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Chapter 2
Product Costing
Prepared by
Diane Tanner
University of North Florida
Assigning Costs to Cost Objects
• Three methods
– Actual costing
– Normal costing
– Standard costing
• Differ in how product costs are assigned to
products or services
Actual
Costing
Normal
Costing
Standard
Costing
Direct Materials
Actual
Actual
Budgeted*
Direct Labor
Actual
Actual
Budgeted*
Manufacturing Overhead
Actual
Budgeted
Budgeted*
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Normal Vs. Actual Costing
 Normal costing
 Used effectively when there are multiple products
 Allocates manufacturing overhead to individual
products based on a ‘predetermined’ rate
calculation
Estimated MOH
 Based on estimates Estimated Activity
 Actual costing
 Allocates manufacturing overhead to individual
products based on an end of period rate
calculation
Actual MOH
 Based on actual amounts Actual Activity
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How Costs Get Assigned to Products
 Direct materials and direct labor
 Traced to a product or service provided
 Because it is easy to determine which
product/service to which the cost belongs
 By definition, direct costs are directly associated
 Manufacturing overhead
 Consists solely of indirect costs
 Indirect costs cannot be easily identified with one
specific product or service
 Allocated to products and services
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Production Departments
Materials Storeroom
Factory/Production Area
Raw Materials
Work in Process
Costs in departments
correlate to inventory
accounts.
Ready
for
Sale
Finished Goods
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Acquiring Raw Materials
1
The Purchasing Manager fills out an electronic
purchase order to order materials from a supplier
Materials Storeroom
2
When materials are received, the Materials
Storeroom Clerk records and stocks the
materials in the storeroom.
Debit Raw Materials
Credit Cash or Accounts Payable
3 The Materials Storeroom Clerk sends the
receiving report to Accounting for
payment.
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Materials Requisition
Factory/Production Area
1
The production supervisor
fills out a materials
requisition form.
A materials requisition form
authorizes the use of materials
on a product or job
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The materials storeroom
clerk delivers the
requested materials to
the production area.
DIRECT MATERIALS
Debit Work in Process
Credit Raw Materials
INDIRECT MATERIALS
Debit Manufacturing Overhead
Credit Raw Materials
3 The processed form is
sent to Accounting.
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Direct Labor
• Employees fill out time tickets which indicate the hours
worked on each product
• Time tickets = source documents
• Direct labor cost = gross wages + fringe benefits
 Gross wages = [Hourly rate] × [Number of hours worked]
 Fringe benefits
 Normally included as part of the direct labor ‘rate’
 Overtime premium (the extra ‘half’ time paid)
 If the result of production problems, treat as manufacturing
overhead
 If the result of accepting a rush order, treat as direct labor
 Idle time
 Treat as overhead
Incur direct labor costs
 Debit Work in Process
 Credit Cash or Wages Payable
Manufacturing Overhead
Includes indirect materials, indirect labor, and factory
(production facility) related costs
Incur factory-related costs
 Debit Manufacturing Overhead
 Credit Cash, Payables, Prepaids, etc.
Requisition indirect materials to production
 Debit Manufacturing Overhead
 Credit Raw Materials
Incur indirect labor costs
 Debit Manufacturing Overhead
 Credit Cash, Salaries payable, etc.
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Accounting for Overhead in a Normal
Costing System
 When actual overhead costs are incurred
 Debit to MOH expense account
 Apply (allocate) overhead to products
 Predetermined MOH rate(s)
 Traditional method - use a single rate
 Activity based costing – use multiple rates
 Multiply the rate(s) times the actual activity
 Debit WIP
 Credit MOH expense
 When is overhead applied?
 As the activity occurs
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This chapter assumes
a single rate
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Assigning Overhead
NORMAL COSTING
• Overhead rate is determined at the beginning of
the period using estimated amounts
• MOH is ‘applied’ (allocated) to products
– During production
ACTUAL COSTING
• Overhead rate is determined at the end of the
period using actual amounts
• MOH is ‘applied’ (allocated) to products
– At the end of the period
Selecting an Activity
 The denominator of the pre-determined overhead rate
is ‘estimated activity’
 Common estimated activities include
 Number of units to be produced
 Number of direct labor hours to be used
 Number of direct labor dollars to be incurred
 Number of machine hours to be used
 Based on management’s best guess of what causes
costs to increase
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Applying Overhead Based on Units
McAlister Company provided the following amounts:
Estimated MOH costs = $50,000
Actual MOH costs = $49,500
Estimated units to be produced = 4,000
Actual units produced = 4,100
The company allocates overhead based on units produced.
Step 1: Determine the allocation rate (POHR) =
$50,000/4,000 = $12.50/unit
Step 2: Apply overhead:
Applied = $12.50 x 4,100 = $51,250
MOH
49,500
51,250
1,750 overapplied
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Applying Overhead Based on DL Hours
McAlister Company provided the following amounts:
Estimated MOH costs = $50,000
Actual MOH costs = $49,500
Estimated direct labor hours = 12,500
Actual direct labor hours = 12,400
The company allocates overhead based on DL hours.
Step 1: Determine an allocation rate (POHR) =
$50,000/12,500 = $4.00/DL hour
Step 2: Apply overhead:
Applied = $4.00 x 12,400 = $49,600
MOH
49,500
49,600
100 overapplied
Applying Overhead Based on DL Cost
McAlister Company provided the following amounts:
Estimated MOH costs = $50,000
Actual MOH costs = $49,500
Estimated direct labor cost = $156,250
Actual direct labor cost = $153,600
The company allocates based on DL hours.
Step 1: Determine an allocation rate (POHR) =
$50,000/156,250 = $0.32 per DL$
Step 2: Apply overhead:
Applied = $0.32 x $153,600 = $49,152
MOH
49,500 49,152
Underapplied 348
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Why is Normal Costing Better
than Actual Costing?
• Overhead is applied during production
– Enables managers to know product and job
costs as production occurs, i.e., on a timely
basis
• Waiting until the end of the period when
actual costs are known makes information
untimely
– Useful for making decisions such as pricing,
product changes, etc.
Overhead cannot be traced to products
because it is impractical or impossible to
identify these costs with a particular product.
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Completing Products
 The cost of completed goods is transferred out
of Work in Process
 Debit Finished Goods
 Credit Work in Process
 The cost transferred out is called Cost of Goods
Manufactured
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Selling Products
 Transfer the cost of products sold out of Finished
Goods
 Debit Cost of Goods Sold
 Credit Finished Goods
 Recognize the sale
 Debit Cash or AR
 Credit Sales Revenue
The End
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