Activity based costing and management chapter 55-1

Activity-Based Costing and Management
Chapter 5
5-1
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Chapter 5: Activity-Based Costing and Management
Learning Objective 5-1 – Compute product costs under a
traditional, volume-based product-costing system.
5-2
5-2

Learning Objective 5-1. Compute product costs under a
traditional, volume-based product-costing system.
Traditional, Volume-Based
Costing System (1 of 2)
5-3
Traditional, volume-based product-costing systems are usually
based on a single volume-based driver, such as direct labor
hours, or machine hours. We will use Dronze Inc. to
demonstrate how volume-based costing is accomplished.
Dronze’s manufacturing plant in Denver produces three product
lines of high-quality drones for recreational and light
commercial use. The company manufactures three products,
including: DZ-Standard (STD), DZ Deluxe (DEL), DZ-Ultimate
(ULT).
This table provides the basic data upon which the company’s
traditional costing system was based.
(LO 5-1)

Costing System (2 of 2)
5-4
This spreadsheet shows the calculation of the product cost for
each of the product lines. Overhead is applied to the products at
the rate of $24 per direct-labor hour. Notice that all of the
plant’s budgeted manufacturing overhead is lumped together in
one single cost-pool. This total budgeted overhead amount of
$4,896,000 is then divided by the total budgeted direct labor
hours of 204,000. This results in the $24.00 per direct-labor
hour that will be used to allocate overhead to all of the
products. Dronze’s labor-hour-based product-costing system is
typical of many manufacturing companies that use a traditional
volume-based costing system. (LO 5-1)
Product-Costing System – Target Selling Price
With these product costs, Dronze Inc. established target selling
prices (Cost × 120%).
496.00 x 1.20
5-5

Now that Dronze Inc. has estimated the production cost per
unit, the target selling price can be set.
The company’s pricing policy has been to set a target price for
each drone equal to 120 percent of its full product cost.
The estimated unit cost is multiplied by 1.20 to arrive at the
target selling price. (LO 5-1)
Learning Objective 5-2 - Explain how an activity-based costing
system operates, including the use of a two-stage procedure for
cost assignment, the identification of activity cost pools, and
the selection of cost drivers.
5-6
Learning Objective 5-2. Explain how an activity-based costing
system operates, including the use of a two-stage procedure for
cost assignment, the identification of activity cost pools, and
the selection of cost drivers.

Activity-Based Costing System (ABC)
ABC systems follow a two-stage procedure to assign overhead
costs to products.
Stage One:
Identify significant activities and assign overhead costs to each
activity in proportion to resources used.
Stage Two:
Identify cost drivers appropriate to each activity and allocate
overhead to the products.
5-7
Activity-based costing (ABC) systems follow a two-stage
procedure to assign overhead costs to products.
Assigning overhead to product costs is a difficult process.
Begin by identifying the major activities. The first stage
identifies significant activities in the production process and
assigns overhead costs to each activity in accordance with the
cost of the organization’s resources used by the activity.
After assigning overhead costs to activity cost pools in stage
one, cost drivers appropriate for each cost pool are identified in
stage two. Overhead assigned to activities are called “cost
pools.” The overhead costs are allocated from each activity cost
pool to each product line in proportion to the amount of the cost
driver consumed by the product line.
This process will be demonstrated in the next set of slides. (LO

5-2)
Learning Objective 5-3 – Explain the cost hierarchy concept,
including unit-level, batch-level, product-sustaining-level, and
facility-level costs.
5-8
5-8
Learning Objective 5-3. Explain the cost hierarchy concept,
including unit-level, batch-level, product-sustaining-level, and
facility-level costs.
Total budgeted cost = $4,896,000
Activity
Cost
Pools
Machinery

cost pool
$1,242,000
Setup
cost pool
$210,000
Engineering
cost pool
$130,000
Facility
cost pool
$2,300,000
Unit-
Level
Batch-
Level
Product-
Sustaining-
Level
Facility-
Level
Identification
of Activity
Cost Pools
Activity
must be
done on
each unit
produced.
Activity
performed
on each
batch
produced.
Activities needed to support

an entire product line
Activity required in order
for the production
process to occur.
5-9
Overhead Costs
Dronze Inc. identified eight activity cost pools, which fall into
four broad categories: unit-level, batch-level, product-
sustaining-level, and facility-level (for the purposes of this
exhibit, we only include one of the batch-level activities, the
others are purchasing costs, material-handling costs, quality-
assurance costs, and packing and shipping costs; see next slide).
The activity at the unit level must be applied to each unit
produced.
The activity at the batch level must be performed one time for
each batch that goes into production.
The product-sustaining activities are required to support the
entire product line, but not needed for each unit or batch.
Facility-level activities are required in order for the entire
production process to occur. (LO 5-3)
Purchasing
cost pool 300,000
Material-Handling

cost pool $340,000
Quality-Assurance
cost pool $110,000
Packaging/Shipping
cost pool $264,000
Machinery
cost pool
$1,242,000
Setup
cost pool
$210,000
Engineering
cost pool
$130,000
Facility
cost pool
$2,300,000
Unit-Level
Batch-Level
Product-Sustaining-
Level
Facility-
Level
5-10
Overhead Cost Pools
For Dronze Inc., only the machinery cost pool is at the unit-
level.
There are five cost pools at the batch-level: setup, purchasing,
material-handling, quality assurance, and the packaging and

shipping cost pool.
The engineering cost pool is at the product-sustaining-level and
the facility cost pool is at the facility level. (LO 5-3)
Learning Objectives 5-4 – Compute product costs under an
activity-based costing system.
5-11
Learning Objective 5-4. Compute product costs under an
activity-based costing system.
Machinery Cost Pool
Total budgeted cost = $1,242,000
Maintenance
Depreciation
Computer Support
Lubrication
Electricity
Calibration

Activity
cost
pool
Various overhead
costs related
to machinery
5-12
Stage One – Machinery Cost Pool
Dronze Inc. estimated the costs of maintenance, lubrication,
depreciation, electricity, computer support, and calibration.
These costs are added together.
The sum is the machinery cost pool budgeted cost. (LO 5-4)
Budgeted Machinery Costs $1,242,000
Budgeted Machine Hours 230,000
$5.40/hour
=
=
5-13
Stage Two – Machinery Cost Pool

