Three manufacturing costsThree manufacturing costsDirect material cost:

Consist of all those material that can be identified with a specific product. Example: wood used in manufacturing of a table.

Direct labor cost :Consist of all those cost that can be specifically traced or

identified with a particular product. Example: wages of workers working on that table.

Overhead (indirect) cost: overhead refers to the cost pool used to accumulate all

indirect manufacturing costs. Indirect costs are allocated to the cost object using of cost allocation method. Example: heat, light and power for the factory, rent on factory building, property taxes on factory building, and all kind of depreciation.

Factory OverheadFactory Overhead

Overhead consists of many individual cost items. These are costs that

can’t be measured or traced for a specific product. Factory overhead

costs are both fixed and variable. The factory overhead controlling

account is debited when costs are incurred and credited when factory

overhead is applied to various job orders. i.e indirect material and

labor, utility costs, depreciation of equipment and salaries of factory

administrative personnel.

Plant-wide (blanket) overhead Plant-wide (blanket) overhead ratesrates

The most simplistic traditional costing system assigns

indirect costs to cost objects using a single overhead rate for

the organization as a whole. The terms blanket overhead

rate or plant-wide rate are used to describe a single

overhead rate that is established for the organization as a

whole.

Job Order CostingJob Order Costing

A job is a production run for a specific product. A relatively small

number of units generally comprise a job. Job order costing

system record actual and estimated production costs in the

formal accounting system leading to manufacturing statements.

Construction firms use a variation of job order costing. Some

overhead is applied to each job so that the contractor can recoup

its general production costs which apply to all jobs but which are

not traceable to any specific job.

Benefits of job costingBenefits of job costing1. You will know on an ongoing basis which projects are profitable

and which ones aren’t.

2. You will be able to get paid on a timely basis as you complete

the job.

3. You can avoid committing resources to projects.

If you manufacture products:

1. You will know what it cost to make each item

2. You will be able to set selling prices that cover your costs and

earn a fair profit

3. You will know what product lines to expand because they’re

profitable, and what product line to drop because they’re

unprofitable.

General approach to job General approach to job costingcosting

1. Identify the job that is chosen cost object

The cost object can be chosen through the job cost record.

Companies keep a job cost record for every specific job. A job

cost record, also called a job cost sheet records and

accumulates all the costs assigned to a specific job, starting

when work begins.

2. Identify the Direct costs of the job: Robinson identified two direct manufacturing cost categories, direct material and direct manufacturing labour. Example can

be seen for the direct costs for the specific job.

3. Select the cost allocation bases to use for allocating indirect cost to the job.

Indirect costs can’t be allocated to a specific product. It will be impossible to complete a job without incurring indirect cost such as supervision, manufacturing engineering, utilities and repairs. Multiple cost allocation bases are used to allocate a indirect cost because different indirect cost have different cost drivers. Example : depreciation or repair of machines is closely related to machine hours so machine hours can be used as a cost driver.

4. Identify the indirect cost associated with each cost allocation base.

Now that the allocation bases has been identified, all indirect cost are now identified for that allocation base. In our example from the Robinson company they use indirect manufacturing costs to machinery hours used.

5. Compute the rate per unit of each cost allocation base used to allocate indirect costs to the job.

Actual manufacturing overhead costs

Actual total quantity of cost allocation baseActual manufacturing overhead rate =

$1215000

27000 direct manufacturing labor hoursActual manufacturing overhead rate =

$45 per direct manufacturing labor hour=

6. Compute the indirect costs allocated to the job.

Indirect cost allocated to a job=actual quantity of each different allocation base x indirect cost rate of each allocation base

7. Compute the total cost of the job by adding all direct and indirect costs assigned to the job.

Total cost= Direct cost + Indirect cost

JOB NO: CUSTOMER:

Date Started: Date Completed:

WPP 298

Feb. 3, 2006 Feb. 28, 2006

JOB-COST RECORD

Western Pulp and Paper

DIRECT MATERIALS

DateReceived

MaterialsRequisition No. Part No.

QuantityUsed

UnitCost

TotalCosts

Feb. 3, 2006

Feb. 3, 2006

2006: 198

2006: 199

MB 468-A

TB 267-F

8

12

$ 14

63

$ 112

756

••

$4,606TotalDIRECT MANUFACTURING LABOR

PeriodCovered

Labor-TimeRecord No.

Employee No.

HoursUsed

HourlyRate

TotalCosts

Feb. 3-9, 2006

Feb. 3-9, 2006

LT 232

LT 247

551-87-3076

287-31-4671

25

5

$ 18

19

$ 450

95

••

$1,579TotalMANUFACTURING OVERHEAD

DateCost poolCategory Allocation-Base

Allocation-BaseUnits Used

Allocation-Base Rate

TotalCosts

Dec. 31, 2006 Manufacturing Direct Manufacturing 88 hours $ 45 $ 3,960Labor-Hours

Total $ 3,960$ 10,145TOTAL MANUFACTURING COST OF JOB

MATERIALS-REQUISITION RECORD

Materials-Requisition Record No:Job No.:

PartNo.

