ACCT 481
Michael Dimond

Costing Methods
• Process Costing
• Job Costing
• Activity-based Costing
Michael Dimond
School of Business Administration

Understanding costs is key to cost management
• A cost object is anything for which a separate measurement of costs is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, and a department
• Direct costs of a cost object are related to the particular cost object and can be traced to that cost object in an economically feasible
(cost-effective) way. Direct costs are traced to a cost object.
• Indirect costs of a cost object are related to the particular cost object but cannot be traced to that cost object in an economically feasible (cost-effective) way. Indirect costs are allocated to a cost object.
• A cost driver is a factor which causes total costs to change in a given period (e.g. sales volume). A change in the cost driver results in a change in the level of total costs.
• A cost pool is a group of indirect cost items which are separate, but related.
• A cost allocation base is used to distribute the indirect costs in a cost pool to cost objects.
Michael Dimond
School of Business Administration

Example of assigning costs to cost object
Michael Dimond
School of Business Administration

Process Costing
• Process costing divides the total costs by the total number of units produced. All units (of goods or services) are identical and indistinguishable. This results in an average production cost per unit, which may be classified in as few as two categories: direct materials and conversion costs
• Process-costing systems separate costs into cost categories according to when costs are introduced into the process.
• Direct materials are usually added at the beginning of the production process, or at the start of work in a subsequent department down the assembly line.
• Conversion costs are generally added equally along the production process.
• Process costing is very high-level and assumes all costs are spread evenly over the production of the identical units.
• There will be complications when the process creates WIP inventory
• FIFO and Average cost inventory methods will be treated differently
Michael Dimond
School of Business Administration

Five Steps in Process Costing
1. Summarize the flow of physical units of output.
2. Compute output in terms of equivalent units.
3. Summarize total costs to account for.
4. Compute cost per equivalent unit.
5. Assign total costs to units completed and to units in ending work in process.
Michael Dimond
School of Business Administration

Process Costing Details
Assume the company has no beginning WIP inventory
Michael Dimond
School of Business Administration

Process Costing Details, cont’d
Michael Dimond
School of Business Administration

Process Costing Details, cont’d
Michael Dimond
School of Business Administration

Inventory Methods in Process Costing
1.
Weighted-averag e process-costing method calculates the equivalentunit cost of all the work done to date (regardless of the accounting period in which it was done), assigns this cost to equivalent units completed and transferred out of the process, and to equivalent units in ending work-in-process inventory.
2.
FIFO computations assign the cost of the previous accounting period’s equivalent units in beginning work-in-process inventory to the first units completed and transferred out of the process and assign the cost of equivalent units worked on during the current period first to complete beginning inventory, next to start and complete new units, and finally to units in ending work-in-process inventory.
3.
Standard-cost procedures attribute costs based on the budgeted standard for the cost item in question. This avoids the intricacies involved in detailed tracking with weighted-average or FIFO methods when there are frequent price variations over time.
Michael Dimond
School of Business Administration

Job Costing
• Job costing assigns direct costs to the production of a unique unit of work based on consumption, then allocates the indirect costs using one of two basic approaches:
• Actual costing: Indirect costs based on the actual indirect-cost rates times the actual activity consumption.
• Normal Costing: Indirect costs based on the budgeted indirect-cost rates times the actual activity consumption.
Michael Dimond
School of Business Administration

Seven Steps in Job Costing
1. Identify the job that is the chosen cost object
2. Identify the direct costs of the job
3. Select the cost-allocation bases to use for allocating indirect costs to the job
4. Identify the indirect costs associated with each costallocation base
5. Compute the rate per unit of each cost-allocation base used to allocate indirect costs to the job
6. Compute the indirect costs allocated to the job
7. Compute the total cost of the job by adding all direct and indirect costs assigned to the job.
Michael Dimond
School of Business Administration

Job Costing Details
• Journal entries are made at each step of the production process.
• The purpose is to have the accounting system closely reflect the actual state of the business, its inventories, and its production processes.
• All product costs are accumulated in the work-in-process control account.
• Direct materials used
• Direct labor incurred
• Factory overhead allocated or applied
• Actual indirect costs (overhead) are accumulated in the manufacturing overhead control account.
Michael Dimond
School of Business Administration

Job Costing Details, cont’d
Michael Dimond
School of Business Administration

Job Costing Details, cont’d
Michael Dimond
School of Business Administration

Job Costing Requires Subsidiary Ledgers
• Subsidiary ledgers keep track of details of a specific job so management can better control costs
Michael Dimond
School of Business Administration

Activity-based Costing
• Activity-based costing (ABC) identifies activities as cost drivers and allocates costs based on the resource demands of each product.
• ABC is a refinement of costing methods which tries to avoid undercosting or overcosting of products (which would lead to poor management decisions).
• Classify as many of the total costs as direct costs as is economically feasible.
• Expand the number of indirect cost pools until each of these pools is more homogenous.
• Use cause-and-effect criteria to identify the cost-allocation base for each indirect-cost pool.
• ABC systems typically use a cost hierarchy with four levels:
• Output unit-level costs, such as variable labor costs
• Batch-level costs, such as production set-up costs
• Product-sustaining costs, such as design costs
• Facility-sustaining costs, such as rent
Michael Dimond
School of Business Administration

ABC Cost Hierarchy Levels
• Output unit-level costs: costs of activities performed on each individual unit of a product or service, and increase as the number of units produced increases.
• Batch-level costs: costs of activities related to a group of units of products or services rather than the individual unit.
• Product-sustaining costs: costs of activities undertaken to support individual products or services regardless of the number of units or batches produced.
• Facility-sustaining costs: costs of activities that cannot be traced to individual products or services but support the organization as a whole.
Michael Dimond
School of Business Administration

ABC is More Precise Than Simple Costing
• Simple Costing
Michael Dimond
School of Business Administration

ABC is More Precise Than Simple Costing
• Simple Costing
Michael Dimond
School of Business Administration

ABC is More Precise Than Simple Costing
• Activity-based Costing
Michael Dimond
School of Business Administration

ABC is More Precise Than Simple Costing
• Activity-based Costing
Michael Dimond
School of Business Administration

ABC is More Precise Than Simple Costing
• Activity-based Costing
Michael Dimond
School of Business Administration

ABC is More Precise Than Simple Costing
Michael Dimond
School of Business Administration