Dronze Inc. selected machine hours for the cost driver, since a
product that uses more machine hours should bear a larger share
of machine-related costs.
The budgeted machinery costs are divided by the budgeted
number of machine hours to arrive at the machinery cost pool
rate of $5.40 per hour.
Then, for each drone, the machinery cost pool rate is multiplied
by the number of machine hours per drone. Finally the cost for
each drone type is divided by the number of units produced to
arrive at an activity cost for each type. In our example, the STD
drone cost per unit is $54. The DEL drone cost per unit is
$64.80, and the ULT drone cost per unit is $91.80. (LO 5-4)
5-14
ABC Pool Cost Calculations – First 4 Activities
We would then continue to follow the same process for
computing the cost per set up – but this time the cost driver is
the number of production runs. For example, the activity cost
pool for the setups is $210,000 and the number of expected
production runs is 200. This comes out to a pool rate of $1,050
per production run. This amount is applied to each type of
drone. Take a moment to look at the spreadsheet and make sure

you understand how to compute each activity rate, and then how
to apply it to each type of drone that the company manufactures.
(LO 5-4)
5-15
ABC Pool Cost Calculations – Last 4 Activities
Here is the spreadsheet showing the computations for the last
four activities of Dronze Inc. (LO 5-4)
Product Costs from ABC
These are the new product costs when ABC is used.
5-16
Now Dronze Inc. has new product costs for each product type.
It is the sum of the costs for direct materials, direct labor, and
all of the accumulated overhead costs based on our ABC
analysis. Note that the direct materials and direct labor costs are
NOT AFFECTED by the use of either the traditional or ABC
costing method…only the manufacturing overhead will be
different. (LO 5-4)

Learning Objective 5-5 – Explain why traditional, volume-based
costing systems tend to distort product costs.
5-17
Learning Objective 5-5. Explain why traditional, volume-based
costing systems tend to distort product costs.
Distorted Product Costs
Both original and ABC target selling prices are based on (Cost
× 120%).
5-18
Using the existing target pricing policy, the unit cost based on
ABC costing is multiplied by 1.20 to arrive at the ABC target

selling price.
What has happened at Dronze? The essence of the problem is
that the traditional, volume-based costing was overcosting the
high-volume product lines – STD and DEL – and undercosting
the complex, relatively low-volume product line – ULT. In
other words, the high-volume products basically subsidized the
low-volume line. The ABC costing system revealed this
problem by more accurately assigning overhead to the three
product lines. (LO 5-5)
5-19
Cost Distortion
This exhibit summarizes the effects of the cost distortion under
the traditional product-costing system. Dronze Inc.’s traditional
system overcosted each STD drone by $9.00, for a total of
$90,000 for the STD product line on a volume of 10,000 units.
Each DEL drone was overcosted by $17.70, for a total of
$141,600 on a volume of 8,000 units for the DEL product line.
These excess costs had to come from somewhere, and that place
was the ULT product line. Each ULT drone was undercosted by
$115.80, for a total of $231,600 for the ULT product line on a
volume of 2,000 units. Notice that the total amount by which
the STD and DEL drone products were overcosted equals the
total amount by which the ULT drone was undercosted. (LO 5-
5)
Two Key Points

A large proportion of non-unit-level activities
A unit-level cost driver, such as direct labor, machine hours, or
throughput, will not be able to assign the costs of non-unit-level
activities accurately.
Product diversity
When the consumption ratios differ widely between activities,
no single cost driver will accurately assign the resulting
overhead costs.
5-20
To summarize, each of the following characteristics will
undermine the ability of a volume-based product-costing system
to assign overhead costs accurately.
A large proportion of non-unit-level activities; and
Product diversity. When the consumption ratios differ widely
between activities, no single cost driver will accurately assign
the resulting overhead costs.
When either of the above characteristics is present, a volume-
based product-costing system is likely to distort product costs.
(LO 5-5)
Learning Objective 5-6 – Explain three criteria for selecting
cost drivers.
5-21

Learning Objective 5-6. Explain three criteria for selecting cost
drivers.
Cost Drivers
A characteristic of an event or activity that results in the
incurrence of costs. In selecting a cost driver, we must consider
. . .
Degree of
Correlation
Cost of
Measurement
Behavioral
Effects
5-22
A cost driver is a characteristic of an event or activity that

results in the incurrence of costs. In activity-based costing
systems, the most significant cost drivers are identified. Then a
database is created, which shows how these cost drivers are
distributed across products. Three factors are important in
selecting appropriate cost drivers.
The first is the degree of correlation. The concept of an
activity-based costing system is to infer how each product line
consumes the activity by observing how each product line
consumes the cost drive, that is, how closely the tw o are
correlated. The closer the correlation, the more accurate the cost
assignments will be.
Designing any information system entails cost-benefit trade-
offs. The more activity cost pools there are in an activity-based
costing system, the greater the accuracy of the cost assignments
will be. However, more activity cost pools also entail more cost
drivers, which results in greater costs of implementing and
maintaining the system.
Information systems have the potential not only to facilitate
decisions but also to influence the behavior of decision makers.
This can be good or bad, depending on the behavioral effects. In
identifying cost drivers, an ABC analyst should consider the
possible behavioral consequences. Dysfunctional behavioral
effects are also possible. (LO 5-6)
Learning Objective 5-7 – Discuss several implementation
processes in activity-based costing, including data collection
and storyboarding.
5-23

Learning Objective 5-7. Discuss several implementation
processes in activity-based costing, including data collection
and storyboarding.
COLLECTING ABC DATA
INTERVIEWS AND PAPER TRAILS - The information for
ABC systems initially comes from interviews with employees in
the support departments and a review of each department’s
records.
STORYBOARDING - A procedure used to develop a detailed
process flow chart, which visually represents activities and the
relationships among activities.
MULTIDISCIPLINARY ABC PROJECT TEAMS - To gather
information from all facets of an organization’s operations, it is
essential to involve personnel from a variety of functional
areas. A typical ABC project team includes ACCOUNTING,
FINANCE, PRODUCTION, OPERATIONS, ENGINEERS,
MARKETING, etc.
5-24

The information used in ABC systems initially comes from
extensive interviews with key employees in each of the
organization’s support departments and a careful review of each
department’s records.
Storyboarding is a procedure used to develop a detailed process
flowchart, which visually represents activities and the
relationships among the activities.
A storyboarding session identifies the key activities involved in
each department.
These activities are written on small cards and placed on a large
board in the order they are accomplished.
After several storyboarding sessions, a completed storyboard
emerges, recording key activity information vital to the ABC
project. (LO 5-7)
Learning Objective 5-8 – Explain the concepts of activity-based
management and two-dimensional activity-based costing.
5-25

Learning Objective 5-8. Explain the concepts of activity-based
management and two-dimensional activity-based costing.
Activity-Based Management
The use of
ABC costing information
to help
management
make decisions
5-26
Using activity-based costing (ABC) information to support
organizational strategy, improve operations, and manage costs
is called activity-based management or ABM. (LO 5-8)
Activity-Based Management (ABM)
Activity-based costing establishes relationships
between overhead costs and activities so that
we can better allocate overhead costs.
Activity-based management focuses
on managing activities to reduce costs.
5-27

Activity-based costing establishes relationships between
overhead costs and activities so that we can better allocate
overhead costs.
Activity-based management focuses on managing activities to
reduce costs. (LO 5-8)
Two-Dimensional ABC and
Activity-Based Management (1 of 2)
Activities
5-28
One way to describe the relationship between ABC and ABM is
in terms of a two-dimensional activity-based costing model.
The activities, which are the center of the model, are the focal
point of ABC and ABM. (LO 5-8)
Two-Dimensional ABC and Activity-Based Management (2 of
2)
Cost Objects
Activities

