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CA5107 - A cost system that uses predetermined

overhead rates and actual costs for direct
Cost Accounting and Control materials and direct labor is referred to as a
normal cost system
Quiz 2
Formula:

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Module 3 - Manufacturing Overhead Budgeted overhead
★ Computation of Predetermined Overhead - is simply the firm’s best estimate of the
Rate using different allocation bases- amount of overhead to be incurred in the
Plantwide and Departmental OH rates coming year. The estimate is often based
(3T, 3P) on last year’s figures, adjusted for
★ The use of alternative capacity levels- anticipated changes in the coming year.
theoretical, practical, expected, and normal Activity Level or Activity Base
capacity (1T) - A measure of what causes the incurrence
★ Disposition of over and under-applied OH of a variable cost, some of which are:
(2T, 2P) 1. Cost of materials
★ Allocation of Support or Common
costs to Producing Departments -Direct,
Step, and Reciprocal/ Algebraic Method 2. Cost of direct labor
(1T, 3P)
★ Computation of total cost (OH cost, and
price of product) after allocation of
support costs (2T, 3P) 3. Direct labor hours
★ Limitations of plantwide and
departmental overhead rates (1T)
★ Activity-Based Costing
★ Classifying activities - unit level, batch 4. Machine hours
level, product level, and facility-level (2T,
1P)
★ Assigning costs (1T, 1P)
★ Computation of product and selling price 5. Units of production
cost using activity-based costing (1T, 1P)

Predetermined Overhead Rate

- A budgeted, constant charge per unit of
activity used to assign overhead to Factors Considered in the Computation of
production or services. Factory Overhead
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Plantwide rate interruptions due to delays, breakdowns,
- Use of single or one rate for all inefficiencies, non- working days, and
producing departments changes in production processes.
- Are applicable when an entity - Maximum output that can be realized if
manufactures only a single product, or everything operates efficiently
different products are being are being Usually results in:
manufactured by same series of (a) Underapplied overhead
productive departments (b) Low product cost
- Limitation: The plantwide average rate Normal Capacity (achievable/more than one
may be too high or too low for a particular year)
product, especially a product involving - Average activity usage that a firm
only one or a few departments. experiences in the long term
Departmental rate - Attainable level of activity
- use of several rates, i.e., one rate for each Considers:
producing department (a) Historical production level
- shall be applied when an entity (b) Estimated future production level
manufactures different products ( 2-3 years)
(c) Cyclical fluctuations
Alternate Capacity Levels When normal capacity is greater than expected
Theoretical/Ideal Capacity (100%) capacity, may result in:
- All production factors are operating (a) Underapplied overhead
perfectly (full capacity) (b) Higher product cost
- absolute maximum production activity - Is the most commonly used type of
of a manufacturing firm capacity level. In calculating normal
Disregards: capacity, not only internal but also
(a) Machinery breakdown external factors, particularly the market
(b) Holiday downtime or the demand for the product, are
Results in: considered.
(a) Significant underapplied overhead - The normal capacity level is used in
(b) Lowest product cost calculating the predetermined or standard
- Refers to the plant’s or department’s factory overhead rate.
capability to produce at full tilt, without Expected Capacity (one year)
interruptions. Though it is highly - Anticipated activity level for the
impossible to attain, it is well calculated to upcoming period based on projected
serve as a basis for establishing other product demand (short term)
capacity levels. - Determined during the budget process
Practical Capacity (75%-85%) - Should closely reflect actual costs
- Is theoretical capacity less internal factors Results in:
such as ordinary and expected
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(a) Immaterial overapplied or - If variance is underapplied, cost of goods
underapplied overhead sold increases
(b) Highest product cost - If variance is overapplied, cost of goods
sold decreases
Problems of Overhead Application
- The difference between the overhead cost
applied to Work in Process and the actual
overhead costs of a period is referred to as
either underapplied or overapplied
overhead.
Underapplied Overhead
- exists when the predetermined overhead
rate is less than the total amount of
overhead actually incurred during the
period.
- (Manufacturing Overhead) MOH
T-account debit is greater than MOH
T-account credit
Overapplied Overhead
- exists the predetermined overhead rate is
greater than the total amount of
overhead actually incurred during the
period.
- MOH T-account debit less than MOH
T-account credit

