direct professional labor cost of part- ners and associates as well as overhead applied based on direct professional labor used in the project.
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3-1 Discuss the role of product and service costing in manufacturing and nonmanufacturing firms.
3-2 Diagram and explain the flow of costs through the manufacturing accounts used in product costing.
3-3 Distinguish between job-order costing and process costing.
3-4 Compute a predetermined overhead rate and explain its use in job-order costing for job-shop and batch-production environments.
3-5 Prepare journal entries to record the costs of direct material, direct labor, and manufacturing overhead in a job-order costing system.
3-6 Prepare a schedule of cost of goods manufactured, a schedule of cost of goods sold, and an income statement for a manufacturer.
3-7 Describe the two-stage allocation process used to assign manufacturing overhead costs to production jobs.
3-8 Describe the process of project costing used in service industry firms and nonprofit organizations.
Product and Service Costing
Product costing is the assignment of production costs to all output of the organiza- tion, whether items manufactured, goods merchandised (resold), or services delivered.
A product-costing system accumulates the costs incurred in a production process and assigns those costs to the organization’s outputs. There are important distinctions between the costing of different types of outputs and we will highlight them as they arise. In refer- ring to these outputs, we follow the standard approach of using the word “product” to refer to physical items manufactured or merchandised, and services to refer to outputs that are less tangible in nature.
Product costing produces data that are needed for a variety of purposes in financial accounting, managerial accounting, and cost management.
Use in Financial Accounting In financial accounting, product costs are needed to value inventory on the balance sheet and to compute cost-of-goods-sold expense on the income statement. Under generally accepted accounting principles, inventory is valued at its cost until it is sold. Then the cost of the inventory becomes cost of goods sold, an expense of the period in which it is sold.
Although services are not inventoried like products are, their costs still appear on the income statement and are matched to the corresponding sales revenues. A product-costing system is used to accumulate the costs of services delivered, which are then recorded on the income statement as cost of services.
Product and Service Costing
Learning Objective 3-1 Discuss the role of product and service costing in manufacturing and nonmanufacturing firms.
Because product costs must be developed for financial accounting, these same costs are often used for decisions inside the organization as well. However, the simple approaches to product costing that are allowed for financial accounting are often inad- equate to support effective decision making.
Use in Managerial Accounting Inside of organizations, product and service costs are needed to help managers with planning and to provide them with high-quality data for decision making. While product costs are interesting for what they tell us about the amount of resources expended to create a particular product or service, they are critical for what they tell us about how the organization earns its profits, which is just the differ- ence between what we can sell output for and what we report as the cost of that output.
If we are interested in the relative profitability of different products and services, and we usually are, the way that we choose to assign costs to them helps to define our perception of those outputs as successful or unsuccessful.
The word “choose” in that last sentence is the key. Most people believe that the cost of a product or service is a very objective number that anyone could agree on, given the right information about material costs, labor costs, and so on. But, in reality, product cost is a slippery concept. Suppose, for example, that a bakery buys 1,000 kilograms of sugar in early December for $1.00 per kilogram and another 1,000 kilograms of sugar in late December for $0.80 per kilogram, with both pur- chases stored in the same storage silo. When they use the sugar from that silo to make cakes during the first week of January, what cost for sugar will be reflected in the product cost of a cake?
• The average cost of sugar in the silo is $0.90 per kilogram.
• The silo is filled from the top and emptied from the bottom, so the sugar used in the first week of January is probably from the first purchase that was put into the silo, costing $1.00 per kilogram.
• The company uses last-in-first-out (LIFO) inventory accounting in its financial accounting system, so the financial accounting system will claim that the cost of sugar is the most recent market price of $0.80 per kilogram.
Each of these costs is right in its own way, and depending upon how the costing sys- tem is designed, any one of these costs could be used in calculating the product cost, and therefore the profit, of the cakes produced and sold.
If measuring and interpreting a direct cost, like sugar, is that ambiguous, imag- ine how many ways there might be to assign an indirect product cost, like the cost of a production-scheduling computer or the salary of a quality control supervisor. Maybe that product cost number isn’t so objective after all! And if the cost number isn’t objective, neither is the profit number.
Decisions about product prices, service charge rates, the mix of products to be pro- duced, and the quantity of output to be manufactured or delivered are among those for which product cost information is needed. Moreover, controlling and reducing produc- tion costs is a frequent goal in organizations, but the organization will find it impossible to accomplish that goal without a clear and reasonably accurate measure of the costs to make its products and deliver its services. And finally, the profits that are derived from the product cost information are used to measure performance and make resource- allocation decisions that can lead to success or failure of a product. All else equal, which product gets more of the advertising budget? The one that appears to be making money for the company.
Thus, product costs provide crucial data for a variety of managerial purposes.
The issues that arise in assigning product costs, and especially the indirect manufac- turing (production) overhead costs, are the topic of this chapter, as well as Chapters 4 and 5.
Use in Reporting to Interested Organizations In addition to financial statement preparation and internal decision making, there is an ever-growing need for product cost information in relationships between firms and various outside organizations. Public utilities, such as electric and gas companies, record product costs to justify rate increases that must be approved by state regulatory agencies. Hospitals keep track of the costs of medical procedures that are reimbursed by insurance companies or by the federal government under the Medicare program. Manufacturing firms often sign cost-plus con- tracts with the government, where the contract price depends on the cost of manufactur- ing the product.