Resource Costs
Cost Assignment View
5-29
The vertical element of the model is the cost assignment view of
an ABC system.
Cost assignment in an ABC system uses a two-stage cost
allocation to assign the costs of resources to the firm’s cost
objects. (LO 5-8)
Two-Dimensional ABC and
Activity-Based Management – Process View
Activity
Triggers
Cost Objects
Activities
Root
Causes
Process View
Activity Analysis
Resource Costs
Cost Assignment View

Performance
Measures
Activity Evaluation
5-30
The horizontal element of the model is the process view of an
ABC system.
The emphasis now is on the activities themselves, the various
processes by which work is accomplished in the organization.
The left-hand side is the activity analysis.
This is the identification and description of the activities
conducted in the enterprise.
Activity analysis also identifies the root causes of activities, the
events that trigger activities, and the linkages among activities.
The right-hand side is the evaluation of activities through
performance measures.
It is these processes of activity analysis and evaluation that
comprise activity-based management. (LO 5-8)
Elimination of Non-Value-Added Costs
Non-value-added activities
Necessary
Unnecessary
Activities

Reduce or
Eliminate
Continually Evaluate
and Improve
5-31
An important goal of activity-based management is to identify
and eliminate non-value-added activities and costs.
Non-value-added activities are operations that are either (1)
unnecessary and dispensable or (2) necessary, but inefficient
and improvable.
Non-value-added costs, which result from such activities, are
the costs of activities that can be eliminated without
deterioration of product quality, performance, or perceived
value. (LO 5-8)
Using ABM to Eliminate Non-Value-Added Activities and Costs
(1 of 2)
Identify Activities.
Identify Non-Value-Added Activities.
Understand Activity Linkages, Root Causes, and Triggers.
Establish Performance Measures.
Report Non-Value-Added Costs.
Specify
parts

Select
vendor
Receive
parts
Produce
goods
Inspect
finished
goods
Rework
defective
products
5-32
There are five steps that provide a strategy for eliminating non-
value-added costs in both manufacturing and service industry
firms. Step 1 identifies all of the organization’s significant
activities. The resulting activity list should be broken down to
the most fundamental level practical.
In step 2, the non-value-added activities are identified. Three
criteria for determining whether an activity adds value are as
follows:
• Is the activity necessary?
• Is the activity efficiently performed?
• Is an activity sometimes value-added and sometimes non-
value-added?
In identifying non-value-added activities, it is critical to

understand the ways in which activities are linked together (step
3). The following chain of activities provides an example:
The rework of defective units is a non-value-added activity. The
rework is triggered by the identification of defective products
during inspection. The root cause of the rework, however, could
lie in any one of a number of preceding activities. Perhaps the
part specifications were in error. Or an unreliable vendor was
selected. Maybe the wrong parts were received. Or the
production activity is to blame. A set of linked activities (such
as that depicted above) is called a process. Sometimes activity
analysis is referred to as process value analysis (PVA).
By continually measuring the performance of all activities, and
comparing performance with benchmarks, management’s
attention may be directed to unnecessary or inefficient activities
(step 4).
Non-value-added costs should be highlighted in activity center
cost reports (step 5). By identifying non-value-added activities,
and reporting their costs, management can strive toward the
ongoing goals of process improvement and elimination of non-
value-added costs. (LO 5-8)
Using ABM to Eliminate Non-Value-Added Activities and Costs
(2 of 2)
Inspection time
Process time
Storage time
Move time
Waiting time
5-33

One approach that cost-management analysts find helpful in
identifying non-value-added activities is to categorize the ways
in which time is spent in a production process.
In most manufacturing operations, time is spent in the five ways
shown above. (LO 5-8)
Learning Objective 5-9 – Explain and execute a customer-
profitability analysis.
5-34
Learning Objective 5-9. Explain and execute a customer-
profitability analysis.
Customer Profitability Analysis (1 of 2)
Customer profitability analysis uses
activity-based costing to determine
the activities, costs, and profit associated
with serving particular customers.
5-35

Customer-profitability analysis uses activity-based costing to
determine the activities, costs, and profit associated with
serving particular customers.
If managers have a good understanding of which customers are
generating the greatest profit, they can make more informed
decisions about customer service. (LO 5-9)
Customer Profitability Analysis (2 of 2)
Orders
small
quantities
Orders
frequently
Often
changes
orders
Requires
special
packaging
Demands
fast
service
A costly customer
5-36

Many factors can result in some customers being more
profitable than others.
Customers that order in small quantities, order frequently, often
change their orders, require special packaging or handling,
demand faster delivery, or need special parts or engineering
design generally are less profitable than customers who demand
less in terms of customized services. (LO 5-9)
Customer Profitability Analysis (Costs)
A company may use these customer
related costs to help determine the
profitability of each customer.
5-37
The first step is to produce an activity-based cost analysis of
certain customer-related costs that could affect a customer’s
profitability.
Recall that ABC analysis relies on a cost hierarchy with cost
levels, such as unit-level, batch-level, …

Process Costing and Hybrid
Product-Costing Systems
Chapter 4
McGraw-Hill/Irwin
4-*
*
Chapter 4: Process Costing and Hybrid Product-Costing
Systems
Learning Objective 4-1 – List and explain the similarities and
important differences between job-order and process costing.
4-*
4-*
*
Learning Objective 4-1. List and explain the similarities and
important differences between job-order and process costing.

Comparison of Job-Order Costing and Process Costing (1 of 2)
4-*
Process
Costing
Process
Costing
Job-Order
Costing
Used for production of small,
identical, low-cost items. Mass produced in automated
continuous production processes. Costs cannot be directly
traced to
each unit of product.
*
This chapter covers process-costing systems. Process costing is
used in repetitive production environments, where large
numbers of identical or very similar products are manufactured
in a continuous flow. (LO 4-1)

Comparison of Job-Order Costing and Process Costing (2 of 2)
4-*
Process
Costing
Process
Costing
Job-Order
Costing
Typical process cost applications: Petrochemical refinery Paint
manufacturer Paper mill
*
Industries using process costing include paper, petroleum,
chemicals, textiles, food processing, lumber, and electronics.
(LO 4-1)

Job-Order Costing vs. Process Costing
Job-order costingCosts accumulated by the job.Work in process
has a job-cost sheet for each job.Many unique, high-cost
jobs.Jobs built to customer order.
Process costingCosts accumulated by department or
process.Work in process has a production report for each batch
of products. A few identical, low-cost products. Units
continuously produced for inventory in automated process.
4-*
*
In many ways, job-order costing and process costing are similar.
Both product-costing systems have the same ultimate purpose—
assignment of production costs to units of output. Moreover, the
flow of costs through the manufacturing accounts is the same in
the two systems. (LO 4-1)
Direct Material
Finished
Goods
Cost of
Goods
Sold
Direct Labor
Manufacturing Overhead
Jobs

