Final Review
Things You Must Know
Product Costs:
All costs required to manufacture the product –
Direct Material, Direct Labor, Manufacturing Overhead
Reported as inventory (inventoriable) on the balance sheet until sold
When products are sold – costs become cost of goods sold on income statement
Period Costs:
Reported on the income statement in the period incurred, not related to manufacturing the product.
Warehouse costs and people who move inventory inside the company
Selling Costs –
costs related to selling, marketing & getting products to customer
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
It is easy to track how much material is required to make one product.
Direct Labor –
Touch the product to make the product, operate the machine to make it
Manufacturing Overhead –
All costs to manufacture, except DM & DL. If the cost has word
“factory”, “plant”, “manufacturing”, or “indirect” it will be part of manufacturing overhead.
Indirect – cannot easily determine how much of these costs it takes to make 1
Indirect labor – Involved in making the product at the plant, does not touch the product to make it. Example: salaries of the managers, supervisors, QC
Indirect Material – Not easy to track the material quantity required to make one
Variable Cost –
The same per unit, changes in total as volume changes
Fixed Cost –
The same in total, varies per unit as volume changes
Relevant Range –
the range of activity where the fixed costs will not change
“assumption about cost behavior remains the same”
Opportunity Cost –
Benefit given up because you chose another alternative, not recorded
Sunk Cost –
Cost that will not change –
Already paid for and can’t recover the cost
Committed –
Can’t be significantly reduced without changing the long-term goals
Discretionary –
Management can decide not to spend without impacting long term goals
A cost that says “per unit or per activity” will always be a variable cost
Direct materials, direct labor, sales commissions paid based on sales
A cost that is paid annually/monthly in a lump sum will always be a fixed cost
Almost all administrative costs are fixed
All salary is fixed
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
Mixed costs behave like variable costs – as activity increases so does the cost
and as activity decreases so does the cost (until you hit the fixed cost amount)
Raw (Direct) 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, put in warehouse until sold
When sold: becomes “Cost of Goods Sold” on the income statement
JOB COST SHEET:
Lists the cost to make a product: consists of DM, DL, MOH applied
Manufacturing Overhead: These are 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 so that it
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
When you have more than one job – Use more than one WIP account. “WIP-xxx”
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
Get the manufacturing overhead account to –0- compare the debit and credit
If immaterial, put to CGS,
If material, allocate to WIP, FG, and CGS
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
This is not according to GAAP, but 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 relate to a single 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 carried out even for 1
(design a product, advertising, plant manager’s salary)
Customer level activities:
relate to specific customers
(sales calls, catalog mailings)
Organization Sustaining:
carried out 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:
Estimated: expect to pay and the quantity you expect to use to make one product A “standard” is normally a “per each” amount
Quantity (Efficiency) Standard – how much you expect to use to make
on Cost (Price) Standard – how much you 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.
Variable Cost Variances
AQ x AP AQ x SP SQ x SP
SQ = Actual units made x Standard Quantity for one unit
Material: price & quantity
Labor: rate & efficiency
Variable Overhead: spending & efficiency
Fixed Manufacturing Overhead Variances
Actual Budget SQ x SP
Fixed Overhead: budget & volume
Budgeted Fixed Overhead Dollars
Applied Fixed Overhead
Estimate of what should have been spent for actual units made
(units made x quantity per unit of activity x rate per activity)
Budget Variance
Volume Variance
Budget compared to Applied. The difference is caused by not producing as much or producing more actual units than expected.
Unfavorable: spent more than standard/budgeted; it actually cost you more- Left > Right
Favorable: spent less than standard/budgeted; it actually cost you less – Left Right>
Absorption Costing (also called Full Costing) – includes all product costs –direct materials, direct labor, variable manufacturing overhead and fixed manufacturing overhead as inventory costs, in accordance with GAAP – sorts by product and period
Variable Costing – includes direct materials, direct labor and variable manufacturing overhead as product costs and 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 unit sold
The real difference in the two methods:
Fixed manufacturing overhead costs is different:
Absorption costing – product cost, becomes part of inventory
Variable costing – it is a period cost and is ALL expensed as incur
Inventory decrease – absorption is lower
Inventory increase – absorption is higher
Centralized Organization:
Decentralized Organization:
Segments –
A segment will be a cost, profit, or investment center
Responsibility Accounting System:
Cost Center
Expected to minimize costs while providing service to the organization
Revenue Center:
Profit Center
Investment Center
Traceable (direct) costs:
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.
Process costing
Used when products are mass produced, homogenous
Separate work in process accounts are used for each department/process
Equivalent Units
The number of whole units you would have 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)
| Quantity | |||
| Beginning Inventory | # | ||
| +Started In Production | # | ||
| =Total Units to be accounted for: (1) | # | ||
| Equivalent Units | |||
| Quantity | Material | Conversion | |
| Beginning Inventory | # | # | # |
| +Started and Completed | # | # | # |
| +Ending Inventory | # | # | # |
| =Total units accounted for (1) | # | # | # |
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 (labor + OH)
| Costs: | Materials | Conversion |
| Beginning Inventory | $ | $ |
| + Current Period | $ | $ |
| = Total Costs | $ | $ |
FIFO only used current period costs. W.A. uses both beginning and current.
Cost per equivalent unit: = Total Costs $
Equivalent Units
Cost Reconciliation Report: (Value work in process and finished goods)
Equivalent unit quantity
x cost per unit in the row for the type of cost
= Value of Inventory
1st – Value WIP –
# equivalent units in Ending WIP row x $ per unit = total cost for each type
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.
Do at 100% and can be considered together.
All units received all costs.
Total E.U. x total $ per unit (material + conversion) = FG value
FIFO:
Finished goods is valued using a three step process:
1) Add in beginning inventory $, this is given
2) Take the equivalent units from the beginning inventory row x the cost per eq. unit = BI this period cost (do for each type)
3) Take the equivalent units from the started/completed row x the total cost per equivalent unit = S/C cost:
Add all three together to get the total cost of finished goods.
Process Costing Journal Entries:
Record Costs added this period:
WIP (total added)
Raw Materials. ($ this period)
Cash, A/P, wages pay ($ this period)
Record Finished Goods:
FG
WIP (amount calc. for FG)
Transfer Price:
Internal change 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:
Maximum—no higher than the lowest price it can be purchased outside the company
Minimum—the total of incremental costs: all variable costs plus any added fixed costs
Negotiated—between the minimum and maximum is usually acceptable
General Rules for Determining the Transfer Price—No Excess Capacity:
Maximum—no higher than the lowest price it can be purchased outside the company
Minimum—no lower than the current price to external customers
Negotiated—between the minimum and maximum is usually acceptable
Common Methods for Determining the Transfer Price:
Cost Based: Costs may be variable/incremental costs only
Costs may be full absorption
Market Based: use the current market sales price
Consider the most objective
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:
Allows for fair evaluation of segment performance
Allows for rational use of goods among segments/divisions
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:
Minimizes goal conflicts among divisions/segments
Balances short and long-term goals and perspectives of the entire company