Chapter 4: INTRODUCTION TO COST ACCOUNTING Test your knowledge 1. A direct cost is able to be traced to a product or service with a high degree of accuracy. Directly traceable means that the cost can be physically and easily (i.e. economically and conveniently) traced to the finished product. Direct materials and direct labour are the two most common direct costs for a business. Examples are: • Raw materials used in making gold ring • Wages of a mechanic in a car repair business • Parts and supplies used in a panel beating business • Cost of bottles used in making wine • Cost of paint used in making a motor cycle Indirect costs are not so easily traced to a product or service. These are items that are not actually incorporated in the product or are too insignificant to make it worth tracing the cost to the finished product. Examples are: • Salary of the factory manager • Local government rates and taxes • Paint used in making a Dolls House • Glue used in making furniture • Oil and lubricants used in maintaining factory machinery • Insurance of the business premises 2. Some costs may be direct in the making of one cost object and be indirect in the making of another cost object. Therefore the distinction between direct and indirect costs is important as it allows the determination of a cost object to be more accurate. 3. The factor that affects the classification of an item as a direct or indirect cost is whether it is traceable to the finished product. To be traceable means that the cost can be physically and easily (i.e. economically and conveniently) traced to the finished product. 4. Cost behaviour is how a cost changes in relation to the level of production activity. This is important as the distinction between fixed, variable and mixed costs is important to the accurate determination of the cost of a product or service. With a fixed cost the unit activity cost will change as the level of units produced increases or decreases, while with a variable cost the unit cost does not change. Fixed costs in total are constant as the level of activity increases whereas with a variable cost the total cost does increase as the level of activity increases. This cost behaviour affects the unit cost of a product or service. 5. Fixed costs are those that do not change in total when the level of activity changes. For example, the rent of a factory building will be the same in total no matter how many units are produced. Examples are: • Depreciation of factory machinery • Office supervisor’s salary • Rent of a shop • Delivery vehicle insurance Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 1 A variable cost is one that changes in total as the level of activity changes. For example, the cost of raw materials in total will increase as the level of units produced increases. Examples are: • Wages for casual staff to make glassware • Raw materials used in the manufacture of a computer • Cost of goods sold • Commission paid to salespeople Mixed or semi‐variable costs are those costs which contain both fixed and variable elements. For example, a telephone bill will contain the line rental cost, which is a fixed cost, and the cost of phone calls made, which is a variable cost. Examples are: • Telephone bill • Maintenance costs • Electricity • Water rates 6. Direct materials are those raw materials that are directly traceable to the product being made. Raw materials are what go into the making of a product. For example, in the making of a men’s suit the raw materials would be such items as the fabric, the lining, buttons and thread. Other examples are in making a bottle of wine the bottle would be a direct material, in making a lounge chair the wood in the chair structure would be a direct material, for a T‐shirt product the cotton material would be a direct material and for shoes the direct material would be leather. The direct labour cost is the amount paid such as wages, salaries, long‐service leave, sick leave, and payroll tax paid to the employees that is traceable to the finished product. Examples are machine operators in a factory making security screens, panel beaters fixing vehicles and bakers making bread products Manufacturing overhead represents costs that are not direct materials or direct labour, but which are still part of the manufacturing process. Examples are: • Indirect materials • Indirect labour • Electricity, water and gas used in the production of a product • Depreciation • Insurance • Maintenance of the factory buildings • Repairs to equipment used in the manufacturing process 7. Costs of operating a business that are not incurred in the manufacturing process are called non‐manufacturing costs. These can be categorised as selling or marketing costs, distribution or transport costs, administration costs and financial costs. Examples are: • Direct materials used in the making of a surfboard • Direct labour used in making a diamond ring • Overheads assigned to the manufacture of a ball gown 8. A product cost includes all those costs that are attributable to a product and are those costs to do with merchandise acquired or manufactured or a service provided. It is recorded as an expense in the period in which the product is sold and this will be recorded as the cost of goods. The product is an asset because it has future economic benefit to the business. Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 2 Costs that are not product costs are period costs. Period costs are an expense and therefore shown in the business income statement in the period in which they are incurred. A period cost is a cost that relates to the current accounting period and which does not have a future economic benefit to the business. Period costs are not carried forward with the product until the time of sale. Examples are: • Advertising • Wages paid to sales personnel • Office rent • Office contents insurance 9. Cost accounting is the measuring, analysing, recording and reporting on the cost of a product or service. Cost accounting is useful to both financial and managerial accounting for such purposes as: • determining profitability – management can determine if it is worth producing or selling the product or service. • the setting of selling prices – often set with reference to the cost of the product or service • control of costs – comparing actual product costs with planned costs and, if necessary, taking