Cost Accounting

- Cost Accounting (Maliyet Muhasebesi) -
Introduction to Cost (Management) Accounting
Introduction to Cost Management Systems
Cost Allocation and Activity Based Costing
Job Costing Systems, Overhead Application, Service

Industries
Process Costing Systems
Flexible Budgets and Variances Analysis
written by F@tm@ K. Page 1 of 71

Chapter 1 - Introduction to Cost (Management) Accounting

Who are the users of Accounting Information?
Accounting is an information system and provides information to the external/internal users.

In general, users of accounting information fall into two categories. One is external users and
the other is internal users. According to this information, we can say that accounting can be
separated in two parts as Management Accounting and Financial Accounting.
Trade Company needs financial accounting

Production Company needs financial accounting + Cost accounting
In a production company, direct materials, direct labour and Factory overhead cost items are
given to the production process as inputs and taken products from this process as output. In
this process, to calculate the cost of produced products we will need inputs costs that will be
taken from financial accounting. At the same time, to prepare main financial statements like
balance sheet and income statement, we will need the cost of the produced products that will
be taken from cost accounting. This explanation shows us the relationship between financial
and cost accounting. After learning this relationship in short, now let us to learn the
distinctions between these two.
Distinctions between Management and Financial Accounting
Management Accounting Financial Accounting

Primary users External parties such as
Managers
banks, government often user
Freedom of choice Constrained by generally
accepted accounting
No constraints, depends on
principles and concerned
management idea
rules, such as tax law,
regulatory bodies
Behavioural implications Primary aim Secondary aim
Time focus Future orientation Past orientation
Time span Varying from hourly to 10 to
Usually 1 year or 1 quarter
15 years
Reports Detailed and as departments, Summarized and as a whole
products and so on of entity
Relationship with the other Heavier use of economics,
Lighter use of related
disciplines statistics, sciences and
disciplines
behavioural sciences

What are the objectives of an Accounting System?
To supply enough information to all of these users, an accounting system and a formal
mechanism are needed for collecting, organizing and communicating information about an
organizations activities.
In a good accounting system, the following three main questions are answered:
1. Scorecard questions: Am I doing well or poorly? Scorekeeping is the accumulation

and classification of data. This aspect of accounting enables to evaluate an
organizations performance.
2. Attention directing questions: which problems should I look into? Reporting and
interpreting information that helps managers to focus on operating problems,
imperfection, inefficiencies and opportunities.
3. Problem-solving questions: Of the several ways of doing a job, which is the best? This
aspect of accounting quantifies probable results of possible courses of decision and
often recommends the best course to follow.
Management Accounting in Service and Non-profit organizations
Service organizations dont make or sell tangible goods. Public accounting firms,
management consultants, real estate firms, transportation companies, banks, insurance
companies and hotels are profit-seeking organizations. Assets must be managed in these
companies to be successful.
The characteristics of profit-seeking and non-profit service organizations:
1. Labour is intensive
2. Output is usually difficult to define
3. Major inputs and outputs cannot be stored. For example, an empty airline seat cannot
be saved for a later flight.
The Management process and accounting
The Management process is a series of activities in a cycle of planning and control. Decisions
within an organization are often divided into two types: (1) planning decisions (2) control
decisions. In practice, planning and control are so intertwined that it seems artificial to
separate them.

Exhibit 1-3: Accounting Framework for Planning and Control
Line Management Internal Accounting System
Planning Budgets
(Deciding) Special Reports
Source Records and

Documents e.g. bills Measurements
Action
from suppliers of actions
(implementing)
General and subsidiary Classifications of

ledgers actions
Evaluation
(Feedback)
Performance reports Reports of

actions
comparing
budgets with
results
The left side of Exhibit 1-3 shows the planning and control cycle of current operations.
Planning provides the answers to two questions: What is desired? When and how is it to be
accomplished? In contrast, controlling refers to implementing plans and using feedback to
attain objectives.
The right side of Exhibit 1-3 shows that accounting formalizes plans by expressing them as
budgets. A budget is a quantitative expression of a plan of action; it is also an aid to
coordinating and implementing the plan. Accounting formalizes control as performance
reports which provide feedback by comparing results with plan and by highlighting variances,
which are deviations from plans. The accounting system records, measures, and classifies
actions in order to produce performance reports. Management by exception concentrates on
areas that deviate from the plan and ignoring areas that are presumed to be running smoothly.
Planning and Control for Product life cycles
To effectively plan for and control production of such goods or services, accountants and
other managers must consider the products life cycle. Typical product life cycle is shown in
Exhibit 1-7.
Exhibit 1-7: Typical Product life cycle
No Sales Sales Growth Stable Sales Level Low Sales No Sales

Product Introd. to market Mature market Phase-out of product
development
Product life cycles range from a few months (for fashion clothing) to many years (for
automobiles). In the planning process, managers must recognize revenues and costs over
entire life cycle. Accounting needs to track actual costs and revenues throughout the life
cycle, too. Periodic comparisons btw. planned costs and revenues and actual costs and
revenues allow managers to asses the current profitability of a product, determine its current
product life cycle slope, and to make any needed changes in strategy.
Accountings Position in the organization
As you know, there are line and staff authority in organizations. Line authority is authority
exerted downward over subordinates. Staff authority is authority to advice but not command.
It maybe exerted downward, latterly or upward. The Top accounting officer of an
organization is often called the controller or, especially in a government organization a
comptroller.
Accounting department does not exercise direct authority over line departments. Rather
Accounting department provides specialized service including advice and help in budgeting,
analyzing variances, pricing and making special decisions.
In theory, controllers have no line authority except over the accounting department. By
reporting and interpreting relevant data, controllers do exert a force or influence that leads
management toward logical decisions that are consistent with the organizations objectives.
Distinctions between controller and treasurer
Controllership Treasureship
1. Planning for control 1. Provision of capital
2. Reporting and interpreting 2. Investor relationships
3. Evaluating and consulting 3. Short-term financing
4. Tax administration 4. Banking and custody
5. Government reporting 5. Credits and collections
6. Protection of assets 6. Investments
7. Economic appraisal 7. Risk management (insurance)
Management accounting is the primary means of implementing the first three functions of
controllership. The treasurer is concerned mainly with the companys financial matters, the
controller with operating matters. The exact division of accounting and financial duties varies
from company to company. In a small organization, the same person might be both treasurer
and controller.
Training for Top Management Positions
In an accounting department, studying accounting and working as a management accountant

can prepare you for the very highest levels of management. Accounting deals with all facets
of an organization, so it provides an excellent opportunity to gain broad knowledge.
Accounting must embrace all management functions, including purchasing, manufacturing,
wholesaling, retailing and a variety of marketing and transportation activities. A number of
recent surveys have indicated that more chief executive officers began their careers in an
accounting position than in any other area, including marketing, production and engineering.
Adaptation to change
Todays economic decisions differ from those of 10 years ago. As decisions change, demands
for information change. Accountants must adopt their systems to the changes in management
practices and technology.

Three major factors are causing changes in management accounting today:
1. Shift from a manufacturing based to a service-based economy

2. Increased global competition
3. Advances in technology
The most dominant influence on management accounting over the past decade has been
technological change. This change has affected both the production and the use of accounting
information. The increasing capabilities and decreasing cost of computers, especially personal
computers (PCs), has changed how accountants gather, store, manipulate and report data. On
the other hand, by using spreadsheet software and graphics packages, managers can use
accounting information directly in their decision process.
At the same time, manufacturing processes are increasingly automated. Automated

manufacturing processes make extensive use of robots and other computer controlled
equipment and less use of human labour for direct production activities. Accountants in such
settings have had to change their systems to produce information for decisions about how to
acquire and use materials and automated equipment efficiently.
The most important recent change leading to increased efficiency in American factories has
been the adoption of a just in time (JIT) philosophy. The essence of the philosophy is to
eliminate waste. Mangers try to reduce the time that products spend on activities that do not
add value (such as inspection and waiting time).
Process time can be reduced by redesigning and simplifying the production process.
Companies can use computer-aided design (CAD) to design products that also use computer-
aided manufacturing (CAM), in which computers direct and control production equipment.
CAM often leads to a smoother, more efficient flow of production with fewer delays. Systems
that use CAD and CAM together with robots and computer-controlled machines are called
computer-integrated manufacturing (CIM) systems. Finally, both external and internal
accountants see below [Importance of ethical conduct]
Importance of Ethical conduct
Both external and internal accountants are expected to obey to ethical standarts. An unethical
act is one that violates the ethical standarts of the profession. Especially after some of the
accounting scandals like Enron example, the importance of ethical standarts were seen very
well than before.
Standarts however leave much room for individual interpretation and justgement. Therefore,
Many ethical dilemmeas require value judgements not simple applications of standarts.To
overcome with these kind of ethical problems, The Institute Of Management Accountants
(IMA) has developed ethical standarts to help management accountants. These standarts are
explained under four main titles as Competence, Confidentiality, Integrity and
Objectivity.
As known, there are also Code of Professional Conduct that was established by AICPA for
its members, and Main Ethics Principles that was established by IFAC. All of them have
same purpose and mainly same subjects to establish ethical act for accountants. In Turkey,
establishing of ethical standards for accountants were started in 1987 with Capital Market
Law regulations and with the other following regulations, some additional ethical Principles

and Rules were issued 1990 and 1996. But first special main regulation for ethical standards
in Turkey was made by TRMOB in 2001.
Competence (Should have enough Professional education and experience)

.Maintain Professional competence as knowledge and skills.
.Perform Professional duties according tothe relevant laws, reulations, and tecnical standarts.
Confidentiality (Should not give any information to any one about customer business)
.Refrain from disclosive learned information about customer busines except when authorzed
or legally obligated.
Integrity (Should be honest)

.Refuse any gift, favor, hospitality or any other benefit that would influence your action.
Objectivity (Should not be stay under the affect of anything during your work)
Communicate information fairly and objectively.
In short, it is easy to do what is right; it is hard to know what is right. To solve these
kind of ethical dilemmas, accountants may discuss these dilemmas with their immediate super
visor or advisor and they can also use a basic rule used by GM is that employees, should
never do anything (they) would be ashamed to explain to (their) families or be afraid to
see on the front page of the local newspaper.
Questions for Introduction Chapter

1.Why does an organization invest resourses in an accounting system?
2.Distinguish among scoreceeping, attention directing, and problem solving characteristics of
an accounting system.
3.Give three examples of service organizations. What distinguishes from other types of
organizations?
4.Why are accountants concerned about the product life cycle?
5.Planning is much more vital than control Do you agree? Explain.
6.How are changes in technology affecting management accounting?
7.Standards of ethical conduct for management accountants have been divided into four major
responsibilities. Decribe each of four in 20 words or less.
8. A news story reported: Rockwells Anderson, a veteran of the companys automotive
operations, re calls that when he sat in an meetings at Rockwells Nort American Aircraft
Operations 20 years ago, thered be 60 or 70 guys talking technical problems, with never a
word on profits such in attention to financial management helped Rockwell lase the F-15
fighter to McDonnell Douglas, Pentagon sources say. Anderson brought in profit orited
excutives, and he has now tranformed North Americans staff meetings to the point that you
seldom hear talk of technical problems anymore he says. ts all financial what is your
reaction to Andersons comments? Are this comments related to management accounting?
9.Ethical Issues
Suppose you are controller of a medium-sized oil exploration company in West Texas. You
adhere to the standards of ethical conduct for management accountants. How would those
standards affect your behavior in each of the following situations?
A.Late on Friday afternoon you receive a geologists report on a newly purchased property. It
indicates a much higher probability of oil than had previously been expected. You are the
only one to read the report that day. At a party on Saturday night, a firend asks about the

prospects for the property.(Confidentiality . shouldnt say anything about companyt to the
others)
B.An oil industry stock analyst invites you and your spouse to spend a week in Hawaii free of
charge. All she wants in return is to be the first to know about any financial information your
company is about to announce to the public. (Integrity. Shouldnt accept any benefit )
C.It is time to make a forecast of the companys annual earnings. You know that some
additional losess will be recognized before the final statements are prepared. The companys
president has asked you ignore these loses in making your prediction because a lower than
expected earnings forecast could adversely affect the chances of obtaining a loan that is being
negotiated and will be completed before actual earnings are announced. (Objectivity)
D.You do not know whether a particular expence is deductible for income tax purposes. You
are deciding whether to reach the tax laws or simply to assume that the item is deductible.
After all, if you are not audited, no one will ever know the difference. If you are audited, you
can plead ignorance of the law.(Competence. )
10. According to the ethical standards for IMA, which guidelines are violated in each
situation?
*You tell your sister that your company will report earnings significantly above financial
analysts estimates (Confidentiality)
*You see that others take home office supplies for personal use. As an intern, you do the same
thing, assuming that this is a perk (Integrity)
*At a conference on e-commerce, you skip the afternoon session and go sightseeing.
(Competence)
*You failed to read the detailed specifications of a new general ledger package that you asked
your company to purchase. After it is installed, you are surprised that it is in compatible with
some of your companys older accounting software (Competence)
*You do not provide top management with the detailed job descriptions they requested
because you fear they may use this information to cut a position from your department
(Competence)

