Download Managerial Accounting Notes Chapters 1-3

INSTRUCTOR NOTES (CHAPTERS 1 – 3)
Job-Order Costing Characteristics
Two Methods:
1. Conventional Costing – uses only one overheard rate to allocate overhead.
2. ABC (Activity Based Costing) – uses several rates to allocate overhead. This method
is widely used for companies that can track the cost by the job, yet have a more complex
production process. By using several activities to allocate overhead to the job, the total
applied overhead will be more accurate and closer to the actual overhead cost.
This textbook covers Conventional Job-Order Costing in Chapter 2 and then continues
the discussion in Chapter 3 with Activity-Based Costing.
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Cost terms and Applications:
Product Cost – also called inventory or Manufacturing cost. Product costs are classified
as Assets and go directly to the Balance Sheet when incurred.
3 Types of Product Costs:
A. Direct Materials – Easily traced to the job (hint the word Direct, which implies
easily traced.
B. Direct Labor – Easily traced to the job (hint the word Direct, which implies easily
traced.
C. Manufacturing Overhead – is not easily traced to a job or product (hint: Overhead
is considered to be indirect material and indirect labor).
Since Manufacturing Overhead is not easily traced to a job or product unit, many
companies use a costing method called Job-Order Costing. Job-Order Costing allows
companies to essentially estimate a total overhead cost at the beginning of the year and
then allocate that overhead to individual jobs based on activities that are associated with
each job. Such activities could include: Direct Labor Hours, Machine Hours, Setup time,
Process Orders, etc...
The basic idea behind Job-Order costing is as follows:
1. First Calculate an Overhead Rate (This rate will be used to apply or assign estimated
overhead to each job).
Rate Formula: Estimated or Budgeted Overhead / Estimated or Budgeted Activity
2. Once the Rate is calculated, simply multiply the rate by the actual activities that are
associated with each job.
Rate X Actual Activity = Applied Overhead
3. Once the estimated overhead has been applied to each job, at the end of the year, the
total applied overhead for each job will be accumulated in the Manufacturing Overhead
Account (Credit Side) and then compared to the total Actual Overhead costs (in the debit
side of the Manufacturing Overhead account). A debit or credit balance will indicate if
overhead is either under or over-applied. Hint: Debit Balance indicates under-applied
and a Credit Balance will indicate over-applied.
In the end, it is important to get rid of the balance in the Manufacturing Overhead
Account, since the actual costs numbers is ultimately what you want to have happen
when you look at the Financial Statements. To correct this situation, simply debit or
credit the overhead account into Cost of Goods.
You will see these journal entries in your textbook so please reference them as you read
this.
Miscellaneous Items:
Period Costs – are expensed as incurred and go directly to the Income Statement as
expenses. Other names for period costs include: Non-Manufacturing Costs and Selling
or Administrative Costs.
Period costs represent activities that support the end product and are not directly involved
in the production aspect of the product. These types of activities include: Selling/Admin,
Advertising, Insurance, or any other costs that is associated with administrative costs.
Hint: an easy way to distinguish between period and product costs is to look for the word
“Factory”. If you see the word “Factory” associated with a cost, then it must be a product
cost. Otherwise, it most likely will be a period cost.
Note: It is very important for you to understand the difference between a Product Cost
and a Period Cost as your Financial Statements will be greatly affected.
A simple look at Cost Flow Assumptions should help you with this concept. Please refer
to the Powerpoints which will give you a good reference for Cost Flows.
To summarize briefly, the first step is as follows:
1. Identify the cost as a Product Cost or Period Cost
2. If the cost is a Period Cost, then it will flow directly to the Income Statement as an
expense.
3. If the cost is a Product Cost, then you next have to identify what type of Product cost
that you are trying to classify. For example, there are 3 Product Costs (Direct Material,
Direct Labor, and Manufacturing Overhead). The Product Cost must fall into one of
these categories.
4. Once the Product Cost has been identified, it then needs to be put appropriately on the
Balance Sheet.