Disposition of Over and Under-applied OH

- Disposition of the over- or underapplied
factory overhead is usually quite simple. At
the end of the accounting period,
it can be either treated as:
(a) a period expense – i.e. closed to Material Overhead Variance
cost of goods sold or directly to - The amount of variance is closed and
Income Summary prorated against the accounts in which
(b) allocated between inventories applied overhead resides: work-in-process
and the cost of goods sold. inventory, finished goods inventory,
Immaterial Overhead Variance and costs of goods sold
- The amount of variance is closed against Let’s try!
cost of goods sold or income summary
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1. Yeji Manufacturing has the following account (b) personnel,
balances at the end of the period, with their (c) warehousing and
materials, labor and overhead components: (d) maintenance department.
- Since these departments support the
production department, the costs incurred
must be allocated to production both in
computing predetermined overhead
rates and in measuring actual overhead
costs of producing to determine the full
costs of a product.

Prepare the entry to close the variance accordingly. Service Costs Allocation Approaches
Solution and Answer: Direct Method
- considered the simplest method of
allocating the cost of service departments
to operating departments.
- Under this method, the costs incurred by
service departments are not allocated to
- 104,400/1,496,400 x 100 = 6.98 each other; rather, they are directly
- 208,800/1,496,400 x 100 = 13.95 allocated to operating departments
- 1,183,200/1,496,400 x 100 = 79.07 using some appropriate allocation base.
- In other words, we can say that the direct
method of departmental cost allocation
ignores the service provided by a service
department to itself and to other service
departments.
Step-Down/Sequential Method
- The method partially recognizes the
services that service departments provide to
each other, although it does not recognize
the mutual exchange of services among
support departments.
Service Department Costs
- defined by ranking the service/support
- Service or support department is a unit
departments in order of the amount of
in an organization that contributes in a
service rendered, from the greatest to the
very indirect way to the conversion of raw
least.
materials in a finished product.
- a hybrid between the direct and the
These units are the:
algebraic methods
(a) purchasing,
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- the department with the highest cost is Allocate the service department costs using direct
seen as rendering the greatest service, method, sequential method, and algebraic method.
which are allocated first. Solution and Answer:
- They are distributed to all support Direct method
departments in a sequence and to all
producing departments. Then, the costs of
the support department next in sequence
are similarly allocated, and so on
- a support department is “eliminated”
once its costs have been assigned.
Simultaneous/Reciprocal/Algebraic Method
- All interrelationships among
Sequential method
departments are recognized and no
decision must be made about a ranking
order of service departments.
- The method, however, is more complex
than the direct and step methods because it
involves solving simultaneous equations.
Let’s try!
1. Solace Manufacturing has four departments.
assembly department and finishing department Algebraic method
make up the production departments while
cafeteria and maintenance department make up the
service departments.

The overhead cost of the cafeteria is allocated

based on the number of employees while the
overhead cost of the maintenance department is
based on the estimated overhead for the period.

In determining the predetermine overhead rates,

the assembly department uses direct labor hours
and the finishing department uses machine
hours. The following information is made
available:
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Product Diversity
- Significant non-unit overhead costs will
not cause product cost distortions
provided products consume the non-unit
overhead activities in the same proportion
as the unit-level overhead activities.
Product diversity, on the other hand,
can cause product cost distortion. It is
Comparison of the three:
caused by such things as differences in
product size, product complexity, setup
time, and size of batches.

