INVENTORY MANAGEMENT

CHAPTER
FIVE
DISCUSSION POINTS:
 Introduction to Inventory.
 Methods of costing inventory in
manufacturing business.
 Job costing illustration.
 Process costing illustration.
 Long term contract costing.

1
5.1. Introduction to Inventory
• Inventory is the term used for goods bought or manufactured
for resale but as yet unsold.
• Inventory enables the timing difference between production
capacity and customer demand to be smoothed. In other
words, maintaining inventories ensures that a company has
product on hand when it is ordered by customers.
• The cost of inventory includes all costs of purchase, conversion
(i.e., manufacture), and those incurred in bringing the
inventory to its present location and condition.
• Costs of purchase include the cost of the purchased inventories plus
import duties and transportation, less any rebates or discounts.
• Costs of conversion include direct labour and an allocation of both
fixed and variable production overheads.

2
• The matching principle requires a business to adjust for
changes in inventory in its statement of comprehensive income
and statement of financial position.
• On a company's statement of comprehensive income, the
cost of inventories is recorded as “Cost of goods sold” and
on the statement of financial position, it is reported under
current assets as “Inventory.”
• For instance, if the inventory of merchandise on hand at the
end of the year decreased from the balance at the beginning
of the year, an expense must be recognized on the
statement of comprehensive income that reflects the sale of
this merchandise (Cost of goods sold expense) and the new
balance of inventory at year-end must be reflected on the
statement of financial position.

3
5.2. Inventory for a Manufacturing Company
• For a manufacturing company, there are three different types of
inventory:
1. Raw materials
2. Work in process
3. Finished goods

• In order to value inventories, a manufacturing company must

track all of the costs of manufacturing its goods.
These costs will include raw materials, direct labour costs
(costs of hourly workers), and manufacturing overhead, such
as rent, utilities, indirect materials, depreciation, and salaries
of plant supervisors.
In order to track these costs, a company will prepare a
statement called the cost of goods manufactured which is
calculated for a manufacturing company as shown in Exhibit
5.2: 4
 Exhibit 5.1 Cost of Goods Manufactured: Manufacturing Company

•.

5
• Next, the cost of goods is calculated similarly to that of a merchandising
company. The main difference is that purchases are replaced by cost of
goods manufactured as shown in Exhibit 5.2

Exhibit 5.2 Cost of Goods Sold Statement: Manufacturing Company

• The reporting of cost of goods sold expense is similar to

that of a merchandising company, while the statement of
financial position of a manufacturing company differs from
that of a merchandising company in that three levels of
inventory are reported.  6
• Exhibit 5.3 shows the format of both the statement of comprehensive income
and the statement of financial position for a manufacturing company.
Exhibit 5.3 Statement of Comprehensive Income and Statement of Financial
Position: Manufacturing Company

7
• Included in the notes to the financial statements would be a
breakdown of the valuation of inventory in the current assets
section of the statement of financial position. This would show
the following:

8
5.3. Flow of Costs
• Exhibits 5.4 show the flow of costs from purchasing to sales for a
manufacturing organization.
Exhibit 5.4 The Flow of Costs in Manufacturing

9
5.4. Valuation of Inventory
• Inventory valuation is important because the determination of
the cost of inventory affects both the cost of goods sold in the
statement of comprehensive income and the inventory
valuation in the statement of financial position.
• The value that companies assign to inventory on both the
statement of comprehensive income and the statement of
financial position must be the lower of cost or net realizable
value (NRV) according to the International Financial Reporting
Standards (IFRS).
• Cost represents the cost of acquiring or manufacturing the
inventory, while (NRV) is the value at which the inventory could
be sold on the open market, less costs of disposal, such as
shipping or reclamation. In most cases, cost is less than NRV
due to inflation.
10
5.5. Methods of Costing Inventory in Manufacturing Cos.
• In manufacturing companies, there are different types of
manufacturing that utilize different methods of inventory
costing:
• Custom: Where unique, custom products are produced
singly; for example, a building. In this case, the company
would use job order costing to value inventory.
• Batch: Where a quantity of the same goods are produced at
the same time (often called a production run); for example,
textbooks. In this case, a company would also use job order
costing.
• Continuous: Where products are produced in a continuous
production process; for example, oil and chemicals, and soft
drinks. In this case, a company uses process costing.

