Semester 1 Week 2a PP (Cost Assignment, Job Costing and Overhead Application) Flashcards
What kind of functions does MA perform?
Companies need cost and management accounting (MA) systems to perform a number of different functions.
The focus of this lecture is on two of these functions:
Allocating costs between cost of goods sold and inventories for internal and external profit reporting.
Providing relevant decision-making information for distinguishing between profitable and unprofitable activities.
What is a Cost object?
Essential: cost assignment to cost objects
Cost Object: anything for which a separate measurement of cost is desired (products, services, customers and locations).
Focus -> how costs are assigned to products in manufacturing firms that produce unique individual products or unique batches of products.
Job-order costing Vs Process Costing
What are they?
Job-order costing system: cost assignment system that keeps track of the cost of each unique product or unique batches of products (a batch).
Process Costing system: the cost object is masses of identical or similar units of a product or service
What are some examples of job costing and process costing in the service, merchandising and manufacturing sector?
What is some terminology?
Direct costs can be specifically and exclusively identified with a given cost object –> they can be accurately traced to cost objects in an economically feasible way –> direct cost tracing is used.
Cost Tracing: the process of assigning direct costs.
Indirect costs (Overheads) cannot be directly (in an economically feasible way) traced to a cost object –> overheads are assigned to cost objects using cost allocations (because the quantity consumed by a particular object cannot be directly measured).
Cost allocation: the process of assigning costs to cost objects that involve the use of surrogate rather than direct measures.
Surrogates known as allocation bases or cost drivers. Example of Surrogate: Cost of receiving materials is strongly influenced by the number of receipts => costs can be allocated to products based on the number of material receipts each product requires.
How do you assign direct and indirect costs?
For accurate cost assignment, allocation bases should be significant determinants of the costs (i.e., cause-and-effect allocations).
Allocation bases that are not significant the determinants of the costs are called arbitrary allocation, as they result in inaccurate cost assignment.
Example: if direct labour hours were used as the base to allocate costs of material receiving (instead of number of receipts).
Allocation -> Inaccurate because the product is not necessarily labour intensive.
What are the types of cost allocation systems?
a) Direct costing system (also known as a marginal or variable costing system) assigns direct costs to cost objects
b) Absorption costing system assigns both direct and indirect costs to cost objectives.
- Absorption costing systems can be subdivided into:
1. Traditional costing systems
2. Activity-based costing (ABC) systems.
- Traditional costing systems developed in early 1900s and are still widely used today.
- ABC systems developed in the 1990s
- Traditional costing systems use arbitrary allocations to a significant extent whereas more recent (ABC) systems rely mainly on cause-and-effect allocations.
What is Actual costing?
Actual costing: only actual costs of direct materials, direct labor, and overhead (allocated) are used to determine unit cost.
However, the use of actual figures can be problematic.
Products costs have to be delayed until the end of the accounting period, since the overhead rate calculations cannot be obtained before this date.
However, information on products costs is required more frequently. -> Timing Problem
Timing problem may be resolved by calculating actual overhead rates at more frequent intervals, but in the short-term overhead rates are subject to large fluctuations because totals overheads are typically fixed, whereas activity will vary from month to month, giving large fluctuations in the overhead rates.
Why is Actual costing problematic?
Numerator reason – Uneven Overhead Costs: Seasonal Patterns (cost of heating charged only during winter) + nonseasonal erratic costs (repair costs for machine breakdown)
Denominator reason – Uneven Production: Low production in one month would give rise to low unit overhead costs, whereas high production in another month would give rise to high unit overhead costs. Yet, production process and total overhead costs remain unchanged.
What is normal costing and how does it compare to actual costing?
Normal costing solves the problems associated with actual costing. A normal costing system determines unit cost by adding actual direct materials, actual direct labor, and estimated overhead.
Overhead can be estimated by approximating the year’s actual overhead at the beginning of the year and then using a predetermined rate throughout the year to obtain the needed unit cost information.
What is Under and Over recovery of overheads?
It is most unlikely that the allocated overheads based on budgeted overhead expenditures to be the same as actual overhead incurred.
Over and under absorption of overheads occur because the predetermined overhead absorption rates are based on estimates (both numerator and denominator)-> Fixed Overhead Volume Variance
Over-absorption means that the overheads charged to the cost of sales are greater than the overheads actually incurred.
