Managerial Accounting:
An Introduction To Concepts, Methods, And Uses
Chapter 2
Measuring Product Costs
Maher, Stickney and Weil
Learning Objectives
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(Slide 1 of 3)
Understand the nature of manufacturing
costs.
Explain the need for recording costs by
department and assigning costs to products.
Understand how the Work-in-Process account
both describes the transformation of inputs
into outputs in a company and accounts for
the costs incurred in the process.
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Learning Objectives
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(Slide 2 of 3)
Compare and contrast normal costing and
actual costing.
Know various production methods and the
different accounting systems each requires.
Compare and contrast job costing and
process costing systems.
Compare and contrast product costing in
service organizations to that in manufacturing
companies.
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Learning Objectives
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(Slide 3 of 3)
Understand the concepts of customer costing
and profitability analysis.
Identify ethical issues in job costing.
Recognize components of just-in-time (JIT)
production methods and understand how
accountants adapt costing systems to them.
Know how to compute end-of-period
inventory book value using equivalent units of
production.
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Manufacturing Costs
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Include three major categories:
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Direct materials

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Direct labor
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Easily traced to a product
Labor of workers who transform materials into a
finished product
Manufacturing Overhead

All other costs of transforming materials into a
finished product
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Relation Between Departmental
Costing and Product Costing(Slide 1 of 3)
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Manufacturing costs are first assigned
to departments or responsibility centers
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A responsibility center is any organizational
unit with its own manager
e.g., divisions, territories, plants
Aids in planning and performance
evaluation
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Relation Between Departmental
Costing and Product Costing(Slide 2 of 3)
Direct Materials
Direct Labor
Manufacturing
Overhead

Record Costs
for Performance
Evaluation
Assign Costs
To Products
Assembly
Dept.
Product A
Finishing
Dept.
Product B
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Relation Between Departmental
Costing and Product Costing(Slide 3 of 3)

Actual manufacturing costs recorded in
departments can be compared to
standard or budgeted amounts
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Differences, called variances, can be
investigated further
Costs are then assigned to products

Useful in managerial decision making such
as evaluating product profitability
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Model of Cost Flows
WIP-Dept.1
Beg.Inv.
 Direct
Mat.
 Direct
Labor
 Overhead
End.Inv.
Finished Goods
Inventory
WIP-Dept.2
Transfer to
Dept.2
Added MLO
in Dept. 2
Cost of
Goods Sold
Beg. Inv.
Costs
Allocated
to Units
Finished
This Period
Costs
of Units
Sold This
Period
End. Inv.
Balance Sheet Accounts
Income Statement
Accounts
Mktg. &
Admin.
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Basis Cost Flow Equation
Beginning Balance + Transfers In=
Transfers Out + Ending Balance
 Transfer In to Work-In-Process include:
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Materials
Labor
Overhead
Equation is useful in determining
reasonableness of inventories
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Cost Measures
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(Slide 1 of 2)
Normal Costing--commonly used to
assign costs to products
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Assigns actual direct materials and direct
labor plus “normal” manufacturing
overhead

Overhead is applied to units produced using an
application rate estimated before the
accounting period begins
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Cost Measures

(Slide 2 of 2)
Actual Costing--assigns actual overhead
to products
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Actual overhead may vary for reasons
unrelated to production activity resulting in
product cost fluctuations unrelated to
production activity
Normal costing tends to smooth out these
fluctuations
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Applying Overhead Costs

Normal costing works as follows:
1. Select a cost driver
2. Estimate overhead and the level of activity
for the accounting period
3. Compute the predetermined
manufacturing overhead rate
4. Apply overhead to production by
multiplying the predetermined overhead
rate times the actual activity
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Overhead Rate Computation

Predetermined manufacturing overhead
rate is calculated as follows:
Estimated Manufacturing Overhead
Normal (or Estimated) Activity Level
=
Predetermined Overhead Rate
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Example-Overhead
Rate Computation

Plantimum Builders estimates that next
year variable overhead will be $100,000
and direct labor will be 50,000 hours

The predetermined overhead rate for next
year will be:
$100,000
50,000 DLHs
= $2.00 Per Direct Labor Hour
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Cost Systems
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Effective cost systems must have the
following characteristics:
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Decision focus
Provide different cost information for
different purposes
Pass the cost-benefit test
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Production Methods and
Accounting Systems
Type Production
Accounting System
Job
Job Costing
(e.g., Custom Homes)
Type Product
Customized
Operations
(e.g., Cars)
Mostly
Standardized
Operation Costing
Continuous Flow
Process Costing
Processing
(e.g., Oil Refinery)
Standardized
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Job Costing
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Collect costs for each “unit” produced
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Typically used by companies producing
customized products or “jobs”
Examples: print shops, customized
construction companies, defense
contractors
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Process Costing
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Company accumulates costs in a
department or production process
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Those costs are spread evenly over units
produced
Essentially, computes an average cost per
unit
Examples: manufacture of soft drinks,
paint, chemicals
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Operation Costing
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A hybrid of job and process costing
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Typically used when production involves a
standardized method of making a product
that is performed repeatedly
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Products may share common production
methods but differ in details
Examples: Clothing, computers, furniture
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Service Organizations
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Flow of costs is similar to that of a
manufacturing company
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Providing a service requires labor,
overhead, and sometimes materials (called
supplies)
Costs are collected by the job or client
Provides info for cost control, performance
evaluation, and future pricing decisions
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Ethical Issues in Job Costing
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Improprieties in job costing generally
arise from:
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Misstating stage of completion
Charging costs to the wrong job
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May be an attempt to avoid the appearance of
cost overruns
Misrepresenting the costs of jobs
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Causes problems when job is billed on a costplus-fee basis
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Just-In-Time (JIT) Methods

Attempt to obtain materials or provide
finished goods just in time
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Reduces or eliminates inventories and
related carrying costs
May allow production costs to be recorded
directly to Cost of Goods Sold (COGS)
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May involve use of “Backflush Costing”
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Used to transfer costs back to inventories when
production costs are initially recorded as COGS
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Spoilage and
Quality of Production
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Normal waste is typically included in the
cost of work performed
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If waste is not “normal” it may be included
in an expense account called “Abnormal
Spoilage”
Companies concerned about quality
production may not treat any waste or
spoilage as normal

Prevents these costs from being buried in
production costs
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Computing Costs of
Equivalent Production
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Five steps required to compute costs of
products, ending inventory, and finished
goods
1.
2.
3.
4.
5.
Summarize flow of physical units
Compute equivalent units
Summarize costs to be accounted for
Compute unit costs
Compute cost of goods completed and transferred
out and cost of ending inventory of WIP
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If you have any comments or suggestions concerning this
PowerPoint Presentation for Managerial Accounting, An
Introduction To Concepts, Methods, And Uses, please contact:
Dr. Donald R. Trippeer, CPA
donald.trippeer@colostate-pueblo.edu
Colorado State University-Pueblo
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