11
5.5.1. JOB ORDER COSTING
• Used by companies that produce goods or services to meet customers’
specifications
• Examples: building construction, custom furniture, accounting firms,
health care, mail order catalogs.
• For custom and batch manufacture, costs are collected through a job
order costing system that accumulates
 the cost of raw materials as they are issued to each job (either a
custom product or a batch of products),
 the cost of time spent by different categories of labour and
 The cost of overhead that is allocated to cover the fixed and variable
manufacturing overheads that are not included in materials or labour.
• When a custom product is completed, the accumulated cost of
materials, labour, and overhead is the cost of that custom product.
• For each batch, the total job cost is divided by the number of units
produced (e.g., the number of copies of a textbook) to give a cost per
unit (e.g., a cost per textbook).
12
Characteristics
Characteristics of
of Job-Order
Job-Order Costing
Costing
 Wide-variety of services or products that
are quite distinct from each other: the
products produced are heterogeneous in
nature.
 Cost accumulated by job
 Jobs built to customer order.
 Unit cost computed by dividing total job
costs by units produced on that job
 Custom home builder

Companies
Companies Shop for customizing vans
applying
applying Television repair shop
job-order
job-order Campbell soup plant
costing
costing Advertising agency
Law firm
The Flow of Costs in a Job-Order Costing System

Costs are traced and

applied to individual
Trac
Direct Materials ed d jobs in a job-order
to e irec
ach tly cost system.
job

Trac
Direct Labor ed d Finished
to e
ach
irec
tly Jobs Goods
job

Applied to each
Manufacturing job using a Cost of
Overhead predetermined Goods
rate Sold
 Sequence of Events in a Job-
Order Costing System
Charge
Chargedirect
direct
Direct
Direct Materials
Materials material
materialand
anddirect
direct
Job
JobNo.
No. 11 labor
labor costs
coststo
to
each
eachjob
jobas
aswork
workisis
performed.
performed.
Direct
DirectLabor
Labor Job
JobNo.
No. 22

Manufacturing
Manufacturing Job
JobNo.
No. 33
Overhead
Overhead
 Sequence of Events in a Job-
Order Costing System

Direct
Direct Materials
Materials
Job
JobNo.
No. 11
Apply
Applyoverhead
overheadtotoeach
each
job
jobusing
usingaa
Direct
DirectLabor
Labor predetermined
predeterminedrate.
rate.
Job
JobNo.
No. 22

Manufacturing
Manufacturing Job
JobNo.
No. 33
Overhead
Overhead
• The primary document for tracking the costs associated with a
given job is the job cost sheet.
• A separate job cost sheet is prepared for each individual job.
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Cost
 PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-01

Date Completed
Department B3 Units Completed
Item Wooden cargo crate A materials requisition form is used to
authorize the use of materials on a job.
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labor Let’s see one
Manufacturing Overhead
Total Cost
Unit Cost
 Materials Requisition Form
PearCo Materials Requisition Form

Requisition No. X7 - 6890 Date 3-4-01

Job No. A - 143
Department B3

Description Quantity Unit Cost Total Cost

2 x 4, 12 feet 12 $ 3.00 $ 36.00
1 x 6, 12 feet 20 4.00 80.00
$ 116.00

Authorized
Signature Will E. Delite
 PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Cost
 PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Workers
Manufacturing use
Overhead
Req. No. Amount Ticket Hours Amount Hours time
Rate tickets
Amount to
X7-6890 $ 116
record the time
spent on each
Cost Summary job.
Units Shipped
Direct Materials $ 116 Date Number Balance
Direct Labor
Manufacturing Overhead Let’s see one
Total Cost
Unit Cost
 Employee Time Ticket
PearCo Employee Time Ticket

Time Ticket No. 36 Date 3/5/01

Employee I. M. Skilled Station 42

Starting Ending Hours Hourly

Time Time Completed Rate Amount Job No.
0800 1600 8.00 $ 11.00 $ 88.00 A-143

Totals 8.00 $ 11.00 $ 88.00 A-143

Supervisor C. M. Workman
 PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor $ 88
Manufacturing Overhead
Total Cost
Unit Cost
 PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed 3-5-01
Department B3 Units Completed 2
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88 8

