Abyssinia college 2012

MODULE TITLE: Producing Job Costing Information

LEARNING OUTCOMES:
At the end of this module the trainer will be able to
LO1: Gather and record operating and cost data.
LO2: Produce cost reports
Cost - What is cost?

In business and accounting, cost is the monetary value that a company has spent in order to produce
something. Or
Cost is a sacrifice of resources to obtain a benefit or any other resource. For example in production of
a car, we sacrifice material, electricity, the value of machine's life (depreciation), and labor wages etc.
Thus these are our costs.
Classifications of cost
Product Costs vs. Period Costs

Product costs are costs assigned to the manufacture of products and recognized for financial reporting
when sold. They include direct materials, direct labor, factory wages, factory depreciation, etc.

Total product cost = Direct materials + direct labor + Manufacturing overhead

Unit product cost = Total product cost / number of units

Period costs are on the other hand are all costs other than product costs. They include marketing costs
and administrative costs, etc.

Breakup of Product Costs

The product costs are further classified into:

Direct materials: Represents the cost of the materials that can be identified directly with the product
at reasonable cost. For example, cost of paper in newspaper printing, cost of
Direct labor: Represents the cost of the labor time spent on that product, for example cost of the time
spent by a petroleum engineer on an oil rig, etc.

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Manufacturing overhead: Represents all production costs except those for direct labor and direct
materials, for example the cost of an accountant's time in an organization, depreciation on equipment,
electricity, fuel, etc.
The product costs that can be specifically identified with each unit of a product are called direct
product costs. Whereas those which cannot be traced to a specific unit are indirect product costs. Thus
direct material cost and direct labor cost are direct product costs whereas manufacturing overhead cost
is indirect product cost.

Prime Costs vs. Conversion Costs

Prime costs are the sum of all direct costs such as direct materials, direct labor and any other direct
costs.
Prime costs = direct materials cost + direct labor cost
Conversion costs are all costs incurred to convert the raw materials to finished products and they equal
the sum of direct labor, other direct costs (other than materials) and manufacturing overheads.

Conversion Costs = Direct Labor + Manufacturing Overheads

Since total manufacturing costs have three components: direct material, direct labor and manufacturing
overheads, conversion costs may also be calculated using the following formula:

Conversion Costs = Total Manufacturing Costs – Direct Material

Cost Classification Diagram

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Example

XYZ Furniture is a small furniture manufacturer. In the month of December 2010, they worked
exclusively on an order to build 5 conference tables. Costs incurred are as follows:

Opening stock of timber-------------- ---------------------- $50

Timber purchased during the week --------------------2,000
Closing stock of timber---------------- ------ ----------------250
Glass purchased for table tops-------- ----------------------500
Labor hours worked -------------------------- 100
Wages per hour ------------------------------------------- 40
Manager’s salary allocated to the job----------- - --- 2,500
Indirect materials and utilities cost allocated to the job----3,000

Required
1. Calculate total direct material consumed
2. Calculate direct manufacturing labor cost
3. Calculate manufacturing overheads
4. Calculate prime cost
5. Calculate conversion cost

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6. Total production cost
7. Make the necessary journal
8. Determine unit cost of product

Solution

Timber consumed = opening stock + purchases − closing stock = $50 + $2,000 − $250 = $1,800

Other direct materials used (glass) = $500

1. Total direct materials cost = $1,800 + $500 = $2,300

2. Direct manufacturing labor cost = hours worked * hourly wage = 100 * $40 = $4,000

3. Manufacturing overheads = manager’s salary + indirect materials and utilities = $2,500 + $3,000 =
$5,500

4. Prime costs = direct materials cost + direct labor cost = $2,300 + $4,000 = $6,300

5. Conversion costs = direct labor cost + manufacturing overheads = $4,000 + $5,500 = $9,500

6. DM+DL+MOH =2300+4000+5500

=11800

7.
I. Purchase timber 2000
Cash 2000
Purchase raw material of timber
II. Purchase glass 500
Cash 500
Purchase raw material of glass

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III. Work in process inventory 2300
Raw material inventory 2300
Recording raw material used
IV. Work in process inventory 4000
Factory payroll 4000
Recording direct labor cost
V. Manufacturing overhead 5500
Factory payroll 5500
Recording indirect labor cost

VI. Finished good inventory 11800

Work in process 11800
To record cost of goods manufactures

8. Product cost per unit = tpc/nu 11800/5

=2360
If unit selling price to be Br.2500
 What will be gross profit?
Fixed Costs vs. Variable Costs

Fixed costs are costs which remain constant within a certain level of output or sales. This certain limit
where fixed costs remain constant regardless of the level of activity is called relevant range. For
example, depreciation on fixed assets, etc.

