Cost Accounting Traditions and Innovations Barfield, Raiborn, Kinney

1. Chapter 3
Organizational Cost Flows
Cost Accounting
Traditions and Innovations
Barfield, Raiborn, Kinney

2. Learning Objectives (1 of 2)
• List the cost classifications
• Describe the conversion process in service
and manufacturing companies
• Explain assumptions about cost behavior
• Analyze mixed costs
– high-low method
– least squares regression analysis

3. Learning Objectives (2 of 2)
• List product cost categories
• Allocate overhead costs
• Describe the cause and treatment of
underapplied and overapplied overhead
• Prepare Statements of Cost of Goods
Manufactured and Sold

4. Cost
Monetary measure of resources
given up to attain an objective
(such as acquiring a good or service)

5. Cost Categories
• Time of incidence
• Reaction to changes in activity
• Classification on the financial statements
• Impact on decision making

6. Cost Categories
• Time of incidence
– Historical
– Budgeted

7. Cost Categories
• Time of incidence
• Reaction to changes in activity
– Variable
– Fixed
– Mixed
– Step

8. Cost Categories
• Time of incidence
• Reaction to changes in activity
• Classification on the financial statements
– Unexpired
– Expired
– Product
– Period

9. Product Costs
• Direct material
– Part of a product
• Direct labor
– Labor used to manufacture a product or
perform a service
• Overhead
– Indirect production cost

10. Period Costs
• Selling and administrative costs
• Distribution costs
– Cost to warehouse, transport, and/or deliver a
product or service
– Major impact on managerial decision making

11. Purchase
raw materials
or supplies
Input
Product or
Service
Output
Conversion Process
Change Inputs into Outputs
CONVERSION

12. Low Degree of Conversion
• Department stores
• Gas stations
• Jewelry stores
• Travel agencies

13. Moderate Degree of Conversion
• Florists
• Meat markets
• Oil-change businesses

14. High Degree of Conversion
• Manufacturing
• Construction
• Agriculture
• Architecture
• Auditing
• Mining
• Printing
• Restaurants

15. Service Company
Significant amount of labor
Tangible or intangible output
Purchase
supplies
Use supplies,
labor, overhead
to provide service
Sell to
customer
Input
Output

16. Retail Company
Purchase finished goods
Resell to customers
Purchase
products
for resale
Warehouse
and/or display
Sell to
customer
Input
Output

17. Manufacturer
Significant amount of labor and machinery
Tangible output
Purchase
raw materials
and supplies
Finished
product
Sell to
customer
Input Output
Production
Center
add labor and
overhead

18. Cost Accumulation in a
Manufacturing Company
Materials
Inventory
Work in Process
Inventory
Finished
Goods
Inventory
Cost of
Goods
Sold
Balance Sheet
Income
Statement

19. Fixed Cost
Variable Cost
Cost Reaction to Changes in Activity
Unit Total
$
Units
$
$
$
Units
Units Units
Within the relevant range

20. Step Cost
Mixed Cost
Cost Reaction to Changes in Activity
$
$
Units
Units
fixed
Within the relevant range
variable

21. Determining Cost Behavior
• Cost Predictor
– Activity accompanied by
consistent, observable
changes in a cost item
– Predicts but may not
cause the cost to change
• Cost Driver
– Activity that has a direct
cause-effect relationship
on cost
– Directly causes the cost
to change

22. Separating Mixed Costs
y = a + bX
y = total cost
a = fixed portion of total cost
b = variable cost
X = activity base to which y is
related
Use formula for a straight line

23. Separating Mixed Costs
• High-Low Method
– Actual cost observations
– Considers only two data points
• highest and lowest levels of activity
– Outliers should be disregarded when analyzing
mixed costs

24. Cost
Volume
High
Low
10,000
2,000
$25,000
9,000
Difference 8,000 $16,000
= $2/unit Variable cost per unit
$16,000
8,000
25,000 = a + (2)(10,000)
a = 5,000 Fixed cost
Y = 5,000 + 2X
Using the High Low Method

25. Product Cost
• Cost object - anything to which costs are
attached or related
• Direct cost - traceable to a cost object
• Indirect cost - not conveniently or
practically traceable to a cost object
– treated as overhead

26. Product Cost - Direct
• Direct Material
– Distinctly and conveniently traced to cost
object
• Direct Labor
– to manufacture a product or perform a service
– includes wages paid to direct labor employees,
production bonuses, payroll taxes
– may include holiday and vacation pay,
insurance, retirement benefits