Cost Summary Units Shipped

Apply
Direct manufacturing overhead
Materials $ 116 to
Datejobs using
Number a
Balance
Direct Labor $ 88
predetermined
Manufacturing Overheadoverhead $ rate
32 of $4 per direct
Total Cost labor hour$ (DLH).
236
Unit Cost $ 118 Let’s do it
 PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed 3-5-01
Department B3 Units Completed 2
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88 8 $ 4 $ 32

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor $ 88
Manufacturing Overhead $ 32
Total Cost $ 236
Unit Cost $ 118
 Application of Manufacturing Overhead
• The predetermined overhead rate (POHR) is determined
before the period begins.
• Using a predetermined rate makes it possible to account
for total job costs sooner, since actual overhead for the
period is not known until the end of the period.

Estimated total manufacturing

overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

Ideally, the allocation base is a

cost driver that causes overhead.
Based on estimates, and
determined before the
period begins.

Overhead applied = POHR × Actual activity

Actual amount of the cost driver

such as units produced, direct
labor hours, or machine hours.
incurred during the period.
 Overhead Application Example
PearCo applies overhead based on direct labor hours. Total estimated
overhead for the year is $640,000. Total estimated labor cost is $1,400,000
and total estimated labor hours are 160,000. What is PearCo’s
predetermined overhead rate per hour?
Estimated total manufacturing
overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

$640,000
POHR =
160,000 direct labor hours (DLH)

POHR = $4.00 per DLH

For each direct labor hour worked on a job, $4.00 of factory
overhead will be applied (charged) to the job.
• PearCo’s actual overhead for the year was $650,000 for a total
of 170,000 direct labor hours.
• How much total overhead was applied to PearCo’s jobs during
the year? Use PearCo’s predetermined overhead rate of $4.00
per direct labor hour.

SOLUTION
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
Job-Order Costing Document Flow Summary

Employee Indirect
Time Ticket Labor

Other Manufacturing
Applied Job Cost
Actual OH Overhead
Overhead Sheets
Charges Account

Materials Indirect
Requisition Material
Job-Order Costing – Typical Accounting Entries

Let’s look at
summary journal
entries for a job-
order costing
system. We’ll omit
the numbers so
that we can focus
on accounts.
Cost Flows – Material Purchases
• Raw material purchases are recorded in an inventory account.

GENERAL JOURNAL Page 3

Post.
Date Description Ref. Debit Credit
Raw Materials XXXXX
Accounts Payable XXXXX

1. Materials costing $2,500 were purchased

on account.
 Cost Flows – 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.
GENERAL JOURNAL Page 3
Post.
Date Description Ref. Debit Credit
Work in Process XXXXX
Manufacturing Overhead XXXXX
Raw Materials XXXXX

2. Materials costing $1,500 DM and 150 indirect

materials were requisitioned for use in production.
 Cost Flows – Labor
• The cost of direct labor incurred increases Work in Process and
the cost of indirect labor increases Manufacturing Overhead.

GENERAL JOURNAL Page 3

Post.
Date Description Ref. Debit Credit
Work in Process XXXXX
Manufacturing Overhead XXXXX
Salaries and Wages Payable XXXXX

3. Direct labor costing $1,530 and $500 indirect labor

was recognized.
 Cost Flows – Actual Overhead
• In addition to indirect materials and indirect labor, other
manufacturing overhead costs are charged to the Manufacturing
Overhead account as they are incurred.
GENERAL JOURNAL Page 3
Post.
Date Description Ref. Debit Credit
Manufacturing Overhead XXXXX
Accounts Payable XXXXX
Property Taxes Payable XXXXX
Prepaid Insurance XXXXX
Accumulated Depreciation XXXXX

4. Actual overhead costs of $415 were incurred:

lease, $200; utilities, $50; depreciation, $100;
accrued wages, $65.
 Cost Flows – Overhead Applied
• Work in Process is increased when Manufacturing
Overhead is applied to jobs.
GENERAL JOURNAL Page 3
Post.
Date Description Ref. Debit Credit
Work in Process XXXXX
Manufacturing Overhead XXXXX

5. Overhead was applied to production at the rate of

$2 per direct labor hour. A total of 170 direct labor
hours were worked.
 Cost Flows – Period Expenses
• Nonmanufacturing costs (period expenses) are charged to
expense as they are incurred.

