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PRODUCT COSTING
A noted earlier, all product costs are charged to inventory. To
facilitate this process,manufacturers break inventory into three
categories: RM inventory, WI inventory, and!" inventory. There are
t#o categories of direct cost $%& ' %M( and then there is
overhead, #hich is a catch)all term for everything e*cept %&
and %M. Ra# materials arecharged to RM inventory #hen purchased and
transferred to WI inventory #hen it isused. %& is charged
directly to WI. Indirect product costs are charged to an
overheadaccount. Then +ust one number is transferred from - to
WI.In a company that produces a variety of products in specific
batches, the total costs thatare charged this #ay are made up of a
series of +obs. Think of inko/s. They dothousands of +obs 0 each of
them has some %M $paper mainly(, some %& $the operator(,and a
lot of - $store rent, electricity, supplies etc and etc.(
1ach +ob is numbered 0 the number you see on your invoice. They
kno# ho# much paper
#as used on a +ob and ho# much time it took.
!or each individual +ob: %M 2 ages used * cost of paper per
page%& 2 Time taken by operator * hourly #age of operator
Then, for the year as a #hole 0 or for a day, a #eek, a month 0
they +ust add up the costsof all the individual +obs to see ho#
much cost they incurred for that period.
The big problem is ho# to charge overhead costs to an
individual+ob. These accumulateover a year and are all indirect
costs i.e., they aren/t collected on an individual +ob likepaper
and #ages. These indirect costs need to be spread out over the
individual +obs or
share among the individual +obs. Most businesses use the
follo#ing method to achievethis 3spreading out4 process that is
called 3applying overhead.4 They start by computingan 3overhead
rate4 using a 3base4 like direct labor hours $%&-(.
verhead rate 2 Total overhead5-ours #orked by operators during
the year.2 -5%&-
This rate is then multiplied by the %&- on an individual +ob
and gives the share ofoverhead applied to that +ob. If total
overhead for the year is 6788,888 and total %&-#orked during
the year is 98,888 hours then the overhead rate #ill be 68 per
direct laborhour. If a +ob takes ; hours, say, then it #ill get
charged #ith ; * 68 or 6ote that #e could also have used something
like machine hours as a base.(
The problem #ith this method is that #e have to #ait to the end
of the year before #e canfigure out the cost of any +ob during the
year. Almost all businesses, therefore, #ork onan estimatedbasis.
They figure an overhead rate in advance using %& hours
$say(:
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bases its rate on direct labor cost. At the beginning of the
year, the company made thefollo#ing estimates:
%epartment=utting !inishing
%irect labor hours F,888 G8,888Machine hours 97,888
;,888Manufacturing overhead cost 6GF8,888 697F,888%irect labor cost
6;8,888 6E8,888