corrective action so that the predetermined targets are met in the future • planning – using past product costs to estimate future product costs • inventory valuation – calculating the value of products that are complete (finished goods) and products that are partially complete (work in progress) at the end of each accounting period for inclusion in the financial statements 10. Absorption costing is the method whereby all fixed manufacturing costs and variable manufacturing costs are included in the product cost. 11. Job order costing is the process of recording all the costs of a distinct product or service. A job order costing system is used when a business creates a single unit or multiple units of a distinct product, makes a product to a customer order or provides a service to meet specific customer requirements. Each job has its own special characteristics and may be, for example, a single product, a batch of the same product or a service provided to an individual client. 12. A predetermined overhead rate allocates the indirect costs of production to the actual quantity of the product or service produced. budgeted manufacturing overhead cost The predetermined overhead rate is calculated as = budgeted allocation base
13. A normal costing system determines the cost of a product or service with job order costing using actual direct materials, actual direct labour and a predetermined overhead rate. These figures are applied to the actual quantity related to a job. The predetermined overhead rate allocates the indirect costs of production to the actual quantity of the product or service produced. 14. Standard costing is a system of product costing where the cost of a product is based on standard costs for direct materials, direct labour and manufacturing overheads. A standard cost is a predetermined cost and based on some preconceived benchmark of what is considered appropriate to the making of a product. Therefore, the direct materials, direct labour and manufacturing overhead are not actual costs but rather estimates based on a standard cost. 15. Variance analysis is the comparison of the actual results compared to the standard amount or value called the flexible budget. The flexible budget is the standard quantity or hours allowed for output multiplied by the standard price or rate 16. The markup is the amount (either in dollars or percentage) added to the unit cost price of a product or service to determine its selling price. Therefore the selling price = cost + (markup percentage × cost) 17. As there are too many possible answers to this question, students should check their answers with their teacher. Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 3 Test your understanding 4.1 Item Clothing factory equipment maintenance Wages of vehicle factory assembly workers Salaries of marketing staff Depreciation of office equipment in a law practice Surfboard factory supervisor’s salary Glue used in the production of chairs Linen cloth used in the upholstery of a chair Stationery used in the administration office of an architect Salary of the business accountant for a chain of jewellery stores Wages of factory store personnel
Depreciation of factory machinery
Electricity used in a factory brewing beer Insurance of business delivery vehicles Varnish paint used in making furniture Dye used in making t‐shirts Manufacturing or Non‐
manufacturing cost Direct or Indirect cost Fixed or Variable cost
or Mixed cost Mixed cost (fixed and variable costs) Product or Period cost Manufacturing cost Indirect cost Product cost Manufacturing cost Direct cost Variable cost Product cost Non‐manufacturing cost
N/A
Fixed cost Period cost
Non‐manufacturing cost N/A Fixed cost Period cost Manufacturing cost
Manufacturing cost
Manufacturing cost
Indirect cost
Indirect cost
Direct cost
Fixed cost Variable cost Variable cost Product cost
Product cost
Product cost
Non‐manufacturing cost N/A Fixed cost Period cost Non‐manufacturing cost N/A Fixed cost Period cost Manufacturing cost
Manufacturing cost
Manufacturing cost
Non‐manufacturing cost
Manufacturing cost
Manufacturing cost
Indirect cost
Indirect cost
Indirect cost
N/A
Indirect cost
Indirect cost
Fixed cost Fixed cost Variable cost Fixed cost Variable cost Variable cost Product cost
Product cost
Product cost
Period cost
Product cost
Product cost
Manufacturing or Non‐
manufacturing cost Manufacturing cost
Manufacturing cost
Non‐manufacturing cost
Manufacturing cost
Direct or Indirect cost Direct cost
Indirect cost
N/A
Direct cost
Fixed or Variable cost
Or Mixed cost Variable cost Fixed cost Variable cost Variable cost Product or Period cost Product cost
Product cost
Period cost
Product cost
Manufacturing cost Direct cost Variable cost Product cost Manufacturing cost
Direct cost
Variable cost Product cost
Non‐manufacturing cost N/A Fixed cost Period cost Non‐manufacturing cost N/A Variable cost Period cost Non‐manufacturing cost N/A Variable cost Period cost Non‐manufacturing cost N/A Variable cost Period cost Non‐manufacturing cost N/A Variable cost Period cost Non‐manufacturing cost N/A Variable cost Period cost Manufacturing cost
Direct cost
Variable cost Product cost
4.2 Item Paper used in the making of a textbook Depreciation of factory machinery
Sales commission paid to sales staff Wages paid to factory assembly workers Wages paid to workers making pizzas in a fast food shop Leather used in making shoes Salary paid to business director of chain of music stores Wages paid to delivery drivers in a transport company Wages paid to pizza delivery drivers in a fast food business Plumbing materials used in a plumbing business Electricity used in repairing a vehicle in a panel beating workshop Oil used by a mechanic in servicing and repairing vehicles Steel used to make pergolas Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 4 4.3 a) Predetermined overhead rate = $90 000/4 350 direct labour hours Therefore = $20.69 per direct labour hour b) Job Number 56 Direct Materials $11 000 $30 000 Manufacturing Overhead (600 hours X $20.69) $12 414 Total cost Job 56 Direct Labour ($50 per hour X 600 hours) $53 414 4.4 a) Predetermined overhead rate Budgeted Factory Overhead Indirect Materials $ 78 000 Indirect Labour $ 64 000 Other overheads $110 000 $ 252 000 Therefore = $252 000/11 350 direct labour hrs Therefore = $22.20 per direct labour hour b) Job Number 658 Direct