Hilton • Maher • Selto
2Product Costing Systems
Concepts and Design Issues
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Product Costs
The cost assigned to
goods that were either purchased or manufactured
for resale.
Product Costs
The cost assigned to
goods that were either purchased or manufactured
for resale.
Period Costs
Costs that are identified with the period in
which they are incurred.
Period Costs
Costs that are identified with the period in
which they are incurred.
The Meaning of “Cost”?
The sacrifice made, usually
measured by the resources given up, to achieve a
particular purpose.
The sacrifice made, usually
measured by the resources given up, to achieve a
particular purpose.
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Manufacturing Companies
There are 3 major categories of manufacturing costs:
There are 3 major categories of manufacturing costs:
Direct Materialsresources that can be feasibly observed being used to make a
specific product.
Direct Materialsresources that can be feasibly observed being used to make a
specific product.
Direct LaborThe cost of
paying employees who convert direct materials into
finished product.
Direct LaborThe cost of
paying employees who convert direct materials into
finished product.
Manufacturing Overhead
Manufacturing Overhead
Indirect materialIndirect material
Indirect laborIndirect labor
Other overheadOther overhead
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Manufacturing Companies
Prime Costs include:Prime Costs include:
Direct MaterialsDirect Materials Direct LaborDirect Labor Manufacturing Overhead
Manufacturing Overhead
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Manufacturing Companies
Conversion Costs include:Conversion Costs include:
Direct MaterialsDirect Materials Direct LaborDirect Labor Manufacturing Overhead
Manufacturing Overhead
Nonmanufacturing Costs are all the costs not used to produce products.
Nonmanufacturing Costs are all the costs not used to produce products.
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Stages of Production and the Flow of Costs
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Stages of Production and the Flow of Costs - Example
What is Ending What is Ending Inventory in Inventory in February?February?
What is Ending What is Ending Inventory in Inventory in February?February?
Axel Electronics makes toasters. On Axel Electronics makes toasters. On February 1, Axel has $15,000 of raw February 1, Axel has $15,000 of raw material on hand. Axel’s purchase material on hand. Axel’s purchase
and transfers to the production floor and transfers to the production floor are indicated below.are indicated below.
Axel Electronics makes toasters. On Axel Electronics makes toasters. On February 1, Axel has $15,000 of raw February 1, Axel has $15,000 of raw material on hand. Axel’s purchase material on hand. Axel’s purchase
and transfers to the production floor and transfers to the production floor are indicated below.are indicated below.
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Axel Electronics makes toasters. On Axel Electronics makes toasters. On February 1, Axel has $15,000 of raw February 1, Axel has $15,000 of raw material on hand. Axel’s purchase material on hand. Axel’s purchase
and transfers to the production floor and transfers to the production floor are indicated below.are indicated below.
Axel Electronics makes toasters. On Axel Electronics makes toasters. On February 1, Axel has $15,000 of raw February 1, Axel has $15,000 of raw material on hand. Axel’s purchase material on hand. Axel’s purchase
and transfers to the production floor and transfers to the production floor are indicated below.are indicated below.
Stages of Production and the Flow of Costs - Example
Now let’s look at Now let’s look at Work-in-Process.Work-in-Process.
Now let’s look at Now let’s look at Work-in-Process.Work-in-Process.
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Stages of Production and the Flow of Costs - Example
What is the What is the amount of cost amount of cost transferred to transferred to
Finished Goods in Finished Goods in February?February?
What is the What is the amount of cost amount of cost transferred to transferred to
Finished Goods in Finished Goods in February?February?
On February 1, Axel had WIP of $30,000 on the factory floor.
During February, Axel paid $92,000 in direct labor wages. Overhead is applied
at 150% of direct labor. On 2/28,
$22,000 is still in WIP.
On February 1, Axel had WIP of $30,000 on the factory floor.
During February, Axel paid $92,000 in direct labor wages. Overhead is applied
at 150% of direct labor. On 2/28,
$22,000 is still in WIP.
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Stages of Production and the Flow of Costs - Example
On February 1, Axel had WIP of $30,000 on the factory floor.
During February, Axel paid $92,000 in direct labor wages. Overhead is applied
at 150% of direct labor. On 2/28,
$22,000 is still in WIP.
