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CA5107 - A cost system that uses predetermined

overhead rates and actual costs for direct
Cost Accounting and Control materials and direct labor is referred to as a
normal cost system
Quiz 2
Formula:

☆☆☆☆☆
Module 3 - Manufacturing Overhead Budgeted overhead
★ Computation of Predetermined Overhead - is simply the firm’s best estimate of the
Rate using different allocation bases- amount of overhead to be incurred in the
Plantwide and Departmental OH rates coming year. The estimate is often based
(3T, 3P) on last year’s figures, adjusted for
★ The use of alternative capacity levels- anticipated changes in the coming year.
theoretical, practical, expected, and normal Activity Level or Activity Base
capacity (1T) - A measure of what causes the incurrence
★ Disposition of over and under-applied OH of a variable cost, some of which are:
(2T, 2P) 1. Cost of materials
★ Allocation of Support or Common
costs to Producing Departments -Direct,
Step, and Reciprocal/ Algebraic Method 2. Cost of direct labor
(1T, 3P)
★ Computation of total cost (OH cost, and
price of product) after allocation of
support costs (2T, 3P) 3. Direct labor hours
★ Limitations of plantwide and
departmental overhead rates (1T)
★ Activity-Based Costing
★ Classifying activities - unit level, batch 4. Machine hours
level, product level, and facility-level (2T,
1P)
★ Assigning costs (1T, 1P)
★ Computation of product and selling price 5. Units of production
cost using activity-based costing (1T, 1P)

Predetermined Overhead Rate

- A budgeted, constant charge per unit of
activity used to assign overhead to Factors Considered in the Computation of
production or services. Factory Overhead

Plantwide rate
- Use of single or one rate for all
producing departments
- Are applicable when an entity
manufactures only a single product, or
different products are being are being
manufactured by same series of
productive departments
- Limitation: The plantwide average rate
may be too high or too low for a particular
product, especially a product involving
only one or a few departments.
Departmental rate
- use of several rates, i.e., one rate for each
producing department
- shall be applied when an entity
manufactures different products
Alternate Capacity Levels
Theoretical/Ideal Capacity (100%)
- All production factors are operating
perfectly (full capacity)
- absolute maximum production activity
of a manufacturing firm
Disregards:
(a) Machinery breakdown
(b) Holiday downtime
Results in:
(a) Significant underapplied overhead
(b) Lowest product cost
- Refers to the plant’s or department’s
capability to produce at full tilt, without
interruptions. Though it is highly
impossible to attain, it is well calculated to
serve as a basis for establishing other
capacity levels.
Practical Capacity (75%-85%)
- Is theoretical capacity less internal factors
such as ordinary and expected
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interruptions due to delays, breakdowns,
inefficiencies, non- working days, and
changes in production processes.
- Maximum output that can be realized if
everything operates efficiently
Usually results in:
(a) Underapplied overhead
(b) Low product cost
Normal Capacity (achievable/more than one
year)
- Average activity usage that a firm
experiences in the long term
- Attainable level of activity
Considers:
(a) Historical production level
(b) Estimated future production level
( 2-3 years)
(c) Cyclical fluctuations
When normal capacity is greater than expected
capacity, may result in:
(a) Underapplied overhead
(b) Higher product cost
- Is the most commonly used type of
capacity level. In calculating normal
capacity, not only internal but also
external factors, particularly the market
or the demand for the product, are
considered.
- The normal capacity level is used in
calculating the predetermined or standard
factory overhead rate.
Expected Capacity (one year)
- Anticipated activity level for the
upcoming period based on projected
product demand (short term)
- Determined during the budget process
- Should closely reflect actual costs
Results in:
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(a) Immaterial overapplied or - If variance is underapplied, cost of goods
underapplied overhead sold increases
(b) Highest product cost - If variance is overapplied, cost of goods
sold decreases
Problems of Overhead Application
- The difference between the overhead cost
applied to Work in Process and the actual
overhead costs of a period is referred to as
either underapplied or overapplied
overhead.
Underapplied Overhead
- exists when the predetermined overhead
rate is less than the total amount of
overhead actually incurred during the
period.
- (Manufacturing Overhead) MOH
T-account debit is greater than MOH
T-account credit
Overapplied Overhead
- exists the predetermined overhead rate is
greater than the total amount of
overhead actually incurred during the
period.
- MOH T-account debit less than MOH
T-account credit

