Chapter Three: Product Costing and Cost Accumulation in A Batch Production Environment

3-1
3 Chapter Three
Product Costing and

Cost Accumulation in a
Batch Production
Environment
McGraw-Hill/Irwin
3-2
Product and Service Costing
Managerial
Financial
Accounting and
Accounting
Cost Management
Product costs are used
to value inventory and Product costs are used
to compute cost of for planning, control,
goods sold. directing, and
management decision
making.
McGraw-Hill/Irwin
3-3
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.
McGraw-Hill/Irwin
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Process Job-Order
Costing Costing
Typical process cost applications:

 Petrochemical refinery
 Paint manufacturer
 Paper mill
McGraw-Hill/Irwin
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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.
McGraw-Hill/Irwin
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Process Job-Order
Costing Costing
 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.
McGraw-Hill/Irwin
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Process Job-Order
Costing Costing
 Typical job-order cost applications:

 Special-order printing
 Building construction
 Also used in service industry
 Hospitals
 Law firms
McGraw-Hill/Irwin
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Sequence of Events in a Job-Order
Costing System
Receive Begin
orders from production
customers
Schedule Order
jobs materials
McGraw-Hill/Irwin
3-9
Accumulating Costs in a
Job-Order Costing System
Manufacturing
overhead (OH)
Applied to each
Direct Tra job using a
materials ced
dire predetermined
to e ctly
ach rate
job
THE JOB
c t l y
d i re
c e d b
Tr a j o
Direct e a ch
to
labor
McGraw-Hill/Irwin
3-10
Charge
Charge direct
direct material
material and
and direct
direct
labor
labor to
to each
each job
job as
as incurred.
incurred.
Direct
DirectMaterials
Materials
Job
JobNo.
No.11 Special
Special
documents
documents
Direct
DirectLabor
Labor Job
JobNo.
No.22 are
are used
used toto
track
track costs
costs
for
for each
each job.
job.
Manufacturing
Manufacturing Job
JobNo.
No.33
Overhead
Overhead
Apply
Apply overhead
overhead to
to each
each job
job
using
using aa predetermined
predetermined rate.
rate.
McGraw-Hill/Irwin
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The primary document

for tracking the costs
associated with a
given job is the job-
cost record.
Let’s investigate
McGraw-Hill/Irwin
3-12
Job-Order Cost Accounting

RoseCo Job-Cost Record
Job Number A - 143 Date Initiated 3-4-X2
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
Cost Summary Units Shipped

Product Costs Amount Date Number Balance
Direct Materials
Direct Labor
Manufacturing Overhead
Total Cost
Unit Cost
McGraw-Hill/Irwin
3-13

Date Completed
Direct Materials A materials requisition
Direct Labor Manufacturing Overhead
form is used to
authorize the use of

materials on a job.
Direct Materials
Direct Labor Let’s see one
Total Cost
Unit Cost
McGraw-Hill/Irwin
3-14
Materials Requisition Form

RoseCo Materials Requisition Form
Requisition No. X7 - 6890 Date 3-4-X2

Job No. A - 143
Department B3
Description Quantity Unit Cost Total Cost

2 x 4, 12 feet 12 $ 3.00 $ 36.00
1 x 6, 12 feet 20 4.00 80.00
$ 116.00
Authorized
Signature Will E. Delite
McGraw-Hill/Irwin
3-15
Materials Requisition Form

RoseCo Materials Requisition Form
Requisition No. X7 - 6890 Date 3-4-X2 Cost of material

Job No. A - 143 is charged to job
Department B3
A-143.
Description Quantity Unit Cost Total Cost
2 x 4, 12 feet 12 $ 3.00 $ 36.00
1 x 6, 12 feet 20 4.00 80.00
$ 116.00
Type, quantity, and
total cost of material
charged to job A-143.
Authorized
The materials requisition
Signature form
Will isE.the source document for
Delite
recording material usage in the accounting records.
McGraw-Hill/Irwin
3-16

Date Completed
X7-6890 $ 116

Direct Materials $ 116
Direct Labor
Total Cost
Unit Cost
McGraw-Hill/Irwin
3-17

Date Completed
Department B3 Units Completed Accumulate
Item Wooden cargo crate direct labor
Direct Materials Direct Labor Manufacturingcosts by
Overhead
X7-6890 $ 116 means of a
work record,
such as a time
Cost Summary ticket,
Units Shippedfor each
employee.
Direct Labor
Total Cost Let’s see one
Unit Cost
McGraw-Hill/Irwin
3-18
Employee Time Ticket