GENERAL JOURNAL Page 3

Post.
Date Description Ref. Debit Credit
Administrative Salaries XXXXX
Salaries and Wages Payable XXXXX

Advertising Expense XXXXX

Accounts Payable XXXXX
 Cost Flows – Cost of Goods
Manufactured
• As jobs are completed, the cost of goods manufactured is
transferred to Finished Goods from Work in Process.

GENERAL JOURNAL Page 3

Post.
Date Description Ref. Debit Credit
Finished Goods XXXXX
Work in Process XXXXX
 Cost Flows – Sales
• When finished goods are sold, two separate entries are
required: (1) to record the sale at the selling price; and (2) to
record Cost of Goods Sold and reduce Finished Goods by the
Cost of Goods Manufactured.
GENERAL JOURNAL Page 3
Post.
Date Description Ref. Debit Credit
Accounts Receivable XXXXX
Sales XXXXX

Cost of Goods Sold XXXXX

Finished Goods XXXXX
 Illustration
• Consider Helo Ltd., a manufacturer of helicopter components,
which it produces in batches of 100. Each batch of 100
components requires the following:
• 500 kg of rolled and formed steel at $12/steel
• 15 direct labour hours at $125/hour
• allocated overhead (at completion) of $2,000
• By month-end, the company had sold 60 of the completed
components for $130 each.
• Required:
1. Determine the total cost of the job
2. Determine unit cost per job
3. Determine cost of goods sold
4. Determine gross profit
5. Determine cost of ending finished goods
inventory 41
 Solution
• The value of completed components will be:

• The cost of goods sold for the 60 components sold is $5,925

(60 @ $98.75).

• The sales income is $7,800 (60 @ $130) and the gross profit is
$1,875 ($7,800 −$5,925).
• The inventory of finished goods is $3,950 (40 @ $98.75).

42
5.5.2. PROCESS COSTING
• For continuous manufacture a process costing system is used (under
which costs are collected over a period of time) together with a
measure of the volume of production.
• At the end of the accounting period, the total costs are divided by the
volume produced (equivalent units) to give a cost per unit of volume.
• In process costing, equivalent units are the number of fully
completed units in production and a measure of the work done
during the period.
• In a process costing environment, at the end of an accounting period,
there are units that are finished (fully completed) and units in process
(work-in-process [WIP] inventory).
• Equivalent units measure the fully completed units by multiplying the
number of units in the work-in-process inventory by their percentage
of completion. This amount is added to the finished units to
determine the equivalent units.
43
Characteristics
Characteristics of
of Process
Process Costing
Costing
1. Process costing is used when a single product is
produced on a continuing basis or for a long
period of time.
2. The products are uniform or relatively
homogeneous and produced in a large volume.
3. Costs accumulated by department or process.
4. The systems compute unit costs by department
or process.
Examples
Examples of
of Exxon oil refinery
Companies
Companies Coca Cola plant
applying
applying
Process
Process Campbell soup plant
costing
costing
 Physicalflow
Physical flowininprocess
processcosting
costingsystem
system
The Flow of Costs in a Processing Costing System

Trac
Direct Materials ed d
to e irec
ach tly
job
Trac
ed d
Direct Labor to e irec
t Processing Finished
ach l y
job Department Goods

Applied to each
Manufacturing process/dep’t using a Cost of
Overhead predetermined Goods
rate Sold
• Either the weighted average method or the first-in, first-out
(FIFO) method can be used to calculate inventory costs for
process costing.
• Under both methods, it is necessary to complete three steps:
1) Determine the number of units completed.
2) Calculate the equivalent units in work in process and the
cost per equivalent unit.
3) Assign the cost to finished goods and ending WIP
inventory.
• Note: In process costing examples, materials are usually
assumed to be added at the beginning of the process, and
conversion costs are added uniformly throughout the process.