Variable costs are costs which change with a change in the level of activity. Examples include direct
materials, direct labor, etc.

Sunk Costs vs. Opportunity Costs

The costs discussed so far are historical costs which means they have been incurred in past and cannot
be avoided by our current decisions. Relevant in this regard is another cost classification, called sunk
costs. Sunk costs are those costs that have been irreversibly incurred or committed; they may also be
termed unrecoverable costs.

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In contrast to sunk costs are opportunity costs which are costs of a potential benefit foregone. For
example the opportunity cost of going on a picnic is the money that you would have earned in that
time.

LO2: Produce cost reports

The Statement of Cost of Goods Manufactured

(PRODUCTION COST STATEMENT)

 Product cost refers to the costs used to create a product. These costs include
direct labor, direct materials, consumable production supplies, and factory
overhead.
 Product cost can also be considered the cost of the labor required to deliver a
service to a customer.

 The statement of cost of goods manufactured supports the cost of goods sold figure on the
income statement.

 The two most important numbers on this statement are the total manufacturing cost and the
cost of goods manufactured. Be careful not to confuse the terms total manufacturing cost and
cost of goods manufactured with each other or with the cost of goods sold.

 Total Manufacturing Cost includes the costs of all resources put into production during the
period (meaning, the direct materials, direct labor and overhead applied).

 Cost of goods manufactured consists of the cost of all goods completed during the period. It
includes total manufacturing costs plus the beginning work in process inventory minus
the ending work in process inventory.

 Cost of goods sold are the costs of all goods SOLD during the period and includes the cost of
goods manufactured plus the beginning finished goods inventory minus the ending finished

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goods inventory. Cost of goods sold is reported as an expense on the income statements and is
the only time product costs are expensed. This chart will summarize the formulas you will
need:

Direct Materials Used = Beginning Raw Materials Inventory + Raw Material Purchases –
Ending Raw Materials Inventory – Indirect Materials Used
Total Manufacturing Cost = Direct Materials + Direct Labor + Overhead applied
Cost of Goods Manufactured Total Manufacturing Cost = (Direct Materials + Direct Labor +
Overhead applied) + Beginning Work In Process Inventory – Ending Work in Process Inventory
Cost of Goods Sold = Beginning Finished Goods Inventory + Cost of Goods Manufactured –
Ending Finished Goods Inventory

The Production Cost Statement is a summary of the ledger

accounts and it shows the total cost of production.

Note be: Make sure you know and understand the format of
2.Production Cost Statement

Production cost statement format

Account amount
Direct material cost xxx
Direct labour cost xxx
Add
= Prime cost xxx
Factory overhead xxx
Add
= Total production cost xxx
Work in process beginning Xxx
Add
xxx

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Less Work in process ending (xxx)

Cost of production of Xxx
finished goods

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Example

You are provided with information relating to Sleepy Comfy Manufacturers for the financial year
ended 28 February 2015.
INFORMATION:
A. The following balances appeared in the ledger at the beginning and end of the financial
year.

28 February 1 March 2014

2015
Raw materials stock 132 600 114 000
Work-in-process stock 229 920 85 800
Finished goods stock 115 440 936 000
Factory Indirect materials stock 21 600 24 600

B. Transactions during the year

B.1 Raw materials purchased on credit, R625 200

B.2 Cost of transporting raw materials to the factory, R35 400

B.3 Wages paid to factory workers involved in making the mattresses, R360 960

B.4 Bought factory indirect materials for cash, R93 000

B.5 Salary paid to the factory manager, R126 000

B.6 Depreciation on factory equipment amounted to R72 600

B.7 Maintenance of factory equipment paid, R44 400. A further R13 200 still owes.

