A D V E R T I S I N G
Exhibit 3–12
Developing Departmental Overhead Rates Using Two-Stage Allocation STAGE ONE
Overhead costs are assigned to production departments.
Manufacturing-Overhead Distribution (General manufacturing-overhead costs are distributed to all departments.)
Service Department Cost Allocation (Service department costs are allocated to the production departments.)
Production Departments
STAGE TWO
Overhead costs are assigned to production jobs.
Overhead Application (All costs accumulated in the production departments are applied to products.)*
Production jobs pass through production departments.
* The Machining Department manufactures bicycle components, such as the bicycle frame pictured. In the Assembly Department, the components are put together. The Machining Department and the Assembly Department each has its own predetermined overhead rate.
Factory Custodial Services Department
Machinery Repair Department Service Departments
Machining Department Assembly Department
annual salaries of $100,000 each. An artistic and communications staff of six associates works on client engagements, and the associates earn $50,000 per year. Generous fringe benefits are provided to help retain these talented professionals, and cost of benefits aver- ages 40 percent of compensation for all employees. Small World Advertising’s direct professional labor budget is as follows:
Partner salaries... $200,000 Partner benefits (40%) ... 80,000 Total partner compensation ... $280,000 Artistic and communications associate salaries ... $300,000 Associate benefits (40%) ... 120,000 Total associate compensation ... $420,000
The ad agency’s annual overhead budget, which totals $756,000, appears in Exhibit 3–13. The overhead budget includes the costs of the support staff, artistic and photographic supplies, office operation, utilities, rent, insurance, advertising, vehicle maintenance, and depreciation. Small World’s accountant has estimated that one-third
Exhibit 3–13 Small World Advertising:
Annual Overhead Budget
Microsoft Office Excel
SMALL WORLD
A D V E R T I S I N G
of the budgeted overhead cost is incurred to support the ad agency’s two partners, and two-thirds of it goes to support the artistic and communications associates. Thus, the fol- lowing two overhead rates are calculated.
Budgeted annual partner support overhead
___________________________________
Budgeted annual partner compensation = ___________$756,000 × 1 ⁄ 3
$280,000 = 90%
Budgeted annual associate support overhead
____________________________________
Budgeted annual associate compensation = ___________$756,000 × 2 ⁄ 3
$420,000 = 120%
Based on the calculations above, overhead is assigned to each advertising engage- ment at the rate of 90 percent of partner direct professional labor plus 120 percent of associate direct professional labor. During May, Small World Advertising completed an advertising project for EyeStyle Global, a company that sells eyeglasses and for each pair sold donates one pair of glasses to nonprofit agencies in low-income countries.
The contract required $1,800 in direct material, $1,200 of partner direct professional
“UT’s indirect cost rate (IDC) agreement, as approved by the government, is available to the public . . . Overhead costs also known as indirect costs are calculated based on actual costs accrued in support of research and are divided into two categories: Facilities and Administrative . . . Components of the administrative costs include general
administration, departmental administration, student services administration and sponsored projects administration costs.
Components of the facilities portion include building depreciation, equipment depreciation, land improvement depreciation, interest, operations and maintenance without utility costs and library costs.” (3h) University of Texas at
Austin
Contract MJH0207: Advertising Program for EyeStyle Global
Direct material ... $1,800 Direct professional labor (partner) ... 1,200 Direct professional labor (associate) ... 2,000 Applied overhead:
Partner support ($1,200 × 90%) ... 1,080 Associate support ($2,000 × 120%) ... 2,400 Total cost ... $8,480
labor, and $2,000 of artistic staff direct professional labor (these labor costs include the cost of benefits). The total cost of the contract is computed as follows:
The total contract cost of $8,480 includes actual direct material and direct profes- sional labor costs, and applied overhead based on the predetermined overhead rates for partner support costs and artistic and communications associate support costs. The con- tract cost can be used by the firm in controlling costs, for planning cash flows and opera- tions, and as one informational input in its contract-pricing decisions. In addition to the contract cost, the firm also should consider the demand for its advertising services and the prices charged by its competitors.
The discussion above provides only a brief overview of cost-accumulation proce- dures in service industry and nonprofit organizations. The main point is that job-order costing systems are used in a wide variety of organizations, and these systems provide important information to managers for planning, decision making, and control.
Focus on Ethics
LEARNING FROM PAST MISTAKES: BOEING FINDS IT DOESN’T PAY TO HIDE PROBLEMS FROM INVESTORS
Aircraft manufacturers use job-order costing to track the cost of an airplane. And, as this chapter discusses, supply chain management and production controls also play an important part in managing and controling production costs. But, try as they might, things don’t always go according to plan.
