Cost Management

System
Traditional Techniques
Production Processes
The production processes employed by companies can be thought of in terms of four classifications:

unit the focus of activity is a physically identifiable job, such as

producing a large turbine generator, building a custom-designed
production house, or performing a consulting job for a client.

Batch (lot)
production a batch of identical items (for example, 100 fuel injectors) moves in
stages from one factory workstation to the next.

assembly-
line the jobs are separately identifiable but tend to be similar (or identical) to
one another, such as assembling Chevrolet Malibus, Apple computers,
production and Whirlpool refrigerators.
In process production, outputs are not identifiable as individual
process units of product until late in the production process; examples
are found in the petroleum, chemical, milling, steel, distillery,
production forest products, and glass container industries.
Spectrum of production process

Pure Process
Job shop

Unit Batch (lot) Assembly line Process

production production

Production process continuum

Cost Management Systems
• Traditional tools
• Job order costing System
• Process Costing Systems

• Modern (Recent) tools

• Activity-Based-Costing (ABC)

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Spectrum of production
process
Job shop Pure Process

Unit Batch Assembly Process

produc (lot) line productio
tion n

Job order costing Process costing

Spectrum of production process

A job order cost system

Job shop
A process cost system
Pure Process

(or simply job cost collects costs for all of the

system) collects costs for products worked on
each physically during an accounting
Unit Batch (lot) Assembly line Process
identifiable
production job or unit of period and determines production
product as it moves unit costs by averaging
through the production the total costs over the
process, regardless of the
Job order costing
total number of units
Process costing
accounting period in worked on.
which the work is done.
Youtube Videos for traditional costing
systems
• https://youtu.be/NrOw7URt2t8
• https://youtu.be/F6RzLSSKlZM
• https://youtu.be/_6en7klrq1Y

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 Pro
Choice of a system
ces
Job s
cos
Costs are recorded as the job moves
order through the various steps in the
production process; these steps usually
In a process cost system, all production
costs for an accounting period (e.g.,
correspond to separate departments.. one month) are collected in the WIP
When each job is completed, the total Inventory account. These costs are not
cost(sum of material, labour and identified with specific units or batches

tin
overhead) recorded on the job cost of product.A record of the number of
record is the basis for the entry units worked on during the period is
transferring the product from WIP also maintained. Dividing total costs by
Inventory to Finished Goods Inventory. the number of units produced gives the
This same cost is the basis for the entry average cost per unit. This cost per unit

g
transferring the product from Finished becomes the basis for calculating the
Goods Inventory to Cost of Sales when dollar amount of the entries that record
the product is sold. The total cost for the transfer from WIP Inventory to
jobs that are still in process as of the Finished Goods Inventory and the
end of an accounting period therefore subsequent transfer from Finished
equals the total of the WIP Inventory Goods Inventory to Cost of Sales.
account at that time.
Choice of a system
Cost centres
• A cost center is a cost object for which costs of one or more related functions or activities
are accumulated.
E.g.:
Marker Pen Company, for example, has a department that manufactures wicks. The wick
department is an example of a cost center; the costs incurred in that department are for the
function or activity of manufacturing wicks for pens. In a product costing system, items of
cost are first accumulated in cost centers and then assigned to products. For this reason, a
cost center is often called an intermediate cost object to distinguish it from a product,
which is a final cost object.