Chapter 2 - Introduction to Cost Management Systems

A cost may be defined as sacrifice or giving up of sources for a particular purpose, frequently
measured by the monetary units that must be paid for goods and services. Cost objective
(cost object) defined as any activity or source for which a separate measurement of costs is
desired. Examples include departments, products and territories. As you see in Exhibit 2-1,
the cost accounting system that is part of the accounting system that measures costs for the
purposes of management decision making and financial reporting, includes two processes:
Exhibit 2-1 1. Cost Accumulation:

Cost Accumulation Raw Material Costs
and Allocation (Metals)
2. Cost Allocation to cost objectives:
A. to departments1 Machining Finishing

Department Department
B. to products2 Cabinets Cabinets
Desks Desks
Table Table
1
Purpose: evaluate performance of manufacturing dept.s
2
Purpose: obtain costs of various products for valuing inventory, determining income and judging product
profitability

Cost accumulation is collecting costs by some natural classification such as materials or

labour. Cost allocation is tracing and reassigning costs to one or more cost objectives such as
departments, customers, or products.
Main cost accounting concepts
For example
damaging sugar with rain
Loss
3 Consume
assets for non aim
Purchasing
Assets Revenue
Flour
Spending 2 Consume asset
Sugar Cake Expense
to have revenue
1
Consume Produced
assets for product
production
Production
Cost
Cake Production Company as a numerical example for main cost accounting concepts
*paid for one year rent 2,400

*Buying machinery for production 50,000
*buying 200kg sugar (1/kg) 200
*buying 100kg flour (0,50/kg) 50
Activities for one year:
-120kg sugar was sold as a sugar 2,50 /kg
-63kg sugar was used for cake production
-45kg flour was used for cake production
-90kg cake was produced and 60kg cake was sold as 85 /kg
-2,400 rent amount will be allocated as 1,000 for period cost and the rest will be assumed
for production activity.
-Depreciation for machinery will be 5,000.
Required
-total spending amount
-total consumed asset for one year period
-total period cost and total production cost of these total consumed asset
-unit production cost for cake

-cost of goods sold for 60kg cake, total revenue and cost of finished cake that are not sold yet.
-prepare an income statement
Solution total spending: rent 2,400+Machinery 50,000+200kg sugar 200+100kg flour

50 = 52,650
Consumed assets For which purpose total

Sugar 183kg 120kg as sugar +63kg for production (183X1) 183,00
Flour 45kg for cake production (45kgX0,50) 22,50
Rent selling sugar +production cake 2,400
Depreciation for production activity 5,000
Total consumed assets 7,605,50
Consumed assets production cost period cost

Sugar 183,00 (63X1) 63,00 (120X1) 120,00
Flour 22,50 22,50
Rent 2,400 assumed 1,400,00 1,000,00
Depreciation 5,000 5,000,00
Total 6,485,50 1,120,00
Unit production cost for cake= total production cost/ production quantity
=6,485,50/90kg
=72,06
cost of goods sold 60kgX72,06=4,323,60
total revenue =revenue from cake selling 60kgX85 +sugar selling 120kgX2,50
=5,100 +300
=5,400,00
cost of finished product (cake) that are not sold yet and we will see them on balance sheet as
assets= 72,06X30kg = 2,161,80
income statement
Revenue 5,400
From cake selling 5,100
Sugar selling 300
(-) cost of goods sold 4,443,60
for cake 4,323,60
for sugar 120,00
gross profit 956,40

(-) activity expense:
rent for sugar selling activity 1,000,00
Activity loss (43,60)

Direct and Indirect costs
Direct costs can be identified specifically and exclusively with a given cost objective in an
economically feasible way. In contrast, indirect costs cannot be identified specifically and
exclusively with a given cost objective in an economically feasible way. Economically
feasible means cost effective, in the sense that managers do not want cost accounting to be
too expensive in relation to expected benefits. E.g.: it may be economically feasible to trace
the exact cost of steel (direct cost) to a specific lot of desk chairs, but it may be economically
infeasible to trace the exact cost of rivets (indirect cost) to the chairs. Other factors also
influence whether a cost is considered direct or indirect. The key is the particular cost
objective. E.g.: consider a supervisors salary in the maintenance department of a telephone
company. If the cost objective is the department, the supervisors salary is direct cost. In
contrast, if the cost objective is a service (the product of the company) such as a telephone
call, the supervisors salary is an indirect cost.
Categories of manufacturing costs
Manufacturing costs are most often divided into three major categories: (1) direct materials,
(2) direct labour, (3) factory overhead.
Direct material costs: The acquisition costs of all materials that are physically identified as a
part of manufactured goods and that may be traced to the manufactured goods in an
economically feasible way. Direct materials often do not include minor items such as tacks or
glue because the costs of tracing those items are greater than the possible benefits of having
more precise product costs. Such items are usually called supplies the factory overhead
described in this lat. In short, if a material is used in manufacturing of a product, which is the
main product of the company, and it is seen as a main structure of the product, we can say that
this material is direct material for that company. Examples are iron castings, lumber,
aluminium sheets and subassemblies.
For example, during the production of fiberboard table; fiberboard will be direct material but
glue wont.
Direct labour costs: The wages of all labour that can be traced specifically and exclusively to
the manufactured goods in an economically feasible way. Examples are the wages of machine
operators and assemblers. Here, we are looking for the main activity area of the company if a
labour is used in manufacturing of a product or service which is the main product or service of
the company and this labour can be traced directly with the product or service, then, we can
say that this labour is direct labour cost for that company. Examples are the wages of
machine operators and assemble.
Factory overhead costs: All costs other than direct material or direct labour that are
associated with the manufacturing process are called factory overhead costs. Examples are
power, supplies, indirect labour, supervisory salaries, property taxes, rent, insurance and
depreciation. In traditional accounting systems, all manufacturing overhead costs are
considered to be indirect. However, computers have allowed modern systems to physically
trace many overhead costs to products in an economically feasible manner. E.g.: meters wired
to computers can monitor the electricity used to produce each product, and costs of setting up
a botch production run can be traced to the items produced in the run.

Products costs and Period costs
Regardless of the type of cost accounting system used, the resulting costs are used in a
companys financial statements. When preparing both income statement and balance sheet,
accountants frequently distinguish btw. product costs and period costs.
Product costs are costs identified with goods produced or purchased for resale. These product
costs (inventory costs) become expenses (in the form of cost of goods sold) only when
inventory is sold. In contrast, period costs are costs that are deducted as expenses during the
current period without going through an inventory stage.
E.g.: look at the top half of Exhibit 2-3.
A merchandising company (retailer or wholesaler) acquires goods for resale without changing
their basic form. The only product cost is the purchase cost of the merchandise. Unsold goods
are held as merchandise inventory cost and are shown as an asset on a balance sheet. As the
goods are sold, their costs become expenses in the form of COGS.
A merchandising company also has a variety of selling and administrative expenses. These
costs are period costs because they are deducted from revenue as expenses without ever being
regarded as a part of inventory.
The bottom half of Exhibit 2-2 illustrates product and period costs in a manufacturing
company. Note that direct materials are transformed into saleable form with the help of direct
labour and factory overhead. All these costs are product costs because they are allocated to
inventory until the goods are sold. As in merchandising accounting, the selling and
administrative expenses are not regarded as product costs but are treated as period costs.

Exhibit 2.2 Relationships of Product Costs and Period Cost
Balance Sheet Income Statement
Merchandising Company Sales

(Retailer or Wholesaler)
Product Merchandise Expiration Cost of

(Inventoriable) Purchases Merchandise Goods Sold
Cost Inventory (an Experise)
Equals Gross
Margin Minus
Selling
Period Expenses and
Costs Administrative
Expenses
Equals Operating Income

Manufacturing Company
Direct Sales
Metarial Direct
Purchases Material
Inventory
Product
(Inventoriable) Expiration
Costs Direct Labor
Work in Finished Cost of
Process Goods Goods Sold
Factory
Inventory Inventory (an Experise)
Overhead
Equals Gross
Margin Minus
Selling
Period Expenses and
Costs Administrative
Expenses
Equals Operating Income

Essential difference btw. the structure of the balance sheet of a manufacturer and that of a
retailer or wholesaler would appear in their current asset section:
Manufacturer company Merchandising company

Cash Cash
+ Receivables + Receivables
+ Finished goods
+ Work in process + Merchandise inventories
+ Direct material
Total inventories
At the same time, for manufacturing and merchandising organizations, the COGS is different:
Calculating COGS in a merchandising company:
beginning of the merchandise inventory

+ purchased merchandise inventory
COG available for sale
(-) ending of the merchandise inventory
COGS
In the manufacturing company, you should overcome with
- used labour, material in production process
- beginning and ending of WIP account
- beginning and ending finished good inventory
Therefore calculating COGS in manufact. comp. is more difficult than in merchand. comp.as
shown below.
Calculation of cost of goods sold for manufacturing company:
Beginning direct material inventory

+ Purchased direct material
=Available direct material for production
-Ending direct material inventory
=Used direct material in production
+Used direct labour in production
+Used factory over head cost
=Total production cost
+Beginning WIP inventory
-Ending WIP inventory
=The cost of completed product in that term
+Beginning finished product cost
=Available finished inventory for sale
-Ending finished inventory
=Cost of goods sold for manufacturing company.

Problem1. Direct material used (24,000); direct labor used (9,000); manufacturing over
head (17,000); beginning WIP (5,000)and ending WIP (4,000) with using these numbers
compute the cost of produced products.
Solution:
Beginning WIP inventory 5,000
+D.material used 24,000
D.labor used 9,000
Factory overhead 17,000
Total manufacturing cost incurred during the period 50,000
=Total manufacturing costs to account for 55,000
-Ending WIP inventory (4,000)
Cost of goods manufactured 51,000
Problem2. Identify the following as either an inventory able product cost or a period cost:
A. Depreciation on plant equipment (it is concerned with production and inventory able cost)
B. Depreciation on sales persons automobiles (Period cost)
C. Insurance on plant building (inventory able cost)
D. Marketing managers salary (period cost)
It is not concerned with production and it will go directly to the income statement for that
term and it is not inventory able cost.(period cost)
Problem3. With using the following data, calculate,

*The cost of the direct material used
*The cost of goods manufactured
*The cost of goods sold
Beginning materials inventory 6, 000

Ending materials inventory 5,000
Ending WIP inventory 1,000
Beginning finished goods inventory 3,000
Ending finished goods inventory 5,000
Direct labor used 30,000
Purchases of direct materials 100,000
Manufacturing overhead 20,000
Solution:
Beginning materials inventory 6,000
+ Purchases of direct materials 100,000
Available for manufacturing 106,000
- Ending materials inventory 5,000
The cost of the direct material used 101,000*

+ The cost of the direct material used 101,000
Direct labor used 30,000
Manufacturing overhead 20,000 151,000

Total maufacturing costs to account for 153,000

- Ending WIP inventory 1,000
Cost of completed product in that term 152,000*
+ Beginning finished goods inventory 3,000
Available finished goods for sale 155,000
- Ending finished goods inventory 5,000
Cost of goods sold 150,000*
Problem4.
Calculate manufacturing overhead cost with using the following data for a camera fixing
company.
Glue for camera frames 250*

Depreciation on company cars used by sales force 3,000
Plant depreciation 10,000*
Interest expense 2,000
Company president salary 25,000
Foreman s salary 4,000*
Plant janitors salary 1,000*
Oil for manufacturing equipment 25*
Flash bulbs 50,000
Solution:Total manufacturing factory overhead would be 15,275 as shown with * items

Activity-based Costing, Value-added Costing and Just In Time production
Activity-based Accounting:
Activity-based costing systems first accumulate overhead costs for each of activities of an
organization and then allocate the costs of activities to the products, services or other cost
objects that caused that activity.
In the traditional cost system, the portion of total overhead allocated to a product depends on
the proportion of total direct labour hours consumed in making the product. In ABC system,
one large overhead cost pool has been broken into several pools, each associated with a key
activity.
Exhibit 2-3: Traditional and Activity-based Cost Systems
Traditional Cost Systems Activity-based Cost (ABC) Systems
Direct Direct Over Direct Direct Over

material Labour head material Labour head
costs Costs Costs costs Costs Costs
Machining
Activity
Costs
Assembly
Direct Direct Direct Direct Activity
Trace Trace Trace Trace Costs
DLH Quality
(Cost Driver) Inspection
Activity
t
Machine Hours
(Cost Driver)
No. of Parts
(Cost Driver)
No. of Inspectors
(Cost Driver)
Products Products