On February 1, Axel had WIP of $30,000 on the factory floor.
During February, Axel paid $92,000 in direct labor wages. Overhead is applied
at 150% of direct labor. On 2/28,
$22,000 is still in WIP.
Now let’s Now let’s look at look at
Finished Finished Goods.Goods.
Now let’s Now let’s look at look at
Finished Finished Goods.Goods.
Transferred Transferred to Finished to Finished
GoodsGoods
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Stages of Production and the Flow of Costs - Example
On February 1, Axel had Finished Goods of $125,000 on hand. At the end of February, a physical inventory count revealed
$96,000 in Finished Goods still on hand.
What was Cost of Goods Sold for February?
On February 1, Axel had Finished Goods of $125,000 on hand. At the end of February, a physical inventory count revealed
$96,000 in Finished Goods still on hand.
What was Cost of Goods Sold for February?
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Stages of Production and the Flow of Costs - Example
On February 1, Axel had Finished Goods of $125,000 on hand. At the end of February, a physical inventory count revealed
$96,000 in Finished Goods still on hand.
What was Cost of Goods Sold for February?
On February 1, Axel had Finished Goods of $125,000 on hand. At the end of February, a physical inventory count revealed
$96,000 in Finished Goods still on hand.
What was Cost of Goods Sold for February?
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Production Costs in the Service Industry
A service provider cannot “inventory” services.
The costs of providing the service can be identified and accounted for just as in a manufacturing environment.
Managing and tracking the costs associated with value-chain activities can provide opportunities for improvement.
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Cost Drivers
An “Activity” is any discrete task than an organization
undertakes to make or deliver a good or
service.
An “Activity” is any discrete task than an organization
undertakes to make or deliver a good or
service.
A “cost driver” is an activity or event that causes costs to be
incurred .
A “cost driver” is an activity or event that causes costs to be
incurred .
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Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges
level within the relevant range. of activity.
Fixed Total fixed cost remains the Fixed cost per unit goessame even when the activity down as activity level goes up.
level changes within therelevant range.
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges
level within the relevant range. of activity.
Fixed Total fixed cost remains the Fixed cost per unit goessame even when the activity down as activity level goes up.
level changes within therelevant range.
Cost BehaviorFixed vs. Variable
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Your total long distance telephone bill is based on how many minutes you talk.
Your total long distance telephone bill is based on how many minutes you talk.
Minutes Talked
To
tal L
on
g D
ista
nce
Tel
eph
on
e B
ill
Cost BehaviorFixed vs. Variable
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Minutes Talked
Per
Min
ute
Tel
eph
on
e C
har
ge
The cost per minute talked is constant. For example, 10 cents per minute.
The cost per minute talked is constant. For example, 10 cents per minute.
Cost BehaviorFixed vs. Variable
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Number of Local Calls
Mo
nth
ly B
asic
T
elep
ho
ne
Bill
Cost BehaviorFixed vs. Variable
Your monthly basic telephone bill is probably fixed and does not change when you make more local calls.
Your monthly basic telephone bill is probably fixed and does not change when you make more local calls.
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Number of Local CallsMo
nth
ly B
asic
Tel
eph
on
e B
ill p
er L
oca
l Cal
l
Cost BehaviorFixed vs. Variable
The fixed cost per local call decreases as more local calls are made.
The fixed cost per local call decreases as more local calls are made.
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componentscomponents
laborlabor
energyenergypartsparts
materialsmaterials
Resources that are acquired specifically for individual units of product or service
Resources that are acquired specifically for individual units of product or service
Unit-level Resources
Unit-level Resources
Directly traceable to the decision toproduce the level
of output
The Hierarchy of Costs
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Acquired as a result of the decision to make a group,or batch of similar products.
Acquired as a result of the decision to make a group,or batch of similar products.
Batch-levelBatch-level
MaterialsMaterials
Equipment Applicable to the BatchEquipment Applicable to the Batch
Specialized LaborSpecialized Labor
The Hierarchy of Costs
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Acquired as a result of the decision to produce andsell a specific product or service.
Acquired as a result of the decision to produce andsell a specific product or service.