In the late 1990s, The Boeing Company’s top manage- ment had been seeking a merger with McDonnell-Douglas Corporation, whose board of directors was reluctant to approve a deal. Finally, the deal went through, and the world’s largest aerospace company was born, a company that could compete in both the commercial and defense aeronautics markets and even in more speculative flight ventures like space shuttles and rockets.
Unfortunately, as reported by BusinessWeek in May 2002 following a three-month investigation, “a
disaster was quietly unfolding inside Boeing’s sprawling factories—one that would ultimately . . . cause several executives to lose their jobs, and lead to claims of accounting fraud.” During this period, high demand for Boeing’s airplanes in a strong economy flew head- on into a disrupted production environment caused by efforts to modernize manufacturing processes, leading to “a manufacturing nervous breakdown.” The result was dramatically reduced profitability, a problem whose size was allegedly hidden from investors so that the inevitable drop in Boeing’s stock price would not jeopardize the McDonnell-Douglas deal.
Moreover, the BusinessWeek article reports that, “Boe- ing did more than simply fail to tell investors about its pro- duction disaster. It also engaged in a wide variety of aggressive accounting techniques that papered over the mess.” After the merger with McDonnell-Douglas, the truth came out in the form of much lower earnings.6
6Stanley Holmes and Mike France, “Boeing’s Secret: Did the Aircraft Giant Exploit Accounting Rules to Conceal a Huge Factory Snafu?” Businessweek, May 20, 2002. Also see Andy Pasztor and Anne Soueo, “Boeing Could Pay Large Penalty to Settle Probes, Avoid Prosecution,” The Wall Street Journal, September 17, 2005.
overruns, its production problems, and the merger with McDonnell-Douglas? Did the company’s top executives act ethically? How about their accountants?
In the years since the Boeing-McDonnell merger, the company has faced other high-profile production problems, and it seems to have taken a lesson from the earlier deba- cle. For example, beginning in the early 2000s and through the present day, Boeing’s new 787 model has faced a vari- ety of problems: delays relating to subcontracting of con- struction and carbon fiber technology; groundings due to problems with lithium-ion batteries; and frustrating fuel sys- tem and engine problems. But in contrast to the secrecy surrounding production problems at the time of the McDonnell-Douglas merger, these challenges have played out in public with a reasonable degree of transparency from Boeing.7
7“Boeing 787 Dreamliner: a timeline of problems,” The Telegraph, July 28, 2013; Dominic Gates, “Boeing 787’s problems blamed on outsourcing, lack of oversight,” Seattle Times, February 2, 2013, updated May 1, 2015; Julie Johnsson and Benjamin D Katz, “Boeing deploys executive to Rolls-Royce to help end 787 engine crisis,” Bloom- berg, May 25, 2018.
company? What would you advise them regarding the ethics of secrecy versus disclosure if a major deal like the McDonnell-Douglas merger were to be on the line in the future?
Chapter Summary
LO3-1 Discuss the role of product and service costing in manufacturing and nonmanufacturing firms. Product costing is the process of accumulating the costs of a production process and assigning them to the firm’s products. Product costs are needed for three major purposes: (1) to value inventory and cost of goods sold in financial accounting; (2) to provide managerial accounting information to managers for planning, cost control, and decision making; and (3) to provide cost data to various orga- nizations outside the firm.
LO3-2 Diagram and explain the flow of costs through the manufacturing accounts used in product costing. The costs of direct material, direct labor, and manufacturing overhead are first entered into the Work-in-Process Inventory account. When goods are completed, the accumulated manufactur- ing costs are transferred from Work-in-Process Inventory to Finished-Goods Inventory. Finally, these product costs are transferred from Finished-Goods Inventory to Cost of Goods Sold when sales occur.
LO3-3 Distinguish between job-order costing and process costing. Job-order costing is used by firms that engage in either job-shop or batch-production operations. Such firms produce relatively small numbers of dissimilar products. Process costing is used by companies that produce relatively large num- bers of nearly identical products.
LO3-4 Compute a predetermined overhead rate and explain its use in job-order costing for job- shop and batch-production environments. Overhead is applied to production jobs using a predeter- mined overhead rate, which is based on estimates of manufacturing overhead (in the numerator) and the level of some cost driver or activity base (in the denominator).
