Fundamentals of

Product Costing
IND2143 COST ANALYSIS
Reasons to calculate product or service cost
•The purpose of calculating product (tangible or intangible) cost:
- To compute inventory values and cost of goods sold for the financial statements.
- To provide individual cost to the various managers in making decisions regarding pricing,
production, promotion, and so on.
•In calculating product cost, joint cost such as overhead cost should be allocate to cost objects on
somewhat arbitrary basis.
 Cost flow diagram of product costing
Direct Manufacturing
Direct Labor Cost pools
Materials Overhead

indirect
direct Cost allocation rule
(allocated
using certain
base)

Alfa Beta Cost objects

Costing in a single product, continuous
process industry
 Beginning balance
(direct materials, direct labor,
Basic Cost Flow Model manufacturing overhead)

The fundamental framework for Transfer In

recording costs in any type of firm is
the cost flow model, which is the
basic inventory equation. It is so
important and helpful in assigning Transfer Out
costs to products.

Ending balance
(direct materials, direct labor,
manufacturing overhead)
Basic cost flow model
Example:

A B C
Beginning balance $51,000 $28,400 $67,000
Ending balance $48,000 $24,800 $56,000
Transferred in ? $88,000 ?
Transferred out $57,000 ? $170,000
Costing with no work-in-process inventories
•Wawawa Paints, Inc is a company makes only one product: white paint.
•Paint manufacturing needs three inputs: direct materials, direct labors, and manufacturing
overhead.
•For this discussion, we assume that all three resourcess are added continously and at the same
rate in the production process.
•Our goal is to find the cost of a gallon of white paint.
Costing with no work-in-process inventories
• Wawawa Paints begin production on April 1, 2018. It starts and completes production of
100,000 gallons of paint in April and has no ending work-in-process inventory.
•Wawawa’s costs of resources used in April consist of the following:
Materials = $400,000
Labor = $100,000
Manufacturing overhead = $500,000
Total cost = $1,000,000
•For April, Wawawa incurred costs of $1,000,000 to produce 100,000 gallons of paint.
•Unit cost =
Costing with ending work-in-process inventories
•Production for Wawawa for May 2018 is as follow:

Gallons
Beginning inventory 0
Started in May
Total 110,000
Ending WIP inventory (50% 20,000
complete)
Transfered out 90,000
Costing with ending work-in-process inventories
•Cost incurred in May 2018 were:
Gallons
Materials $390,000
Labor $100,000
Manufacturing overhead $500,000
Total $990,000
•How much did Wawawa Paints produce in May?
•How much did Wawawa Paints produce in May?
•It transferred 90,000 gallons to finished goods, but some paint still remains in WIP. Therefore,
Wawawa did more than 90,000 gallons worth of work in May. On the other hand, a gallon of
paint in the ending WIP inventory is not the same as a completed gallon of paint because it
requires additional resources to complete. If it did not, it would have been transferred out.
•In the summary of the physical flow, Wawawa’s accountant estimates that on average the paint
still in process is 50% complete. Therefore, we say the paint in process is “equivalent” to 10,000
gallons of finished paint (= 50% * 20,000 gallons).
•Therefore, the amount of work done at Wawawa in May is equivalent to 100,000 gallons of
completed paint.
•Now we can compute the cost of paint for May.
•Wawawa incurred $990,000 of cost and produced 100,000 equivalent gallons, so the paint cost
$9.90 per gallon (= $990,000 / 100,000 gallons).
•Because 90,000 gallons were transferred out, so the cost this: $9.90 * 90,000 = $891,000,
meanwhile the cost of 10,000 gallons = $9.90 * 10,000 = $99,000.
Example:
AHA Inc., produces industrial solvents. On November 1, there is no work-in-process inventory. It
starts production of 13,000 barrels of solvent in November, and 8,000 barrels are completed. The
costs of the resources used by AHA in November consist of the following:

Gallons
Materials $223,000
Conversion costs $272,000
Total $495,000

The production manager estimates that the ending work-in-process is 60% complete. Compute
the cost of solvent transferred to finished goods & the cost of work-in-process ending inventory
on November, 30. Draw the cost flow diagram for AHA Inc., for November.
Costing in a multiple product, discrete
process industry
Using a single allocation base
•Row Company will make two type of boats: C-20 (20-foot sailboat) and C-27 (27-foot sailboat).
•The cost flow diagram:
Using a single allocation base
•Remember, direct materials and direct labors are easily traced.
•However, manufacturing overhead costs cannot be identified directly with individual units of
product. That is why we need to identify one or more allocation bases to use to allocate the
manufacturing overhead to the two boat models.
•Here, in the example, Row keeps track of direct labor-hours for each of its products because the
boat builders complete time cards that show which product they were working on as well as the
starting and ending times.
Using a single allocation base
C27 C20 Total
Units produced 10 30 40
Direct labor-hours 2,000 3,000 5,000
Costs
Direct materials $40,000 $36,000 $76,000
Direct labors $72,000 $78,000 $150,000
Manufacturing $180,000
overhead
$406,000

These are budgeted costs in January 2018, not the actual one, we use them to estimate the costs for the
two models.
Using a single allocation base
•Firstly, calculate predetermined/budgeted manufacturing overhead rate. The predetermined
overhead rate (POHR) is used to allocate manufacturing overhead to product job.

• POHR =
Using a single allocation base
C27 C20 Total
Units produced 10 30 40
Direct labor-hours 2,000 3,000 5,000
Costs
Direct materials $40,000 $36,000 $76,000
Direct labors $72,000 $78,000 $150,000
Manufacturing $72,000 $108,000 $180,000
overhead ($36*2,000) ($36*3,000)
Total costs $184,000 $222,000 $406,000
Unit costs $18,400 $7,400
($18,400 : 10) ($222,000 : 30)
Using a single allocation base
•The cost system estimates a cost of $18,400 to each C-27 and $7,400 to each C-20.
•The estimation useful for decisions about pricing and whether to continue making a particular
product.
Using multiple allocation bases
•Firstly, the cost accounting system at Row Company uses direct labor to allocate all
manufacturing overhead, but a closer inspection suggests that some of the overhead seems to
be related more to machine utilization than direct labor.
•Here we can use two or more allocation bases to allocate manufacturing overhead to the
products.
Using multiple allocation bases
Using multiple allocation bases
•From the diagram, there are two cost pools “labor-related overhead” and “machine-related
overhead”. Also, two allocation bases: direct labor cost and machine-hours.
•Given:
Manufacturing overhead Amount Related to
Utilities $2,400 Machine-related overhead
Supplies $2,500 Labor-related overhead
Training $30,000 Labor-related overhead
Supervision $54,900 Labor-related overhead
Machine depreciation $29,550 Machine-related overhead
Plant depreciation $40,050 Machine-related overhead
Miscellaneous $20,600 Labor-related overhead
Total $180,000
Using multiple allocation bases
•Given:
C-27 C-20 Total
Units produced 10 30 40
Machine-hours 1,000 3,000 4,000
Direct labor-hours 2,000 3,000 5,000
Direct materials $40,000 $36,000 $76,000
Direct labors $72,000 $78,000 $150,000
Manufacturing $180,000
overhead

• How much total costs and unit costs?

Example:
•Anis Apparel produces socks and T-shirts. Most of the production is done by machine.
•Data on operations and costs for October follow:
Socks T-shirts Total
Units produced 10,000 5,000 15,000
Machine-hours 1,000 800 1,800
Direct labor-hours 200 120 320
Direct materials costs $12,000 $8,000 $20,000
Direct labors costs $4,000 $2,400 $6,400
Manufacturing $22,200
overhead costs
Example:
•Management asks the accountant about the product costs. Firstly, he assigns manufacturing
overhead costs to two pools: overhead related to direct materials cost and overhead related to
machine-hours. The analysis of overhead accounts by the cost accountant follows:
Account Amount Related to
Utilities $4,000 Machine-hours
Supplies $2,800 Materials
Machine depreciation & $8,800 Machine-hours
maintenance
Purchasing & storing $3,200 Materials
materials
Miscellaneous $3,400 Machine-hours
Example:
•Calculate the predetermined/budgeted overhead rates assuming that Anis Products uses
machine-hours to allocate machine-related overhead costs and materials costs to allocate
materials-related overhead costs.
•Calculate the total costs of production and the cost per unit for each of two products for
October.