Final Paper Accounting 206
ready2learn
acc206_chapter_04.pdf
chapter 4
Costing Methods
Learning Objectives
• Understand the ethical duty of managerial accountants to provide proper costing information.
• Apply concepts and techniques that are used to fairly measure and report job costs.
• Be able to track job costs, including overhead, through a typical accounting system.
• Understand alternative costing concepts, such as process costing and activity-based costing.
istockphoto
waL80281_04_c04_083-112.indd 1 9/25/12 1:02 PM
84
CHAPTER 4Chapter Outline
Chapter Outline
4.1 Job Costing Job Costing and the Ledger Actual Overhead Differences Between Actual and Applied Overhead Mandatory Reporting of Overhead Job Costing Is Not Only for Manufacturing
4.2 Process Costing Environments Cost of Production Report Case Study in Process Costing
4.3 Activity-Based Costing ABC Modeling ABC Example
What is the cost of producing a product or service? To the untrained accountant, this question seems simple enough. But, the more you learn about accounting, the more difficult this question becomes to answer. How does one identify all of the necessary ele- ments that are needed to produce an output? The answer to this question necessarily includes direct material and direct labor. But you are also very familiar with other factory and nonfactory-related costs that must be incurred before a product may be produced. Typically, accountants will devise schemes by which costs are captured and assigned to products. When an accountant reports on the cost of a product or service, he or she is really reporting on measurements based on systematic processes for cost assignment.
Accountants should not be flippant in developing their costing procedures. Key busi- ness decisions that impact the allocation of business resources, and ultimately peoples’ livelihoods, are at stake. As such, accountants have a high ethical duty to develop and correctly deploy fair and defensible models for product costing. This chapter provides insight into costing techniques that offer general acceptability in arriving at an answer to the all-important question about the cost of a product or service.
Several methods can be used for costing purposes. They are somewhat dependent on the nature of the product that is being produced and/or the process by which production occurs. One such method is job costing, which is best suited to those situations in which goods and services are produced upon receipt of a customer order, according to customer specifications, or in separate batches. For example, a home builder would likely accumulate costs for each unique house that it produces. Materials and labor can be readily identified with each house, and the costing method will accumulate costs accordingly. In contrast, process costing captures costs for each process or department. It is applicable to homog- enous goods that are produced in batches or continuous processes. An example is the pro- duction of candy. Candy might be produced in stages such as mixing, cutting, and cooking. Within the mixing department, the cost of all ingredients and labor is accumulated and divided across the total pounds of finished goods to find a per-pound (or other measure) cost for the mixed material. Similar cost assignment processes are followed within each department to arrive at the cost of a final box of candy. The bulk of the remainder of this chapter will introduce you to the key components in job and process costing techniques.
waL80281_04_c04_083-112.indd 2 9/25/12 1:02 PM
85
CHAPTER 4Section 4.1 Job Costing
Accountants have long thought about costing methods and have challenged the basic assumptions on which costing decisions are made. There is considerable literature on this subject, and alternative models have been proposed. One model that has a strong group of proponents is activity-based costing. This chapter will close with a brief introduction to this alternative approach to answering questions about what a product or service costs.
4.1 Job Costing
Job costing entails the development of a tracking system or database by which costs are matched to jobs. This generally entails specifically identifying the amount of direct labor and direct material that is used on a specific job. The other overhead costs are then assigned to a job by reliance on a predetermined overhead allocation formula. One com- mon approach is to take the period’s total anticipated overhead and divide it by the antici- pated labor hours to arrive at an amount of overhead that is expected to be incurred “per labor” (overhead can be applied on other application bases, such as material usage; the goal is to try to closely associate overhead to jobs based on consumption of overhead).
A logical starting point for costing a job is to determine the amount of direct labor that is attributable to a specific job. Employees typically complete reports (via a time card, electronic clock, spreadsheet, etc.) indicating the amount of time they worked. From the employees’ perspective, these time reports are important because they may be used to establish how much they are owed (i.e., how many hours they worked). However, in addi- tion to hours worked, time reports usually have codes to identify the work performed. These codes can be matched to specific tasks on specific jobs, but they will also include time spent on travel, breaks, job setups, and other work-related tasks that do not track to a specific product that is being produced. By querying the company’s accounting system, it then becomes possible to determine all of the direct labor time that was spent on a specific job. The indirect labor costs not traced to a specific job become part of the overhead cost pool, which is allocated across all jobs using the overhead application rate.
Direct materials are assigned to jobs in a manner very similar to direct labor. It is very important that material that is used on a specific job be matched to the job. Just as employees are expected to maintain time records, they should also complete materials requisition forms. These forms are used to pull raw materials from inventory and transfer them into work in process. A very detailed coding system must be established that allows tracking of material from inventory into a specific job. Sometimes, a materials requisition form will only show inventory by part number and not identify the cost of the material. When this is the case, additional systems must be put in place to subsequently allow the company to identify the cost of the materials. Great care must always be taken to match the right cost to the right item and the right item to the right job. Indirect materials, such as tape, screws, and touch-up paint, are not traced to a specific job. These costs should instead be contemplated in the overhead cost pool that is allocated among all jobs.
Previously, it was mentioned that a predetermined overhead rate is used to assign over- head to a particular job. It has likely already occurred to you that there can be differences between the actual overhead incurred and the amount applied to production via the pre- determined overhead application rate. This difference cannot be ignored indefinitely, and you will soon see how it is to be processed. For the moment, let’s not be concerned with those potential differences and instead focus on a job cost sheet (Exhibit 4.1) that sum- marizes direct labor, direct material, and overhead cost that is applied to a particular job:
waL80281_04_c04_083-112.indd 3 9/25/12 1:02 PM
86
CHAPTER 4Section 4.1 Job Costing
Exhibit 4.1
D ir e ct
L a b o r
S o u rc
e C
o d e
R a te
H o u rs
Q ty
To ta
l To
ta l
C o st
P e r
U n it
Q ty
B a si
s To
ta l
R a te
D ir e ct
M a te
ri a l
A p p lie
d O
ve rh
e a d
To ta
l
N o v.
1 5 , 2 0 X
7
B o b T
h u rm
a n
S u sa
n M
a rk
e y
S te
e l
W h e e ls
N o v.
1 6 , 2 0 X
7
B o b T
h u rm
a n
R a vi
R a jn
a r
N o v.
