1. 2 kinds of production environments lo1: describe the different kinds of production environments

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Kinds of Production Environments

LO1: Describe the different kinds of production environmentsLO1: Describe the different kinds of production environments

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Production Environments• Job shops and Job costing

Customized products in small lots Shipyards, custom-built houses

High traceability of many costs Overhead is an exception

• With small batches and make-to-stock The batch is the unit of analysis

Has distinct job number All units move as one through the production process

Job is either complete or not Cost therefore either in COGM or in WIP

LO1: Describe the different kinds of production environmentsLO1: Describe the different kinds of production environments

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Production Environments• Process shops and process costing

Similar products in large lots Chemicals, fertilizer

Limited traceability of costs to individual units Units in the same batch might be at different levels of

completion Need to allocate costs between COGM and WIP

• Operations costing Aspects of both job and process costing

Garment manufacturing

LO1: Describe the different kinds of production environmentsLO1: Describe the different kinds of production environments

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a) an oil refinery.

b) a paper company.

c) a custom-home builder.

d) a car dealership.

Test Your Knowledge!The most logical business which would use job order costing would be:

A maker of custom ordered items would most likely use job order costing.

A maker of custom ordered items would most likely use job order costing.

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Cost Flows Through Accounts

LO2: Explain the flow of costs in a job LO2: Explain the flow of costs in a job shopshop

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Cost Flows• Regardless of environment, flow of costs through

the inventory accounts is similar• Job shops

Individual job is the “unit of analysis” Can trace materials and labor to individual job Have to allocate overhead

Account balances are sum of costs if individual jobs

LO2: Explain the flow of costs in a job LO2: Explain the flow of costs in a job shopshop

Beginning WIP = Value of jobs unfinished at start of accounting periodBeginning WIP = Value of jobs unfinished at start of accounting period

Ending WIP = Value of jobs unfinished at end of accounting periodEnding WIP = Value of jobs unfinished at end of accounting period

COGM = Value of jobs completed during the accounting periodCOGM = Value of jobs completed during the accounting period

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a) Finished goods inventory.

b) Work-in-process inventory.

c) Cost of goods manufactured.

d) Raw materials inventory.

Test Your Knowledge!In a job-order costing system, direct labor costs are shown as an increase to what account?

Direct labor costs increase work-in-process inventory.Direct labor costs increase work-in-process inventory.

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Cost Flows in a Job Shop: Magna

LO2: Explain the flow of costs in a job LO2: Explain the flow of costs in a job shopshop

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Inventory Accounts

(12/1): Magna

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Analyzing Materials

• Materials flow through the inventory accounts Might separate accounts by kind of material

• For direct materials, keep track of which job materials were issued to Examples: Components

• For indirect materials, put into overhead control account Examples: Supplies

LO2: Explain the flow of costs in a job LO2: Explain the flow of costs in a job shopshop

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Analyzing Materials: Magna

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Analyzing Labor Costs

• Accumulated in control account Avoids having to deal with salary, bonus, and other

benefits as separate items Avoids having to deal with separate wage rates for

different workers (e.g., due to seniority)

• If direct labor, charge out to individual jobs

• If indirect labor, charge out to overhead control

LO2: Explain the flow of costs in a job LO2: Explain the flow of costs in a job shopshop

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Analyzing Labor: Magna

LO2: Explain the flow of costs in a job LO2: Explain the flow of costs in a job shopshop

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Analyzing Overhead

LO3: Apply overhead to jobs using predetermined LO3: Apply overhead to jobs using predetermined ratesrates

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Pre-Determined Overhead Rates

• Calculate Rate at start of accounting period Use estimated costs and denominator volume

• Use this rate to apply overhead to individual jobs Overhead applied to Job N = driver units in job N * pre-

determined rate Normal costing

• Triggers end of period adjustments

LO3: Apply overhead to jobs using predetermined LO3: Apply overhead to jobs using predetermined ratesrates

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• Suppose: Predetermined variable overhead rate = $0.30 per

direct labor dollar. Predetermined fixed overhead rate = $1.20 per

direct labor dollar.

Overhead Costs: Magna

LO3: Apply overhead to jobs using predetermined LO3: Apply overhead to jobs using predetermined ratesrates

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Analyzing WIP Accounts

We get the data for individual amounts for materials, labor and overhead for each job from the prior analyses

LO3: Apply overhead to jobs using predetermined LO3: Apply overhead to jobs using predetermined ratesrates

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Flow Through the WIP Account

LO3: Apply overhead to jobs using predetermined LO3: Apply overhead to jobs using predetermined ratesrates

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Flow Through The FG Account: COGS

LO3: Apply overhead to jobs using predetermined LO3: Apply overhead to jobs using predetermined ratesrates

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Under LIFO, all 2,200 units would be sold from December’s production. Thus, 2,200 x $68 = $149,600.

Under LIFO, all 2,200 units would be sold from December’s production. Thus, 2,200 x $68 = $149,600.

