MANAGERIAL ACCOUNTING Topic5 COSTING SYSTEMS part I.
Structureofthelecture5 5.1 Key terms 5.2 Costing systems 5.3 Absorption vs. variable costing 5.4 Actual vs. Normal vs. Extended normal costing 5.5 Job costing vs. Process costing 5.6 Job costing in service organization 5.7 Job costing in manufacturing organization
5.1 Keyterms Cost unit The smallest unit of production for which an organization calculates the cost. The cost might be a single item(e.g. Table) or parts of an item(e.g. Wings of an aeroplane) or multiple items(e.g. 1000 plastic caps). Calculated quantity The number of cost units for which total cost are traced, allocated or budgeted. Cost object Anything for which a separate measurement of costs is desired. Cost pool The aggregation of costs which will be charged to products on the basis of a common cost driver, grouping of individual cost items. They can range from the very broad (companywide total-cost pool for telephones) to the very narrow (costs of operating the car used by traveling saleperson).
5.1 Keyterms Cost centre The section of an organization for which costs are collected. Each cost centre should be clear responsibility of one manager. Two main types: a) production, and b) service. Cost driver A factor within an organization that causes costs. (i.e. cost driver for machine set-up costs number of different jobs that the machine has to do). Cost drivers need to be identified as part of activity based costing (ABC).
5.1 Keyterms Cost allocation The assignment of cost directly to a product or a cost centre. Cost-allocation base Cost-allocation base A factor that is the common denominator for systematically linking an indirect cost or group of indirect costs to a cost object. A cost-allocation base can be financial(direct labour cost) or nonfinancial(number of car km/miles travelled). Costdriver of the indirect costsis usedas costallocation base.
5.2 Costingsystems Costing systemsaim to report cost numbers that indicate the manner in which particular cost objects use the resources of an organization. Costing formula = calculation of cost, contribution margin, profit, salepriceetc., per unit(service, product,activity, operation, )
5.2 Costingsystems Classification of costing methods: - Absorption costing x variable costing - Actual costing x (extended) normal costing - Job costing x process costing - Costing by dividing x overhead rates costing - Traditional costing x activity based costing - target costing, estimate costing, operational costing,
5.3 Absorptioncostingx variablecosting Absorption costing Historically first costing system; Allocates such costs to cost object which were spent for its creation; Costs are classified to direct and indirect. Absorption costing formula: direct unit costs + direct overhead costs + indirect overhead costs
5.3 Absorptioncostingx variablecosting Retrograde (variable) costing Calculation of contribution margin (in different levels) Costs are classified to variable and fixed Use: managing the profit. Retrograde costing formula: sale price (of output) (-)variable costs on output = contribution margin on output
5.4 Actualcostingx normalcostingx Actual costing extendednormalcosting = costing method that traces direct costs to a cost object by using the actual direct-cost rate(s) and actual quantity of the direct-cost input(s) allocates indirect costs based on the actual indirect-cost rate(s) and the actualquantity of the cost-allocation base.
5.4 Actualcostingx normalcostingx extendednormalcosting Actual costing formulas: Direct cost traced to cost object = Actual direct-cost rate multipliedby actual quantity of the direct-cost inputs Indirect cost allocated = Actual indirect-cost rate multipliedby actual quantity of the cost-allocation base Actual indirect-cost rate = Actual total costs in indirect-cost pool divided by actual total quantity of cost-allocation base
5.4 Actualcostingx normalcostingx Normal costing extendednormalcosting = costing method that traces direct costs to a cost object by using the actualdirect-cost rate(s) and actual quantity of the direct-cost input allocates indirect costs based on the budgetedindirect-cost rate(s) and the actual quantity of the cost-allocation base(s).