Materials $250 000 Direct Labour $ 70 000 Manufacturing Overhead (250 hours X $22.20) $ 5 550 Total cost Job 658 $ 53 414 4.5 a) Predetermined overhead rate Budgeted Factory Overhead Indirect Materials $ 83 000 Indirect Labour $ 67 000 Other overheads $130 000 $ 280 000 Therefore = $280 000/2 150 machine hrs Therefore = $116.28 per direct labour hour Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 5 b) Job Number 130 Direct Materials $20 000 Direct Labour $ 3 600 Manufacturing Overhead (24 hours X $116.28) $ 2 791 Total cost Job 130 $26 391 c) $26 392/10 000 = $2.64 per bottle for choc milk 4.6 a) Predetermined overhead rate = $154 000/2 300 machine hrs Therefore = $66.96 per machine hour b) Batch Number 15 Hand Lotion Direct Materials $15 000 $ 2 750 Manufacturing Overhead (80 hours X $66.96) $ 5 357 Total cost Job 15 Direct Labour ($55 per hour X 50 hours) $23 107 $32 000 $ 3 850 Manufacturing Overhead (120 hours X $66.96) $ 8 035 Total cost Job 16 $43 885 Batch Number 16 After Shave Lotion Direct Materials Direct Labour ($55 per hour X 70 hours) c) Batch number 15 $23 107/1 000 = $23.11 per bottle of hand lotion Batch number 16 $43 885/1 500 = $29.26 per bottle of after shave lotion 4.7 a) Predetermined overhead rate = $74 000/4 000 direct labour hrs Therefore = $18.50 per direct labour hour b) Job Number 134 Direct Materials $ 650 $4 410 Manufacturing Overhead (70 hours X $18.50) $1 295 Total cost Job 134 $6 355 Direct Labour ($63 per hour X 70 hours) Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 6 Job Number 135 Direct Materials $ 540 $3 780 Manufacturing Overhead (60 hours X $18.50) $1 110 Total cost Job 135 Direct Labour ($63 per hour X 60 hours) $5 430 $ 720 $5 040 Manufacturing Overhead (80 hours X $18.50) $1 480 Total cost Job 136 $7 240 Job Number 136 Direct Materials Direct Labour ($63 per hour X 80 hours) 4.8 a) Predetermined overhead rates Mixing Department = $35 000/600 machine hrs Therefore = $58.33 per machine hour Cooking Department = $56 000/1 000 machine hrs Therefore = $56.00 per machine hour Packaging Department = $25 000/6 300 direct labour hrs Therefore = $3.97 per direct labour hour b) Direct Materials Mixing Department Sugar $2 500 Citric Acid $ 50 Gelatine $ 80 Essence $ 60 Food Colouring $ 45 Packaging Department Plastic $ 300 Paper boxes $ 200 $3 775 Mixing Department 12 hours @ $45 per hour $ 540 Cooking Department 25 hours @ $55 per hour $ 1 375 Packaging Department 42 hours @ $40 per hour $ 1 680 Total Direct labour cost $ 3 595 Total Direct Materials cost Direct labour Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 7 Manufacturing overheads Mixing Department 10 machine hours @ $58.33 per hour $ 583 Cooking Department 23 machine hours @ $56 per hour $1 288 Packaging Department 42 direct labour hours @ $3.97 per hour $ 167 Total Manufacturing overhead $2 038 Total cost of a batch of Jelly Beans $9 408 c) Cost of a packet of Jelly Beans $9 408/1 000 = $9.41 4.9 a) Predetermined overhead rates Set‐up Department = $43 000/5 500 direct labour hrs Therefore = $7.82 per direct labour hour Print Department = $67 000/2 900 machine hrs Therefore = $23.10 per machine hour b) Costs for Job 271 from before July 2011: Total of incomplete jobs $ 5 700 Job 269 ($2 800 – 1 000) ($1 800) Job 270 ($2 700) Job 271 therefore $ 1 200 Current Months Manufacturing costs for Job Number 271 Direct Materials Set‐up Department $ 90 Print Department $1 900 Total Direct Materials cost $1 990 Set‐up Department 18 hours @ $45 per hour $ 810 Print Department 3 hours @ $25 per hour $ 75 Total Direct labour cost $ 885 Mixing Department 2 machine hours @ $7.82 per hour $ 16 Cooking Department 12 machine hours @ $23.10 per hour $ 277 Total manufacturing overhead $ 293 Total cost of Job number 271 $3 168 Direct labour Manufacturing overheads Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 8 4.10 Total Overheads Electricity costs incurred $ 4 500 Water costs incurred $ 1 800 Cleaning costs incurred $ 15 000 Repairs and maintenance of equipment $ 2 900 Deprecation of equipment $ 12 600 Indirect materials used $ 35 600 Rent cost incurred $ 27 800 Insurance cost incurred $ 5 100 Hairdresser manager $ 67 000 Miscellaneous costs incurred $ 16 450 $188 750 Predetermined overhead rate Direct labour hours 7.5 X 5 X 9 X 52 = 17 550 Therefore 188 750/17 550 = 10.75 Cost of the ladies style cut Direct materials $ 3.50 Direct labour ($26 per hour X 30 minutes) $13.00 Overheads ($10.75 X 30 minutes) $ 5.38 $21.88 4.11 a) Total cost of labour: Partners $250 000 X 4 = $1 000 000 Seniors $140 000 X 5 = $ 700 000 Juniors $ 80 000 X 5 = $ 400 000 $2 100 000 Apportion of overheads: Partners 1 000 000/2 100 000 = 48% Seniors 700 000/2 100 000 = 33% Juniors 400 000/2 100 000 = 19% Partners 48% X 490 000 = $235 200 Seniors 33% X 490 000 = $161 700 Juniors 19% X 490 000 = $ 93 100 Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 9 Overheads to be covered by each category of lawyer Partners 235 200/4 = 58 800 Seniors 161 700/5 = 32 340 Juniors 93 100/5 = 18 620 Overheads to be covered each hour: Partners 58 800/1 700 = 34.59 per hour Seniors 32 340/1 700 = 19.01 per hour Juniors 18 620/1 700 = 10.95 per hour Direct labour cost per category of lawyer Partners 250 000/1 700 = 147.06 per hour Seniors 140 000/1 700 = 82.35 per hour Juniors 80 000/1 700 = 47.06 per hour Charge our rate for each category of lawyer: Partners 34.59 + 147.06 = 181.65 Seniors 19.01 + 82.35 = 101.36 Juniors 10.95 + 47.06 = 58.01 b) Amount to charge Brian Epstein Pty Ltd Partner 30 hours X 181.65 = $5 449.50 Senior 25 X 101.36 = $2 534 Juniors 30 X 58.01 = $1 740.30 Total = $9 724 4.12 a) Predetermined overhead rate: Total of budgeted overheads Electricity costs incurred $ 8 700 Water costs incurred $ 2 800 Cleaning costs incurred $ 34 000 Repairs and maintenance of equipment $ 7 400 Repairs and maintenance of warehouse $ 9 600 Deprecation of equipment $ 11 000 Deprecation of warehouse $ 15 000 Insurance costs incurred $ 7 600 Warehouse manager $ 88 000 Security guards and dogs $ 55 000 Miscellaneous costs incurred $165 000 $404 100 Predetermined overhead rate: 404 100/17 000 = $23.77 Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 10 b) Rate to charge of fuel per kilometre Cost of fuel: $1.50 per litre of fuel X 150 kilometres = $225 Therefore $225/900 kilometres = 25 cents (0.25) to charge per kilometre c) Job – Amber