Chapter 3

Product Costing and Cost

Accumulation in a Batch
Production Environment

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Product and Service Costing

Managerial
Financial
Accounting and
Accounting
Cost Management
Product costs are
used to value Product costs are
inventory and to used for planning,
compute cost of control, directing, and
goods sold. management decision
making.
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Flow of Costs in Manufacturing Firm

Work-in-Process Inventory Finished Goods Inventory

Direct material cost Product cost transferred
Direct labor cost
Manufacturing overhead when product is finished

Cost of Goods Sold Income Summary

Expense closed into

Income Summary at end

of accounting period

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Types of Product-Costing Systems
Process Job-Order
Costing Costing

 Used for production of large, unique, high-cost items.

 Built to order rather than mass produced.
 Many costs can be directly traced to each job.
 TWO TYPES:
 Job-shop operations
 Products manufactured in very low volumes or one at
a time.
 Batch-production operations
 Multiple products in batches of relatively small
quantity.
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Types of Product-Costing Systems

Process Job-Order
Costing Costing

 Typical job-order cost applications:

 Special-order printing
 Building construction
 Also used in the service industry
 Hospitals
 Law firms
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Types of Product-Costing Systems
Process Job-Order
Costing Costing

 Used for production of small, identical, low cost

items.
 Mass produced in automated continuous
production process.
 Costs cannot be directly traced to each unit of
product.
 Typical process cost applications:
 Petrochemical refinery
 Paint manufacturer
 Paper mill
3-6
 Actual and Normal Costing

Actual direct material Actual direct material

and direct labor and direct labor
combined with combined with
actual overhead. predetermined overhead.

Using a predetermined rate makes it

possible to estimate total job costs sooner.
Actual overhead for the period is not
known until the end of the period.
7
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 Manufacturing Overhead Costs
Overhead is applied to jobs using a predetermined overhead rate
(POHR) based on estimates made at the beginning of the
accounting period.

Budgeted manufacturing overhead cost

POHR =
Budgeted amount of cost driver (or activity base)

Overhead applied = POHR × Actual activity

Based on estimates, and Actual amount of the allocation

determined before the base, such as direct labor hours,
period begins incurred during the period
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Manufacturing Overhead Costs
Overhead is applied to jobs using a predetermined
overhead rate (POHR) based on estimates made at the
beginning of the accounting period.

Budgeted manufacturing overhead cost

POHR =
Budgeted amount of cost driver (or activity base)

Overhead applied = POHR × Actual activity

Recall the Aluminum Boat example where:

Overhead applied = $30 per DLH × 600 DLH = $18,000

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Job-Order System Cost Flows

Let’s examine the

cost flows in a
job-order costing
system. We will
use T-accounts
and start with
materials.
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 Job-Order System Cost Flows
Work in Process
Raw Materials (Job-Cost Record)
•Material •Direct •Direct
Purchases Material Material
•Indirect
Material

Mfg. Overhead
•Indirect
Material

3-11
Job-Order System Cost Flows

Next let’s add

labor costs and
applied
manufacturing
overhead to the
job-order cost
flows. Are you
with me?
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Job-Order System Cost Flows
Work in Process
Wages Payable (Job-Cost Record)
•Direct •Direct
Labor Material
•Indirect •Direct
Labor Labor

Mfg. Overhead
•Indirect
Material
•Indirect
Labor

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Job-Order System Cost Flows
Work in Process
Wages Payable (Job-Cost Record)
•Direct •Direct
Labor Material
•Indirect •Direct
Labor Labor
•Overhead
Applied
Mfg. Overhead If actual and applied
•Indirect •Overhead manufacturing overhead are
Material Applied to not equal, a year-end
•Indirect Work in adjustment is required. We
Labor Process will look at the procedure to
accomplish this later.
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Job-Order System Cost Flows

Now let’s
complete the
goods and sell
them. Still with
me?

