Product and Service Costing

Financial Accounting
Product costs are used to value inventory and to compute cost of goods sold.

Managerial Accounting and Cost Management

Product costs are used for planning, control, directing, and management decision making.

Types of Product-Costing Systems

Process Costing Job-Order Costing

Used for production of small, identical, low cost items. Mass produced in automated continuous production process. Costs cannot be directly traced to each unit of product.

Types of Product-Costing Systems

Process Costing Job-Order Costing

Used for production of large, unique, high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.

Examples of Job Costing and Process Costing in the Service, Merchandising, and Manufacturing Sectors
Service Sector Auditing engagements Consulting-firm engagements Job Costing Advertising-agency campaigns Used Law cases Auto-repair shops Merchandising Sector Sending special-order items by mail order Special Promotion of new store products Manufacturing Sector Aircraft assembly House construction

Bank-check clearing Grain dealer Process Postal delivery Lumber dealer Costing (standard items) Used

Oil refining Beverage production

Sequence of Events in a JobOrder Costing System

Receive orders from customers Begin production

Schedule jobs

Order materials

Accumulating Costs in a Job-Order Costing System

Manufacturing overhead (OH) Direct materials

Applied to each job using a predetermined rate

THE JOB
Direct labor

Accumulating Costs in a Job-Order Costing System

Charge direct material and direct labour to each job as incurred.
Direct Materials Job No. 1 Direct Labour Job No. 2

Manufacturing Overhead

Job No. 3

Special documents are used to track costs for each job.

Apply overhead to each job using a predetermined rate.

Cost Smoothing or Peanut Butter Costing (Undercosting, Overcosting & Cost Cross Subsidisation)

Entre Anita Anurag Ajit Anshul Total Average Rs.110 200 150 140 Rs.600 Rs.150

Dessert Rs.0 80 40 40 Rs.160 Rs.40

Drinks Rs.40 140 80 60 Rs.320 Rs.80

Total Rs.150 420 270 240 Rs.1,080 Rs.270

Building-Block Concepts of Costing Systems

Cost Assignment
Direct Costs Indirect Costs Cost Tracing Cost Object

Cost Allocation

Cost Pools and Cost-Allocation Bases

Cause-and-Effect Relationship That Motivates the Choice of Allocation Base

Activity

Example of Costs

Cost-Allocation Base

Design

Design engg. salaries

Parts times cubic feet

Complex products (more parts and larger size) require greater design resources.
Overhead costs of the setup activity increase as setuphours increase.

Setups of machines

Setup labor and equipment cost

Setup-hours

Manufacturing operations

Plant and equipment, energy

Machine-hours

Manufacturing operations overhead costs support machines and, hence, increase with machine usage. Distribution overhead costs increase with cubic feet of product shipped.

Distribution

Shipping labor and equipment

Cubic feet

Costing System at Plastim Corporation 1. Product: Plastim Corporation manufactures lenses for the rear lamps (taillights) of automobiles. The lense, made from black,red,orange or white plastic,is the part of the lamp visible on the automobiles exterior. Plastim makes two type of lenses: a complex lens, CL5 and a simple lens S3. Product Features: The complex lens CL5, is a large lens with a special features such as multi color molding and complex shapes that wrap around the corner of the car. The S3 lens is simpler to make because it is a single color and has few special features Product & Process Design: Plastim design products and processes each year on the basis of specifications given by the Corporate customers. Plastims design department designs the molds from which the lenses will be made and specifies the processes needed (details of the manufacturing operations). Manufacturing operations: The lenses are molded, finished, cleaned and inspected. Lenses are made by injecting molten plastic into a mold to give the lamp its desired shape. The mold is cooled to allow the molten plastic to solidified, and the lens is removed. Shipping & Distribution: Finished lenses are packed and sent to customers. Plastim is operating at capacity and incurs very low marketing and customer costs, because of its high quality products.

2.

3.

4.

5. 6.

