitable to continue processing a joint product after the split-off point so long as theincremental revenue from such processing exceeds the incremental processing costs incurred after the split-off point .C. Sell or process further decisions – an example i. Assume the facts as shown with respect to Sawmill, Inc.1. Sawmill has two joint products – lumber and sawdust . Selected financial information is shown for each joint product.2. The incremental revenue from further processing of the lumber and sawdust is $130 and $10, respectively.3. The financial advantage (disadvantage) of further processing is $80 for the lumber and ($10) for the sawdust.4. The lumber should be processed further and the sawdust should be sold at the split-off point .D. Activity-based costingand relevant costs i. Activity-based costing can be used to help identify potentially relevant costs for decision-making purposes. However, managers should exercise caution against reading more into this “traceability” than really exists. People often assume that if a cost is traceable to a segment, then the cost is automatically avoidable, which is untrue . Before making a decision, managers must decide which of the potentially relevant costs are actually avoidable.。
Chapter 4Lecture NotesChapter theme: Managers need to assign costs to products to facilitate external financial reporting and internal decision making. This chapter illustrates an absorption costing approach to calculating product costs known as process costing .I. Comparison of job-order and process c ostingA. Similarities between job-order and process costingi. Both systems assign material , labor, andoverhead costs to products and they provide a mechanism for computing unit product costs.ii. Both systems use the same manufacturing accounts,including Raw Materials, Work in Process,Manufacturing Overhead, and Finished Goods . iii. The flow of costs through the manufacturingaccounts is basically the same in both systems.B. Differences between job-order and process costingi. Process costing is used when a single product is produced on a continuing basis or for a long periodof time. Job-order costing is used when many different jobs having different productionrequirements are worked on each period.ii. Process costing systems accumulate costs by department and assign them uniformly to all units processed during the period. Job-order costing systems accumulate costs by individual jobs .iii. Process costing systems compute unit costs bydepartment. Job-order costing systems compute unit costs by job on the job cost sheet.Quick Check - process vs. job-order costing II.Cost flows in process costingA. Processing departments - An organizational unit where materials, labor, or overhead costs are added to the product.i. The activity performed in a processing department is performed uniformly on all units passing through it. Furthermore, the output of a processing department must be homogeneous . ii. Products in a process costing environment typically flow in a sequence from one department to another.Learning Objective 1: Record the flow of materials, labor, and overhead through a process costing system.B.The flow of materials, labor, and overhead costsi.The flow of costs through the manufacturing accounts is basically the same for process and job-order costing.1.Direct materials, direct labor, andmanufacturing overhead are added to Work inProcess. When work in process is completed,the costs are transferred to Finished Goods.When finished goods are sold, the costs aretransferred to Cost of Goods Sold.ii.Nonetheless, there is a key fundamental difference between process and job-order costing systems.1.Job-order costing systems trace and applymanufacturing costs to jobs.a.One Work in Process account is often usedto accumulate costs for all jobs. Theindividual job cost sheets serve as asubsidiary ledger.2.Process costing systems trace and applymanufacturing costs to departments.a.A separate Work in Process account ismaintained for each processing department.b.Material, labor, and overhead coststransferred from one department’s Work inProcess account to another department’sWork in Process account are calledtransferred-in costs.iii.T-account and journal entry views of process cost flows (For purposes of this example, assume there are two processing departments—A and B).Helpful Hint: Explain that the journal entries for job-order and process costing are similar, with theexception of the specific Work in Process account for each department under process costing.1.The flow of raw material costs.a.In T-account form:(1).Direct material costs are debited to theappropriate departmental Work inProcess account depending upon wherethe materials were added to theproduction process. The Raw Materialsaccount is credited for thecorresponding amounts.b.In journal entry form:(1).Debit the respective departmental Workin Process accounts. Credit RawMaterials.2.The flow of labor costs.a.In T-account form:(1).Direct labor costs are debited to theappropriate departmental Work inProcess account depending upon wherethe labor was added to the productionprocess. Salaries and Wages Payable iscredited for the corresponding amounts.b. In journal entry form: (1). Debit the respective departmental Work in Process accounts. Credit Salaries and Wages Payable. 