Disposition of Over and Under-applied OH

- Disposition of the over- or underapplied
factory overhead is usually quite simple. At
the end of the accounting period,
it can be either treated as:
(a) a period expense – i.e. closed to Material Overhead Variance
cost of goods sold or directly to - The amount of variance is closed and
Income Summary prorated against the accounts in which
(b) allocated between inventories applied overhead resides: work-in-process
and the cost of goods sold. inventory, finished goods inventory,
Immaterial Overhead Variance and costs of goods sold
- The amount of variance is closed against Let’s try!
cost of goods sold or income summary

1. Yeji Manufacturing has the following account
balances at the end of the period, with their
materials, labor and overhead components:
Prepare the entry to close the variance accordingly.
Solution and Answer:
- 104,400/1,496,400 x 100 = 6.98
- 208,800/1,496,400 x 100 = 13.95
- 1,183,200/1,496,400 x 100 = 79.07
Service Department Costs
- Service or support department is a unit
in an organization that contributes in a
very indirect way to the conversion of raw
materials in a finished product.
These units are the:
(a) purchasing,
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(b) personnel,
(c) warehousing and
(d) maintenance department.
- Since these departments support the
production department, the costs incurred
must be allocated to production both in
computing predetermined overhead
rates and in measuring actual overhead
costs of producing to determine the full
costs of a product.
Service Costs Allocation Approaches
Direct Method
- considered the simplest method of
allocating the cost of service departments
to operating departments.
- Under this method, the costs incurred by
service departments are not allocated to
each other; rather, they are directly
allocated to operating departments
using some appropriate allocation base.
- In other words, we can say that the direct
method of departmental cost allocation
ignores the service provided by a service
department to itself and to other service
departments.
Step-Down/Sequential Method
- The method partially recognizes the
services that service departments provide to
each other, although it does not recognize
the mutual exchange of services among
support departments.
- defined by ranking the service/support
departments in order of the amount of
service rendered, from the greatest to the
least.
- a hybrid between the direct and the
algebraic methods
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- the department with the highest cost is Allocate the service department costs using direct
seen as rendering the greatest service, method, sequential method, and algebraic method.
which are allocated first. Solution and Answer:
- They are distributed to all support Direct method
departments in a sequence and to all
producing departments. Then, the costs of
the support department next in sequence
are similarly allocated, and so on
- a support department is “eliminated”
once its costs have been assigned.
Simultaneous/Reciprocal/Algebraic Method
- All interrelationships among
Sequential method
departments are recognized and no
decision must be made about a ranking
order of service departments.
- The method, however, is more complex
than the direct and step methods because it
involves solving simultaneous equations.
Let’s try!
1. Solace Manufacturing has four departments.
assembly department and finishing department Algebraic method
make up the production departments while
cafeteria and maintenance department make up the
service departments.

The overhead cost of the cafeteria is allocated

based on the number of employees while the
overhead cost of the maintenance department is
based on the estimated overhead for the period.

In determining the predetermine overhead rates,

the assembly department uses direct labor hours
and the finishing department uses machine
hours. The following information is made
available:

Comparison of the three:
Limitations of Traditional: Plantwide and
Departmental Overhead Rates
Assuming, however, that the overhead costs are a
significant percentage of total manufacturing
costs, at least two major factors can impair the
ability of the unit-based plantwide and
departmental rates to assign overhead costs
accurately:
1. the proportion of non-unit-related
overhead costs to total overhead costs is
large, and
2. the degree of product diversity is great.
Non-Unit-Related Overhead Costs
- The use of either plantwide rates or
departmental rates assumes that a
product’s consumption of overhead
resources is related strictly to the units
produced.
- Non-unit-based drivers are factors, other
than the number of units produced, that
measure the demands that cost objects
place on activities. Thus, unit-level drivers
cannot assign these costs accurately to
products.
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Product Diversity
- Significant non-unit overhead costs will
not cause product cost distortions
provided products consume the non-unit
overhead activities in the same proportion
as the unit-level overhead activities.
Product diversity, on the other hand,
can cause product cost distortion. It is
caused by such things as differences in
product size, product complexity, setup
time, and size of batches.
Overhead Allocation Approaches
Traditional Costing
- factory overheadcosts are allocated to
products by using a single activity or cost
driver (e.g., labor hours). In some
accounting literature, traditional costing is
also called peanut-butter costing.
Activity-Based Costing
- The transactions-based approach to
overhead allocation
- is based on several activities, which are
considered any event, unit of work, or task
with a specific goal.
- recognizes that significant overhead costs
may not be caused by volume of output.
- Compared to traditional cost accounting,
ABC represents a more thorough
application of cost tracing.
Formula:
- Activity Cost Pool
- is an aggregate of all the costs
- is a group of similar costs usually
increased or decreased by a single cost
driver.
- Cost Driver
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- is identified for each activity, such as 2. Solve for product cost and gross profit
purchase orders or machine setups, to under activity based costing
establish a cause-effect relationship Solution and Answer:
between an activity and a cost object Traditional Costing
(product/service).
- Cost Driver Rate
- which is the cost pool total divided by
cost driver, is used to calculate the
amount of overhead and indirect costs
related to a particular activity.
Let’s Try!
1. The following cost information has been
established by the accounting department
Activity-based Costing
of XYZ Manufacturing Company:
Step 1: Calculate for the overhead rates per
- Factory overhead → cost pool
activity based on cost drivers

Step 2: Allocate overhead based on activity using

the rates calculated
Detailed cost information is provided as:

In this problem, let’s assume that:

a. Produced and sold 2,500 units each of all
products
b. Selling prices are: P400 for product X.
P410 for product Y and P405 for product Step 3: Compute for the total manufacturing
Z cost of each product
c. No beginning and ending work-in-process
and finished goods inventory
Requirement:
1. Solve for product cost and gross profit
Step 4: Compute for gross profit
under traditional costing

Levels of Activity (Cost Drivers)
To help identify activity drivers and enhance the
management of activities, activities are often
classified into one of the following four general
activity categories:
1. Unit-level activities/drivers
- are variable in relation to change in
production volume.
- are those activities that have a one-to-one
correspondence with a unit of output.
- Example: A telescope manufacturer may
have to perform some final calibration
activity to each finished product. Thus,
calibration may be seen as a unit-level
activity
2. Batch-level activities/drivers
- vary with the number of batches but are
fixed (and, therefore, independent) with
respect to the number of units in each
batch.
- are those activities that must be performed,
but can relate to one or more units of
output.
- Example: Assume that XYZ is an online
bookstore. Some customers order only one
book while others may order a dozen
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books at a time. In each case, the
customer’s books must be packaged and
shipped. Roughly the same activity is
required independent of how many books
are put in a box. Thus, Shipping can be
seen as an excellent example of a batch
process.
3. Product-level activities/drivers
- are those activities performed wherein
costs incurred to support the number
different or various products of a company
to be produced and sold.
- are carried out at the product level/line,
no matter the volume of production.
- Example: Product design and
marketing are activities that may have a
one-to-one relation to the number of end
products.
4. Organizational or facility or plant-level
activities/drivers
- are those that sustain a factory’s general
manufacturing processes. Several levels of
costs and drivers can exist above the
product level.
- Floor space occupied is referred to often as
the organizational or facility or plant-level
driver for assigning plant-level costs.
- Example: depreciation, property taxes,
and insurance of the factory building.
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1. Winkel Woodcrafters produces special order
Assigning Costs to Activities wood products. The company uses job order
- After identifying and describing activities, costing for pricing and cost accumulation process.
the next task is determining how much it The following costs were incurred on two recent
costs (labor, materials, energy, and capital) jobs:
to perform each activity.
- In summary, ABC is a ‘two-stage’
allocation process. First, overhead costs are
traced to activities; then, overhead costs are
allocated to products on the basis of the The company adds a 50% markup on cost in
activities performed by a particular determining the amount to charge for each job.
product. Prepare a schedule showing the cost and the
amount to be charged for each job.
Solution and Answer:
☆☆☆☆☆
Module 4: Job Order Costing System
★ Source documents in Job-Order Costing
(2T)
★ Journal Entries for Job-Order Costing
using Normal Costing (3T, 3P)
★ Computation of product cost using a
Job-Order Costing System (3P)
★ Nature of production losses in Job-Order
(1T)