MB 468-A

WPP 298Part

DescriptionMetal

Brackets

Date:

Quantity

8

2006: 198Feb. 3, 2006Unit TotalCost Cost

$14 $112

Issued By:B. ClydeReceived By: L. Daley

Date:Date:

Feb. 3, 2006Feb. 3, 2006

Panel 1

Job Number: J4369 Date: July 6, 2000Customer: Michigan MotorsProduct: Automobile engine valves (Valve #L181)Engineering Design Number: JDR-103Number of Units: 1,500

Panel 2

MaterialRequisitionNumber Description Quantity Rate Amount 47624 Bar steel 720 lbs $11.50 $8,280.00 Stock 3”A35161 Subassemblies 290 units 38.00 $11,020.00

Total direct materials cost $19,300.00

Panel 3

Dates Number Hours Rate Amount8/2, 8/3, 8/4, 8/5 M16 24 $28.00 $672.008/2, 8/3, 8/4, 8/5 M18, M19, M20 64 26.00 1,664.008/6, 8/7, 8/8, 8/9, 8/10 A25, A26, A27 120 18.00 2,160.008/6, 8/7, 8/8, 8/9, 8/10 A32, A34, A35 60 17.00 1,020.00Total direct labor cost 268 $5,516.00

Panel 4

Support Cost Amount117 Machine hours @ $40 per hour $ 4,680.00268 Direct labor hours @ 36 per hour 9,648.00

Total overhead cost $14,328.00

Directcosts

Indirectcosts

Cost Tracing

Cost Allocation

CostObject

Cost Assignment

Concept of Costing System

Assigning direct and indirect costsAssigning direct and indirect costs

A cost allocation is the process of assigning costs when a direct measure

does not exist for the quantity of resources consumed by a particular cost

object. Example: consider an activity such as receiving incoming materials.

Assuming that the depreciation of the machine is strongly related to the

number of hours machine was used. The basis that is used to allocate costs

to cost objects is called an allocation base or cost driver.

Two types of systems can be used to assign indirect costs to cost objects.

They are traditional costing system and activity-based-costing(ABC) systems.

Traditional costing systems

ABC systems

Directcosts

Indirectcosts

Cost tracing

Cost allocations

Costobjects

Cost Allocations and Cost Tracing

Traditional Costing Systems

Overhead cost accounts(for each individual category of expenses)

Costcenter

1(Normally

departments)

Costcenter

2(Normally

departments)

Costcenter

N(Normally

departments)

Cost objects (Products, services and customers)

First stage allocations

Second stageallocations

(Direct labour ormachine hour)

Directcost

Applying the three-stage allocation process requires the following four steps:

1.Assigning all manufacturing overheads to production and service

cost centres;

2.Reallocating the cost assigned to service cost centres to

production cost centres;

3.Computing separate overhead rates for each production cost

centre;

4.Assigning cost centre overheads to products or other chosen cost

objects.

An illustration of the three-stage An illustration of the three-stage process for a traditional costing systemprocess for a traditional costing system

• Inexpensive to operate

• Extensive use of arbitrary

cost allocations

• Low levels of accuracy

• High cost of errors

Simplistic systems

Traditional Costing System Levels of Sophistication

Servicedept

S1 S2 S3 S4

ProducingdeptDM

DLFO

DMDLFO

DMDLFO

Conceptual view of the separate

department overhead

rates

Costobjects

Costobjects

Costobjects

Costobjects

Costobjects

Costobjects

StageStage 1 : Assigning all manufacturing overhead 1 : Assigning all manufacturing overhead

to production and service departments.to production and service departments.

Cost Basis of allocation

Property taxes, lighting and heating

Employee-related expenditure:

works management, works canteen, payroll office

Depreciation and insurance of plant and machinery

Area

Number of employees

Value of items of plant and

machinery

Common cost are allocated to all the departments. Some cost can be directly related such as salary of the engineer working in the service quality department, however other need to be allocated using an allocation base.

StageStage 2 :Reallocating the cost assigned to service 2 :Reallocating the cost assigned to service

cost centers to production cost centers. cost centers to production cost centers.

the next step is to reallocate the costs that have been assigned to service cost centres to production cost centres. Service departments or support department are those departments that exist to provide services of various kinds of other units within the organization. For example, the costs of the cafeteria can be reallocated to the production cost center by using number of workers in the factory as the allocation base.

There are three methods in reallocating the cost from service to production departments.