Problem faced by Plastim Corporation Plastims business environment is very competitive with respect to simple lenses. At a recent meeting Huyandis (existing customer of Plastim) purchasing manager indicated that a new competitor, who makes only simple lenses, was offering to supply the S3 lens to Hyundi at a price of Rs. 530 per lens, well below Plastims Rs. 630 per lens. Fortunately, the same competitive pressures do not exists for the complex lens, which Plastim currently sells to Hyundai at Rs. 1370 per lens. Options available: Plastim can give up the Hyundi business in Simple lenses. Plastim reduce the price of simple lens. Plastim aggressively seek to reduce costs. Existing Single Indirect Cost Pool System The cost objects are 60,000 S3 lenses & 15,000 CL5 lenses. Direct material cost & Direct manufacturing labor cost of 60,000 S3 lenses are Rs. 1,12,50,000 and Rs. 60,00,000 respectively while Direct material & Direct manufacturing labor cost of 15,000 CL5 are Rs. 67,50,000 & 19,50,000 respectively.

Plastim groups all indirect costs, totaling Rs. 2,38,50,000 into a single overhead cost pool and decides to use direct manufacturing labor hours as the only allocation base to allocate all indirect costs to S3 & CL5
Plastim uses 30,000 total direct manufacturing labor hours to make the S3 lenses and 9,750 direct manufacturing labor hours to make CL5 lenses.

Products Costs at Plastim, Using Existing Single Overhead Cost Pool

Overview of Plastims Existing Single Overhead Cost Pool INDIRECT-COST POOL All Indirect Costs Rs.2,38,50,000

INDIRECT COSTALLOCATION BASE

39,750 Direct Manufacturing Labor-Hours Rs. 600 direct manufacturing labor-hour

COST-OBJECT:S3 AND CL5 LENSES

Indirect-Costs Direct-Costs

DIRECT COSTS

Direct Materials

Direct Manufacturing Labor

Products Costs at Plastim, Using Existing Single Overhead Cost Pool

60,000 Simple Lenses (S3) Total (1) Direct materials Direct manufacturing labor Total direct costs Indirect costs allocated Total costs Rs.1,12,50,000 60,00,000 Rs.1,72,50,000 1,80,00,000 Rs.3,52,50,000 (2) = (1) 60,000 Rs.187.50 100.00 Rs.287.50 300.00 Rs.587.50 per Unit Total (3)

15,000 Complex Lenses (CL5) (4) = (3) 15,000 Rs.450 130 Rs.580 390 Rs.970 per Unit Total (5) = (1) + (3) Rs.1,80,00,000 79,50,000 Rs.2,59,50,000 2,38,50,000 Rs.4,98,00,000

Rs.67,50,000 19,50,000 Rs.87,00,000 58,50,000 Rs.1,45,50,000

Products Costs at Plastim,Using Existing Single Overhead Cost Pool

60,000 Simple Lenses (S3) Total (1) Revenues Costs Operating income Operating income + Revenues 6.75% Rs.3,78,00,000 3,52,50,000 Rs.25,50,000 per Unit (2) = (1) / 60,000 Rs.630.00 587.50 Rs.42.50 Total (3)

15,000 Complex Lenses (CL5) per Unit (4) = (3) / 15,000 Rs.1,370.00 970.00 Rs.400.00 29.20% Total (5) = (1) + (3) Rs.5,83,50,000 4,98,00,000 Rs.85,50,000

Rs.2,05,50,000 1,45,50,000 Rs.60,00,000

Setup data for the simple S3 lens and the complex CL5 lens
Simple S3 Lens Complex CL5 Lens

Total

1
2 3 = (1) (2) 4

Quantity of lenses produced

Number of lenses produced per batch Number of batches Setup time per batch

60,000
240 250 2 hours

15,000
50 300 5 hours

5 = (3) x (4)

Total setup-hours

500 hours
Simple S3 Lens Rs.22,64,150

1,500 hours
Complex CL5 Lens Rs.7,35,850

2,000 hours

Cost allocated using direct manufacturing labor-hours: Rs. 75.4717 x 30,000; Rs.75.4717 x 9,750 Cost allocated using setup-hours: Rs.1,500 x 500; Rs.1,500 x 1,500

Total Rs.30,00,000

Rs.7,50,000 Rs.22,50,000

Rs.30,00,000

Refining a Costing System Three guidelines for refining a system Direct cost tracing : Classify as many of the total costs as direct costs of the cost object. Indirect cost pools : Expand the number of indirect cost pools until each of these pools is more homogeneous. Cost allocation base : To identify the cost allocation base for each indirect cost pool.