Overhead Allocation Approaches

Traditional Costing
- factory overheadcosts are allocated to
Limitations of Traditional: Plantwide and products by using a single activity or cost
Departmental Overhead Rates driver (e.g., labor hours). In some
Assuming, however, that the overhead costs are a accounting literature, traditional costing is
significant percentage of total manufacturing also called peanut-butter costing.
costs, at least two major factors can impair the Activity-Based Costing
ability of the unit-based plantwide and - The transactions-based approach to
departmental rates to assign overhead costs overhead allocation
accurately: - is based on several activities, which are
1. the proportion of non-unit-related considered any event, unit of work, or task
overhead costs to total overhead costs is with a specific goal.
large, and - recognizes that significant overhead costs
2. the degree of product diversity is great. may not be caused by volume of output.
Non-Unit-Related Overhead Costs - Compared to traditional cost accounting,
- The use of either plantwide rates or ABC represents a more thorough
departmental rates assumes that a application of cost tracing.
product’s consumption of overhead Formula:
resources is related strictly to the units
produced.
- Non-unit-based drivers are factors, other - Activity Cost Pool
than the number of units produced, that - is an aggregate of all the costs
measure the demands that cost objects - is a group of similar costs usually
place on activities. Thus, unit-level drivers increased or decreased by a single cost
cannot assign these costs accurately to driver.
products. - Cost Driver
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- is identified for each activity, such as 2. Solve for product cost and gross profit
purchase orders or machine setups, to under activity based costing
establish a cause-effect relationship Solution and Answer:
between an activity and a cost object Traditional Costing
(product/service).
- Cost Driver Rate
- which is the cost pool total divided by
cost driver, is used to calculate the
amount of overhead and indirect costs
related to a particular activity.
Let’s Try!
1. The following cost information has been
established by the accounting department
Activity-based Costing
of XYZ Manufacturing Company:
Step 1: Calculate for the overhead rates per
- Factory overhead → cost pool
activity based on cost drivers

Step 2: Allocate overhead based on activity using

the rates calculated
Detailed cost information is provided as:

In this problem, let’s assume that:

a. Produced and sold 2,500 units each of all
products
b. Selling prices are: P400 for product X.
P410 for product Y and P405 for product Step 3: Compute for the total manufacturing
Z cost of each product
c. No beginning and ending work-in-process
and finished goods inventory
Requirement:
1. Solve for product cost and gross profit
Step 4: Compute for gross profit
under traditional costing
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books at a time. In each case, the
customer’s books must be packaged and
shipped. Roughly the same activity is
required independent of how many books
are put in a box. Thus, Shipping can be
seen as an excellent example of a batch
process.
3. Product-level activities/drivers
- are those activities performed wherein
costs incurred to support the number
different or various products of a company
to be produced and sold.
- are carried out at the product level/line,
Levels of Activity (Cost Drivers) no matter the volume of production.
To help identify activity drivers and enhance the - Example: Product design and
management of activities, activities are often marketing are activities that may have a
classified into one of the following four general one-to-one relation to the number of end
activity categories: products.
1. Unit-level activities/drivers 4. Organizational or facility or plant-level
- are variable in relation to change in activities/drivers
production volume. - are those that sustain a factory’s general
- are those activities that have a one-to-one manufacturing processes. Several levels of
correspondence with a unit of output. costs and drivers can exist above the
- Example: A telescope manufacturer may product level.
have to perform some final calibration - Floor space occupied is referred to often as
activity to each finished product. Thus, the organizational or facility or plant-level
calibration may be seen as a unit-level driver for assigning plant-level costs.
activity - Example: depreciation, property taxes,
2. Batch-level activities/drivers and insurance of the factory building.
- vary with the number of batches but are
fixed (and, therefore, independent) with
respect to the number of units in each
batch.
- are those activities that must be performed,
but can relate to one or more units of
output.
- Example: Assume that XYZ is an online
bookstore. Some customers order only one
book while others may order a dozen
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1. Winkel Woodcrafters produces special order
Assigning Costs to Activities wood products. The company uses job order
- After identifying and describing activities, costing for pricing and cost accumulation process.
the next task is determining how much it The following costs were incurred on two recent
costs (labor, materials, energy, and capital) jobs:
to perform each activity.
- In summary, ABC is a ‘two-stage’
allocation process. First, overhead costs are
traced to activities; then, overhead costs are
allocated to products on the basis of the The company adds a 50% markup on cost in
activities performed by a particular determining the amount to charge for each job.
product. Prepare a schedule showing the cost and the
amount to be charged for each job.
Solution and Answer:
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Module 4: Job Order Costing System
★ Source documents in Job-Order Costing
(2T)
★ Journal Entries for Job-Order Costing
using Normal Costing (3T, 3P)
★ Computation of product cost using a
Job-Order Costing System (3P)
★ Nature of production losses in Job-Order
(1T)

