A&MIS 212 – Session 2

A&MIS 212 1W. F. Bentz

A&MIS 212 – Session 2

William F. BentzJanuary 10, 2002

Fisher College of Business


Thursday’ Agenda

Chapter 2, Exercise 3Chapter 2, Problem 13Introduce Job-Order Costing Systems


Key Issues in Product Costing

TerminologyPoints of potential confusion Accounts


Concept of “Cost”

Cost is a sacrifice; a measurable cost is the relinquishment of a measurable asset or the creation of a measurable liability.


GAAP Product Cost

For Work-in-Process and Finished Goods inventory purposes (GAAP), only manufacturing costs are included in “product” costs. Product costs remain in inventory until the associated product are sold or decline in value. When the associated products are sold, the “product cost” is added to Cost of Goods Sold.


Meanings of Product Cost

R&D DesignProduc-

tionConsumer

ServiceDistri-bution

Market-ing

Inventoriable product costs

Reimbursable government

contract costs

Decision-relevant costs


GAAP Expenses (Period Costs)

Costs are incurred for activities that do not directly create products, but support the creation of products. These costs are charged to expense accounts during the accounting period incurred and thus are called period expenses.


GAAP Expenses--Examples

Administrative Expenses◈Corporate officers◈Corporate buildings◈Corporate costs like the annual audit fees◈Corporate costs like

Selling (Marketing) ExpensesDistribution Expenses


Accounting-Speak

Costs Incurred

Period Expenses

Product Costs

(Inventory)

Expensed During a Period

Assets (Prepaids)

(PP&E)


Concept—Service Potential

In accounting, service potential can be thought of as the present value of the cash flows from an activity, at some level of risk, or adjusted for risk.


Concept—Cost

Actions that decrease the present value of cash outflows, at a given level of risk, are actions that decrease cost. Actions that increase the present value of future cash outflows, at a given level of risk, are actions that increase cost.


Concept—Cost

Actions that increase the risk of future cash flows are actions that increase cost. Actions that decrease the risk of future cash flows are actions that decrease cost. and so on.


Terminology—Costing

Costing is the process of estimating the cost (sacrifice) of taking action. Costs are the result of undertaking and maintaining activities. Thus, costing is largely a matter of assigning costs (sacrifices) with the activities which caused those sacrifices.


Terminology—Cost Object

A cost object is any activity for which a separate measurement of cost is desired. An activity involves doing something

Cost objects are derived from the purposes for which the cost information is to be used (different costs for different purposes).


Terminology—Costing Systems

Costing systems are the information systems used to accumulate cost data either regularly or intermittently. Usually cost systems are flexible enough to collect information for a variety of purposes.


Terminology—Costing Systems

A variety of costing systems may exist in any one organization (engineering, accounting, production, distribution).


Terminology—Cost Analysis

Cost analysis is the process of assessing the expected impact of managerial decisions on the financial performance of an entity. Decision analysis includes cost analysis.


Terminology—Cost Incurred

Cost incurred is the cost that an entity has experienced as a result of the execution of some activity for a specified period of time. Although it is in the past, cost incurred may have to be estimated. Accurate, valid measures of cost incurred require information about separable activities.


“Product Costs (GAAP)

Product (inventoriable) costs include all manufacturing costs regardless of traceability or behavior. • Direct materials• Direct labor• Indirect labor, materials, depreciation,

services, etc.

Conversion

Prime cost


The Flow of Costs

Inventory System

Work in Process

Finished Goods

Inventory

Cost of Goods Sold

Payroll System

Indirect Costs

Assigned


Costing Objects

Next, let us consider how one associates the costs incurred to a set of cost objects in the costing process.

Costs

Incurred

Object 1

Object 2

Object 3


Cost Assignment

Tracing – direct costs can be traced to cost objects

1. Ability to trace with acceptable accuracy, validity, and cost• Technology is improving our ability to trace• The more complex the production process, the

more difficult and costly the tracing process


Cost Assignment

Tracing (continued)2. Cost-effective to trace costs

• The greater the cost, the greater the value of tracing

• Technology is reducing the cost of tracing• The value of tracing increases with competition• More complex mfg. systems increase the need

to trace


Cost Assignment

Cost allocation is the process of assigning costs to cost objects when those costs cannot be traced cost-effectively. Cost allocation ranges from relatively unambiguous,

with high face validity, to relatively arbitrary. Most distortions in product and service costing are

related to cost allocation, not cost tracing.


Job-Costing

One costing system is called job-costing or job-order costing. Job-costing systems are designed to cost a single unit or project, or one or more batches of very similar units.


Job-Costing Applications

Job-costing is suited to: Ship building Construction projects Printing shops with diverse jobs Medical procedures Repair shops Consulting projects


Costing Jobs--Materials

When materials and component parts are taken out of inventory and put into process, the cost of those materials are traced to the job for which they were used. The total cost of all materials used in a period is debited to Work-in-Process. That debit amount must equal the total of the material costs charged to individual jobs.


Costing Jobs--Labor

When the total cost of labor is determined each period, that cost is either traced to specific jobs or charged to indirect cost. Workers and their supervisors must have a system for keeping tract of who worked on what jobs.


Costing Jobs—Indirect Costs

Indirect costs are allocated to jobs based on predetermined (budgeted) overhead (indirect manufacturing cost rates (PORs). In the least complex systems, there will be one POR. In more complex processes, there may be a number of cost drivers involved, and a corresponding POR for each cost driver.


To cost a specific job

Trace the direct costs to each job For each job record the amount of the

driver activity for each BICR Multiply the BICR times the amount of

activity for each cost driver Add the cost components to compute the

total cost (inventory value) of each job


The Flow of Costs

Adjustment

Indirect Costs

Allocated

Indirect Costs

Incurred

Cost of Goods Sold

Finished Goods

Inventory

Work in Process

Payroll System

Inventory System


Inventory values

The cost of any job is the cumulative amount of the costs charged to that job in the current and previous periods. The cost accumulates until the job is completed. The costs incurred for long-term construction contracts, as discussed in A&MIS 521, would be accumulated using a job-cost system.


Updating the costs of jobs

Direct materials would likely be accounted for using a perpetual inventory system

Direct labor costs would be updated every time a payroll is computed and at the end of every accounting period.

Indirect costs are charged to jobs at the end of every accounting period prior to completion and when they are finished.


Refinements

One can keep track of categories of cost within a job. For example, a large construction company I once worked for kept track of the cost of; (1) concrete floors, (2) walls & piers, (3) electrical systems, (4) roofing, and (5) mechanical systems. The company used this information to price bids and to select subcontractors on the basis of costs.


Problem Areas

A major consideration in the quality of the direct cost information lies in the tracing of costs to jobs. A potential problem occurs when workers are involved in several jobs each morning or afternoon and do not keep accurate time records.


Documents

A&MIS 212 – Session 2