However, before you do this, one more major classification needs to be identified. This
classification is Inventory. Although the concept of Product Cost does mean inventory, it
is also important to realize that there are 3 different types of Inventory. These 3
categories are:
1. Raw Materials Inventory
2. Work in Process Inventory (WIP)
3. Finished Goods Inventory
To fully understand cost flow, you need to visualize that product costs first begin with
Raw Materials, and then proceed to Work in Process as you are working on the product.
Finally, the product cost will flow to Finished Goods when finished.
The best way to really see this is to set up 3 T-Accounts for these inventory categories
and then draw arrows to indicate that the product costs will go from Raw Materials to
WIP and then to Finished Goods Inventory.
I always tell my students in class that no matter what, Work in Process will contain all of
the product costs at one point in time. Thus, Direct Materials, Direct Labor, and
Manufacturing Overhead, will all go through Work in Process at one point in time before
flowing to Finished Goods.
Schedule of Goods Manufactured: This schedule simply summarizes your product
costs. Again, let us go back to the basic concept of Product Cost to put this into
perspective. First, there are 3 Basic Product Costs (Direct Materials, Direct Labor, and
Manufacturing Overhead). Second, there are 3 categories of Inventory (depending on the
stage of production; Raw Materials, Work in Process, and Finished Goods). Lastly, look
that the formula for calculating the Schedule of Goods Manufactured:
Beg Raw Materials
+ Raw materials Purchased
= Raw materials Available
- Ending Raw Materials
= Raw materials used in production (Product Cost #1)
Plus: Direct Labor (Product Cost # 2)
Plus: Manufacturing Overhead (Product Cost #3)
Add the 3 product costs together and add these into Work in Process.
Raw Materials Used (Assume direct unless stated otherwise)
Direct Labor
Manufacturing Overhead
+ Beginning WIP
= Total Manufacturing Costs
- Ending WIP
= Cost of Goods Manufactured (Hint: this is the cost of Finished Goods)
If you take a close look at the formula on this schedule, you will see that it simply
summarizes all of your product costs and groups them into the different inventory
categories. Ultimately, you will end up with the cost of the finished goods.
The basic cost flow structure will be the same for the entire semester. Thus, once you
have an understanding of this after the first 3 chapters, you should be more comfortable
with more advanced and miscellaneous concepts that will be introduced later in the
semester.
Relating Job-Order Costing to the Schedule of Goods Manufactured
This is actually a very easy concept. Simply look at your Cost of Goods Manufactured
formula. It is the same for any costing method. The only thing that is different about this
formula for the schedule, is that you use APPLIED OVERHEAD, not Actual Overhead.
Actual Overhead is not used in a job order costing system when initially calculating the
cost of goods manufactured.
Since both Chapters 2 and Chapter 3 relate to Job-Order Costing, go back to Chapter1
and review the basic formula. However, for Chapters 2 and Chapter 3, substitute Applied
Overhead to get the cost of goods manufactured. Any variance with the actual overhead
data will be corrected with the Manufacturing Overhead Account and Cost of Goods Sold
at the end of the period.
It is very easy to get distracted in a lot of the textbook problems as the authors will show
you several different terms relating to overhead…but do not get confused…keep it simple
and follow my in class lecture and you should be fine.
Other Miscellaneous Items
Conversion Costs – Direct Labor + Overhead
Prime Costs – Direct Materials + Direct Labor
Sunk Costs – past costs and considered not relevant for decision making.
Cost Behavior
1.
Fixed Cost
a. Total Fixed Cost – Do not change within the relevant range (For example
Rent is fixed within a relevant time period; 6 month lease).
b. Per unit Fixed Cost – Vary inversely with activity. This means that has
activity increases, per unit Fixed Costs decrease…in other words, as you
produce more, your per unit costs actually decreases…or even more
simply put, your cost per unit will decline.
2. Variable Cost
a. Total Variable Cost – Varies directly with activity. For example, if you
produce more units, your total variable costs will increase (Direct labor).
b. Per Unit Variable Cost – is fixed within a relevant range. For example,
the labor rate per hour is fixed within a 40 hour work week.