ABC systems are more complex and costly than traditional systems, but more and more
organizations are adopting activity-based systems for a variety of reasons: why activity-based
costing systems are being adopted by more and more organizations?
- Accounting to the decreasing profits margins, companies need more accurate cost
information.
- Business complexity has increased, which results in greater diversity in the types of
products and services as well as customer classes.
- New production techniques have increased the proportion of indirect costs. In many
industries direct labour is being replaced by automated equipment.
- Decreasing product life cycle. Hence, companies do not have time to make price or
cost adjustments once costing errors are discovered.
- Computer technology has reduced the costs of developing and operating cost systems
that track many activities.
What is the next step after activity-based costing?
The answer of this question is activity-based management. In activity-based management,

managers apply the information collected using ABC to make better decisions. Activity-based
management focuses on managing activities including identifying non-value-added activities
that can be eliminated and making sure that needed activities are carried out efficiently.
Managers can use ABC to
- produce parts with the lowest cost process,
- design parts to minimize manufacturing costs,
- modify equipment to reduce costs,
- increase prices of products priced below ABC costs, and
- drop unprofitable products.
Cost Management Systems and Value-added Costing
A cost management system identifies how managements decisions affect costs. To do so, it
first measures the resources used in performing the organizations activity and then assesses
the effects on costs of changes in those activities.
The cornerstone of cost management is distinguishing btw. value-added costs and non value-
added costs. A value-added cost is the cost of an activity that cannot be eliminated without
affecting a products value to the customer. In contrast, non value-added costs can be
eliminated without affecting a products value to the customer. Handling and storing
inventories, transporting partly finished products from one part of the plant to another are
examples for non value-added activities.
JIT systems
Just In Time production system, is a system in which an organization purchases materials and
parts and produces components just when they are needed in production process, the goal
being to have zero inventory, because holding inventory is a non value-added activity.
Several factors are crucial to the success of JIT system:
- Focus on quality: JIT systems emphasize total quality control (TQC) and continuous
improvement in quality
- Short production cycle times: Keeping production cycle times short allows timely
response to customer orders and reduces the level of inventories.
- Smooth flow of production: To achieve smooth production flow, JIT companies
simplify the products process to reduce the possibilities of delay, develop close

relationships with suppliers to assure timely delivery and high quality of purchased
materials, and perform routine maintenance on equipment to prevent costly
breakdowns.
- Flexible production operations: Two dimensions are important: facilities flexibility
and employee flexibility. Facilities should be able to produce a variety of components
and products to provide extra capacity. Cross training employees training employees
to do a variety of jobs provides further flexibility one company reported a reduction
in setup time from 45 minutes to 1 minute by training production workers to perform
the set up operations.
Accounting for a JIT system is often simpler than for other systems. In true JIT systems,
material, labour and overhead costs can be charged directly to COGS because the aim of the
system is zero inventory.
Classifications of Labour costs
Labour costs can be divided in two main part of production company as non production
labour for example labour for marketing department and production(factory) labour as direct
labour and indirect labour costs. Supervisor salary, repair labour payment in production line
and idle time payments and overtime payments for direct labour can be given as examples for
indirect labour costs.
All factory labour wages, other than those for direct labour and managers salaries, are usually
classified as indirect labour cost, a major component of factory overhead. Two classes of
indirect labour deserve special mention: overtime premium and idle time.
Overtime premium paid to all factory workers is usually considered a part of overhead. If a
operator earns $8 per hour for straight time and time and one-half for overtime, the premium
is $4 per overtime hour. If the operator works 44 hours, including 4 overtime hours in 1 week,
gross earnings are classified as follows:
Direct labour 44 hours x $8 $352

Overtime premium (factory overhead) 4 hours x $4 $16
Total earnings for 44 hours $368
In most companies, the overtime premium is not allocated to any specific job. Instead,
overtime premium is considered to be attributable to the heavy overall volume of work, and
its cost is thus regarded as a part of the indirect manufacturing costs (factory overhead)
Another subsidiary classification of indirect labour costs is idle time. This cost typically
represents wages paid for unproductive time caused by machine breakdowns, material
shortages, sloppy production scheduling, and the like. E.g.: if the same operators machine
broke down for 3 hours during the week, the operators earnings would be classified as
follows:
Direct labour 41 hours x $8 $328

Overtime premium (factory overhead) 4 hours x $4 $16
Idle time (factory overhead) 3 hours x $8 $24
Total earnings for 44 hours $368

Payroll Fringe Costs:

Employer contributions to employees as benefits such as social security, life insurance, health
insurance and pensions. Most companies classify these as factory overhead. In some
companies, however fringe benefits related to direct labour are changed as an additional direct
labour costs.

Chapter 3 - Cost Allocation and Activity-based costing

Costs are allocated for four major purposes:
1. To predict the economic effects of planning and control decisions

2. To obtain desired motivation
3. To compute income and asset valuations. Costs are allocated to products and projects
to measure inventory costs and COGS
4. To justify costs or obtain reimbursement. Sometimes prices are based directly on costs
There are three basic types of cost allocations
1) Allocation of costs to the appropriate organizational unit: Direct costs are physically
traced to the unit; but costs used jointly by more than one unit are allocated based on
cost driver activity in the unit. Examples are allocating rent to departments based on
floor space occupied or allocating depreciation on jointly used machinery based on
machine-hours. After finishing first allocation, all of the assets consumptions are
collected in these three main cost centres as service cost centres, production cost
centres and period cost centres. Direct material, direct labour and some of the FOC
like supervisor salary can be recorded to these cost centres directly but the others
allocated with using cost drivers like rent because rent has indirect relationship with
the cost centres and it should be allocated to the cost centres by using flour space
occupied as cost driver.
2) Re-allocation of costs from one organizational unit to another. Some units, called
service departments and their costs are totally re-allocated. Examples include
personnel departments, laundry departments in hospitals. This allocation is called as
second allocation.
3) Allocation of costs of a particular organizational unit or activity to products or
services. With this third allocation, we can get unit production cost.
Allocation of service department costs
Reciprocal Services (second allocation)

Service departments often support other service departments in addition to producing
departments. Consider a manufacturing company with two producing departments, moulding
and finishing and two service departments, facilities management (rents, heat, light, sanitation
services, etc.) and personnel. We have following data for the company:

Service Departments Production Departments

Facilities Mngmnt Personnel Moulding Finishing
Direct dep.t costs $126,000 $24,000 $100,000 $160,000

st
(comes fr. 1 alloc.)
Square meter 3,000 9,000 15,000 3,000
No. of employees 20 30 80 320
Direct-labour hours 2,100 10,000

Machine hours 30,000 5,400
There are two popular methods for allocating service department costs in such cases: the
direct method and the step-down method.
Direct Method: ignores other service departments when any given service departments costs
are allocated to the raven producing (operating) departments. (Ignores reciprocal services
among service departments)
Facilities Costs Distribution Moulding Finishing

(criterion cost driver)
Mngmnt Dept.s $126,000 Squaremeter 15/18 x 126,000 3/18 x 126,000

= $105,000 = $21,000
Personnel Dept.s $24,000 No. of employees 80/400 x 24,000 320/400 x 24,000

= $4,800 = $19,200
$150,000 $109,800 $40,200
$150,000
Step-down Method: recognizes reciprocal services among service department as partial. In

this method there are some rules:
- To know whether which service departments costs will be distributed first; we should
check whether which service department gave the service to the greatest number of
department. First check the number if it is same, if not, in this time, we will check the
amount of the costs.
In our example both of the service department gave their service for four departments. Then
we can check the costs of both service departments. Since the costs of the facilities
Management department is higher than personnel departments, facilities management costs
are allocated first.
- The other rule is that when the costs of a certain service department is allocated, any
costs are not distributed itself from its costs.
- The last rule After facilities management costs are allocated, no costs are allocated
back to facilities management, even though personnel does provide some services for
facilities management.

Facilit. Mngmnt Personnel Moulding Finishing Total
Direct dept. $126,000 $24,000 $100,000 $160,000 $410,000

cost before
allocation
Step 1: ($126,000) (9/27) x 126,000 (15/27) x 126,000 (3/27)x126,000 0

Facil. Mngmnt = +$42,000 = $70,000 = $14,000
Step 2: $66,000 (80/400) x 66,000 (320/400)x66,000 0

Personnel = $13,200 = $52,800
Total cost
after alloc. 0 0 $183,200 $226,800 $410,000
Which method is better? Generally, the step down method. Why? Because it recognizes the
effects of the most significant support provided by service departments to other service depts.
The greatest advantage of the direct method is its simplicity if the two methods do not
produce significantly different results; many companies elect the direct method because it is
easier for managers to understand.
Here is another example to make it clearer:
Service Departments Production Departments

Plant Maintenance Info Syst. Machining Assembly Total
After 1st allocation $600,000 $116,000 $600,000 $200,000 $1,316,000
For Plant M. dep.

Labour hours ---------- 1,600 2,400 4,000 8,000
As percentage ---------- 20% 30% 50% 100%
For IS dep.
Computer time 200 1,600 200 2,000
As percentage 10% 80% 10% 100%

Direct Method: purpose distributes total Service Dept. Costs to Prod. Dept.s
Facilities Costs Distribution Machining Assembly

(criterion cost driver)
Plant department $600,000 Labour hours 30/80 x 600,000 50/80 x 600,000

= $225,000 = $375,000
IS department $116,000 Computer time 80/90 x 116,000 10/90 x 116,000

= $103,111 = $12,889
$716,000 $328,111 $387,889

$716,000
Step-Down Method:
Plant Maint. Info Systems Machining Assembly
Direct dept. $600,000 $116,000

cost bef. All.
Step 1: ($600,000) (20/100) x 600,000 (30/100) x 600,000 (50/100) x 600,000

Plant Maint. = $120,000 = $180,000 = $300,000
Step 2: ($236,000) (80/90) x 236,000 (10/90) x 236,000

Info Systems = $209,778 = $26,222
Total cost $389,778 $326,222

after alloc. $716,000
Costs not related to cost drivers
In our examples, a single cost driver caused all costs in a given service department. But what
if some of the costs in facilities management are independent of square footage?
Three alternative methods of allocation should be considered:
1. Identify additional cost drivers. Divide facilities management costs into two or more
different cost pools and use a different cost driver to allocate the costs in each pool.
2. Divide facilities management costs into two cost pools one with costs that vary in
proportion to the square footage (variable costs) and one with costs not affected by
square footage (fixed costs).
3. Allocate all costs by the direct or step-down method using square footage of the cost
driver.
Allocation of costs to outputs
Costs are allocated to products for inventory valuation purposes and for decision purposes
such as pricing, adding products, and promoting products.
Consider our manufacturing example, and assume that the step-down method was used to
allocate service department costs. Exhibit 13-3 showed total costs of $183,200 accumulated in
moulding and $226,800 in finishing of the end of the second allocation. To allocate these

costs to the products produced, cost drivers must be selected for each department. Suppose
machine hours is the best measure (as cost driver) of what causes costs in the moulding
department, and direct-labour hours drive costs in finishing.
Exhibit 13-2 showed 30,000 total machine hours used in moulding and 10,000 direct labour
hours in finishing. Then costs are allocated to products as follows:
Moulding: $183,200/30,000 machine hours = $6.11 per machine hour

Finishing: $226,800/10,000 direct labour hours = 22.68 per direct labour hour
A product that takes 4 machine hours in moulding and 2 direct labour hours in finishing
would have a cost of: (4 x $6.11) + (2 x $22.68) = $24.44 + $45.36 =$69.80 [ = unit
production cost]
Example Problem for Allocation of Service Department Costs

Manufac. Departments Measures of output
Radiology X-ray films processed
Laboratory Tests administered
Daily patients services Patient-days of care (i.e., the number of patients multiplied by the
Number of days of each patients stayt
Budgeted output for 200x7 is 60,000 x-ray films processed in Radiology, 50,000tests administered in
the Laboratory, and 30,000 patient-days in daily patient services. The hospital has decided that the cost
driver for Administrative and fiscal services costs is the direct department costs of the other
departments. The cost driver for plant operations and maintenance is square meter occupied, and for
laundry is pounds of laundry. The pertinent budget data for 200x7 are;
Direct department Square meter Paunds of

Costs Occupied Laundry
Administrative and fiscal services 1,000,000 1,000 ---
Plant operations and maintenance 800,000 2,000 ---
Laundry 200,000 5,000 ---
Radiology 1,000,000 12,000 80,000
Laboratory 400,000 3,000 20,000
Daily patient services 1,600,000 80,000 300,000
Total 5,000,000 103,000 400,000
Required:
1. Allocate service department costs using the direct method
2. Allocate service department costs using the step down method.

Solution:
Administrative Plant Daily
and Operations Patient
Fiscal Services and Laundry Radiology Laboratory Services
Accumulated Base Accumulated Costs Sq.Footage Pounds
1.Direct Method
Direct departmental cost before
allocation $1,000,000 $800,000 $200,000 $1,000,000 $400,000 $1,600,000
Administrative and Fiscal Services (1,000,000) - - 333,333* 133,333 533,334
Plant Operations and Maintenance (800,000) - 101,053* 25,263 673,684
Laundry (200,000) 40,000* 10.000* 150,000*
Total Cost After Allocation $1,474,386 $568,596 $3,957,018
Product output in films, tests, and
Patient-days,respectively 60,000 50,000 30,000
3a.Cost per unit of output $24,573 $11,372 $98,567
2.Step-down Method
Direct departmental costs before
allocation $1,000,000 $800,000 $200,000 $1,000,000 $400,000 $1,600,000
Administrative and Fiscal Services (1,000,000) 200,000 50,000 250,000 100.000 400,000
Plant Operations and Maintenance (1,000,000) 50.000* 120,000 30,000 800,000
Laundry (300,000) 60,000* 15,000 225,000
Total Cost After Allocation $1,430,000 $545,000 $3,025,000
Product output in films, tests, and
Patient-days,respectively 60,000 50,000 30,000
3b. Cost per unit of output $23,000 $10,000 $100,833
$1,000,000/($1,000,000+$400.000+$1,600,000)=33 1/3%;33 1/3%*$1,000,000=$333,333;etc.

