CHAPTER 14 PROCESS COSTING AND THE COST ACCOUNTING CYCLE 14-1 Dell Computer's Costing Methods Dell almost certainly does not use job-order costing, nor can it use process costing, because units differ The company could use standard costing, but with such a small amount of work in Process and finished goods inventory, it could also use backflushing Dell's business model requires low inventories and quick response times Prices of computer components fall, sometimes rapidly, so buying inventory well in advance of selling it reduces profits We have referred to this situation in several Insights 14-2 Strategic Uses of Overhead Allocation The benefit is that managers will concentrate on reducing cycle time, which is a highly desirable result The lower the cycle time, the faster the response, the more satisfied the customer and the higher the profit Allocations based on labor or machine time can encourage managers and engineers to reduce those times, but might not lower overall costs, as the Tektronix example in Chapter 10 described We refer to the Tektronix example to remind students that reported costs of products play an important role in how managers (and design engineers) approach those products The 8th edition of this book contained the following material that you might want to use in class Teijin Seiki Co., Ltd manufactures machines and components for industries as diverse as textiles, aerospace, and printing Managers at a division that made reduction gears for earthmoving equipment were dissatisfied with the standard costing system because it applied direct labor and overhead to products based on standard machine times The managers therefore expected that when they reduced standard machine times, costs should also drop, but results were disappointing The problem was that the standard machine time, which is value-adding time, was much less than the lead time, or total time a component was in process Lead time includes waiting time, which is, of course, not value-adding, but which generates significant amounts of overhead The division changed its allocation base from standard manufacturing time to lead time, so that managers were motivated to reduce lead time, which in turn reduced inventories and costs The overhead rate was calculated as Overhead rate = Total budgeted overhead Total lead times The denominator, total lead times, was the sum of the lead times for all of the parts the division made Reducing machine time still saves costs under the new method, but the new method directs managerial attention to the entire flow of parts through the factory Source: Makoto Kawada and Daniel F Johnson, "Strategic Management Accounting−Why and How," Management Accounting, August 1993, 32-38 14- 14-3 Cost of Accounting Systems Job-order costing is almost certainly the costliest, requiring that the company track materials and labor, as well as any overhead drivers such as setup time, to specific jobs Even though bar coding and other technologies can reduce costs, job-order costing probably still leads the field Backflushing is probably the cheapest system because it requires entries only at a few points in the production/sale process A single product factory could probably operate a standard costing or process costing system cheaply as well The cost of the accounting system depends partly on the complexity of the operation, how many parts/components, how many departments, operations, etc A job-order system is costly partly because job-order operations are probably more complicated than others 14-4 Cost/Benefit of Accounting System Caterpillar almost certainly needs the more accurate system because its manufacturing costs and inventories are relatively much higher than Intel's Caterpillar's cost of sales is about 77% of sales, while Intel's is about 38% Certainly, Intel cares about costs, but a point or two increase for Intel will not have the same negative effect as will a similar increase for Caterpillar The two companies’ inventories are about the same percentages of cost of sales