27. Product Cost - Indirect
• Overhead - indirect production costs
– Fringe benefits, if cannot be easily traced to
product
– Overtime, if due to random scheduling
– Cost of quality

28. Product Cost Behavior
• Direct Material Variable
• Direct Labor Variable
• Overhead Variable, fixed, mixed

29. Overhead Cost Allocation
Assign indirect costs to one
or more cost objects
• To determine full cost (GAAP)
• To motivate management
• To compare alternative courses of
action for planning, controlling, and
decision making
Allocation process should be
rational and systematic

30. Allocating Overhead
Actual Cost System
Product Cost
• Direct Materials
• Direct Labor
• Overhead
Cost Used
• Actual
• Actual
• Actual

31. Allocating Overhead
Actual Cost System
• The Actual Cost System is not timely
• All costs must be known before calculating
product cost

32. Allocating Overhead
Actual vs. Normal
Product Cost
Direct Materials
Direct Labor
Overhead
Actual Cost
System
Actual
Actual
Actual
Normal Cost
System
Actual
Actual
Predetermined
Overhead Rate

33. Predetermined Overhead Rate
• Allows overhead to be assigned during the
period
• Compensates for fluctuations
– that are not related to activity level
– in activity level that do not affect fixed
overhead

34. Predetermined Overhead Rate
Total budgeted
overhead
Activity level
(Volume)
A budgeted, constant charge per unit of
activity used to assign overhead to
production or services

35. Predetermined Overhead Rate
Total budgeted
overhead
Activity level
(Volume)
$500,000
100,000
machine hours
= $5
per machine
hour

36. The Activity Level
(The Denominator)
• Relationship between the overhead cost and
the activity
– production volume
– direct labor hours
– direct labor cost
– machine hours

37. Overhead Account
(Combined)
Actual Overhead Applied Overhead
Record actual overhead
Variable Overhead 15,000
Fixed Overhead 10,000
Various Accounts 25,000
Variable 15,000
Fixed 10,000
Recording and Applying Overhead

38. Overhead Account
(Combined)
Actual Overhead Applied Overhead
Applying overhead
Work in Process 23,000
Variable Overhead 12,000
Fixed Overhead 11,000
Variable 15,000
Fixed 10,000
Variable 12,000
Fixed 11,000
Recording and Applying Overhead

39. Overhead Account
(Combined)
Actual Overhead Applied Overhead
Variable 15,000
Fixed 10,000
25,000
Variable 12,000
Fixed 11,000
23,000
Recording and Applying Overhead
Overhead is underapplied
$25,000 of overhead was incurred
Only $23,000 was applied to Work in Process

40. Disposing of Overhead Differences
• Immaterial
– Cost of Goods Sold
• Material
– Work in Process
– Finished Goods
– Cost of Goods Sold

41. Alternative Capacity Level
• Capacity measure of volume or some other
activity base
• Alternative measures:
– Theoretical
– Practical
– Normal
– Expected

42. Flow of Product Costs
Raw Materials Inventory
Accounts Payable
Work in Process Inventory
Raw Materials Inventory
Work in Process Inventory
Salaries/Wages Payable

43. Flow of Product Costs
Fixed Overhead Control (actual)
Salaries/Wages Payable
Variable Overhead Control (actual)
Utilities Payable
Work in Process Inventory
Variable Overhead Control (applied)
Fixed Overhead Control (applied)

44. Flow of Product Costs
Finished Goods Inventory
Work in Process Inventory
Accounts Receivable
Sales
Cost of Goods Sold
Finished Goods Inventory

45. Statement of Cost of Goods
Manufactured
• Beginning work in process xxxx
– Raw materials used xxx
– Direct labor xxx
– Variable overhead xxx
– Fixed overhead xxx
• Current period manufacturing costs xxxx
• Total costs to account for xxxx
• Ending work in process <xxxx>
• Cost of goods manufactured xxxx

46. Statement of Cost of Goods
Manufactured
Raw Materials Used
Beginning raw materials xxx
Purchases of raw materials xxx
Raw materials available xxx
Ending raw materials <xxx>
Total raw materials used xxx
To Statement of Cost of Goods Manufactured

47. Schedule of Cost of Goods Sold
Beginning Finished Good xxxx
Cost of Goods Manufactured xxxx
Cost of Goods Available for Sale xxxx
Ending Finished Goods xxxx
Cost of Goods Sold xxxx
From Schedule of Cost of Goods Manufactured

48. Questions
• What is the difference in the conversion
process for a service company and a
manufacturing company?
• In a normal cost system, how are overhead
costs allocated to products and services?
• How is cost of goods manufactured
calculated?