1 7 , 2 0 X
7
B o b T
h u rm
a n
S u sa
n M
a rk
e y
G la
ss
A p p lie
d O
ve rh
e a d
T im
e C
a rd
# 6 5 7 3
T im
e C
a rd
# 6 9 9 8
M a te
ri a ls
R e q . A
5 6
M a te
ri a ls
R e q . B
1 7
T im
e C
a rd
# 6 5 7 3
T im
e C
a rd
# 7 0 0 2
T im
e C
a rd
# 6 5 7 3
T im
e C
a rd
# 6 9 9 8
M a te
ri a ls
R e q . B
2 4
To ta
ls
8 .0
0
6 .0
0
6 .0
0
8 .0
0
2 .0
0
8 .0
0
3 8 .0
0
$ 1 2
$ 8
$ 1 2
$ 1 5
$ 1 2
$ 1 8
$ 9 6 .0
0
$ 1 0 8 .0
0
$ 7 2 .0
0
$ 1 2 0 .0
0
$ 2 4 .0
0
$ 1 4 4 .0
0
$ 5 6 4 .0
0
4 0 0 lb
s
6 u
n its
2 5 s
q f t
$ 2 .0
0
$ 1 5 .0
0
$ 3 .0
0
$ 8 0 0 .0
0
$ 9 0 .0
0
$ 7 5 .0
0
$ 9 6 5 .0
0
3 8 .0
0 $ 1 1
$ 9
6 .0
0
$ 1
0 8 .0
0
$ 8
0 0 .0
0
$ 9
0 .0
0
$ 7
2 .0
0
$ 1
2 0 .0
0
$ 2
4 .0
0
$ 1
4 4 .0
0
$ 7
5 .0
0
$ 4
1 8 .0
0
$ 1 ,9
4 7 .0
0
$ 4 1 8 .0
0
$ 4 1 8 .0
0
Tu rn
k e y E
n te
rp ri
s e s
J O
B C
O S
T S
H E
E T
L a b o r
H o u rs
waL80281_04_c04_083-112.indd 4 9/25/12 1:02 PM
87
CHAPTER 4Section 4.1 Job Costing
Exhibit 4.1 is quite typical. The direct labor hours are drawn from the employee time cards and associated with each employee’s wage rate. The direct materials are drawn from the materials requisition forms (or similar documents) and associated with the cost of specific inventory items, and the overhead is applied based on the predetermined rates.
Be aware that technology can greatly facilitate preparation of job cost sheets. For instance, materials can be automatically tracked to jobs by scanners and radio frequency identifica- tion chips. Furthermore, the job cost sheet is really just a compilation of data into a use- ful report format. The data may be mined from within a sophisticated database. Beyond this summarized data, you also need to recognize that information must be captured by a company’s general ledger system and lead to the preparation of aggregated data for reporting purposes.
Job Costing and the Ledger
The data, which are foundational for the preceding job cost sheet, must also be transferred to a company’s general ledger system. A robust information system will do this quite easily and automatically. However, it is necessary for you to see the debit/credit process to fully comprehend the cost flow through an accounting system and into the resulting financial statements.
Let’s begin by considering the cost flows for the various factors of production. The typical sequence of steps for direct materials entails the purchase of raw materials from a sup- plier, a transfer of raw materials into work in process as production occurs, the transfer of the cost of completed goods into finished goods inventory, and finally the transfer of inventory to cost of goods sold when products are sold and delivered to a customer. Direct labor is slightly simpler because the first step is essentially not applicable. As wages are incurred, those costs are accumulated straight into Work in Process. Upon completion, the labor cost is transferred to Finished Goods Inventory and then on to Cost of Goods Sold at the time of sale. The factory overhead items, such as factory depreciation, main- tenance, supplies, indirect labor, and indirect material, are not directly added to Work in Process. Instead, these costs are introduced into Work in Process based on the predeter- mined application base; if overhead is applied based on labor hours, it may well be that overhead is attached concurrent with direct labor costs. The following entries illustrate the full process for assigning job costs. Carefully review each entry, taking special note of the related journal entry description:
10-1-X2 Raw Materials Inventory 965
Accounts Payable 965
To record purchase of materials, placing costs into raw materials inventory
10-15-X2 Work in Process Inventory 1,947
Raw Materials Inventory 965
Salaries Payable 564
Factory Overhead 418
To transfer raw materials to production, record direct labor costs on job, and apply overhead at the predetermined rate of $11 per direct labor hour
waL80281_04_c04_083-112.indd 5 9/25/12 1:02 PM
88
CHAPTER 4Section 4.1 Job Costing
10-24-X2 Finished Goods Inventory 1,947
Work in Process Inventory 1,947
To transfer total cost of a completed unit to finished goods inventory
10-28-X2 Accounts Receivable 2,500
Sales 2,500
To record sale of finished for $2,500
Cost of Goods Sold 1,947
Finished Goods Inventory 1,947
To remove cost of sold unit from the finished goods inventory
Actual Overhead
Students are sometimes slightly confused by their first exposure to the accounting for factory overhead. In previous chapters, you saw how salaries, utilities, depreciation, the consumption of supplies, and similar costs were charged (i.e., debited) directly to vari- ous expense accounts. The accounting for these types of costs in a manufacturing envi- ronment now gets a slight twist. In the preceding entries, we credited an account titled “Factory Overhead” for the allocated amount of overhead cost. What is the nature of this overhead account? It clearly is not Cash, Accounts Payable, or some other familiar account that would ordinarily be related to an expenditure. Instead, it is a unique account that is used to accumulate and allocate the actual overhead costs. The credit you witnessed was the allocation effect. The accumulation of the actual costs results in a debit to Factory Overhead as follows:
10-XX-X2 Factory Overhead 450
Salaries Payable 150
Supplies 75
Accumulated Depreciation 100
Utilities Payable 125
To record actual factory overhead costs
The previous credits are those customarily associated with incurring salaries, using sup- plies, recording depreciation, and utilizing utilities. However, instead of debiting the cus- tomary expense accounts, the costs are charged to Factory Overhead. The net result of this process is to debit Factory Overhead for the actual costs incurred and credit Factory Over- head as these costs are allocated to Work in Process (which eventually gets transferred to expense as Cost of Goods Sold as shown via the preceding entries). You may be wonder- ing what happens if the amount of overhead actually incurred differs from the amount allocated, and that question is answered in the following discussion.
