November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
Costs by Business Function
a.k.a. the value chain
R&D
Manufacturing
Marketing,
Distribution,
Sales
Costs Classified By
Business Function
______
R&D
MFG.
GAAP
Marketing,
Distribution,
Sales
PRODUCT
PLANNING
&
PRICING
November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
Cost Flows for a
Manufacturing Firm
Raw Mat.s
Direct
Labor
W.I.P.
F/G Inv.
COGS
Mfg O/H
= Balance
Sheet
account
= expense
account
= Income
Statement
Account
Overview of Job Costing for
Manufacturing Companies
Indirect
Cost Pool
Manufacturing
Overhead
Cost
Allocation
Base
the
“Job”
Direct
Costs
Machine Hours
Indirect Costs
Direct Costs
Direct
Materials
Direct
Labor
Five Step Approach
To Job Costing
1 Identify the cost object.
2 Identify the direct cost categories for the job.
3 Identify the indirect cost pools associated
with the job.
4 Select the cost allocation base for each
indirect cost pool.
5 Calculate the rate per unit of the allocation
base to allocate indirect costs.
Calculation Of Overhead Rates
Over- = total costs in the cost pool
head
total quantity of the cost
Rate
allocation base
Calculation Of Overhead Rates
Over- = total costs in the cost pool
head
total quantity of the cost
Rate
allocation base
When indirect costs are allocated using
budgeted rates, step 5 involves the following:
5a For the budget period, prepare estimates of
the total quantity of the cost allocation base to
be incurred (or available).
5b For the budget period, estimate total
indirect costs (overhead $$$).
5c budgeted indirect cost rate = 5b / 5a
November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
Actual versus Budgeted Amounts
• Actual or budgeted rates for overhead.
• Actual or budgeted prices/rates of direct
inputs.
• Actual quantities of direct inputs, or
standard quantities based on actual
production.
• Actual quantity of overhead, or standard
quantity based on actual production.
Why Use Budgeted Amounts?
• Actual costs may not be known on a timely
basis.
• Actual costs may be subject to short-run
fluctuations.
• When actual O/H rates are used, production
volume for one product affects the reported
costs of other products.
• A system using budgeted numbers may be
more economical.
November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
The Levi Strauss factory in Albuquerque makes jeans
and Dockers. Each product line has its own production
line on the factory floor.
Budgeted and actual
overhead costs for the entire factory for 1997 were
$1,200,000 and $1,100,000, respectively. Budgeted
production for each product line was 500,000 units for
the year (one million units for the factory in total).
Actual production of jeans was equal to budget.
However, actual production of Dockers was curtailed to
400,000 units, due to increased competition in the
casual slacks market.
Budgeted Overhead:
$1.2 million
Actual Overhead:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Calculate the overhead allocation rate per pair of pants,
using budgeted overhead dollars and production.
Calculate the overhead allocation rate per pair of pants,
using actual overhead dollars and production.
Budgeted Overhead:
$1.2 million
Actual Overhead:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Calculate the overhead allocation rate per pair of pants,
using budgeted overhead dollars and production.
$1,200,000  (500,000 + 500,000) = $1.20 per unit
Calculate the overhead allocation rate per pair of pants,
using actual overhead dollars and production.
$1,100,000  (500,000 + 400,000) = $1.22 per unit
Budgeted Overhead:
$1.2 million
Actual Overhead:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Calculate the overhead allocation rate per pair of pants,
using budgeted overhead dollars and production.
$1,200,000  (500,000 + 500,000) = $1.20 per unit
Calculate the misapplied overhead:
Budgeted Overhead:
$1.2 million
Actual Overhead:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Calculate the overhead allocation rate per pair of pants,
using budgeted overhead dollars and production.
$1,200,000  (500,000 + 500,000) = $1.20 per unit
Calculate the misapplied overhead:
$1.20 per unit x 900,000 units = $1,080,000 applied
$1,080,000 applied - $1,100,000 actual = $20,000
underapplied.
Misapplied Overhead
• The use of budgeted overhead rates usually
results in underallocated or overallocated
overhead.
• Possible disposition of these variances include:
1) Restate to actual cost
2) Write off to COGS
3) Prorate between COGS & inventory
4) Treat as a period cost
Budgeted Overhead:
$1.2 million
Actual Overhead:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Calculate the overhead allocation rate per pair of pants,
using actual overhead dollars and production.
$1,100,000  (500,000 + 400,000) = $1.22 per unit
Calculate the misapplied overhead:
Budgeted Overhead:
$1.2 million
Actual Overhead:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Calculate the overhead allocation rate per pair of pants,
using actual overhead dollars and production.
$1,100,000  (500,000 + 400,000) = $1.22 per unit
Calculate the misapplied overhead:
$1.22 per unit x 900,000 units = $1,100,000 applied
$1,100,000 applied - $1,100,000 actual = $0 misapplied.
Misapplied Overhead
• Restatement using actual overhead rates is
preferred conceptually, but is not necessarily
the most conservative.