• In a product costing system, items of cost are first accumulated in cost centers and then
assigned to products. For this reason, a cost center is often called an intermediate cost
object to distinguish it from a product, which is a final cost object.
• Most cost centres are also referred as responsibility centres.
Cost driver
• By definition, the indirect costs of a cost object must be allocated
to it. The activity or volume measure used in an overhead rate has
traditionally been called the allocation basis. More recently, the
term cost driver has come into usage because it more strongly
connotes that the allocation basis should represent the force that
drives (i.e., causes) the indirect costs to be incurred.
• They can be: payroll-related, material related, facility-related
(space-related), transaction-related, product-related, customer-
related etc.
Overhead Rate
• The process of assigning indirect costs to individual cost objects is
called allocation. The verb to allocate means to assign indirect costs
to individual cost objects. Indirect costs are allocated to products by
means of an overhead rate (also called an absorption rate, an
allocation rate, or a burden rate).
Overhead cost absorbed
Predetermined overhead rates
• The accumulation of overhead costs in cost centers and their
eventual allocation to products is done by ascertaining first
the amount of cost for the month and then assigning this
amount was subsequently to products.
• In general practice, a better way of allocating overhead costs
in most situations is to establish in advance, usually once a
year, an overhead rate for each production cost center and
then use these predetermined overhead rates throughout the
year.
Youtube video
• https://youtu.be/qrnTwV2zbPM
Standard Volume (average level of activity)

• The most uncertain part of the process of

establishing predetermined overhead rates is
estimating what the average monthly level of
activity will be. This amount is called the
standard volume, or normal volume.
Overhead rate at standard volume
• the center’s budgeted overhead costs at
standard volume, divided by that standard
volume.
• In Marker Pen Company, it is estimated
that, in the coming year, the factory will
operate at 75 percent of capacity. When the
factory operates at this level, the barrel
department’s average volume is 1,000 DLH
per month.
• Therefore, for the barrel department, OH
rate is $10,600 /1,000 DLH =$10.60 per
DLH.
Predetermined OH vs. Actual OH
Underabsorbed and overabsorbed overhead

• When a predetermined overhead

rate is used, the amount of
overhead costs allocated to
If the amount of overhead cost absorbed
products in a given month is Overabs by products exceeds the amount actually
likely to differ from the amount of orbed incurred, overhead is said to be
overhead costs actually incurred overabsorbed
in that month. This is because
the actual overhead costs
assigned to the cost center in the Underab If the amount of overhead cost absorbed
month and/or the actual activity
sorbed by products is less, overhead costs are
level for the month are likely to underabsorbed (or unabsorbed)
be different from the estimates
used when the predetermined
overhead rate was calculated.
Problem
Problem
• The Excellent Company had the following
inventories on April 1, 2019:
 Problem
• During the month the cost of material purchased was $120,000, direct
labor cost incurred was $160,000 and factory overhead applicable to
production was $60,000, on April 30 inventories were:

• Required: Prepare Journal entries on April 30, to show the flow of

cost through the proper summary accounts and also give the
subsidiary records.
Raw material used
 Problem

• The Moon Manufacturing Co. has a partial job order cost system instead of predetermining a factory overhead
rate. The company computes a separate factory overhead rate at the end of each month and this rate is used to
charge factory overhead to the jobs worked on during that month using the number of direct labour hours used on
the jobs as the basis of such allocation. In the following table, the actual factory overhead costs and the direct
labour hours for the past two months are listed. May June
Actual Factory
Overhead $6,000 $12,000
Costs
Actual direct
15,000 20,000
labour hours

• During this two month period one customer sent in an identical order each month, calling for the production of
1,000 units, requiring 400 direct labour hours at $1.00 per hour and material $750.
• Required: Compute (a) The total and the unit cost for the job in each of the two months and (b) Give your
comments regarding this method of charging actual factory overhead costs to jobs.
Problem
• A Furniture Mart received an order to manufacture furniture for a school the order was
assigned a job code FS-6. FS-6 job was priced at Rs. 400,000 and selling & admin cost
allocated to the job was 10% of selling price.
FOH cost is applied at Rs. 180 per direct labor hour
(OAR).

Requirement: Make a Job Order Cost Sheet for FS-6

Problem
• The Bharat Manufacturing Company’s product passes through two distinct
processes, X and Y, and then to the finished stock. It is known from the past
experience that wastage occurs in the process as under:

• In Process X, 5% of the units entering the process. In Process Y, 10% of the units
entering the process. The scrap value of the wastages in process X is Rs.8 per 100
units and in process Y is Rs.10 per 100 units.