waL80281_04_c04_083-112.indd 6 9/25/12 1:03 PM
89
CHAPTER 4Section 4.1 Job Costing
Differences Between Actual and Applied Overhead
An actual company would, of course, have many jobs in process, so the preceding journal entries for only one job present a very simple picture of costs flows within the organiza- tion. Nevertheless, it is a realistic portrait. Notice that assigned costs totaled $1,947 (pro- ducing a $553 profit: $2,500 sales price 2 $1,947 of goods sold), including allocated over- head of $418. However, the actual overhead was $450. The fact that actual overhead was more than the amount assigned to production represents underapplied overhead. This is indicative of an unfavorable outcome. More was actually spent than was anticipated based on the application rate. This amount cannot be ignored. Based on the previous journal entries, the Factory Overhead account contains a net debit of $32 ($450 in debits and $418 in credits). Accountants dispose of this balance by one of several processes. A popular approach is to adjust cost of goods sold as follows:
10-31-X2 Cost of Goods Sold 32
Factory Overhead 32
To transfer underapplied overhead to cost of goods sold
This entry causes an increase in cost of goods sold for the excess overhead spending. Alternative methods for clearing the Factory Overhead account are usually covered in advanced accounting classes. What is most important for you to note at this time is that the Factory Overhead is indeed zeroed out. It is not a financial statement account. Rather, it is a temporary account for accumulating and transferring overhead costs into produc- tion. If applied overhead had exceeded the actual amount, overhead would have been overapplied. Overapplied overhead would be cleared in just the opposite manner of that illustrated for underapplied overhead.
Mandatory Reporting of Overhead
Although managerial accounting information is generally viewed as for internal use only, be mindful that many manufacturing companies do prepare external financial statements. Also, generally accepted accounting principles (GAAP) dictate the form and content of those reports. GAAP requires that underapplied overhead relating to idle facilities, wasted material, the allocation of fixed production overhead, and so forth be charged to current period income by means similar to those just illustrated.
Job Costing Is Not Only for Manufacturing
Most textbook illustrations tend to demonstrate job costing in the context of a product- manufacturing scenario. However, at least in the United States, most employees now work in the service sector. This includes the fields of accounting, sales, law, food service, elec- tronic information, and transportation. In addition, the not-for-profit and governmental sectors are significant components of the economy. Activities relate to education, health care, fire protection, law enforcement, transportation, human services, and the like. The idea of a “job” can easily be expanded from a tangible product to a particular activity. In health care, a job could be a surgical procedure. In accounting, a job could be preparation
waL80281_04_c04_083-112.indd 7 9/25/12 1:03 PM
90
CHAPTER 4Section 4.2 Process Costing Environments
of a tax return. In education, a job could be a particular course. Measuring the cost of this output is equally important, and the job costing techniques remain fully applicable. For example, an architectural firm would likely track time (direct labor) devoted to each design. Direct materials can relate to printing of blueprints. Overhead allocations can become substantial, including the office costs, computers, software, and so forth. Success- ful management of a service-related entity requires careful attention to costing informa- tion. As you can imagine, it is easy to underestimate the full cost of providing services to customers; it is ultimately necessary to recover not only direct labor but also the other significant costs of operations.
4.2 Process Costing Environments
Sometimes job costing techniques simply do not apply. Production may instead involve a continuous flow of raw materials through production departments. The output is not identifiable as discrete jobs. Rather, output consists of a homogenous product. Paint, petroleum distillates, paper products, steel, glass, and many other products display such attributes. It becomes virtually impossible to match direct labor and direct material to a particular gallon, pound, square foot, or other measure of final output. Nevertheless, it is vitally important for management to be able to assess the cost of production. Companies facing this challenge often turn to process costing. Process costing allocates the total cost of production across all units of output. This usually entails accumulation of costs for each stage (or department) of production and assigning those costs to all output from that stage.
Process costing has certain attributes in common with job costing. Material, labor, and fac- tory overhead are all still assigned to work in process, and they are eventually transferred on to finished goods and then to cost of goods sold. In this respect, the journal entries are quite like those applicable to job costing. The main difference between job costing and process costing is that process costing captures costs by process or department rather than by specific job. If you consider a candy factory, three departments define the basic processes: mixing ingredients, cutting the ingredients into bite-sized pieces, and cooking. A separate Work in Process account will likely be used for each department.
The Work in Process account for the mixing department will capture (i.e., be debited) the aggregate amount of direct material, direct labor, and allocated factory overhead incurred during a period. The accounts utilized in this entry would appear like the October 15 entry that was used for the job costing illustration. Assuming a weighted-average cost assumption (in contrast to FIFO or some other technique), the total dollar amount accu- mulated in this account would be divided by the total production (this could be pounds or some other measure) to find per-unit cost (e.g., dollars per pound). The per-unit cost can then be used to allocate cost between goods still in process and those that were completed and transferred to the cutting department. The journal entry to reflect a transfer out of cost from the mixing department to the cutting department would appear as follows:
waL80281_04_c04_083-112.indd 8 9/25/12 1:03 PM
91
CHAPTER 4Section 4.2 Process Costing Environments
10-30-X2 Work in Process Inventory 2 Cutting 50,000
Work in Process Inv. 2 Mixing 50,000
To transfer cost assigned to completed pounds of mixed candy to the cutting department
The cutting department’s Work in Process account would therefore include the direct material, direct labor, and factory overhead generated directly within that department and also the carried forward cost from the preceding mixing department. A similar pro- cess would be used to transfer work completed by the cutting department to the cooking department. At the end of the production process, the Work in Process account of the final stage (cooking) would be cleared of the accumulated costs by a transfer of those costs to finished goods inventory. This entry would be just as the October 24 entry for the job cost- ing example. By carefully following this approach, the finished goods inventory will have completely captured the costs of production generated within each department.
Cost of Production Report
When process costing methods are used, management of each department will likely receive a cost of production report for each period. This report is very similar in purpose to a job cost sheet. It details the amount of direct material, direct labor, and factory overhead incurred by the department (rather than by job as with a job cost sheet). It then shows how those costs were allocated to total production and provides supporting documentation for the journal entries that were used to transfer costs to successive departments.
To understand a cost of production report requires the introduction of one new dimen- sion, that of equivalent units. An equivalent unit is a physical unit expressed in terms of a finished unit. This is a relatively simple concept. As an example, assume that 100 pounds of candy was 40% complete within a particular department. This is assumed to be equivalent to the production of 40 pounds (100 pounds 3 40% complete). Although none of the 100 pounds is complete, we can abstractly say that we produced the equiva- lent of 40 pounds.
The concept of equivalent units is exceedingly important to grasp. It is rare that a com- pany will not have goods in production at the end of an accounting period. Accounting periods end on regular intervals, but there is no compelling business reason to cease pro- duction with the flip of a page on a calendar. Indeed, many production processes are dif- ficult to stop and restart effectively (e.g., heating a kiln). It is better to keep the production flow going. Thus, it is frequently necessary for managerial accountants to estimate the equivalent units under production. As you examine the example cost of production report that follows, you will see how this concept comes into play.