The work-in-process account consists of individual jobs in a
job-order cost system.
Differences Between Process and Job-Order Costing (1 of 2)
4-*
*
In job-order costing, costs are accumulated by job order and
recorded on job-cost records. The cost of each unit in a
particular job order is found by dividing the total cost of the job
order by the number of units in the job. This cost flow was
described in the previous chapter. (LO 4-1)
Direct Material
Finished
Goods
Cost of
Goods
Sold
Products
The work-in-process account consists of individual products in
a process-cost system.
Differences Between Process and Job-Order Costing (2 of 2)
Direct Labor
& Overhead

(Conversion)
When direct labor is a relatively small amount compared to
material and overhead, it is often combined with overhead.
4-*
*
In process costing, costs are accumulated by department, rather
than by job order or batch. The cost per unit is found by
dividing the total costs incurred by the units produced. (LO 4-1)
Learning Objective 4-2 – Prepare journal entries to record the
flow of costs in a process-costing system with sequential
production departments.
4-*
*
Learning Objective 4-2. Prepare journal entries to record the
flow of costs in a process-costing system with sequential
production departments.

Process Cost Flows – Single Department
4-*
*
In a single production department situation, direct-material,
direct-labor, and manufacturing-overhead costs are added to a
Work-in-Process Inventory account. As goods are finished,
costs are transferred to Finished-Goods Inventory. During the
period when goods are sold, the product costs are transferred to
Cost of Goods Sold. Let’s take a look at the specific journal
entries involved in a two-department process. (LO 4-2)
Journal Entry
Direct Material, Direct Labor, and Overhead Applied
4-*
The journal entry for the case of two sequential departments is
demonstrated. In this journal entry, we see $50,000 of direct
materials, $20,000 of direct labor, and $30,000 of
manufacturing overhead applied to the WIP account for
Department A – the first department. The overhead would have
been applied using the same method as we learned about in the
job order costing chapter. The numbers used in the journal entry
are assumed for the purpose of showing the form of the entries.
(LO 4-2)

Process Cost Flows –Two Departments
4-*
*
In the two-department case, when goods are finished in the first
production department, costs accumulated in the Work-in-
Process Inventory account for production department A are
transferred to the Work-in-Process Inventory account for
production department B. Let’s take a look at a typical entry
when the costs are transferred from one department to the next.
(LO 4-2)
Journal Entry
Dept. B – Transferred In Costs
4-*
When production in Department A completes its work on some
units of the product, those units are transferred to production
Department B. The costs assigned to these goods are transferred
from the Work-in-Process Inventory account for Department A
to the Work-in-Process Inventory Account for Department B. In
Department B, the costs assigned to those partially completed

products are called transferred-in costs. (LO 4-2)
Journal Entry
Dept. B – Direct Material, Direct Labor, and Manufacturing
Overhead
4-*
Direct material and direct labor are used in production
Department B, and manufacturing overhead is applied using a
predetermined rate. These costs are accumulated in Department
B and recorded as shown. (LO 4-2)
Journal Entry
Goods Completed
4-*
As goods are completed in Department B, the cost of those
goods are transferred out of Work-in-Process and into Finished-
Goods Inventory. (LO 4-2)

Journal Entry
Cost of Goods Sold
4-*
The costs of the goods completed stay in the Finished-Goods
Inventory account until the units are sold, at which point the
costs are transferred OUT of Finished-Goods Inventory and
INTO Cost of Goods Sold. At this point, the cost has finally
been transferred to the Income Statement. The costs have no
more future value. (Note: Just as in Job-Order Costing, the
revenue earned from the units sold would also typically be
recorded when the goods are sold.) (LO 4-2)
Learning Objective 4-3 – Prepare a table of equivalent units
under weighted-average process costing.
4-*
*
Learning Objective 4-3. Prepare a table of equivalent units
under weighted-average process costing.

Equivalent Units: A Key Concept
By definition, units in work-in-process inventory at both the
beginning and end of the period are only partially complete
(finished units are transferred out).
Equivalent units is a concept expressing these partially
completed units.
Equivalent units refers to the amount of manufacturing activity
that has been applied to a batch of physical units.
4-*
The term equivalent units is used in process costing to refer to
the amount of manufacturing activity that has been applied to a
batch of physical units. (LO 4-3)
*
Equivalent Units Example
Two half completed products are equivalent to one completed
product.
So, 10,000 units that are 70% complete
are equivalent to 7,000 complete units.
4-*

l
+
=
*
For example, two units which are 50 percent complete are
equivalent to one unit that is 100 percent complete. Likewise,
10,000 units that are 70 percent complete is 7,000 equivalent
units. (LO 4-3)
For the current period, Jones started 15,000 units and completed
10,000 units, leaving 5,000 units in process 30% complete. How
many equivalent units of production did Jones have for the
period?
a. 10,000
b. 11,500
c. 13,500

d. 15,000
Equivalent Units Question 1
4-*
*
Jones started 15,000 units and transferred 10,000 units to
finished goods. The remaining 5,000 units were 30 percent
complete. How many equivalent units did Jones have for the
period? (LO 4-3)
For the current period, Jones started 15,000 units and completed
10,000 units, leaving 5,000 units in process 30 percent
complete. How many equivalent units of production did Jones
have for the period?
a. 10,000
b. 11,500
c. 13,500
d. 15,000
10,000 units + (5,000 units × .30)
= 11,500 equivalent units
Equivalent Units Question 1 (Solved)
4-*
*
The 5,000 units that are 30 percent complete are equivalent to
1,500 units. Add that to the 10,000 units that are 100 percent

complete for a total of 11,500 equivalent units. (LO 4-3)
Jones incurred $27,600 in production costs for the 11,500
equivalent units. What was Jones’s cost per equivalent unit for
the period?
a. $1.84
b. $2.76
c. $2.40
d. $2.90
4-*
Equivalent Units Question 2
*
The production costs incurred for the period were $27,600.
What is the cost per equivalent unit? (LO 4-3)
Jones incurred $27,600 in production costs for the 11,500
equivalent units. What was Jones’s cost per equivalent unit for
the period?
a. $1.84
b. $2.76
c. $2.40
d. $2.90

4-*
Equivalent Units Question 2 (Solved)
$27,600 ÷ 11,500 equivalent units
= $2.40 per equivalent unit
*
The production costs are divided by the number of equivalent
units to arrive at the cost per equivalent unit. (LO 4-3)
Calculating and Using Equivalent Units of Production
To calculate the direct materials and conversion costs per
equivalent unit for the period:
Materials cost per equivalent
unit
=
Materials cost for the period
Materials equivalent units for the period
Conversion cost per equivalent
unit
=
Conversion cost for the period
Conversion equivalent units for the period
4-*