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• Use of estimated rates means a difference between the inflows and outflows into the overhead control accountActual overhead = Amount of overhead costsApplied overhead = Allocate to products by a pre-determined rate

• We can charge out too much or too little. IF

• Generally,

End of Period Adjustments

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

Under or Over-applied

Overhead=

Actual Overhead

–Applied

Overhead

Actual Rate < Pre-determined Rate

Under-applied overhead

Actual Rate > Pre-determined Rate

Over-applied overhead

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Calculations for Magna

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

Actual fixed overhead costs $76,582 (Given)

Applied fixed overhead cost $83,544 (120% of $69,620)

Overapplied fixed overhead $ 6,962

Check To See Why

Actual labor cost $69,620

Actual fixed overhead rate for the month

___________

Predetermined overhead rate $1.20 per labor $

Error in rate ___________

Error in rate × actual labor cost ___________

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$78,582

$69,620

$1.10 / labor $

$83,544

$6,962 (over-applied)

$6,962

$0.10 higher

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Disposition

• Three methods permitted Write off entire amount to COGS Prorate (i.e., allocate) among WIP, FG and

COGS accounts Re-compute the rates

• All three methods comply with GAAP All methods essentially allocate the

under- / over-applied overhead Differ in the accounts charged for the error

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

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$4,623,800

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Add under-applied overhead and subtract overapplied overhead to determine the adjusted COGS as $4,629,450.

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$4,629,450

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Disposition: Comparison

• Write off is least correct Assumes entire error relates to COGS

• Proration is better Assumes error is proportional to end of period value Should be proportion to current period overhead in the

account

• Correcting rates is most accurate

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

WIP Inventory

FG Inventory

COGS

Write off to COGS X

Proration (allocation) X X X

Actual rates (assignment) X X X

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Which Method To Use?

• Write off to COGS is the easiest method. OK if amount is not large Easy to implement. Most inaccurate.

• Proration (i.e., allocating among) is common. Uses of end of year balances as the basis Most commonly used

• Re-computing rates is most accurate. Easy if system is computerized

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

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Examples• If overhead is under-applied, we have used “smaller than

actual” rates. Thus, inventory accounts are under-valued. The adjustment therefore increases inventory values and cost of goods sold. Opposite reasoning of over-applied overhead. The adjustment

decreases inventory values and COGS.

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

Unadjusted cost of goods sold (Jan-Nov) $4,245,000

Cost of goods sold 378,000

Total unadjusted cost of goods sold $4,263,800

- Over-applied variable overhead for the year 25,689

+ Under-applied fixed overhead for the year 15,963

= Adjusted cost of goods sold $4,614,074

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Example: Proration• Proration allocates the under- or over-applied

overhead to WIP, FG and COGS accounts

• Uses end of year balances as the allocation basis

LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead. LO4: Perform end-of-period adjustments for disposing of under- or overapplied overhead.

WIP Inventory

FG Inventory

COGS

Unadjusted balance as of 12/31 $21,000.00 $285,500.00 $4,623,600.00

% of total 0.4% 5.8% 93.8%

Unadjusted balance as of 12/31 $21,000.00 $285,500.00 $4,623,600.00

- Over-applied variable overhead 1,014.42 1,487.58 24,092.00

+ Under-applied fixed overhead 67.99 924.37 14,970.63

= Adjusted values $20,958.57 $284,936.79 $4,614,648.63

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Basic job costing (LO2) Tubbs and Company manufactures custom motorcycles. Tubbs uses a job-cost system and provides the following information related to the work-in-process account for the month of January:

Required:Determine the cost of goods manufactured during January.

Exercise 14.26

January 1 balance $22,500

Direct material used 25,000

Direct labor incurred 24,000

Manufacturing overhead applied 36,000

Tubbs applies manufacturing overhead based on direct labor cost. Job No. 232 was the only job still in process at the end of January. As of January 31, this job, which was started in January, contains direct materials of $4,250 and direct labor of $2,500.

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Exercise 14.26 (Continued)Determine the cost of goods manufactured during January.

We can use the inventory equation for the WIP account to answer the question.

Beginning WIP + (materials + labor + applied overhead) = COGM + Ending WIP.

We know the items on the left hand side. But, we need to calculate Ending WIP, which will be the costs charged to job 232.

We can use the inventory equation for the WIP account to answer the question.

Beginning WIP + (materials + labor + applied overhead) = COGM + Ending WIP.

We know the items on the left hand side. But, we need to calculate Ending WIP, which will be the costs charged to job 232.

Direct materials $4,250        

Direct labor $2,500        

Mfg. overhead $3,750   $2,500 × $1.50 per labor $

Ending WIP $10,500        

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Exercise 14.26 (Concluded)Determine the cost of goods manufactured during January.

Direct materials $4,250        

Direct labor $2,500        

Mfg. overhead $3,750   $2,500 × $1.50 per labor $

Ending WIP $10,500        

(We use the total amounts charged to WIP to calculate the overhead rate as $36,000 applied overhead /$24,000 labor $ = $1.50 per labor

dollar.)

(We use the total amounts charged to WIP to calculate the overhead rate as $36,000 applied overhead /$24,000 labor $ = $1.50 per labor

dollar.)

Thus, we have:

COGM = $22,500 + (25,000+24,000 + 36,000) - $10,500 = $97,000.

Thus, we have:

COGM = $22,500 + (25,000+24,000 + 36,000) - $10,500 = $97,000.