The following example shows a simplified cost of production report for one department for 1 month. As you inspect this report, take special note that the ending work in process was assumed to be 40% complete. This report shows that of the total cost of $1,500,000, $1,250,000 was transferred to the next department, and $250,000 remained in work in pro- cess at the end of the month.
waL80281_04_c04_083-112.indd 9 9/25/12 1:03 PM
92
CHAPTER 4Section 4.2 Process Costing Environments
SWEET CANDY COMPANY Cost of Production Report for Mixing Department
for the Month of October 20XX
Total Pounds
Percent Complete
Equivalent Units
Transferred to Cutting Department 500,000 100% 500,000
In production at end of month 250,000 40% 100,000
Total equivalent units for the month
600,000
Cost Calculations
Cost of beginning inventory $ 400,000
Additional costs during the month 1,100,000
Total costs to account for $1,500,000
Equivalent units from above ÷ 600,000
Per unit cost $ 2.50
Equivalent Units
Per Unit Cost
Cost Assignment
Total pounds transferred to Cutting Department
500,000 $2.50 $1,250,000
Equivalent units in ending work in process
100,000 $2.50 250,000
600,000 $1,500,000
The preceding cost of production report was simplified by an assumption that materials, labor, and overhead were all introduced into production uniformly. If you study more advanced cost accounting courses, you will learn how to account for scenarios where that assumption is violated. Essentially, it becomes necessary to separate the cost of materials, labor, and overhead so that you derive separate costs per equivalent for each component.
waL80281_04_c04_083-112.indd 10 9/25/12 1:03 PM
93
CHAPTER 4Section 4.2 Process Costing Environments
Case Study in Process Costing
To further illustrate process costing, let’s focus on a comprehensive case study. Yum Gum produces chewing gum in a three-step process consisting of (a) blending ingredients, (b) cooking, and (c) cutting and packing. Each process involves a uniform incurrence and introduction of materials, labor, and overhead. Following are cost of production reports for each of the three departments for August. The amounts are all assumed, but do take note of how costs transferred out of one department are received into the next department.
YUM GUM Cost of Production Report for Blending Department
for the Month of August
Total Pounds
Percent Complete
Equivalent Units
Transferred to Cooking Department
300,000 100% 300,000
In production at end of month 100,000 25% 25,000
Total equivalent units for the month
325,000
Cost Calculations
Cost of beginning inventory $ 80,000
Additional costs during the month 570,000
Total costs to account for $650,000
Equivalent units from above ÷ 325,000
Per unit cost $2.00
Equivalent Units
Per Unit Cost
Cost Assignment
Total pounds transferred to Cutting Department
300,000 $ 2.00 $600,000
Equivalent units in ending work in process
25,000 $ 2.00 50,000
325,000 $ 650,000
waL80281_04_c04_083-112.indd 11 9/25/12 1:03 PM
94
CHAPTER 4Section 4.2 Process Costing Environments
YUM GUM Cost of Production Report for Cooking Department
for the Month of August
Total Pounds
Percent Complete
Equivalent Units
Transferred to Cutting Department 250,000 100% 250,000
In production at end of month 60,000 30% 18,000
Total equivalent units for the month
268,000
Cost Calculations
Cost of beginning inventory $ 35,000
Costs transferred in from Blending Department
600,000
Additional costs during the month 236,000
Total costs to account for $ 871,000
Equivalent units from above ÷ 268,000
Per unit cost $ 3.25
Equivalent Units
Per Unit Cost
Cost Assignment
Total pounds transferred to Cutting Department
250,000 $3.25 $812,500
Equivalent units in ending work in process
18,000 $3.25 58,500
268,000 $871,000
waL80281_04_c04_083-112.indd 12 9/25/12 1:03 PM
95
CHAPTER 4Section 4.2 Process Costing Environments
YUM GUM Cost of Production Report for Cutting Department
for the Month of August
Total Pounds
Percent Complete
Equivalent Units
Transferred to Finished Goods 275,000 100% 275,000
In production at end of month 40,000 60% 24,000
Total equivalent units for the month
299,000
Cost Calculations
Cost of beginning inventory $ 260,000
Additional costs during the month 123,500
Costs transferred in from Cooking Department
812,500
Total costs to account for $1,196,000
Equivalent units from above ÷ 299,000
Per unit cost $ 4.00
Equivalent Units
Per Unit Cost
Cost Assignment
Total pounds transferred to Finished Goods
275,000 $4.00 $1,100,000
Equivalent units in ending work in process
24,000 $4.00 96,000
299,000 $1,196,000
The cost of production report for each department triggers information necessary to sup- port the following journal entries. Be sure to observe the unique entries where costs are handed off from one department to the next.
waL80281_04_c04_083-112.indd 13 9/25/12 1:03 PM
96
CHAPTER 4Section 4.2 Process Costing Environments
Journal entries related to blending:
8-31-XX Work in Process Inventory 2 Blending 570,000
Raw Materials Inventory 190,000
Salaries Payable 190,000
Factory Overhead 190,000
To transfer raw materials to production, record direct labor costs for blending, and apply overhead at the predetermined rate
8-31-XX Work in Process Inventory 2 Cooking 600,000
Work in Process Inventory 2 Blending 600,000
To transfer cost assigned to completed pounds of blended gum to cooking department
Journal entries related to cooking:
8-31-XX Work in Process Inventory 2 Cooking 236,000
Raw Materials Inventory 78,667
Salaries Payable 78,667
Factory Overhead 78,667
To transfer raw materials to production, record direct labor costs for cooking, and apply overhead at the predetermined rate
8-31-XX Work in Process Inventory 2 Cutting 812,500
Work in Process Inventory 2 Cooking 812,500
To transfer cost assigned to completed pounds of cooked gum to cutting department
Journal entries related to cutting:
8-31-XX Work in Process Inventory 2 Cutting 123,500
Raw Materials Inventory 41,167
Salaries Payable 41,167
Factory Overhead 41,167
To transfer raw materials to production, record direct labor costs for cutting, and apply overhead at the predetermined rate
8-31-XX Finished Goods Inventory 1,100,000
Work in Process Inventory 2 Cutting 1,100,000
To transfer cost assigned to completed pounds of cut gum to finished goods
waL80281_04_c04_083-112.indd 14 9/25/12 1:03 PM
97
CHAPTER 4Section 4.3 Activity-Based Costing
This comprehensive example shows how costs are monitored, accumulated, and assigned to finished goods. Bear in mind that the comingling of ingredients and involvement of numerous steps makes it exceedingly difficult to have an intuitive awareness of costs for goods that are produced via continuous processes. Process costing is essential for con- trolling costs and setting pricing in such environments.