RoseCo Employee Time Ticket
Time Ticket No. 36 Date 3-5-X2

Employee I. M. Skilled Station 42
Starting Ending Hours Hourly

Time Time Completed Rate Amount Job No.
0800 1600 8.00 $ 11.00 $ 88.00 A-143
Totals 8.00 $ 11.00 $ 88.00 A-143
Supervisor C. M. Workman
McGraw-Hill/Irwin
3-19

Date Completed
X7-6890 $ 116 36 8 $ 88

Direct Labor $ 88
Total Cost
Unit Cost
McGraw-Hill/Irwin
3-20

Date Completed
X7-6890 $ 116 36 8 $ 88

Apply
Direct manufacturing overhead
Materials $ 116 to jobs using a
predetermined
Direct Labor overhead$ rate
88 based on direct
labor hours (DLH).
Total Cost
Unit Cost
Let’s do it
McGraw-Hill/Irwin
3-21

Date Completed 3-5-X2
Department B3 Units Completed 2
X7-6890 $ 116 36 8 $ 88 8 $ 4 $ 32

Direct Labor $ 88
Manufacturing Overhead $ 32
Total Cost $ 236
Unit Cost $ 118
McGraw-Hill/Irwin
3-22
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
McGraw-Hill/Irwin
3-23
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.
POHR =
Overhead applied = POHR × Actual activity

Recall the wooden crate example where:
Overhead applied = $4 per DLH × 8 DLH = $32
McGraw-Hill/Irwin
3-24
Overhead Application Example

RoseCo applies overhead based on direct-
labor hours. Total estimated overhead for the
year is $640,000. Total estimated labor cost is
$1,400,000 and total estimated labor hours are
160,000.
What is RoseCo’s predetermined overhead
rate?
McGraw-Hill/Irwin
3-25

POHR =
$640,000
POHR =
160,000 direct-labor hours (DLH)
POHR = $4.00 per DLH
For each direct labor hour worked on a

job, $4.00 of factory overhead will be
applied to the job.
McGraw-Hill/Irwin
3-26

Job Number X - 32 Date Initiated 3-9-X2
Date Completed
X7-7456 $ 240 23 26 $ 286

Direct Labor
What amount of$ overhead
286
will
Total Cost RoseCo apply to Job X-32?
Unit Cost
McGraw-Hill/Irwin
3-27

Job Number X - 32 Date Initiated 3-9-X2
Date Completed 3-11-X2
Department B3 Units Completed 6
X7-7456 $ 240 23 26 $ 286 26 $ 4 $ 104

SOLUTION
Overhead applied = POHR × $Actual
Direct Labor 286 Direct Labor Hours
Manufacturing Overhead $ 104
Overhead applied = $4.00 per DLH × 26 DLH = $104
Total Cost
Unit Cost
McGraw-Hill/Irwin
3-28
Job-Order
Job-Order Costing
Costing
Document
Document Flow
Flow Summary
Summary
Let’s summarize
the document
flow we have
been discussing
in a job-order
costing system.
McGraw-Hill/Irwin
3-29
Job-Order Costing
Document Flow Summary
The materials Direct JobCost
Cost
materials Job
requisition Job Cost
Sheets
Job-Cost
Sheets
indicates the Sheets
Records
cost of direct Materials
Materials
Ledger Cards
material Materials
Ledger Cards
Materials
Ledger Cards
to charge to Requisition
jobs
and the cost of Manufacturing
indirect material Overhead
Indirect
to charge to Account
materials
overhead.
McGraw-Hill/Irwin
3-30
Job-Order Costing
Employee time Direct JobCost
Cost
Labor Job
tickets indicate Job Cost
Sheets
Job-Cost
Sheets
Sheets
the cost of Records
direct labor Employee Time
Employee Time
Ticket
Employee
to charge to Employee Time
Ticket
Time
Ticket
jobs Ticket
and the cost
Manufacturing
of indirect labor Overhead
to charge to Indirect Account
overhead. Labor
McGraw-Hill/Irwin
3-31
Job-Order Costing
Employee Indirect
Time Ticket Labor
Overhead
Other Manufacturing Applied Job-Cost
Actual OH Overhead Records
with
Charges Account
POHR
Materials Indirect
Requisition Material
McGraw-Hill/Irwin
3-32
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.
McGraw-Hill/Irwin
3-33

Work in Process
Raw Materials (Job-Cost Record)
•Material •Direct •Direct
Purchases Material Material
•Indirect
Material
Mfg. Overhead
•Indirect
Material
McGraw-Hill/Irwin
3-34
Next let’s add

labor costs and
applied
manufacturing
overhead to the
job-order cost
flows. Are you
with me?
McGraw-Hill/Irwin
3-35

Work in Process
Wages Payable (Job-Cost Record)
•Direct •Direct
Labor Material
•Indirect •Direct
Labor Labor
Mfg. Overhead
•Indirect
Material
•Indirect
Labor
McGraw-Hill/Irwin
3-36