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 Job-Order System Cost Flows
Work in Process
(Job-Cost Record) Finished Goods
•Direct
Material •Cost of •Cost of •Cost of
Goods Goods Goods
•Direct
Mfd. Mfd. Sold
Labor
•Overhead
Applied
Cost of Goods Sold
•Cost of
Goods
Sold

3-16
Job-Order System Cost Flows

Let’s return to
AFB Company
and see what we
will do if actual
and applied
overhead are not
equal.

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 Overhead Application Example

Actual Overhead costs for the year: $5,050,000

Actual direct labor hours worked for the year: 170,000

Applied Overhead = POHR × Actual Direct Labor Hours

Applied Overhead = $30.00 per DLH × 170,000 DLH = $5,100,000

Applied overhead exceeds actual overhead by $50,000

This difference is called overapplied overhead.

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 Overapplied and Underapplied
Manufacturing Overhead
$50,000 $50,000 may be
may be allocated closed directly to
to these accounts. cost of goods sold.
OR
Work in Finished
Process Goods Cost of
Goods Sold
Cost of
Goods Sold AFB Company’s
Method
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 Overapplied and Underapplied
Manufacturing Overhead
AFB’s Cost AFB’s
of Goods Sold Mfg. Overhead
for the year for the year
Unadjusted Actual Overhead
Balance overhead Applied
costs to jobs
$50,000 $5,050,000 $5,100,000

Adjusted $50,000 $50,000

Balance overapplied

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 Overapplied and Underapplied
Manufacturing Overhead -
Summary
Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . Allocation of Goods Sold

UNDERAPPLIED INCREASE INCREASE

Work in Process Cost of Goods Sold
(Applied OH is less Finished Goods
than actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASE

Work in Process Cost of Goods Sold
(Applied OH is greater Finished Goods
than actual OH) Cost of Goods Sold
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Schedule of Cost of Goods Manufactured
Schedule of Cost of Goods Manufactured

Direct material:
Raw material inventory, beginning $xxx
Add: Raw material purchases xxx
Raw material available for use $xxx
Deduct: Raw material, ending xxx
Raw material used $xxx

Direct labor xxx

Manufacturing overhead
Indirect material $xxx
Indirect labor xxx
Other actual overhead charges xxx
Total actual manufacturing overhead $xxx
Add: Overapplied overhead
or Deduct: Underapplied overhead xxx
Overhead applied to work-in-process xxx

Total manufacturing costs $xxx

Add: Work-in-process inventory, beginning xxx
Subtotal $xxx
Deduct: Work-in-process inventory, ending xxx
Cost of goods manufactured $xxx
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Schedule of Cost of Goods Sold

Schedule of Cost of Goods Sold

Finished goods inventory, beginning $xxx

Add: Cost of goods manufactured* xxx
Cost of goods available for sale $xxx
Deduct: Finished goods inventory, ending xxx
Cost of goods sold $xxx
Add: Underapplied overhead
or Deduct: Overapplied overhead xxx
Cost of goods sold (adjusted) $xxx

* From Cost of Goods Manufactured Schedule

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 Two-Stage Cost Allocation
Indirect Indirect Other
Stage One: Labor Materials Overhead
Costs assigned
to pools

Department Department Department

Cost pools
1 2 3

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Departmental Overhead Rates
Indirect Indirect Other
Stage One: Labor Materials Overhead
Costs assigned
to pools
Department Department Department
Cost pools
1 2 3
Direct Machine Raw
Stage Two: Labor Hours Materials
Costs applied Hours Cost
to products
Products
Departmental Allocation Bases
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 Job-Order Costing in
Nonmanufacturing Organizations

THE JOB

Cases Missions

Programs Contracts
3-26
Changing Technology in Manufacturing
Operations

 Computerized data interchange has

eliminated much of the paperwork
associated with job-order
cost systems.

 Scanning devices have simplified

data entry to record material and
labor use.

3-27