Product costing system

A system that accumulates product-related costs and uses a series of procedures to assign them to the organization's final products
Why product costing:
- Pricing
- Performance evaluation
- Planning and controlling costs

Different product costs for different purposes

 For external reporting purpose:
o Only manufacturing / production costs are included in product costs.
 For managerial decisions:
 Short-term decisions – variable manufacturing and downstream costs
 Long-term decisions – total costs (both manufacturing and upstream & downstream costs) associated with the product

Cost flow in manufacturing businesses

*Cost of goods sold is

an expense. Although
it is more descriptive,
the term cost of goods
sold expense is not
used as much in
practice as the
simpler term ˆcost of
goods sold.

Allocating MOH costs to products

Four steps to allocate MOH costs to products:

1. Aggregate the overhead costs into cost pools.
2. Identify the overhead cost driver.
3. Calculate a predetermined overhead rate:
Pre. OH rate = Total budgeted overhead costs
Total budgeted level of activity
4. Apply overhead costs to products at the predetermined overhead rate:
Applied OH costs = pre. OH rate × actual level of activity

Example 1
The following information relates to the Moonie Park Manufacturing Company for the year 2011.
Budgeted level of production was 29,000 machine hours
Budgeted manufacturing overhead was $174,000
Actual manufacturing overhead for the year was $175,000
Actual machine hours used were 30,000
Assume the machine hour is the cost driver of MOH, calculate the overhead costs applied to the product.

Calculate a predetermined overhead rate:

Pre. OH rate =

=
Apply overhead costs to products at the predetermined overhead rate:
Applied OH costs =

Accounting for MOH

Two types of MOH are recorded in an accounting system:
 Actual manufacturing overhead
 Manufacturing overhead costs incurred throughout the accounting period
 Debited to the manufacturing overhead account
 Credited to various accounts

 Applied manufacturing overhead

 Estimate of the overhead resources used to manufacture a product (calculated as pre. OH rate × actual level of activity)
 Credited to the manufacturing overhead account
 Debited to the WIP account

Manufacturing Overhead
Actual manufacturing overhead Manufacturing overhead is
costs are accumulated as they applied to products WIP1800
are incurred W/P2000

Wage Payable (W/P)

Various accounts Work in Process Inventory
The associated credits are to various Manufacturing overhead is
accounts related to manufacturing added to work in process
overhead costs MOH2000 inventory MOH 1800

Actual MOH (i.e. unpaid indirect labour) incurred was $2000

Dr
Cr
MOH applied $1800
Dr
Cr

What if total actual MOH is not equal to total applied MOH?

 If Actual MOH > Applied MOH
→ Underapplied MOH = actual MOH – applied MOH
Dispose of underapplied MOH by
Dr COGS
Cr MOH

 If Actual MOH < Applied MOH

→ Overapplied MOH = applied MOH – actual MOH
Dispose of overapplied MOH by
Dr MOH
Cr COGS

Example 2
Company B allocates overhead costs on the basis of the number of machine hours. Details concerning manufacturing overhead for the
year are as follows:
Budgeted manufacturing overhead $420 000
Actual manufacturing overhead $480 000
Budgeted machine hours 30 000
Actual machine hours 31 000
Determine the extent to which overhead is under/ over allocated for the year. Provide the adjusting journal entry to account for the
over or under applied amount of overhead.

Pre. OH rate = Total budgeted overhead costs

Total budgeted level of activity
=

Applied OH costs = Pre. OH rate × actual level of activity

=
=
Therefore, MOH is under applied by
Adjusting journal entry:
Dr
Cr
Types of product costing systems
Base on the nature of production environment
o Job costing system – a costing system that assigns manufacturing (or product-related) costs to individual jobs.
o Process costing system – a costing system that assigns all production costs to processes or departments, and averages them across
all units produced.
Note: as required by AASB only manufacturing costs are assigned to products for external reporting purpose.

