There are three kinds of inventory for manufacturing companies:
1. Raw materials → Materials used to make a product.
2. Work-in-process → Goods that are in manufacturing process but not complete.
3. Finished goods → Completed goods not yet sold.
Direct and indirect costs:
• Direct cost → Can be easily and cost-effectively traced to a cost object.
- Cost object is anything for which managers want a separate measurement of cost.
• Indirect cost → Cannot be easily or cost-effectively traced directly to a cost object.
Manufacturing costs are:
• Direct materials → Raw materials used in production.
• Direct labor → Labor of employees working on the products.
• Manufacturing overhead → Indirect product costs associated with production, including:
- Indirect materials
- Indirect labor
- Factory costs for rent, utilities, insurance, etc.
Prime and conversion costs:
• Prime costs → Combine the direct costs of direct materials and direct labor (DM + DL).
• Conversion costs → Combine direct labor with manufacturing overhead (DL + MOH).
Period and product costs:
• Period costs → Non-manufacturing costs:
- Selling expenses
- Administrative expenses
- Expensed when incurred
• Product costs → Manufacturing costs:
- Direct materials
- Direct labor
- Manufacturing overhead
- Recorded first as an asset, expensed when sold
Objective 3.1: Describe the flow of costs through a process costing system
Job order costing system → Accounting system that accumulates costs by job. Used by companies that manufacture
unique products or provide specialized services.
Process costing system → Accounting system that accumulates costs by process. Used by companies that manufacture
identical units through a series of uniform production steps or processes. Two methods are:
1. Weighted-average
2. First-in, first-out (FIFO)
,Production costs accumulate during each process, and a company assigns these costs to the products passing through
that process. Costs per unit of each process are used to:
1. Control costs → Look for ways to cut costs when actual production costs are more than planned costs.
2. Set sales prices → Sales price has to cover the costs of making the product, the selling and administrative costs,
as well as earn a profit.
3. Calculate account balances → Ending balances are needed in WIP and FG inventory for the balance sheet and
COGS for the income statement.
Objective 3.2: Calculate equivalent units of production for direct materials and conversion costs
Companies may have products still in process at the end of the accounting period. The total production costs incurred in
each process must be split between the following:
1. The units that have been completed in that process and transferred to the next process (A)
2. The units not completed and remaining in WIP inventory (B)
Unit cost of completed units is more than the unit cost of the incomplete units. Equivalent units of production (EUP):
• Used to measure the direct materials, direct labor, and MOH incurred on partially completed units and expressed
in terms of fully completed units.
• Conversion costs → Cost to convert direct materials into finished goods: DL + MOH.
• The equivalent units of production can be different for direct materials and conversion costs and, therefore, must
be calculated separately.
• For some partially completed products, the direct material costs may already be 100% incurred → product is
complete from the perspective of material costs.
Objective 3.3: Prepare a production cost report for the first department using the weighted-average method
Production cost report → Report prepared by a processing department for equivalent units of production, production
costs, and the assignment of those costs to the completed and in process units. The four steps are:
1. Summarize flow of physical units (Units to account for)
- Physical units are the actual units that the company will account for during the period
2. Compute output in terms of equivalent units of production (Units accounted for)
- Separately for DM and conversion costs
3. Compute cost per equivalent unit of production (Costs to account for)
- Weighted-average method → Combines the beginning work-in-process costs and the costs added during the
period into one cost pool (accumulation of individual costs)
4. Assign costs to units completed and units in process (Costs accounted for)
- Multiplying cost per equivalent unit of production x equivalent units of production
Two unique terms are used on the production cost report:
• To account for → Includes the amount in process at the beginning of the period plus the amount started or added
during the period.
• Accounted for → Shows what happened to the amounts to account for. They are either still in process B or
completed A and transferred out. Transferred out + In process
, MAC chapter 8
Goal 1: Prepare flexible budgets and performance reports using static and flexible budgets
A budget variance is the difference between an actual amount and a budgeted amount. Companies use budgets to specify
how much they expect different parts of the firm’s operations to cost. Budget performance reports can then be constructed
afterwards by comparing the budget with the actual outcome.
Static budget → A budget prepared for only one level of sales volume.
Budget performance report → Report that summarizes actual results, budgeted amounts, and differences.
Variance → Difference between an actual amount and the budgeted amount:
- Favorable → If actual amount increases operating income
- Unfavorable → If actual amount decreases operating income
Static budget variance → Difference between actual results and the expected results in the static budget.
Static budget performance report is useful to:
1. Evaluate manager’s effectiveness when actual level of sales closely approximates budgeted amount.
2. Evaluate manager’s ability to control fixed manufacturing costs and fixed selling and administrative expenses.
Not helpful in evaluating variable costs.
Flexible budget → A budget prepared for various levels of sales volume. The flexible budget generally means the budget
constructed at the actual level of sales. Useful because:
1. They show operating income at several different levels of activity
2. They help to isolate how variable costs change based on different levels of activity
Categories of the static budget variance:
1. Flexible budget variance → Difference between the actual results and the expected results in the flexible
budget for the actual units sold. Variance because company has different revenues and/or costs than expected
for the actual units sold.
2. Sales volume variance → Volume difference between actual sales and budgeted sales.
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