Managerial accounting chapter 3 System design ( Job order costing )
Management accounting includes the field of product costing , process of assigning manufacturing costs to manufactured goods.
Why do we say that it is important?
We say it is important as the purpose of a costing system is to provide information to the manager for the role of decision making .
The unit cost is needed for :
a) Pricing products and services ( dont ignore market forces or competition)
Examples : Pharmaceuticals, Beverages, cosmetics.
You sell normally at a higher prices for those products.
b) Adding and dropping products. Make bunch of products , focus on products that making higher margins of sales. Could make or buy decisions. Do we make something or do we buy from someone else. UBC starbucks, Do we make it or do we buy from someone else ( outsourcing ) . Another example is hotels. Do i clean the towels and laudry or do i outsource it for someone else to do it for me. Make 10000 towels the day , not enough to spread out the economies of scale. Another example is white spot, do i make my own desserts or do i get it from someone else.
c) Access or reject special orders ( excess capacity ) , we need product cost information for balance sheet , We will accept a project if the price is greater than the variable cost as you will have higher margin of profit.
Process costing system : homogenous product , things like beer and milk.
The only thing you will do in theory would be single homogenous products that is produced for a long time.
The basic approach would be to take cost for entire period and divide by the number of units producted during the period
Job order costing
Used in situations where many different jobs , products and services are being manufactured or provided each period.
Service industry for example. Different products , different clients , Make to order.
The manufacturing of any product involves what kind of costs ?
Direct labout, direct material and manufacturing overhead.
Production process begins with transfer of raw material to production line , transfer may be direct materials and also may include indirect materials. Why is it important to distinguish between both ?
It is because direct materials go into work in process whereas indirect materials go into actual Manufacturing overhead.
Manufacturing overhead ?
IT is easy to assign materials and labour costs to product and services . why?
Because they are direct costs
However its is difficult to assign manufacturing overhead costs to product and services since they are indirect costs.
Predetermined overhead rate is used to assign overhead costs to products and services. It is based on estimated data and it is established before a period begins ( at the beginning of the period )
Why do we use estimated data ?
Waiting until the period ( month or year ) to actually determine actual overhead cost would be too late. Managers need timely information for decision making purposes such as setting price for cost plus contracts and bidding for contracts and requests for proposals.
2 ) Overhead cost sometimes are uniform from month to month while activity may change substantially from month to month and vice versa. We need to average sometimes.
Predetermined overhead rate ( POH) =
Estimated total fixed and variable moh costs/ estimated activity level ( MH, DLH, ETC)
Assumes ubc allocates overhead cost to jobs on the basis of machine hours , for the coming year in 2013 we estimates that we will incur an amount of 600 000$ in manufacturing overhead and work 75000 machine hours.
My POH RATE = 600 000 / 75000= $8 PER MH
Refer to previous example now we will apply the manufacturing overhead. If the particular job requires 5000 $ for direct material and 3000 $ for labour, and the job requirement is 500 machine hours to complete the cost of the job therefore will be
Direct materials ( actual ) $ 5000
Direct Labour ( actual ) $3000
Applied MOH $ 4000 ( 500*8), as 8$ was my poh rate
What drives an overhead cost?
Cost driver , the incurrence of cost like machine hours as machine hours go up , moh goes up its a direct relationship.
Nowadays since automation we see a divergence towards more fixed costs since automation
Therefore the importance of direct labour is that it is decreasing and that MOH is increasing.
If an inaccurate base is used therefore we would yield inaccurate results.
A reminder of the rules of debits and credits would be
Dead = debits increase for (expenses, assets and dividends)
Assets liabilities
Dr + DR –
Cr – CR+
Shareholders equity is comprised of common shares and retained earnings
Common shares Retained earnings
Dr – DR –
CR + CR+
Retained earnings is comprised of expenses , dividends and revenues
Expenses dividends Revenues
Dr + DR + DR –
Cr – CR + CR +
Now lets take this as an example
a) UBC purchases raw material ( direct and indirect ) purchased on account for an amount of $ 150 000
Raw material inventory 150000
Accounts payable 150000
b) UBC purchases and issues / and requisitioned for used in production $ 160 000 ( 85 % direct materials and 15 % indirect materials )
Work in process inventory 0.85 *160000= 136000
MOH 0.15*136000= 24000
Raw material inventory 160000
c) UBC employee service costs : Direct labour of 200000, Indirect labour 85000, Selling and administrative salaries 90000
Work in process 200000
MOH 85000
Salaries expense 90000
Salaries and wage payable 90000
d) UBC Utilities cost for their wood processing factory 40000
MOH 40000
Cash 40000
e) Prepaid insurance expired during the year , 20000 ( 80 % factory operations , 20 % selling and administrative expenses)
MOH 0.8 *20000 $16000
Insurance expense 0.2*20000 4000 period cost
Prepaid insurance 20000
f) UBC Sauder school of business advertising costs incurrence $ 100 000
Advertising expense $ 100 000 Period cost
Cash $ 100000
G) Amortization/ Depreciation was recorded on UBC factory assets $ 145000, and selling and administrative assets $ 15000
Manufacturing overhead 145000
Amortization expense 15000 ( Period cost )
Accumulated amortization 160000
We will never see wage expenses ( factory workers or amortization expense as separate line items on a manufacturing company income statement ? No, these are product costs.
Dm used , dl and applied moh go into WIP, which goes into Finished goods when completed which goes into cogs when sold, therefore cogs is the ultimate expense for all manufacturing costs.