about 19% for both), but Intel’s is much smaller as a percentage of sales \ Intel might still benefit from a sophisticated, costly system, particularly an ABC system, for evaluating profitability of individual products, but Caterpillar would probably benefit more 14-5 Basic Process Costing (15 minutes) 33,000 Units completed Equivalent units in ending inventory (5,000 x 60%) Equivalent unit production $1.40 $4,200 $42,000 30,000 3,000 33,000 ($6,400 + $39,800)/33,000 = $46,200/33,000 3,000 x $1.40 30,000 x $1.40 The assignment does not ask for a reconciliation of costs, but it is always wise to one The $46,200 total cost is accounted for below Ending inventory $ 4,200 Transferred to finished goods 42,000 Total costs $46,200 Conversion Costs Various Credits $39,800 Work in Process Inventory Conversion Costs $39,800 Finished Goods Inventory Work in Process Inventory $42,000 $39,800 $39,800 $42,000 14- 14-6 a b1 b2 c1 c2 d e Job-Order Costing Journal Entries Work in Process Inventory Materials Inventory $5,120 Direct Labor Cash or Wages Payable 8,760 Work in Process Direct Labor 8,760 Factory Overhead Various credits 9,610 Work in Process Factory Overhead 9,610 8,760 8,760 9,610 9,610 18,660 Cost of Goods Sold Finished Goods 15,200 18,660 15,200 Work in Process Inventory | $ 5,120 | 8,760 | 9,610 | $18,660 (d) 23,490 18,660 $ 4,830 Bal $5,120 Finished Goods Work in Process (a) (b2) (c2) 14-7 (20 minutes) Basic Process Costing Weighted-Average (10-15 minutes) 74,000 Units completed Equivalent units in ending inventory (15,000 x 60%) Equivalent unit production $3.50, $31,500, $3.50 x 9,000 equivalent units $227,500, $3.50 x 65,000 65,000 9,000 74,000 ($8,880 + $250,120)/74,000 = $259,000/74,000 The $259,000 total cost is accounted for below Ending inventory Transferred to finished goods Total costs $ 31,500 227,500 $259,000 14-8 Basic Process Costing FIFO (Continuation of 14-7, Appendix) minutes) 67,600 14- (10-15 Units completed Equivalent units in ending inventory (15,000 x 60%) Total Less beginning inventory (8,000 x 80%) Equivalent unit production $3.70, $250,120/67,700 $33,300, $3.70 x 9,000 $225,700 65,000 9,000 74,000 6,400 67,600 Cost of beginning inventory Cost to complete BI* (1,600 x $3.70) Cost to start and complete 57,000 units** at $3.70 Total costs transferred $ 8,880 5,920 210,900 $225,700 * The 1,600 units is 20% x 8,000 units ** 65,000 - 8,000 The $259,000 total cost to account for is the same regardless of the cost-flow assumption, because there is no beginning inventory Ending inventory Transferred to finished goods Total costs $ 33,300 225,700 $259,000 The difference between the results here and in the weighted-average case are not significant because the unit costs are only $0.20 apart and the ending inventory is not large in relation to units completed 14-9 Journal Entries (Continuation of 14-7) Materials Inventory Cash and Accounts Payable To record purchases of materials (14-20 minutes) $ 81,000 $ 81,000 Work in Process Inventory 68,000 Raw Materials Inventory To record cost of materials put into process Direct Labor Cash or Accrued Payroll 68,000 52,040 52,040 Work in Process Inventory 52,040 Direct Labor To charge direct labor cost to work in process Manufacturing Overhead Various Credits To record overhead costs 52,040 130,080 130,080 Work in Process Inventory 130,080 Manufacturing Overhead 130,080 To apply manufacturing overhead to work in process Finished Goods Inventory 227,500 Work in Process Inventory 227,500 To transfer costs of goods completed to finished goods Work in Process Inventory 14- Beginning balance Materials Direct Labor Overhead $ 8,880 | 68,000 | 52,040 | 120,080 | $227,500 to Finished Goods 259,000 | $227,500 Ending Balance $ 31,500 14-10 Journal Entries (Continuation of 14-8 and 14-9) (14-20 minutes) Note to the Instructor: If you assigned 14-9, you can compare the entries The only difference is the transfer to Finished Goods Inventory Students sometimes need to be reminded that different costing methods not affect physical, economic