3. The flow of manufacturing overhead costs. a. In T-account form: (1). Manufacturing overhead costs are debited to the respective departmental Work in Process accounts. Manufacturing Overhead is credited by the corresponding amounts. (a). Predetermined overhead rates are usually used to apply overhead to the departments. b. In journal entry form: (1). Debit the appropriate departmental Work in Process accounts. Credit Manufacturing Overhead.4. The flow of manufacturing costs for partially completed units transferred fromDepartment A to Department B:a. In T-account form:(1). The cost of direct materials, direct labor,and manufacturing overhead assignedto partially completed units fromDepartment A is debited to DepartmentB and credited to Department A.(3). The transferred-in costs from Department A are added to the manufacturing costs incurred in Department B. b. In journal entry form: (1). Debit Work in Process - Department B and credit Work in Process - Department A. 5. The flow of manufacturing costs from the final processing department to finished goods . a. In T-account form: (1). Debit Finished Goods and credit Work in Process - Department B for the amount of the cost of goods manufactured. b. In journal entry form: (1). Debit Finished Goods and credit Work in Process - Department B. 6. The flow of manufacturing costs from Finished Goods to Cost of Goods Sold. a. In T-account form: (1). Debit Cost of Goods Sold and credit Finished Goods. b. In journal entry form: (1). Debit Cost of Goods Sold and credit Finished Goods.III. Process costing computations: three key conceptsA. Key concept #1: Two methodsi. Equivalent units can be calculated two ways .1. The FIFO method is covered in the appendix;theweighted-average method is includedwithin the main portion of the chapter (and it is covered next).2. Characteristics of the weighted-averagemethod:a. This method makes no distinction between work done in the prior and current periods.It blends together units and costs from theprior and current periods.b. The equivalent units of production for adepartment are the number of unitstransferred to the next department (orfinished goods) plus the equivalent units inthe department’s ending work in processinventory.B. Key concept #2: Conversion costsi. Direct labor costs are often small in comparison to the other product costs in process cost systems.1. Therefore, direct labor and manufacturing overhead are often combined into one classification of product cost called conversion costs . The example combines these costs.C. Key concept #3: Equivalent unitsi. Equivalent units - Defined as the product of the number of partially completed units and the percentage completion of those units. ii. Equivalent units need to be calculated because a department usually has some partially completed units in its beginning and ending inventories. These partially completed units complicate the determination of a department’s output for a given period and the unit cost that should be assigned to that output.Helpful Hint: Explain that equivalent units simply restate the ending work in process inventory as if it were comprised of a smaller number of fully completed units.iii. Equivalent units - the basic idea: 1. Two half completed products are equivalent to one complete product. 2. 10,000 units 70% completed are equivalent to 7,000 complete units. Quick Check - calculating equivalent unitsLearning Objective 2: Compute the equivalent units of production using the weighted-average method.IV. W eighted-average method--ExampleA. Assume that Smith Company’s Assembly Department reported activity for June as shown on this slide. i. Step 1: Compute the equivalent units of production (weighted average method)1. The first component in the calculation of the equivalent units is to identify the units completed and transferred out of the department in June (5,400 units for materials and conversion ).2. The second component is to identify the equivalent units of production in ending work in process with respect to materials for the month (540 units ) and adding this to the 5,400 units from step one.3. The third component is to identify the equivalent units of production in ending work in process with respect to conversion for the month (270 units ) and adding this to the 5,400 units from step one.Helpful Hint: Explain that there will most likely be differences in the equivalent unit calculations between materials and conversion costs, as materials are usually added at the beginning of production, while conversion costs are added during the period.4. The equivalent units of production equals the units completed and transferred out (5,400 units ) plus the equivalent units remaining in work in process (540 units for materials and 270 units for conversion ).5. A different visual depiction of the equivalent units calculation for materials is shown on this slide.6. A different visual depiction of the equivalent units calculation for conversion is shown on this slide. Helpful Hint: The treatment of beginning inventory under the weighted-average method often puzzles students, since work done in the prior periods is included in the equivalent units. Explain that this is called the weighted-average method precisely because it averages together beginning inventory and work performed in the current period. Costs and units are treated consistently. Both the equivalent units and the costs that go into the unit cost calculations under the weighted-average method include amounts already in beginning inventory.Learning Objective 3: Compute the cost per equivalent unit using the weighted-average method. ii. Step 2: Computing the cost per equivalent unit (weighted average method)1. Assume the following additional facts with respect to Smith Company’s Assembly Department.2. The formula for computing the cost per equivalent units is as shown.3. The numerators for Smith Company ($124,740 for materials and $85,050 for conversion ) are computed as shown.4. The cost per equivalent unit for materials ($21.00) and conversion ($15.00) is computed as shown.a. The equivalent units of production (5,940for materials and 5,670 for conversion )were computed on a prior slide.iii. Step 3: Assign costs to units (weightedaverage method)Learning Objective 4: Assign costs to units using the weighted-average method.1. Computing the cost of ending work in processinventory. a. The first component of the calculation is to record the equivalent units of production inending work in process inventory (540 unitsfor materials and 270 units forconversion).b. The second component of the calculation is to record the cost per equivalent unit ($21.00for materials and $15.00 for conversion).compute the cost of ending work in process inventory ($11,340 for materials, $4,050 for conversion, and $15,390 in total).2.Computing the cost of units transferred out .a.The first component of the calculation is to record the units transferred out to the next department (5,400 units for materials and conversion ). b. The second component of the calculation is to record the cost per equivalent unit ($21.00 for materials and $15.00 for conversion ). c. The third component of the calculation is to compute the cost of units transferred out ($113,400 for materials, $81,000 for conversion, and $194,400 in total ). Learning Objective 5: Prepare a cost reconciliation report using the weighted-average method. iv. Step 4: Prepare a cost reconciliation report1. Computing the costs to be accounted for: a. The first component of the calculation is to record the cost of beginning work in process as shown on slide 43 ($10,039).to record the costs added to production during the period as shown on slide 43 ($199,751). c. The third component of the calculation is to sum these two costs ($209,790). 2. Computing the costs accounted for : a. The first component of the calculation is to record the previously computed cost of ending working process inventory ($15,390). b. The second component of the calculation isto record the previously computed cost ofunits transferred out ($194,400).c. The third component of the calculation is to sum these two costs ($209,790).3. Notice the two totals agree indicating that all costs have been accounted for.V.Operation costingA. Operation costing is a hybrid of job-order and process costing because it possesses attributes of both approaches. i. Operation costing is commonly used when batches of many different products pass through the same processing departments.1.For example, similar to job-order costing, a Array shoe manufacturer may charge each batch ofshoes for its own specific material costs (e.g., shoes made with expensive leather would becharged accordingly, as would shoes madewith inexpensive synthetic materials).2.Similar to process costing, the shoemanufacturer may accumulate the labor andoverhead costs by department and assign thesame conversion cost per unit to each shoeregardless of the shoe style.。
Chapter 3Lecture NotesChapter theme: Companies use job-order costing to assign manufacturing costs to individual jobs. This chapter describes how companies use job-order costing to prepare a balance sheet and an income statement for external reporting purposes.Important vocabulary termsA.Job-order costing– A costing system used insituations where many different products, jobs, orservices are produced each period.B.Absorption costing– A costing method that includesall manufacturing costs—direct materials, direct labor,and both variable and fixed manufacturing overhead—in the cost of a product.C.Allocation base– A measure of activity such as directlabor-hours or machine-hours that is used to assigncosts to cost objects.D.Predetermined overhead rate– A rate used to chargemanufacturing overhead cost to jobs that is establishedin advance for each period. It is computed using thefollowing equation:i.Predetermined overhead rate = Estimated totalmanufacturing overhead cost ÷ Estimated totalamount of the allocation base3E. Overhead application – The process of assigning overhead costs to specific jobs using the following formula:i. Overhead applied to a particular job =Predetermined overhead rate x Amount ofallocation base incurred by the jobF. Normal costing – A costing system in which overhead costs are applied to a job by multiplying apredetermined overhead rate by the actual amount of the allocation base incurred by the job.G. Job cost sheet – A form that records the direct materials, direct labor, and manufacturing overhead cost charged to a job.II.Job-order costing the flow of costsLearning Objectives 1 and 2: Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs. Use T-accounts to show the flow of costs in a job-order costing system.Helpful Hint: Sometimes students need a brief review of journal entries and the use of T-accounts beforebeginning this section of the chapter.A.Key definitionsi.Raw materials– Include any materials that go into the final product.ii.Work in process– Consists of units of production that are only partially complete and will requirefurther work before they are ready for sale tocustomers.iii.Finished goods– Consist of completed units of product that have not yet been sold to customers.iv.Cost of goods manufactured– Includes the manufacturing costs associated with the goods thatwere finished during the period.B.Flow of cost: a conceptual overviewi.Raw materials purchases are recorded in the RawMaterials inventory account.ii.When raw materials are used in production as direct materials, their costs are transferred to theWork in Process inventory account.iii.To transform direct materials into completed jobs, direct labor cost is added to the Work in Processinventory account.iv.Manufacturing