Full Cost and Thier Uses Essay Example

(the costs that are directly traced to it) and (2) a fair share of the indirect costs (those costs incurred jointly for several cost objects) Ex.Ms. Chen paid $35 for a pair of jeans at a store. $35 is the full cost because $35 of her resources was used to acquire a pair of jeans. Note: The full cost of a cost object is the sum of its direct costs plus a fair share of applicable indirect costs.

Direct Costs of a cost object are items of costs that are specifically traced to or caused by that cost object. Ex. Denim used in manufacturing a batch of jeans is a direct cost of that batch of jeans, and so are the earnings of the employees who worked directly in making that batch of jeans.Indirect Costs are elements of costs that are associated with or caused by two or more cost objects jointly but that are not directly traced to each of them individually. *it is not possible or at least not feasible to measure directly how much of the cost is attributable to a single cost object. Ex.

Indirect Costs of a batch of jeans - factory manager’s salary and insurance on the factory building and equipment. *However, if the cost object were instead specified to be the factory where the jeans are produced, then the factory manager’s salary and the insurance costs are direct costs of that cost object.Elements of Product Cost Product -a tangible good (ex. batch of jeans) or a service (ex.

repair job on an automobile) Product Costing System -the system that accumulates and reports the costs of product cost objects

*Elements of Product Cost are either material, labor or services. Direct Material Cost -the quantities of material that can be specifically identified with a cost object in an economically feasible manner, priced at the unit price of direct material. Ex. raw materials Direct Labor Cost the labor quantities that can be specifically identified with a cost object in an economically feasible manner, priced at the unit price of direct labor. Ex.

earnings of workers who assemble parts into a finished good or operate machines in its production. cost of a technician’s time spent repairing an automobile is a direct labor cost of the repair job. Other Direct Costs -any direct cost traced to a single product Ex. energy costs are direct costs of manufacturing energy-intensive products such as glass services purchased from an outside company are direct costs if they are identifiable with a single productOverhead Cost -all indirect product costs – all production costs other than direct costs Ex.

supervisors, janitors, materials handlers, stockroom personnel, inspectors, crane and forklift operators heat, light, power (utilities expenses), maintenance, depreciation, taxes and insurance related to assets used in the production process. Conversion Cost -the sum of direct labor cost and overhead cost -all production costs needed to convert direct materials into finished goods *As factories become automated, direct material costs tend to become a much ore significant cost element that direct labor which makes the distinction of direct labor and indirect labor blurred. As a result, some companies no longer distinguish between direct labor and overhead cost; instead the single category of conversion cost is used. Full Production Cost -the sum of direct material cost and conversion

cost *In manufacturing firms, FPC is called inventory cost because this is the cost at which completed goods are carried as inventory and the amount that is reported as cost of sales when the goods are sold. In manufacturing firms, FPC includes only the costs that are incurred “within the four factory walls”. *In financial accounting FPC’s that flow through inventory accounts are called product costs to distinguish them from period costs, which do not flow through inventory accounts but rather are charged as expenses of the period in which they are incurred.

The term inventory cost is more descriptive of full production costs rather than product cost because the full cost of a product cost object also includes non-manufacturing costs such as the cost of selling the product. Inventory costs can also be referred as product costs. Non-Production Cost -also called period costs -all costs incurred in an organization other than inventory costs Ex. selling costs, research and development costs, general and administrative costs and interest costs.

*In a company’s income statement, many of these costs are reported as a lump sum under the single caption “Selling, general and administrative expense” (SG&A). *In manufacturing firms, selling costs include both marketing (order-getting) costs and logistics (order-filling) costs.Marketing Costs – incurred before a sales order is received – include market research, advertising, point-of-sale promotions and salespersons’ compensation and travel costs Logistics Costs – incurred after the goods have been produced – include warehousing and delivery costs as well as the recordkeeping costs associated with processing an order Full Cost -the sum of all the cost elements described under Non-Production Cost -includes both inventory (full production) cost

and non-production cost *However, in practice, many accountants use the term full cost to mean only full production cost.T-Account Flowchart is helpful in understanding the flow of costs through a cost accounting system. *Most of the accounts on a cost accounting flowchart are either asset accounts or expense accounts.

*Increases are shown in the debit side while decreases are shown on the credit side Example: Illustration 17-2 shows the flowchart concept and the essential cash flows in a manufacturing company. This flowchart contains a hypothetical set of figures for a month’s operation in Marker Pen Company, a small company that manufactures and sells felt tip pens.The flowchart is divided into three sections: (1) acquisition, containing the accounts related to the acquisition of resources; (2) production, containing the accounts related to the production process; and (3) sale, containing the accounts related to the sale of products. The following explains the cycle of operations depicted on the flowchart: 1. During the month $52,000 of materials were purchased on open account, $20,000 of various other assets were purchased for cash, and $60,000 of accounts payable were paid.