events such as buying and using materials Materials Inventory Cash and Accounts Payable To record purchases of materials $ 81,000 $ 81,000 Work in Process Inventory 68,000 Raw Materials Inventory 68,000 To record cost of materials put into process Direct Labor Cash or Accrued Payroll 52,040 52,040 Work in Process Inventory 52,040 Direct Labor To charge direct labor cost to work in process Manufacturing Overhead Various Credits To record overhead costs 52,040 130,080 130,080 Work in Process Inventory 130,080 Manufacturing Overhead 130,080 To apply manufacturing overhead to work in process Finished Goods Inventory 225,700 Work in Process Inventory 225,700 To transfer costs of goods completed to finished goods Beginning balance Materials Direct Labor Overhead Ending Balance 14-11 $16 Process Inventory | | | | $225,700 to Finished Goods | $225,700 Relationships Income, Production, and Volume Variance (20 minutes) ($320,000/20,000 units) Sales (20,000 x $30) Standard gross profit Standard cost of sales Work in 8,880 68,000 52,040 130,080 259,000 $ 33,300 $ $600,000 280,000 $320,000 (all fixed) $16,000 favorable An intuitive approach to this part is to prepare an income statement, leaving the volume variance blank 14- Sales Standard cost of sales, all fixed Standard gross profit Volume variance Selling and administrative expenses Income 24,000 units $600,000 320,000 280,000 ? 90,000 $174,000 Production level used to set standard fixed cost ($400,000/$16 standard fixed cost) Favorable volume variance, units ($16,000/$16) Production 25,000 1,000 24,000 $110,000 Sales Fixed costs, $400,000 + $90,000 Income $600,000 490,000 $110,000 An alternative approach is to work with the difference between absorption costing and variable costing incomes Absorption costing income Increase in inventory (24,000 produced - 20,000 sold) Fixed cost per unit Fixed cost carried to following year Equals variable costing income 14-12 Process Costing−T-account $20.80 ($23,700 + $766,700)/38,000 = $790,400/38,000 Ending inventory Transfers Total Beginning balance Current costs Ending balance 14-13 $ 62,400 728,000 $790,400 ($20.80 x 3,000) ($20.80 x 35,000) Work in Process Inventory $ 23,700 | 766,700 | $728,000 790,400 | 728,000 $ 62,400 To finished goods (15 minutes) $766,700/37,400 Units completed Equivalent units in ending inventory (5,000 x 60%) Total Less beginning inventory (3,000 x 20%) Equivalent unit production FIFO 35,000 3,000 38,000 Process Costing (Extension of 14-12, Appendix) $20.50 64,000 $110,000 (15 minutes) Units completed Equivalent units in ending inventory (5,000 x 60%) Equivalent unit production weighted-average $174,000 4,000 $16 Ending inventory ($20.50 x 3,000) Transfers: Beginning inventory 14- 35,000 3,000 38,000 600 37,400 $ 61,500 $ 23,700 Cost to complete* ($20.50 x 2,400) Started and completed** ($20.50 x 32,000) Total transfers Total 49,200 656,000 728,900 $790,400 * 80% x 3,000 = 2,400 ** 35,000 - 3,000 = 32,000 Beginning balance Current costs Ending balance 14-14 Backflush Costing Work in Process Inventory $ 23,700 | 766,700 | $728,900 To finished goods 969,600 | 728,900 $ 61,500 (5 minutes) Ending inventory (10,000 x $7.60) Cost of goods sold (90,000 x $7.60) Total costs $ 76,000 684,000 $760,000 Unit cost = ($410,000 + $350,000)/100,000 = $7.60 Note to the Instructor: This simple exercise and the ones that follow show how straightforward and simple backflushing is Of course, the conditions must be right to use backflushing no significant inventories 14-15 Backflush Costing, Journal Entries (Continuation of 14-14) minutes) Materials and In-Process Inventory Cash, Accounts Payable (5-10 $410,000 $410,000 Conversion Costs 350,000 Cash, Accounts Payable, Accumulated Depreciation 350,000 Cost of Sales Finished Goods Inventory Materials and In-Process Inventory Conversion Costs 410,000 350,000 684,000 76,000 14-16 Backflush Costing with Standards (Continuation of 14-14) minutes) (10 The use of standard costs with backflushing does not appear in the text, but the