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Cost accounting

Purpose Current / Future Product Costs Short-term decisions: product mix, pricing Future Longer-term strategic decisions Long-term pricing Plan future product-related costs Control of product costs Current Reimbursement contracts External reporting (inventory calculation) All the information cannot come from one source. The main accounting system may accumulate current and past costs but for much decision-making and planning, estimates of future costs will need to be generated outside of that accounting system.

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ARQ. 3 How common are product costing systems in practice? Why might a business choose to do without a product costing system? L-S, T & H, page 134. A recent survey of members of the Chartered Institute of Management Accountants COMA) found that less than 50 per cent of respondents had systems for costing products in their organization, and in small organizations this figure fell to 34 per cent (COMA, 2009). The range of costs included within a product costing system varies from one organization to another.

A comprehensive picture of product costs requires the inclusion of upstream and downstream costs. In practice many businesses confine their product costing systems to manufacturing costs. This is particularly true of small to medium-sized manufacturing businesses since more comprehensive costing systems cost more to implement and maintain. The costing systems that only include manufacturing costs produce the inventory valuations for external financial reporting required by Australian accounting standards.

Any additional product-related costs must be identified through special studies. Often, smaller businesses do not have the resources for special studies, and managers may rely on product costs developed for although it must reflect management’s assessment of the costs and benefits of obtaining more relevant product cost information! ARQ. 5 ‘We don’t need a product costing system. We are a small manufacturer with a Just-in-time approach so that our inventories are minimal. We have no influence over product price; whatever the big fellows do, we follow.

Anyway•ay, our accountant only comes in on Fridays and she is already far too busy to bother with a product costing system. ‘ Is this a reasonable attitude? Explain why. L-S, T & H, pages 130-134. This is not entirely satisfactory. There are a range of decisions that product costs may be useful for. Even though the business is a ‘price-taker’, they may well need to consider whether they should be making all of the products in the range, as some may be unprofitable. A wrong decision on one product may cost the firm more than it goes to keep a costing system going.

A product costing system may well help them control production costs and recognize problems before it is too late. The firm will need some product costs at year-end to value inventory even if it is minimal. ARQ. 7 Describe the flow of costs through a product costing system used to value inventory. What special ledger accounts are involved, and how are they used? L-S, T & H, pages 134-136. When direct material, direct labor and manufacturing overhead costs are incurred, they are applied to work in process inventory by debiting the account.

When goods re finished, the costs are removed from the work in process account with a credit, and are then transferred to finished goods inventory by debiting that account. Subsequently, when the goods are sold, the finished goods inventory is credited and the costs are added to the cost of goods sold, with a debit. See Exhibit 4. 3 below: ARQ. 8 Applying manufacturing overhead to products involves four steps. Describe each step. L-S, T & H, page 138. Firstly, what is manufacturing overhead? Manufacturing overhead is indirect costs attributed to manufacturing activities.

Some examples of manufacturing overhead costs are depreciation of production chicanery, quality inspector’s salary, local council rates for the factory, and electricity costs. These costs cannot be easily traced to particular products so a proportion of these costs must be assigned to each product. The easiest way to do this is to accumulate overhead costs in one or more cost pools and then allocate these costs to products using cost drivers. The three steps followed when applying manufacturing overhead to products are: (1) Aggregating the overhead costs into cost pools.

Gathering up similar costs into cost pool(s). (2) Identifying the overhead cost driver, which is the factor that causes the overhead costs to be incurred; (3) Calculating the predetermined (or budgeted) overhead rate per unit of cost driver, which is usually based on the budgeted annual manufacturing overhead cost, divided by the budgeted annual volume of cost driver; and (4) Applying manufacturing overhead costs to products, by multiplying the predetermined overhead rate by the amount of cost driver consumed by the product. ARQ. 9 What are the causes of underplayed and oversupplied overhead?

When T & H, pages 139-140. Oversupplied or underplayed overhead is caused by errors in estimating the predetermined overhead rate. These errors can occur in the numerator (budgeted manufacturing overhead), or in the denominator (budgeted level of the cost driver). The text book recommends that the oversupplied or underplayed overhead account should be closed at the end of the year only. If the oversupplied or underplayed is closed at the end of each month, the monthly fluctuations in overhead costs and cost driver volumes are shifted out to the cost of goods sold.

Over the year many of these fluctuations are likely to average out. Oversupplied and underplayed overhead should be considered for the whole year, not at the end of each month. ARQ. 10 Briefly describe two ways of disposing of oversupplied and underplayed overhead at the end of the accounting period. L-S, T & H, page 140. Oversupplied or underplayed overhead can be closed directly into cost of goods sold, or it can be prorated among work in process inventory, finished goods inventory and cost of goods sold. If the amount of underplayed or oversupplied overhead is significant, it should be prorated. ARQ. 1 Explain the difference between Job costing and process costing. Give three examples (other than those in the chapter) of businesses that you would think would use: a. Job costing system b. Process costing system. Explain your choices. L-s, T & H, pages In a Job costing system, costs are assigned to batches or Job orders of production. Job costing systems are used by firms that produce relatively small numbers of dissimilar products. Job costing would be used in any situation where products are produced to customers’ specifications, such as in a dressmaking business, an architectural firm, or in a panel-beating shop.

In a process costing system, production costs are averaged over a large number of product units. Process costing systems are used by firms that reduce large numbers of nearly identical products, such as paint, beer or bricks. In Job costing situations, the Job has specific characteristics that allow it to be identified from the outset, and direct costs can be traced to the Job. In a process costing environment, such as producing paint, each litter of paint is identical to every other litter and cannot be distinguished.

This means that direct costs must be traced to the production process and then averaged across all units produced. ARQ. 14 What are the purposes of the following documents? (a) Job cost sheet? (b) Material requisition form? C) Labor time sheet? L-s, T & H pages 144-148. (a) The Job costing sheet is used to summaries the costs of direct material, direct labor, and manufacturing overhead that relates to a particular Job. (b)A material requisition form authorities the transfer of raw material from the warehouse to the production department, and is used to record the cost of materials for Jobs. C) A Explain the meaning of the following terms in the schedule of the cost of goods manufactured: (a) Total manufacturing costs. (b) Manufacturing costs to account for. (c) Cost of goods manufactured. L-s, T & H, pages 152-154. A) Total manufacturing cost is the cost of materials and labor used and the overhead applied during the period. (b) Manufacturing costs to account for includes the cost of opening inventory for work in process and the total manufacturing costs for the period (requirement a). (c) Cost of goods manufactured is the total manufacturing cost adjusted for opening and closing inventory.

ARQ. 18 (appendix, Part 1). Describe how inventories are measured under Australian accounting standard SAAB 102 Inventories. Australian accounting standard SAAB 102 has several requirements relating to inventories arising from production: The cost of inventories reduced include the costs of: direct materials direct labor and on-costs sub-contracted work a systematic allocation of production overheads. The balance sheet must disclose separately the accounting policies adopted for measuring inventories, including work in process and finished goods.

Both of these requirements involve costs determined using Job costing systems and process costing systems. The valuing of work in process using process costing is not dealt with until Chapter 5. ARQ. 20 (appendix Part 2). Describe one advantage and one disadvantage of prorating oversupplied or underplayed overhead. An advantage of rotating oversupplied or underplayed overhead is that it results in the adjustment of all the accounts affected by inseminating the overhead rate.

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