Job-Order Costing
- Is a system that takes place when
Documents used in Job Order System
customers order small, unique batches of
Materials Requisistion Form
products.
- A form that is used as a basis for the
- Determines the price of each individual
recording of raw materials issuance
product and ensures that the cost for each
product is reasonable enough for a
customer to purchase
- A job can be a: client or customer,
project, contract, product
- The cost of materials used, labor incurred
and overhead applied is summarized in
WIP account while maintaining a job cost
sheet for each job
Let’s try!
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Time Ticket
- As an employee works on a unique order,
they are often required to fill out a
timesheet recording the work they have
completed

Job Order System Cost Flow

Recording of Labor Costs

Job Cost Sheet

- Is the main source for tracking an item to
keep pricing and inventory accurate
Shows the total cost incurred in the
manufacture of a particular order and
it contains the following:
1. Job Number
2. Job Description
3. Name and Address of the
Customer
4. Date ordered and Date of
Delivery
5. Direct Materials showing:
(a) description of materials
used
(b) quantity of materials
used
(c) cost of materials Applying Manufacturing Overhead
6. Direct labor section showing:
(a) the number of hours
worked
(b) the rate per hour
(c) the total cost of direct
labor
7. Overhead Section (Applied FOH)

Transferring Units Sold

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Manufacturing Overhead account as they
are incurred.

Applying Manufacturing Overhead

- Work in Process is increased when
Manufacturing Overhead is applied to
Journal Entries
jobs.
Purchase of Materials
- Raw material purchases are recorded in an
Inventory account.

Transferring Completed Units

- As jobs are completed, the Cost of Goods
Manufactured is transferred to Finished
Material Usage
Goods from Work in Process.
- Direct materials issued to a job increase
Work in Process and decrease Raw
Materials. Indirect materials used are
charged to Manufacturing Overhead and Transferring Units Sold
also decrease Raw Materials. - When finished goods are sold, two entries
are required: (1) to record the sale, and (2)
to record COGS and reduce Finished
Goods.

Labor Costs
- The cost of direct labor incurred increases
Work in Process and the cost of indirect
labor increases Manufacturing Overhead.

Materials and Production Losses in Job Order

Costing
Production losses may result in losses of direct
Actual Manufacturing Overhead
materials or imperfect units that cannot be sold as
- In addition to indirect materials and
regular items:
indirect labor, other manufacturing
Shrinkage
overhead costs are charged to the
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- are reductions or losses inherent in the a. Loss is anticipated on all jobs or entire
manufacturing process. (e.g. evaporation, production.
leakage or oxidation) - Loss is caused by employee error/worn out
Scrap ( waste materials) machinery.
- by product of the production of the - Predetermined overhead OH rate include
primary product. These are trimmings the amount for the net loss ( cost of
remaining after processing materials; spoilage or spoilage minus disposal value).
broken parts resulting from Used if the reason for spoilage is normal to
employee/machine failure; defective the process.
materials that cannot be used or returned b. Loss is specifically identified/attributed to a
to the vendor. specific or particular job.
Production errors or partially completed - Loss is caused by the customer. Thus,
products: predetermined overhead rate does not
Spoiled goods or spoilage include the cost of spoilage. Used if the
- are completed goods which in the process reason for spoilage is the job itself.
of manufacture developed some Abnormal Loss
imperfection which cannot be - are charged to a loss account in the period
economically corrected/reworked. (e.g., in which they are incurred.
plastic product molded with a wrong color - Period costs
dye). a. Anticipated on all jobs
Defective goods - Include cost when calculating
- are completed goods which in the process predetermined overhead application rate
of manufacture developed some - Include cost less the estimated disposal
imperfection, for which through value
additional expenditure for labor or b. Specific to a job
possibly materials can be reworked and - Applied to the specific job
be made into perfect finished goods. (e.g., - Include cost less the estimated disposal
Plastic product with bubbles can be value
corrected by re-sanding and repainting).
Rework cost
- is a product or period cost depending on
whether the rework relates to normal or
abnormal defective production.

Normal and Abnormal Losses in Job Order

Costing
Normal Loss
- loss that are inherent and unavoidable.
- This is expected during production.