*
Direct material is usually placed into production at the
beginning of the production process. In contrast, direct labor
and manufacturing overhead, called conversion costs, usually
are incurred uniformly throughout the process. When an
accounting period ends, the partially completed goods that
remain in process generally are at different stages of completion
with respect to material and conversion activity. The most
important feature of process costing is that the costs of direct
material and conversion are assigned to equivalent units rather
than to physical units. (LO 4-3)
Departmental Production Report
4-*
Production
Report
Analysis of
physical flow
of units
Calculation
of equivalent
units

Computation
of unit costs
Analysis of
total costs
*
The key document in a typical process-costing system is the
departmental production report, prepared for each production
department at the end of each accounting period. The
departmental production report summarizes the flow of
production quantities through the department, and it shows the
amount of production cost transferred out of the department’s
Work-in-Process Inventory account during the period. There are
four steps used in preparing a departmental production report:
1. Analysis of physical flow of units.
2. Calculation of equivalent units.
3. Computation of unit costs.
4. Analysis of total costs.
(LO 4-3)
Equivalent Units of Production –
Weighted-Average Method

The weighted-average method . . .
Makes no distinction between work done in the prior period and
work done in the current period.Blends together units and costs
from the prior period and the current period.The FIFO method is
a more complex method and is rarely used in practice.
4-*
*
The method of process costing that we will focus on in this
chapter is called the weighted-average method. This method is
almost always used in practice by companies using process
costing. There is another process-costing method called the
first-in, first-out, or FIFO, method. (LO 4-3)
Production Report Example (1 of 2)MVP Sports Equipment
Company makes baseball gloves in two departments, Cutting
and Stitching. MVP uses the weighted-average process
costing.Material is added at the beginning of the Cutting
Department, while conversion is incurred uniformly throughout
the process.Using the following information for the month of
March, let’s prepare a production report for the Cutting
Department.
4-*
*
The MVP Sports Equipment Company manufactures baseball
gloves. Two production departments are used in sequence: the
Cutting Department and the Stitching Department. In the
Cutting Department, direct material is placed into production at

the beginning of the process. Direct-labor and manufacturing
overhead costs are incurred uniformly throughout the process.
The predetermined overhead rate used in the Cutting
Department is 125 percent of direct-labor cost. (LO 4-3)
Production Report Example (2 of 2)
Work in process, March 1: 20,000 units
Cost
Materials: 100% complete $
50,000
Conversion: 10% complete
7,200
Units started into production in March: 30,000 units
Units completed and transferred out in March: 40,000 units
Work in process, March 31: 10,000 units
Materials 100% complete
Conversion 50% complete
Costs incurred during March
Materials cost 90,000
Conversion costs:
Direct labor $ 86,000
Applied manufacturing overhead
107,500
Total conversion costs
193,500
Total costs to account for $ 340,700
4-*

*
This slide presents a summary of the activity and costs in the
Cutting Department during March. The direct-material and
conversion costs for the March 1 work in process consist of
costs that were incurred during February. These costs were
assigned to the units remaining in process at the end of
February. Materials costs of $90,000 and conversion costs of
$193,500 were added during the month of March. The beginning
work in process and the costs added during March equal the
total costs to be accounted for. (LO 4-3)
Analysis of Physical Flow of Units
Production Report Example – Units Accounted For
4-*
*
The first step is to prepare a table summarizing the physical
flow of production units during March. (LO 4-3)
Sheet1PhysicalUnitsWork in process, March 120,000Units
started during March30,000Total units to account
for50,000Units completed and transferred out during
March40,000Work in process, March 3110,000Total units
accounted for50,000
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Production Report Example – Equivalent Units (1 of 2)
4-*Calculation of Equivalent Units
50% of 10,000 units
Beginning inventory % is not used in weighted-average method.
*
The second step is to calculate the equivalent units of direct
material and conversion activity. The table of equivalent units,
displayed on this slide, is based on the table of physical flows
prepared in Step 1. The Cutting Department completed its work
on 40,000 physical units. Thus, it represents 40,000 equivalent
units for both direct material and conversion. The 10,000 units
in the Cutting Department’s ending work-in-process inventory
are 50 percent complete with respect to conversion. Therefore,
the ending work-in-process inventory represents 5,000
equivalent units of conversion activity (10,000 physical units x
50% complete). (LO 4-3)
Sheet: Sheet1
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Conversion
Equivalent Units
Physical
Percentage
Direct
Units
Complete
Material
Conversion
Work in process, March 1
20000.0
0.1
Units started during March
30000.0
Total units to account for
50000.0
Units completed and transferred
40000.0
1.0
40000.0
40000.0
Work in process, March 31
10000.0

0.5
10000.0
5000.0
Total units accounted for
50000.0
Total equivalent units
50000.0
45000.0
Production Report Example - Equivalent Units (2 of 2)
100% of 10,000 units, all
material added at beginning
4-*Calculation of Equivalent Units
*
With respect to direct material, the 10,000 units in the Cutting
Department’s ending work-in-process inventory are 100 percent
complete. Therefore, the ending work-in-process inventory
represents 10,000 equivalent units of direct material. (LO 4-3)
Sheet1ConversionEquivalent
UnitsPhysicalPercentageDirectUnitsCompleteMaterialConversio
nWork in process, March 120,00010%Units started during
March30,000Total units to account for50,000Units completed
and transferred40,000100%40,00040,000Work in process,
March 3110,00050%10,0005,000Total units accounted
for50,000Total equivalent units50,00045,000
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Learning Objective 4-4 – Compute the cost per equivalent unit
under the weighted-average method of process costing.
4-*
4-*
*
Learning Objective 4-4. Compute the cost per equivalent unit
under the weighted-average method of process costing.
Computation of Unit Costs
4-*

$2.80 + $4.46
*
The third step in the process-costing procedure is calculating
the cost per equivalent unit for both direct material and
conversion activity. The cost per equivalent unit for direct
material is computed by dividing the total direct-material cost,
including the cost of the beginning work in process and the cost
incurred during March, by the total equivalent units (from Step
2). The same procedure is used for conversion costs. (LO 4-4)
Sheet1DirectMaterialConversionTotalWork in Process, March
1$ 50,000$ 7,200$ 57,200Costs incurred during
March90,000193,500283,500Total costs to account for$
140,000$ 200,700$ 340,700Equivalent
units50,00045,000Cost per equivalent unit$ 2.80$ 4.46$
7.26
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Learning Objective 4-5 – Analyze the total production costs for
a department under the weighted-average method of process
costing.
4-*
*
Learning Objective 4-5. Analyze the total production costs for a
department under the weighted-average method of process
costing.
Production Report Example – Total Costs (1 of 2)
Analysis of total costs
4-*
*
The final step is to determine the total cost to be transferred out
of the Cutting Department’s Work-in-Process Inventory account
and into the Stitching Department’s Work-in-Process Inventory