But, wage expense and amortization expense are period costs for the office equipment , ( Expensed as incurred)
g) Manufacturing overhead was applied to WIP. UBC predetermined overhead rate ( poh ) for 2011 was based on the following estimated data. Manufacturing overhead : 315 000 , Direct labour cost 210000
Estimate therefore would be 315000/210000= 150 % of direct labour cost
Therefore manufacturing overhead would be activity * rate
200000 * 150 %= 300 000
Therefore the journal entry to record the actual moh would be
Work in process inventory 300 000
Manufacturing overheard 300000
h) Costs of good manufactured of 650000 was transferred into finished goods.
Therefore this is the cost of goods manufactured.
We will :
Finished goods inventory 650000
Wip 650000
i) Sales for the entire year was on account an amount of 900000 $
Account receivable 900 000
Sales reveunue 900 000
J ) The company gross margin therefore would be 33 .333 % which means the company cost of goods sold is ( 67% )
Cost of goods sold 600000
Finished goods 600000
Raw material inventory
| 20000 | |
| a) 150000 | B ) 160000 |
Balance 10000
Manufacturing overhead
| b) 24000 | |
| c) 85000 | |
| d) 40000 | |
| e) 16000
|
|
| f) 145000 | |
| g) 300000 |
Therefore actual 310000 applied moh 300 000
Therefore balance 10000
Underappplied moh as actual is greater than applied moh, just to note that the ubc moh is 310000 actual one but what has been applied is only 300 000
Work in process inventory
| Balance 74000 | |
| 136000 | |
| 200000 | |
| 300000 | 650000 |
Balance 60000
Finished goods inventory
|
||||||||||
| Nothe that whatever was credited from Gogm was debited in Finished goods
And also Whatever would be credited from Finshed goods ( GOGS ) would be debited in GOGS |
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GOGS
| j) 600 000 | |
We need to dispose under and overapplied overhead since its is put into wip account which goes into finished goods and eventually into cogs. Applied overhead is based on a predetermined overhead rate ( poh rate ) at the beginning of the year.
By the end of the year then we know that the actual overhead is known. We want to include the actual moh in the wip , FG and GOGS account , however we cant until the the end of the year. During the year , for planning and decision making purposes , we calculate a poh rate and apply overhead to wip.
We prorate if its material , which means we allocate the under and over applied overhead to WIP , FG and COGS account if ( material) which is under over applied / actual >=5 %
Whereas we close under/over applied into gogs if immaterial <5 %
Therefore as 10 000/310000 = 3.2 %
Close the balance to cost of goods sold
Cost of goods sold 10000
Manufacturing overhead 10 000 Which is immaterial we want to make the underapplied overapplied which is immaterial zero
But if the results were Material >=5 %
| Work in process inventory | 60000 | 8% |
| Finished goods | 90000 | 12% |
| Cost of goods sold
Total |
600 000
750000 |
80%
100%
|
Therefore we can close the journal entry to get rid of MOH
WORK IN PROCESS 8 % *10000 800
FINISHED GOODS 12 %*10000 1200
GOGS 0.8* 10000 8000
MANUFACTURING OVERHEAD 10000
Also note that whatever is prorated to wip and finished goods will eventually end up as cost of goods sold next year.
What are managers biased to do :
Sometimes managers, based on bonus measure on profitability
Underapplied means that MOH will have a DR balance and then to close we will debit cost of goods solds and credit MOH. Thus COGS would be higher, there fore managers would want to prorate as it will result in a higher profit based since less than 100 % of cost of goods sold..
If overapplied this means that moh will have a CR balance and to clise we will credit cost of goods sold and debit MOH. Thus Cost of goods sold will be lower and therefore managers would prefer to Close to cost of goodsd sold as it will result in a higher profit. ( Since it will result in a higher profit. Since 100 % would be cr into cost of goods sold and a higher bonus thereby.
Therefore for the income statement we will have
UBC
Income statement
For the year ended December 31, 2011
Sales revenue $900 000
Cost of goods sold $ 610 000
Gross Margin $ 290 000
Summary of the overhead concepts
Estimated overhead costs = Amount of overhead cost that management will be incurred. The estimate is made before period begins in order to compute the predetermined overhead rate
Actual overhead Cost
The amount of overhead cost that is actually incurred in a period ( IDM, IDL, Utilities, rent and so on for the factory )
Applied overhead cost ( DR WIP. CR MOH) amount of overhead cost applied to work in process. Amount is computed by multiplying actual actvity used during a period by predetermining overhead rate
General models of cost flow
Raw material inventory
| Debited for purchases | Credited for Dm added to WIP |
| Credited for IM added to MOH | |
Work in process inventory
| Debited for cost of DM used , DL incurred, Applied moh | Credited for COGM |
Wage Payable
| Debited for wages paid ( direct and indirect) | Credited for labour into WIP |
| Credited for indirect labour into moh | |
Manufacturing overhead
| ACTUAL MOH | APPLIED MOH |
| UNDERAPPLIED | OVERAPPLIED
|
FINISHED GOODS INVENTORY
| GOGM | GOGS |
GOGS
| DEBITED COGS | |
WORK IN PROCESS
| Beginning balance | |
| Dm used ( this period) | Cogm |
| Dl incurred this period | |
| Applied MOH this period |
Where COGM = dm used + dl +applied moh + bwip – ewip
BWIP= dm used + dl uncured + applied moh
Incomplete at the period
EWIP
Dm USED + dl incurred + applied moh
Only jobs incomplete at the end of the period
Accounts receivable
| Beginning | ||
| Credit sales | Collection | |
| Ending balance | ||
Accounts payable
| Beginning balance | |
| Credit purchase | |
| Payments | |
| Ending balance |
Wage payable
| BEGINNING | |
| WAGES INCURRED | |
| WAGES PAID | |
| ENDING BALANCE |