Product-levelProduct-level
SoftwareSoftware
Personnel Applicable to that Product or ServicePersonnel Applicable to that Product or Service
Specialized EquipmentSpecialized Equipment
The Hierarchy of Costs
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Acquired as a result of the decision to serve specificcustomers.
Acquired as a result of the decision to serve specificcustomers.
Customer-levelCustomer-level
SoftwareSoftware
Personnel Dedicated to Specific CustomersPersonnel Dedicated to Specific Customers
Specialized EquipmentSpecialized Equipment
The Hierarchy of Costs
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Labor Force
Labor Force
ManagementManagementBuildingsBuildings
LandLand
Business
Support Services
Business
Support Services
Resources that are acquired specifically for individual units of product or service
Resources that are acquired specifically for individual units of product or service
Facility-level Facility-level
The Hierarchy of Costs
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Committed costs are fixed costs that are not intended to vary with production or sales volume.
Committed costs are fixed costs that are not intended to vary with production or sales volume.
If we get rid of John, we can
replace him with a new professor
making $20,000 a year less!
If we get rid of John, we can
replace him with a new professor
making $20,000 a year less!
That will certainly lower our budgeted
fixed costs.
That will certainly lower our budgeted
fixed costs.
Committed Costs, Opportunity Costs, & Sunk Costs
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Well, team, it looks like we are
gonna be working
overtime all week on this job.
Well, team, it looks like we are
gonna be working
overtime all week on this job.
Opportunity cost measures what is sacrificed when one alternative is chosen.
Opportunity cost measures what is sacrificed when one alternative is chosen.
And I passed up $95,000
with IBM for this?
Committed Costs, Opportunity Costs, & Sunk Costs
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Sunk costs are past payments for resources that cannot be undone.
Sunk costs are past payments for resources that cannot be undone.
I don’t want to replace John. We just spent
$30,000 to train him on the new
equipment!
I don’t want to replace John. We just spent
$30,000 to train him on the new
equipment!
But don’t you see? That $30,000 is gone. It is
irrelevant to our decision.
But don’t you see? That $30,000 is gone. It is
irrelevant to our decision.
Committed Costs, Opportunity Costs, & Sunk Costs
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Direct CostsAssigning resource costs to products and services through reliable observations and
documentation of resource use.
Direct CostsAssigning resource costs to products and services through reliable observations and
documentation of resource use.
Some products use more of a given resource than
others.
Some products use more of a given resource than
others.
Tracing is often more effective than using Average Cost, which assumes that each
product uses the same amount of each resource.
Tracing is often more effective than using Average Cost, which assumes that each
product uses the same amount of each resource.
Traceability of Resources
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Indirect CostsAttaching or assigning indirect costs to products,
services, or organizational units by some reasonable method of averaging.
Indirect CostsAttaching or assigning indirect costs to products,
services, or organizational units by some reasonable method of averaging.
Applied to costs that cannot be
efficiently traced.
Applied to costs that cannot be
efficiently traced.
Methods such as Activity-Based Costing result in more tracing and less
allocation.
Methods such as Activity-Based Costing result in more tracing and less
allocation.
Example
Traceability of Resources
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Tracing versus Allocating Costs - Example
Brickley, Inc. makes two products; bricks and play sand. The products are produced in two separate facilities, and the plant supervisors work at both plants. Allocate rent
and salaries based on revenues.
Brickley’s headquarters is downtown.
Brickley, Inc. makes two products; bricks and play sand. The products are produced in two separate facilities, and the plant supervisors work at both plants. Allocate rent
and salaries based on revenues.
Brickley’s headquarters is downtown.
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The brick operation consumes 70% of the material purchased. The play sand uses the remaining 30%.
Labor has an average cost of $10 per hour. The brick operation uses 21,000 labor hours. The play sand
operation uses 14,000 labor hours.
The company pays all utilities on one bill that goes to the headquarters. Headquarters allocates 50% of the utilities
cost to each product.
The brick operation consumes 70% of the material purchased. The play sand uses the remaining 30%.
Labor has an average cost of $10 per hour. The brick operation uses 21,000 labor hours. The play sand
operation uses 14,000 labor hours.
