Student lecture notes

CHAPTER 18
PRODUCT COSTS: MATERIALS, LABOUR AND OVERHEADS
Statement of cost of a production item ..........

Direct materials
Direct labour
Other direct costs

Indirect materials
xxx
Indirect labour
xxx
Other indirect costs
xxx
Production overhead

xxx
xxx
xxx
xxx

xxx
xxx

Definition
A job costing system is a system of . where there is an
identifiable activity for which costs may be collected. The activity is usually specified in terms of a
.. or a .. contributing to a stage in the production or
service process.

Total product cost =

Collecting the details for the job cost record
Materials

From ..: quantity of materials issued.

From : price per unit charged by the supplier.

Labour

From ..: hours worked.

From ..: hourly rates.

Direct expenses

From .

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.1

Accounting for materials costs

Materials control procedures
Production manager decides on minimum level of stock to be held

Storekeeper makes regular checks of physical stock levels against minimum requirements

When stock has fallen to minimum level, storekeeper sends a request

to the buying department for replacement items to be purchased

Buying department sends an order to supplier

Goods arrive and are received by storekeeper

Supplier's invoice received by accounts dept

Storekeeper issues goods to production department on the basis of a requisition note

Materials handling and control documents

purchase requisition
purchase order
delivery note
goods received note
suppliers invoice
stores requisition

Documentation in materials control procedures

Purchase requisition
Origin
Storekeeper or production
manager
Purchase order
Origin
Buying department

Destination
Buying department

Use

Destination
1 Supplier

Use

2 Storekeeper

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.2

Delivery note
Origin
Delivery driver

Destination
Storekeeper

Use

Materials received note

Origin
Storekeeper

Destination
1 Buying department

Use

2 Accounts department
Suppliers invoice
Origin
Supplier

Destination
Accounts department

Use

Stores requisition
Origin
Production departments

Destination
1 Storekeeper

Use

2 Accounts department
Materials costs when input prices are changing
First-In-First-Out (FIFO)
Assume that the goods which arrived .. are issued ..
Last-In-First-Out (LIFO)
Assume that the goods which arrived . are issued
Average cost
Assume that all goods are issued at the .. of the stock held.

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.3

Basic data
Date

Received

Unit price
Units
100
50

150

1 June
20 June
24 June
28 June
Total

Price paid

Issued to production

20
22

2,000
1,100

3,100

Units

60
70
130

Calculations
Basis
FIFO

Date

Quantity and unit price

24 June
28 June

60 units at 20
40 units at 20
30 units at 22
20 units at 22

30 June
Total
LIFO

Issued to production

1,200

28 June
30 June

50 units at 22
10 units at 20
70 units at 20
20 units at 20

2,700

Average

1,240
1,447

60 units at 20.67*
70 units at 20.67*
20 units at 20.67*

Total

440
440

3,100

400
400

3,100

413
413

3,100

1,300
1,400

Total

24 June
28 June
30 June

Total

1,460
2,660

24 June

Held in stock

2,687

* Weighted average [(100 20) + (50 22)]/150 = 20.67.

Financial and Management Accounting, Third Edition
P Weetman and P Gordon. Copyright Pearson Education Limited 2002

Student notes 18.4

Production overheads
Examples are:
In a manufacturing business:

In a service business:

All the production overhead costs have to be allocated to the products.

Allocation and apportionment

....
.
.
Allocate means assign whole item of cost to single cost unit.
Apportion means spread cost over two or more cost units.
Examples of methods of apportionment of costs over cost centres
Cost item
Rent of building
Lighting
Power for machines
Production supervisors salary
Canteen costs
Depreciation and insurance of
machinery

Method of apportionment to cost centres

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.

Examples of methods of allocating total costs of service cost centres over production
centres
Service cost centre

Method of allocation to production cost

centres

Maintenance department
Employees restaurant and coffee bar
Stores department
Finished goods quality inspection
Safety inspectors
Absorbing costs into product
Methods of absorbing overheads [see section 18.4.4]

Cost per direct labour hour.

Cost per machine hour.
Cost per of labour cost.
Cost per unit.

Predetermined overhead rates [see section 18.4.5]

Cost drivers [see section 18.4.6]
More questions [see section 18.4.6]
Illustration of the calculation of an overhead cost rate
Table 1 Indirect costs
Cost item
Indirect materials
Indirect labour
Rent
Insurance
Depreciation
Total

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Total cost this month

36,000
40,000
1,000
1,600
2,000
80,600

Student notes 18.