LO3-5 Prepare journal entries to record the costs of direct material, direct labor, and manu- facturing overhead in a job-order costing system. Journal entries, as illustrated in the chapter, are used to track the flow of manufacturing costs through the various accounts, such as Raw- Material Inventory, Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold. Two meth- ods for periodically adjusting overapplied and underapplied overhead are described and illustrated.
112
Ethics Unwrapped concept videos that particularly apply to this Focus on Ethics include Bounded Ethicality and Moral Myopia.*
*The Ethics Unwrapped concepts videos are an entertaining and helpful resource published by the University of Texas at Austin. The videos and other material relating to ethical behavior by managers, accountants, and others in organizations can be found at https://
ethicsunwrapped.utexas.edu.
With permission of the University of Texas at Austin, McCombs School of Business
• Manufacturing overhead during the first quarter included charges for depreciation ($54,400), indi- rect labor ($96,000), indirect materials used ($8,000), and other factory costs ($223,200).
• Piedmont Paint Company completed job JY65 and job DC66. Job DC66 was sold on account, pro- ducing a profit of $55,520 for the firm.
Required:
1. Determine Piedmont Paint Company’s predetermined overhead application rate.
2. Prepare journal entries as of March 31 to record the following. (Note: Use summary entries where appropriate by combining individual job data.)
a. The issuance of direct material to production and the direct labor incurred.
b. The manufacturing overhead incurred during the quarter.
c. The application of manufacturing overhead to production.
d. The completion of jobs JY65 and DC66.
e. The sale of job DC66.
3. Determine the cost of the jobs still in production as of March 31.
4. Did the finished-goods inventory increase or decrease during the first quarter? By how much?
5. Was manufacturing overhead under- or overapplied for the first quarter of the year? By how much?
LO3-6 Prepare a schedule of cost of goods manufactured, a schedule of cost of goods sold, and an income statement for a manufacturer. These accounting schedules, which are illustrated in the chap- ter, provide information to management about the costs incurred in a production operation.
LO3-7 Describe the two-stage allocation process used to assign manufacturing overhead costs to production jobs. In stage one, cost distribution and service-department cost allocation are used to assign all manufacturing overhead costs to production departments. In stage two, cost application is used to assign overhead costs from production departments to production jobs using a predetermined overhead rate.
LO3-8 Describe the process of project costing used in service industry firms and nonprofit organizations. Job-order costing methods are used in a variety of service industry firms and non- profit organizations. Accumulating costs of projects, contracts, cases, programs, or missions provides important information to managers in such organizations as hospitals, law firms, and government agencies.
Piedmont Paint Company uses a job-order costing system, and the company had two jobs in process at the beginning of the current year. Job JY65 currently has a cost of $134,400 assigned to it, and job DC66 currently has a cost of $85,600 assigned to it. The following additional information is available.
• The company applies manufacturing overhead on the basis of machine hours. Budgeted overhead and machine activity (based on practical capacity) for the year were $1,344,000 and 16,000 hours, respectively.
• The company worked on four jobs during the first quarter. Direct materials used, direct labor incurred, and machine hours consumed were as follows:
Review Problem on Job-Order Costing
Job No. Direct Material Direct Labor Machine Hours
JY65 ... $33,600 ... $ 56,000 ... 1,200 DC66 ... — ... 35,200 ... 700 SG78 ... 70,400 ... 104,000 ... 2,000 RG82 ... 24,000 ... 14,080 ... 500
Solutions to Review Problems
1. Predetermined overhead rate = budgeted overhead ÷ budgeted machine hours = $1,344,000 ÷ 16,000 = $84 per machine hour 2. (a) Work-in-Process Inventory ... 128,000*
Raw-Material Inventory ... 128,000 Work-in-Process Inventory ... 209,280†
Wages Payable ... 209,280 *$33,600 + $70,400 + $24,000 = $128,000
†$56,000 + $35,200 + $104,000 + $14,080 = $209,280
(b) Manufacturing Overhead ... 381,600
Accumulated Depreciation ... 54,400 Wages Payable ... 96,000 Manufacturing Supplies Inventory ... 8,000 Miscellaneous Accounts ... 223,200 (c) Work-in-Process Inventory ... 369,600*
Manufacturing Overhead ... 369,600 *(1,200 + 700 + 2,000 + 500) × $84 = $369,600
(d) Finished-Goods Inventory ... 504,400*
Work-in-Process Inventory ... 504,400 *Job JY65: $134,400 + $33,600 + $56,000 + (1,200 × $84) = $324,800
Job DC66: $85,600 + $35,200 + (700 × $84) = $179,600 $504,400 = $324,800 + $179,600
(e) Accounts Receivable ... 235,120*
Sales Revenue ... 235,120 *$179,600 + $55,520 = $235,120
Cost of Goods Sold ... 179,600
Finished-Goods Inventory ... 179,600 3. Job SG78 and RG82 are in production as of March 31:
Job SG78: $70,400 + $104,000 + (2,000 × $84) ... $342,400 Job RG82: $24,000 + $14,080 + (500 × $84) ... 80,080 Total ... $422,480 4. Finished-goods inventory increased by $324,800 ($504,400 − $179,600).
