Chapter 18

Additional Aspects of Product

Costing Systems

Job Order or Process CostingJob Order

• Small quantities• Batches of identifiable,

tailor-made products• User-specific services• Tracks costs by job

Process

• Large quantities

• Homogeneous goods

• Tracks costs by batch of goods by department

Job Order Costing• A job is a single unit or group of units identifiable as being

produced to distinct customer specifications

• A job can be a

– Client– Engagement– Project – Contract

Methods of Product Costing

• Cost Accumulation System defines

– cost object – method of assigning costs to production

• Valuation Method specifies

– how product costs will be measured

Six Possibilities

Job Order• Actual• Normal• Standard

Process • Actual• Normal• Standard

VAL MU EA TT HI OO DN

COST ACCUMULATION SYSTEM

Job Order Costing System

• Each job is a cost object

• Costs are accumulated for each job

• A job can consist of one or more units of output

• There is a subsidiary ledger for each job

Job Order Costing System

WIP ControlJob 2Job 1 Job 3

Job 1 + Job 2 + Job 3 = WIP Control

WIP Subsidiary Ledger

=Job 1 100Job 2 200Job 3 500Total 800

100 200 500

Material Requisition Form

• Tracks who is responsible for materials

• Verifies flow of materials from warehouse to department to job

Job Order Cost Sheet

• All financial information about a job

– direct material (from material requisition)– direct labor (from time sheets or labor tickets)– applied overhead– budgeted cost information

• When job is complete, use job order cost sheet to analyze actual costs compared to budgeted costs

Standard Cost System

• Actual cost

• Normal cost

• Standard cost

– Predetermined norms (or standards) for materials, labor, and overhead

– Compare actual costs to standard costs - difference is a variance

Management Use of Job Order Costing Systems

• Estimate future job costs

• Establish realistic bids and selling prices

• Develop budgets and standards

• Compare actual costs to estimated costs

• Furnish performance evaluation information based on profitability of jobs

Differences

Absorption costing• Fixed manufacturing

overhead is a product cost

Variable costing• Fixed manufacturing

overhead is a period cost

• Variable operating expenses are subtracted from product contribution margin to equal contribution margin

Predetermined Overhead Rate

• Allows overhead to be assigned during the period, fulfilling the matching principle

• Adjusts for variations not related to activity

• Compensates for fluctuations in activity level that do not affect fixed overhead

• Allows managers to be aware of product, product line, customer, and vendor profitability

The Activity Level(The Denominator)

• Relationship between the overhead cost and the activity– production volume– direct labor hours– direct labor cost– machine hours– number of purchase orders or parts– machine setups– material handling time

• Plantwide Overhead Rate– Homogeneous activities throughout plant

• Departmental Overhead Rate– Different types of work effort in departments– Diverse material requiring different times in

departments– Usually provides better information for

planning, control, and decision making

Plantwide vs. Departmental Predetermined Overhead Rates

Activity-Based Management

• Focuses on activities during production and performance process

• Improves the value received by customers

• Enhances profitability

Activity

An activity is a repetitive action performed in fulfillment of a business

function

Activity-Based Management

Activity analysis

Cost driver analysis

Activity-based costing

Continuous improvement

Operational controlQuality managementBusiness process improvementPerformance measurement

Activity Based Management• External Benefits

– Increased customer value

– Enhanced profitability

• Internal Benefits

– More efficient production

– More accurate cost determination

– More effective performance evaluation

Activity Analysis

Value-added activity• Increases worth of

product or service to a customer

• Customer is willing to pay for it

Non-value-added activity• Increases time spent on

product or service but does not increase worth

• Unnecessary from customer perspective

• Can be reduced, redesigned or eliminated without affecting market value or quality

• Business-value-added activities are essential

Cost Driver Analysis

• Cost drivers are factors that have a direct cause-effect relationship to a cost– Limit the number of cost drivers

– Cost of measurement should not exceed benefit of using the cost driver

– Easy to understand

– Directly related to activity being performed

– Appropriate for measurement

Cost Driver Analysis• Unit-level costs

– direct material, direct labor

• Batch-level costs

– setup, inspection

• Product/process-level costs

– engineering changes, product development

• Organizational or facility costs

– building depreciation, plant manager’s salary

Activity-Based Costing

• Recognizes several levels of costs

• Accumulates costs into related cost pools

• Uses multiple cost drivers to assign costs to products and services

Two-Step Allocation • Collect costs in general ledger and

subsidiary accounts

• Identify activity centers

• Accumulate costs into activity center cost pools – cost drivers

• Allocate costs to products and services– activity driver measures demands placed on

activities, thus, the resources consumed by products/services

Traditional vs. ABC Costing

• When ABC is implemented

– Cost is reduced for high volume, standard products

– Cost is increased for low-volume, complex specialty products

Use ABC Costing for.1. Product Variety and Process Complexity

– Caused by mass customization• Too many choices, opportunity for errors• Pareto Principle• Commonality of parts

– Reduced by• Simultaneous (or Concurrent) Engineering• Design for Manufacturability

Use ABC Costing when….

2. Lack of Commonality in Overhead Costs- Some products/services use substantially more

overhead than others

3. Problems with Current Cost Allocations- Significant changes in process with no change in

cost allocations

- Expense majority of period costs when incurred

Use ABC Costing when….

4. Changes in Business Environment

– Increase in competition

– Change in management strategy