account. The cost per equivalent unit, $7.26, was calculated in
step 3. The number of units transferred is multiplied by the total
cost per equivalent unit. (LO 4-5)
Sheet1Cost of goods completed and transferred during
MarchCost of goods completed and transferred during
MarchCost of goods completed and transferred during
March40,000 units x $7.26 per equivalent unit$ 290,40040,000
units × $7.26 per equivalent unit$ 290,40040,000 units x $7.26
per equivalent unit$ 290,400Costs remaining in work-in-
process on March 31Costs remaining in work-in-process on
March 31Costs remaining in work-in-process on March 31Direct
Material:Direct Material:Direct Material:10,000 equivalent
units x $2.80 per equivalent unit$ 28,00010,000 equivalent
units × $2.80 per equivalent unit$ 28,00010,000 equivalent
units x $2.80 per equivalent unit$
28,000Convserion:Conversion:Convserion:5,000 equivalent
units x $4.46 per equivalent unit22,3005,000 equivalent units ×
$4.46 per equivalent unit22,3005,000 equivalent units x $4.46
per equivalent unit22,300Total cost of March 31 work-in-
process50,300Total cost of March 31 work-in-
process50,300Total cost of March 31 work-in-
process50,300Total costs accounted for$ 340,700Total costs
accounted for$ 340,700Total costs accounted for$ 340,700
Sheet2
Sheet3
Cost of goods completed and transferred during March
40,000 units × $7.26 per equivalent unit290,400$
Costs remaining in work-in-process on March 31
Direct Material:
10,000 equivalent units × $2.80 per equivalent unit28,000$
Conversion:
5,000 equivalent units × $4.46 per equivalent unit22,300
Total cost of March 31 work in process50,300
Total costs accounted for340,700$

MBD000EA94A.xls
Sheet: Sheet1
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Cost of goods completed and transferred during March
40,000 units × $7.26 per equivalent unit
290400.0
Costs …
Product Costing and Cost Accumulation in a Batch Production
Environment
Chapter 3
McGraw-Hill/Irwin

3-*
Chapter 3: Product Costing and Cost Accumulation in a Batch
Production Environment
Learning Objective 3-1 – Discuss the role of product and
service costing in manufacturing and nonmanufacturing firms.
3-*
Learning Objective 3-1. Discuss the role of product and service
costing in manufacturing and nonmanufacturing firms.
Product and Service Costing
Financial Accounting
Product costs are used to value inventory on the balance sheet
and to compute cost of
goods sold on the income statement.
Managerial Accounting and Cost Management
Product costs are used for planning, control, directing, and
management decision making.

Other Interested Organizations
There is an ever-increasing need for product cost information
for external organizations as well.
3-*
Product costing is the assignment of production costs to all
output of the organization. A product-costing system
accumulates the costs incurred in a production process and
assigns those costs to the organization’s outputs. Product
costing produces data that are needed for a variety of purposes
in financial accounting, managerial accounting, and cost
management.
Use in Financial Accounting – Product costs are used to value
inventory on the balance sheet and to compute the cost of goods
sold on the income statement.
Use in Managerial Accounting – Product costs are needed to
help management plan, control, and direct operations. In
addition, they are needed to help with management decision
making.
Use in Reporting to Interested Organizations – Product cost
information is often required between firms and outside
organizations. Public utilities, hospitals, and governmental
agencies are a few examples. (LO 3-1)

Learning Objective 3-2 – Diagram and explain the flow of costs
through the manufacturing accounts used in product costing.
3-*
Learning Objective 3-2. Diagram and explain the flow of costs
through the manufacturing accounts used in product costing.
3-*
Flow of Costs in a Manufacturing Firm
Manufacturing costs consist of direct material, direct labor, and
manufacturing overhead. As production takes place, all
manufacturing costs are added to the Work-in-Process Inventory
(WIP) account with a debit. As soon as products are completed,
their product costs are transferred from Work-in-Process
Inventory to Finished-Goods Inventory with a credit to Work in
Process and a debit to Finished Goods. During the time period
when products are sold, the product cost of the inventory sold is
removed from Finished Goods and added to Cost of Goods Sold,
which is an expense of the period in which the sale occurred. A
credit to Finished Goods and a debit to Cost of Goods Sold
completes this step. Cost of Goods Sold is closed into the
Income Summary account at the end of the accounting period,
along with all other expenses and revenues of the period. We
will look at this in more detail and go through each journal
entry recorded as the costs progress through the accounting
system. (LO 3-2)

Learning Objective 3-3 – Distinguish between job-order costing
and process costing.
3-*
Learning Objective 3-3. Distinguish between job-order costing
and process costing.
Process
Costing
Job-Order
Costing
3-*
Types of Product-Costing Systems (1 of 2)
Used for production of large, unique, high-cost items. Built to
order rather than mass produced. Many costs can be directly

traced to each job. TWO TYPES: Job-shop operations Products
manufactured in very low volumes or one at
a time. Batch-production operations Multiple products in
batches of relatively small
quantity.
Job-order costing is used by companies with job-shop
operations or batch-production operations. In a job-shop
environment, products are manufactured in very low volumes or
one at a time. In job-order costing, each distinct batch of
production is called a job or job order. The cost-accounting
procedures are designed to assign costs to each job. Then the
total costs assigned to each job are divided by the units of
production in the job to obtain an average cost per unit.
Examples of job-shop environments include film production,
custom home building, and aircraft manufacturing.
In a batch-production environment, multiple products are
produced in batches of relatively small quantity. Examples
include furniture manufacture, printing, agricultural equipment,
and pleasure boat production. (LO 3-3)
Process
Costing
Job-Order
Costing
3-*
Types of Product-Costing Systems (2 of 2)

Used for production of small, identical, low-cost
items. Mass produced in a continuous-flow
production process (can be batch-oriented as well). Costs
cannot be directly traced to each unit of
product. Typical process cost applications: Petrochemical
refinery Paint manufacturer Paper mill
Process costing is used by companies that produce large
numbers of identical units. A process-costing system
accumulates all the production costs for a large number of units
of output, and then these costs are averaged over all of the
units.
Process costing is used by companies that produce large
numbers of identical units in a continuous-flow manufacturing
process. In addition, some batch-production environments use
process costing when the manufacturing process requires that
the product be produced in discrete batches, but batch after
batch of identical products are produced.
Firms that produce chemicals, microchips, gasoline, beer,
fertilizer, textiles, processed food, and electricity are among
those using process costing. In these kinds of firms, there is no
need to trace costs to specific batches of production because the
products in the different batches are identical. (LO 3-3)

