Prof. Cristiano Busco - Dott. Fabrizio Granà
Responsibility CostingCost Allocation
Direct vs. Indirect Costs
Planning & Control
Responsibility Based Cost Measurement Systems
Importance of costing (full costing)
Costing terminology
Categories of costs
•Direct and indirect (focus on)
Allocation of costs
2
Why do managers want to know the full cost?
Pricing decisions
Outsourcing (make or buy decision)
Planning/Budgeting for the future
Control and benchmarking
Performance evaluation
Responsibility Based Cost Measurement Systems
Costs(resource
consumption)
Responsibility Centers Products
Responsibility Based Cost Measurement Systems
Records, tracks and reports information on resources consumed by cost objects in the organization.
Allows organizations to test the success of initiatives (including products and services) in achieving goals.
Helps managers make informed decisions about products, processes, units, employees.
Why do companies need a cost measurement system?
Responsibility cost measurement systems use
responsibility centers as the focal point of cost
collection.
A responsibility center is any subunit in the
organization that has a manager who is
responsible for performance and has a
budget.
Overview of Responsibility Cost Measurement Systems
Record costs as incurred into normal descriptive
categories (direct materials, supplies, direct labor,
indirect labor, rent, utilities, etc.)
Assign those costs to responsibility centers
When responsibility center works on cost object,
attach the costs in the responsibility center to the cost
object as it passes through.
Responsibility Cost Measurement Systems
•Materials
•Wages and
salaries
•Utility costs
•Sales
commissions
•Equipment
purchase
•Advertising
•Supplies
Functional
Costs
•General &
Administrative
•Sales/marketing
•Financing
Responsibility
Centers
•Stamping
•Assembly
•Testing
Inventory
Cost
Cost of
Goods
Sold
Products
•HK 195
•HK 290
•Others
Cost
Elements
Period
Expenses
Production
manufacturing
Non -
manufacturing
Responsibility Cost Measurement Systems
Definition of cost
Cost – the monetary value of the resources sacrificed to
achieve a specific objective (FULL COST)
Cost Object – anything for which a separate
measurement of costs is desired (e.g., product, service,
project, activity, department, etc).
Cost center – an organizational unit (responsibility
center) in which a manager is accountable only for costs
Product – a bicycle
Service – an airline flight from Manchester to Rome
Project – an airplane assembled by Airbus for BA
Activity – a test to determine the quality of a car
Department – the resources consumed by the marketing dpt.
Different Costs Classification for different purposes
Cost behavior in relation to Output
*Fixed and *Variable Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Financial statement perspective
*Product (capitalized) and *Period Costs
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal)
(COSTING SYSTEMS – 1ST PART
JOB COSTING AND PROCESS COSTING
(COSTING SYSTEMS – 2ND PART
ACTIVITY-BASED COSTING
Direct and indirect costs
Direct Cost of a Cost Object
Cost that is related to the particular
cost object and that can be traced to
it in an economically feasible way.
Indirect Cost (Overhead) of a Cost Object
Cost that cannot be traced to the cost
object in an economically feasible way
and need to be allocated to it.
1. Direct (raw) materials - cost of materials that can be
economically traced to a unit of output
2. Direct labor - labor cost that can be economically
traced to the creation of particular unit of output
• Other direct costs - cost that can be economically traced
to the creation of particular unit of output
3. Manufacturing overhead - all other manufacturing
costs except direct material and direct labor
1
2
Cost Classifications
Indirect or
Manufacturing Overhead Costs
Overhead costs include all costs incurred to manufacture a
product/service that cannot be uniquely or economically
traced to that product/service.
Components of Overhead Costs:
Indirect materials (packing supplies, forms, cleaning
products, lubricants . . .)
Indirect labor (salaries of plant managers, supervisors,
inspectors, engineers)
Other (plant utilities, training programs, equipment
depreciation, property taxes. .)
Some definitions
Prime cost is the cost of direct materials, direct
labour and other direct costs of production
Manufacturing (production) overhead is the total
of indirect materials, indirect labour and other indirect
costs of production
Total product cost (full cost) =
Prime cost plus production overhead cost
Conversion costs = direct labor + manufacturing
overhead used to "convert" materials into product
Statement of cost of a production item
£ £
Direct materials xxx
Direct labour xxx
Other direct costs xxx
Prime cost xxx
Indirect materials xxx
Indirect labour xxx
Other indirect costs xxx
Manufacturing (Production) Overhead xxx
Total product cost (full cost) xxx
Costing Terminology: from Financial Accounting(inventories)
Raw materials (inventory): materials purchased for
making products for re-sale (but not yet used).
Work in Progress (inventory) : goods that are
partially completed (but not yet finished)
Finished Goods: Products ready for sale (but not
yet sold)
16
Job — individual products or services for a particular
client (custom home, individual lawsuit, etc)
Batch (Operations) - A group of like products produced
according to specifications (Chubby Hubby Ben & Jerry’s
ice cream, 5000 pairs of Levi’s 505 jeans)
Continuous process — homogenous products
produced on a continuous basis (oil refineries, breweries)
Jobs, Batches, or Continuous Process
Define the cost object !
Trace direct costs to responsibility centers and
to cost objects
Allocate indirect costs (overhead) to
responsibility centers and to cost objects.
Steps in Determining Product or Service FULL Cost
A record is created to accumulate cost data for the job or batch.
As the job or batch is worked on in a responsibility center, costs of
direct materials and direct labor used is recorded directly on the job or
batch’s record.
The job or batch is charged a “fair” share of the responsibility center’s
overhead cost using an allocation method.
Job or Batch Costing
Overhead Allocation Systems
Two systems:
Traditional volume-based cost system
Uses allocation bases that are related to
number of units produced (direct labor
hours, dollars, machine hours, etc.)