• Restatement can result in higher net income
and ending inventory than write-off to COGS
when variances are unfavorable.
• Is there justification for treating unfavorable
variances as a period cost?
Budgeted O/H: $1.2 million
Actual O/H:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Assume that the budgeted overhead of $1,200,000
consisted of $800,000 budgeted for variable overhead
and $400,000 for fixed overhead. Also assume that the
factory has the capacity to produce 1.5 million pairs of
pants, and that the fixed overhead rate is calculated
using capacity in the denominator.
Calculate the budgeted overhead rates for fixed overhead
and for variable overhead.
Budgeted O/H: $1.2 million
Actual O/H:
$1.1 million
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Assume that the budgeted overhead of $1,200,000
consisted of $800,000 budgeted for variable overhead
and $400,000 for fixed overhead. Also assume that the
factory has the capacity to produce 1.5 million pairs of
pants, and that the fixed overhead rate is calculated
using capacity in the denominator.
Calculate the budgeted overhead rates for fixed overhead
and for variable overhead.
Variable O/H rate: $800K  1,000,000 = $.80 per unit
Fixed O/H rate: $400,000  1,500,000 = $.27 per unit
Total:
$1.07 per unit
Budgeted O/H: $1.2 million; Actual O/H: $1.1 million.
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Assume that 500,000 direct labor hours were used in
production in 1997, 200,000 for jeans, and 300,000 for
Dockers.
Calculate the overhead rate (one rate for both fixed and
variable overhead) using direct labor hours as the
allocation base, and using actual costs and actual labor
hours.
Using the allocation rate above, how much overhead
would be allocated to jeans in 1997?
Budgeted O/H: $1.2 million; Actual O/H: $1.1 million.
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Assume that 500,000 direct labor hours were used in
production in 1997, 200,000 for jeans, and 300,000 for
Dockers.
Calculate the overhead rate (one rate for both fixed and
variable overhead) using direct labor hours as the
allocation base, and using actual costs and actual labor
hours.
$1,100,000  500,000 = $2.20 per direct labor hour
Using the allocation rate above, how much overhead
would be allocated to jeans in 1997?
Budgeted O/H: $1.2 million; Actual O/H: $1.1 million.
Budgeted production: 500K jeans, 500K Dockers.
Actual production:
500K jeans, 400K Dockers.
Assume that 500,000 direct labor hours were used in
production in 1997, 200,000 for jeans, and 300,000 for
Dockers.
Calculate the overhead rate (one rate for both fixed and
variable overhead) using direct labor hours as the
allocation base, and using actual costs and actual labor
hours.
$1,100,000  500,000 = $2.20 per direct labor hour
Using the allocation rate above, how much overhead
would be allocated to jeans in 1997?
$2.20 per direct labor hour x 200,000 direct labor hours
= $440,000; which is $0.88 per pair of jeans.
November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
Two Ways To Treat Fixed
Manufacturing Overhead
• Variable Costing
• Absorption Costing
• Also called Direct
Costing
• Also called Full
Costing
• Fixed Mfg O/H is a • Fixed Mfg O/H is an
Period Cost
Inventoriable Cost
• Focus is on Contri- • Focus is on Gross
bution Margin
Margin
• This isn’t G.A.A.P.
• This is G.A.A.P.
Variable Costing
Absorption Costing
What Costs Are
Included In Inventory?
Non-manufacturing
costs (e.g. selling,
general & admin.)
Variable manufacturing costs (& any
direct, fixed costs)
Fixed
Manufacturing
Overhead
Example comparing absorption
costing and variable costing
10,000 units are made and sold.
Each unit sells for $350.
Variable mfg costs are $150 per unit.
Fixed mfg costs are $700,000.
Variable non-mfg costs are $50 per unit.
Fixed non-mfg costs are $400,000.
Gross Margin
Income Statement
Sales
$3,500,000
Cost of Goods Sold
2,200,000
Gross Margin
1,300,000
Non-manufacturing costs
Income
900,000
$
400,000
COGS: $700K FMOH ÷ 10K units = $70 per unit
$150 variable mfg + $70 FMOH = $220 per unit.
Contribution Margin
Income Statement
Sales
$3,500,000
Variable Costs
Manufacturing costs
1,500,000
Non-manufacturing costs
500,000
Contribution Margin
$1,500,000
Fixed Costs
Manufacturing costs
700,000
Non-manufacturing costs
400,000
Income
$ 400,000
November 16, Part 4
• The Value Chain
• Job Costing and Overhead Rates
• Actual versus Budgeted Amounts
• Levi Strauss Factory Example
• Absorption Costing and Variable Costing
• The Eskimo Pie Company
The Eskimo Pie Company
The Eskimo Pie Company
The Eskimo Pie Company makes and sells the
famous Eskimo Pie ice cream bar. The company’s
cost structure is as follows: fixed manufacturing
overhead costs per month are $50,000.