5.4 Actualcostingx normalcostingx extendednormalcosting Normal costing formulas: Direct cost traced to cost object = Actual direct-cost rate multipliedby actual quantity of the direct-cost inputs Indirect cost allocated = Budgeted indirect-cost rate multipliedby actual quantity of the cost-allocation base Budgeted indirect-cost rate = Budgeted total costs in indirect-cost pool divided by budgeted total quantity of cost-allocation base
5.4 Actualcostingx normalcostingx extendednormalcosting Extended normal costing (budgeted costing) = costing method that traces direct costs to a cost object by using the budgeteddirect-cost rate(s) and actual quantity of the direct-cost input allocates indirect costs based on the budgetedindirect-cost rate(s) and the actual quantity of the cost-allocation base(s).
5.4 Actualcostingx normalcostingx extendednormalcosting Extended normal costing (budgeted costing) Direct cost traced to cost object = Budgeted direct-cost rate multipliedby actual quantity of the direct-cost input Indirect cost allocated = Budgeted indirect-cost rate multipliedby actual quantity of the cost-allocation base Budgeted direct-labour cost rate = Budgeted total costs in indirect-cost pool (totaldirect-labour costs) divided by budgeted total quantity of costallocation base(budgeted total direct labour-hours to be billed)
5.4 Actualcostingx normalcostingx extendednormalcosting Summary use ofrates Actual costing Normal costing Extended normal costing Direct-cost rates Actual rates Actual rates Budgeted rates Indirect-cost rates Actual rates Budgeted rates Budgeted rates
5.4 Actual costing x normal costing x extended normal costing Budgeted indirect-cost rates Advantage: they are more timely than actual indirect-cost rates. Actual cost is known until the end of acc.period, budgeted rates of indirect costs can be assigned to individual jobs on an ongoing basis. Disadvantage: they likely will be inaccurate, having been made up to 12 months before actual costs are incurred.
5.4 Actual costing x normal costing x extended normal costing End-of-period adjustments When the indirect costs allocated differ from the actual indirect costs incurred. Underallocated(underapplied, underabsorbed) indirect costs When the allocated amount of indirect costs in an acc.periodis lessthan the actual (incurred) amount in that period. Overallocated(overapplied, overabsorbed) indirect costs When the allocated amount of indirect costs in an acc.periodexceedsthe actual (incurred) amount in that period. Disposal of the difference: - the adjusted allocation rate approach; - the proration approach.
5.4 Actual costing x normal costing x extended normal costing Adjusted allocation rate approach restates all entries by using actual cost rates rather than budgeted rates: 1)actual indirect-cost rate is computed at the end of each period; 2)every job is recomputed using the actual rate = every single job cost recordaccurately represents actual indirect cost incurred. Proration approach spreading of under-or over-allocated overhead among ending inventories and cost of sold product inventories: 1) Proration is based on the total amount of indirect costs allocated in the ending balances of work in process, finished products (goods) and cost of products sold. 2) Proration is based on the total in the ending balancesof work in process, finished products (goods) and cost of products sold. 3) Year-end write-off to cost of products(goods) sold.
5.5 Job costingx Processcosting Job-costing system costs are assigned to a distinct unit, batch, or lot of a product or service. Job is a task for which resources are expended in bringing a distinct product or service to market. The product or service is often custom-made (e.g. audit by an accounting firm). Process costing system -cost of a product or service is obtained by using broad averages to assign costs to masses of similar units. Identical items are massproduced for general sale (e.g. Barbie dolls). Most companies combine elements of both job costing and process costing.
5.5 Job costingx Processcosting Examples: Service sector Merchandising sector Manufacturing sector Job Accounting firms audit Sending a catalog to a Aircraft assembly Advertising company House construction campaign costing used mailing list Special promotion of a new store product Process costing used Deposit processing Postal delivery Grain dealing Processingnew magazine subscription Oil refining Beverages production
5.5 Job costingx Processcosting GENERAL APPROACH TO JOB COSTING (applied in the service, merchandising as well as manufacturing sectors): 1) Identify the job that is the chosen cost object 2) Identify the direct costs for the job 3) Identify the indirect-cost pools associated with the job 4) Select the cost-allocation base to use in allocation each indirect-cost pool to the job 5) Develop the rate per unit of the cost-allocation base used to allocate indirect costs to the job 6) Assignthe costs to the cost object by adding all direct costs and all indirect costs.