Pty Ltd Direct Materials Fuel – 4 000 kilometres X 0.25 $1 000 Direct Labour 5 days X 12 hours X $70 per hour $4 200 Accommodation – 4 nights X $90 per night $ 360 Food allowance – 4 breakfasts X $15 $ 60 4 lunches X $15 $ 60 4 dinners X$25 $ 100 Overheads – 60 hours X $23.77 per hour $1 426 Total cost $7 206 Job – Lucky Pty Ltd Direct Materials Fuel – 3 500 kilometres X 0.25 $ 875 Direct Labour 4.5 days X 12 hours X $70 per hour $3 780 Accommodation – 4 nights X $90 per night $ 360 Food allowance – 4 breakfasts X $15 $ 60 4 lunches X $15 $ 60 4 dinners X$25 $ 100 Overheads – 54 hours X $23.77 per hour $1 284 Total cost $6 519 4.13 Standard Cost Men’s Shirt Direct Materials Cotton – 2 metres per shirt X $7.00 per metre $14.00 per shirt Buttons – 3 buttons X 0.50 per button $1.50 per shirt $15.00 per shirt Direct labour 0.5 hours per shirt X $30.00 per hour Overheads $160 000/18 000 direct labour hours = $8.80 per direct labour hour Therefore – 0.5 hours per shirt X $8.80 per direct labour hour Total standard cost of making a shirt Cost of making a batch of 5 000 shirts is: 5 000 X $34.90 per shirt = $174 500 Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 11 $4.40 per shirt $34.90 per shirt 4.14 Predetermined overhead rate $79 000/11 520 direct labour hours = $6.86 per direct labour hour Standard cost of a batch of incense burners Direct materials Clay – 500 kilos X $8.00 per kilo $ 4 000 Glaze – 300 litres X $2.00 per litre $ 600 Paint – 80 litres X $5.00 per litre $ 400 Sealant – 200 litres X $3.50 per litre $ 700 Total direct materials cost $ 5 700 200 hours X $30.00 per hour $ 6 000 Direct labour Overheads 200 direct labour hours X $6.86 per direct labour hour $ 1 372 Standard cost of a batch $13 072 Cost of making one incense burner: $13 072/2 000 = $6.54 4.15 Predetermined overhead rate Leather goods factory: $200 000/5 400 direct labour hours = $37.04 per direct labour hour Farming $200 000/5 000 = $40 per Crocodile Slaughter, drying and cutting $90 000/5 000 = 18 per Crocodile Standard cost of farming each crocodile Direct materials $100 per crocodile Direct labour $ 80 per crocodile Overheads $ 40 per crocodile $220 Total cost of farming one crocodile Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 12 Standard cost of slaughtering, drying and cutting each crocodile Direct materials $ 50 per crocodile Direct labour $ 60 per crocodile Overheads $ 40 per crocodile Total cost of slaughtering, drying and cutting one crocodile $150 Standard cost of direct materials relating to one crocodile: Farming $220 Slaughtering, drying and cutting $150 Total cost $370 $23.13 Lining – half a metre at $5.00 per metre $ 2.50 Studs – 6 @ 30 cents per stud $ 1.80 Zip – one @ $3.00 pre zip $ 3.00 Rings – four @ 30 cents per ring $ 1.20 Latch – one @ 80 cents per latch $ 0.80 $32.43 $19.50 $27.78 $79.71 $ 46.25 Lining – one a metre at $5.00 per metre $ 5.00 Studs – 12 @ 30 cents per stud $ 3.60 Zip – one @ $3.00 pre zip $ 3.00 $ 1.20 Latch – one @ $1.00 cents per latch $ 1.00 $ 60.00 Standard cost of making a batch of handbags Small Handbags Direct materials Crocodile skin – $370/16 Direct labour Time to make one small bag – 300 hours/400 items = ¾ hour @ $26.00 per hour Overheads ¾ hour @ $37.04 per direct labour hour Total cost of making one small handbag Large Handbags Direct materials Crocodile skin – $370/8 Rings –four @ 30 cents per ring Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 13 Direct labour Time to make one small bag – 400 hours/400 items =One hour @ $26.00 per hour
$ 26.00 Overheads 1 hour @ $37.04 per direct labour hour $ 37.04 $123.04 $ 18 000 Electricity incurred (15 000 X 0.75) $ 11 250 Factory office costs $ 35 000 $ 19 500 Repairs and maintenance of factory machinery and equipment $ 12 000 Repairs and maintenance of factory $ 9 500 Insurance costs incurred (13 500 X 0.75) $ 10 125 Factory manager $110 000 Security guards and dogs $ 54 000 Miscellaneous factory costs incurred $ 77 000 Finance costs (19 400 X 0.75) $ 14 550 Total overhead costs $370 925 Total cost of making one small handbag 4.16 a) Predetermined overhead rates Overhead costs Factory building depreciation Cleaning costs incurred (26 000 X 0.75) Therefore $370 925/3 500 = 105.98 per machine hour 25 cents 424 Allocation to departments Stage 1 Department 105.98 X 30% = $31.79 per machine hour Stage 2 Department 105.98 X 50% = $52.99 per machine hour Stage 3 Department 105.98 X 20% = $21.20 per machine hour b) Direct materials cost Stage 1 Department $2 010 000 X 35% = $703 500/10 500 000 = 67 cents per litre @2 litres = $1.34 DM per tub Stage 2 Department $900 000 X 35% = $315 000/1 000 000 = 31.5 cents per gram @ 2 grams = 63 cents DM per tub Stage 3 Department $360 000 X 35% = $126 000/256 000 = $1.02 DM per tub Direct materials cost total = $2.99 DM per tub Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 14 c) Direct labour Stage 1 Department $450 000 X 30% = $135 000/5 400 hours = $25/278 tubs = 9 cents DLH per tub 135 000/25/ Stage 2 Department $360 000 X 30% = $108 000/4 909 hours = 22/314 tubs = 7 cents DLH per tub Stage 3 Department $300 000 X 30% = $90 000/4 500 hours 20/100 = 20 cents DLH per tub Total Direct Labour cost = 36 cents DLH per tub d) Overhead cost per tub Stage 1 Department $31.79 per machine hour/425 = 7 cents per tub Stage 2 Department $52.99 per machine hour/500 = 11 cents per tub Stage 3 Department $21.20 per machine hour/350 = 6 cents per tub Total overhead cost per tub = 24 cents per tub (e) Total cost of making a tub of supreme ice cream Direct materials $2.99 per tub Direct Labour $0.36 per tub Overhead $0.24 per tub Total cost per tub $3.59 per tub 4.17 Direct materials price and quantity variances Actual results Actual quantity of inputs X actual price 950 square metres X $11.00 per sq metre = $10 450 Flexible budget Standard quantity allowed for output X standard price 1 000 square metres (1 000 outdoor deck chairs x 1 sq metre per chair) X $10.00 = $10 000 Quantity variance is $500 F Actual quantity of inputs X standard price 950 square metres X $10.00 = $9 500 Price variance is $950 U Direct labour rate and efficiency variances Actual results Actual hours of inputs X actual rate
550 hours X $18.30 per hour wage rate = $10 065 Flexible budget Standard hours allowed for output X standard rate 500 (1 000 outdoor deck chairs x ½ hour per chair) hours X $18.00 per hour = $9 000 Efficiency variance is $900 U Actual hours of inputs X standard rate
