Managerial Accounting : Cost Accounting Systems

 Cost Accounting Systems :

Cost accounting involves measuring, recording, and reporting product costs. Companies determine both the total cost and the unit cost of each product. 

▰ The accuracy of the product cost information is critical to the success of the company. 

▰ Companies use this information to determine which products to produce, what price to charge, and the amounts to produce. 

▰ Accurate product cost information is also vital for effective evaluation of employee performance

▰ There are two basic types of cost accounting systems: 

• (1) job order cost system 
• (2) process cost system

JOB ORDER COST SYSTEM

• Under a job order cost system, the company assigns costs to each job or to each batch of goods. 
• An example of a job is the manufacture of a mainframe computer by IBM, the production of a movie by Disney, or the making of a fire truck by American LaFrance. 
• An example of a batch is the printing of 225 wedding invitations by a local print shop, or the printing of a weekly issue of Fortune magazine by a high-tech printer such as Quad Graphics.
• An important feature of job order costing is that each job or batch has its own distinguishing characteristics. 
• For example, each house is custom built, each consulting engagement by a CPA fi rm is unique, and each printing job is different.
• The objective is to compute the cost per job. 
• At each point in manufacturing a product or providing a service, the company can identify the job and its associated costs. 
• A job order cost system measures costs for each completed job, rather than for set time periods.

PROCESS COST SYSTEM

• A company uses a process cost system when it manufactures a large volume of similar products. Production is continuous. 
• Examples of a process cost system are the manufacture of cereal by Kellogg, the refining of petroleum by ExxonMobil, and the production of ice cream by Ben & Jerry’s. 
• Process costing accumulates product-related costs for a period of time (such as a week or a month) instead of assigning costs to specific products or job orders.
• In process costing, companies assign the costs to departments or processes for the specified period of time.
• Can a company use both types of cost systems? Yes. 
• For example, General Motors uses process cost accounting for its standard model cars, such as Malibus and Corvettes, and job order cost accounting for a custom-made limousine for the President of the United States.
• The objective of both cost accounting systems is to provide unit cost information for product pricing, cost control, inventory valuation, and financial statement presentation.

JOB ORDER COST FLOW

• The flow of costs (direct materials, direct labor, and manufacturing overhead) in job order cost accounting parallels the physical flow of the materials as they are converted into finished goods.  
• Companies first accumulate manufacturing costs in the form of raw materials, factory labor, or manufacturing overhead. 
• They then assign manufacturing costs to the Work in Process Inventory account. When a job is completed, the company transfers the cost of the job to Finished Goods Inventory. 
• Later when the goods are sold, the company transfers their cost to Cost of Goods Sold.
• The previous illustration provides a basic overview of the flow of costs in a manufacturing setting. 
• There are two major steps in the flow of costs: (1) accumulating the manufacturing costs incurred, and (2) assigning the accumulated costs to the work done.

Accumulating Manufacturing Cost

To illustrate a job order cost system, we will use the January transactions of Wallace Company, which makes custom electronic sensors for corporate safety applications (such as fire and carbon monoxide) and security applications (such as theft and corporate espionage)

Raw Materials Cost 

• When Wallace receives the raw materials it has purchased, it debits the cost of the materials to Raw Materials Inventory. 
• The company would debit this account for the invoice cost of the raw materials and freight costs chargeable to the purchaser. 
• It would credit the account for purchase discounts taken and purchase returns and allowances. Wallace makes no effort at this point to associate the cost of materials with specific jobs or orders.

Example

To illustrate, assume that Wallace purchases 2,000 lithium batteries (Stock No. AA2746) at $5 per unit ($10,000) and 800 electronic modules (Stock No. AA2850) at $40 per unit ($32,000) for a total cost of $42,000 ($10,000 1 $32,000). The entry to record this purchase on January 4 is:

Factory Labor Costs

• Some of a company’s employees are involved in the manufacturing process, while others are not. 
• As discussed in Chapter 1, wages and salaries of nonmanufacturing employees are expensed as ………. 
• Costs related to manufacturing employees are accumulated in Factory Labor to ensure their treatment as product costs. 
• Factory labor consists of three costs: (1) gross earnings of factory workers, (2) employer payroll taxes on these earnings, and (3) fringe benefits (such as sick pay, pensions, and vacation pay) incurred by the employer. 
• Companies debit labor costs to Factory Labor as they incur those costs.

Example

To illustrate, assume that Wallace incurs $32,000 of factory labor costs. Of that amount, $27,000 relates to wages payable and $5,000 relates to payroll taxes payable in February. The entry to record factory labor for the month is shown below. The company subsequently assigns direct factory labor to work in process and indirect factory labor to manufacturing overhead.

Manufacturing Overhead Costs

• A company has many types of overhead costs. 
• If these overhead costs, such as property taxes, depreciation, insurance, and repairs, relate to overhead costs of a nonmanufacturing facility, such as an office building, then these costs are expensed as period costs (e.g., Property Tax Expense, Depreciation Expense, Insurance Expense, and Repairs Expense). 
• 
  If the costs relate to the manufacturing process, then they are accumulated in Manufacturing Overhead, to ensure their treatment as product costs.

Assigning manufacturing costs to work in process results in the following entries: 

• 1. Debits made to Work in Process Inventory 
• 2. Credits made to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead. 

An essential accounting record in assigning costs to jobs is a job cost sheet. 

A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job.

▰ The company may use any of the inventory costing methods (FIFO, LIFO, or averagecost) in costing the requisitions to the individual job cost sheets. Periodically, the company journalizes the requisitions.
▰ For example, if Wallace uses $24,000 of direct materials and $6,000 of indirect materials in January, the entry is:

Factory Labor Costs

• Companies assign factory labor costs to jobs on the basis of time tickets prepared when the work is performed. 
• The time ticket indicates the employee, the hours worked, the account and job to be charged, and the total labor cost. 
• Many companies accumulate these data through the use of bar coding and scanning devices. When they start and end work, employees scan bar codes on their identification badges and bar codes associated with each job they work on. 
• When direct labor is involved, the time ticket must indicate the job number. The employee’s supervisor should approve all time tickets.

Example :

 The time tickets are later sent to the payroll department, which applies the employee’s hourly wage rate and computes the total labor cost. Finally, the company journalizes the time tickets. It debits the account Work in Process Inventory for direct labor and debits Manufacturing Overhead for indirect labor. For example, if the $32,000 total factory labor cost consists of $28,000 of direct labor and $4,000 of indirect labor, the entry is:

Manufacturing Overhead Costs

• Companies charge the actual costs of direct materials and direct labor to specific jobs. 
• In contrast, manufacturing overhead relates to production operations as a whole. 
• As a result, overhead costs cannot be assigned to specific jobs on the basis of actual costs incurred. Instead, companies assign manufacturing overhead to work in process and to specific jobs on an estimated basis through the use of a predetermined overhead rate.
• The predetermined overhead rate is based on the relationship between estimated annual overhead costs and expected annual operating activity, expressed in terms of a common activity base. 
• The company may state the activity in terms of direct labor costs, direct labor hours, machine hours, or any other measure that will provide an equitable basis for applying overhead costs to jobs. Companies establish the predetermined overhead rate at the beginning of the year. 
• Small companies often use a single, company-wide predetermined overhead rate. Large companies often use rates that vary from department to department.