Chapter04.ppt/Management Accounting Costing Systems

© McGraw-Hill Education (UK) Limited 2013
Costing
Systems
Chapter 4
1

• LO1 Understand and explain different
approaches to product and service costing
• LO2 Understand how labour and material costs
can be traced to jobs
• LO3 Calculate a manufacturing overhead rate
to assign jobs
• LO4 Calculate a job cost and understand its use
in decision making
Learning Outcomes
2

• LO5 Deal with under or over allocated
manufacturing overhead
• LO6 Understand how non-manufacturing
overheads are treated
• LO7 Understand how job costing can be used
in contracting and service businesses
• LO8 Record job costs and how these relate to
the accounting system
Learning Outcomes
3

• All business owners and managers need to
know the underlying cost of products or
services
• How costs are assigned to products depends
on the type of business
Introduction
4

• In this chapter, an absorption costing
approach is used to calculate costs for jobs or
services. The examples used in the chapter
depict a typical manufactured product
• All costs of manufacture are assigned to a
product, that is, materials, labour and a
portion of manufacturing overhead
Introduction
5

• Costs are assigned to products or services using some
recognized method which reflects the interrelationship
with the cost object and how a business or organization
runs.
• There are three cost system types typically associated
with manufacturing companies and in some service-
sector organizations:
̶ Job costing
̶ Process costing
̶ Contract costing
Cost Systems
6

• A Job costing system is one where many uniquely
identifiable products/services are the norm
• A Contract costing system is similar to job costing
however it varies in that product or service occurs over a
longer period of time
• A Process costing system is used when a manufacturing
process exists in which a unique product or unit cannot
be identified
Cost Systems
7

What type of
organization or
industry may use
each type of
costing system?
Cost Systems
8

• Job costing systems are typically associated
with a manufacturing business, although it is
also used in the service sector
• Manufacturing costs are generally classified as
materials, labour and manufacturing overhead
Overview of a Job Costing System
9

© McGraw-Hill Education (UK) Limited 2013 10
Exhibit 4.1: Typical flow of costs in a job costing system

• Looking at Exhibit 4.1, you can see how the
cost of a product is accumulated as the
manufacturing process occurs
• At any point in time, it should be possible to
put a reasonably accurate value on any
notebook computer
11

• You could also think of each cost and stage in
Exhibit 4.1 as a ledger account–a materials
cost account, a labour cost account and an
overhead cost account
• You do not normally see these accounts in
practice, but they are still there in the
background of the information systems used
to capture and accumulate costs
12

Materials Cost
• The materials necessary to make any products are
usually purchased by a purchasing management
function
• The quantity to be purchased is determined by a
number of factors, as follows:
̶ Inventory level
̶ Price
̶ Stock required for customer orders
13

Materials Cost
• How is the cost of materials needed for customer
orders calculated?
• The price of materials is actually a key issue to be
addressed in tracing material costs to products
• It may not be possible to determine the actual cost
of all materials to an individual product
14

Materials Cost
• When it is difficult to trace materials to individual
products then assumptions are made on the
movement of materials under FIFO, LIFO and AVCO
• These assumptions are not related to how materials
physically move or flow in reality
• Of course, actual cost can be used instead of the
above assumptions if a business has adequate
information systems
15

Labour Cost
• Labour costs in a job costing system typically refer to
the costs of employees directly working on the
manufacture of a product
• The time worked on each job/order needs to be
captured
• Traditionally, the time worked was captured on a job
card, however today more technologically
sophisticated methods are more likely to be used
16

Labour Cost
• What to do with labour hours that are not or
cannot be traced to a particular job?
• They are usually treated as part of manufacturing
overhead
• Other labour costs, e.g. supervisor/maintenance
crew wages are usually treated as indirect labour
costs and are also included in manufacturing
overhead
17

• Any manufacturing operations will have costs other
than material and labour which cannot be traced
directly to products
• International accounting standards require a
proportion of manufacturing overhead be included in
the valuation of inventory
• How do you trace/allocate a portion of overhead to a
product?
18
Manufacturing Overhead Allocation –
Traditional Approach

• The accounting standards do not provide a
solution
• Broadly speaking there are two general
approaches used which are:
̶ Traditional approach
̶ Activity-based approach
19