$800,000/(12,000+3,000+80,000)=$8.4210526;$8.4210526*12,000 sq.ft.=$101,053;etc.
$200,000/(80,000+20,000+300,000)=$.50;$.50*80,000=$40,000;etc.
$1,000,000/($800,000+$200,000+$1,000,000+$400,000+$1,600,000)=25%;25%*$800,000=$200,000;etc.
$1,000,000/(5,000+12,000+3,000+80,000)=$10,00;$10,00*5,000 sq.ft.=$50,000;etc
$300,000/(80,000+20,000+300,000)=$.75;$.75*80,000

Activity-based Costing
In the past, most departments used direct labour hours as the only cost driver for applying
costs to products. But the use of direct labour hours is not a very good measure of the cause of
costs in modern, highly automated departments. Therefore many companies are implementing
activity-based costing to develop measures that better reflect the consumption of resources
and related costs in their environment.
Why do we need ABC system for factory over head cost?
Deniz, Mehmet and Melih are three college friends who share an apartment. They agree to
split the following monthly costs equally:
Rent and utilies 570

Cable TV 50
Internet access 40
Groceries 240
Total monthly costs 900
After the first few months later, Deniz calls a meeting. Since I started to have my dinner out
side each night, I dont want to pay for the groceries any more. On the other side, Mehmet
told that He was so busy studying on nternet . Therefore he didnt want to pay for cable Tv.
And Melih , since your girl friend eats here most evening , you should pay a double share of
the groceries costs. And Melih told that to the Mehmet f this is the way you feel, then you
should pay for nternet , since you are the only one around here who uses it.
What happened? The friends originally agreed to share the costs equally. But splitting these
costs equally is not equitable. The roommates could use an approach that better matches costs
with the people who participate in each activity. This means splitting the cable TV costs
between Deniz and Melih , assigning the internet acces cost to Mehmet, and allocating the
grocery bill 1/3 to Mehmet and 2/3 to Melih. The following exhibit shows us the results of
this refined system with the original system.
Deniz Mehmet Melih Total

More refined cost allocation system:
Rent and utilies 190 190 190 570
Cable TV 25 -- 25 50
Internet access -- 40 -- 40
Groceries -- 80 160 240
Total costs allocated 215 310 375 900
Less-refined original cost allocation system 300 300 300 900

Difference (85) 10 75 0
As you see total monthly costs are same (900) under both systems. The only difference is
how that 900 is allocated among the three roommates. The amount by which Deniz is
overcosted (85) must exactly equal the amounts by which Mehmet and Melih are
undercosted (10+75).

Principles of Activity-based Costing
Direct materials and direct labour are directly traced to products because there is a physical
measure of their consumption by a particular product. In activity-based costing, by using
appropriate cost drivers, many manufacturing overhead costs can be accurately traced to
products or services.
Why are activity-based costing systems becoming popular? For two main reasons: First, the
profitability of products and customers is more accurately measured by an activity based
costing system. As global competition increases, product mix, pricing and other decisions
require better product cost information.
Illustration of Activity-based Costing
The moulding, process produces three products lines with diverse demands on various
activities and resources. In the former costing system, the rate used to allocate factory
overhead was $27 per direct labour hours. This rate was calculated by dividing the total
expected factory overhead ($1,080,000) by the total of the direct labour hours (40,000). The
use of this volume based driver to allocate factory overhead cost resulted in the unit cost for
the three product line shown in Exhibit 3-1.
Exhibit 3.1 Product cost based on former costing system(traditional system)
Product line A Product line B Product line C

Direct material $1,050,000 $575,000 $240,000
Direct labour 344,000 303,000 123,000
Factory overhead
$27 per DLH
Product line A 486,000
(18,000 DLH)
Product line B 432,000
(16,000 DLH)
Product line C 162,000
(6,000 DLH)
Total costs $1,880,000 $1,310,000 $525,000
Units produced 1,000,000 500,000 150,000
Unit cost $1.88 $2.62 $3.50
A study was performed to determine the activity based costs for the three product lines.
Step 1: Determine the cost objective, key activity centres, resources, and related cost
drivers.
Step 2: Develop a process-based map representing the flower of activities, resources, and
their interrelationships btw. Activities and resources were determined.
Step 3: Collect relevant data concerning costs and the physical flow of cost driver units
among resources and activities.

The costing objective is to determine the costs of product lines A, B, C. Direct material and
direct labour (machine operators) are traced directly to each product. The remaining overhead
resources are listed in Exhibit 3-2 together with the two activity centres and chosen cost
drivers.
Exhibit 3-2: Activity centres, cost-drivers, and resources moulding department
Activity Centre Cost Driver Resources Consumed

Maintenance mechanic time
Supervisor time
Energy (machines had to remain on during
Set up No. of setups
setup activity)
Occupancy space
Moulding machine time
Supplies
Energy
Moulding Supervisor time
Machine hours
process Moulding machine time
Occupancy space
Maintenance mechanic time
Exhibit 3-3 is a graphical representation and summary of the data collected for the two
activity centres identified in step 1. For each activity centre, data collected included traceable
overhead costs and the physical flow of cost driver units.
Exhibit 3-3: Activity-based Costing System
Moulding department
Total Traceable Overhead Cost,
$1,080,000
Traceable overhead costs: $855,000 $225,000

Activity: Moulding process Setup
Physical Flow of C.D. units: 3,800 Machine hours 225 Setups
Cost per driver unit: $225 per machine hour $1,000 per setup
Cost: Product line C Product line B Product line A

Physical Flow of Cost Driver: 1,050 machine 1,750 machine 1,000 machine
hours hours hours
Units for each cost object: 130 setups 70 setups 25 setups

Step 4: Calculate and interpret the new activity-based information.
Notice that the use of just two additional cost drivers (machine hours and setups) can make a
significant difference in product costing. E.g.: product line C was being under-cost by ($4.86 -
$3.50)/$3.50 = 39%. In other words, when the calculation was made in traditional way the
unit cost of product line C was $3.50. But under the calculation of activity-based costing, the
unit cost of product line C is seen as $4.86. Many companies use more than 20 different cost
drivers to improve the accuracy of their costing systems, but the cost associated with using
many activity centres can be high. The benefit-cost criteria applied in each case.
Now, again, what are the steps for calculating under the ABC System?
Find main activities in each production department

Factory Overhead Costs should be recorded of main activity level under the main
account.
Find the best cost drivers for each main activity.
Find how many machine hours and setup numbers did I spent to produce these A, B, C
products.
Calculate for each smaller cost pool, the factory overhead cost application rate.
With using these two factory overhead cost application rates, allocate the total factory
overhead costs to each product line.

Exhibit: 3-5 Key results of Activity-based Costing Study
Activity/Resource (Driver units) Traceable costs (1) Total Physical Flow of C.D. (2) Cost per Driver Unit (1)(2)
Setup (number of setups) $225,000 225 setups $1,000
Moulding process (machine hours) $855,000 3,800 machine hours $225
Product line A Product line B Product line C

Cost per Physical Flow of Cost Physical Flow of Cost Physical Flow of Cost
driver unit driver units driver units driver units
Direct material $1,050,000 $575,000 $240,000
Direct labour 344,000 303,000 123,000
Setup costs $1,000 25 25,000 70 70,000 130 130,000
Moulding process $225 1,000 225,000 1,750 393,750 1,050 236,250
Total $1,644,000 $1,341,750 $729,250
Unit produced 1,000,000 500,000 150,000
Cost per unit $1.64 $2.68 $4.86
(activity-based)
Cost per unit $1.88 $2.62 $3.50
(traditional-based)

Another example for ABC Application:
Indianapolis Auto Parts (IAP) has a seat manufacturing department that uses activity based
costing. IAPs system has the following features:
Activity Allocation base Cost allocation rate

Purchasing Number of purchasing orders 60.00 per purchase order
Assembling Number of parts 0.50per part
Packaging Number of finished seats 0.90 per finished seat
Each seat has 20 parts; direct materials cost per seat is 11. Suppose Ford has asked for a bid
on 50,000 built-in baby seats. IAP will use a total of 200 purchase orders if Ford accepts
IAPs bid.
Required:1. Compute the total cost IAP will incur to purchase the needed materials and then
assemble and package 50,000 baby seats. Also compute the average cost per seat.
2.For bidding, IAP adds a 30% markup to total cost. What price will the company bid for ford
order?
3.Suppose that instead of an ABC system., IAP has traditional product costing system that
allocates all costs other than direct materials at the rate of 65 per direct labor hour. The
baby-seat order will reqire 10,000 direct labor hours. What price will AIP bid using this
systems total costs?
4.Use your answers to requirements 2 and 3 to explain how ABC can help IAP make a better
decision about the bid price it will offer Ford?
Solution:1.Direct materials, 50,000x11.00 550,000

Activity costs: Purchasing,200x60.00 12,000
Assembling,50,000x20x0.50 500,000
Packaging,50,000x0.90 45,000
Total cost of order 1,107,000
Divide by number of seats 50,000
Average cost per seat 22.14
2.Bid price (ABC) system)

Bid price (1,107,000x130%) 1,439,100
3.Bid price (traditional system)

Direct materials, 50,000x11.00 550,000
Other product costs, 10,000x65 650,000
Total cost of order 1,200,000
Bid price (1,200,000x130%) 1,560,000
4. Higher bid price that reduces IAPs chance of winning the bid. The ABC system shows that
IAP can increase its change of winning the bid by bidding a lower price and still make profit.

Problem for ABC 1
Assume that Circuitech Corporation is one of Deels circuit board suppliers. This company
uses a traditional costing system that allocates all indirect manufacturing costs based on
machine hours, but at Dells urging, it decided to move to activity based costing, Youve been
asked to compare the two costing methods for the next company board meeting. Your
supervisor has given you the following quarterly data for products LP.7310 and PC.33:
Assembly Soldering Inspection

Total indirect costs for the quarter 630,0000 270,000 160,000
Allocation base MH Number of batches Testing hours
LP-7310 PC-33
Direct cost of production (materials, labor) 162,400 178,240
Machine hours (assemply) 480 1,080
Number of batches produced (Soldering) 60 40
Testing hours (Inspection) 6,000 8,000
Number of units per batch 100 100
When you completed your calculations answer these questions.
1.What is the total manufacturing cost per unit under traditional costing for both of the
products?
2. What is the total manufacturing cost per unit under activity based costing for both of the
products?
3.What conclusions do you draw from these calculations? Explain it.
Problem for ABC 2
A company has the following data:

Activity Cost driver
Materials handling Direct material cost
Engineering Engineering change notices
Power Kilowatt hours
Three types of cordless phohes are produced: CL3,CL5, and CL9. Direct costs and cost driver
activity for each product for a recent month are as follows:
CL3 CL5 CL9 Total
Direct materials cost 25,000 50,000 125,000 200,000
Direct labor cost 4,000 1,000 3,000 8,000
Kilowatt hours 50,000 200,000 150,000 400,000
Engineering change notices 13 5 2 20
Manufacturing overhead for the month was:

Materials handling 10,000
Engineering 30,000
Power 24,000
Total manufacturing cost 64,000
Required 1. Compute the manufacturing overhead allocated to each product with the activity
based accounting system.
2.Suppose all manufacturing over costs had been allocated to products in proportion to their
direct labor costs. Compute the manufacturing overhead allocated to each product.

