ADDITIONAL ASPECT OF PRODUCT COSTING SYSTEM

Job Order or Process Costing

Job Order Small quantities Batches of identifiable, tailormade products User-specific services Tracks costs by job

Process Large quantities Homogeneous goods Tracks costs by batch of goods by department

Job Order Costing A job is a single unit or group of units identifiable as being produced to distinct customer specifications A job can be a Client Engagement Project Contract

Methods of Product Costing Cost Accumulation System defines Cost object. Method of assigning costs to production.

 Valuation Method specifies How product costs will be measured?

Job Order Costing System Each job is a cost object Costs are accumulated for each job A job can consist of one or more units of output There is a subsidiary ledger for each job

WIP Subsidiary Ledger

Material Requisition Form Tracks who is responsible for materials Verifies flow of materials from warehouse to department to job

Job Order Cost Sheet All financial information about a job direct material (from material requisition) direct labor (from time sheets or labor tickets) applied overhead budgeted cost information When job is complete, use job order cost sheet to analyze actual costs compared to budgeted costs

Standard Cost System Actual cost Normal cost Standard cost Predetermined norms (or standards) for materials, labor, and overhead Compare actual costs to standard costs - difference is a variance

Management Use of Job Order Costing Systems Estimate future job costs Establish realistic bids and selling prices Develop budgets and standards Compare actual costs to estimated costs Furnish performance evaluation information based on profitability of jobs

Differences Absorption costing Fixed manufacturing overhead is a product cost Variable costing Fixed manufacturing overhead is a period cost Variable operating expenses are subtracted from product contribution margin to equal contribution margin

Predetermined Overhead Rate Allows overhead to be assigned during the period, fulfilling the matching principle Adjusts for variations not related to activity Compensates for fluctuations in activity level that do not affect fixed overhead Allows managers to be aware of product, product line, customer, and vendor profitability

The Activity Level (The Denominator) Relationship between the overhead cost and the activity production volume direct labor hours direct labor cost machine hours number of purchase orders or parts machine setups material handling time

Plantwide vs. Departmental Predetermined Overhead Rates Plantwide Overhead Rate Homogeneous activities throughout plant Departmental Overhead Rate Different types of work effort in departments Diverse material requiring different times in departments Usually provides better information for planning, control, and decision making

Activity-Based Management Focuses on activities during production and performance process Improves the value received by customers Enhances profitability

An activity is a repetitive action performed in fulfillment of a business function

Activity-Based Management 1. Activity analysis 2. Cost driver analysis 3. Activity-based costing 4. Continuous improvement 5. Operational control 6. Quality management 7. Business process improvement 8. Performance measurement

Activity Based Management External Benefits Increased customer value Enhanced profitability Internal Benefits More efficient production More accurate cost determination More effective performance evaluation

Activity Analysis

Value-added activity Increases worth of product or service to a customer Customer is willing to pay for it

Non-value-added activity Increases time spent on product or service but does not increase worth Unnecessary from customer perspective Can be reduced, redesigned or eliminated without affecting market value or quality Business-value-added activities are essential

Cost Driver Analysis Cost drivers are factors that have a direct cause-effect relationship to a cost Limit the number of cost drivers Cost of measurement should not exceed benefit of using the cost driver Easy to understand Directly related to activity being performed Appropriate for measurement

1. Unit-level costs - direct material, direct labor. 2. Batch-level costs - setup, inspection. 3. Product/process-level costs - engineering changes, product development 4. Organizational or facility costs - building depreciation, plant managers salary

Activity-Based Costing Recognizes several levels of costs Accumulates costs into related cost pools Uses multiple cost drivers to assign costs to products and services

Two-Step Allocation Collect costs in general ledger and subsidiary accounts Identify activity centers Accumulate costs into activity center cost pools cost drivers Allocate costs to products and services activity driver measures demands placed on activities, thus, the resources consumed by products/services

Traditional vs. ABC Costing When ABC is implemented Cost is reduced for high volume, standard products Cost is increased for low-volume, complex specialty products

Use ABC Costing for.

1. Product Variety and Process Complexity Caused by mass customization Too many choices, opportunity for errors Pareto Principle Commonality of parts Reduced by Simultaneous (or Concurrent) Engineering Design for Manufacturability 2. Lack of Commonality in Overhead Costs Some products/services use substantially more overhead

than others 3. Problems with Current Cost Allocations Significant changes in process with no change in cost

allocations - Expense majority of period costs when incurred 4. Changes in Business Environment - Increase in competition - Change in management strategy