4.3 Activity-Based Costing
Both job costing and process costing methods divide costs between product and period costs. As you know, period costs are charged against income as they occur, and they generally relate to selling, general, and administrative (SG&A) activities. In contrast, direct materials, direct labor, and factory overhead are assigned to inventory. One concep- tual shortcoming is that it becomes difficult to fully contemplate the true cost of a finished product. Arguably, the cost of producing a product should sometimes take into account a portion of the organization’s SG&A. For instance, buying raw materials is an adminis- trative task: Why is the cost of this activity not assigned to inventory? Conversely, lawn maintenance for a factory is usually part of factory overhead: Why does the cost of that activity become assigned to inventory when the cost will be incurred no matter how many units are produced?
Activity-based costing (ABC) attempts to overcome deficiencies such as those cited in the preceding paragraph. ABC requires a new mind-set as compared to traditional cost- ing methods. Some companies have embraced ABC, and others see it as too radical of a departure from traditional costing methods. Indeed, ABC is not acceptable for external reporting under GAAP. Thus, companies that implement aspects of ABC typically do so to supplement traditional costing information. ABC is normally for internal use only and is intended to facilitate internal decision-making processes by pinpointing actual (full) production costs more precisely.
ABC requires one to abandon attempts to distinguish product and period costs. Instead, ABC is a costing model that divides production into core cost objects and activities, defines the costs for each, and then allocates activity costs to cost objects based on how much of a particular activity is consumed by the cost object. This results in products absorbing costs of manufacturing and nonmanufacturing activities alike. Conversely, some manufactur- ing costs may not attach to any products. The driving principle of ABC is that a product’s cost is based only on the cost of capacity utilized in producing the product. Unused capac- ity is not assessed or allocated to production.
Remember that traditional costing approaches usually allocate all manufacturing costs (via the overhead application rate), whether related to excess capacity or not, to the inven- tory actually produced. This has the potential to distort the measured cost of production, thereby limiting a manager’s ability to make decisions about pricing and production. As you might suspect, important business decisions are based on assessment of product prof- itability. To the extent a product’s sales price is set by market conditions, and profit is seen as the sales price minus product cost, the determination of a product’s cost becomes criti- cal in deciding on its fate.
waL80281_04_c04_083-112.indd 15 9/25/12 1:03 PM
98
CHAPTER 4Section 4.3 Activity-Based Costing
ABC Modeling
If you think about traditional costing, you will quickly conclude that the cost object is normally a product or service. With ABC, the concept of a cost object is far more expan- sive. Cost objects expand to also include customers, markets, and similarly identifiable items or events that require activity to support. For example, a customer may receive a quarterly visit from a sales representative, no matter the level of purchasing activity. The customer would be a cost object, and activities to support the customer might include an airline ticket, hotel bill, and so forth. These activities have a clear cost that is traceable to the customer (i.e., the cost object) rather than the products produced/sold or period incurred. A business is apt to have many cost objects and hundreds of activities in sup- port thereof. Therefore, the first step in ABC implementation entails a detailed study of processes and costs. This study is usually supported by flowcharts and diagrams, and it may resemble something that looks more like it was developed by an engineer than a managerial accountant.
In linking activities to cost objects, it is important to consider that activities occur at many levels. Some activities occur at the unit level. There is a one-to-one correspondence with a unit of output. Final inspection of each car for an automobile manufacturer is an example. Other activities occur at a batch level. Global shipping of containers is an example; the same amount of effort must be expended to clear customs, regardless of the quantity of individual products within a container. Thus, shipping a container would be a batch-level activity. Other activities occur at much higher levels. Product-level activities include designing a new product. Customer-level activities include developing catalogs and sales calls; in other words, the amount of activity is dependent on the number of custom- ers. Some businesses even identify market-level activities (Asia, Europe, North America, etc.). At the highest level are entity-sustaining activities, such as the cost of a corporate audit. The identification of activities is unique to each company, and considerable study and thought is needed to properly map a company’s activities.
Once all activities and cost objects have been identified, it next becomes necessary to study how the organization’s costs align with activities and objects. Basically, each cost is identified as one of three types. First, some costs are directly traceable to a specific cost object. Direct material is a clear example of a cost that is attributable to the “product” cost object. You are quite familiar with this concept because this piece is the same under traditional costing and ABC. Moving to a less familiar concept, the cost of printing a cata- log would be traced to a “customer” cost object. Once all costs that can be directly traced are determined, the second step is to attempt to allocate remaining costs to specific activi- ties. For some costs, this is very logical. The cost of a new product design team would be allocated to the product-level design activity. At other times, considerable judgment must be applied to make the allocation. Consider the light bill for the office space; perhaps 10% of this amount is for electricity usage within the design department’s space. You can see that ABC quickly entails a degree of complexity. Finally, some costs do not seem to match with any cost object or activity. This third grouping of costs is not assigned to any activity or cost object. The fact that a cost is not assigned to a cost object or activity does not mean that it is to be ignored; it is expensed but should be closely monitored by management.
The final step in ABC requires that the cost of activities be allocated to cost objects. For example, the accumulated cost of the design activity must finally be allocated to cost objects. If three new products were developed, it might be appropriate that the design activity’s total cost be shared one-third by each new product.
waL80281_04_c04_083-112.indd 16 9/25/12 1:03 PM
99
CHAPTER 4Section 4.3 Activity-Based Costing
Exhibit 4.2 is an attempt to recap the overall design of an ABC system:
Exhibit 4.2
ABC Example
Because of its complexity, it is easy to quickly lose sight of the purpose of ABC. ABC is intended to improve measures of cost. By introducing activity cost pools as an interme- diate step for selected costs (rather than allocating every cost directly to a product or period), we are much better able to allocate the costs to end objects (products, customers, etc.). Without activity cost pools, it becomes difficult to connect each cost with final cost objects. A simplified example should prove quite helpful in clarifying how ABC works.
Hong sells three products. Each product generates exactly $1,750,000 in total sales. Two products (A and B) are manufactured internally, and one (C) is outsourced. A and C are sold via direct sales efforts, and B is sold only via a website. For simplicity, assume Hong has only four identifiable activities: manufacturing, direct sales, administration, and web sup- port. The cost of manufacturing ($1,000,000, excluding direct materials and direct labor) is allocated 50% to A and 50% to B. The study of the cost of direct sales ($800,000) revealed that it is attributable 70% to A and 30% to C. Administrative activities ($1,200,000) are found to be consumed 20% by A, 30% by B, and 50% by C. Finally, web support ($100,000) is 100% attributable to B. Let’s assume that there are no costs that cannot be traced to a particular cost object or activity.