3.In which product costs, those in requirement 1 or those in requirement 2, do you have the
most confidence?Why?
Solution: 1.
CL3 CL5 CL9

Material handling activity cost allocation, cost driver direct material cost
(25/200)X10000=1250 (50/200)X10000= 2500 (125/200)X10000=6250
Engineering activity cost allocation, cost driver engineering change notice
(13/20)X30000= 19500 (5/20)X30000= 2500 (2/20)X30000= 3000
Power activity cost allocation, cost driver Kilowatt hours
(50/400)X24000=3000 (200/400)X24000=12000 (150/400)X24000= 9000
Total FOC for -------- --------- ----------
Each product 23750 22000 18250
2. Total FOC /Cost driver =FOC application rate for traditional system
64,000/8,000DLC =8/per DLC
CL3 CL5 CL9

Used DLC for each product 4,000 1,000 3,000
Allocation rate 8/DLC 8 8
Allocated FOC for each product 34,000 8,000 24,000
For traditional system
Allocated FOC for each product

For ABC system 23750 22000 18250
Over (under) applied 8,250 (14,000) 5,750 difference 0
3. Of course first costing system is the most confidence. Because we did more detail
calculation for it.
Allocation of joint costs and by-product-costs
By definition; such costs relate to more than one product and cannot be separately identified
with an individual product.
Milk dairy farm

A butter
Production
B cream
process
C - milk
Joint costs
split off point
Joint costs
Joint costs include all inputs of material, labour and overhead costs that are incurred before
the split off point. Allocation of joint costs should not affect decisions about the individual
products. Nevertheless, joint product costs are routinely allocated to products for purposes of
inventory valuation and income determination. Joint cost allocations results should not be

used in the decision making process, because there is no cause-and-effect relationship

between joint products and the sources demanded each joint products.
Two conventional ways of allocating joint costs to products are widely used:
- physical units method
- relative sales value method
A department in Dow Chemical Company produces two chemicals, X and Y. The joint cost is
$100,000 and production is 1,000,000 litres of X and 500,000 litres of Y. X can be sold for
$0.09 per litre and Y for $0.06 per litre.
If physical units method were used, the joint costs would be allocated as follows:
Joint product Litres Weighting x Joint Allocation of Joint

Cost costs
X 1,000,000 10/15 x $100,000 $66,667
Y 500,000 5/15 x $100,000 $33,333
$1,500,000 $100,000
The physical unit method requires a common physical unit for measuring the output of each
product. E.g.: board feet is a common unit for a variety of product in the lumber industry.
However, sometimes such a common denominator is locking. Consider the production of
meat and hides from butchering a steer. You might use pounds as a common denominator, but
pound is not a good measure for the output of hides. As an alternative, many companies use
the relative sales value method for allocating joint costs:
Joint product Relative sales value Weighting x Joint Allocation of Joint

at split off Cost costs
X 90,000 90/120 x $100,000 $75,000
Y 30,000 30/120 x $100,000 $25,000
$120,000 $100,000
The relative-sales-value method can also be used when one or more of the joint products
cannot be sold of the split-off point. To apply the method, we approximate the sales value at
split-off as follows:
Sales value at split-off = Final sales value separable costs
E.g.: suppose the 500,000 litres of Y requires $20,000 of processing beyond the split-off
point, after which it can be sold for $0.10 per litre. The sales value at split-off would be
($0.10 x 500,000) = $50,000 - $20,000 = $30,000.
By-Product Costs
They have relatively insignificant total sales values in comparison with the other products
emerging at split-off. Examples of by-products are glycerine from soap making and mill ends
of cloth and carpets. In a meat processing company, whilw meat is example for joint product,
bone will be given an example for by product. Because its relative sales value is lower than
meat sales value.
If an item is accounted for as a by-product, only separable costs are allocated to it. All joint
costs are allocated to the main products. Any revenues from by-products, less their separable
costs, are deducted from the cost of the main products.
Consider a lumber company that sells sawdust generated in the production of lumber to
companies making particle board. Suppose the company regards the sawdust as a by-product.
In 20X2 sales of sawdust totalled $30,000. Inventory cost of the sawdust would consist of

only the $20,000 separable cost. None of the joint cost of producing lumber and sawdust
would be allocated to the sawdust. Difference between revenue and separable cost, $30,000 -
$20,000 = $10,000 would be deducted from the cost of the lumber produced.

Chapter 4 Job Costing Systems, Overhead Application, Service Industries

We can make the following classifications of cost accounting systems:
According to the used numbers in costing system:
Actual costing accounting system

Future orientated accounting system
According to the taken cost items in production cost:
Full costing accounting system

Variable costing accounting system
According to the nature of production line (process):
Job order costing system

Hybrid order costing system
Process order costing system
Distinction btw. Job costing and Process costing
Two extremes of product costing are job costing and process costing.
Job order costing allocates costs to products that are readily identified by individual units or
batches, each of which requires varying degrees of attention and skill. Industries that
commonly use job order methods include construction, printing, aircraft, furniture, special-
purpose machinery, and any manufacture of tailor-made or unique goods.
Process costing averages costs over large numbers of nearly identical products. It is most
often found in such industries as chemicals, oil, textiles, plastics, paints, flour, rubber, glass,
mining, cement, and meat packing. These industries involve mass production of like units,
which usually pass in continuous fashion through a series of uniform production steps called
operations or processes.
Job costing and process costing are extremes along a continuum of potential costing systems.
Each company designs its own accounting system to fit its underlying production activities.
Many companies use hybrid costing systems, which are blends of ideas from both job costing
and process costing.
Illustration of Job order costing
The centrepiece of a job costing system is the job cost record (also called a job cost sheet or
job order), shown in Exhibit 4-1. All costs for a particular product, service or batch of
products are recorded on the job costing record. This job costing sheet is a vice notebook of
the work on process inventory account (in short WIP).
The job cost record summaries information contained on source documents such as materials
requisitions and labour time tickets. Material requisitions are records of materials issued to

particular jobs. Labour time tickets (or time cards) record the time a particular direct labour
spends on each job.
As each job begins, a job-cost record is prepared. As units are worked on, entries are made on
the job-cost record. Three classes of costs are applied to the units as they pass through the
departments: material requisitions are the source of direct material costs, time tickets provide
direct labour costs, and budgeted overhead rates are used to apply factory overhead to
products.

Exhibit 4-1: Completed job-cost record and sample source documents
Job Cost Record: Machining Department
Date Started 1/7/X6 Job No 963

Date Completed 1/4/X6 Units Completed 12
Cost Date Ref. Quantity Amount Summary

Direct Materials:
6Bars 1/7/X6 N41 24 120.00
Casings 1/9/X6 K56 12 340.00 450.00
Direct Labor:
Drill 1/8/X6 7Z4 7.0 105.00
1/9/X6 7Z5 5.5 82.50
Grind 1/13/X6 9Z2 4.0 80.00 267.50
Factory Overhead:
Applied 1/14/X6 9.0 Mach.Hrs. 180.000 180.00
Total Cost 907.50
Unit Cost 75.625
Direct Materials Requisition: No N41 Time ticket no Z74

Job No. 963 Date 1/7/X6 Employee no 464-89-7265
Department Machining Department Machining
Date 1/8/X6
Descript Quantity Unit Amount
Cost Start End Hours Rate Amount Job
6Bars 24 5.00 120.00 8:00 11:30 3.5 15.00 52.50 963
12:30 4:00 3.5 15.00 52.50 963
Authorization J.Hays 4:00 6:00 1.0 15.00 15.00 571
Totals 8.0 120.00
Supervisor M.Butler

The following is a summary of pertinent transactions for the year 19x6:
Machining Assembly Total

1. Direct materials - - $1,900,000
purchased on account
2. Direct materials $1,000,000 $890,000 $1,890,000
requisitioned for
manufacturing
3. Direct labor cost 200,000 190,000 390,000
incurred
4a. Factory overhead 290,000 102,000 392,000
incurred
4b. Factory overhead 280,000 95,000 375,000
applied
5. Cost of good - - 2,500,000
completed and
transferred to
finished-goods
inventory
6a. Sales on account - - 4,000,000
6b. COGS - - 2,480,000
Explanation of transactions
The following transaction-by-transaction summary analysis will explain how product costing
is achieved.
Journal records
1)
Direct Material Inventory 1,900,000
Accounts Payable 1,900,000
Direct materials purchased
2)
WIP Inventory 1,890,000
Direct-materials inventory 1,890,000
According to the direct materials requisitions, requisitioned direct materials
3)
WIP inventory 390,000
Accrued Payroll 390,000
According to the labour time tickets, incurred direct labour costs
4a)
Factory department overhead control 392,000
Cash, Accounts Payable, and so on 392,000
Actual overhead are recorded when they incurred.

4b)
WIP inventory 375,000
Factory department overhead control 375,000
Applied overhead are recorded without waiting the end of the period. (A fuller explanation occurs later in this chapter)
5)
Finished goods inventory 2,500,000
WIP inventory 2,500,000
When the product is completed, the cost of goods completed is recorded to the finished goods inventory.
6a)
Accounts Receivable 4,000,000
Sales 4,000,000
Sales on account is recorded
6b)
COGS 2,480,000
Finished goods inventory 2,480,000
As goods are sold, their costs become expense in the form of cost of goods sold.
With an additional journal record under applied or over applied overhead is corrected.
Journal Flows of costs (thousands)

General ledger
Direct Direct Materials Inventory Work in Process Inventory Finished goods Inventory COGS
Material Bal. 110 Bal. 12
Purchases (1) 1,900 (2) 1,890 (2) 1,890 (5) 2,500 (5) 2,500 (6b) 2,480 (6b) 2,480
Direct
labour (3) 390
$390 Factory Dept Overh Contr
(4a) 392 (4b) 375 (7) 17 under-
Factory (7) 17 (4b) 375 applied applied
Overhead This subject will be explained later!
$392
Accounting for factory overhead
In our example, factory overhead of $375,000 was applied to the WIP account. This section
describes how to determine the amount of applied factory overhead.
Few companies wait until the actual factory overhead is finally known before computing the
costs of products. Instead they compute a budgeted (predetermined) overhead rate at the
beginning of a fiscal year and use it to apply overhead costs as products are manufactured.
The following steps summarize how to account for factory overhead:
1. Select one or more cost drivers to serve as a base for applying overhead costs.
2. Prepare a factory-overhead budget for the planning period, ordinary a year.
3. Compute the budgeted factory-overhead rate(s) by dividing the budgeted total
overhead by the budgeted cost driver activity.
4. Obtain actual cost driver data (such as machine hours) as the year unfolds
5. Apply the budgeted overhead to the jobs by multiplying the budgeted rate(s) times the
actual cost driver data
6. At the end of the year, account for any differences btw. the amount of overhead
actually incurred and overhead applied to products.
Illustration of overhead application
The following manufacturing-overhead budget has been prepared for the coming year 20x7:
Machining Assembly
Indirect labour $75,600 $36,800
Supplies 8,400 2,400
Utilities 20,000 7,000
Repairs 10,000 3,000
Factory rent 10,000 6,800
Supervision 42,600 35,400
Depreciation on equipm. 104,000 9,400
Insurance, property taxes etc. 7,200 2,400
$277,800 $103,200
Budgeted overhead application rate = Total budgeted factory overhead

Total budgeted amount of cost driver
(such as direct labour costs or machine hours)
Suppose machine hours are chosen as the only cost driver in machining department, and direct
labour cost is chosen in assembly department. The overhead rates are as follows:
Year 20x7
Machining Assembly
Budgeted manufact. overh. $277,800 $103,200
Budgeted machine hours 69,450
Budgeted direct labour costs $206,400
Budgeted overhead rate per
$4
machine hour:
(is a factory overhead cost)
$277,800/69450
Budgeted overhead rate per
direct labour dollar: 50%
$103,200/206,400
We can calculate the total overhead applied in our illustration with multiplying actual
machine hours or labour costs with the budgeted overhead rates:
Machining: actual machine hours of 70,000 x $4 = $280,000

Assembly: actual direct labour cost of $190,000 x 50% = $95,000
Total factory overhead applied $375,000
As you see it before in entry 4b, journal entry for the application was:
_________________________________/_______________________________
4b)
WIP Inventory $375,000
Factory Department overhead control $375,000
Disposition of under-applied or over-applied overhead
Our example contained the following data:
Transaction:
4a) Factory overhead incurred $392,000
4b) Factory overhead applied $375,000 (-)
Under-applied factory overhead $ 17,000
When the amount applied to product exceeds the amount incurred by the departments,
difference is called as over-applied overhead. When the amount applied is less than incurred,
the difference ($17,000 under-applied in our example) is disposed of either through a write off
or through pro-ration.
Immediate write-off method
This is a common used approach. The immediate write off entry, labelled as transaction 7 in
Exhibit 14-2.
7)
COGS 17,000
Factory Department Overh. Control 17,000
To close ending under-applied overhead directly to COGS:
__________________________________/_______________________________

Pro-ration among Inventories Method
This method prorates under or over-applied overhead among three accounts. So a practical
attach is to prorate on the basis of the ending balances in each of three accounts. (WIP:
$155,000; Finished Goods: $32,000; and COGS: $2,480,000)
(1) (2) (3)

Unadjusted Balance, Pro-ration of under-applied Adjusted
End of 19x2 overhead Balance, End of
19x2
WIP $155,000 155/2,667 x 17,000 = $988 $155,988
Finished goods 32,000 32/2,667 x 17,000 = 204 32,204
COGS 2,480,000 2,480/2,667 x 17,000 = 15,808 2,495,808
$2,667,000 $17,000 $2,634,000
The journal entry for the pro-ration follows:

____________________________________/__________________________________
WIP 988
Finished goods 204
COGS 15,808
Factory Department overhead control 17,000
To prorate ending under-applied overhead among three accounts:

____________________________________/___________________________________
Another example of job order costing application:
Estimated values:
Dep. A Dep. B
Direct Labour Cost 1,500,000 200,000
Factory Overhead 1,820,000 1,000,000
DLH 90,000 125,000
MH 350,000 20,000
Job order no. 455
Dep. A Dep. B
Direct Material Cost 12,000 32,000
Direct Labour Cost 10,800 10,000
DLH 900 1,250
MH 3,500 150

1. What is the budgeted overhead cost for Dep. A and B?
Budgeted overhead rate for:
Dep. A: 1,820,000/350,000 = $5.20 per MH

Dep. B: 1,000,000/125,000 = $8.00 per DLH
2. What is the total applied overhead cost of job order no. 455?
Dep. A: 3,500 MH x 5.20 = $18,200

Dep. B: 1,250 DLH x 8.00 = $10,000
Total applied overhead c. for job order no. 455 $28,200
3. If job order no. 455 consists of 120 units of product, what will the unit cost of this
product be?
Dep. A Dep. B Total