5.6 Job costingin serviceorganizations Service sector companies provide: Services; Intangible products. Jobs in service organization: often differ considerably in terms of their length, complexity, and resources used. (e.g. repair of an equipment, audit engagement, making of movie, university research project for government agency, )
5.6 Job costingin serviceorganizations EXAMPLE Job costing overview of an auditing company 1) Identify the job that is the chosen cost object: annual audit of financial statement XYZ,Ltd. 2) Identify the direct costs for the job: professional labour 3) Identify the indirect-cost pools associated with the job: audit support (e.g. general audit, secretarial support, ) 4) Select the cost-allocation base to use in allocation each indirectcost pool to the job: professional labour-hours 5) Develop the rate per unit of the cost-allocation base used to allocate indirect costs to the job 6) Assign the costs to the cost object by adding all direct costs and all indirect costs.
5.6 Job costingin serviceorganizations Job costing overview of a company, which provides independent auditing for accounting firms INDIRECT COST POOL Auditing Support INDIRECT COST- ALLOCATION BASE COST OBJECT: job of auditing Professional labour-hours Indirect costs Direct costs DIRECT COSTS Professional labour
5.7 Job costing in manufacturing Are more detailed than those in the service and merchandising sector: production process in manufacturing is more complex, i.e.: manufacturers convert material into work in process and then into finished products (contrasting with service and merchandising firms: they provide their customers with service and merchandise that have not been significantly altered from their input).
5.7 Job costing in manufacturing Transaction in manufacturing sector Purchases of materials and other manuf.inputs Conversion into work in process Conversion into finished products Sale of finished products Transaction in merchandising sector Purchases of merchandise Sale of merchandise
5.7 Job costing in manufacturing EXAMPLE Job costing overview of a company, which manufactures specialized machinery for the paper-making industry (using normal costing method ) 1) Identify the job that is the chosen cost object: PULP MACHINE MANUFACTURED FOR THE PAPER COMPANY, Ltd. 2) Identify the direct costs for the job: 2 DIRECT MANUFACTURING COST CATEGORIES DIRECT MATERIAL and DIRECT MANUFACTURING LABOUR. 3) Identify the indirect-cost pools associated with the job: MANUFACTURING OVERHEAD (i.e. A SINGLE INDIRECT MANUFACTURING COST POOL : INDIRECT COSTS OF THE MANUFACTURING DEPARTMENT SUCH AS depreciation on equipment, energy costs, indirect materials, and indirect manufacturing labour and salaries).
5.7 Job costing in manufacturing EXAMPLE Job costing overview of a company, which manufactures specialized machinery for the paper-making industry (using normal costing method ) 4) Select the cost-allocation base to use in allocation each indirect-cost pool to the job: MACHINE-HOURS 5) Develop the rate per unit of the cost-allocation base used to allocate indirect costs to the job: e.g., when budgeted manufacturing overhead costs to be 1,280,000 and quantity of machine-hours as 16,000, budgeted indirect-cost rate for manufacturing overhead is 80 PER MACHINE-HOUR. 6) Assign the costs to the cost object by adding all direct costs and all indirect costs.
5.7 Job costing in manufacturing Job costing overview of a company, which manufactures specialized machinery (using normal costing method ) INDIRECT COST POOL Manufacturing overhead COST-ALLOCATION BASE COST OBJECT: SPECIALIZED MACHINERY Machine-hours Indirect costs Direct costs DIRECT COSTS Direct materials Direct manufacturing labour
5.7 Job costing in manufacturing Job-costing system in manufacturing company is used to help: Manage costs in manufacturing department Determine the cost of individual jobs Direct materials Direct cost tracing : Directmanuf. labour Depreciation of P&E Energy costs Direct cost tracing : Indirect cost allocation Manufacture of specialized machinery Indirect manuf.labour Other indirect manuf.costs Manufacturing department