3-*
The primary document for tracking the costs associated with a
given job is the
job-cost record.
Accumulating Costs in a Job-Order Costing System
Three major sections on the job-cost record are used to
accumulate the costs of direct material, direct labor, and
manufacturing overhead assigned to the job. The other two
sections are used to record the total cost and average unit cost
for the job, and to keep track of units shipped to customers. (LO
3-3)
3-*
Job-Order Cost Accounting: Material Requisition
Let’s see one
A material requisition form is used to authorize the use of
materials on a job.
As raw materials are needed for the production process, they are
transferred from the warehouse to the production department.
To authorize the release of materials, the production department

supervisor completes a material requisition form and presents it
to the warehouse supervisor. (LO 3-3)
3-*
Job-Order Cost Accounting: Material Requisition Example
A copy of the material requisition form goes to the cost
accounting department. (LO 3-3)
3-*
Job-Order Cost Accounting: Direct Materials
There it is used as the basis for transferring the cost of the
requisitioned material from the Raw-Material Inventory account
to the Work-in-Process Inventory account, and for entering the
direct-material cost on the job-cost record for the production
job in process. (LO 3-3)

Accumulate direct-labor costs by means of a work record, such
as a time ticket, for each employee.
Let’s see one
3-*
Job-Order Cost Accounting: Direct Labor
The assignment of direct-labor costs to jobs is based on time
records filled out by employees. (LO 3-3)
3-*
Job-Order Cost Accounting: Time Record Example (1 of 2)
A time record is a form that records the amount of time an
employee spends on each production job. (LO 3-3)
3-*
Job-Order Cost Accounting: Time Record Example (2 of 2)
The time record is the source document used in the cost

accounting department as the basis for adding direct-labor costs
to Work-in-Process Inventory and to the job-cost records for the
various jobs in process. (LO 3-3)
Apply manufacturing overhead to jobs using a
predetermined overhead rate based on direct labor hours
(DLH).
Let’s do it
3-*
Job-Order Cost Accounting: Manufacturing Overhead
(1 of 2)
Manufacturing overhead is a pool of indirect production costs,
such as indirect material, indirect labor, utility costs, and
depreciation. These costs often bear no obvious relationship to
individual jobs or units of product, but they must be incurred
for production to take place. Therefore, it is necessary to assign
manufacturing-overhead costs to jobs in order to have a
complete picture of product costs. (LO 3-3)

3-*
Job-Order Cost Accounting: Manufacturing Overhead
(2 of 2)
This process of assigning manufacturing-overhead costs to
production jobs is called overhead application. A predetermined
overhead rate is used to apply overhead on the job-cost record.
(LO 3-3)
3-*
Job-Order Cost Accounting: Cost Summary
Once manufacturing overhead has been applied, the cost
summary can be completed. Total direct material costs, total
direct labor costs, and total manufacturing overhead costs are
added together to determine total costs. These costs are divided
by the number of units completed to arrive at the unit cost. (LO
3-3)

3-*
Job-Order Cost Accounting: Shipping Summary
The shipping summary is completed when the completed units
are shipped to the customer. This summary shows units shipped,
units remaining, and the cost of the units remaining in
inventory. (LO 3-3)
Learning Objective 3-4 – Compute a predetermined overhead
rate and explain its use in job-order costing for job-shop and
batch-production environments.
3-*
3-*
Learning Objective 3-4. Compute a predetermined overhead rate
and explain its use in job-order costing for job-shop and batch-
production environments.
Overhead is applied to jobs using a predetermined overhead
rate based on estimates made at the beginning of the accounting

period.
Overhead applied = Rate × Actual activity
Based on estimates, and determined before the period begins
Actual amount of the allocation base, such as direct labor hours,
incurred during the period
3-*
=
Manufacturing Overhead Costs (1 of 2)
Predetermined
Rate
Budgeted manufacturing overhead cost
Budgeted amount of cost driver (or activity base)
The accounting department chooses some measure of productive
activity to use as the basis for overhead application. In
traditional product-costing systems, this measure is usually
some volume-based cost driver (or activity base), such as
direct-labor hours, direct-labor cost, or machine hours. An
estimate is made of (1) the amount of manufacturing overhead
that will be incurred during a specified period of time and (2)
the amount of the cost driver (or activity base) that will be used
or incurred during the same time period. (LO 3-4)
Overhead is applied to jobs using a predetermined overhead
rate (POHR) based on estimates made at the beginning of the

accounting period.
$360,000 / 40,000 hours = $9 per machine hour
Overhead applied = Hours on Job = 30 × $9 per hour = $270
3-*
Manufacturing Overhead Costs (2 of 2)
Rate =
Budgeted manufacturing overhead cost
Budgeted amount of cost driver (or activity base)
So if we assume that the company has budgeted manufacturing
overhead for the period of $360,000 and it expects to use a total
of 40,000 machine hours over that same period, then the pre-
determined rate would be computed by taking the estimated
overhead of $360,000 and dividing it by the number of machine
hours to be used over that same period – in this case 40,000
hours. This equates to a rate of $9 per machine hour that will be
used to charge overhead to all of the jobs. If one specifi c job
took 30 machine hours to complete, then a total of $270 or 30
hours multiplied by $9 per hour would be charged to the job.
(LO 3-4)
Learning Objective 3-5 – Prepare journal entries to record the
costs of direct material, direct labor, and manufacturing
overhead in a job-order costing system.

3-*
3-*
Learning Objective 3-5. Prepare journal entries to record the
costs of direct material, direct labor, and manufacturing
overhead in a job-order costing system.
Production Order for Job
The material requisition indicates the cost of direct material to
charge to jobs and the cost of indirect material to charge to
overhead.
Material Requisition
The production order for the job authorizes the start of the
production process.
Labor Time Records
Employee time tickets indicate the cost of direct labor to charge
to jobs and the cost of indirect labor to charge to overhead.
Actual Cost Driver (or Activity Base)
X
Predetermined Overhead Rate
Apply Manufacturing Overhead
3-*
Job-Order Costing Document Flow Summary
The production order for the job authorizes the start of the
production process. The material requisition form identifies the
amount of direct material to add to the job-cost records and the
amount of indirect materials to add to the manufacturing
overhead account.

The employee time tickets identity the amount of direct labor to
add to the job-cost records and the amount of indirect labor to
add to the manufacturing overhead account.
Overhead is applied to the job-cost records using some cost
driver or activity base and a predetermined overhead rate.
Let’s examine the cost flows in a job-order costing system. We
will use T-accounts and start with materials. (LO 3-5)
Raw MaterialsMaterial
PurchasesDirect
MaterialDirect
Material
Mfg. OverheadIndirect
MaterialIndirect
Material
Work in Process
(Job-Cost Record)
3-*
Job-Order System Cost Flows: Materials
Materials purchases are recorded with a debit to the raw
materials account. When materials are placed into production,

the raw materials account is credited. Work-in-process is
increased with a debit for the amount of the raw materials and
manufacturing overhead is increased with a debit for the amount
of the indirect materials. The amount of direct materials for
each job is recorded on the individual job-cost records. Now
let’s review the resulting journal entries for these transactions.
(LO 3-5)
Journal Entry
Purchase of Materials
3-*
A company worked on two jobs during the accounting cycle.
During the month, the company purchased, on account, $38,000
worth of materials and parts to be used in the manufacturing
operation. The journal entry to record the purchase of the
materials on account is shown. (LO 3-5)
3-*
Journal Entry
Use of Direct Materials