Actual direct material cost 12,000 32,000 44,000
Actual direct labour cost 10,800 10,000 20,800
Applied factory overhead 18,200 10,000 28,200
Total prod. Cost for job order no. 455 93,000
Unit production cost 93,000/120 units = $7.75 per unit
4. At the end of period, actual results for the years operations were as follows:
Dep. A Dep. B
Actual factory overhead cost 1,300,000 1,200,000
Actual DL hours 80,000 120,000
Actual working hours 300,000 25,000
Find the under-applied or over-applied overhead for each department and for the factory as a
whole!
Dep. A Dep. B Total

Actual overhead 1,300,000 1,200,000 2,500,000
Applied overhead as a whole
company:
For Dep. A: 300,000 MH x 5.20 1,560,000
For Dep. B: 120,000 DLH x 8.00 960,000 2,520,000
Over-/ under-applied factory 260,000 (240,000) 20,000
overhead over-applied for under-applied over-applied for the
Dep. A for Dep. B company as a whole

New problem for making correction about under or over applied FOC
Actual factory overhead 134,000

Applied factory overhead 126,000
COGS 525,000
Gross Profit 60,000
Ending inventory:
Direct Material 25,000
WIP 75,000
Finished Goods 150,000
250,000
1. Was factory overhead over- or under-applied? By how much?
Actual 134,000
Applied 126,000
8,000 under-applied FOC
2. Under the assumption of the write-off method, make the correction journal entry.
COGS 8,000
Fact. Dep. Overh. 8,000
(To close ending under-applied overhead directly to the COGS Account)
And compute adjusted gross profit!
60,000 8,000 = 52,000

After correction, our gross profit will be seen as 52,000
3. Assume that actual factory overhead was 124,000 and solve the problem with using
write-off method.
Actual 124,000
Applied 126,000
2,000 over-applied

COGS 2,000
Gross profit: 60,000 + 2,000 = 62,000
4. Solve the problem under the assumption of distribution of inventories method.
WIP 75,000 75/750 800

Finished goods 150,000 150/750 1,600
COGS 525,000 525/750 5,600
750,000 750 8,000
under-applied

WIP 800
Finished goods 1,600
COGS 5,600
Product costing in service and non-profit organizations
This chapter has concentrated on how to apply costs to manufactured products. However, the
job-costing approach is used in non-manufacturing situations too. E.g.: universities have
research projects, airlines have repair and overhead jobs, and public accountants have
audit engagements. In such situations, the focus shifts from the costs of products to the
costs of services.
In service industries such as repairing, consulting, legal, and accounting services each
customer order is a different job with a special account or order number. E.g.: automobile
repair shops typically have a repair order for each car worked on, with space for allocating
materials and labour costs.

Chapter 5 - Process Costing Systems
Process costing compared with job costing
As you know, job costing and process costing are used for different types of products. In
firms of industries such as printing, construction, and furniture manufacturing, job costing
system is used. Process costing is used when there is mass production through a sequence of
several processes, such as mixing and cooking.
Examples include chemicals, flour, glass and toothpaste.
Exhibit 5-1: Comparison of job order and process costing
Panel A: Job order costing
Job 100
Direct materials Finished COGS

Direct labour Job 102 Goods
Factory overhead
Job 101
Work in Process Finished Goods COGS

xxx xxx xxx xxx xxx xxx
Panel B: Process Costing
Process A
Direct materials
Direct labour Process B
Factory overhead
Finished COGS
Assembly Goods
Work in Work in Work in Finished COGS

Process Process Process Goods
Department A Department B Assembly
xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Process-costing systems are usually simpler and less expensive than job-order costing. There
are no job-cost records. The unit cost for inventory purposes is calculated by accumulating the
costs of each processing department and dividing the cost by an appropriate measure of
output.
Application of Process Costing
Oakville Wooden Toys Inc., buys wood as a direct material for its Forming Department. The
department processes only one type of toy marionettes. The marionettes are transferred to the
Finishing Department. Forming department manufactured 25,000 units during April and its
costs that month were:
Direct materials: $70,000
Conversion costs:
Direct Labour $10,625
Factory Ovhd $31,875 $42,500
Costs to account for $112,500
It is not difficult to calculate the unit cost of this product under this information like this.
Total forming department cost $112,500__

Product units 25,000 units = $4.50
But what if not all 25,000 unit marionettes were completed during April? E.g.: assume that
5,000 were still in process at the end of April only 20,000 were started and fully completed.
Under this information, it can not be written as 25,000 units on the above formula. To give an
answer for this problem, we shall follow the following basic five steps:
Step 1: Write the flow of physical units
Step 2: Calculate output in terms of equivalent units
Step 3: Summarize the total cost to account for, which are the costs applied to work in process
Step 4: Calculate unit costs with dividing costs to equivalent units.
Step 5: Apply costs to units completed and to units in the ending work in process
Physical Units and Equivalent Units (Steps 1 and 2)
Equivalent unit = unfinished unit X completed percent, for example, if 2 unfinished units
were completed 50% then 2 x 50% is called as 1 equivalent unit.
In other reality, computation of equivalent unit requires estimates of degrees of completion

for inventories in process. In our example, the end of April it is assumed that 20,000 units
were completed and transferred to the finishing department and 5,000 units were completed
25% for conversion costs and 100% completed for direct material.
Under this information, we can prepare the following calculations in Exhibit 15-2.

Exhibit 5-2: Forming Department Output in Equivalent units for the month ended April 30,
19x1
Step 1 Step 2
Physical units Equivalent units (EU)
Flow of production Direct materials Conversion costs
Started and
20,000 20,000 20,000
completed
Work in process,
5,000 5,000 1,2503
ending inventory
Units accounted for
25,000 25,000 EU 21,250 EU
work done to date
Calculation of Product costs (Steps 3 to 5)
Exhibit 5-3 is a production-cost report. It shows steps 3 to 5 of process costing.

Exhibit 5-3: Forming Department Production Cost Report month ended April 30, 19x1
Details
Total Costs Direct Conversion
Material cost Costs
Step 3: Cost to account for $112,500 $70,000 $42,500
Step 4: Divide by equiv. units 25,000 21,250
Unit costs $4.80 $2.80 $2.00
Step 5: Application of costs

- to units completed and transferred to the $96,000
Finishing Department: 20,000 units x $4.80 =
$96,000
- to units not completed and still in process, April
30, 5000 units
Direct materials $14,000 (5,000 x $2,80)
Conversion costs 2,500 (1250 x $2.00)
Work in process, April 30 $16,500
Journal entries for the data in our illustration would be:

1)Work in process-Forming 70,000
Direct materials inventory 70,000
(Materials used in production in April)
2)Work in process Forming 10,625
Accrued Payroll 10,625
(Direct labour in April)
3)Work in process Forming 31,875
Factory Overhead 31,875
(Factory overhead applied in April)
4)Work in process Finishing 96,000
Work in Process Forming 96,000
(Cost of goods completed and transferred in April from Forming to Assembly)
3
5,000 physical units x .25 degree of completion of conversion costs

The $112,500 added to the work in process Forming account less the $96,000 transferred
out leaves an entry balance of $16,500:
Work in process - Forming

1. Direct materials $70,000 4. Transferred out to finishing $96,000
2. Direct labour 10,625
3. Factory overhead 31,875
Costs to account for $112,500
Balance, April 30 $16,500
Problem: The following data was taken from a company:

Units:
Started and completed: 30,000 units
Started and still in process: 10,000 units; 100% completed for direct materials, but 60%
completed for conversion costs
Costs applied:
Total: $81,600; direct materials, $60,000; conversion, $21,600
Required: Compute the cost of work completed and the cost of the ending inventory of
work in process.
Solution:
Step 1 Step 2
Physical units Equivalent units
Flow of production Direct materials Conversion
Started and 30,000 30,000 EU 30,000 EU
completed
Ending work in 10,000 10,000 EU4 6,000 EU5
process
Work done to date 40,000 40,000 EU 36,000 EU
Details
Direct Conversion
Total Costs
Methods Costs
Step 3: Cost to account for $81,600 $60,000 $21,600
Step 4: Divide by equiv. units 40,000 36,000
Unit costs $2.10 $1.50 $0.60

- to units completed and $63,000
transferred: 30,000 units x
$2.10 = $63,000
- to units not completed and
still in process, 10,000 units
Direct materials $15,000 (10,000 x $1,50)
Conversion costs 3,600 (6,000 x $0.60)
4
10,000 x 100%
5
10,000 x 60%

Work in process, April 30 $18,600

Total cost accounted for $81,600
Effects of Beginning inventories
When beginning inventories are present, product costing becomes more complicated. Because
we need an assumption for the relationship btw. the cost of the beginning inventories and the
cost of started and completed products in calculation period. To do this, we will discuss
common methods: the weighted average method and the first-in, first-out method. (FIFO)
Data for calculations:

Started units in April: 22,000 units
March 31 April 30
Beginning inventories: Ending inventories:

6
3,000 units started and completed 5,000 units
Completed percent: Completed percent:
Dir. Mat.: 100% 17,000 units Dir. Mat.: 100%
Conversion: 40% Conversion: 25%
Costs :
Work in process, March 31
Direct materials $7,320
Conversion costs 2,119 $9,439
Direct materials added during April 70,180
Conversion costs added during April 42,506
(10,625 + 31,881)
Total costs to account for $112,125
Completed in April 20,000units
Weighted Average Method
In this method, the costs of (1) all work done in the current period to (2) the work done in the
preceding period on the current periods beginning inventory of work in process. This total is
divided by the equivalent units of work done to date, whether that work was done in the
current period or previously.
The computation of equivalent units ignores whether all 25,000 units to account for came
from beginning work in process, or all were started in April, or some combination thereof.
6
started and completed = completed beginning inventory
20,000 3,000 = 17,000 units

Solution:
Step 1 Step 2
Physical
Equivalent units
units
Work in process, March 31 3,000 30,000 EU 30,000 EU
Started in April 22,000 10,000 EU 6,000 EU
To account for 25,000 40,000 EU 36,000 EU
Completed and transferred 20,000 20,000 EU 20,000 EU
Work in process, April 30 5,0007 5,000 EU 1,250 EU
Units accounted for 25,000 25,000 EU 21,250 EU
Details
Material costs Costs
Step 3: Work in process, March $9,439 $7,320 $2,119
31
Cost added currently 112,686 70,180 42,506
Total costs to account for $122,125 $77,500 $44,625
Step 4: Divisor, equivalent units 25,000 21,250
for work done to date
Unit costs (weighted averages) $5.20 $3,10 $2.10

Completed and transferred, $104,000
20,000 units x $5,20
Work in process, April 30,
5,000 units
Direct materials $15,000 (5,000 EU x $3.10)
Conversion costs 2,625 (1,250 EU x $2.10)
Total work in process $18,125
Total costs accounted for $122,125
First-In, First-Out Method
This method sharply distinguishes the current work done from the previous work done on the
beginning inventory of work in process. The calculation of equivalent units is confined to the
work done in the current period. (April in this illustration)
7
direct material 100%, conversion cost 25%

Exhibit 5-6: Forming Department
Step 1 Step 2
Physical Equivalent units
units
Work in process, March 31 3,000
Started in April 22,000
To account for 25,000
Work in process, April 30 5,000 5,000 1,2508
Units accounted for 25,000
Work done to date 25,000 EU 21,250 EU
Less: Equivalent units of work - 3,0009 - 1,20010
from previous periods included
in beginning inventory
Work done in current period 22,000 EU 20,050 EU
only
Exhibit 5-7 Forming Department Production Cost

Report for the month ended April 30, 19x1 (FIFO method)
Details
Step 3: Work in process, March $9,439
Work done before April
31
of work done in April only
Unit costs (FIFO) $5.31 $3,19 $2.12

Work in process, April 30
Direct materials $15,950 (5,000 EU x $3.19)
Conversion costs 2,650 (1,250 EU x $2.12)
Completed and transferred $103,52511
out (20,000 units) $122,125 -
$18,100
8
5,000 x 25%
9
3,000 x 100%
10
3,000 x 40%
11
Check: Work in process, March 31 $9,439
Additional costs to complete, conversion costs of 60% (3,000 x 2.12) $3,816
Started and completed, 22,000 5,000 = 17,000 x $5.31 $90,270
Total costs transferred $103,525
Unit cost transferred, $103,525 20,000 units = $5.17625

Differences Between FIFO And Weighted-Average Methods
- The key difference between the FIFO and weighted-average computation is equivalent units:
FIFO-Equivalent units are the work done in the current period only.
Weighted-average-Equivalent units are the work done to date including the earlier
work done on the current periods beginning inventory of work in process.
- Differences in unit costs between FIFO and weighted average methods are ordinarily
insignificant.
- The FIFO method involves more detailed computations than the weighted average method.
That is why FIFO is almost never used in practice in process costing for product-costing
purposes. However, the FIFO equivalent units for current work done are essential for planning
and controlling purposes.
Problem
With using the following data, calculate the cost of work completed and the cost of the ending
inventory of work in process, using both the (1) Weighted-average (WA) method and (2)FIFO
method.
Units
Beginning work in process:5,000units; 100% completed for materials,40% comleted for
conversion cots.
Started during month:28,000 units
Comleted during month:31,000 units
Ending work in process:2,000 units;100% completed for materials, 50% completed for
conversion costs.
Costs
Beginning work in process
Direct materials 8,060
Conversion costs 1,300 9,360
Direct materials added in current month 41,440
Conversion costs added in current month 14,700
Total costs to account for 65,500