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.
McGraw-Hill/Irwin
3-37
Now let’s
complete the
goods and sell
them. Still with
me?
McGraw-Hill/Irwin
3-38

Work in Process
(Job-Cost Record) Finished Goods
•Direct
•Cost of •Cost of •Cost of
Material
•Direct Goods Goods Goods
Mfd. Mfd. Sold
Labor
•Overhead
Applied
Cost of Goods Sold
•Cost of
Goods
Sold
McGraw-Hill/Irwin
3-39
Let’s return to
RoseCo and see
what we will do if
actual and
applied overhead
are not equal.
McGraw-Hill/Irwin
3-40
RoseCo’s actual overhead for the year was $650,000

and a total of 170,000 direct-labor hours were worked.
Using RoseCo’s predetermined overhead rate of $4.00
per direct-labor hour, how much overhead was
applied to all of RoseCo’s jobs during the year?
McGraw-Hill/Irwin
3-41

Using RoseCo’s predetermined overhead rate of $4.00
applied to all of RoseCo’s jobs during the year?
SOLUTION
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
McGraw-Hill/Irwin
3-42

Using RoseCo’s
RoseCo predetermined overhead rate of $4.00
has overapplied
overhead
applied tofor
allthe year
of RoseCo’s jobs during the year?
by $30,000. What will
RoseCo do?
SOLUTION
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
McGraw-Hill/Irwin
3-43
Overapplied and Underapplied
$30,000 $30,000 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 RoseCo’s Method
McGraw-Hill/Irwin
3-44
RoseCo’s Cost RoseCo’s

of Goods Sold Mfg. Overhead
for the year for the year
Unadjusted Actual Overhead
Balance overhead Applied
costs to jobs
$650,000 $680,000
$30,000
overapplied
McGraw-Hill/Irwin
3-45
RoseCo’s Cost RoseCo’s

of Goods Sold Mfg. Overhead
for the year for the year
Unadjusted Actual Overhead
Balance overhead Applied
costs to jobs
$30,000
$650,000 $680,000
Adjusted $30,000 $30,000
Balance overapplied
McGraw-Hill/Irwin
3-46
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
McGraw-Hill/Irwin
3-47
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.
McGraw-Hill/Irwin
3-48
The Concept of Activity-Based
Costing (ABC)
One of the most

difficult tasks in Assigning
overhead is
computing accurate sure difficult.
I agree!
unit costs lies in
determining the
proper amount of
overhead cost to
assign to each job.
McGraw-Hill/Irwin
3-49
The Concept of Activity-Based
Costing (ABC)
Activity-Based
Costing
Departmental
Overhead
i ty
Rates ex
pl
o m
Plantwide f C
Overhead l o
ve
Rate Le
Overhead Allocation
McGraw-Hill/Irwin
3-50
Plantwide Overhead Rate
Companies tend to use direct labor

as the overhead allocation base.
McGraw-Hill/Irwin
3-51
Departmental Overhead Rates
Finishing Department
A two-stage process is
Painting Department necessary because different
departments may have
Shipping Department different cost drivers.
McGraw-Hill/Irwin
3-52

Indirect Indirect Other
Labor Materials Overhead
Stage One:
Costs assigned
to pools
Department Department Department
Cost pools
1 2 3
McGraw-Hill/Irwin
3-53

Stage One:
Costs assigned
to pools
Cost pools
1 2 3
McGraw-Hill/Irwin
3-54

Stage One:
Costs assigned
to pools
Cost pools
1 2 3
McGraw-Hill/Irwin
3-55

Stage One:
Costs assigned
to pools
Cost pools
1 2 3
Direct Machine Raw
Stage Two: Labor Hours Materials
Costs applied Hours Cost
to products
Products
Departmental Allocation Bases
McGraw-Hill/Irwin
3-56
Activity-Based Costing
In
In the
the ABC
ABC method,
method,
we
we recognize
recognize that
that many
many
activities
activities within
within aa
department
department drive
drive
overhead
overhead costs.
costs.
McGraw-Hill/Irwin
3-57
Assigning Costs to Activity
Centers
Assign costs to the

activity centers
where they are
accumulated while
waiting to be
applied to
products.
McGraw-Hill/Irwin
3-58
Selecting Cost Drivers
Assign costs from When selecting a cost

driver consider:
the activity center
 The ease of obtaining
to the product data.
using appropriate  The degree to which
cost drivers. the cost driver

