Chapter 5

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Fundamentals of Product & Service Costing
Chapter 5
Learning Objectives
1. Explain the fundamental themes underlying the
design of cost systems.
2. Explain how cost allocation is used in a cost
management system.
3. Explain how a basic product costing system
works.
4. Understand how overhead cost is allocated to
products.
5. Explain the operation of a two-stage
allocation system for product costing.
6. Describe the three basic types of product costing
systems: job order, process and operations.
5-2
5-3
Cost System
Keys to a good cost system
Oriented to the
needs of the
decision makers
Designed so that
benefits exceed costs
Cost System Objective
L.O. 1 Explain the fundamental themes underlying the
design of cost systems.
Provide information about costs relevant for
decision making.
The cost system accumulates and
reports costs about processes,
products, and services.
5-4
5-5
Why Calculate the Cost of a Product?
For Decision Making
What should we sell?
At what sales price?
What is the cost of goods sold?
What is the cost of inventory?
5-6
Designing a Cost System
Focus
Different
information
for different
purposes
Test
Decision making
the
past
Cost-benefit
the
future
5-7
Cost Allocation
L.O. 2 Explain how cost allocation is used in a cost management system.
$ Direct
materials DM
$ Direct
labor
DL
Traced
Directly
Product A
$ Overhead
OH
Allocated using
Direct labor $
Product B
5-8
The Inventory Accounts
Raw Materials
Beg. Inventory
+Purchases
= Raw Materials
Available for
Production
- Raw Materials
Transferred to WIP
= Ending Inventory
Work-In-Process
Beg. Inventory
+ Direct Materials
Transferred from
Raw Materials
+ Direct Labor
+ Manufacturing
Overhead
= Total Manufacturing
Costs
- Cost of Goods
Completed and
Transferred to Finished
Goods
= Ending Inventory
Balance Sheet
Finished Goods
Beg. Inventory
+ Cost of Goods
Completed and
Transferred from WIP
= Goods Available
for Sale
Cost of
Goods Sold
= Ending Inventory
To the income
statement
A Product Costing System at Work
5-9
L.O. 3 Explain how a basic product costing system works.
How costs and units move through inventories.
Beginning
Balance
BB
True for
Transfers
In
TI
Transfers
Out
TO
BB
TI
TO
EB
BB
TI
TO
EB
Raw Materials
RM
Work-In-Process
WIP
Finished Goods
FG
Ending
Balance
EB
5-10
Product Costing System Continued
How costs and units move through inventories.
RM
BB
WIP
Purchases
DM
BB
DL
OH
FG
BB
Transfers
from WIP
DM to WIP
EB
IM to OH
Transfers
to FG
EB
Cost of
goods sold
EB
To income
statement
5-11
Product Costing System Continued
Baxter Paint
April WIP Inventory
Units – gallons of paint
BB
TI
TO
EB
0
100,000
gallons
100,000
gallons
0
FG
A Product Costing System at Work
Baxter Paint
April WIP Inventory
Costs
BB
$0
TI
DM
$400,000
DL
$100,000
OH
$500,000
TO
$1,000,000
$1,000,000
Cost per
gallon
$1,000,000
100,000
EB
$0
FG
$10 per gallon
5-12
5-13
Work-In-Process Costs
Let’s rewrite the basic cost flow model
BB
TI
What are
the costs?
$0
DM
$400,000
DL
$100,000
OH
$500,000
$1,000,000
TO
EB
Where are the
costs at the end
of the period?
$1,000,000
$0
FG
5-14
Costing with Ending WIP Inventory
Baxter Paint
May WIP
Units
BB
TI
0
110,000
gallons
TO
90,000
gallons
EB
20,000 gallons
These gallons are
half finished.
FG
5-15
Equivalent Units
Ending WIP Inventory
How do we cost Baxter’s 20,000 gallons of
paint that are only half finished?
20,000 gallons
½ finished
Equivalent to
10,000 gallons finished
20,000
.5
90,000 To FG
10,000 Ending WIP
Total equivalent units
100,000
Costing a Product Continued
Baxter Paint
May WIP
Costs
BB
$0
TI
TO
DM
$390,000
DL
$100,000
OH
$500,000
$990,000
?
EB
?
FG
Where is the $990,000?
What is the cost of the 90,000 gallons transferred to
FG and the 20,000 gallons still in WIP?