5. The company’s actual overhead amounted to $381,600, whereas applied overhead totaled
$369,600. Thus, overhead was underapplied by $12,000.
Key Terms
For each term’s definition refer to the indicated page, or turn to the glossary at the end of the text.
activity base, 93 actual costing, 106 actual manufacturing
overhead, 99 applied manufacturing
overhead, 98
bill of materials, 90
cost distribution (sometimes called cost allocation), 108
cost of goods manufactured, 103
departmental overhead centers, 108
departmental overhead rate, 107
job-cost record, 87 job-order costing, 86
material requisition form, 89 normal costing, 106
overapplied overhead, 101 overhead application (or
absorption), 92
plantwide overhead rate, 107
predetermined overhead rate, 93
process-costing system, 87 product costing, 82 product-costing system, 82 proration, 101
schedule of cost of goods manufactured, 103 schedule of cost of goods
sold, 103
service department cost allocation, 108
service departments, 108 source document, 89 supply chain, 89
throughput time (or cycle time), 107
time record, 91
two-stage cost allocation, 107 underapplied
overhead, 100 volume-based cost
driver, 93
Review Questions
3–1. List and explain four purposes of product costing.
3–2. Explain the difference between job-order and process costing.
3–3. How is the concept of product costing applied in ser- vice industry firms?
3–4. What are the purposes of the following documents: (a) material requisition form, (b) labor time record, and (c) job-cost record.
3–5. Why is manufacturing overhead applied to prod- ucts when product costs are used in making pricing decisions?
3–6. Explain the benefits of using a predetermined overhead rate instead of an actual overhead rate.
3–7. Describe one advantage and one disadvantage of prorat- ing overapplied or underapplied overhead.
3–8. Describe an important cost-benefit issue involv- ing accuracy versus timeliness in accounting for overhead.
3–9. Explain the difference between actual and normal costing.
3–10. When a single, volume-based cost driver (or activity base) is used to apply manufacturing overhead, what is the managerial accountant’s primary objective in select- ing the cost driver?
3–11. Describe some costs and benefits of using multiple overhead rates instead of a plantwide overhead rate.
3–12. Describe the process of two-stage cost allocation in the development of departmental overhead rates.
3–13. Define each of the following terms, and explain the relationship among them: (a) overhead cost distribu- tion, (b) service department cost allocation, and (c) overhead application.
3–14. Describe how job-order costing concepts are used in professional service firms, such as law practices and consulting firms.
3–15. What is meant by the term cost driver? What is a volume-based cost driver?
3–16. Describe the flow of costs through a product-costing system. What special accounts are involved, and how are they used?
3–17. Give an example of how a hospital, such as the Mayo Clinic, might use job-order costing concepts.
3–18. Why are some manufacturing firms switching from direct-labor hours to machine hours or production time as the basis for overhead application?
3–19. What is the cause of overapplied or underapplied overhead?
3–20. Briefly describe two ways of closing out overapplied or underapplied overhead at the end of an accounting period.
3–21. Describe how a large retailer such as Lowes would assign overhead costs to the products it sells in its stores.
3–22. Explain how a nonprofit organization like Doctors Without Borders might assign overhead costs to their operations in a particular refugee camp.
Exercises
For each of the following companies, indicate whether job-order or process costing is more appropriate.
1. Manufacturer of swimming pool chemicals.
2. Manufacturer of custom hot tubs and spas.
3. Architectural firm.
4. Manufacturer of ceramic tile.
5. Producer of yogurt.
6. Manufacturer of custom tool sheds.
7. Manufacturer of papers clips.
8. Engineering consulting firm.
9. Manufacturer of balloons.
10. Manufacturer of custom emergency rescue vehicles.
The controller for Tender Bird Poultry, Inc., estimates that the company’s fixed overhead is $100,000 per year. She also has determined that the variable overhead is approximately $.10 per chicken raised and sold.
Since the firm has a single product, overhead is applied on the basis of output units, chickens raised and sold.