48
 3
Cost of Production Report shows:
1) Analysis of the flow of physical units
2) Calculation of equivalent units
3) Computation of unit costs
4) Valuation of inventories (goods transferred out and
ending work in process)
5) Cost reconciliation

6-49
 1. Weighted-Average Costing Method
1. Makes no distinction between work done in prior or current
periods.
2. Beginning work in process not part of computation of
equivalent units
3. Blends together units and costs from prior and current periods.
4. Determines equivalent units of production for a department by
adding together the number of units transferred out plus the
equivalent units in ending Work in Process Inventory.
5. Calculates the value of inventory based on an average cost of
units in inventory.
 Illustration-Weighted Average Method
• Smith company reported the following activity in the mixing department for the
month of June. Basic Information

Required: Compute physical unit flow

 Compute equivalent units of production
 Compute unit production costs
 Prepare a cost reconciliation schedule
Solution
Step 1: Compute Physical Unit Flow
Physical units
actual units to be accounted for during a period,
regardless of work performed.
Total units to be accounted for
units started (or transferred) into production during
period + units in production at beginning of period.
Total units accounted for
units transferred out during period + units in production
at end of period.
Step 1: Compute Physical Unit Flow - Continued
 Step 2: Compute Equivalent Units of Production
Two computations required:
one for materials and one for conversion costs.
Beginning work in process is ignored.
Equivalent units of production always equals:
Units completed and transferred
+ Equivalent units remaining in work in process
Step 3: Compute Unit Production Costs
Costs expressed in terms of equivalent units of production
When equivalent units of production are different for
materials and for conversion costs, three unit costs are
computed:
 materials
 conversion
 total manufacturing
Materials
Direct Materials Cost in Beginning Work in Process $ 50,000
Direct Materials Added to Production during Month 400,000
Total Materials Cost $450,000

The computation of unit materials cost:

Conversion Costs
Conversion Costs in Beginning Work in Process $ 35,000
Conversion Costs Added to Production during Month 170,000
Total Conversion Costs $205,000

The computation of unit conversion cost:

 Step 4: Assign cost to the Ending WIP inventory and Units
Transferred Out
Mixing Department
Cost of Ending WIP Inventory and Units Transferred Out
Materials Conversion Total
Ending WIP inventory:
Equivalent units 200,000 120,000
Cost per equivalent unit $ 0.50 $ 0.25
Cost of Ending WIP inventory $ 100,000 $ 30,000 $ 130,000
Units completed and transferred out:
Units transferred (Finished Goods) 700,000 700,000
Cost per equivalent unit $ 0.50 $ 0.25
Cost of units transferred out $ 350,000 $ 175,000 $ 525,000
Total Manufacturing Cost Per Unit
The computation of unit total manufacturing cost:
Step 5: Prepare a Cost Reconciliation Schedule
Determines cost of goods transferred to the next
department
Assigns total costs to units transferred out and to ending
work in process
Shows that total costs
accounted for equal total costs
to be accounted for
Costs charged to Mixing Department
Cost of beginning Work in Process $ 85,000
Costs started into production during period 570,000
Total costs to be accounted for $655,000

A cost reconciliation report.

2. FIFO COSTING METHOD
• If a FIFO method of costing and inventory valuation is used, a
variation of the previous calculation is necessary.
• The FIFO method differs from the weighted-average method in
two ways:
1. The computation of equivalent units.
2. The way in which the costs of beginning inventory are treated.

• The beginning WIP inventory is assumed to be completed first,

but those costs are not averaged into a rate per equivalent unit
as is done in the weighted average method.
• Here, the equivalent units and manufacturing costs in beginning
work in process are excluded from the current period unit cost
calculation. 61
 Illustration-FIFO Method
• Smith company reported the following activity in the mixing
department for the month of June.
Basic Information
Solution

Step 1: Compute Physical Unit Flow

Expanded to include transferred out units
Reports beginning work in process and units started and
completed
The equivalent units in the FIFO method is the
 Sum of the work performed to
(1) Finish the units of beginning work in process
inventory
(2) Complete units started into production during the
period, and
(3) Start, but only partially complete, units in ending
work in process inventory
Step 2: Compute Equivalent Units of Production
Materials:
• Added at beginning of process
• No additional materials cost to complete beginning work in
process
• 100% of material costs incurred on ending work in process

