5. Cost Accumulation Systems (ABC, Process Costing ..)

Question 1

Job Order Costing

Answer 1

• Appropriate when producing products with individual characteristics or identifiable groups are possible.
• Costs are recorded as classified such as DM, DL and MOH on job cost sheet
• DM, DL are applied based on ACTUAL costs. MOH are applied based ESTIMATED (applied) costs.
• MOH applied are assigned to WIP - WIP (debit), MOH applied (credit).
• Any MOH costs paid throughout the year are accumulated in MOH control account. WIP is not affected when actual OH costs are incurred - MOH control (debit), payables (credit)
• At the end of the period, MOH applied and MOH control accounts are netted to examine any difference. It will result credit if OH was overapplied and debit if OH is underapplied - If the result is immaterial it can be closed directly to COGS, if difference is material it should be allocated on relative values of WIP, Finished goods and COGS
• Normal spoilage is treated as PRODUCT cost. The amount is normal spoilage is included in cost of goods units produced. If the normal spoilage is worthless it should be discarded and no entry is required. If normal spoilage can be sold it SHOULDN’T be included cost of goods unit produced, Spoiled inventory at FV (debit), WIP (credit).
• When scrap is sold under normal spoilage the entry would be Cash (debit), Factory OH control (credit)
• Abnormal spoilage is treated as PERIOD cost. If the amount is WORTHLESS it should be discarded and entry is Loss abnormal spoilage (debit), WIP (credit). If the abnormal spoilage can be sold entry is Spoiled inventory, Loss of abnormal spoilage (debit) WIP (credit)
• Unusual overnight power failure is considered as Abnormal spoilage

Question 2

Process Costing

Answer 2

• It is applicable to relatively homogeneous products that are mass produced on continuous basis
• Accumulation of costs under process costing is by department rather than by project.
• DM, DL and MOH are applied based on actual costs
• Standard costs are applied at later stage for purpose of variance analysis
• EUP included only calculation rules
• Advantages and disadvantages of using weighted average method to calculate EUP:
  1) It is easier to use and calculation is simpler
  2) EUP cost includes both current and previous period costs
  3) Is APPROPRIATE when conversion cost, inventory levels and raw material prices are STABLE
• Advantages and disadvantages of using FIFO method to calculate EUP:
  1) Is based on work done in the current period
  2) Is APPROPRIATE when conversion cost, inventory levels and raw material prices re fluctuating
• Similar to Job Order Costing, normal spoilage is treated as PRODUCT cost and abnormal spoilage is treated is PERIOD cost.
• The manufacturer establishes INSPECTION POINTS where those goods not meeting specifications are pulled out from the process. Unlike Job Order Costing in which a unit can be judged to be spoiled AT ANYTIME
• Loss of abnormal spoilage equals the number of units of abnormal spoilage * department EUP cost
• Normal spoilage for process costing and ABC should be allocated between units completed and ending WIP
• Normal and abnormal spoiled units are not transferred to finished goods account but the cost of completed units and NORMAL spoilage are included in the cost of units transferred to the next department
• Normal spoilage may affect current income if part of the spoiled goods got sold

Question 3

ABC

Answer 3

• ABC is a response to the significant increase in INDIRECT costs resulting from rapid advance of technology
• ABC is more accurate to provide management with information that can make pricing decisions for each product
• ABC normally results in a greater unit cost for low volume products that it is reported under traditional costing
• Under traditional volume based costing system, OH is accumulated into a single cost pool and spread evenly across all products
• Under traditional costing system it results in inaccurate averaging or spreading of OH that sometime called peanut butter costing. Peanut butter costing results in product cost cross subsidization in which the MISCOSTING of one product causes the miscosting of other product.
• Activity analysis types under ABC:
  1) Unit level activity such as DM, DL and inspection
  2) Batch level activity such as material handling, materials ordering and production line setup
  3) Product sustaining such as product design, product testing and engineering changes
  4) Facility sustaining activities - CAN’T be traced to a PRODUCT and treated as PERIOD cost such as depreciation, insurance, HR, accounting, rent, utilities and maintenance
• Cost of materials used in manufacturing products is not used as a cost driver
• Design of an ABC system STARTS with process value analysis
• Two types of activities under process value analysis:
  1) Value adding activity - it can’t be reduced without affecting quality, quantity and responsiveness of a product
  2) Nonvalue adding activity - it can be eliminated, reduced or redesigned without impairing quality, quantity and responsiveness of a product
• ABM is the linkage of product costing and continuous improvement of processes - it encompasses activity analysis, driver analysis and performance measurement. It increase effectiveness of activities BUT it the customer DOESN’T benefit from it.
• Cost driver must be chosen on the basis of cause and effect relationship
• WIP is an intermediate cost object, finished goods is final cost object
• Advantages of ABC system:
  1) Uses process value analysis
  2) Reduces product under or over costing
  3) Uses with companies having high level of FIXED costs
  5) More useful when OH costs are relatively high
• Disadvantages of ABC system:
  1) Its cost and increased time and efforts
  2) Not useful if company produces only SINGLE product
  3) May not conform with GAAP
  4) Will have same result of cost allocation of traditional costing if the company have single product
  5) Service organizations may have some difficulties in implementing ABC because they tend to have high facility level costs
• ABC, Process and Job Order Costing systems can be used for both internal and external reporting
• Most likely conditions for organizations to benefit from ABC system:
  1) Used with products or services that vary significantly in volume
  2) Diversity if activities
  3) Complexity of operations
  4) Relatively high OH costs
• Sales commission determination is not an object of a cost accounting system
• Cost accounting is used internally for planning and control. Externally to the extent its product costing function satisfies its external reporting
• Value chain analysis is series of activities in which customer usefulness is added to the product

