Session 3: Manufacturing Costs and Job Overheads Flashcards
What are product costs (aka manufacturing costs)?
Product Costs Product costs are the direct costs involved in producing a product. A manufacturer, for example, would have product costs that include: - Direct labor - Raw materials - Manufacturing supplies
Overhead that is directly tied to the production facility such as electricity. For a retailer, the product costs would include the supplies purchased from a supplier and any other costs involved in bringing their goods to market. In short, any costs incurred in the process of acquiring or manufacturing a product are considered product costs.
Product costs are often treated as inventory and are referred to as inventoriable costs because these costs are used to value the inventory. When products are sold, the product costs become part of costs of goods sold (expensed) as shown in the income statement. This ensures a proper matching of revenue with costs necessary to produce it.
What is flow of costs?
Flow of costs refers to the manner or path in which costs move through a firm. Typically, the flow of costs is relevant with manufacturing companies whereby accountants must quantify what costs are in raw materials, work in process, finished goods inventory, and cost of goods sold.
Flow of costs applies not only to inventory but also to factors in other processes to which a cost is attached, such as labor and overhead.
Understanding Flow of Costs
The process of the flow of costs begins with valuing the raw materials used in manufacturing. The flow of costs then moves to the work-in-process inventory. The cost of the machinery and labor involved in production are added as well as any overhead costs. The flow of costs next moves to the inventory stage where the finished goods are stored until they’re sold. Following the sale of the goods, the flow of costs finally moves to cost of goods sold.
There are several methods for accounting for the flow of costs. These include LIFO (last in, first out), FIFO (first in, first out), specific identification, and weighted-average cost. For example, the costs of raw materials might vary over time, whereby some are higher in price than others. After the goods are sold, the company must account for the cost of goods sold by removing the items from inventory to COGS.
Under the FIFO method, the first raw material purchased would be moved from inventory and charged to COGS as an expense. Conversely, if the company used the LIFO method, the last unit of raw materials purchased would be moved from inventory and charged to COGS as an expense.
In other words, with the LIFO method, the oldest raw materials are kept or recorded in inventory longer while FIFO leaves the recently purchased materials in inventory. Companies must use the same cost flow calculations and assumptions.
What drives the cost flows in job costing?
• In Job Order Costing systems a Job-Cost Sheet is
used to accumulate/capture:
– Direct Material Cost (from materials requisitions forms)
– Direct Labour Cost (from time tickets/sheets)
– Manufacturing Overhead - based on firm’s overhead
absorption approach, and more specifically:
• Job’s quantity of the allocation base consumed (e.g. direct labour hours)
• € overhead allocation rate (e.g. € per direct labour hour)
What is the formula for department O/H absorption rates?
Department O/H Absorption Rates = Overhead costs/Allocation Base Volume
What are the challenges with manufacturing O/H?
- Can’t be directly traced to goods/services produced
- Increasingly material e.g. due to automation
Overhead allocation imperfections likely to be
material…and therefore create challenges (1) for decision making e.g. product pricing, product & customer profitability (2) for reporting that drives the right behaviour.
• Stage 1 OHs may not be readily traceable to departments; Apportionments may be used but not be truly valid e.g.
• Stage 2 Allocation base(s) do not ‘drive’ all the OH costs – so
OH ‘saved’ by say cutting Direct Labour exaggerated
• OH costs may actually be fixed in the short run anyway
• Aspects of OH likely non-controllable by product managers
• Overall Allocating OH may reduce focus on it in department
where it originates and may be most controllable
What are the different ways of allocating Manufacturing O/H, by level of complexity?
By level of complexity: one plant-wide O/H rate; departmental O/H rates; Activity-Based Costing. Each level increases the number of cost pools.
What is the O/H absorption rate formula (pre-determined)?
Overhead absorption rates typically Pre-determined
i.e. = Budgeted (expected) overhead
Budgeted (expected) allocation base volume (e.g. DLHs)
Why should predetermined O/H absorption rates be used?
– Actual overheads & allocation base volume(s) will only
be known after-the-fact
– But need overhead absorption rate(s) earlier e.g.
• for pricing / quotations
• for valuation of inventory in monthly management accounts
– Overhead absorption rates prepared intra year may
be distorted by seasonality in production
What should be done with under- or over-applied OH?
At the end of the accounting period, the amount of under- or over-applied OH is equal to the balance in Manuf. OH. This account must be closed, and accounts must be adjusted to reflect actual OH costs. If the amount is very small, because estimates were well done, the account is typically closed and CoGs adjusted (Debit CoGs, Credit Mf.OH). However, if the amount is material and not very close to the original predetermined rate estimations, it is preferable to apportion costs across WIP, Finished Goods, CoGs (Debit WIP, Finished Goods, CoGs, Credit MfOH for the sum of all the previous three).
What is the difference between product and period costs?
Period costs and product costs are two categories of costs for a company that are incurred in producing and selling their product or service. Below, we explain each and how they differ from one another.
KEY TAKEAWAYS
Product costs are those directly related to the production of a product or service intended for sale.
Period costs are all other indirect costs that are incurred in production.
Overhead and sales & marketing expenses are common examples of period costs.
What are indirect materials / indirect material costs?
Materials that are not directly traced to a product, where tracing the costs to a particular product, while possible, is likely not worthwhile (e.g. glue, screws).
What is manufacturing O/H?
The cost of all manufacturing activities other than direct material and direct labour. It includes indirect material, indirect labour, and a variety of other costs, e.g. depreciation.
What is a product cost?
Those costs assigned to goods produced.
What is a period cost?
Those cost identified with accounting periods rather than with goods produced. These include selling and general and administrative costs, e.g. this would include rent paid on an office building, but NOT rent paid on a factory.
What does full cost refer to in terms of GAAP?
Means that product costs include variable and fixed manufacturing O/H, as well as direct material and direct labour.