Conversion Costs:
 Step 3: Compute Unit Production Costs
Costs expressed in terms of equivalent units of
production
Costs in beginning work in process are ignored
When equivalent units of production are different for
materials and for conversion costs, three unit costs
computed: materials, conversion, and total
manufacturing

Cost per
Cost added during the period
equivalent =
Equivalent units of
unit production
Step 3: Compute Unit Production Costs - Continued
Production costs incurred during current period:
Direct Materials $400,000
Conversion Costs 170,000
Total Costs $570,000

Computation of unit costs:

 Step 4: Applying Costs to ending Work in Process
Inventory and units transferred out
A. Compute the cost of ending Work in Process Inventory.
Mixing Department
Cost of Ending WIP Inventory
Materials Conversion Total
Ending WIP inventory:
Equivalent units 200,000 120,000
Cost per equivalent unit $ 0.5000 $ 0.2270
Cost of Ending WIP inventory $ 100,000 $ 27,240 $ 127,240

200,000
200,000 ×× $0.5
$0.5 120,000
120,000 ×× 0.227
0.227
 B. Compute the total cost of units transferred out.
Mixing Department
Cost of Units Transferred Out in June
Materials Conversion Total
Cost of Units Transferred Out:
Cost in beginning WIP inventory $ 50,000 $ 35,000 $ 85,000
Cost to complete beginning WIP
Equivalent units to complete - 30,000
Cost per equivalent unit $ 0.5000 $ 0.2270
Cost to complete beginning WIP $ - $ 6,810 6,810
Cost of units started and completed:
Units started and completed 600,000 600,000
Cost per equivalent unit $ 0.5000 $ 0.2270
Cost of units started and completed $ 300,000 $ 136,200 436,200
Cost of Units Transferred Out $ 528,010

• The total cost assigned to Ending WIP inventory and Finished goods is $ 655, 250
($ 655, 250 + $127,240 ). $ 250 is due to the rounding error.
 Step 5: Prepare a Cost Reconciliation Schedule

Shows that total costs accounted for equal total costs to be

accounted for
 Costs charged to Mixing Department
Cost of beginning Work in Process $ 85,000
Costs started into production during period 570,000
Total costs to be accounted for $655,000

The cost reconciliation assigns the $655,000 to

 Units transferred out to the Baking Department,
and
 Units in ending Work in Process
FIFO VS WEIGHTED AVERAGE
The weighted-average method has one major advantage:
Simple to understand and to apply
When prices do not fluctuate significantly, the weighted-
average method is very similar to the FIFO method.
Conceptually, the FIFO method is superior because
Current performance is measured using only
costs incurred in the current period
and
The FIFO method provides current cost information
which leads to more accurate pricing strategies
2.11.5.3. Long-Term Contract Costing
• Long-term contract costing is a method of job costing that applies to
large units which are produced over long periods of time; for example
construction projects. Because of the length of time the contract takes to
complete, it is necessary to apportion the profit over several accounting
periods.
• Although the goods that are the subject of the contract have not been
delivered, the IFRS (International Accounting Standard 11) requires that
revenue and costs be allocated over the period in which the contract
takes place (e.g., the construction period).
• The percentage of completion method is the most common costing
method to be applied to long-term contracts. Under this method,
revenues and gross profit are recognized in the applicable periods of
production, not when production has been completed. The costs
incurred in reaching the relevant stage of completion are then matched
with income.
• Long-term contracts frequently allow for progress payments to be made
by a customer at various stages of completion. For construction
contracts, there will typically be an architect's certificate to support the
stage of completion..
73
• Consider Macro Builders Ltd., which has entered into a two-
year contract to construct a building. The contract price is $1.2
million, with an expected cost of construction of $1 million.
After one year, the following costs have been incurred:
1. Material delivered to site $500,000
2. Salaries and wages paid 130,000
3. Overhead costs 170,000
• The architect certifies the value of work completed to the
contractual stage for a progress payment as $600,000. Macro
estimates that it will cost $250,000 to complete the contract
over and above the costs already incurred.
• Exhibit 5.5 shows the calculations for anticipated profit on the
contract and the amount of profit that can be considered to
have been earned to date.

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Exhibit 5.5 Anticipated Profit and Profit to Date

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