ASSIGN COSTS TO ACTIVITIES WHEN NOT TRACEABLE TO COST
OBJECT
ADOPT ALLOCATION SCHEME TO TRANSFER
ACTIVITY COSTS TO COST OBJECTS
CHARGED TO EXPENSE BUT MONITORED
CLOSELY AS PART OF OVERALL FINANCIAL
MANAGEMENT
FINAL COST DETERMINATION FOR
COST OBJECTS
DETERMINE COSTS
STUDY COSTS AND PROCESSES
TRACE COSTS TO COST OBJECTS WHEN POSSIBLE
COSTS THAT ARE NOT TRACEABLE OR ASSIGNABLE
waL80281_04_c04_083-112.indd 17 9/25/12 1:03 PM
100
CHAPTER 4Section 4.3 Activity-Based Costing
Table 4.1 reveals the ABC approach to assessing costs for each final product.
Table 4.1: The ABC approach to assessing costs
Product A Product B Product C
Direct materials and labor (traceable) $500,000 $750,000
Purchase of outsourced product (traceable) $900,000
Manufacturing activity (allocated activity) 500,000 500,000
Direct sales (allocated activity) 560,000 240,000
Administration (allocated activity) 240,000 360,000 600,000
Web support (allocated activity) - 100,000 -
Total cost assignment $1,800,000 $1,710,000 $1,740,000
The costs in the preceding table were either directly traceable to cost object A, B, and C or allocated based on the given percentages. The resulting total cost assignment shows that only products B and C are profitable (remember that each product had total sales of $1,750,000). A traditional costing model would not pinpoint these facts nearly so precisely. Why? The answer is that each product would have a high gross profit (sales minus cost of sales, based only on the traceable and allocated manufacturing costs). Furthermore, sell- ing and administrative costs would be deducted in the aggregate as follows:
Product A Product B Product C Total
Sales $1,750,000 $1,750,000 $1,750,000 $5,250,000
Cost of sales 1,000,000 1,250,000 900,000 3,150,000
Gross profit $750,000 $500,000 $850,000 $2,100,000
Sales (800,000)
Administration (1,200,000)
Web support (100,000)
Net income -
This quite simplified example of ABC is intended to show how alternative costing models can shed additional light on business operations and enable much better decision making. More advanced managerial accounting courses frequently go into ABC in much greater depth. The allocation tables are similar to those given here but will potentially encompass far more cost objectives, activities, and allocation steps. In business, ABC would become almost impossible to implement without modern information systems and software that tracks and allocates complex cost arrays with relative ease.
For now, your coverage of ABC is intended to make you aware of the limitations of traditional costing models and show an alternative thoughtful approach. Even ABC has its critics. It is no better than the processes used to identify activities and allocation
waL80281_04_c04_083-112.indd 18 9/25/12 1:03 PM
101
CHAPTER 4Concept Check
percentages, and these are inherently judgmental. Indeed, this facet of ABC underscores that an ethical manager must provide strong leadership to be sure that whatever cost- ing model is used, it must be thoughtfully designed and implemented. Without strong knowledge and leadership in costing, poor signals will be produced. Poor signals lead to bad decisions and wasted resources. This can be viewed as unethical from the per- spective of failing to discharge appropriate stewardship over company resources.
Concept Check
The five questions that follow relate to several issues raised in the chapter. Test your knowledge of the issues by selecting the best answer. (The correct answers can be found at the end of your text.)
1. Which of the following businesses would be least likely to use a job costing system? a. Automobile repair shop b. Custom home builder c. Crude oil refinery d. Motion picture producer
2. The journal entry to record the use of indirect materials in production activities is a. debit Work in Process; credit Raw Materials. b. debit Factory Overhead; credit Raw Materials. c. debit Raw Materials; credit Work in Process. d. debit Work in Process; credit Factory Overhead.
3. Direct materials, direct labor, and factory overhead applied are initially brought together in which of the following accounts?
a. Work in Process b. Finished Goods c. Cost of Goods Sold d. Income Summary
4. SRT Inc. applies factory overhead on the basis of direct labor cost. The company’s accountant has forecast $180,000 of factory overhead and $200,000 of direct labor for 20X5. Actual factory overhead and direct labor for 20X5 amounted to $185,000 and $210,000, respectively. Overhead for 20X5 is
a. underapplied by $4,000. b. underapplied by $9,000. c. overapplied by $4,000. d. overapplied by $9,000.
5. In today’s modern manufacturing environment, many companies: a. are experiencing a decrease in overhead application rates. b. are experiencing a decrease in factory overhead and an increase in direct labor cost. c. can ignore cost drivers because of a recent pronouncement from the Financial
Accounting Standards Board. d. have a labor component that may be as low as 5% of total product cost.
waL80281_04_c04_083-112.indd 19 9/25/12 1:03 PM
102
CHAPTER 4Critical Thinking Questions
activity-based costing (ABC) A costing method typically reserved for internal use only, which is intended to facilitate internal decision-making processes by pinpointing actual (full) production costs more precisely.
batch level Represents activity regarding a number of similar units.
cost of production report A report that details the amount of direct material, direct labor, and factory overhead incurred by the department and then shows how those costs were allocated to total production and provides supporting documentation for the journal entries that were used to transfer costs to successive departments.
customer-level Represents activity at the customer level, such as developing cata- logs or sales calls.
entity-sustaining Represent the high- est level of activities, such as the cost of a corporate audit.
equivalent unit A physical unit expressed in terms of a finished unit.
job cost sheet A form that summarizes direct labor, direct material, and overhead cost that is applied to a particular job.
job costing Used in situations in which goods and services are produced upon receipt of a customer order, according to customer specifications, or in separate batches.
market-level Market-level activities repre- sent market-oriented actions.
materials requisition A form that is used to pull raw materials from inventory and transfer them into work in process.
process costing Allocates the total cost of production across all units of output and is applicable to homogenous goods that are produced in batches or continuous processes.
product-level Represents high levels of activity, such as designing a new product.
underapplied overhead A figure that results when the actual overhead is more than the amount assigned to production.
unit level Represents a one-to-one corre- spondence with a unit of output.
Key Terms
Critical Thinking Questions
1. Briefly explain several of the problems encountered when trying to compute the actual cost of a good or service.
2. Discuss the general features associated with a job order costing system. In what types of applications are job order systems used?
3. Explain how the flow of costs through an accounting system parallels the flow of goods and materials through a manufacturing plant.