Job-Order Costing
- Is a system that takes place when
Documents used in Job Order System
customers order small, unique batches of
Materials Requisistion Form
products.
- A form that is used as a basis for the
- Determines the price of each individual
recording of raw materials issuance
product and ensures that the cost for each
product is reasonable enough for a
customer to purchase
- A job can be a: client or customer,
project, contract, product
- The cost of materials used, labor incurred
and overhead applied is summarized in
WIP account while maintaining a job cost
sheet for each job
Let’s try!
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Time Ticket
- As an employee works on a unique order,
they are often required to fill out a
timesheet recording the work they have
completed

Job Order System Cost Flow

Recording of Labor Costs

Job Cost Sheet

- Is the main source for tracking an item to
keep pricing and inventory accurate
Shows the total cost incurred in the
manufacture of a particular order and
it contains the following:
1. Job Number
2. Job Description
3. Name and Address of the
Customer
4. Date ordered and Date of
Delivery
5. Direct Materials showing:
(a) description of materials
used
(b) quantity of materials
used
(c) cost of materials Applying Manufacturing Overhead
6. Direct labor section showing:
(a) the number of hours
worked
(b) the rate per hour
(c) the total cost of direct
labor
7. Overhead Section (Applied FOH)

Transferring Units Sold

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Manufacturing Overhead account as they
are incurred.

Applying Manufacturing Overhead

- Work in Process is increased when
Manufacturing Overhead is applied to
Journal Entries
jobs.
Purchase of Materials
- Raw material purchases are recorded in an
Inventory account.

Transferring Completed Units

Material Usage
- Direct materials issued to a job increase
Work in Process and decrease Raw
Materials. Indirect materials used are
charged to Manufacturing Overhead and
also decrease Raw Materials.
- As jobs are completed, the Cost of Goods
Manufactured is transferred to Finished
Goods from Work in Process.
Transferring Units Sold
- When finished goods are sold, two entries
are required: (1) to record the sale, and (2)
to record COGS and reduce Finished
Goods.

Labor Costs
- The cost of direct labor incurred increases
Work in Process and the cost of indirect
labor increases Manufacturing Overhead.

Materials and Production Losses in Job Order

Costing
Production losses may result in losses of direct
Actual Manufacturing Overhead
materials or imperfect units that cannot be sold as
- In addition to indirect materials and
regular items:
indirect labor, other manufacturing
Shrinkage
overhead costs are charged to the

- are reductions or losses inherent in the
manufacturing process. (e.g. evaporation,
leakage or oxidation)
Scrap ( waste materials)
- by product of the production of the
primary product. These are trimmings
remaining after processing materials;
broken parts resulting from
employee/machine failure; defective
materials that cannot be used or returned
to the vendor.
Production errors or partially completed
products:
Spoiled goods or spoilage
- are completed goods which in the process
of manufacture developed some
imperfection which cannot be
economically corrected/reworked. (e.g.,
plastic product molded with a wrong color
dye).
Defective goods
- are completed goods which in the process
of manufacture developed some
imperfection, for which through
additional expenditure for labor or
possibly materials can be reworked and
be made into perfect finished goods. (e.g.,
Plastic product with bubbles can be
corrected by re-sanding and repainting).
Rework cost
- is a product or period cost depending on
whether the rework relates to normal or
abnormal defective production.
Normal and Abnormal Losses in Job Order
Costing
Normal Loss
- loss that are inherent and unavoidable.
- This is expected during production.
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a. Loss is anticipated on all jobs or entire
production.
- Loss is caused by employee error/worn out
machinery.
- Predetermined overhead OH rate include
the amount for the net loss ( cost of
spoilage or spoilage minus disposal value).
Used if the reason for spoilage is normal to
the process.
b. Loss is specifically identified/attributed to a
specific or particular job.
- Loss is caused by the customer. Thus,
predetermined overhead rate does not
include the cost of spoilage. Used if the
reason for spoilage is the job itself.
Abnormal Loss
- are charged to a loss account in the period
in which they are incurred.
- Period costs
a. Anticipated on all jobs
- Include cost when calculating
predetermined overhead application rate
- Include cost less the estimated disposal
value
b. Specific to a job
- Applied to the specific job
- Include cost less the estimated disposal
value