overhead cost is applied to Work in Process by multiplying the predeterminedoverhead rate by the actual quantity of theallocation base consumed by each job.v. When jobs are completed , their costs aretransferred from the Work in Process inventoryaccount to the Finished Goods inventory account.vi. The amount transferred from the Work in Processinventory account to the Finished Goods inventory account is referred to as the cost of goodsmanufactured .vii. As goods are sold , their costs are transferred fromthe Finished Goods inventory account to Cost of Goods Sold.viii. Period costs (or selling and administrativeexpenses) do not flow through inventories on the balance sheet. They are recorded as expenses on the income statement in the period incurred.C. Transactions (in T-account and journal entry form) that capture the flow of costs in a job-order costing system are as follows:i. The purchase and issue of materials1. In T-account form :a. The cost of raw material purchases isdebited, and although not shown, the creditside of the transaction would be to AccountsPayable.b. The cost of direct material requisitioned isdebited to Work in Process and added to thejob cost sheets which serve as a subsidiaryledger.c. The cost of indirect material requisitions isdebited to Manufacturing Overhead.a. Debit Raw Materials and credit Accounts Payable.b. Debit Work in Process and Manufacturing Overhead and credit Raw Materials.ii.The recording of labor cost1.In T-account form : a.Direct labor costs are debited to Work in Process and added to the job cost sheetswhich serve as a subsidiary ledger. b. Indirect labor costs are debited to Manufacturing Overhead. 2. In journal entry form : a. Debit Work in Process and Manufacturing Overhead and credit Salaries and Wages Payable. iii.Recording actual manufacturing overhead costs (other than indirect materials and indirect labor) 1. In T-account form : a. As they are incurred, the actual manufacturing overhead costs are debited to Manufacturing Overhead.b. The credit side of the entry is to Cash orvarious liability accounts (e.g., AccountsPayable and Property Taxes Payable),prepaid asset accounts (e.g., PrepaidInsurance), and contra-asset accounts(e.g., Accumulated Depreciation).a. Debit Manufacturing Overhead and credit various accounts as shown.iv. Applying manufacturing overhead costs to workin process1. In T-account form : a. Work in process is debited and Manufacturing Overhead is credited by the amount of the actual quantity of the allocation base multiplied by the predetermined rate . b. Actual manufacturing overhead costs are not debited to Work in Process, nor are they charged to jobs via the job cost sheets. c. The Manufacturing Overhead account is a clearing account . The actual amount of overhead incurred during the period on the debit side of the account will almost certainly not equal the amount applied to Work in Process as shown on the credit side of the account. This requires a year-end adjusting entry that will be discussed shortly.2. In journal entry form : a. Debit Work in Process and creditManufacturing Overhead.Helpful Hint: Students sometimes have difficulty understanding the use of Manufacturing Overhead as a clearing account. Explain that the purpose of the clearing account is to find any discrepancy that exists between the amount of overhead applied to inventory and the amount of overhead actually incurred. Actual overhead incurred is debited to the account. Overhead applied to inventory using the predetermined rate is credited to the account.v.Accounting for nonmanufacturing costsHelpful Hint: Review the concepts of product and period costs at this point. Since period costs are not directly related to the actual manufacture of the products, they are expensed as incurred.panies that use job-order cost systems toassign manufacturing costs to products alsoincur nonmanufacturing costs.2.Nonmanufacturing costs should not go intothe Manufacturing Overhead account.3.Nonmanufacturing costs are not assigned toindividual jobs, rather they are expensed inthe period incurred. For example:a.The salary expenses of employees thatwork in a marketing, selling, oradministrative capacity are expensed inthe period incurred.b.Advertising expenses are expensed in theperiod incurred.vi. Transferring completed jobs from work inprocess to finished goods1. In T-account form : a. The sum of all amounts transferred from work in process to finished goods represents the cost of goods manufactured for the period. b. The Finished Goods Inventory is debited and the Work in Process account is credited.2. In journal entry form : a. Debit Finished Goods and credit Work in Process.vii.Transferring finished goods to cost of goods s old 1. In T-account form : a. Debit Cost of Goods Sold and credit Finished Goods. b. If only a portion of the units associated with a particular job are shipped, then the unit cost figure from the job cost sheet is used to determine the amount of the journal entry. c. This journal entry is also accompanied by a journal entry that recognizes the sales revenue. 