Table 2 Information about each department

Assembly
Direct materials used for production
400,000
No. of employees
10
Floor area
300 sq ft
Value of machinery
30,000
No.of direct labour hours worked on
55,000
production

Finishing
500,000
25
600 sq ft
50,000
64,000

Maintenance
not applicable
5
300 sq ft
20,000
not applicable

Step 1 Apportioning costs over departments using a suitable method for each
Table 3

Indirect materials1
Indirect labour2
Rent3
Insurance4
Depreciation5
Total

Total

36,000
40,000
1,000
1,600
2,000
80,600

Assembly

Finishing

Maintenance

1 = basis is direct materials 4 : 5

2 = basis is employees 10 : 25 : 5
3 = basis is space 3 : 6 : 3
4 = basis is value 3 : 5 : 2
5 = basis is value 3 : 5 : 2
Step 2 Apportioning service department costs over production departments on the
basis of value of machines in each department
Proportions : .
5,970 =
5,970 =
Table 4

Total cost per dept

Transfer Maintenance to
Assembly and Finishing
Total per dept

Total

80,600

Assembly

27,330

Finishing

47,300

Maintenance

5,970

80,600

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.

Step 3 Absorbing total overhead costs of each production department into units
produced during the period
Divide the total cost of each department by the number of direct labour hours:
Assembly: ../ hours = . pence per direct labour hour.
Finishing: ../. hours = pence per direct labour hour.
Step 4 Finding the overhead costs of any job
Table 5
Department
Assembly
Finishing
Total overhead cost

Calculation

Methods of allocating overhead costs to jobs

Four possible methods of allocating overhead costs to products are:

Cost per direct labour hour.

Cost per machine hour.
Cost per of labour cost.
Cost per unit.

Predetermined overhead cost rates

Estimated at the start of a reporting period.
Adjusted to actual at the end of the period.
Use of a predetermined fixed overhead cost rate
Estimated labour hours for normal activity
Estimated fixed overhead cost in total
Predetermined overhead cost rate

10,000 hours
50,000

Actual hours worked on jobs

Overhead costs applied to jobs (costing records)
Actual fixed overhead incurred (cash book)
Under-applied fixed overhead

8,000 hours
50,000

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.

Activity-based costing
A method of allocating .. to products and
services.
Asks the question: What d cost?
Example: Social work department of local authority
Department A uses taxis for travel to client work; Department B takes bus or walks.
Overhead cost of travel (taxi plus bus) is shared across A and B by number of people
in each department.
What drives cost of taxis? ..
Four stages
1 Identify a.
2 Identify c. d.. that influence the cost of an
activity.
3 Create a c..p for each activity.
4 Allocate costs to products using d for each activity.
Tracing costs of Products A, B and C in a single cost centre
Step 1 Direct tracing of direct costs
Step 2 Sharing of indirect costs (overhead) by apportionment to products

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.

Traditional approach to flow of overhead costs

Identify overhead costs and identify cost centres that accumulate costs
Step 1: Allocate indirect costs to cost centres
Step 2: Apportion service cost centre to production cost centres
Step 3: Absorb overhead costs into product

Traditional product cost allocation

Activity-based costing

Identify cost centres in which costs may

be accumulated. Cost centres are
determined by the nature of their
function (e.g. production or service
department cost centres)

Identify the way in which products drive

the activity of the business and define
suitable cost pools for collecting the
costs relating to each activity. Activity
pools are determined by the activities
which drive the costs (e.g. obtaining new
customers, negotiating customer
contracts)

Collect costs in cost centres

Collect costs in activity cost pools

Determine an overhead cost rate for

Determine a cost driver rate for each
each production cost centre (e.g. cost per cost activity pool, e.g. a cost per
direct labour hour)
customer contract, cost per customer
order received

Allocate cost to products using the

Allocate cost to products according to
calculated cost rate and the measure of
the product's demand for the activity
the product's consumption of that
which drives cost
department's cost (e.g. number of labour
Financial and Management Accounting, Third Edition
P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.

hours required)

Financial and Management Accounting, Third Edition

P Weetman and P Gordon. Copyright Pearson Education Limited 2003

Student notes 18.