1.DIRECT METHOD2.STEP METHOD 3.ALGEBRIC METHOD

Y

X A

B

Y

X A

B

Y

X A

B

Producing departmentService department

Part 1Direct method

Part 2Step method

Part 3Algebraicmethod

Diagram of 3 diff, allocation methods

Stage 3: Assigning cost center overheads to Stage 3: Assigning cost center overheads to products or other chosen cost objects.products or other chosen cost objects.

In the final step is to allocated the overheads to products passing through the

production centers. Volume base allocation is used to assign the overhead

costs to the products. Example, number of units produced, number of

machine hours used.

(£) (£)

Indirect wages and supervision Machine cenres: X Y Assembly Materials procurement General factory supportIndirect materials Machine centres: X Y Assembly Materials procurement General factory supportLighting and heatingProperty taxesInsurance of machineryDepreciation of machineryInsurance of buildingsSalaries of works management

1 000 0001 000 0001 500 0001 100 0001 480 000 6 080 000

500 000805 000105 000 0 10 000 1 420 000

500 0001 000 000 150 0001 500 000 250 000 800 000 4 200 000

11 700 000

The annual costs for the Enterprise Company which has three production centres (two machine centres and one assembly centre) and two service centres (materials procurement and general factory

support) are as follows:

The following information is also available:

BookValue of

Machinery(£)

AreaOccupied

(sq. metres)

NumberOf

employees

DirectLabourhours

Machinehours

Machine shop: X YAssemblyStoresMaintenance

8 000 0005 000 0001 000 000 500 000 500 000

15 000 000

10 000 5 00015 00015 000 5 000

50 000

300200300100100

1000

1 000 0001 000 0002 000 000

2 000 0001 000 000

Details of total material issues to the production centres are as follows:

(£)

Machine shop XMachine shop YAssembly

4 000 0003 000 0001 000 0008 000 000

Item ofexpenditure

Indirect wage and supervisionIndirect materialsLighting and heatingProperty taxesInsurance of machinery

Depreciation of machinery

Insurance of buildingsSalaries of works management

Reallocation of service centre costs Materials procurement

General factory support

Machine hours and direct labour hoursMachine hour overhead rateDirect labour hour overhead rate

Direct

DirectArea

AreaBook value of machineryBook value of machineryArea

Number of employees (1)

Value of materials issuedDirect labour hours (2)

Total(£)

Basis ofallocation

Machinecentre Y

(£)

Assembly(£)

Materialsprocurement

(£)

Generalfactory support

(£)

Machinecentre X

(£)

6 080 000

1 420 000 500 000

1 000 000

150 000

1 500 000 250 000

800 00011 700 000

2 000 000

11 700 000

1 000 000

500 000 100 000

200 000

80 000

800 000 50 000

240 0002 970 000 2 690 000 2 480 000 1 760 000 1 800 000

880 000

450 000

660 000

450 000

220 000

900 000 4 300 000 3 800 000 3 600 000

1 800 000

1 760 000

1 000 000 2 000 000£2.15 £3.80

£1.80

OVERHEAD ANALYSIS SHEET Production centres Service centres

1 000 000

805 000 50 000

100 000

50 000

500 000 25 000

160 000

1 500 000

105 000 150 000

300 000

10 000

100 000 75 000

240 000

1 100 000

150 000

300 000

5 000

50 000 75 000

80 000

1 480 000

10 000 50 000

100 000

5 000

50 000 25 000

80 000

2 000 000

11 700 000

880 000

450 000

660 000

450 000

220 000

900 000 4 300 000 3 800 000 3 600 000

1 800 000

1 760 000

1 000 000 2 000 000£2.15 £3.80

£1.80

Reallocation ofService centre costs Materials procurement

General factory support

Machine hours and direct labour hoursMachine hour overhead rateDirect labour hour overhead rate

Value of materials issuedDirect labour hours (2)

cost centre overheads

cost centre direct labour hours or machine hours

Machine centre X =

Machine centre Y =

Assembly department =

£4 300 000

£3 800 000

£3 600 000

= £2.15 per machine hour

= £3.80 per machine hour

= £1.80 per direct labour hour

2 000 000 machine hours

1 000 000 machine hours

2 000 000 direct labour hours

Product A £

Direct costs (100 units x £100)Overhead allocations Machine center A (100 units x 5 machine hours x £2.15) Machine center B (100 units x 10 machine hours x £3.80) Assembly (100 units x 10 direct labour hours x £1.80)Total costCost per unit (£16 675/100 units) = £166.75

10 000

1 075 3 800 1 800

16 675

Product B £

Direct costs (200 units x £200)Overhead allocations Machine center A (200 units x 10 machine hours x £2.15) Machine center B (200 units x 20 machine hours x £3.80) Assembly (200 units x 20 direct labour hours x £1.80)Total costCost per unit (£66 700/200 units) = £333.50

40 000

4 30015 200 7 20066 700