Student lecture notes

CHAPTER 18

PRODUCT COSTS: MATERIALS, LABOUR AND OVERHEADS

Statement of cost of a production item ..........

£ £
Direct materials xxx
Direct labour xxx
Other direct costs xxx
………………………… xxx
Indirect materials xxx
Indirect labour xxx
Other indirect costs xxx
Production overhead xxx
………………………… xxx

Definition

A job costing system is a system of …………………………………………. where there is an

identifiable activity for which costs may be collected. The activity is usually specified in terms of a
…………………….. or a …………………………….. contributing to a stage in the production or
service process.

Total product cost = ………………………………………………………………………

Collecting the details for the job cost record

Materials

 From ………………………..: quantity of materials issued.

 From …………………………: price per unit charged by the supplier.

Labour

 From …………………………..: hours worked.

 From …………………………..: hourly rates.

Direct expenses

 From …………………………….

Financial and Management Accounting, Third Edition Student notes 18.1

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Accounting for materials costs

Materials control procedures

Production manager decides on minimum level of stock to be held

ê
Storekeeper makes regular checks of physical stock levels against minimum requirements
ê
When stock has fallen to minimum level, storekeeper sends a request
to the buying department for replacement items to be purchased
ê
Buying department sends an order to supplier
ê
Goods arrive and are received by storekeeper
ê
Supplier's invoice received by accounts dept
ê
Storekeeper issues goods to production department on the basis of a requisition note

Materials handling and control documents

 purchase requisition
 purchase order
 delivery note
 goods received note
 supplier’s invoice
 stores requisition

Documentation in materials control procedures

Purchase requisition
Origin Destination Use
Storekeeper or production Buying department
manager

Purchase order
Origin Destination Use
Buying department 1 Supplier

2 Storekeeper

Financial and Management Accounting, Third Edition Student notes 18.2

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Delivery note
Origin Destination Use
Delivery driver Storekeeper

Materials received note

Origin Destination Use
Storekeeper 1 Buying department

2 Accounts department

Supplier’s invoice
Origin Destination Use
Supplier Accounts department

Stores requisition
Origin Destination Use
Production departments 1 Storekeeper

2 Accounts department

Materials costs when input prices are changing

First-In-First-Out (FIFO)
Assume that the goods which arrived …………….. are issued ……………..

Last-In-First-Out (LIFO)
Assume that the goods which arrived …………. are issued ………………

Average cost
Assume that all goods are issued at the …………………….. of the stock held.

Financial and Management Accounting, Third Edition Student notes 18.3

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Basic data
Date Received Unit price Price paid Issued to production
Units £ £ Units
1 June 100 20 2,000 –
20 June 50 22 1,100 –
24 June – – – 60
28 June – – – 70
Total 150 3,100 130

Calculations
Basis Date Quantity and unit price Issued to production Held in stock Total
FIFO £ £ £
24 June 60 units at £20 1,200
28 June 40 units at £20
30 units at £22 1,460
30 June 20 units at £22 440
Total 2,660 440 3,100
LIFO £ £ £
24 June 50 units at £22
10 units at £20 1,300
28 June 70 units at £20 1,400
30 June 20 units at £20 400
Total 2,700 400 3,100

Average £ £ £
24 June 60 units at £20.67* 1,240
28 June 70 units at £20.67* 1,447
30 June 20 units at £20.67* 413
Total 2,687 413 3,100

* Weighted average [(100  20) + (50  22)]/150 = £20.67.

Financial and Management Accounting, Third Edition Student notes 18.4

P Weetman and P Gordon. Copyright © Pearson Education Limited 2002
Production overheads

Examples are:

In a manufacturing business:

………………………………………………
………………………………………………
………………………………………………

In a service business:
………………………………………………
………………………………………………
………………………………………………

All the production overhead costs have to be allocated to the products.

Allocation and apportionment

……………………………………………………
……………………………………………...…….
…………………………………………………….
…………………………………………………….

Allocate means assign whole item of cost to single cost unit.

Apportion means spread cost over two or more cost units.

Examples of methods of apportionment of costs over cost centres

Cost item Method of apportionment to cost centres

Rent of building
Lighting
Power for machines
Production supervisor’s salary
Canteen costs
Depreciation and insurance of
machinery

Financial and Management Accounting, Third Edition Student notes 18.5

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Examples of methods of allocating total costs of service cost centres over production
centres

Service cost centre Method of allocation to production cost

centres
Maintenance department
Employees’ restaurant and coffee bar
Stores department
Finished goods quality inspection
Safety inspectors

Absorbing costs into product

Methods of absorbing overheads [see section 18.4.4]

 Cost per direct labour hour.

 Cost per machine hour.
 Cost per £ of labour cost.
 Cost per unit.