During the month, materials were requisitioned for use to
manufacture the products. One job (Job D42) requisitioned
$34,000 of direct materials and the second job (Job S116)
requisitioned $28,000 of direct materials. The journal entries
record the release of the materials requested into production.
(LO 3-5)
3-*
Journal Entry
Use of Indirect Materials
Since the cost of indirect materials incurred is relatively small
and it affects all units, no attempt is made to trace the costs to
specific jobs. The company accumulates all manufacturing-
overhead costs in the Manufacturing Overhead account. All
actual overhead costs are recorded by debiting this account. The
account is debited when indirect materials are requisitioned,
when indirect-labor costs are incurred, when utility bills are
paid, when depreciation is recorded on manufacturing
equipment, and so forth. (LO 3-5)
Direct
Labor

MaterialDirect
MaterialIndirect
LaborDirect
LaborIndirect
Labor
Wages Payable
Work in Process
(Job-Cost Record)
3-*
Job-Order System Cost Flows: Labor
Direct labor and indirect labor costs are taken from the time
tickets and recorded with a credit to wages payable. The direct
labor costs are recorded with a debit to work-in-process.
Manufacturing overhead is increased with a debit for the
amount of the indirect labor. The amount of direct labor for
each job is recorded on the individual job-cost records. Let’s
take a look at the journal entry to record labor costs. (LO 3-5)
3-*
Journal Entry
Use of Direct Labor

The cost accounting department uses the labor time records
filed during the month to determine the following direct labor
costs of all jobs. One job (Job D42) used $19,000 worth of
direct labor costs and the other job (Job S116) used $12,000 of
direct labor costs. The journal entry to record these costs is
shown. (LO 3-5)
3-*
Journal Entry
Use of Indirect Labor
The analysis of labor time records also revealed that the
company incurred $14,000 of labor costs that were not charged
out to any particular job. This labor cost comprises some
production supervisor time and wages of various employees who
spent some of their time on maintenance and general clean up of
the factory. This journal entry records the indirect labor costs to
manufacturing overhead. (LO 3-5)
Direct
Labor

MaterialDirect
MaterialOverhead
Applied to Work in
Process
Actual and applied manufacturing overhead are usually not
equal so a year-end adjustment is required. We will look at the
procedure to accomplish this later.Indirect
LaborDirect
LaborOverhead
AppliedIndirect
Labor
Wages Payable
Work in Process
(Job-Cost Record)
3-*
Job-Order System Cost Flow: Manufacturing Overhead
In a previous slide, we saw how overhead costs were incurred or
accumulated on the debit side of the manufacturing overhead
account. Overhead must be applied to each job-cost record
based on the predetermined overhead rate and the actual activity
for that job. The overhead applied is also recorded in the work-
in-process account with a debit. The manufacturing overhead
account is decreased by the amount of overhead applied with a
credit. The actual overhead cost incurred and the amount of
applied overhead rarely will match. This is caused by errors in
the estimates of overhead and activity used to compute the

predetermined overhead rate. Let’s see how overhead is applied
through the journal entry process. (LO 3-5)
Journal Entry
Manufacturing Costs Incurred
3-*
Actual Costs Incurred:
Journal Entry to record the costs:
The company incurred various overhead costs or indirect
production costs provided during the month. After analyzing the
costs, the compound entry is made to record these overhead
costs. (LO 3-5)
Application of Overhead
Actual use of machine hours for the two jobs were as follows:
3-*
Recall that we discussed the pre-determined overhead rate
earlier. The rate was computed by taking the company’s
estimated manufacturing overhead and dividing by the total
budgeted machine hours. We computed the rate per machine
hour to be $9.00.

The company reviewed factory machine usage records that
indicated that the actual machine usage was as shown. Now let’s
make a journal entry to reflect the application of the overhead
costs to the jobs. Job number D42 used 1,800 machine hours
and so that job will be charged with $16,200 in overhead costs.
Job S116 used 2,000 machine hours and so that job will be
charged with $18,000 in overhead costs. The journal entry to
show how the overhead is applied will be shown next. (LO 3-5)
Journal Entry
Application of Manufacturing Overhead
3-*
The journal entry to add applied manufacturing overhead to
Work-in-Process using the previous computations includes a
debit to WIP and a credit to Manufacturing Overhead. (LO 3-5)
Summary of Manufacturing Overhead
3-*
This slide summarizes the accounting procedures used for
manufacturing overhead. The left side of the Manufacturing

Overhead account is used to accumulate actual manufacturing-
overhead costs as they are incurred throughout the accounting
period. The right side is used to record overhead applied to the
Work-In-Process account. The two sides of the account rarely
equal. The balance of the account is usually relatively small.
We will talk about how to dispose of the balance later in the
chapter. (LO 3-5)
Journal Entry
Selling and Administrative Costs
3-*
During the month, the company incurred some typical selling
and administrative costs as shown. Remember that these costs
are period costs, not product costs. They are NOT
manufacturing costs and so they do NOT go through the WIP
account. They are instead treated as expenses of the accounting
period in which they are incurred. Take a moment to review the
costs incurred and the resulting journal entry. (LO 3-5)
Cost of
Goods

Mfd.
Finished GoodsCost of
Goods
Sold Cost of
Goods
Mfd.
Cost of Goods SoldCost of
Goods
Sold Direct
MaterialDirect
LaborOverhead
Applied
Work in Process
(Job-Cost Record)
3-*
Job-Order System Cost Flows: Completion and Sale of Goods
When the goods are completed, the cost of the goods
manufactured are transferred to the finished goods inventory
with a credit to work-in-process and a debit to finished goods.
When goods are sold, the cost becomes an expense in the period
of the sale. It is recorded with a debit to cost of goods sold and
a credit to finished goods inventory. (LO 3-5)

Journal Entry
Completion of a Production Job
3-*
Job Number S116 was completed during the period, whereas Job
umber D42 remained in process at the end of the period. As the
job-cost record (or Cost Summary) for Job S116 indicates, the
total cost of job S116 was $48,000. Since this job was
completed, the cost of $48,000 is transferred out of the WIP
account and into Finished-Goods. (LO 3-5)
Journal Entry
Sale of Goods
3-*
Sixty of the standard product in job number S116 were sold for
$900 each during the period. The cost of each unit sold was
$600 as shown in the job record. The following journal entries
are made. The first one for $54,000 records the revenue
generated by the sale and can be computed by taking the sixty

units sold multiplied by the selling price of $900 each. Next,
the per unit cost associated with the sale was $600 each. So the
$36,000 or $600 multiplied by 60 units was taken out of the
Finished-Goods inventory and charged to Cost of Goods Sold.
The remaining unsold units are still in Finished Goods account
and will remain there until the units are sold. (LO 3-5)
3-*
Underapplied and Overapplied Overhead
Remember that the company incurred …

Activity based costing and management chapter 55-1

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Activity based costing and management chapter 55-1