550 hours X $18.00 per hour = $9 900 Rate variance is $165 U Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 15 4.18 a) and b) Direct materials price and quantity variances Distilled Water Actual results Actual quantity of inputs X actual price 650 litres X $30.00 per litre = $19 500 Actual quantity of inputs X standard price 650 litres X $29.00 = $18 850 Price variance is $650 U Flexible budget Standard quantity allowed for output X standard price 600 litres ((120 mLs X 5 000 items)/1 000) X $29.00 per litre = $17 400 Quantity variance is $1 450 U Alcohol Actual results Actual quantity of inputs X actual price 380 litres X $40.00 per litre = $15 200 Actual quantity of inputs X standard price 380 litres X $41.00 = $15 580 Price variance is $380 F Flexible budget Standard quantity allowed for output X standard price 400 litres ((80 mLs X 5 000)/1 000 litres X $41.00 = $16 400 Quantity variance is $820 F Lavender fragrance Actual results Actual quantity of inputs X actual price 260 litres X $60.00 per litre = $15 600 Actual quantity of inputs X standard price 260 litres X $61.00 = $15 860 Price variance is $260 F Flexible budget Standard quantity allowed for output X standard price 250 litres ((50 mLs X 5 000)/1 000 litres X $61.00 = $15 250 Quantity variance is $610 U c) and d) Direct labour rate and efficiency variances Actual results Actual hours of inputs X actual rate
300 hours X $23.00 per hour wage rate = $6 900 Rate variance is $0 Flexible budget Actual hours of inputs X Standard hours allowed for output X standard rate standard rate 300 hours X $23.00 per hour = 312.5 hours (5 000/16) X $23.00 per hour $6 900 = $7 187.50 Efficiency variance is $287.50 F 4.19 a) and b) Fixed overhead spending and production volume variances Actual results $70 000 Budgeted Budgeted amount regardless of output $60 000 Flexible budget
Budgeted amount regardless of output $60 000 Spending variance is $10 000 U
Allocated fixed overhead applied Standard hours allowed for output X standard rate
625 direct labour hours (5 000 deserts X 7 ½ minutes per desert) X $87.27 per direct labour hour = $54 543.75 Production volume variance is $9 000 U Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 16 Overhead application rate Budgeted Direct labour hours 5 500 X 7 ½ minutes per desert = 687.5 hours Budgeted Fixed Overhead costs $60 000/687.50 = $87.27 per direct labour hour c) and d) Variable overhead spending and efficiency variances Actual results Actual hours of inputs X actual rate
$80 000 (600 labour hours X $133.33 per hour*) Flexible budget Actual hours of inputs X standard rate Standard hours allowed for output X standard rate $81 000 (600 labour hours X $135.00 per hour) $84 375 (625 direct labour hours X $135.00 per hour) Spending variance is $1 000 F Efficiency variance is $3 375 F * $80 000/600 = $133.33 4.20 a) and b) Fixed overhead spending and production volume variances Actual results $50 000 Budgeted Budgeted amount regardless of output $40 000 Spending variance is $10 000 U
Flexible budget
Allocated fixed overhead applied Budgeted amount Standard hours allowed for output X standard rate
regardless of output 3 360 machine hours (420 units X 8 machine hours per unit) X $12.20 per machine hour = $40 992 $40 000 Production volume variance is $992 F Overhead application rate Budgeted Fixed Overhead costs $40 000/3 280 = $12.20 per machine hour c) and d) Variable overhead spending and efficiency variances Actual results Actual hours of inputs X actual rate
$165 000 (3 465 machine hours X $47.62 per hour*) Flexible budget Actual hours of inputs X standard Standard hours allowed for output X rate standard rate $173 250 (3 465 machine hours X $168 000 (3 360 machine hours X $50.00 per hour) $50.00 per machine hour) Spending variance is $8 250 F Efficiency variance is $5 250 U * $165 000/3 465 = $47.62 4.21 a) and b) Direct materials price and quantity variances Actual results Actual quantity of inputs X actual price 99 200 square metres (31 sq metres X 3 200) X $0.33 per sq metre = $32 736 Flexible budget Actual quantity of inputs X Standard quantity allowed for standard price output X standard price 99200 square metres (31 sq metres 96 000 square metres (30 sq X 3 200) X $0.30 = $29 760 metres X 3 200) X $0.30 = $28 800 Price variance is $2 976 U Quantity variance is $960 U Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 17 c) and d) Direct labour rate and efficiency variances Actual results Actual hours of inputs X actual rate
800 hours (3 200 frames X 15 minutes per frame) X $24.00 per hour wage rate = $19 200 Rate variance is $165 U Flexible budget Actual hours of inputs X standard Standard hours allowed for output rate X standard rate 800 hours (3 200 frames X 15 853.33 hours (3 200 frames X 16 minutes per frame) X $22.00 per minutes per frame) X $22.00 per hour = $17 600 hour = $18 773.26 Efficiency variance is $1 173.26 F g) and h) Fixed overhead spending and production volume variances Actual results Actual hours of inputs X actual rate $14 080 (1 600 machine hours X $8.80 per machine hour) Budgeted Budgeted amount regardless of output $13 496 (1 400 machine hours X $9.64 per machine hour) Spending variance is $584 U Flexible budget
Budgeted amount regardless of output $13 496 (1 600 machine hours X $8.44 per machine hour) Allocated fixed overhead applied Standard hours allowed for output X standard rate $14 395.70 (1 493.33 machine hours (3 200 frames X 28 minutes per frame) machine hours X $9.64 per machine hour) Production volume variance is $899.70 F e) and f) Variable overhead spending and efficiency variances Actual results Actual hours of inputs X actual Actual hours of inputs X rate standard rate $13 280 (1 600 machine hours $13 712 (1 600 machine hours (3 200 X 30 minutes) $8.30 per (3 200 X 30 minutes) X $8.57 machine hour) per machine hour Spending variance is $432 F Flexible budget Standard hours allowed for output X standard rate $12 797.84 (1 493.33 hours (3 200 frames X 28 minutes) machine hours X $8.57 per machine hour) Efficiency variance is $914.16 U 4.22 Direct materials price and quantity variances Actual results Actual quantity of inputs X Actual quantity of inputs X actual price standard price 7 200 square metres X $210 per 7 200 square metres X $200 sq metre = $1 512 000 per sq metre = $1 440 000 Price variance is $72 000 U Flexible budget Standard quantity allowed for output X standard price 6 900 square metres (3 sq metres X 2 300 rugs) X $200 per sq metre = $1 380 000 Quantity variance is $60 000 U Direct labour rate and efficiency variances Actual results Actual hours of inputs X actual Actual hours of inputs X rate standard rate 4 400 hours X $22.00 per hour 4 400 hours X $21.00 per hour wage rate = $96 800 = $92 400 Rate variance is $4 400 U Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 18 Flexible budget Standard hours allowed for output X standard rate 4 600 hours (2 300 rugs x 2 hour per rug) X $21.00 per hour = $96 600 Efficiency variance is $4 200 F Fixed overhead spending and production volume variances Actual results Budgeted Actual hours of inputs X Budgeted amount actual rate regardless of output $60 000 (50 000 machine $63 750 (51 000 hours X $1.20 per machine machine hours X $1.25 hour ($60 000/50 000 per machine hour) machine hours) Spending variance is $3 750 F Flexible budget
Budgeted amount regardless of output $63 750 (50 000 machine hours X $1.275 per machine hour) Allocated fixed overhead applied Standard hours allowed for output X standard rate $67 500 (54 000 machine hours (27 000 rugs X 2 hours per rug) X $1.25 per machine hour) Production volume variance is $3 750 F Overhead application rate Budgeted Fixed Overhead costs $63 750/51 000 machine hours = $1.25 per machine hour Variable overhead spending and efficiency variances Actual results Actual hours of inputs X actual Actual hours of inputs X standard rate rate $38 000 (50 000 machine $45 500 (50 000 machine hours x hours x $0.76 per hour*) $0.91 per hour) Spending variance is $7 500 F Flexible budget Standard hours allowed for output X standard rate $49 140 (54 000 machine hours (27 000 rugs X 2 hours per rug) x $0.91 per machine hour) Efficiency variance is $3 640 F * $38 000/50 000 machine hours = $0.76 per machine hour $46 000/51 000 machine hours = $0.91 per machine hour 4.23 a) Predetermined overhead per machine hour $430 000/4 570 = $94.09 per machine hour b) Cost of new outback tent Direct materials ($463 000/500) $ 926 per tent Direct labour ($23 560/500) $ 47 per tent Overheads ($94.09 X 160 hours = $15 054.40/500) $ 30 per tent Total cost of one tent $1 003 c) Price to be charged of one new tent $1 003 + ($1 003 X 35%) $1 003 + 351 = $1 354 Therefore the price to charge of one new camping tent is $1 354 d) The factors that would be considered would be: o
The selling price that the customer is willing to pay o
The selling price that is competitive in the marketplace o
The desired rate of return on investment, that is, what profit margin does the business wish to make. o
The business’s costs, as all costs must be covered. Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 19 4.24 a) Predetermined overhead rates Cutting and Assembly Department $460 000/7 200 machine hours = $63.89 per machine hour Finishing Department $250 000/3 500 direct labour hours = $71.43 per direct labour hour b) Production targets Model Basic – 1 500 X 70% = 1 050 products Model Luxury – 1 500 X 30% = 450 products Cost of making Model Basic Direct Materials: Cutting and Assembly – 890 000 X 60% = 534 000/1 050 $ 508.57 Direct Materials: Finishing – 370 000 X 60% = 222 000/1 050 $ 211.43 Direct labour Cutting and Assembly – 1 400 hours X 50% = 700 hours X $30 per hour = 21 000/1 050 $ 20.00 1 750 hours X $35 per hour = 61 250/1 050 $ 58.33 5 040 hours X $63.89 per hour = $322 005.60/1 050 $ 306.67 1 750 hours X $71.43 per hour = $125 002.50/1 050 $ 119.05 Total cost of making the Model Basic $1 224.05 Cutting and Assembly – 890 000 X 40% = 356 000/450 $ 791.11 Finishing – 370 000 X 40% = 148 000/450 Finishing – 3 500 hours X 50% = Overheads Cutting and Assembly – 7 200 X 70% = Finishing – 3 500 X 50% = Cost of making Model Luxury Direct Materials $ 328.89 $ 46.67 $ 136.11 Direct labour Cutting and Assembly – 1 400 hours X 50% = 700 hours X $30 per hour = 21 000/450 Finishing – 3 500 hours X 50% = 1 750 hours X $35 per hour = 61 250/450 Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 20 Overheads Cutting and Assembly – 7 200 X 30% = 2 160 hours X $63.89 per hour = $138 002.40/450 $ 306.67 1 750 hours X $71.43 per hour = $125 002.50/450 $ 277.78 Total cost of making the Model Basic $1 887.23 Finishing – 3 500 X 50% = c) Price Model Basic $1 224.05 + ($1 224.05 X 25%) $1 224.05 + 306.01 = $1 530 Therefore the price to charge for Model Basic is $1 530 Price Model Luxury $1 887.23 + ($1 887.23 X 30%) $1 887.23 + 566.17 = $2 453 Therefore the price to charge for Model Basic is $2 453 4.25 a) Charge our rate for a partner and an associate Cost of overheads Salaries of secretarial staff $ 90 000 Electricity $ 5 700 Insurance $ 3 700 Rent of office space $ 40 000 Office supplies $ 18 500 Depreciation of office equipment $ 19 500 Repairs to equipment $ 2 700 Professional requirements costs $ 10 000 Miscellaneous costs $ 15 500 Total overhead $205 600 Total hours 1 800 X 7 staff = 12 600 hours Predetermined Overhead Rate $205 600/12 600 hours = $16.32 per hour Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 21 Partners charge our rate Salary costs ($270 000/1 800) $150.00 per hour Overhead costs $ 16.32 per hour Total cost $166.32 per hour Salary costs ($120 000/1 800) $ 66.67 per hour Overhead costs $ 16.32 per hour Total cost $ 82.99 per hour Associates charge out rate b) Cost of preparing the three types of personal tax returns Basic personal tax returns Partners time 2 ½ hours X 20% = ½ hour X $166.32 per hour $ 83.16 Associates time 2 ½ hours X 80% = 2 hours X $82.99 per hour $ 165.98 Total cost $ 249.14 Standard personal tax returns Partners time 5 hours X 40% = 2 hours X $166.32 per hour $ 332.64 Associates time 5 hours X 60% = 3 hours X $82.99 per hour $ 248.97 Total cost $ 581.61 Difficult personal tax returns Partners time 10 hours X 60% = 6 hour s X $166.32 per hour $ 997.92 Associates time 10 hours X 40% = 4 hours X $82.99 per hour $ 331.96 Total cost $1 329.88 c) Standard hourly rate for each type of personal tax return Basic personal tax returns $249.14 + ($249.14 X 20%) = $298.97 $298.97/2.5 hours = $120 per hour Standard personal tax returns $581.61 + ($581.61 X 20%) = $697.93 $697.93/5 hours = $140 per hour Difficult personal tax returns $1 329.88 + ($1 329.88 X 20%) = $1 595.86 $1 