2. In journal entry form : a. Debit Accounts Receivable and credit Sales.b. Debit Cost of Goods Sold and creditFinished Goods.Helpful Hint: As a concluding thought, remind studentsthat all inventory accounts are governed by the samelogic: Beginning inventory + Additions = EndingInventory + Transfers out. In the case of raw materials,transfers out consist of both direct and indirectmaterials requisitions. Direct materials requisitions areadded to Work in Process inventory. Indirect materialsrequisitions are debited to Manufacturing Overhead.Additions to Work in Process consist of direct materialsrequisitions, direct labor, and overhead applied.Transfers out of Work in Process consist of coststransferred to Finished Goods. Transfers out ofFinished Goods consist of Cost of Goods Sold.III.Schedules of cost of goods manufactured and cost of goods soldLearning Objective 3: Prepare schedules of cost ofgoods manufactured and cost of goods sold and anincome statement.A.Key conceptsi.This schedule contains three types of costs,namely direct materials, direct labor, andmanufacturing overhead.ii.It calculates the cost of raw material and direct labor used in production and the amount ofmanufacturing overhead applied to production.iii.I t calculates the manufacturing costs associated with goods that were finished during the period.B. Product cost flowsiv. T o create a schedule of cost of goods manufactured, as well as a balance sheet and income statement, it is important to understand the flow of product costs: 1. Raw material purchases made during the period are added to beginning raw materials inventory. The ending raw materials inventory is deducted to arrive at the raw materials used in production . a. As items are removed from raw materials inventory and placed into the production process, they are called direct materials . 2. Direct labor used in production and manufacturing overhead applied to production are added to direct materials to arrive at total manufacturing costs . 3. Total manufacturing costs are added to the beginning work in process to arrive at total work in process . 4. The ending work in process inventory is deducted from the total work in process for the period to arrive at the cost of goods manufactured . 5. The cost of goods manufactured is added to the beginning finished goods inventory to arrive at cost of goods available for sale. The ending finished goods inventory is deducted from this figure to arrive at cost of goods sold . Quick Check product cost flowsIV. Underapplied and overapplied overhead —a closer lookLearning Objective 4: Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.A. There are two key concepts related to this topic, the first of which is:i. Defining and computing underapplied overheadand overapplied overhead1. The difference between the overhead costapplied to Work in Process and the actualoverhead costs of a period is termed eitherunderapplied overhead or overapplied overhead.a. Underapplied overhead exists when theamount of overhead applied to jobs duringthe period using the predetermined overheadrate is less than the total amount ofoverhead actually incurred during the period.b. Overapplied overhead exists when theamount of overhead applied to jobs duringthe period using the predetermined overheadrate is greater than the total amount ofoverhead actually incurred during the period.Helpful Hint: Students need to understand thatmanufacturing overhead must be estimated at the beginning of the production period. Therefore, theremost likely will be a difference between actual andapplied overhead. A debit balance in the Manufacturing Overhead account indicates more overhead has beenincurred than has been applied to inventory andoverhead is underapplied. A credit balance indicates more overhead has been applied than has beenincurred and overhead is overapplied.puting underapplied or overapplied Array overhead, an example:a.Assume that PearCo’s actual overheadand direct labor hours for the year were$650,000 and 170,000, respectively.b.Recall that PearCo’s total estimatedoverhead and direct labor hours for theyear were $640,000 and 160,000,respectively. Therefore, thepredetermined overhead rate would be $4per direct labor hour.c.The amount of overhead applied to jobsduring the year would be 170,000 directlabor hours × $4 per hour = $680,000.d.In this example, overhead wasoverapplied by $680,000 - $650,000 =$30,000.Quick Check - underapplied overhead and overappliedoverheadii. Disposition of underapplied or overapplied overhead balances1.Any remaining balance in the Manufacturing Overhead account, such as PearCo’s $30,000 of overapplied overhead, is disposed of in one of two ways : a. It can be closed out to Cost of Goods Sold . b. It can be allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied during the current period in the ending balances of these accounts. 2. The journal entry, in T-account form, to close out PearCo’s $30,000 of overapplied overhead into Cost of Goods Sold would be as follows: a. Debit Manufacturing Overhead and credit Cost of Goods Sold. 3. Calculating the allocation of underapplied or overapplied overhead between Work in Process, Finished Goods, and Cost of Goods Sold . a. Assume the overhead applied in Ending Work in Process Inventory, Ending Finished Goods Inventory, and Cost of Goods Sold is $68,000, $204,000, and $408,000, respectively (total value of accounts $680,000). b. In this case, the allocation percentages for Work in Process, Finished Goods, andCost of Goodsc. Sold would be 10%, 30%, and 60%, respectively.d. The allocation of the $30,000 of overapplied overhead would be: Work in Process, $3,000; Finished Goods, $9,000; and Cost of Goods Sold, $18,000. 4. The journal entry to close out the $30,000 of overapplied overhead to each of the three accounts would be: a. Debit Manufacturing Overhead and credit Work in Process, Finished Goods, and Cost of Goods Sold. 5. In summary, there are two methods for disposing of underapplied and overapplied overhead. a. Close out to Cost of Goods Sold. b. Allocate between Work in Process, Finished Goods, and Cost of Goods Sold. c. The latter method is considered more accurate, but it is more complex to compute.Quick Check under- and overapplied overhead。