Required:
1. Calculate the predetermined overhead rate under each of the following output predictions: 200,000 chickens, 300,000 chickens, and 400,000 chickens.
2. Does the predetermined overhead rate change in proportion to the change in predicted production?
Why?
Finley Educational Products started and finished job number B67 during June. The job required $4,600 of direct material and 40 hours of direct labor at $17 per hour. The predetermined overhead rate is $5 per direct-labor hour.
Required: Prepare journal entries to record the incurrence of production costs and the completion of job number B67.
Visit the website of a film producer, such as Disney, MGM, or Warner Brothers.
Exercise 3–23 Job-Order versus Process Costing
(LO 3-1, 3-3)
Exercise 3–24 Fixed and Variable Costs;
Overhead Rate; Agribusiness (LO 3-1, 3-4)
Exercise 3–25 Basic Journal Entries in Job- Order Costing
(LO 3-5)
Exercise 3–26 Job-Order Costing; Feature Film Production; Use of Internet
(LO 3-1, 3-3)
All applicable Exercises are available in Connect.
®
Walt Disney Studios www.disney.com
MGM www.mgm.com
Warner Brothers www.warnerbros.com
Required: Read about one of the company’s recent (or upcoming) film releases. Then discuss why or why not job-order costing would be an appropriate costing method for feature film production. Would your answer be any different depending on the type of film being produced (e.g., animation in a studio versus filming on location in Timbuktu)?
Bodin Company manufactures finger splints for kids who get tendonitis from playing video games. The firm had the following inventories at the beginning and end of the month of January.
Exercise 3–27 Job-Order Costing Basics (LO 3-2, 3-4, 3-6)
The following additional data pertain to January operations.
Raw material purchased ... $191,000 Direct labor ... 300,000 Actual manufacturing overhead ... 175,000 Actual selling and administrative expenses ... 115,000 January 1 January 31 Finished goods ... $125,000 $117,000 Work in process ... 235,000 251,000 Raw material ... 134,000 124,000
The company applies manufacturing overhead at the rate of 60 percent of direct-labor cost. Any overapplied or underapplied manufacturing overhead is accumulated until the end of the year.
Required: Compute the following amounts.
1. The company’s prime cost for January.
2. The total manufacturing cost for January.
3. The cost of goods manufactured for January.
4. The cost of goods sold for January.
5. The balance in the manufacturing overhead account on January 31. Debit or credit?
(CMA, adapted)
McAllister, Inc., employs a normal costing system. The following information pertains to the year just ended.
• Total manufacturing costs were $2,500,000.
• Cost of goods manufactured was $2,425,000.
• Applied manufacturing overhead was 30 percent of total manufacturing costs.
• Manufacturing overhead was applied to production at a rate of 80 percent of direct-labor cost.
• Work-in-process inventory on January 1 was 75 percent of work-in-process inventory on December 31.
Required: Compute the following to support the preparation of financial statements.
1. Compute the total direct-labor cost for the year.
2. Calculate the total cost of direct material used during the year.
3. Compute the value of the company’s work-in-process inventory on December 31.
(CMA, adapted)
Garrett Toy Company incurred the following costs in April to produce job number TB78, which con- sisted of 1,000 teddy bears that can walk, talk, and play cards.
Direct Material:
4/1/20x0 Requisition number 101: 400 yards of fabric at $.80 per yard
4/5/20x0 Requisition number 108: 500 cubic feet of stuffing at $.30 per cubic foot Direct Labor:
From employee time cards for 4/1/20x0 through 4/8/20x0: 500 hours at $12 per hour Manufacturing Overhead:
Applied on the basis of direct-labor hours at $2.00 per hour.
Job number TB78 was completed on April 15. On April 30, 700 of the bears were shipped to a local toy store.
Required: Prepare a job-cost record using the information given above. (Use Exhibit 3–3 as a guide.) Crunchem Cereal Company incurred the following actual costs during 20x1.
Exercise 3–28 Cost Relationships; Normal Costing System
(LO 3-2, 3-4, 3-6)
Exercise 3–29 Job-Cost Record (LO 3-2, 3-3, 3-4)
Exercise 3–30 Schedule of Cost of Goods Manufactured
(LO 3-2, 3-4, 3-6) Direct material used ... $275,000
Direct labor ... 120,000 Manufacturing overhead ... 252,000
The firm’s predetermined overhead rate is 210 percent of direct-labor cost. The January 1 inventory balances were as follows:
Raw material ... $30,000 Work in process ... 39,000 Finished goods ... 42,000