Variable manufacturing costs are $1.40 for each
delicious Eskimo Pie. Fixed non-manufacturing
costs (selling, general and administrative costs)
are $27,000 per month. Variable nonmanufacturing costs are $0.10 for each Eskimo
Pie sold.
The Eskimo Pie Company
The Eskimo Pie Company makes and sells the famous
Eskimo Pie ice cream bar. The company’s cost structure
is as follows: fixed manufacturing overhead costs per
month are $50,000. Variable manufacturing costs
are $1.40 for each delicious Eskimo Pie. Fixed nonmanufacturing costs (selling, general and administrative
costs) are $27,000 per month. Variable nonmanufacturing costs are $.10 for each Eskimo Pie sold.
Required:
1. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and sells 19,999
Eskimo Pies, what is the cost of ending inventory under
Absorption (i.e., Full) Costing?
The Eskimo Pie Company
The company’s cost structure is as follows: fixed mfg
O/H costs per month are $50,000. Variable mfg
costs are $1.40 for each delicious Eskimo Pie. Fixed
non-mfg costs (selling, general and administrative
costs) are $27,000 per month. Variable non-mfg
costs are $.10 for each Eskimo Pie sold.
1. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and sells 19,999
Eskimo Pies, what is the cost of ending inventory
under Absorption (i.e., Full) Costing?
F.M.O.H. rate = $50,000 ÷ 20,000 pies = $2.50 per pie.
$2.50 fixed mfg + $1.40 variable mfg = $3.90 per pie
$3.90 per pie x 1 pie = $3.90
The Eskimo Pie Company
The Eskimo Pie Company makes and sells the famous
Eskimo Pie ice cream bar. The company’s cost structure
is as follows: fixed manufacturing overhead costs per
month are $50,000. Variable manufacturing costs are
$1.40 for each delicious Eskimo Pie. Fixed nonmanufacturing costs (selling, general and administrative
costs) are $27,000 per month. Variable nonmanufacturing costs are $0.10 for each Eskimo Pie sold.
Required:
2. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and sells 19,999
Eskimo Pies, what is the cost of ending inventory under
Variable Costing?
The Eskimo Pie Company
The Eskimo Pie Company makes and sells the famous
Eskimo Pie ice cream bar. The company’s cost structure
is as follows: fixed manufacturing overhead costs per
month are $50,000. Variable manufacturing costs are
$1.40 for each delicious Eskimo Pie. Fixed nonmanufacturing costs (selling, general and administrative
costs) are $27,000 per month. Variable nonmanufacturing costs are $0.10 for each Eskimo Pie sold.
2. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and sells 19,999
Eskimo Pies, what is the cost of ending inventory under
Variable Costing?
$1.40 per pie x 1 pie = $1.40
The Eskimo Pie Company
The company’s cost structure is as follows: fixed
manufacturing overhead costs per month are $50,000.
Variable manufacturing costs are $1.40 for each delicious
Eskimo Pie. Fixed non-manufacturing costs (selling,
general and administrative costs) are $27,000 per
month. Variable non-manufacturing costs are $0.10 for
each Eskimo Pie sold.
Required:
3. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and doesn’t sell any
pies, what is net income (loss) for the month under
Absorption (i.e., Full) Costing?
The Eskimo Pie Company
The company’s cost structure is as follows: fixed mfg
overhead costs per month are $50,000. Variable mfg
costs are $1.40 for each delicious Eskimo Pie. Fixed
non-mfg costs (selling, general and administrative costs)
are $27,000 per month. Variable non-mfg costs are
$0.10 for each Eskimo Pie sold.
3. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and doesn’t sell any
pies, what is net income (loss) for the month under
Absorption (i.e., Full) Costing?
$27,000 loss (fixed non-mfg costs). (All mfg costs are
capitalized in ending inventory, and no variable non-mfg
costs have been incurred.
The Eskimo Pie Company
The Eskimo Pie Company makes and sells the famous
Eskimo Pie ice cream bar. The company’s cost structure
is as follows: fixed manufacturing overhead costs per
month are $50,000. Variable manufacturing costs are
$1.40 for each delicious Eskimo Pie. Fixed nonmanufacturing costs (selling, general and administrative
costs) are $27,000 per month. Variable nonmanufacturing costs are $0.10 for each Eskimo Pie sold.
Required:
4. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and doesn’t sell any
pies, what is net income (loss) for the month under
Variable Costing?
The Eskimo Pie Company
The company’s cost structure is as follows: fixed mfg
overhead costs per month are $50,000. Variable mfg
costs are $1.40 for each delicious Eskimo Pie. Fixed
non-mfg costs (selling, general and administrative costs)
are $27,000 per month. Variable non-mfg costs are
$0.10 for each Eskimo Pie sold.
4. If the company begins the month with zero inventory,
manufactures 20,000 Eskimo Pies, and doesn’t sell any
pies, what is net income (loss) for the month under
Variable Costing?
$27,000 + $50,000 = $77,000 loss. (The variable mfg
costs are capitalized in ending inventory, and no variable
non-mfg costs have been incurred.)