The journal entries recording these transactions are as follows: a.Materials inventory....

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52,000 Accounts Payable.....

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.. 52,000 b. (other asset and liability accounts)..

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20,000 Cash....

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20,000 c. Accounts Payable....

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60,000 Cash....

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60,000 (for complete illustration and transactions, see page 514 of Accounting: Text and Cases book by Robert N. Anthony, et al. ) Uses of Full Costs 1. Financial ReportingFull Production Cost is the basis for reporting work in process inventory and finished goods inventory on the balance sheet and cost of sales on the income statement *When a company constructs or acquires

fixed asset, for its own use, the amount recorded in the accounts and reported on the balance sheet is the asset’s full cost. *Cost accounting information is also used to measure the income of the principal segments of the business.

**FASB requires that shareholder annual reports of large companies report revenues, operating profit and identifiable asset amounts for each significant business segment. . Analyses of Profitability Cost accounting makes it possible to make similar analyses of individual parts of a business such as an individual product, product line (a family of related products), plant, division, sales territory or any other subdivision of a company that is of interest. *If the part does not earn a reasonable profit – or if the revenue generated by this part does exceed these costs by an amount representing a reasonable return on assets employed – there is an indication that something is wrong. 3.

“What did it cost? ” “What was the cost of eliminating pollution in a certain river?What does the last presidential election cost? What was the cost of police protection last year in City X, etc.? ” These questions are answered by measuring the full costs of the product. 4. Arriving at Prices in Regulated Industries *Many prices are set not by the forces of the marketplace but by regulatory agencies.

The regulatory agency allows a price equal to full cost plus an allowance for profit. 5. Normal Pricing Differentiated Products and Commodities *Differentiated Product – is a product that consumers prefer over competing productsCharacteristics: Consumers are persuaded by advertising Warranty or credit terms, etc. *Undifferentiated Product – commodities that consumers buy without paying attention to

the manufacturer or brand name Ex. agricultural products, generic drugs, minerals, many timber and paper products *Cost measurements are used in arriving at the price of differentiated products but not the price of commodities. Normal Pricing -each product should bear a fair share of the total costs of the business -the selling price of a product should be high enough to: 1)Recover its direct costs (2)Recover a fair share of all applicable indirect costs; and (3)Yield a satisfactory profit Profit Component of a Price -the profit component of a product’s price should be related to the amount of assets employed in making the product Ex.

A retail shoe decides that a satisfactory profit is a 15% return (before income taxes) on its investment. If its total investment in inventory, accounts receivable and other assets is estimated to be $600,000, then its profit must be $600,000 * 15% = $90,000 for the year.If its total operating costs, excluding the cost of the shoes, are estimated to be $210,000, then its selling price must be such that the gross margin above the cost of the shoes amounts to $210,000 + 90,000 = $300,000. If the store expects to sell shoes that cost $900,000 in total, then total sales revenue must be $1,200,000 in order to obtain this $300,000. Time and Material Pricing -one pricing rate is established for direct labor and a separate pricing rate for direct material -this method of pricing is used in repair shops (e.

g. for automobile and television repairs), printing shops and similar types of establishments. -this method of pricing is also used by many professionals and organizations including physicians, lawyers, engineers,

ski instructors, consultants of various types and public accounting firms. -the time component is expressed as a labor rate per hour is calculated as the sum of (1) direct salary and fringe benefit costs of the employee; (2) an equitable share of all indirect costs, except those related to material; and (3) an allowance for profit. (also called billing rate in professional service firms)Non-Profit Organizations -the same pricing practices described in Time and Material Pricing are used with an exception - it does not need to earn a profit as a return on investment because it has no shareholder equity. -nevertheless, most organizations do need a small margin above full costs to provide a safety allowance for unforeseen contingencies and to pay for the cost of holding current assets (which usually is not counted as an element of product cost).

Adjusting Costs to Prices -Target Costing – “how much cost can the company afford to incur if it is to earn a satisfactory profit at the given price” used by Japanese firms for automobiles and consumer electronic products, among others Ex. In the apparel business, it is customary to use retail “price points”: $19. 95, $29. 95, $39. 95 and so on.