595.86/10 hours = $160 per hour Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 22 Standard price for each type of personal tax return Basic personal tax return – 2 ½ hours X $120 per hour = $300 Standard personal tax return – 5 hours X $140 per hour = $700 Difficult personal tax return – 10 hours X $160 per hour = $1 600 4.26 Costs Predetermined overhead rate $75 per direct labour hour X 15 hours (3 workers X 5 hours each) $1 125 Direct materials $1 700 Direct labour $62 per hour X 15 hours (3 workers X 5 hours) $ 930 Total cost $3 755 $6 000 $ 180 Overheads – $23 per machine hour X 10 hours $ 230 Total cost Mark up Cost $3 755 + ($3 755 X 25%) = $4 694 Quote for repairing the vehicle is $4 694 4.27 Costs Prefabrication Department Direct materials Direct labour – 4 hours X $45 per hour $6 410 $ 300 $ 440 Overheads – $18 per machine hour X 8 hours $ 144 Total cost Cutting Department Direct materials Direct labour – 8 hours X $55 per hour $ 884 $ 500 $1 830 Overheads – $3 per machine hour X 30 hours $ 90 Total cost Construction Department Direct materials Direct labour – 30 hours X $61 per hour $2 420 Total overall cost $9 714 Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 23 Mark up $9 714 + ($9 714 X 28%) = $12 434 Quote for making and erecting the patio is $12 434 4.28 a) Predetermined overhead rate Manufacturing Department Air‐conditioners – $530 000/5 000 machine hours $106 per machine hour $ 86 per machine hour $210 000/30 000 direct labour hours $ 7 per direct labour hour Manufacturing Department Other Parts – $257 000/3 000 machine hours Installation Department – Model A67 costs Direct materials Manufacturing Department Air‐conditioners – $1 958 000 Manufacturing Department Other Parts – $1 120 000 Total Direct materials cost $3 078 000 $ 87 750 2 470 X 30% = 741 hours X $35 per hour $ 25 935 Total Direct labour cost $ 113 685 $ 185 500 Direct labour Manufacturing Department Air‐conditioners – 9 750 X 30% = 2 925 hours X $30 per hour Manufacturing Department Other Parts – Overheads Manufacturing Department Air‐conditioners – 5 000 X 35% = 1 750 hours X $106 per hour Manufacturing Department Other Parts – 3 000 X 35% = 1050 hours X $86 per hour $ 90 300 Total Overhead cost $ 275 800 $3 467 485 Total cost to make Model A67 Cost of making one Model A67: Production 2 500 X 40% = 1 000 air conditioners Therefore $3 467 485/1 000 = $3 467 each Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 24 b) Direct materials Installation Department – $190 000 30 000 X 30% = 9 000 hours X $35 per hour $315 000 Direct labour Installation Department – Overheads Installation Department – 30 000 X 30% = 9 000 hours X $7 per hour $ 63 000 Total cost of one $568 000 Cost of one Basic Installation Package: Production 2 500 X 40% = 1 000 air conditioners Therefore $568 000/1 000 = $568 each c) Quote for Holly Spears One A67 Basic Air Conditioner $3 467 One Basic Installation Package $ 568 Other parts for installation $ 250 Extra direct labour time 2 hours $35 per hour = $ 70 Total cost $4 355 Plus mark up $4 355 X 25% $1 089 Total cost to make and install $5 444 Essay The following is a skeleton outline only showing some key points. Cost accounting is important to the accurate measuring, analysing, recording and reporting on the cost of a product or service so as to determine the selling price of an item and its profitability. Cost accounting information is therefore used to make informed decisions and to maximise profits. The business can see how profit is linked closely with costs and the level of business activity. Costing can be used to improve the efficiency and effectiveness of business operations through identifying value‐added and non‐value‐added costs. The latter can then be eliminated to make the business more profitable. Specifically cost accounting is important and useful as follows: • control of costs – comparing actual product costs with planned costs and, if necessary, taking corrective action so that the predetermined targets are met in the future • planning – using past product costs to estimate future product costs • inventory valuation – calculating the value of products that are complete (finished goods) and products that are partially complete (work in progress) at the end of each accounting period for inclusion in the financial statements • the setting of selling prices – often set with reference to the cost of the product or service • determining profitability – management can determine if it is worth producing or selling the product or service. Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 25 In explaining how it is useful students should give examples for each of the above relating to manufacturing, service and retail businesses. Job order costing is the process of recording all the costs of a distinct product or service. A job order costing system is used when a business creates a single unit or multiple units of a distinct product, makes a product to a customer order or provides a service to meet specific customer requirements. Each job has its own special characteristics and may be, for example, a single product, a batch of the same product or a service provided to an individual client. In each case the job uses its own specific resources. A batch may be a variety of wine, a type of shirt made for a particular market or a small quantity of invitations printed for an expo. The business may manufacture a number of different unique products in small or large quantities or provide a number of different services to meet client requests. The product being manufactured or service provided is unique and different to the other products being made by the business. Job order costing is used in both manufacturing and service industries but is rarely used in merchandising firms as the cost of the product is already known. Many firms are not purely manufacturing, merchandising or service firms, but a bit of each, as they may make and/or sell a product and also provide a service to the customer. For example, a firm may manufacture, sell and install swimming pools or a café may make sandwiches, sell pre‐purchased cakes and provide customers with an agreeable venue to eat them in. Job order costing is used in such service industries as accounting firms, legal firms and repair shops. Job order costing records all the costs for each finished job whereby all costs are traced and