Product Costs:
All costs required to manufacture the product
DM, DL, M O/H
Reported as inventory (inventoriable) on the balance sheet until sold
Become cost of goods sold on income statement when products are sold

Period Costs:
Reported on the income statement in the period incurred,
Not a cost to manufacture the product.

Warehouse costs and people who move inventory inside the company
Selling Costs: marketing, get products to customer, customer service/support
Administrative Costs: support the organization; “corporate”, “administrative”

Other Terms That Are Used:
Prime Costs – direct materials plus direct labor
Conversion Costs – direct labor plus manufacturing overhead
Direct Cost – easily and conveniently traced to one product (DM & DL)
Indirect Cost – cannot be easily and conveniently traced to one product (MOH, Period)

PRODUCT COSTS
Incurred to manufacture products.
Anything that becomes part of the product, anyone who touches the product to make it, and all the costs of the facilities and management incurred to make the product.

Direct Materials –
Raw materials that become a part of the finished product
Easy to track how much material is required to make one product.

Direct Labor
Touch the product to make the product or operate the machine to make it

Manufacturing Overhead –
All costs to manufacture except DM & DL.
Cost has word “factory”, “plant”, “manufacturing”, or “indirect”
Indirect: cannot easily determine how much of the cost is required to make 1

Indirect labor
Involved in making the product at the plant; does not actually make the product
Example: salaries of the managers, supervisors, QC

Indirect Material –
Not easy (cost beneficial) to track how much of the material is required to make one unit

 

Variable Cost as volume changes
Cost per unit remains the same
Total cost changes

Fixed Cost as volume changes
The same in total
Varies per unit

Relevant Range
The range of activity where the fixed costs will not change
The “assumption about cost behavior remains the same”

Opportunity Cost
Revenue/Income not achieved because you chose another alternative
Not a recorded cost

Sunk Cost
cost that cannot change; already been paid for

Committed
Can’t be significantly reduced without changing long-term goals

Discretionary
Management can decide not to spend without impacting long term goals

 

Mixed Costs (also known as semi-variable costs):
Contains both variable and fixed costs

Fixed: minimum cost of having a service ready and available for use
Variable: cost incurred for additional or actual consumption of the service

Step costs behave like variable costs
As activity increases so does the cost
As activity decreases so does the cost

Inventory is Reported on the Balance Sheet:

Raw Materials
Materials on the shelf that will go into the product
Work in Process
Material, labor and manufacturing overhead added to make product
Finished Goods
Completed product; in warehouse until sold

Reported on the Income Statement for products sold
Product costs becomes “Cost of Goods Sold” on the income statement

COST SHEET:
Lists the cost to make a product: consists of DM, DL, MOH applied

Manufacturing Overhead:
Indirect costs which are impossible to trace to one particular product
Allocated to each job using a “predetermined overhead rate”

Applying overhead puts manufacturing O/H into the cost of the product
MOH becomes part of WIP, and then FG, and then CGS.

General rules for journal entries at a manufacturing company

Debit WIP for the use of product costs
Direct material, direct labor, apply manufacturing O/H

Debit manufacturing overhead for actual manufacturing overhead incurred

Debit finished goods, credit WIP when completed.

Debit CGS and credit finished goods when the goods are sold,

Expense all period costs; selling, administrative, warehouse, shipping

Use a separate WIP account for each product
    “WIP: xxxx”

Under or over applied manufacturing overhead

Compare the applied manufacturing O/H incurred to actual manufacturing O/H

The difference in the actual and the estimate is stated in terms of

Underapplied – applied overhead (estimated) costs is less than actual costs
Overapplied — applied overhead (estimated) costs is more than actual costs

Manufacturing overhead account must =0
Compare the debit and credit

If immaterial – move to CGS
If material – allocate to WIP, FG, and CGS

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Traditional product costing
One overhead allocation rate per one activity
Only manufacturing costs are assigned to products (required by GAAP)
Costs is spread equally over all products whether or not they require equal effort