4. Contrast the proper accounting treatments of direct materials and indirect materials. 5. How does the use of a predetermined overhead rate smooth product costs over a
period of time? 6. Explain how an overhead application rate is developed and used to apply over-
head to specific jobs.
waL80281_04_c04_083-112.indd 20 9/25/12 1:03 PM
103
CHAPTER 4Exercises
7. List the characteristics of a good overhead application base. 8. Ritten Company’s factory depreciation for the year just ended totaled $40,000 and
was recorded as follows:
Depreciation Expense 40,000
Accumulated Depreciation: Factory 40,000
Comment on the appropriateness of Ritten’s journal entry.
9. Discuss the relationship between the Work in Process account and individual job cost sheets.
10. If overhead is underapplied, will the Factory Overhead account contain a debit or credit balance? What is the probable effect of the underapplication on the Work in Process balance (before adjustment) at the end of the accounting period?
11. What is probably the most popular application base for overhead? Can this base be criticized in light of today’s manufacturing environment? Briefly explain.
12. List several possible applications of job costing systems by service enterprises. 13. Distinguish between a direct cost and an indirect cost.
Exercises
1. Manufacturing journal entries The following selected transactions and events occurred at Pipeline Manufacturing during March:
Mar. 3 Purchased $10,000 of direct materials and $7,300 of indirect materials on account from Sunbelt Distributors.
7 Issued $3,100 of direct materials and $700 of indirect materials from the storeroom.
14 Incurred $5,600 of direct labor and $3,400 of indirect labor.
17 Recorded $1,300 of overhead incurred on account.
Mar. 20 Applied $2,800 of overhead to production.
23 Noted that $6,200 of production had been completed.
26 Sold goods on account at a profit of 30% of cost. The goods cost
$5,000.
Prepare journal entries to record the preceding transactions and events.
waL80281_04_c04_083-112.indd 21 9/25/12 1:03 PM
104
CHAPTER 4Exercises
2. Analysis of job cost sheet Sumpter Manufacturing began job No. 587 in December 20X6 and recorded mate- rial, labor, and overhead charges of $38,800 through year-end. The bottom portion of page 2 of the job’s cost sheet is reproduced here:
Summary of January charges
Direct materials used $ 12,600
Direct labor (580 hours) 4,350
Factory overhead applied 6,728
Total $ 23,678
Job No. 587 was completed on January 30, 20X7.
a. Determine Sumpter’s overhead application rate, assuming the company uses direct labor hours for an application base.
b. What is the total cost of job No. 587? c. Prepare the journal entries recorded in January related to job No. 587.
3. Cost flows and overhead application Cleveland Metals uses a job cost system and applies factory overhead to produc- tion at a predetermined rate of 180% of direct labor cost. Data pertaining to recent operations follow:
• Job No. 636 was the only job in process on January 1 of the current year. The Work in Process account contained a $24,600 balance on this date.
• Job Nos. 637, 638, and 639 were started during January.
• Total direct material requisitions and direct labor incurred during January amounted to $89,200 and $114,500, respectively.
• The only job that remained in process on January 31 was job No. 638, with costs of $15,000 for direct materials and $20,000 for direct labor.
a. Compute the total cost of the work in process inventory on January 31. b. Compute the cost of jobs completed during January, and present the proper jour-
nal entry to reflect job completion.
4. Job costing and overhead application Uniflex applies overhead on the basis of direct labor cost. In December 20X4, the company’s cost accountant made the following predictions for 20X5 operations: direct labor cost, $620,000; factory overhead, $961,000.
Uniflex worked on job Nos. 241 and 242 in January. The costs incurred and production status of these two jobs appear in the table that follows.
waL80281_04_c04_083-112.indd 22 9/25/12 1:03 PM
105
CHAPTER 4Exercises
Job No. 241 Job No. 242
Direct materials $26,000 $47,000
Direct labor 18,000 24,000
Production status In process In process
By the end of 20X5, actual direct labor cost amounted to $612,500, and factory over- head incurred totaled $967,500. There was no work in process on January 1, 20X5.
Compute the following:
a. Uniflex’s overhead application rate. b. The balance of the Work in Process account on January 31, 20X5. c. The amount of over- or underapplied overhead for 20X5. Be sure to indicate
whether overhead was overapplied or underapplied.
5. Job costing and overhead application Oxford Enterprises uses a job costing system to accumulate manufacturing costs. Overhead is applied to products on the basis of machine hours in the machining department and direct labor cost in the assembly department. The following esti- mates pertain to 20X4:
Machining Assembly
Machine hours 40,000 5,000
Direct labor cost $270,000 $800,000
Factory overhead 810,000 960,000
Job No. 328 was the only job in process at the end of 20X4. Its cost sheet revealed the data that follow:
Machining Assembly
Machine hours 100 10
Direct labor cost $1,100 $3,500
Direct materials cost 1,900 3,400
a. Compute Oxford’s overhead application rates in the machining department and the assembly department.
b. Calculate the total amount of overhead applied to job No. 328. c. Determine the total cost of job No. 328.
waL80281_04_c04_083-112.indd 23 9/25/12 1:03 PM
106
CHAPTER 4Exercises
6. Overview of job costing and overhead application Evaluate the comments that follow as being true or false. If the comment is false, briefly explain why.
a. A materials requisition forms the basis for the following journal entry: debit Work in Process, credit Raw Materials.
b. The Work in Process account normally contains the following costs for the jobs in production at year-end: direct materials used, direct labor, and actual factory overhead.
c. Direct labor cost is a good overhead application base to use if a company is highly automated.
d. The amount of over- or underapplied overhead at year-end is normally closed to the Work in Process account.
e. An overhead application rate is derived by the following computation: estimated factory overhead divided by an estimated application base.
7. Overhead application: Working backward The Towson Manufacturing Corporation applies overhead on the basis of machine hours. The following divisional information is presented for your review:
Division A Division B
Actual machine hours 22,500 ?
Estimated machine hours 20,000 ?
Overhead application rate $ 4.50 $ 5.00
Actual overhead $110,000 ?
Estimated overhead ? $90,000
Applied overhead ? $86,000
Over- (under-)applied overhead ? $ 6,500
Find the unknowns for each of the divisions.
8. Direct costs and indirect costs Executive Airlines is studying whether to begin flight service from Chicago to St. Louis. Identify the following costs as a direct cost or an indirect cost of the Chicago/St. Louis flight segment, assuming the route would be serviced by aircraft that would continue to be flown throughout Executive’s extensive route system:
a. Passenger beverage service b. Airport landing fees c. Monthly engine maintenance service d. Fuel consumed e. Commissions paid to travel agents on tickets sold f. Salary of Executive’s director of route planning
waL80281_04_c04_083-112.indd 24 9/25/12 1:03 PM
107
CHAPTER 4Problems
9. Cost drivers, service business Don’t Bug Me treats insect-infested homes and trees in Omaha, Nebraska. The company utilizes many liquid pesticides that are purchased in 55-gallon drums and later divided into 10-gallon containers for crew use. The pesticides are accounted for as indirect materials (i.e., supplies) in the firm’s job cost system.
a. Why do you think the company treats pesticides as indirect materials (as op- posed to direct costs) of servicing a client?
b. What is a cost driver? c. Management insists that crews estimate square footage and tree height, respectively,
for homes and trees serviced. Why is this procedure necessary?