allocated to the job and the quantity noted. It is possible then to calculate the average cost per unit of the item being made or service provided. A job order costing system is used when a business creates a single unit or multiple units of a distinct product, makes a product to a customer order or provides a service to meet specific customer requirements. Each job has its own special characteristics and may be, for example, a single product, a batch of the same product or a service provided to an individual client. In each case the job uses its own specific resources. A batch may be a variety of wine, a type of shirt made for a particular market or a small quantity of invitations printed for an expo. The business may manufacture a number of different unique products in small or large quantities or provide a number of different services to meet client requests. The product being manufactured or service provided is unique and different to the other products being made by the business. Job order costing is used in both manufacturing and service industries but is rarely used in merchandising firms as the cost of the product is already known. Job order costing is used in such service industries as accounting firms, legal firms and repair shops. Job order costing records all the costs for each finished job whereby all costs are traced and allocated to the job and the quantity noted. It is possible then to calculate the average cost per unit of the item being made or service provided. Actual costing calculates the cost of a product or service using the actual direct materials, actual direct labour and actual overheads costs. All costs are applied to the actual quantity. In the case of the actual overhead costs, an actual overhead rate is applied at the end of each accounting period to the product or service to determine the total unit cost. Normal costing determines the cost of a product or service with job order costing using actual direct materials, actual direct labour and a predetermined overhead rate. These figures are applied to the actual quantity related to a job. The predetermined overhead rate allocates the indirect costs of production to the actual quantity of the product or service produced. Absorption costing is the method whereby all fixed manufacturing costs and variable manufacturing costs are included in the product cost. Standard costing is a system of product costing where the cost of a product is based on standard costs for direct materials, direct labour and manufacturing overheads. A standard cost is a predetermined cost and based on some preconceived benchmark of what is considered appropriate to the making of a product. Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 26 A direct cost is able to be traced to a product or service with a high degree of accuracy. Directly traceable means that the cost can be physically and easily (i.e. economically and conveniently) traced to the finished product. Direct materials and direct labour are the two most common direct costs for a business. Indirect costs are not so easily traced to a product or service. These are items that are not actually incorporated in the product or are too insignificant to make it worth tracing the cost to the finished product Fixed costs are those that do not change in total when the level of activity changes. For example, the rent of a factory building will be the same in total no matter how many units are produced. A variable cost is one that changes in total as the level of activity changes. For example, the cost of raw materials in total will increase as the level of units produced increases A product cost includes all those costs that are attributable to a product and are those costs to do with merchandise acquired or manufactured or a service provided. It is recorded as an expense in the period in which the product is sold and this will be recorded as the cost of goods. The product is an asset because it has future economic benefit to the business. Costs that are not product costs are period costs. Period costs are an expense and therefore shown in the business income statement in the period in which they are incurred. A period cost is a cost that relates to the current accounting period and which does not have a future economic benefit to the business. Period costs are not carried forward with the product until the time of sale. Ethics case study The General Manager may have chosen direct labour hours for the allocation of overheads instead of the machine hours recommended by the Financial Controller so as to ensure that more or less cost is charged to the contract. The selection of the inappropriate cost allocation base could see more or less cost charged to the contract than would otherwise be the case if machine hours had been chosen. The first ethical issue relates to the over‐charging or under‐charging of cost to the Sarich contract. The question here is why? Is it to make extra profit out of the Sarich contract or is under‐charge them so as to ensure further business in the future. The other question related to this is ethical issue is: what is the relationship of the General Manager to the Sarich contract? Is there a conflict of interest? A further ethical issue relates to the perceived technical competence of the financial controller. This decision of the General Manager could reflect poorly, although not correctly so, on the Financial Controller. If a problem was to occur in the future with the Sarich business and this contract, and the Board of Directors was to investigate all aspects of the contract, it could perhaps incorrectly attribute some of the problem to financial controller for not selecting the appropriate allocation base. This business may have under‐charged or over‐charge Sarich and may blame this on the Financial Controller. The Financial Controller has a number of possible options. He/she could contact the Board of Directors of Digital Electronics Ltd and explain his/her concerns to them. He/she could write a memo to the General Manager outlining his/her concerns and in this way place it on the records. He/she could contact the Sarich business, although this may be seen by Digital as breaking confidentiality. A further possible course of action is for the Financial Controller to resign. Nelson Accounting and Finance for WA 3A3B 9780170182058 © Cengage Learning Australia 2010 27