Lecture 2

Job Costing is used for costing specific job orders from customers. It is used in those manufacturing situation where many different products, jobs or batches of production are being produced. Each product or Job is different from all others and require a separate accumulation of cost traceable to each job. Production Overhead You will recall that overheads are those cost which cannot be traced directly to a cost object. Under the traditional costing method, production overheads are absorbed based on the overhead absorption rate (OAR). Manufacturing overhead is charged to production on a predetermined basis. We develop a predetermined overhead rate. This is an estimate of the amount of overhead cost per unit of production activity that will prevail during a period. The rate is established at the beginning of the period based on estimates of what actual manufacturing overhead cost will be for the period and on estimates of what level of production activity will prevail during the period. We calculate the overhead rates for each production department by dividing the estimated amount of overhead cost by estimated level of activity. Production activity is generally expressed in term of DLH, DLC or Machine Hours. Example Wright Wood Products has two production departments: Cutting and Assembly. The Company has been using a single predetermined cost driver rate based on plantwide direct labour hours DLH. That is the plantwide cost driver rate is computed by diving plantwide support costs by total plantwide direct labour hours. The estimates for support costs and quantities to cost driver for 2003 follows Manufacturing support Direct Labour Hours Machine Hours Cutting $25,000 1,000 4,000 Assembly $35,000 3,000 2,000 Total $60,000 4,000 6,000

a) What is the single plantwide cost driver rate at 2003 b) Determine departmental cost driver rates based on direct labour hours for assembly and machine hours for cutting. Ans Estimated overhead cost = 600,000 Estimated level of activity = 4000

a) Manufacturing Support 60000/4000 = 15 per DLH b) Cutting 25000/4000 = 6.25 per Machine Hour Assembly 35000/3000 = 11.67 per DLH Cost Allocation vs Cost Apportionment Cost allocation refers to the situation where the whole of a cost, that is without splitting or separation is given or allocated in full to a cost centre. For example maintenance costs to the maintenance department. Cost apportionment, on the other hand, is the process of sharing common costs among cost centres on some equitable basis, some basis that reflects the benefits received such as rent and rates shared on the basis of floor area, canteen cost shared on the basis of the number of employees and insurance shared on the basis of value of the machine. OVERHEADS

Floor Area

Labour Hrs

# of Employees

COST CENTRES

A comprehensive problem in calculating the OAR, Cost Allocation and Cost Apportionment. Jamdown Garment Manufacture Ltd. has four departments in its production function. Cutting Dept., Assembly Dept., Packing Dept., which are production depts..and the maintenance department, a service department. The actual production overheads incurred in the month are given below. $ Maintenance wages 1,510 Canteen expenditure 2,400 Rent 2,500 Depreciation 1,200 Electricity 5,200

There is also the following additional information: Cutting Dept Floor Area(M2) # of Employees Val of Machinery Machine capacity In Voltage We want to: 1. Apportion the overhead cost to the departments using the most logical methods. The maintenance department costs are to be shared equally among the production departments. 2. Calculate the overhead absorption rates, given that the following hours were worked in production: Cutting Department Assembly Department Packing Department Production Overhead Miant Wages Canteen Expend. Rent Basis of Apportion Cutting Dept. 250 hours 200 hours 222 hours Assembly Dept. 1000 750 600 2400 4750 820 5570 Packaging Dept. 400 500 100 400 1400 820 220\20 Maintenance Total Dept 1510 1510 200 250 100 400 2460 (2,460) 0 2400 2500 1200 5200 12810 2000 40 40000 10000 Assembly Dept 1500 50 60000 12000 Packing Dept 1000 20 10000 2000 Maintenance Dept 500 10 10000 2000

# of 800 Employees Floor Area 1000 400 2000 4200 820 5020

Depreciation Val of Machine Electricity Machine Capacity Sub-total Apportion of Maintenance Total

1. Calculate the OAR Overhead cost / Level of Activity Cutting 5020/250 = 20.08 per hour Assembly 5570/200= 27.85 per hour Packaging 2200/222= 10.00 per hour Notice that the maintenance department is a service department and so the total cost of that department, (2460) were re-apportioned to the production department. There are situation in which there are more than one service department and the cost of these service departments. There are two methods of allocating these service departments 1. Direct Method 2. Sequential Method In the direct method , all cost are allocated directly to the production department In the sequential method service department are charged to other service department as well as production department. Example. Cooper Company has two service departments and two production departments. Information on annual manufacturing support costs and cost drivers follows: Service Departments S1 S2 65000 55000 2000 1500 800 1200 Production Department P1 P2 160000 240000 2000 3000 2400 2600

Support Cost Direct Labour Hours Number of Square feet

The company allocates service department cost using the sequential method. First, S1 costs are allocated based on direct labour hours. Next, S2 cost are allocated based on square footage. The square footage for S1 is assumed to be zero for this purpose. Determine the total support costs allocated to each of the two production departments. First let us look at the Direct Method, even though the question did not ask for this method to bee done. Direct Method Basis Support Cost 240000 Alloc of S1 39000 Alloc of S2 28600 DLH Square ft S1 65000 (65000) (55000) S2 55000 P1 160000 26000 26400 P2

Total 307600

212400

Workings for S1 allocations DLH for P1 and P2 = 2000 + 3000=5000 Allocate to P1 2000/5000 * 65000 = 26000 Allocate to P2 3000/5000 * 65000 = 39000 Workings for S2 # of Square Feet for P1 ans P2 = 2400+2600=5000 Allocate to P1 2400/5000 *55000 = 26400 Allocate to P2 2600/5000 * 55000= 28600 Sequential Method Basis Support Cost 240000 Alloc of S1 Alloc of S2 Total 306400 DLH Square ft 0 S1 65000 (65000) S2 55000 15000 (70000) 0 P1 160000 20000 33600 213600 P2 30000 36400

Working for S1 Allocation to P1, P2 and S2 DLH = 1500+2000+3000=6500 Allocate to S2 1500/6500 * 65000 = 15000 P1 2000/6500*65000=20000 P2 3000/6500*6500=30000 Working for S2 Allocate to P1 P2 Square feet = 2400+2600=5000 Allocate P1 2400/5000*70000=33600 P2 2600/5000*70000=36400

Notice that only S1 is allocated to S2 but S2 is not allocated to S1. There is a method known as the reciprocal method that will allow this but this is outside the scope of this syllabus. Now thy on your own San Miguel Company has two production departments, Assembly and Finishing, and two service departments, machine setup and inspection. Machine setup cost are allocated on the basis of number of setups, while inspection cost are allocated on the basis of number of direct labour hours. Selected information on the four departments follows Items Machine Setup Inspection Assembly Finishing Direct Cost 40000 15000 25000 20000 Number of Setups 0 0 300 100 Direct Labour Hrs 0 0 200 500

Using the Direct method determine the costs to be allocated to each production Department. Ans. Basis Direct Cost Alloc of machine Alloc of Inspection Total setup DLH Machine 40000 (40000) 0 Inspection 15000 (15000) 0 Assembly 25000 30000 4286 59286 Finish 20000 10000 10714 40714