The manufacturer designs individual garments to fit one of these price points. In order to ensure that the manufacturer makes a satisfactory profit on a garment, the retail selling price is taken as a given, the retailer’s normal gross margin is deducted to arrive at the manufacturer’s selling price, and then the manufacturer’s normal gross margin is subtracted.The remainder is how much the manufacturer can afford to spend on cloth, labor and other

elements of production cost. Importance of Timely Cost Data -The relevant cost data are typically current costs and estimates of near-term future costs. However, the cost system data may not report current costs especially in inflationary times. -if costs have increased, price increases can at least be considered to avoid bankruptcy (this is not just passing the increases to customers in the form of higher prices but also adjusting for the company’s stability)Strategic Positioning Strategic Cost Management -the use of cost data to help managers understand their company’s advantages and disadvantages relative to their competitors -“should the company choose a strategy based on a position of cost leadership or based on superior product designs or features? ” Additional Aspects of Product Costing Systems Production Processes Unit Production – the focus of the activity is a physically identifiable job Ex.

producing a large turbine generator, building a custom-designed job or performing a consulting job for a clientBatch/Lot Production – a batch of identical items moves in stages from one factory workstation to the next Ex. 100 fuel injectors Assembly-Line Production – the jobs are separately identifiable but tend to be similar or identical) to one another Ex. computers, refrigerators Process Production – outputs are not identifiable as individual units of product until late in the production process Ex. petroleum, chemical, milling, steel, distillery, forest products and glass container industries Averaging product costing systems deal with costing complications by averaging some total cost items to arrive at unit cost amounts *For some direct labor costs, it is not feasible to track the cost to a specific unit of product. Ex. On an automobile assembly line, a worker

may have a minute or less to perform the designated task on a specific vehicle.

Obviously, there is not enough time for the worker to record the vehicle identification number and task starting and ending times necessary to charge that worker’s actual time to that specific vehicle.Basic Types of Systems Job Order Costing – collects costs for each physically identifiable ob or unit of product as it moves through the production process regardless of the accounting period in which the work is done – organizations that operate according unit production and batch production ordinarily use this type of system *The sum of all the costs charged to job cost records during an accounting period is the basis for the entries debiting Work In Process (WIP) Inventory and crediting Materials Inventory, Wages Payable and Overhead accounts.Process Costing – collects costs for all of the products worked on during an accounting period and determines unit costs by averaging the total costs over the total number of units worked on – all production costs for an accounting period are collected in the WIP Inventory account – organizations that operate according unit assembly line and process production operations ordinarily use this type of system Equivalent Production the partially completed units and the completed units that are completed into a common base (the equivalent of one completed unit) partially completed units cannot be accounted for as if they cost as much as completed units because only a fraction of their total cost has so far been incurred *to convert the number of partially completed products into their equivalence in terms of completed units, it is often assumed that units in

process at the end of the period are 50% complete. Thus, in order to calculate the number of equivalent units produced for the period: 1.

each unit completed and transferred out to finished goods is given a weight of one 2. each unit in process at the end of the period is given a weight of one-half; and . these two amounts are added to arrive at the period’s equivalent units of production *finding the equivalent units of production allows one to find the average cost per equivalent unit by adding the cost of beginning WIP Inventory to the production costs of the period and then dividing that sum by the equivalent units of production. (see Illustration 18-3 on MS-Excel) Illustration 18-3 shows how to make this calculation. In a certain factory, production costs incurred in May amounted to $60,000. On May 1, the WIP inventory was valued at a cost of $12,000.

During May, 2,450 completed units were transferred from WIP inventory to finished goods inventory. On May 31, 550 equivalent units (1,100 half-completed units) were in WIP inventory. Thus, during May, 3,000 (2,450+550) equivalent units were produced, as is shown in Part B of the illustration. This means that May’s production activities were equivalent to the amount of work that would be needed to start work on and completely produce 3,000 finished units. Note how the procedures shown in Part C assign the $72,000 sum of beginning WIP inventory and May production costs to Finished Goods Inventory and nding WIP inventory.

First, the average cost per equivalent unit is calculated. Then, this amount to ($24. 20) is used to value the equivalent units transferred

to Finished Goods Inventory ($59,290) and the partially completed units in ending WIP inventory ($13,310). Direct Material Cost direct material cost may be treated differently, depending on when material enters the production process material added evenly throughout the process could reasonably be costed along with the conversion costs by use of the 50% assumption described earlier see Illustration 18-3 on MS-Excel) Refer again to Illustration 18-3.