principle should be clear Show inventories at standard cost and variances as adjustments to standard cost of sales Ending inventory, 10,000 x $7.20 $ 72,000 Standard cost of sales, 90,000 x $7.20 $648,000 Variances* 40,000U Cost of sales 688,000 Total costs $760,000 Materials Conversion Costs Actual cost $410,000 $350,000 Standard cost, $4.00 x 100,000, 400,000 $3.20 x 100,000 320,000 Variance $ 10,000 U $ 30,000 U 14-17 Process Costing Two Departments 14- (20 minutes) $0.30 for Mixing ($25,620/85,400); $0.75 for Distilling ($60,000/80,000) Mixing 80,000 5,400 85,400 Gallons completed Ending inventory (9,000 x 60%) Equivalent production Distilling 80,000 80,000 $1,620 (5,400 x $0.30) Cost of goods sold, $68,250 (65,000 x $1.05, which is $0.30 + $0.75) Ending inventory, $15,750 (15,000 x $1.05) The reconciliation of total costs follows Ending inventory of work in Process (requirement 2) Transferred to finished goods (80,000 x $1.05) Total production costs ($25,620 + $60,000) 14-18 Relationships−Income, Sales, and Volume Variance $18, $ 1,620 84,000 $85,620 (15 minutes) $1,836,000/102,000 The simplest approach is to prepare an income statement so far as we know the numbers Sales Standard cost of sales (102,000 x [$6 + $8]) Standard gross profit Volume variance Actual gross margin ($200,000 + $224,000) Selling and administrative expenses Income ? 1,428,000 ? 16,000F 424,000 200,000 $ 224,000 We can see that actual gross margin is $424,000 ($200,000 + $224,000) and standard gross margin must then be $408,000 because of the $16,000 favorable volume variance Sales are then $1,836,000 ($408,000 + $1,428,000) 100,000 The volume variance was $16,000 favorable, which means that production of 102,000 (inventories were unchanged per the assignment) was 2,000 units ($16,000/$8) above the volume used to set the $8 standard fixed cost $800,000 14-19 $8 x 100,000 Process Costing (20-25 minutes) Equivalent production Gallons completed Ending inventory (30,000 x 100%, 80%) Equivalent production Materials 180,000 30,000 210,000 Conversion Costs 180,000 24,000 204,000 Unit costs Beginning inventory July costs Totals Divided by equivalent production Equals unit cost 14- $ 3,240 42,960 $ 46,200 210,000 $ 0.22 $ 9,620 127,060 $136,680 204,000 $ 0.67 Total unit cost = $0.89 ($0.22 + $0.67) Finished Goods Inventory (180,000 x $0.89) Work in Process Inventory $160,200 $160,200 Work in Process Inventory $ 12,860 | 170,020 | $160,200 To finished goods 182,880 | 160,200 Ending balance $ 22,680 Beginning balance = $3,240 + $9,620; July costs = $42,960 + $127,060 Beginning balance Current costs Proof of inventory Materials 30,000 $0.22 $ 6,600 Equivalent units in inventory Cost per unit Inventory cost Total inventory cost = $22,680 14-20 Equivalent Production and Unit Costs (20-25 minutes) Equivalent production Units completed Ending inventory (20,000 x 100%, 60%) Equivalent production Conversion Costs 24,000 $0.67 $16,080 Materials 150,000 20,000 170,000 Unit costs Beginning inventory $ 14,650 July costs 366,150 Totals $380,800 Divided by equivalent production 170,000 Equals unit cost $ 2.24 Total unit cost = $5.89 ($2.24 + $3.65) Conversion Costs 150,000 12,000 162,000 $ 19,400 571,900 $591,300 162,000 $ 3.65 $88,600 ending inventory, $883,500 transferred Materials 20,000 $2.24 $44,800 Equivalent units in inventory Cost per unit Inventory cost Total inventory cost = $88,600 Units transferred Total unit cost Total cost transferred Conversion Costs 12,000 $3.65 $43,800 150,000 $5.89 $883,500 The components of the transfer are: Materials (150,000 x $2.24) Conversion costs (150,000 x $3.65) Total transfer $336,000 547,500 $883,500 Note to the Instructor: You might wish to a reconciliation of costs to reinforce the point that it is a good idea Total costs from above Materials $380,800 14- Conversion Costs $591,300 Less ending inventory Transferred 14-21 44,800 $336,000 43,800 $547,500 Equivalent Units and Standard Costs (Appendix) 2,300 units 14-10 (14-20 minutes) Material Use Variance Material Inventory (11,000 x $3.20) Finished Goods Inventory (7,200 x $13.80) Work in Process Inventory 320 35,200 99,360 99,360 Cash and Accounts Receivable Sales Cost of Sales (6,500 x $13.80) Finished Goods Inventory 325,000 Selling and Administrative Expenses Cash and Accrued Expenses 106,000 325,000 89,700 89,700 106,000 Income statement under standard costing Sales Cost of sales at standard Standard gross profit Plus variances: Material price Material use Direct labor rate Direct labor efficiency Variable overhead spending Variable overhead efficiency Fixed overhead budget Fixed overhead volume Actual gross profit Selling and administrative expenses Income $325,000 89,700 235,300 $1,200U 320F 1,650U 2,400F 2,090U 1,200F 500F 1,800U 2,320U 232,980 106,000 $126,980 Summary of Variances: Materials Budget for 12,000 pounds Actual Purchases $39,600 $38,400 $1,200 U Actual Use at Standard Price $3.20 x 11,000 $35,200 Standard Cost for 7,400 Equivalent Units lbs $3.20 x 1.5 x 7,400 $4.80 x 7,400 $35,520 $320 F Direct Labor Actual Cost $28,850 Budget for 1,700 Hours Standard Cost for 7,400 Units $16 x 1,700 $27,200 $4 x 7,400 $29,600 $1,650 U $2,400 F Variable overhead 14-25 or $8 x 1,700 $13,600 $15,690 $2 x 7,400 $14,800 $2,090 U $1,200 F Fixed Overhead $23,500 $24,000 $22,200 (7,400 x $3) $1,800 U $500 F 14-36 Special Order (20 minutes) The order should be accepted because it will return contribution margin of $0.80 per case, or $20,000 in total The standard cost per unit of $6 contains $2 fixed cost, calculated from the information about the volume variance and base for determining unit fixed cost [The volume variance of $120,000 is for 60,000 units (400,000 - 340,000), giving $2 fixed cost per unit at standard.] The variable costing income statements show this clearly, and it may be helpful to start with requirement 2 Without Order Sales 300,000 at $8 25,000 at $4.80; 300,000 at $8 Variable costs at $4 per unit Contribution margin Fixed production costs Gross profit With Order $2,400,000 1,200,000 1,200,000 800,000 $ 400,000 $2,520,000 1,300,000 1,220,000 800,000 $ 420,000 The $800,000 fixed production cost is $2 x 400,000 units (the base used to compute standard fixed cost per unit) Sales Standard cost of sales Standard gross profit Volume variance [(400,000 - 365,000) x $2] Actual gross profit With Order $2,520,000 1,950,000 570,000 (70,000) $ 500,000 Note to the Instructor: This problem illustrates several points One is that increases in sales without increases in production result in increases in income equal to sales price minus standard cost per unit times the increase in sales In this case, the result was a $30,000 decrease because the selling price of $4.80 was $1.20 less than standard cost and $30,000 is $1.20 x 25,000 units However, if sales and production change in the same amount, income will change by contribution margin per unit times the change in volume This is because the volume variance will be reduced by fixed cost per unit times the change in volume of production, and standard gross profit by the selling price minus standard cost times the change in volume Hence, while standard cost of sales will rise, the volume variance will fall by the same amount, leaving a net increase equal to contribution margin When absorption costing is used, the criterion discussed in Chapter 5-that an action should be taken if it results in an increase in profit must be modified The modification is that inventory levels remain at what they would have been if the special order were not accepted, which is shown in requirement Finally, some students will have a problem because the fixed cost per unit concentrate on the other aspects of the class ahead of time that the fixed cost 14-26 great deal of trouble starting this is not given In order to problem, you may wish to tell the included in the standard cost is $2 14-37 Job-order Costing Standards and Variances (25-30 minutes) Standard costs for jobs Job 82 80 Units of Model 803 Job 83 50 Units of Model 407 Materials: Wood (80 x $24) $ 1,920 (50 