Question 4

Life Cycle Costing

Answer 4

• Life cycle approach is used as a basis for a product planning and product costing
• Five phases for product life cycle:
  1) Research and Development - No sales and high cost
  2) Introduction - Few competitors
  3) Growth - Number of competitors increases and opportunity for cost reduction is the maximum
  4) Maturity - Sales growth decline, competitors are highest at this stage and profit tends to be the highest
  5) Decline - Competitor decreases
• Value chain during life cycle costing:
  1) Upstream costs incurs BEFORE production includes Research and development, Product Design
  2) Downstream cost incurs AFTER production includes marketing and Distribution, Customer service
• For EXTERNAL reporting reasons value chain costs are divided as follows:
  1) Expense upstream and downstream costs
  2) Capitalize manufacturing costs
• For INTERNAL reporting reasons value chain costs are All capitalized including manufacturing costs
• Life cycle costing highlights the potential for cost REDUCTION during UPSTREAM phase
• In target costing, the market price is taken as given
• Target costing is used to create competitive advantage and on products that have NOT been developed yet
• Traditional costing focuses on cost control as opposed to cost reduction, also it ignores the after purchase cost
• Value engineering is a means of reaching targeted cost levels without reducing customer satisfaction though minimizing nonvalue adding costs
• Life cycle costing provides a better measurement for evaluating the performance of product manager

Question 5

Rules for Calculation

Answer 5

• Beg WIP units + Units started current period = Units transferred out (completed) + Ending WIP units
• Total units accounted for =
  1) Beg WIP units + Units transferred in OR
  2) Ending WIP units + Units transferred out
• The equivalent units for transferred-in costs are calculated in the same way as those for materials added at the beginning of the process
• Units transferred out under FIFO = Units started - Ending WIP unit
• Units transferred out under Weighted avg = Beg WIP units + Units started - Ending WIP units
• Beg WIP = Units completed + Ending WIP - units started
• Units started and completed =
  1) Units completed - Beg WIP OR
  2) Units started - Ending WIP
• Ending WIP = Beg WIP + units started - units completed
• Equivalent units = Beg WIP + units started and completed + Ending WIP
• Materials added at the beginning :
  FIFO = Beg WIP unit * 0%
  + Units started and completed * 100%
  + Ending WIP units * 100%

Weighted Avg = Beg WIP unit * 100%
+ Units started and completed * 100%
+ Ending WIP units * 100%

• Materials added throughout the process:
  FIFO = Beg WIP unit * % to complete
  + Units started and completed * 100%
  + Ending WIP units * current completed %

Weighted Avg = Beg WIP units * 100%
+ Units started and completed * 100%
+ Ending WIP units * current completed %

• Materials added at specific intervals:
  Beg WIP = assume that materials are added at 50% completion. If beg WIP is 20% complete, materials have not be added yet. All materials will be added in the current period and the units will count 100% toward EUP. Same applies to Ending WIP but reversely
• EUP for conversion costs - apply same treatment as materials added throughout the process
• Under FIFO to calculate EUP cost per unit we consider ONLY current costs
• Under weighted avg to calculate EUP cost per unit we consider current costs + beginning period costs
• ABC allocation = Activity driver of product 1 / ( Activity driver of product 1 + Activity driver of product 2) *
  Cost driver
• ABC OH per unit = Cost driver of product 1 / ( Cost driver of product 1 + Cost driver of product 2) * Cost of department / Number of units
• Plantwide application rate = (Department 1 cost + Department 2 cost) / ( Department 1 driver + Department 2 driver )
• Product life costing example P.23
• Whole life cost under life cycle costing = Life cycle cost + after purchase cost