Under-absorption mean that insufficient overheads have been included in the cost of sales.
What are the steps of normal costing and estimating overheads?
In normal costing, overhead is estimated and applied to production. The basics of overhead application can be described in three steps:
Step 1: Calculate the predetermined overhead rate
Step 2: Apply overhead to production throughout the year
Step 3: Reconcile the difference between the total actual overhead incurred during the year and the total overhead applied to production
Predetermined overhead rates help companies maintain a constant application of overhead throughout the year.
These rates do not allow seasonality or variations in production to affect unit cost.
Step 1: Calculating the Predetermined Overhead Rate:
Predetermined overhead rate is calculated at the beginning of the year.
Predetermined Overhead Rate= Estimated Annual Overhead/ Estimated Annual Activity Level
Notice that the predetermined overhead rate includes estimated amounts in both the numerator and the denominator.
Estimation is necessary because the predetermined overhead rate is calculated in advance, usually at the beginning of the year
Estimated overhead is the firm’s best estimate of the amount of overhead (utilities, indirect labor, depreciation, etc.) to be incurred in the coming year
Estimates may be based on last year’s figures adjusted for anticipated changes in the coming year
The associated activity level depends on which activity is best associated with overhead
The number of machine hours could be a good choice of activity level for the overhead of a company that has automated production.
Step 2: Applying Overhead to Production.
Once the overhead rate is computed, company can begin to apply overhead to production
Applied Overhead = Predetermined Overhead Rate × Actual Activity Level
Total cost of the product for the period:
Total Normal Product Costs = Actual Direct Materials + Actual Direct Labor + Applied Overhead
Step 3: Reconciling Actual Overhead with Applied Overhead
Recall that two types of overhead are recorded:
Actual overhead: Costs are tracked throughout the year in the overhead account
Applied overhead: Costs are computed throughout the year and added to actual direct materials and actual direct labor to get total product cost
At the end of the year, any difference between actual and applied overhead must be recognized and closed to the cost of goods sold account so that it reflects actual overhead spending. The difference between actual overhead and applied overhead is called an overhead variance.
If actual overhead is greater than applied overhead, then the variance is called underapplied overhead.
If actual overhead is less than applied overhead, then the variance is called overapplied overhead.
If overhead has been underapplied, then product cost has been understated.
If overhead has been overapplied, then product cost has been overstated. Something must be done with the overhead variance at year-end to report costs at actual amounts on the financial statements
Generally, the entire overhead variance is assigned to Cost of Goods Sold, since the amount is usually small or immaterial
Underapplied overhead is added to Cost of Goods Sold
Overapplied overhead is subtracted from Cost of Goods Sold
If the overhead variance is material, or large, the variance would be allocated among the ending balances of Work in Process, Finished Goods, and Cost of Goods Sold.
How to Calculate the Predetermined Overhead Rate and Apply Overhead to Production at the beginning of the year
How to Reconcile Actual Overhead with Applied Overhead
Over and Under Absorption statement, what would it look like? (Use any numbers)
An adjustment to reconcile the overheads charged to the actual overheads necessary and the over-absorbed overhead will be credited to the profit and loss accounting at the end of the accounting period.
How do you do a job-cost record?
What are departmental overhead rates?
If there is more than one department and jobs do not spend an equal amount of time in each department the blank overhead rate is not appropriate.
A separate absorption rate used for each department, better captures the amount and effort of resources put into the production of a product.
A plant wide rate can only be justified when all products consumed departmental overheads in approximately the same proportions (i.e., low product diversity applies).
Product Z: requires 20 hours (all in department C, No A +B )
Blanket overhead rate charge = € 300 (20hrs x € 15)
Separate Department Overhead Rate Charge = € 100 (20hrs x € 5)
Separate departmental rates should be used since product Z only consumes overheads in department C.
A blanket overhead rate can only be justified if all products consume departmental overheads in approximately the same proportions:
Product X spends 1 hour in each department and product Y spends 5 hours in each department (Both blanket and departmental rates would allocate £45 to X and £225 to Y).
However, If a diverse range of products is produced with products consuming departmental resources in different proportions of time in each department, separate departmental (or cost centre) rates should be established.
How to Calculate the Overhead Rate and Apply Overhead to Production Convert using Plantwide Data
How to Calculate Predetermined Departmental Overhead Rates and Apply Overhead to Production