Continuum of conventional costing systems

Production Produced individually Repetitive, mass

environment or in batches production

Product features Individual, unique Identical or very similar

Costing system Job costing Other costing systems Process costing

Job costing: calculation of job costs

1. Identify the direct costs of the job
 Direct materials
 Direct labour
2. Allocating overhead costs to the Job
a) Aggregating the overhead costs into cost pools
b) Identifying overhead cost driver (allocation base)
c) Calculate a predetermined overhead rate
d) Applying manufacturing overhead costs to products

Example 3– Job costing

Ranjith construction builds residential houses. It uses job-costing system with on indirect cost pool (building support or
manufacturing over head). Direct labour-hours is the allocation base for building support costs.
Budget for 2011 Actual results for 2011
Building support costs $8,800,000 $7,380,000
Direct labour-hours 160,000 164,000

Two builds were started and completed during 2011

L Model house M Model house
Direct material costs $106,450 $127,604
Direct labour costs $36,276 $41,410
Direct labour-hours 900 1,010

Required
1. Compute applied MOH costs for each model.
Predetermined overhead rate
= Budgeted OH Costs/ Budgeted direct labour hours
=

Applied overhead allocated for the job

= Predetermined overhead rate X Actual direct labour hours
For L house: Applied MOH =
For M house: Applied MOH=

2. What are the job costs of L model house and M model house?
Job costs for each model = DM + DL + MOH
For L house: job costs =
For M house: job costs=

3. Assume the actual MOH costs incurred for L and M models were $40500 and $45450 respectively.
Calculate the under/over applied MOH for each model house and provide the adjusting journal entry.
Under/(over) = Actual overhead - Overhead applied
L-model house
M-model house

Hence, the adjusting entry is:

Dr
Cr

Job costing: journal entries and T- accounts

1. Purchase of materials (assuming materials are purchased on credit)
Dr Cr
Raw material inventory xxxx
Account payable xxxx
DR CR
2. Transferring direct material to WIP 6. Completion of production
Work in process inventory xxxx Finished goods inventory xxxx
Raw material inventory xxxx Work in process inventory xxxx

3. Charging direct labour costs 7. Sale of goods

Work in process inventory xxxx Cost of goods sold xxxx
Wages payable xxxx Finished goods inventory xxxx

4. MOH applied Accounts receivable xxxx

Work in process inventory xxxx Sales revenue xxxx
Manufacturing overhead xxxx
8. Adjust underapplied overhead
5. MOH actually incurred Cost of goods sold xxxx
Manufacturing overhead xxxx Manufacturing overhead xxxx
Various accounts xxxx (Or the reverse entry if overhead is overapplied)

Example 4
The following information is provided in relation to Shanker Corporation for January.
(1) Opening balances:
Raw materials inventory $10,000
Work in process inventory $24,000
Finished goods inventory $53,000
(2) Closing balances:
Work in process inventory $32,000
Finished goods inventory $26,000
(3) Raw materials were purchased on credit for $63,000.
(4) Direct labour costs of $75,000 were incurred at a rate of $15 per hour.
(5) Manufacturing overhead was applied at a rate of $13.20 per direct labour hour.
(6) Actual manufacturing overhead costs incurred during January were $71,000 (including $50000 unpaid indirect labour
and $21000 office supplies inventory).
(7) Jobs were sold on credit during the month for $345,000. The cost of goods sold (before any adjustment was made)
during the month was $222,000.
Complete the relevant T- accounts (provided on next page) to show the flow of costs.

*Total DL hours = 75000/15=5000 hrs

MOH=$13.2*5000=66000

Prepare relevant journal entries in lecture example 4

1. Purchase of materials
Dr
Cr

2. Transferring direct material to jobs

Dr
Cr

3. Charging direct labour to jobs

Dr
Cr

4. Application of manufacturing overhead

Dr
Cr

5. Completion of production
Dr
Cr

6. Sale of goods
Dr
Cr

Dr
Cr

7. MOH actually incurred

Dr Manufacturing overhead 71,000
Cr
Cr

8. Adjust underapplied overhead

Dr
Cr