Solution the problem
Step 1 Step 2
Physical Equivalent units
units
Work in process begining 5,000
Started in April 28,000
To account for 33,000
Work in process, ending 2,000 2,000 1,00012
Units accounted for 33,000
Work done to date WA 33,000 EU 32,000 EU
Less: Equivalent units of work - 5,00013 - 2,00014
from previous periods included
in beginning inventory
Work done in current period 28,000 EU 30,000 EU
only FIFO
Production Cost Report for the month ended (FIFO method)
Details
Step 3: Work in process, begining $9,360 Work done before month
of work done in April only
Unit costs (FIFO) $1,97 $1,48 $0,49

Work in process, ending
Direct materials $2,960 (2,000 EU x $1,48)
Conversion costs 490 (1,000 EU x $0,49)
Completed and transferred $62,05015
out (31,000 units) $65,500 -
$3,450
12
2,000x100%=2,000;2,000x50%=1,000
13
5,000x100%=5,000
14
5,000 x 40%=2,000
15
Check: Work in process, begining $9,360
Additional costs to complete, conversion costs of 60% (5,000 x 0,49) $1,470
Started and completed, 31,000 5,000 = 26,000 x $1,97 $51,220
Total costs transferred $62,050
Unit cost transferred, $62,050 31,000 units = $2.00161

Production Cost Report for the month ended (WA method)
Details
Step 3: Work in process, begining $9,360 $8,060 $1,300
Total costs to account for $65,500 $49,500 $16,000
for work done to date
Unit costs (weighted averages) $2,00 $1,50 $0,50

Completed and transferred, $62,000
31,000 units x $2,00
Work in process, ending
2,000 units
Direct materials $3,000 (2,000 EU x $1,50)
Conversion costs 500 (1,000 EU x $0,50)

Chapter 6 - Flexible Budgets and Variances Analysis

All the master budgets are static or inflexible because they are prepared for only one level of
activity for example, in Dominion Company the master budget called for production and sales
of 9,000 units, but only 7,000 units were actually produced and sold. Exhibit 6-1 shows
variances of actual results from the master budget; these are called as master (static) budget
variances.
Actual revenues that exceed expected revenues result in favourable revenue variances or
actual expenses that are less than budgeted expenses result in favourable expense variances.
Exhibit 6-1: Dominion Company Performance Report Using Master Budget for the month
ended June 30, 19x3
Master Budget
Actual (1) Master Budget (2)
variances (3)
Units 7,000 9,000 2,000
Sales $217,000 $279,000 $62, 000U
Variable expenses:
Variable manufacturing $151,270 $189,000 $37,730F
expenses
Shipping expenses 5,000 5,400 400F
(selling)
Administrative expenses 2,000 1,800 200U
Total variable expenses $158,270 $196,200 $37,930F
Contribution margin $58,790 $82,800 $24,070U
Fixed expenses:
Fixed manufacturing $37,300 $37,000 $300U
expenses
Fixed selling and 33,000 33,000 -
administrative expenses
Total fixed expenses $70,300 $70,000 $300U
Operating income (loss) $(11,570) $12,800 $24,370U
U = Unfavourable expense variances occur when actual expenses are more than budgeted
expenses
F = Favourable expense variances
Why is there an operating loss of $11,570 when a profit of $12,800 was budgeted?
Considering the lower-than protected level of sales activity, was cost control really
satisfactory? The comparison of actual results with a master budget does not give much help
in answering those questions.

Flexible Budgets
In contrast, a more helpful data for analysis is the flexible budget. A flexible budget adjusts
for changes in sales volume and other cost driver activities. For performance evaluation, the
flexible budget would be prepared at the actual levels of activity achieved.
Flexible budgets have the following main advantages;
(1) They may be prepared for a range of activity and
(2) They provide a dynamic basis for comparison with the actual results.
Flexible-Budget Formulas
Flexible budget is based on knowledge of cost behaviour regarding appropriate cost drives-
cost functions or flexible-budget formulas. The flexible budget incorporates effects on each
cost and revenue caused by changes in activity. Exhibit 6-2 and 6-3 show Dominion
Companys simple flexible budget, Dominion Companys cost functions or flexible budget
formulas are believed to be valid within the relevant range of 7,000 to 9,000 units. Note that
fixed costs are expected to be constant across this range of activity.
Exhibit 6-2: Dominion Company Flexible Budgets
Flexible Budgets for various levels of sales/production activity

BUDGET FORMULA PER UNIT
Units 7,000 8,000 9,000
Sales $31.00 $217,000 $248,000 $279,000
Variable costs/expense:
Variable manufacturing costs $21.00 $147,000 $168,000 $189,000
Shipping expenses (selling) 0.60 4,200 4,800 5,400
Administrative 0.20 1,400 1,600 1,800
Total variable costs/expenses $21.80 $152,600 $174,400 $196,200
Contribution margin $9.20 $64,400 $73,600 $82,800
BUDGET FORMULA PER MONTH
Fixed Costs:
Fixed manufacturing costs $37,000 $37,000 $37,000 $37,000
Fixed selling & admin. costs 33,000 33,000 33,000 33,000
Total fixed costs $70,000 $70,000 $70,000 $70,000
Operating income (loss) $(5,600) $3,600 $12,800

Exhibit 6-3: Dominion company Graph of flexible budget of costs
$320,000 Total cost =

$70,000 per month
250,000 + $21.80 per unit
Variable cost =
Total $21.80 per unit
Costs 200,000
150,000
100,000
50,000 Fixed cost =

$70,000 per month
7 8 9
No. of units (thousands)
For example, total costs for 9,000 unit activity level will be calculated with using total cost or
flexible budget formula: TC = 70,000 + $21.80 (9,000 units) = $266,200
Then profit for 9,000 units for this company: Total Sales Total costs ($279,000 - $266,200 =
$12,800 as you see in Exhibit 8-12.
Evaluation of Financial Performance Using Flexible Budget
There are basically two reasons why actual results might not have conformed to the master
budged.
Only one is that sales and other cost-driver activities were not the same as originally
forecasted. The second is that revenues or variable costs per unit of activity and fixed costs
per period were not as expected.
Total master budget variances are divided under two main variances as;
1-Total flexible-budged variances and

2-Total sales activity variances
While these variances between the flexible budget and actual results are called as flexible
budged variances, differences between the master budged amounts and the amounts in the
flexible budged are also called as activity-level variances like this in exhibit 6-4.

Exhibit 6-4: Dominion Company Summary of Performance for the Month Ended June
30,19x4
Actual
Flexible
Results at Flexible
Budget for Sales activity Master
actual Budget
actual sales variances Budget
activity Variances17
activity18
level16
(1) (2)= (1) (3) (3) (4)= (3) (5) (5)
Units 7,000 - 7,000 2,000 U 9,000
Sales $217,000 - $217,000 $62,000 U $279,000
U
Variable 158,270 5,670 152,600 43,600 F 196,200
costs
Contribution $58,730 $5,670 U $64,400 $18,400 U $82,800
margin
Fixed costs 70,300 300 U 70,000 70,000
Operating ($11,570) ($5,970) U ($5,600) $18,400 U $12,800
income
Total flexible budget variances Total sales-activity variances
U U
$5,970 $18,400
Total Master budget variances, U$24,370
Flexible Budged Variances
Flexible budged variances measure the efficiency of operations of the actual level of activity.
Total flexible budged variance=total actual results-total flexible budged, planned results
= (- $11,570) - (-$5,600)
= $ - 5,970 or $5,970 Unfavourable
Total flexible-budged variance arises from sales prices received and the variable and fixed
cost incurred. Operations managers are in the best position to explain flexiblebudged
variances. If that information is used against them, lower-level managers can be expected to
withhold are misstate valuable information for their own-self protection.
Exhibit 6-5 gives an expanded, line by line computation of variances for all master budged
items at Dominion.
16
Figures are from Exhibit 8-1
17
Figures are shown in more detail in Exhibit 8-5
18
Figures are from the 7,000 unit column in Exhibit 8-2

Exhibit 6-5: Dominion Company Cost Control Performance Report for the Month ended June
30, 19x4
Flexible
Actual Costs Flexible
Budget Explanation
Incurred Budget19
Variances20
Units 7,000 7,000 -
Variable costs:
Lower prices but higher
Direct materials $69,920 $70,000 $80F
usage
Higher wage rates and
Direct labour 61,500 56,000 5,500U
higher usage
Indirect labour 9,100 11,900 2,800F Decreased setup time
Excessive machine
Idle time 3,550 2,800 750U
breakdowns
Cleanup time 2,500 2,100 400U Cleanup of spilled solvent
Higher prices and higher
Supplies 4,700 4,200 500U
usage
Variable
manufacturing $151,270 $147,000 $4,270U
costs
Use of air freight to meet
Shipping 5,000 4,200 800U
delivery
Excessive copying and
Administration 2,000 1,400 600U
long-distance calls
Total variable
$158,270 $152,600 $5,670U
costs
Fixed costs:
Factory
$14,700 $14,400 $300U Salary increase
supervision
Factory rent 5,000 5,000 -
Equipment
15,000 15,000 -
dep.n
Other fixed
2,600 2,600 -
factory costs
Fixed
manufacturing $37,300 $37,000 $300U
costs
Fixed selling &
33,000 33,000 -
administr. Costs
Total fixed costs $70,300 $70,000 $300U
Total variable
$228,570 $222,600 $5,970U
and fixed costs
19
From 7,000 units column of Exhibit 8-2
20
This is a line by line breakout of the variances in column 2 of Exhibit 8-4

Sales Activity Variances
Sales activity variances measure how effective managers have been in meeting the planned
sales objective-The total of the sales activity variances informs the manager that falling short
of the sales target by 2,000 units caused operating income to be $18,400 lower than initially
budgeted (a $5,600 loss instead of a $12,800 profit). In summary, the short fall of sales by
2,000 units caused Dominion Company to incur a total sales activity variance of 2,000 units at
a contribution margin of $9.20 per unit. (from the just column of exhibit 6-2)
Total sales activity variance:

(actual sales units master budget sales units) x (budgeted contribution margin per unit)
(9,000 7,000) x ($9.20) = $18,400 Unfavourable
Since marketing managers are typically in the best position to explain why sales activities
attained different from plans, they usually have the primary responsibility for reach up the
sales level specified in the italic budged. Of course variations in sales may be attributable to
many factors. For example, sales-activity variances can be subdivided into sales quantity,
sales mix, market size, and market share variances. To see the details of these variances, you
can use the Cost Accounting: A Management Emphasis that was written by Charles T.
Herngen, George Foster DP758-763.
Expectations, Standard Costs, and Standard Cost System
Expectations or standard costs are the building blocks of a planning and control systems.
An expected cost is the cost that most likely to be attained.
A standard cost is a carefully developed cost per unit that should be attained. Both of them are
concerned with future. But standard cost is more reliable than expected cost. Because standard
costs are determined by using scientifically methods in detail.
In standard cost systems, produced products are valued according to standard costs.
The expected costs used in flexible budgets also may be called standards because they are
bench marks or objectives to be attained. The fact that they are called standards does not
imply that the organization also must have a standard cost system for inventory valuation or
that it must use the standard cost system for planning and control.
When to investigate variances
When should variances be investigated? The most trouble some aspect of using the feedback
from flexible budgeting is deciding when a variance is large enough to warrant managements
attention. The accountant expects variances to fluctuate randomly within some normal limits.
Consequently, the more a variance randomly fluctuates, the larger the variance required to
make investigation worth while. There are two questions. First, what is a large versus a small
variance? Second, is a large variance random or controllable? Usually, the second question is
answered only after an investigation, so answering the first question is critical. Because
knowing exactly when to investigate is difficult, many organizations have developed such
rules of thumb as, investigate all variances exceeding $5,000 and 25% of expected cost. For
example in a cost title there is 40% variance but this titles variance is lower than $5,000, it
will not be investigated.