The company pays all utilities on one bill that goes to the headquarters. Headquarters allocates 50% of the utilities
cost to each product.
Tracing versus Allocating Costs - Example
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Compute the missing values and information.
Compute the missing values and information.
Tracing versus Allocating Costs - Example
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Sales Revenue is TRACED to each product based on the actual revenue each product generates.
Example: Sand Revenue = 30,000 tons × $90 per ton
Sales Revenue is TRACED to each product based on the actual revenue each product generates.
Example: Sand Revenue = 30,000 tons × $90 per ton
Tracing versus Allocating Costs - Example
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Tracing versus Allocating Costs - Example
Material and Labor are traced to each product based on how much of each resource each product uses.
Example; Bricks labor = 21,000 hours × $10 per hour
Material and Labor are traced to each product based on how much of each resource each product uses.
Example; Bricks labor = 21,000 hours × $10 per hour
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Tracing versus Allocating Costs - Example
Supervisor salaries and rent are allocated on the basis of relative revenues. Approximately 35.7% goes to
Bricks. Approximately 64.3% goes to Sand.
Supervisor salaries and rent are allocated on the basis of relative revenues. Approximately 35.7% goes to
Bricks. Approximately 64.3% goes to Sand.
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The utilities are allocated from the home office with 50% of the utilities being charged to each product.
The utilities are allocated from the home office with 50% of the utilities being charged to each product.
Tracing versus Allocating Costs - Example
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Variable Costing measures product cost by the unit-level resources
used.
Variable Costing measures product cost by the unit-level resources
used.
Absorption Costing allocates indirect costs to products
along with unit-level and variable costs.
Absorption Costing allocates indirect costs to products
along with unit-level and variable costs.
Income-Reporting Effects of Alternative Product-Costing Methods
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Absorption Costing
Variable Costing
Direct materialsDirect labor Product costs
Product costs Variable mfg. overhead
Fixed mfg. overheadPeriod costs
Period costs Selling & admin. exp.
Absorption Costing
Variable Costing
Direct materialsDirect labor Product costs
Product costs Variable mfg. overhead
Fixed mfg. overheadPeriod costs
Period costs Selling & admin. exp.
Income-Reporting Effects of Alternative Product-Costing Methods
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Absorption Costing vs. Variable Costing - Example
Howell, Inc. produces a single product with a sales price of $40 and the following cost information:
Howell, Inc. produces a single product with a sales price of $40 and the following cost information:
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Unit product cost is determined as follows:
Selling and administrative expenses arealways treated as period expenses and deducted from
revenue.
Selling and administrative expenses arealways treated as period expenses and deducted from
revenue.
Absorption Costing vs. Variable Costing - Example
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Absorption Costing vs. Variable Costing - Example
Howell, Inc. had no beginning inventory, produced 30,000 units and sold 28,000 units this year.
Howell, Inc. had no beginning inventory, produced 30,000 units and sold 28,000 units this year.
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Variable CostingSales (28,000 × $40) 1,120,000$ Less variable expenses: Beginning inventory -$ Add COGM (30,000 × $12) 360,000 Goods available for sale 360,000 Ending inventory (2,000 × $12) 24,000 Variable cost of goods sold 336,000 Variable selling & administrative expenses (28,000 × $4) 112,000 448,000 Contribution margin 672,000 Less fixed expenses: Manufacturing overhead 210,000$ Selling & administrative expenses 250,000 460,000 Net income 212,000$
Variable CostingSales (28,000 × $40) 1,120,000$ Less variable expenses: Beginning inventory -$ Add COGM (30,000 × $12) 360,000 Goods available for sale 360,000 Ending inventory (2,000 × $12) 24,000 Variable cost of goods sold 336,000 Variable selling & administrative expenses (28,000 × $4) 112,000 448,000 Contribution margin 672,000 Less fixed expenses: Manufacturing overhead 210,000$ Selling & administrative expenses 250,000 460,000 Net income 212,000$
Absorption Costing vs. Variable Costing - Example
Variablecostsonly.
Variablecostsonly.
All fixedmanufacturing
overhead isexpensed.
All fixedmanufacturing
overhead isexpensed.
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End of Chapter
Hu-man!
I will absorb
you!