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Chapter04.ppt/Management Accounting Costing Systems
- 2. © McGraw-Hill Education (UK) Limited 2013
• 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
- 3. © McGraw-Hill Education (UK) Limited 2013
• 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
- 4. © McGraw-Hill Education (UK) Limited 2013
• 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
- 5. © McGraw-Hill Education (UK) Limited 2013
• 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
- 6. © McGraw-Hill Education (UK) Limited 2013
• 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
- 7. © McGraw-Hill Education (UK) Limited 2013
• 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
- 8. © McGraw-Hill Education (UK) Limited 2013
What type of
organization or
industry may use
each type of
costing system?
Cost Systems
8
- 9. © McGraw-Hill Education (UK) Limited 2013
• 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
- 10. © McGraw-Hill Education (UK) Limited 2013 10
Overview of a Job Costing System
Exhibit 4.1: Typical flow of costs in a job costing system
- 11. © McGraw-Hill Education (UK) Limited 2013
• 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
Overview of a Job Costing System
- 12. © McGraw-Hill Education (UK) Limited 2013
• 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
Overview of a Job Costing System
- 13. © McGraw-Hill Education (UK) Limited 2013
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
Overview of a Job Costing System
- 14. © McGraw-Hill Education (UK) Limited 2013
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
Overview of a Job Costing System
- 15. © McGraw-Hill Education (UK) Limited 2013
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
Overview of a Job Costing System
- 16. © McGraw-Hill Education (UK) Limited 2013
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
Overview of a Job Costing System
- 17. © McGraw-Hill Education (UK) Limited 2013
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
Overview of a Job Costing System
- 18. © McGraw-Hill Education (UK) Limited 2013
• 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
- 19. © McGraw-Hill Education (UK) Limited 2013
• The accounting standards do not provide a
solution
• Broadly speaking there are two general
approaches used which are:
̶ Traditional approach
̶ Activity-based approach
19
Manufacturing Overhead Allocation –
Traditional Approach
- 20. © McGraw-Hill Education (UK) Limited 2013
• 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
Manufacturing Overhead Allocation –
Traditional Approach
- 21. © McGraw-Hill Education (UK) Limited 2013
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 –
Traditional Approach
- 22. © McGraw-Hill Education (UK) Limited 2013
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
Manufacturing Overhead Allocation –
Traditional Approach
- 23. © McGraw-Hill Education (UK) Limited 2013
Reallocating service centre costs:
23
Manufacturing Overhead Allocation –
Traditional Approach
- 24. © McGraw-Hill Education (UK) Limited 2013
Under/over-allocation of Manufacturing overhead
• Allocation of manufacturing overhead to jobs is an
estimation exercise and does not reflect actual
overhead costs
24
Manufacturing Overhead Allocation –
Traditional Approach
- 25. © McGraw-Hill Education (UK) Limited 2013
• 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
Manufacturing Overhead Allocation –
Traditional Approach
Under/over-allocation of Manufacturing overhead
- 26. © McGraw-Hill Education (UK) Limited 2013
• 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
- 27. © McGraw-Hill Education (UK) Limited 2013
• 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
- 28. © McGraw-Hill Education (UK) Limited 2013
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
Overview of Contract and Process
Costing Systems
- 29. © McGraw-Hill Education (UK) Limited 2013
• 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
Overview of Contract and Process
Costing Systems
Contract costing systems
- 30. © McGraw-Hill Education (UK) Limited 2013
• 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
Overview of Contract and Process
Costing Systems
Process costing systems
- 31. © McGraw-Hill Education (UK) Limited 2013
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
Overview of Contract and Process
Costing Systems
Process costing systems
- 32. © McGraw-Hill Education (UK) Limited 2013
• Process costs with closing inventory
• See Worked Example 4.7, p. 88-9
32
Overview of Contract and Process
Costing Systems
Process costing systems
- 33. © McGraw-Hill Education (UK) Limited 2013
Process costing
• Process costs with opening inventory
• See Worked Example 4.8, p. 89-91
33
Overview of Contract and Process
Costing Systems
Process costing systems
- 34. © McGraw-Hill Education (UK) Limited 2013
• Some service-type companies can adopt job-
costing techniques
Job Costing in the Service Sector
34
- 35. © McGraw-Hill Education (UK) Limited 2013
• 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
- 36. © McGraw-Hill Education (UK) Limited 2013
• 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
- 37. © McGraw-Hill Education (UK) Limited 2013
• Bhimani, A. and M. Bromwich (2010)
Management Accounting: Retrospect and
Prospect, London: CIMA.
• International Accounting Standard 11,
Construction Contracts, www.ifrs.org
References
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