ACCT431 Spring 2006

Chapter 3 DeGeorge

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Cost Accumulation for Job/Shop and Batch Production Operations

Different types of operations lend themselves to different Cost Systems Job-Order Costing each job/product/order is unique and costs are captured at the job level. (Think big items or service) Process Costing the process creates large quantities of products that are relatively homogeneous and indistinguishable from one another. (Think fluid) Operations Costing hybrid of Job-Order and Process Costing (think batches). Regardless of the operating process and therefore the specific costing system, absorption costing seeks to assign ALL production costs incurred during a particular period to the jobs or products produced during that time period.

For Absorption Costing all manufacturing costs are either direct or indirect Direct Costs are production costs that can be (and are) specifically identified to a particular job or product. Indirect Costs (or manufacturing overhead) are all production costs that are not direct costs. Indirect costs must be allocated to products. By its very nature, the allocation of indirect costs to specific jobs/products, causes errors. If a cost could be directly assigned to a product it would not be an indirect cost. Allocation is a necessary evil. MINIMIZE IT.

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Allocating Indirect Costs Cost Driver Must be common to all allocation targets (jobs/products) Should cause the indirect cost Common cost drivers: Direct Labor Dollars Machine Hours Direct Labor Hours Direct Material Burden Rate = Total Costs to be allocated Total actual cost driver To apply overhead to a job: Actual job specific cost driver X Burden Rate Overhead to be applied See basic allocation spreadsheet. Plant-wide versus departmental burden rates If overhead varies from department to department (rates or drivers) and overhead is significant, departmental burden rates may result in a more accurate allocation of overhead. See Plant-wide versus departmental spreadsheet. Predetermined Burden Rates The actual burden rate for a period will not be known until after an accounting period is over. CEOs (and good cost managers) dont like to wait until after the period is over to know how we are doing. Accordingly, cost systems estimate overhead during an accounting period by applying overhead to jobs using a predetermined rate. Predetermined Overhead Rate = Total Estimated Overhead Costs Total Estimated Cost Drivers Applied Overhead = Actual job specific cost driver X Predetermined Overhead Rate At the end of a period, there will be a difference between the actual total overhead and the applied overhead. This difference must be assigned to the jobs/product produced during the period. Unfortunately, at the end of the period, some of this product is in WIP, some is in FG and some is in COGS. The author, and many companies, allocates this unapplied allocation in proportion to the preliminary balances of WIP, FG and COGS. DeGeorge is not real wild about this. See predetermined overhead spreadsheet

ACCT431 Spring 2006

Chapter 3 DeGeorge

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Did I mention that allocation is a necessary evil? Minimize it! Recording Inventory Activity The author does a very nice job depicting the flow of production costs through the four inventory accounts to arrive at COGS. Debits Credits Raw Material Inventory Beginning Balance Direct Material to WIP RM Purchases Indirect Material to Mnfg. Overhead Manufacturing Overhead (Temporary Account no beginning or ending) Indirect Costs Including Indirect Mtrl And Indirect Labor Applied Overhead to WIP Inventory Over-applied AJE Under-applied AJE WIP Inventory Beginning Balance Direct Material from RM Direct Labor Applied Overhead from Mnfg. Overhead Under-applied AJE Finished Goods Inventory Beginning Balance COGM from WIP Under-Applied AJE Cost of Goods Sold COGS from FG Under-Applied AJE

COGM to FG Inventory Over-Applied AJE

COGS to COGS Over-Applied AJE

Over-Applied AJE

However, please note that much of these entries are generated not from third party transactions, but rather through transfers captured and identified by the costing system. Also notice that actual costs incurred get lost in the ledger detail. Knowing that COGS MUST = Beg Inv + Costs Incurred Ending Inventory DeGeorge suggests that you can run all of your costs to COGS and simply record the change in inventory as an adjusting entry. Your costing system is already doing the work that you need it to do. Every journal entry that you prepare and post has at least eight opportunities for errors. Think about it; and just like allocation, minimize it.