Activity-based cost system (ABC) - Use
multiple allocation bases called drivers.
Both systems typically use Predetermined
Overhead Rates
Rate=
Estimated indirect/overhead costs
Estimated volume of allocation base
When a product passes through a responsibility center, it
can be charged with its (1) direct material and (2) direct
labor costs, and then using the predetermined rate, it
can also be charged for a fair share of (3) overhead.
• The three of these costs together constitute the manufacturing
cost of the product.
• Notice that this cost excludes the cost of marketing,
administration, and financing the company.
Predetermined Overhead Rates
Budgeted!
• Old Time Potter manufactures custom designed pottery products for gift shops. Its product line includes coffee mugs, beer steins, footpath stones, and pasta bowl sets. Gift shops specify custom design options and place orders for a minimum quantity of each item ordered. Since goods are custom designed, Old Time Potter defines the cost object as a batch of products produced for a customer’s job.
• Products go through three production responsibility centers: shaping, paint & glaze, and firing. George, the owner of Old Time Potter, after recording costs into descriptive categories such as rent, utilities, direct material, labor, supplies, etc., traces all direct manufacturing costs (direct materials, direct labor) to the production center that incurred the cost. For the month of June, the following costs were directly traceable to each production center:
Old Time Potter
Direct Materials $16,000
Direct Labor $13,000
Shaping Paint & Glaze Firing
Direct Materials $1,000
Direct Labor $5,000
Direct Material $5,800
Direct Labor $12,000
• In addition to the direct manufacturing costs, Old Time Potter incurs indirect production (manufacturing) costs (MOH) including rent, depreciation on equipment, insurance, supplies, and repairs & maintenance. George develops a predetermined overhead rate at the beginning of each year using (1) budgeted overhead cost for the year divided by (2) budgeted direct labor dollars (the allocation base), Old Time’s measure of volume in its different products. For this year, Old Time uses an overhead rate of approx 20% of its direct labor cost to assign overhead to responsibility centers and to products.
Budgeted Manufacturing Overhead $63,000
Budgeted Direct Labor $312,000
Predetermined Overhead Rate 20.19%
Manufacturing Overhead
Budget for 2007
Cost Item Amount
Rent $20,000
Depreciation 10,200
Insurance 1,800
Supplies 22,800
Utilities 3,600
R&M 4,600
$63,000
Direct Labor Budget, 2007
Shaping $130,000
Paint & Glaze 122000
Firing 60000
$312,000
Old Time Potter (Overhead allocation)
12
Amelia’s Specialty Gifts ordered 1000 custom beer steins from Old Time Potter to be delivered in June. These steins went through each of the three production centers. As the steins passed through the center, the direct materials and direct labor costs (PRIME COSTS) for the order were recorded on the job card by the employees (given!) – EASY TO TRACE!
Shaping
Direct Materials $ 920.
Direct Labor 1,400
Amelia’ Gifts
Job Order 101
Paint & Glaze
Direct Materials $ 875
Direct Labor 2,250
Firing
Direct Materials $ 250.
Direct Labor 550
Amelia’ Gifts
Job Order 101
Amelia’ Gifts
Job Order 101
Old Time Potter
When Amelia’s job was complete, George applied overhead to the job and determined the total (manufacturing) cost of the job and the cost per stein. Based on the data collected, the total job cost $7,093.08, or about $7.09 per stein. From this, George can calculate the profit and determine if the proper amounts of materials and labor were used by each responsibility center for this job. By totaling the costs traced to all jobs in the month of June and comparing those totals to the costs incurred in each responsibility center, George can also understand how those centers are controlling their costs.
Amelia's Gifts
Job Number 101
Description: 1000 Beer Steins
Direct Materials Direct Labor Overhead
Department Amount Amount Amount Total
Shaping 920.00 1,400.00 282.69 2,602.69
Paint & Glaze 875.00 2,250.00 454.33 3,579.33
Firing 250.00 550.00 111.06 911.06
Total 2,045.00 4,200.00 848.08 7,093.08$
Cost per Stein 2.05$ 4.20$ 0.85$ 7.0931$
MOH
are 20,19%
of DL
Old Time Potter
Predetermined Overhead Absorption Rate=
Estimated indirect/overhead costs
Estimated volume of allocation base
Predetermined Overhead Rates
Budgeted!
At the end of the accounting period if the actual O/Hs and the actual activity base are the same as what was estimated (budgeted) then all is ok (rarely happens!).
However there is likely to be a situation where actual figures not equal to the estimates used:
• The total O/Hs to be allocated (the numerator in the previous formula) is different to what was anticipated
• The allocation base volume (the denominator in the previous formula) e.g. labour hrs or machine hrs are different to what was anticipated
• Both the O/Hs and the allocation base are different to what was anticipated
These differences cause under or over absorption of O/Hs 27
Under/Over
Absorption of O/Hs
Meaning of Under-absorption of overheads
Under-absorption of overheads means that the amount
of overheads absorbed in the production is less than the
amount of actual overheads-incurred.
For example if the overheads absorbed on a
predetermined basis are $1,000 and the actual overheads
incurred are $1,200, there is
under-absorption of $200.
Under-absorption is also termed as 'under recovery'
Meaning of over-absorption of overheads
Over-absorption of overheads means the excess of
overheads absorbed (based on budgeted data) over the
actual amount of overheads incurred. In other words when
the amount absorbed is more than the expenditure
incurred due to expenses being less than the estimates it
would mean over-absorption of overheads.
Over-absorption is also formed as 'over recovery'.
For example if the “absorbed” overheads are $3,000 and
the actual overheads are $2,750 then there will be over-
absorption of $250.
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