Problem One
Refer to the data contained in exhibit 6-1 and 6-2. Suppose actual production and sales were
8,500 units instead of 7,000 units; actual variable costs were $188,800;and actual fixed costs
were $71,200. The selling price remained at $31 per unit.
Required
1-Compute the master budget variance what does this tell you about the efficiency of
operations?
2-Compute the sales activity variance. Is the performance of the marketing function the sale
explanation for this variance? Why?
3-Using a flexible budget at the actual activity level compute the budgeted contribution
margin, budgeted operating income, and flexible-budget variance. What do you learn from
this variance?
Solution to Problem One
1. Actual operating income = (8,500 x $31) - $188,800 - $71,200

= $3,500
Master budget operating income = $12,800 (from exhibit 8-1)
Master budget variance = $12,800 - $3,500 = $9,300
Three factors affect the master budget variance: sales activity, efficiency, and price changes.
There is no way to tell from the master budget variance alone how much of the $9,300 U was
caused by any of these factors alone.
2. Sales activity variance=budgeted unit contribution margin x difference between the master
budget unit sales and the actual unit sales
= $9,20 per unit CM x (9,000 units 8,500) (from exhibit 8-2)
= $4,600 U
This variance is called as a sales-activity variance because if quantifies the impact on

operating income of the deviation from an original sales target while holding price and
efficiency factors constant. This is a measure of the effectiveness of the operations
Dominion was ineffective in meeting its sales objective. Of course, the failure to reach target
sales may be traceable to several causes beyond the control of marketing personnel including
material shortages, factory break downs, and so on.
3. The budget formulas in exhibit 8-2 are the basis for following the answers:
Flexible budget contribution margin= $9,20 x 8,500 = $78,200
Flexible budget operating income= $3,500 (from requirement 1)
Flexible budget variance= $8,200 - $3,500 = $4,700 U
The flexible budget variance shows that the company spent $4,700 more to produce and sell
the 8,500 units then it should have if operations had been efficient and unit costs had not
changed. Note that this variance plus the $4,600 U sales activity variance total to the $9,300 U
master budget variance.

Flexible Budget Variances in Detail
The emphasis is on subdividing labour, material, and overhead cost variances into usage and
price or spending components.
Variances from material and labour standards
Assume the following data about Dominion Company:
Standards
Standard inputs Standard price Standard cost
expected per unit of expected per unit of expected per unit of
output input output
Direct material 5 pounds $2 $10
Direct labour hour 16 8
To show the analysis of variances, we will reconsider Dominions direct materials and direct
labours costs, as shown in exhibit in 8-5 and assume that the following actually occurred for
the production of 7,000 units of out put:
Direct material: 36,800 pounds of material were purchased and used at an actual
unit price of $1,90 for a total actual cost of $69,920.
Direct labour: 3,750 hours of labour were used at an actual hourly price (rote) of
$16.40, for a total cost of $61,500.
These additional data enable us to subdivide the flexible budget variances (column 3) from
exhibit 8-5 into the separate usage and price components, which are shown below in columns
4 and 5.
(1) Actual (2) Flexible (3) Flexible (4) Price (5) usage
Costs Budget Budget variance variance
varianc
Direct material $69,920 $70,000 $80F $3,680F $3,600U
Direct labour 61,500 56,000 5,500U 1,500U 4,000U
Flexible budget values are calculated like these:
Flexible = Units of good x Input allowed x Standard unit

budget or output achieved per unit of price of input
total output
standard
cost allowed
Standard = 7,000 units x 5 pounds x $2 per pound =
direct $70,000
materials
cost allowed
Standard = 7,000 units x hour x $16 per hour =
direct labour $56,000
cost allowed

Price and usage variances subdivide each flexible-budget variance in to the following:
1) Price variance: difference between actual input prices and standard input prices
multiplied by the actual quantity of inputs used
2) Usage variance: difference btw. the quantity of inputs actually used and the
quantity of inputs that should have been used to achieve the actual quantity of
output multiplied by the expected price of the input
According to this information, for Dominion Company the price variances are:
Direct material price variance = (actual price standard price) x actual quantity
= ($1.90 - $2.00) per pound x 36,800 pound
= $3,680 Favourable
Direct labour variance = (actual price standard price) x actual quantity

= ($16.40 - $16.00) per hour x 3,750 hours
The usage variances are:

Dir. material usage variance = (actual quantity used standard quantity allowed) x stand. pr.
= [36,800 (7,000 x 5)] pounds x $2.00 per pound
= (36,800 35,000) x $2
= $3,600 Unfavourable
Direct labour usage variance = (actual quantity used standard quantity allowed) x stand. pr.
= [3,750 (7,000 x )] hours x $16 per hour
= (3,750 3,500) x $16
= $4,000 Unfavourable
To determine whether a variance is favourable or unfavourable, use logic rather than

memorizing a formula: A price variance is favourable if the actual price is less than the
standard. The opposite relationships imply unfavourable variances.
Since the sum of the direct labour price and usage variances equals the direct labour flexible
budget variances, thus is also reality for direct material price and usage, then:
Direct material flexible budget variance = $80 favourable $3,680 favourable

- $3,600 unfavourable
Direct labour flexible budget variance = $5,500 unfavourable $1,500 unfavourable

+ $4,000 unfavourable
Exhibit 6-6 shows the price and usage variances for labour graphically.
Exhibit 6-6: Graphical Representation of Price and Usage Variances for Labour
Actual price
Input Price variance
price Standard price
Standard Usage
cost variance
Standard Usage
quantity quantity

Overhead variances
Direct material and direct labour variances are often subdivided as price and usage
components, many organizations believe that it is not useful to monitor individual overhead
items to the same extent. But in some cases, it may be useful to subdivide the flexible budget
overhead variances, especially those for variable overhead.
When actual cost driver activity differs from the standard amount allowed for the actual
output achieved, a variable overhead efficiency variance will occur.
Suppose that Dominion Companys cost of supplies, a variable-overhead cost, is driven by

direct labour hours. A variable overhead cost rate of $0.60 per unit at Dominion would be
equivalent to $1.20 per direct labour hour (because hour is allowed per unit of output) of
the $500 unfavourable variance, $300 unfavourable is due to using 3,750 direct labour hours,
rather than the 3,500 allowed by the flexible budget, as calculated below:
Variable-overhead efficiency variance for supplies =
(act. direct labour hours standard D.L. hours allowed) x stand. variable overh. rate per hour)
(3,750 actual hours 3,500 standard hours allowed) x $1.20 per hour = $300 unfavourable
The remainder of the flexible-budget variance measures control overhead spending itself,
given actual cost driver activity.
Variable-overhead spending variance for supplies =
Actual variable overhead (expected variable overhead rate x actual direct labour hours used)
$4,700 - ($1.20 x 3,750 hours) =
$4,700 - $4,500 = $200 unfavourable
That is, the variable overhead spending variance is the difference btw. the actual variable
overhead and the amount of variable overhead budgeted for the actual level of cost driver
activity.
Summary:
Flexible budgets provide to changing levels of activity rather than to the single. They can also
tell how much revenue and cost to expect for any level of activity (what if analysis).
Cost functions, or flexible budget formulas, reflect fixed and variable cost behaviour and
allow how managers to compute budgets for any desired output or cost driver activity level.
The evaluation of performance is aided by feedback that compares actual results with
budgeted expectations. The flexible budget approach helps managers explain why the master
budget was not achieved. Master budget variances are divided into (sales) activity and flexible
budget variances. Activity variances reflect the organizations effectiveness in meeting
financial plans. Flexible budget variances reflect the organizations efficiency at actual levels
of activity.
Expectations form the basis for budgeting and performance evaluation. Expectations may be
formalized as standard costs and may be incorporated into standard cost systems, but only
expectations (which may be called standards) are required for master and flexible budgets.
The most commonly used standards are considered to be attainable with reasonable effect.

Flexible budget variances for variable inputs can be further broken down into price (or
spending) and usage (or efficiency) variances. Price variances reflect the effects of changing
input prices, holding usage of inputs constant at actual use. Usage variances reflect the effects
of different levels of input usage, holding prices constant at expected prices.
Problem Two
The following questions are based on the data contained in the Dominion Company
illustration used in this chapter, on page 8-11.
- Direct materials: standard, 5 pounds per unit at $2 per pound
- Direct labour: standard, hour at $16 per hour
Suppose the following were the actual results for production of 8,500 units.
1. Direct material: 46,000 pounds purchased and used at an actual unit price of $1.85 per
pound, for an actual total cost of $85,000.
2. Direct labour: 4,125 hours of labour used at an actual hourly rate of $16.80, for a total
actual cost of $69,300.
Required
1. Compute the flexible budget variance and the price and usage variances for direct
labour and direct material.
2. Suppose the company is organized so that the purchasing manager bears the primary
responsibility for purchasing materials, and the production manager is responsible for
the use of materials. Assume the same facts as in requirement 1 except that the
purchasing manager bought 60,000 pounds of material. This means that there is an
entity inventory of 14,000 pounds of material. Re-compute the material variances.

Solution to Problem Two

1. The variances are:
A B C
Flexible Budget
Actual Cost Flexible Budget Based on Standart
Incurred: Actual Based on Actual Inputs Allowed for Actual
Inputs x Actual Inputs x Expected Outputs Achived x
Prices Prices Expected Prices
Direct 46,000lb x $1,85/lb 46,000lb x $2,00/lb 8,500 units x 5 lb x $2,00/lb

Material =$85,100 =$92,000 =$85,000
Price variance Usage variance
( A-B )= ( B-C )
$85,100-$92,000 $92,000-$85,000=
$6,900 F $7,000 U
Flexible budget variance ( A-C )

$85,100-85,000=
$100 U
Direct 4,125 hr x $16,80/hr 4,125 hr x $ 16,00/hr 8,500 units x 5 hr x $16,00/hr

Labor =$69,300 =$66,000 =$68,000
Price variance Usage variance
( A-B )= ( B-C )
$69,300-$66,000 $66,000-$68,000=
$3,300 U $2,000 F
Flexible budget variance ( A-C )

$69,300-68,000=
$1,300 U
2. Price variances are isolated at the most logical control point-time of purchase rather than
time of use. <n turn, the operating departments that later use the materials are generally
charged at some predetermined buget, expected or Standard price rather than at actual prices.
This represents a slight modification of the approch in requirement 1 as shown at the top of
next page.
Note that this favorable price variance on balance may not be good outcome-Domination
Company may not desire the extra inventory in excess of its immediate needs, and the
favorable price variance may reflect that quality of the metarial is lower than planned. Note
also that the usage variance is the same in requirements 1 and 2. Typically, the price and

usage variances for materials now would be reported separately and not added together
because they are based on different measures of volume. The price variance is based on
inputs purchased, but the usage variance is based on inputs used.
Control point A B C
for direct Flexible Budget
materials Actual Cost Flexible Budget Based on Standard
Incurred: Actual Based on Actual Inputs Allowed for Actual
Inputs x Actual Inputs x Expected Outputs Achieved x
Prices Prices Expected Prices
Purchasing 60,000 lb x $1,85/lb 60,000 lb x $2,000/lb

Price variance
( A-B )=
$111,000-$120,000
$9,000 F
Using 46,000 lb x 2,000/lb 42,500 lb x $2,00/lb

=$92,000 =$85,000
Usage variance
( B-C )
$92,000-$85,000=
$7,000 U
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- Cost Accounting (Maliyet Muhasebesi) -

Introduction to Cost (Management) Accounting

Introduction to Cost Management Systems

Cost Allocation and Activity Based Costing

Job Costing Systems, Overhead Application, Service

Process Costing Systems

Flexible Budgets and Variances Analysis

written by F@tm@ K. Page 1 of 71

Chapter 1 - Introduction to Cost (Management) Accounting

Accounting is an information system and provides information to the external/internal users.

Trade Company needs financial accounting

Distinctions between Management and Financial Accounting

Management Accounting Financial Accounting

written by F@tm@ K. Page 2 of 71

What are the objectives of an Accounting System?

1. Scorecard questions: Am I doing well or poorly? Scorekeeping is the accumulation

Management Accounting in Service and Non-profit organizations

The characteristics of profit-seeking and non-profit service organizations:

The Management process and accounting

written by F@tm@ K. Page 3 of 71

Exhibit 1-3: Accounting Framework for Planning and Control

Line Management Internal Accounting System

Source Records and

General and subsidiary Classifications of

Performance reports Reports of

Planning and Control for Product life cycles

Exhibit 1-7: Typical Product life cycle

No Sales Sales Growth Stable Sales Level Low Sales No Sales

Accountings Position in the organization

Distinctions between controller and treasurer

Training for Top Management Positions

In an accounting department, studying accounting and working as a management accountant

written by F@tm@ K. Page 5 of 71

Three major factors are causing changes in management accounting today:

1. Shift from a manufacturing based to a service-based economy

At the same time, manufacturing processes are increasingly automated. Automated

Importance of Ethical conduct

written by F@tm@ K. Page 6 of 71

Competence (Should have enough Professional education and experience)

Integrity (Should be honest)

Questions for Introduction Chapter

written by F@tm@ K. Page 7 of 71

written by F@tm@ K. Page 8 of 71

Chapter 2 - Introduction to Cost Management Systems

Exhibit 2-1 1. Cost Accumulation:

2. Cost Allocation to cost objectives:

A. to departments1 Machining Finishing

B. to products2 Cabinets Cabinets

written by F@tm@ K. Page 9 of 71

Cost accumulation is collecting costs by some natural classification such as materials or

Main cost accounting concepts

*paid for one year rent 2,400

-unit production cost for cake

Solution total spending: rent 2,400+Machinery 50,000+200kg sugar 200+100kg flour

Consumed assets For which purpose total

Consumed assets production cost period cost

cost of goods sold 60kgX72,06=4,323,60

gross profit 956,40

written by F@tm@ K. Page 11 of 71

Direct and Indirect costs

Categories of manufacturing costs

written by F@tm@ K. Page 12 of 71

Products costs and Period costs

written by F@tm@ K. Page 13 of 71