• When management accountants refer to ‘allocating
overhead’ or ‘absorbing overhead’, they are referring
to some method used to divide manufacturing
overhead costs between each product produced
• What costs are to be classified as manufacturing
overheads?
• How to divide these overhead costs between
products?
20

Steps in manufacturing overhead allocation
• Decide on plant-wide or cost-centre rate and then
take steps outlined below
1. Estimate total manufacturing overhead
2. Select an allocation base
3. Calculate the manufacturing overhead rate:
Planned Manufacturing overhead cost
Planned quantity of allocation base
4. Allocate overhead to jobs/products
21

Manufacturing overhead allocation
• If a company has a detailed cost-centre
structure, then it is likely it has devised
methods to trace as many costs as possible
directly to cost centres
• Cost centres such as maintenance or materials
handling are often called service centres in
that they provide a ‘service’ to other cost
centres
22

Reallocating service centre costs:
23

Under/over-allocation of Manufacturing overhead
• Allocation of manufacturing overhead to jobs is an
estimation exercise and does not reflect actual
overhead costs
24

• The actual overhead costs are debited to the account in the
same way as any other expense account.
• As jobs occur, a portion of the overhead is credited out of the
account and debited to the work-in-progress account
25
Under/over-allocation of Manufacturing overhead

• How are non-manufacturing overheads traced or
allocated to jobs?
• Can use same steps as for manufacturing overhead
• If costs are allocated to cost-centres then the best
base is the one which relates the non-manufacturing
cost to the job
• This is not easy and sometimes results in arbitrary
allocation of costs
26
Non-Manufacturing Overhead

• A contract-costing system is similar to a job-costing
system in that a uniquely identifiable cost object is
present, that is, a contract
• There are two main differentiating factors in a contract
costing system
̶ Longer time frame causes issues for reporting
revenues and costs
̶ There are more direct costs: for example,
supervisors’ wages, depreciation of equipment and
insurance are much more likely to be direct costs of
a particular contract
Overview of Contract and Process
Costing Systems
27

Contract costing
• See Worked Example 4.5, p. 86/87
• The portion of any revenues or profits to be
recognized is usually determined using some
method which approximates the degree of
completion of a contract
28
Costing Systems

• The key point is to recognize a loss straight away and some fair
portion of profit when applicable
• A contract is like a job in that it is a unique cost object, but it is
much easier to trace costs directly to a contract
• Indirect costs may be allocated on the basis of contract value
or number of employees on site
• The value of stock is treated as any other inventory
29
Costing Systems
Contract costing systems

• A process environment means that the output of the
manufacturing process does not become a ‘physical’ product
until the end of the process
• The process itself is the cost object
• Unlikely that output is sold in one large lot
• Managers need to find some form of unit as a cost object to
help identify costs and profits
30
Costing Systems
Process costing systems

Some method is
required to
allocate indirect
costs, it could be
on the basis of
process hours, the
area of factory
space used by a
process or some
other method
31
Costing Systems

• Process costs with closing inventory
• See Worked Example 4.7, p. 88-9
32
Costing Systems

Process costing
• Process costs with opening inventory
• See Worked Example 4.8, p. 89-91
33
Costing Systems

• Some service-type companies can adopt job-
costing techniques
Job Costing in the Service Sector
34

• As with previous manufacturing examples, an overhead
rate needs to be used
• Budgeted overhead figures are used and allocated using
a suitable base
• Companies like Facebook or Google do not have a
product/service in the traditional sense
• Job costing may not be the most suitable method of
allocation of overheads in relation to service-sector
companies
35
Job Costing in the Service Sector

• Costing systems depend on the business type
–Job costing is used when unique
jobs/orders/services are identified
–Contract costing – unique contracts, but
longer term
–Process costing – no unique product until
end of process. A cost per unit is
determined based on the process cost
Summary
36

• Bhimani, A. and M. Bromwich (2010)
Management Accounting: Retrospect and
Prospect, London: CIMA.
• International Accounting Standard 11,
Construction Contracts, www.ifrs.org
References
37

Chapter04.ppt/Management Accounting Costing Systems

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