Activity Based costing
More than one overhead allocation rate and activity
Non manufacturing costs and manufacturing costs are assigned to products
Not according to GAAP
Useful for internal management
Cost of doing an activity is allocated to the product based on how often the activity occurs

Activity
Something that is done in support of a product or customer

Cost Driver/Transaction Driver
Quantifiable event that occurs causing costs

Activity Cost Pool
All costs related to one type of activity

Types of Activities for Activity Based Costing:

Unit level activities:
Performed each time a unit is produced
(electricity to run equipment, direct labor, direct materials)

Batch level activities:
Performed each time a batch is handled or processed
(purchase orders, equipment set-up, customer invoicing)

Product level activities:
Relate to specific products and must be done if only 1 product
(design a product, advertising, plant manager’s salary)

Customer level activities:
Relate to specific customers (sales calls, catalog mailings)

Organization Sustaining:
Done regardless of how many products are sold
(computer network, executive salaries, corporate expenses)

Determine a cost per activity for each cost pool

Multiply the cost per activity by the quantity of activity for each product to apply

Standard
Expect to pay and the quantity you expect to use to make one product.
Normally a “per each” amount

Quantity (Efficiency) Standard
Expect to use to make one

Cost (Price) Standard
Expect to pay for each one

Variance
Difference in actual dollars incurred and the standard/budgeted dollars to make the product.

Variance analysis
Compares actual to budgeted costs.

Material: price & quantity
Labor: rate & efficiency
Variable Overhead: spending & efficiency
Fixed Overhead: budget & volume

Unfavorable:
Actual cost is more than expected
Left > Right

Favorable
Actual cost is less than expected
Left < Right

Budgeted Fixed Overhead Dollars
Total expect to spend for an estimated level of production

Applied Fixed Overhead
Estimated expect to spend for actual units made
(units made x quantity per unit of activity x rate per activity)

Budget Variance
Actual compared to Budget.
Spent more or less total dollars than expected.

Volume Variance
Budget compared to Applied.
Caused by producing more or less actual units than expected.

Journal entries used to record variances:

_________________________________________________________________

Closing out the variance accounts:

Inventory costs (RM, WIP, FG, and CGS) are recorded at standard.
The variance account represents the difference between actual and standard.

End of the period, close the variance accounts (transferred) to the inventory accounts in order to adjust inventory accounts from standard to actual.

Material price variance:
Allocate to RM, WIP, FG, and CGS based on the % of the total for these four account balances.

Material quantity variance and all other variances:
Allocate to WIP, FG, and CGS based on the % of the total for these three account balances.

Variances occur when making the product so the difference are not put to RM since the RM have not yet been used to make the product.

Variances go to CGS and are not allocated if not significant.

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Absorption Cost (also called Full Cost)
Includes all product costs as inventory costs in accordance with GAAP
Direct materials, direct labor, variable manufacturing overhead and fixed manufacturing
Sorts by product and period

Variable Cost
Includes direct materials, direct labor and variable manufacturing overhead as product costs Considers fixed manufacturing overhead to be a period expense. This is not in accordance with GAAP – sorts by cost behavior, variable & fixed

When preparing the income statement:
Total variable costs = cost per unit x units sold

The real difference in the two methods:
Fixed manufacturing overhead costs is different:

Absorption cost: Fixed MOH is a product cost that becomes part of inventory
Variable cost: Fixed MOH is a period cost and is ALL expensed as incurred

Inventory decrease: absorption is lower
Inventory increase: absorption is higher

Centralized Organization:
Executive management make all decisions

Decentralized Organization:
Functional managers make decisions

Segments
Part or activity of the business where revenue or cost data is evaluated
A segment is a cost, profit, or investment center

Responsibility Accounting System:
Reports by cost, profit, and investment centers.

