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Chapter 4

Product costing systems

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Outline
Product costing
Different costs for different purposes
Designing product costing systems
Flow of costs in manufacturing businesses
Allocating overhead costs to products
Accounting for manufacturing overhead
Types of product costing systems
Job costing
Process costing
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Product costing
Product costing systems
Accumulate product-related costs to assign
to the organisations final products
Product-related costs are called production
costs
Upstream costsresearch and
development, product design, supply
Downstream costsmarketing,
distribution, customer service

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The product costing system

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Different product costs for
different purposes
Only production costs are included in
product costs for external reporting
purposes
For managerial decisions, product costs
may include upstream, manufacturing
and downstream costs
Current or future product costs
Current product costs
Estimates of future product costs (cont.)

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Different product costs for
different purposes (cont.)
Types of costs to be included in
product costs for managerial decisions
depends on
The type of managerial decision to be
made
Whether the decision has short-term or
long-term implications
Managers personal preferences

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4-6
Relevance of product cost measures to
management decisions

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Different product costs for
different purposes (cont.)
Frequency of provision of product cost
information
Infrequently for long-term decisions
More regularly for cost control and
inventory valuation
Product costs may differ over
The range of costs included
Current or future costs
Frequency information is required
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Designing product costing
systems
Identify the managers needs
Identify where product cost information
may come from
Cost and benefits of providing various
types of cost estimates
Businesses sometimes use product
costs developed for external reporting
for managerial decision making
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Flow of costs in
manufacturing businesses
For inventory valuation in external financial
reports only manufacturing costs are
assigned to products, as required by
accounting standards
Manufacturing costs consist of three
components
Direct material
Direct labour
Manufacturing overhead
(cont.)

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Flow of costs in
manufacturing businesses (cont.)
Manufacturing costs flow through
several ledger accounts
Accounting standards require that
upstream and downstream costs are
expensed in the period in which they
are incurred
May be included in product costs where
relevant to managers decision making

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Flow of costs through
manufacturing accounts

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Allocating overhead costs
to products
Estimating the cost of a product
Some resources are consumed directly
by products and are traced directly to
each product
Overhead costs are essential to
production but as they have no
observable relationship with the product
they need to be allocated to products
(cont.)

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Allocating overhead costs
to products (cont.)
Aggregate overhead costs into cost
pools
Identify the overhead cost driver
Calculate a predetermined (or
budgeted) overhead rate per unit of
cost driver
Apply manufacturing overhead costs
to products
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Direct and indirect costs of products

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Accounting for
manufacturing overhead
Two types of manufacturing overhead
are recorded in an accounting system
Actual manufacturing overhead
Accumulated as they are incurred
throughout the accounting period
Applied manufacturing overhead
Overheads applied to work in process
inventory using a predetermined overhead
rate (cont.)

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Accounting for manufacturing
overhead (cont.)
At the end of an accounting period,
total actual manufacturing overhead
may not equal total applied
manufacturing overhead
Dispose of underapplied or
overapplied overhead at the end of
the accounting period

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Types of product costing
systems
Conventional product costing systems
range from job costing to process
costing
Job costing
Manufacturing costs traced to individual
jobs
Products produced are significantly
different and may be produced in distinct
jobs/batches
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Process costing
Production costs traced to
process/department and averaged across all
units produced
Mass production or repetitive processes
environment
Process costing involves
Estimating the cost of production processes
Calculating the average cost per unit
Sequential processes
Some product costing systems have features
of both job costing and process costing
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Continuum of conventional
costing systems

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Comparison of job costing
and process costing

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Job costing
Bill of materialslists all the materials
required for a job
Material requisition formauthorises
the movement of raw materials from
the warehouse to the production
department
Job cost sheetsummarises the
costs of direct material, direct labour
and manufacturing overhead for a
(cont.)
particular job
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Job costing (cont.)
Purchase of materials
Raw material inventory xxxx
Accounts payable xxxx
Transferring direct material to jobs
Work in process inventory xxxx
Raw material inventory xxxx

(cont.)

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Job costing (cont.)
Use of indirect material in production
Manufacturing overhead xxxx
Manufacturing supplies inventoryxxxx
Charging direct labour to jobs
Work in process inventory xxxx
Wages payable xxxx

(cont.)

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Job costing (cont.)
Accounting for indirect labour
Manufacturing overhead xxxx
Wages payable xxxx
Accounting for manufacturing costs
Manufacturing overhead xxxx
Prepaid rent xxxx
Depreciation on equipment xxxx

(cont.)

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Job costing (cont.)
Application of manufacturing overhead
Work in process inventory xxxx
Manufacturing overhead xxxx
Completion of production job
Finished goods inventory xxxx
Work in process inventory xxxx

(cont.)

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Job costing (cont.)
Sale of goods
Accounts receivable xxxx
Sales revenue xxxx
Cost of goods sold xxxx
Finished goods inventory xxxx

(cont.)

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Job costing (cont.)
Underapplied overhead
Cost of goods sold xxxx
Manufacturing overhead xxxx
Or the reverse entry if overhead is
overapplied

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Exe 4.24

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Process costing
The approach taken in process costing
depends on
The existence of work in process (WIP)
inventory at the end of the accounting
period
The degree to which products are identical
in their consumption of direct material and
specific production processes
Simple forms of process costing assume
no WIP inventory
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Production processes in the Mixing
and Finishing Departments, Spritz

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Exe 4.28

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Summary
Different measures of product costs are
appropriate for different purposes
Overhead costs are allocated to product
costs according to their consumption of
an overhead cost driver
The choice of product costing system
depends on the characteristics of the
product and production environment
may range from job costing to process
costing
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