For purposes of materials calculations, the equivalent units of production for May equal the sum of the 2,450 units that were transferred out of WIP plus the 1,100 units that were on hand May 31 (each with a weight of one for materials), a total of 3,550 equivalent units. The materials cost in beginning WIP inventory would be added to the costs of materials issued in May and this sum would then be divided by the 3,550 units equivalent production to arrive at the average material cost per equivalent unit.This unit cost would be multiplied by 2,450 to get the materials component of the goods transferred out and by 1,100 to get the materials cost of the ending WIP inventory. Finally, these materials calculations are combined with those for conversion costs as in the illustration to arrive a the total amounts for transfers to Finished Goods Inventory and month-end WIP Inventory. Direct Labor Cost 2 Aspects: 1. measuring the quantity of labor time expended; and use of daily time card or comparable record if paid per piece, the number of pieces completed 2.

scertaining the price per unit of labor time direct labor are priced at the amounts actually earned by the employees Assume that the four departments work

on a certain job and that the time worked in each department (as shown by the time cards) and the labor rates are as indicated below. From this information, the total direct labor cost of the job can be determined: Department Direct Labor – Hours on Job Hourly Labor Rate Direct Labor Cost A 20 $ 16. 00 $ 320. 00 B 3 $ 15. 50 46. 50 C 6 $ 17.

80 106. 80 D 40 $ 17. 00 680. 00 Total direct labor cost of job $ 1153. 30 Direct Material Cost Aspects: 1.

measuring the quantity of material used; and determined from requisitions that are used to order material out of the stockroom and into production 2. measuring the price per unit of quantity material may be priced solely at its purchase or invoice cost or some or all of the following material-related costs (purchasing department costs, inspection costs, moving costs, etc. ) *Many production operations such as automated production, assembly lines and refineries and other continuous flow operations, require a basic workforce no matter what output is produced.The cost of this “core” workforce constitutes a cost required for the operation of the facility in general much like heat and light. As manufacturing becomes increasingly automated, more companies classify these core labor costs as overhead. *Some companies have entirely eliminated the direct labor category, combining overhead and labor costs into a single conversion cost category.

Cost Center – is a cost object for which costs of one or more related functions or activities are accumulated. Ex. Marker Pen Company 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. Types: Production Cost Center - either (1) produces a product or a component of a product or a component of a product or (2) performs a distinct step or task of such production. Ex.

The barrel, wick and assembly departments in the pen factory are production cost centers. Each selling department in a store is in essence a production cost center. Service Cost Center provide serves to production cost centers, to other service cost centers or for the benefit of the organization as a whole. Ex. maintenance department and general factory office *Some organizations have an occupancy cost center - all the costs associated with the physical premises , including rent and depreciation, property, taxes, insurance, and utilities cost *Calculating an overhead rate for a cost center is only possible after a series of steps in which total overhead costs are assigned to the production cost centers.Allocation of overhead Costs to Product (Final Cost) – Three Steps: 1.

All overhead costs for an accounting period are assigned to the service and production cost centers, which are intermediate cost objects. 2. The total cost accumulated in each service cost center is reassigned to production cost centers. 3.

The total overhead costs accumulated in each production cost center including the reassigned service center costs are allocated to the products that pass through the production cost center. Cost Drivers (Allocation Bases) – the activity or volume measure used in an overhead rateEx. If a factory space were doubled, the total occupancy costs presumably would approximately double Maintenance costs were

driven by the number of maintenance hours of work performed. Categories: 1. Payroll Related -the employer’s share of Social Security Taxes, health insurance and other fringe benefits may be allocated on the basis of total labor costs 2. Headcount Related -human resource department costs and other costs associated with the number of employees rather than with the amount that they are paid may be allocated on the basis of number of employees. headcount) 3. Material Related -includes costs of purchasing and receiving materials, including counting, weighing or inspecting them -alternately, they may be excluded from the cost center overhead costs and instead assigned to products as part of their material cost. Ex. If the material-related cost rate is 10% of direct material cost, then, a product with $5 direct material cost will have the cost “grossed up” to $5. 50 so as to include the material related costs. 4. Space Related -allocated on the basis of the relative floor area or cubic space of the cost centers also called facility-related or facility-sustaining cost 5. Transaction Related -costs which are caused by the number of times some activity is performed rather than by the value of the goods or services associated with the activity Ex. The cost of preparing a purchase order is unaffected by the dollar amount of the items on the order. 6. Product Related -costs which are caused by the existence of the product itself Ex. The cost of maintaining product-related documents such as drawings, bills of material and production routings and sometimes the entire costs of a edicated manufacturing facility 7. Customer Related -costs which are caused by the demands placed on

the company by specific customers or customer groups Ex. The cost of sales calls, customer service, special trade shows, tailored advertising programs and unique packaging or delivery arrangements 8. Business Related -costs which are necessary for the functioning of the business or factory but they are independent of all the categories of cost drivers Ex. A company needs a Chief Executive Officer (CEO), Human Resources Manager, etc.