Cost Center
Manager is responsible for costs
Generates no revenue
Must minimize costs while providing service to the organization

Revenue Center:
Manager is responsible for sales but does not determine sales price

Profit Center
Manager is responsible for both revenues and costs

Investment Center
Manager is responsible for revenues, cost, investment in assets

Traceable (direct) costs:
Costs that would not be incurred if the segment were closed
Only traceable or direct costs are written in the segment column

Common (allocated) costs:
Costs incurred in support of more than one segment.
If the segment is discontinued, the costs will be allocated to other segments.
Common costs are not allocated to segments.
Report only in total company column
Common costs are also called nontraceable, allocated, corporate, indirect

Segment Margin:
The profitability of the segment after it has covered all its direct costs.

Allocating Costs:

Support Departments

Service: provides a specific functional task to other internal units

Administrative: performs activities that benefit the entire organization

Methods for Allocating Support Department Costs:

1) Direct Method:
Allocate based on a percentage of _____ to revenue generating departments.

2) Step Method:
Allocate to cost units and revenue generating units based on ranking

Process costing
Use when products are mass produced, homogenous
Separate work in process accounts are used for each department/process

Equivalent Units

The number of whole units if all units in process were complete

The number of whole units that could have been produced from the material added and the effort put in this period

Equivalent Units Schedule (all quantity, no dollars)

Weighted Average:
Beginning inventory = 100% of the quantity

FIFO:
Beginning inventory = the % done this period only times quantity

Always:
Started/Completed = 100% of the quantity

Always:
Ending inventory = the % complete this period times the quantity

Calculate total production costs

FIFO include only current period costs.
W.A. include both beginning and current costs.

Calculate cost per equivalent unit for each type of cost:

  Total Costs $
Equivalent Units

Cost Reconciliation Report:
(Value work in process and finished goods)

The value of inventory is always:
Equivalent unit quantity x cost per equivalent unit

1st – Value WIP

Equivalent units in Ending WIP row x $ per eq. unit

Do this for each type of cost; material, labor, overhead, conversion

2nd – Value finished goods:
Do differently for W.A. and FIFO

Weighted Average:

Add BI + SC eq. units together = total equivalent units.
All at 100% and can be considered together because all units received all costs.
Total E.U. x total $ per unit (material + conversion) = FG value

FIFO:

Finished goods is valued using a 3-step process:
1) Add in beginning inventory $ (given)
2) Equivalent units on the beginning inventory row
       x the cost per eq. unit
         = BI this period cost (do for each type)
3) Equivalent units from the started/completed row
       x the total cost per equivalent unit
       = Started/Completed cost:

Add all three together to get the total cost of finished goods.

Spoilage – Process Costing

Shrinkage/Spoilage:
Lost units when combining material through evaporation, leakage, oxidation or a bad manufacturing process

Normal Loss:
The level management expects

Abnormal Loss:
Any loss in excess of the normal loss

Continuous Spoilage:
Occurs fairly uniformly throughout the production process
No inspection point to discover the spoilage

Discrete Spoilage:
Found at a specific inspection point:

Add two rows below ending inventory for spoiled units,
1 for normal spoilage
1 for abnormal spoilage

Normal Spoilage – Continuous:
Put 0 units in equivalent unit schedule
Increases average cost per unit

Normal Spoilage – Discrete:
Units in schedule = units x % complete at inspection

Abnormal spoilage (continuous or discrete):
Units in schedule = units x % complete at inspection

If continuous or inspection is at the end:
Use 100% for equivalent units for abnormal

The affect of spoilage on inventory costs:

Abnormal spoilage costs are expensed in the period incurred (added to CGS)

Total $ expensed = equivalent units x $ cost per equivalent units for each type

Normal continuous spoilage – 0 equivalent units
Lower equivalent units increase the cost per unit and spreads the cost over all units in FG and WIP.

Is an expected part of inventory cost.