5-16
Costing a Product Continued
5-17
Cost Flow Diagram
Product Costing at Baxter Paints
DM
DL
OH
$390,000
$100,000
$500,000
Total $990,000
90,000 gallons
10,000 gallons
Equivalent Gallons
(90%)
(10%)
100,000
FG
$891,000
WIP
$99,000
Costing Multiple Products
5-18
Sammy’s Skis and Boards
Units
Skis
Snowboards
Total
Units produced
500
150
650
Direct labor hours
4,000
900
4,900
Machine hours
2,000
450
2,450
75,000
15,000
90,000
100,000
22,500
122,500
Costs
Direct Material
Direct Labor
Costing Multiple Products
Direct Materials
Cost Pools
Cost Objects
$90,000
Direct Labor
$122,500
Direct
Direct
Skis
Snowboards
$75,000
$15,000
$100,000
$22,500
5-19
5-20
Predetermined Overhead Rates
L.O. 4 Understand how overhead cost is allocated to products.
OH is indirect. Where do indirect costs belong?
With the skis?
Or with the boards?
Indirect costs are allocated using a
predetermined overhead rate.
POHR
POHR is the cost per unit of the allocation
base used to charge overhead to products.
POHR
$
Base
5-21
Predetermined Overhead Rates Continued
What are the estimated costs?
POHR
Estimated overhead $
Estimated allocation base
What activity drives the overhead costs?
Why use estimates?
We need to cost products during the period.
We don’t know the exact amount of indirect
costs until the end of the period.
Sammy’s Skis and Boards
Skis
Direct Labor hours
Snowboards
4,000
Estimated Overhead Costs
POHR
$98,000
4,900
900
$98,000
$20 / DLH
5-22
Total
4,900
Allocating OH to the Products
Cost Pool
OH
$98,000
Cost
Allocation
Rule
Direct Labor Hours
Cost Objects
Skis
Snowboards
$80,000
4,000DLH
$20 / DLH
$20
$18,000
900DLH
$20
5-23
Sammy’s Skis and Boards
Units
Skis
Units produced
Snowboards
5-24
Total
500
150
650
4,000
900
4,900
Direct Material
$75,000
$15,000
$90,000
Direct Labor
100,000
22,500
122,500
80,000
18,000
98,000
$255,000
$55,500
$310,500
$510
$370
Direct Labor hours
Costs
OH @ $20/DLH
Total
Cost per unit
Two-Stage Allocation Systems
5-25
L.O. 5 Explain the operation of a two-stage allocation system
for product costing.
Cost Pool
Overhead
$98,000
Intermediate
Cost Pools
Cost
Allocation
Rule
Labor-related
Machine-related
$73,500
$24,500
Direct Labor
Hours
Machine
Hours
5-26
Two-Stage Allocation Systems Continued
Intermediate
Cost Pools
Labor-related
$73,500
Cost
Allocation
Direct Labor
Hours 4,900
$15/DLH
Cost Objects
Machine-related
$24,500
Machine
Hours 2,450
$10/MH
Skis
Snowboards
DL
$60,000
$13,500
MH
$20,000
$4,500
$80,000
$18,000
Allocated Overhead
Sammy’s Skis and Boards
Costs
Skis
Snowboards
5-27
Total
Direct Material
$75,000
$15,000
$90,000
Direct Labor
100,000
22,500
122,500
OH @ $15/DLH
60,000
13,500
73,500
OH @ $10/MH
20,000
4,500
24,500
$255,000
$55,500
$310,500
$510
$370
Total
Cost per unit
Product Costing Systems
5-28
L.O. 6 Describe the three basic types of product costing systems:
job order, process, and operations.
Job Costing
Process Costing
An accounting
system that traces
costs to individual
units or to specific
jobs, contracts, or
batches of goods.
An accounting
system used when
identical units are
produced through
a series of uniform
production steps.
Custom Homes
Cornflakes
Movies
Facial Tissues
Services
Paint
Product Costing Systems
Job Costing
Operation Costing
Process Costing
An accounting
system that
traces costs to
individual units or
to specific jobs,
contracts, or
batches of
goods.
A hybrid costing
system often used
in manufacturing
of goods that
have some
common
characteristics
plus some
individual
characteristics.
An accounting
system used
when identical
units are
produced
through a series
of uniform
production steps.
Automobiles
Computers
Clothing
5-29
5-30
Chapter 5
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