Problems
1. Preparation of job cost sheet and journal entries Nycom Inc. manufactures items that are used in the electronics industry. The com- pany, which uses a job costing system, has two departments: machining and fin- ishing. The machining department applies overhead to products at the rate of $15 per machine hour. Finishing, in contrast, uses an application rate of 250% of direct labor cost.
On March 19, 20X3, Nycom received an order from Sensormatic for 225 photons, Model No. 116. Production began immediately, and the order (known as job No. 4155) was completed on March 31. Paperwork supporting the order revealed the following:
Document* Date Department Hours Amount
MR 1165 3/19 Machining — $5,600
MR 1169 3/21 Machining — 3,500
TT 1450-52 3/23 Machining 45 400
MUR 46 3/23 Machining 105 —
MR 4330 3/27 Finishing — 700
TT 1475-76 3/31 Machining 30 300
MUR 47 3/31 Machining 50 —
TT 6608-13 3/31 Finishing 200 2,000
*MR, materials requisition; MUR, machine usage report; TT, time ticket.
waL80281_04_c04_083-112.indd 25 9/25/12 1:03 PM
108
CHAPTER 4Problems
Instructions a. Prepare a job cost sheet for the Sensormatic order as of March 31. Use the following
column headings:
Direct Materials Direct Labor Machine Usage Factory
Overhead
Date Requisition Amount Ticket Hours Amount Report Hours Amount
b. Prepare journal entries to record (1) the issuance of direct materials, (2) direct labor incurred on the order, and (3) the application of factory overhead. All mate- rials requisitions should be combined in one entry, all time tickets in another, and so forth.
c. If company policy is to sell goods at a profit of 80% of total job cost, present the journal entries necessary to recognize completion and sale of the photons.
2. Computations using a job order system General Corporation employs a job order cost system. On May 1, the following bal- ances were extracted from the general ledger:
Work in process $ 35,200
Finished goods 86,900
Cost of goods sold 128,700
Work in Process consisted of two jobs, No. 101 ($20,400) and No. 103 ($14,800). Dur- ing May, direct materials requisitioned from the storeroom amounted to $96,500, and direct labor incurred totaled $114,500. These figures are subdivided as follows:
Direct Materials Direct Labor
Job No. Amount Job No. Amount
101 $ 5,000 101 $ 7,800
115 19,500 103 20,800
116 36,200 115 42,000
Other 35,800 116 18,000
$96,500 Other 25,900
$114,500
Job No. 115 was the only job in process at the end of the month. Job No. 101 and three “other” jobs were sold during May at a profit of 20% of cost. The “other” jobs contained material and labor charges of $21,000 and $17,400, respectively.
waL80281_04_c04_083-112.indd 26 9/25/12 1:03 PM
109
CHAPTER 4Problems
General applies overhead daily at the rate of 150% of direct labor cost as labor summaries are posted to job orders. The firm’s fiscal year ends on May 31.
Instructions a. Compute the total overhead applied to production during May. b. Compute the cost of the ending work in process inventory. c. Compute the cost of jobs completed during May. d. Compute the cost of goods sold for the year ended May 31.
3. Job order costing, overhead emphasis Toledo Company uses a job order system to accumulate manufacturing costs. On December 31, 20X1, the work in process inventory consisted of job No. 764, costed as follows:
Direct materials $ 4,800
Direct labor 12,500
Applied overhead 10,000
$27,300
Because of changing plant conditions and labor markets, the cost accounting department calculated a new overhead application rate for use throughout 20X2. Estimated totals for direct labor cost and factory overhead for 20X2 amounted to $300,000 and $270,000, respectively. Actual results follow:
Direct materials used $259,600
Direct labor 316,000
Indirect materials 23,700
Indirect labor 144,900
Factory depreciation 55,300
Factory taxes 12,700
Factory utilities 55,200
$867,400
All jobs were completed and sold by December 31, 20X2, except for job no. 821, which contained direct material costs of $10,900 and direct labor charges of $22,500. This job was still in production and was anticipated to be completed in early January. The company charges any under- or overapplied overhead to Cost of Goods Sold.
waL80281_04_c04_083-112.indd 27 9/25/12 1:03 PM
110
CHAPTER 4Problems
Instructions a. Determine the 20X2 overhead application rate, using direct labor cost as the
application base. b. Determine the total cost of the company’s work in process inventory as of Decem-
ber 31, 20X2. Determine the amount of under- or overapplied overhead for the year. Be sure to indicate whether overhead was underapplied or overapplied.
c. Compute the company’s cost of goods sold. Toledo had no finished goods inven- tory on January 1, 20X2.
4. Job costing in a service business Diego, Hyatt, and Stevens, a prestigious law firm located in San Antonio, uses a job order system to monitor the cost of servicing clientele. The office manager has prepared the following budget for 20X7:
Client billings $11,520,000
Less: Professional staff costs (85%) $6,000,000
Administrative staff costs (75%) 2,000,000
Computer time (80%) 500,000
Photocopying (70%) 200,000
Other office costs (20%) 300,000 9,000,000
Net income $ 2,520,000
The numbers in parentheses indicate the percentage of cost that is directly traceable to client jobs. The remaining, nontraceable portion is charged to clients by using a predetermined overhead application rate. The office manager feels that total direct cost is the most appropriate overhead application base.
In March, the firm completed work on a suit for Picante Foods. The following costs were directly chargeable to Picante:
Professional staff $25,000
Administrative staff 6,400
Computer time 2,500
Photocopying 3,700
Other office costs 400
waL80281_04_c04_083-112.indd 28 9/25/12 1:03 PM
111
CHAPTER 4Problems
Instructions a. Determine the firm’s total budgeted traceable and nontraceable costs and the
overhead application rate. b. Calculate the firm’s estimated income for the year as a percentage of traceable costs. c. Compute the total cost of the Picante job and the amount that Diego, Hyatt, and
Stevens would bill the client. d. The office manager can acquire new software that would allow the firm to increase
the percentage of direct (as opposed to indirect) costs. Briefly explain why Diego, Hyatt, and Stevens would be interested in this software.
waL80281_04_c04_083-112.indd 29 9/25/12 1:03 PM
waL80281_04_c04_083-112.indd 30 9/25/12 1:03 PM