Cost Hierarchies A cost hierarchy categorizes costs into different cost pools on the basis of different types of cost drivers or cost allocation bases or different degrees of difficulty in determining cause and effect relationship. ABC systems commonly use a cost hierarchy having four levels : Output unit level costs : Manufacturing operations costs Batch level costs : Setup costs, Procurement costs Product sustaining costs : Design costs, Engineering costs Facility Sustaining costs : General administration costs

Identify the Direct Costs of the Products

60,000 Simple Lenses (S3) Cost Hierarchy Description Direct materials Direct manuf. labor Cleaning & maintenance Total direct costs Category Output unit-level Output unit-level Batch-level Total (1) Rs.1,12,50,000 60,00,000 12,00,000 Rs.1,84,50,000 per Unit (2) = (1) 60,000 15,000 Complex Lenses (CL5) per Unit (4) = Total (3) Rs.67,50,000 19,50,000 15,00,000 Rs.1,02,00,000 (3) 15,000 Total (5) = (1) + (3) Rs.1,80,00,000 79,50,000 27,00,000 Rs.2,86,50,000

Rs.187.50
100.00 20.00 Rs.307.50

Rs.450.00
130.00 100.00 Rs.680.00

Activity-Cost Rates for Indirect-Cost Pools

(Step 3) Cost Hierarchy Activity (1) Design Category (2) Productsustaining Setups of molding machines M anufacturing operations Batchlevel Output unit-level Rs.63,75,000 Rs.30,00,000 Total Costs (3) Rs.45,00,000 (Step 4) Quantity of CostAllocation Base (4) 100 partssquare feet 2,000 setuphours 12,750 molding machinehours Overhead Allocation Rate (5) = (3) (4) Rs.45,000 per part-suare foot Rs.1,500 per setup-hour Rs.500 per molding machine-hour Brief Explanation of the Cause-andEffect Relationship That Motivates the Choice of the Allocation Base (6) Complex molds (more parts and larger surface area) require greater Design Department resources Overhead costs of the setup activity increase as setup hours increase Plastim has mostly automated molding machines. M anufacturing overhead costs support automated molding machines and hence, increase with molding machine usage Shipment setup Batchlevel Distribution Output unit-level Administration Facilitysustaining Rs.25,50,000 Rs.39,15,000 Rs.8,10,000 200 shipments 67,500 cubic feet 39,750 direct Rs.4,050 per shipment Rs.58 per cubic foot shipped Rs.64.151 per direct manuf. Costs incurred to prepare batches for shipment increase with the number of shipments Overhead costs of the distribution activity increase with cubic feet of packages shipped Administration Department resources support direct manufacturing labor(Step 5)

Product Costs at Plastim Corporation, Using Activity-Based Costing

PANEL A: OVERVIEW OF PLASTIMS ACTIVITY-BASED COSTING SYSTEM

INDIRECT-COST POOL
Design Activity Rs. 45,00,000 Setup Activity Rs.30,00,000 Manufacturing Operations Activity Rs.63,75,000 Shipping Setup Activity Rs.8,10,000 Distribution Activity Rs.39,15,000 Administration Activity Rs.25,50,000