measures actual
consumption by
products.
McGraw-Hill/Irwin
3-59
Job-Order Costing in
Nonmanufacturing Organizations
THE JOB
Cases Missions
Programs Contracts
McGraw-Hill/Irwin
3-60
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.
McGraw-Hill/Irwin
3-61
Job-Order Costing – Typical
Accounting Entries
Let’s look at
summary journal
entries for a job-
order costing
system. We’ll omit
the numbers so
that we can focus
on accounts.
McGraw-Hill/Irwin
3-62
Material Purchases
Raw material purchases are recorded in an

inventory account.
GENERAL JOURNAL Page 3

Post.
Date Description Ref. Debit Credit
Raw Material Inventory XXXXX
Accounts Payable XXXXX
McGraw-Hill/Irwin
3-63
Material Use
Direct materials issued to a job increase Work in
Process and decrease Raw Materials. Indirect
materials used on a job are charged to Manufacturing
Overhead and also decrease Raw Materials.

Post.
Work-in-Process Inventory XXXXX
Manufacturing Overhead XXXXX
Raw Material Inventory XXXXX
McGraw-Hill/Irwin
3-64
Labor
The cost of direct labor incurred on a job increases
Work in Process and the cost of indirect labor on a
job increases Manufacturing Overhead.

Post.
Wages Payable XXXXX
McGraw-Hill/Irwin
3-65
Other Actual Manufacturing
Overhead
In addition to indirect materials and indirect labor,
other manufacturing overhead costs are charged to
the Manufacturing Overhead account as they are
incurred.

Post.
Prepaid Rent XXXXX
Accumulated Depreciation XXXXX
Prepaid Insurance XXXXX
McGraw-Hill/Irwin
3-66
Applying Manufacturing Overhead

Work in Process is increased when Manufacturing
Overhead is applied to jobs.

Post.
McGraw-Hill/Irwin
3-67
Selling and Administrative
Expenses
Nonmanufacturing costs (period expenses)
expenses are
charged to expense as they are incurred.

Post.
Selling and Admin. Expenses XXXXX
Wages Payable XXXXX
Prepaid Rent XXXXX
Office Supplies Inventory XXXXX
McGraw-Hill/Irwin
3-68
Cost of Goods Manufactured

As jobs are completed, the cost of goods
manufactured is transferred to Finished Goods
from Work in Process.

Post.
Finished-Goods Inventory XXXXX
McGraw-Hill/Irwin
3-69
Sales
When finished goods are sold, two entries are
required: (1) to record the sale; and (2) to record
Cost of Goods Sold and reduce Finished Goods.

Post.
Accounts Receivable XXXXX
Sales XXXXX
Cost of Goods Sold XXXXX

Finished-Goods Inventory XXXXX
McGraw-Hill/Irwin
3-70
Underapplied Manufacturing
Overhead
Underapplied manufacturing overhead is closed
into Cost of Goods Sold.

Post.
Cost of Goods Sold XXXXX
McGraw-Hill/Irwin
3-71
End of Chapter 3
McGraw-Hill/Irwin

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3-1

Product Costing and

Product and Service Costing

Types of Product-Costing Systems

 Used for production of small,

Types of Product-Costing Systems

Typical process cost applications:

Types of Product-Costing Systems

 Used for production of large,

Types of Product-Costing Systems

Types of Product-Costing Systems

 Typical job-order cost applications:

The primary document

Job-Order Cost Accounting

Cost Summary Units Shipped

Job-Order Cost Accounting

authorize the use of

Materials Requisition Form

Requisition No. X7 - 6890 Date 3-4-X2

Description Quantity Unit Cost Total Cost

Materials Requisition Form

Requisition No. X7 - 6890 Date 3-4-X2 Cost of material

Job-Order Cost Accounting

Cost Summary Units Shipped

Job-Order Cost Accounting

Employee Time Ticket

Time Ticket No. 36 Date 3-5-X2

Starting Ending Hours Hourly

Totals 8.00 $ 11.00 $ 88.00 A-143

Job-Order Cost Accounting

Cost Summary Units Shipped

Job-Order Cost Accounting

Cost Summary Units Shipped

Job-Order Cost Accounting

Cost Summary Units Shipped

Manufacturing Overhead Costs

Overhead applied = POHR × Actual activity

Based on estimates, and Actual amount of the allocation

Manufacturing Overhead Costs

Overhead applied = POHR × Actual activity

Overhead Application Example

Overhead Application Example

Budgeted manufacturing overhead cost

POHR = $4.00 per DLH

For each direct labor hour worked on a

Overhead Application Example

Cost Summary Units Shipped

Overhead Application Example

Cost Summary Units Shipped

Job-Order System Cost Flows

Let’s examine the

Job-Order System Cost Flows

Job-Order System Cost Flows

Next let’s add

Job-Order System Cost Flows

Job-Order System Cost Flows

Job-Order System Cost Flows

Job-Order System Cost Flows