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B.8 Commission paid to salesmen, R108 000

B.9 Water and electricity paid, R25 200. This must be split between the factory and
the office in the ratio 4:1.

B.10 Rent paid amounted to R129 600. This must be allocated to the departments
according to the floor area. The factory accounts for 400 square metres of the
total area of 600 square metres.

REQUIRED:

1. Calculate the Direct materials costs

2. Prepare the Note for Factory Overhead Cost

3. Prepare the Production Cost Statement for the year ended 28 February 2015.

ANSWER
1. Calculate the Direct materials costs

114 000 + 625 200 + 35 400 – 132 600

= R642 000

2. SLEEPY COMFY MANUFACTURERS

FACTORY OVERHEAD COST NOTE

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Indirect materials (24 600 + 93 000 – 21 600) 96 000

Salary (manager) 126 000
Depreciation 72 600
Maintenance (44 400 + 13 200) 57 600
Water and electricity (25 200 x 4/5) 20 160
Rent paid (129 600 x 2/3) 86 400

458 760

3. PRODUCTION COST STATEMENT FOR THE YEAR ENDED 28

FEBRUARY 2015

Direct material cost 642 000

Direct labour cost 360 960

Prime cost 1 002 960

Factory overhead costs 458 760

Total production costs 1 461 720

Work-in-process at beginning of year 85 800

1 547 520

Work-in-process at end of year (229 920)

Cost of production of finished goods 1 317 600

Cost of Goods Sold

Next, we subtract cost of goods sold. Cost of goods sold is the cost of all the products (goods) that
were sold during the period. If the company uses a perpetual inventory system, cost of goods sold is
being calculated every time a sale takes place. In this case, no calculation is needed. We can simply

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take the amount from the cost of goods sold account on the trial balance. And you thought you could
forget everything from financial accounting!

If the company uses a periodic inventory system, we must do some calculations to figure out cost o f
goods sold. Under a periodic inventory system, all goods purchased as placed in the Purchases
account, not the inventory account. When sales are recorded, there is no adjustment to inventory and
cost of goods sold like there is in a perpetual system. Therefore, at the end of the year, we must look at
how much was purchased and physically count how much inventory is left in order to manually
calculate cost of goods sold.

Under a periodic system, we add beginning inventory to the cost of purchases. This gives us goods
available for sale. Goods available for sale are the maximum value of goods that could be sold. If we
sold every unit we had on hand and had no inventory left at the end of the year, goods available for
sale would equal cost of goods sold. If there is inventory remaining, we must subtract the ending
inventory from goods available for sale to calculate cost of goods sold.

To calculate cost of goods sold under a period inventory system:

Beginning Inventory
Plus: Purchases
= Goods Available for Sale
Less: Ending Inventory
= Cost of Goods Sold

Let’s look at an example to help illustrate the point.

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Example #1

Kin gram Pencil Pushers sells pencils to office supply stores and other retailers around the world. On
January 1, the company’s inventory was $41,000. During the year, the company purchased $895,000
worth of pencils. A physical count of the inventory on December 31 revealed that there were $23,000
worth of pencils remaining. Calculate cost of goods sold for the year.

Whenever you are working on a word problem, the first thing you want to do is remove the numbers
from the problem and label them. We are told that January 1 inventory is $41,000. How would you
label this number? If you said beginning inventory you are correct. January 1 is the beginning of the
year, hence our beginning inventory.

$41,000 beginning inventory

How would you label $895,000? Well we are told this is what the company purchased, therefore this is
the amount of our purchases.

$41,000 beginning inventory

$895,000 purchases

Can you guess what the last number is? Ending inventory! If January 1 is the beginning of the year
then December 31 is the end of the year.

$41,000 beginning inventory

$895,000 purchases
$23,000 ending inventory

What is the problem asking us to do with these numbers? Calculate cost of goods sold.

$41,000 beginning inventory

$895,000 purchases
$23,000 ending inventory
?????? Cost of goods sold

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Putting together the income statement

It’s been a long, strange journey to get here but we are finally ready to do our income statement. Once
you have cost of goods sold, the rest of the statement is fairly easy. Here is the format:

Sales
Less: Cost of Goods Sold
=Gross Profit
Less: Selling and Administrative Expenses
=Operating Income

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