INDIRECT COSTALLOCATION BASE

100 PartsSquare feet

2.000 SetupHours

12,750 Molding MachineHours

200 Shipments

67,500 Cubic Feet Shipped

39,750 Direct Manufacturing Labor-Hours

Rs.45,000 per partsquare foot

Rs.1,500 setuphour

Rs.500 molding machine-hour

Rs.4,050 shipment

Rs.58.0 cubic foot shipped

Rs.64.151 direct manufacturing labor-hour

COST-OBJECT: S3 AND CL5 LENSES

Indirect Costs

Direct Costs

DIRECT COSTS

Direct Materials

Direct Manufacturing Labor

Mold Cleaning and Maintenance

Product Costs at Plastim, Corporation, Using Activity-Based Costing PANEL B: PRODUCT COSTS USING THE ACTIVITY-BASED COST SYSTEM
60,000 Simple Lenses (S3) per Unit Description of Cost and the Quantity of Activity Used by Each Type of Lens Direct costs Direct materials Direct manufacturing labor Direct mold cleaning and maintenance costs Total direct costs Indirect Costs Design activity costs S3, 30 parts-sq.ft. x Rs.45,000 CL5, 70 parts-sq.ft. x Rs.45,000 Setup activity costs S3, 500 setup-hours x Rs.1,500 CL5, 1,500 setup-hours x Rs.1,500 M anufacturing operations activity costs S3, 9,000 molding machine-hours x Rs.500 CL5, 70 molding machine-hours x Rs.500 Shipping setup activity S3, 100 shipments x Rs.4,050 CL5, 100 shipments x Rs.4,050 Distribution activity S3, 45,000 cubic feet shipped x Rs.58.0 CL5, 22,500 cubic feet shipped x Rs.58.0 Administration activity S3, 30,000 dir.manuf.labor-hours x Rs.64.151 CL5, 9,750 dir.manuf.labor-hours x Rs.64.151 Total indirect costs Total costs 4,05,000 6.7 4,05,000 26,10,000 43.5 13,05,000 19,24,530 Rs.1,15,39,530 Rs.2,99,89,530 32.1 6,25,470 192.3 Rs.499.8 96,10,470 Rs.1,98,10,470 41.7 640.7 Rs.1,320.7 25,50,000 2,11,50,000 Rs.4,98,00,000 87.0 39,15,000 27.0 8,10,000 7,50,000 12.5 22,50,000 45,00,000 75.0 18.75,000 125.0 63,75,000 150.0 30,00,000 13,50,000 22.5 31,50,000 210.0 45,00,000 Total (1) Rs.1,12,50,000 60,00,000 12,00,000 Rs.1,84,50,000 (2) = (1) 60,000 Rs.187.50 100.00 20.00 Rs.307.50 15,000 Complex Lenses (CL5) per Unit

Total (3) Rs.67,50,000 19,50,000 15,00,000 Rs.1,02,00,000

(4) = (3) 15,000

Total (5) = (1) + (3) Rs.1,80,00,000 79,50,000 27,00,000 Rs.2,86,50,000

Rs.450 130 100 Rs.680

Comparing Alternative Costing Systems

Existing Single Indirect-Cost Pool System ABC System Difference

(1) Direct-cost categories 2 Direct materials Direct manufacturing labor

(2) 3 Direct materials Direct manufacturing labor Direct cleaning and maintenance labor

(3) =(2) - (1) +1

Total direct costs Indirect-cost pools

Rs.2,59,50,000 1 Single indirect-cost pool allocated using direct manufacturing labor-hours

Rs.2,86,50,000 6 Design cost pool allocated using parts-square feet Molding machine setup cost pool allocated using setup-hours Manufacturing operations cost pool allocated using machine-hours Shipment setup cost pool allocated using number of shipments Distribution cost pool allocated using cubic feet of packages shipped

Rs.27,00,000 5

Overview Diagram of Allocation of Corporate Overhead and Division Overhead Costs to Products, Whirlpool
CORPORATE COST

Corporate Treasury Costs

Corporate Human Resource Management (CHRM) Costs

Corporate Administration (CA) Costs

CORPORATE COSTALLOCATION BASE CORPORATE COSTS ALLOCATED TO DIVISIONS DIVISION INDIRECT COSTS

Cost of New Assembly Equipment

Salary and Labor Costs

Division Administration Costs

Refrigerator Division

Clothes Dryer Division

Allocated Corporate Treasury Costs MachineHours on New Equipment

Design (including CHRM costs)

Machine Setup (including CHRM costs)

Manufacturing Operations (including CHRM costs)

Distribution Administration (including (including CHRM CHRM costs) and CA costs)

Facility Costs

DIVISION COSTALLOCATION BASE

Parts Cubic feet

SetupHours

MachineHours

Cubic Feet

Revenues

COST OBJECT: REFRIGERATOR AND CLOTHES RYER PRODUCTS DIRECT COSTS

Indirect Costs Direct Costs Direct Materials Direct Manufacturing Labor