Predetermined overhead rates [see section 18.4.5]

Cost drivers [see section 18.4.6]

More questions [see section 18.4.6]

Illustration of the calculation of an overhead cost rate

Table 1 Indirect costs

Cost item Total cost this month
£
Indirect materials 36,000
Indirect labour 40,000
Rent 1,000
Insurance 1,600
Depreciation 2,000
Total 80,600

Financial and Management Accounting, Third Edition Student notes 18.6

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Table 2 Information about each department
Assembly Finishing Maintenance
Direct materials used for production £400,000 £500,000 not applicable
No. of employees 10 25 5
Floor area 300 sq ft 600 sq ft 300 sq ft
Value of machinery £30,000 £50,000 £20,000
No.of direct labour hours worked on 55,000 64,000 not applicable
production

Step 1 Apportioning costs over departments using a suitable method for each

Table 3
Total Assembly Finishing Maintenance
£ £ £ £
Indirect materials1 36,000
Indirect labour2 40,000
Rent3 1,000
Insurance4 1,600
Depreciation5 2,000
Total 80,600

1 = basis is direct materials 4 : 5

2 = basis is employees 10 : 25 : 5
3 = basis is space 3 : 6 : 3
4 = basis is value 3 : 5 : 2
5 = basis is value 3 : 5 : 2

Step 2 Apportioning service department costs over production departments on the

basis of value of machines in each department

Proportions ……………… : ……………………….

         5,970 =

         5,970 =

Table 4
Total Assembly Finishing Maintenance
£ £ £ £
Total cost per dept 80,600 27,330 47,300 5,970
Transfer Maintenance to
Assembly and Finishing
Total per dept 80,600

Step 3 Absorbing total overhead costs of each production department into units
produced during the period

Financial and Management Accounting, Third Edition Student notes 18.7

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
 Divide the total cost of each department by the number of direct labour hours:

Assembly: £………../………… hours = ……. pence per direct labour hour.

Finishing: £………../…………. hours = …… pence per direct labour hour.

Step 4 Finding the overhead costs of any job

Table 5
Department Calculation £
Assembly
Finishing
Total overhead cost

Methods of allocating overhead costs to jobs

Four possible methods of allocating overhead costs to products are:

 Cost per direct labour hour.

 Cost per machine hour.
 Cost per £ of labour cost.
 Cost per unit.

Predetermined overhead cost rates

Estimated at the start of a reporting period.

Adjusted to actual at the end of the period.

Use of a predetermined fixed overhead cost rate

Estimated labour hours for normal activity 10,000 hours

Estimated fixed overhead cost in total £50,000
Predetermined overhead cost rate

Actual hours worked on jobs 8,000 hours

Overhead costs applied to jobs (costing records)
Actual fixed overhead incurred (cash book) £50,000
Under-applied fixed overhead

Financial and Management Accounting, Third Edition Student notes 18.8

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Activity-based costing

A method of allocating …………………………………………….. to products and

services.

Asks the question: What d…………………… cost?’

Example: Social work department of local authority

Department A uses taxis for travel to client work; Department B takes bus or walks.
Overhead cost of travel (taxi plus bus) is shared across A and B by number of people
in each department.

What drives cost of taxis? …………………………………..

Four stages

1 Identify a………………….

2 Identify c…………………. d…………………….. that influence the cost of an

activity.

3 Create a c………..p…………… for each activity.

4 Allocate costs to products using d……………… for each activity.

Tracing costs of Products A, B and C in a single cost centre

Step 1 Direct tracing of direct costs

Step 2 Sharing of indirect costs (overhead) by apportionment to products

Financial and Management Accounting, Third Edition Student notes 18.9

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003
Traditional approach to flow of overhead costs

Identify overhead costs and identify cost centres that accumulate costs
Step 1: Allocate indirect costs to cost centres
Step 2: Apportion service cost centre to production cost centres
Step 3: Absorb overhead costs into product

Traditional product cost allocation Activity-based costing

Identify cost centres in which costs may Identify the way in which products drive
be accumulated. Cost centres are the activity of the business and define
determined by the nature of their suitable cost pools for collecting the
function (e.g. production or service costs relating to each activity. Activity
department cost centres) pools are determined by the activities
which drive the costs (e.g. obtaining new
customers, negotiating customer
contracts)
 
Collect costs in cost centres Collect costs in activity cost pools
 
Determine an overhead cost rate for Determine a cost driver rate for each
each production cost centre (e.g. cost per cost activity pool, e.g. a cost per
direct labour hour) customer contract, cost per customer
order received
 
Allocate cost to products using the Allocate cost to products according to
calculated cost rate and the measure of the product's demand for the activity
the product's consumption of that which drives cost
department's cost (e.g. number of labour
hours required)

Financial and Management Accounting, Third Edition Student notes 18.10

P Weetman and P Gordon. Copyright © Pearson Education Limited 2003