Normal spoilage discrete –
The cost of equivalent units is added to inventory
Equivalent units x $ cost per unit for each = $ amount
Add to finished goods and expensed when sold as cost of goods sold

Process Costing Journal Entries:

Record Costs added this period:

WIP                (total added)
         Raw Materials       ($ this period)
         Cash, a/p, wages pay         ($ this period)

Record Finished Goods (calculated FG amount):

FG
            WIP

Record Abnormal spoilage (eq. units x $per)

Loss on Abnormal Spoilage
            WIP

         __________________________________________________________________

Joint Process:
More than one product is produced by the same process

By Products/Scrap:
Incidental outputs of a joint process that are sold for a very low profit

Waste:
Has no sales value and must be disposed of

Split-Off point:
The point where the output is first identifiable as individual products

Joint Costs:
The material, labor, and manufacturing O/H incurred in the joint process
Joint cost is allocated at the split off point to only joint products

By Products:
Subtract total NRV of by-products from total joint costs before allocating joint costs to joint products.

Allocating Joint Costs to Joint Products:

Quantity:
Total Joint Cost / total physical base = $ Cost Per x quantity related to each product

Sales Value at Split-Off:
Calculate total revenue for each product at split-off and allocate based on percentage of total revenue for all joint products

Net Realizable Value:
Use when all joint products are marketable at split-off
Net Realizable Value = sales price at split off – cost to sell/dispose

Approximate Net Realizable Value:
Use when all are not marketable at split-off
Final Sales Price – Incremental processing and selling costs

Record Joint Product Costs:
WIP – Joint Processing or Department
            Raw materials
            Other processing costs

Allocate Joint Costs:
WIP – Prod. 1
WIP – Prod. 2
             WIP – Joint Processing

Add costs for further processing
WIP – Prod. 1
WIP – Prod. 2
            Raw materials
            Other processing costs

Net Realizable Value Approach for Scrap – indirect method:
CGS reduced for net realizable value

WIP
            Cash
WIP
            CGS

Scrap or BP
            WIP

Cash
            Scrap or BP

Net Realizable Value Approach for Scrap – direct method:
Inventory cost reduced for net

Cash
            WIP (or CGS)

Realized Value Approach for scrap:
No value is recognized until the product is sold
Costs are debited to WIP, which later becomes a higher CGS
Sales price is credited to Other Revenue when scrap is not typically sold

Transfer Price:
Internal charge for the exchange of goods or services between organizational units of a company

Used for internal reporting purposes only in companies having more than one segment or division

The final pricing arrangement should always reflect organization goals, which will vary among companies and business circumstances.

General Rules for Determining the Transfer Price – Excess Capacity:

1) Maximum: no higher than the lowest price purchased outside

2) Minimum: total incremental costs (all variable costs plus added fixed costs)

3) Negotiated: between the minimum and maximum is usually acceptable

General Rules for Determining the Transfer Price – No Excess Capacity:

1) Maximum: no higher than the lowest outside purchase price

2) Minimum: no lower than the current price to external customers

3) Negotiated: between the minimum and maximum is usually acceptable

Common Methods for Determining the Transfer Price:

1) Cost Based:
Costs may be variable /incremental costs only
Costs may be full absorption

2) Market Based:
Use the current market sales price
Considered the most objective

3) Negotiated:
Managers of the two segments negotiate a price

Dual Pricing Arrangement:
The selling division records a transfer at a market price and the buying division records the transfer based on cost.

The difference is recorded to an inter-company transfer account.

Advantages of a well thought out transfer price:
1) allows for fair evaluation of segment performance
2) allows for rational use of goods among segments/divisions
3) motivates managers to achieve goal congruence in decentralized organization

International Transfer Pricing:
Consider tax rates of each country of operations
Lowest tax rate should earn highest profits

A good transfer pricing system will accomplish:
1) appropriately utilizes company resources
2) minimizes goal conflicts among divisions/segments
3) balances short and long-term goals and perspectives of the entire company