x 4,820 Fabric (80 x $46) 3,680 (50 x 8,280 Other (80 x $13) 1,040 (50 x 2,090 Total materials 6,640 15,190 Direct labor (80 x $65) 5,200 9,700 Variable overhead (80 x $104) 8,320 15,520 Total standard variable cost $20,160 $40,410 $58) $ 2,900 $92) 4,600 $21) 1,050 $ 8,550 (50 x $90) 4,500 (50 x $144) 7,200 $20,250 Variances Actual Use at Standard Price Variance Material use: Wood $ 4,855 Fabric 8,360 Other 2,090 Totals $15,305 Direct labor efficiency 10,250 Variable overhead efficiency (2,050 x $8) 16,400 Variable overhead budget ($16,850 - $16,400) Total variances Totals Standard Cost $ 4,820 8,280 2,090 $15,190 9,700 15,520 $ 35U 80U $ 115U 550U 880U 450U $1,995U Carlson Company Income Statement for June Sales Cost of sales standard Standard gross profit Variable cost variances, unfavorable Actual gross profit Fixed costs: Production Selling and administrative Income $97,000 40,410 56,590 1,995 54,595 $24,600 18,700 43,300 $11,295 Note to the Instructor: To focus on the question of using standard costs in a job-order system, we did not provide data on the costs chargeable to each job (actual quantities at standard prices) Thus, the variances attributable to each job cannot be calculated This information would be valuable, especially if it highlighted changes in conditions that might make it desirable to change standards (For example, persistent variances such as material use or labor efficiency for a particular model might indicate that the standards should be revised.) You could point out in class that most companies would, if possible, keep track of material and labor use for each job, thereby allowing the isolation of efficiency variances by job-order 14-27 14-38 Comprehensive Problem on Costing Methods Absorption Costing (b) Budgeted Production (a) Actual Sales (160,000 units) (35-40 minutes) $2,400,000 Cost of sales: Production costs: Materials-actual 375,000 -standard (1) Labor-actual 580,000 -standard (2) VOH-actual 395,000 -standard (3) FOH-actual 208,000 -applied (4) Total 1,558,000 Less ending inventory (5) 173,112 Standard cost of goods sold Variances: Materials ($360,000 - $375,000) Labor ($540,000 - $580,000) VOH ($360,000 - $395,000) Fixed overhead budget ($200,000 - $208,000) Volume (6) Total variances Cost of goods sold 1,384,888 Gross profit 1,015,112 S & A expenses 700,000 Income $ 315,112 Sales (160,000 units) Cost of sales: Production costs: Materials-actual -standard (1) Labor-actual -standard (2) Variable overhead-actual -standard (3) Total Less ending inventory (5) Standard cost of goods sold Variances: Materials ($360,000 - $375,000) Labor ($540,000 - $580,000) Variable overhead ($360,000 - $395,000) Total variances Cost of goods sold Gross profit Fixed overhead Selling and administrative expenses Income 14-28 (c) Practical Capacity $2,400,000 $2,400,000 360,000 360,000 540,000 540,000 360,000 360,000 180,000 1,440,000 160,000 1,280,000 144,000 1,404,000 156,000 1,248,000 15,000U 40,000U 35,000U 15,000U 40,000U 35,000U 8,000U 20,000U 118,000U 1,398,000 1,002,000 700,000 $ 302,000 8,000U 56,000U 154,000U 1,402,000 998,000 700,000 $ 298,000 Variable Costing (d) (e) Standard Actual $2,400,000 $2,400,000 375,000 360,000 580,000 540,000 395,000 360,000 1,260,000 140,000 1,120,000 15,000U 40,000U 35,000U 90,000U 1,210,000 1,190,000 ( 208,000) ( 700,000) $ 282,000 1,350,000 150,000 1,200,000 1,200,000 ( 208,000) ( 700,000) $ 292,000 (1) (Budgeted material cost of $400,000/200,000 budgeted production = $2 standard cost per unit) x 180,000 = $360,000 (2) (Budgeted labor cost of $600,000/200,000 budgeted production = $3 standard cost per unit) x 180,000 = $540,000 (3) (Budgeted variable overhead of $400,000/200,000 budgeted production = $2 standard cost per unit) x 180,000 = $360,000 (4) Fixed costs are computed as follows: (b) (Budgeted fixed costs of $200,000/200,000 budgeted production = $1 standard cost per unit) x 180,000 = $180,000 (c) (Budgeted fixed costs of $200,000/250,000 practical capacity = $.80 standard cost per unit) x 180,000 = $144,000 (5) Inventories are at the relevant unit cost, as follows: (a) 20,000 units x $8.6556 ($1,558,000/180,000) = $173,112 (b) 20,000 units x $8 ($2 + $3 + $2 + $1) = $160,000 (c) 20,000 units x $7.80 ($2 + $3 + $2 + $.80) = $156,000 (6) Volume variances are as computed below: (b) $1 x (200,000 - 180,000) = $20,000U (c) $.80 x (250,000 - 180,000) = $56,000U The differences in incomes relate to the differences in inventories The two "actual" income, (a) and (e), were higher than the related standard incomes because part of the unfavorable variances were deferred in inventory Production exceeded sales, so all variations of absorption costing produced incomes higher than those under variable costing; and the income based on practical capacity was lower than that based on budgeted production because a lower fixed standard cost per unit is deferred in ending inventory 14-39 Comprehensive Problem on Costing Methods (Continuation of 14-38) 40 minutes) Absorption Costing (a) (b) (c) Budgeted Practical Actual Production Capacity Sales (160,000 units) $3,000,000 $3,000,000 $3,000,000 Cost of sales: Beginning inventory 173,112 160,000 156,000 Production costs: Materials-actual 400,000 -standard (1) 380,000 380,000 Labor-actual 590,000 -standard (2) 570,000 570,000 VOH-actual 410,000 -standard (3) 380,000 380,000 FOH-actual 215,000 -applied (4) 253,327 152,000 Total 1,788,112 1,743,327 1,638,000 Less ending inventory (5) 85,000 83,333 78,000 Standard cost of goods sold 1,659,994 1,560,000 Variances: Materials ($400,000 - $380,000) 20,000U 20,000U Labor ($590,000 - $570,000) 20,000U 20,000U VOH ($410,000 - $380,000) 30,000U 30,000U Fixed overhead budget ($200,000 - $208,000) 15,000U 15,000U Volume (6) 53,327F 48,000U Total variances 31,673U 133,000U Cost of goods sold 1,703,112 1,691,667 1,693,000 Gross profit 1,296,888 1,308,333 1,307,000 14-29 (35- S & A expenses Income $ 720,000 576,888 $ 720,000 720,000 588,333 $ 587,000 Variable Costing (d) (e) Standard Actual $3,000,000 $3,000,000 Sales (160,000 units) Cost of sales: Beginning inventory 140,000 150,000 Production costs: Materials-actual 400,000 -standard (1) 380,000 Labor-actual 590,000 -standard (2) 570,000 Variable overhead-actual 410,000 -standard (3) 380,000 Total 1,470,000 1,550,000 Less ending inventory (5) 70,000 73,684 Standard cost of goods sold 1,400,000 Variances: Materials ($400,000 - $380,000) 20,000U Labor ($590,000 - $570,000) 20,000U Variable overhead ($410,000 - $380,000 30,000U Total variances 70,000U Cost of goods sold 1,470,000 1,476,316 Gross profit 1,530,000 1,523,684 Fixed overhead ( 215,000) ( 215,000) Selling and administrative expenses ( 720,000) ( 720,000) Income $ 595,000 $ 588,684 (4) Fixed overhead applied to production: (b) 190,000 x $1.3333 ($200,000/150,000) = $253,327 (c) 190,000 x $.80 = $152,000 (5) Inventory of 10,000 units (20,000 + 190,000 - 200,000) at the relevant cost, as follows (a) 10,000 x $8.50 ($1,615,000/190,000) = $85,000 (b) 10,000 x $8.3333 ($7 + 1.3333) = $83,333 (c) 10,000 x $7.80 = $78,000 (d) 10,000 x $7 = $70,000 (e) 10,000 x $7.3684 = [($400,000 + $590,000 + $410,000)/190,000] = $73,684 (3) Volume variances are computed as follows: (b) $1.3333 x (150,000 - 190,000) = $53,333 (adjusted to $53,327 for the income statement to agree with the amount applied in excess of budgeted) (c) $0.80 x (250,000 - 190,000) = $48,000 14-40 Standard Costs and Product Profitability (30 minutes) This problem contains much irrelevant information The solution requires only the contribution margins of each product, their required machine-hours, and total available machine-hours A first step is to determine the contribution margins per machine-hour the capacity limitation Two-inch Selling price $17.00 Standard variable costs 8.00 Contribution margins 9.00 Machine-hours required per carton 30 Contribution margin per machine-hour (contribution margins/hours) $30.00 14-30 Three-inch $24.00 11.00 13.00 40 Four-inch $31.00 16.00 15.00 60 Six-inch $40.00 19.00 21.00 80 $32.50 $25.00 $26.25 The six-inch folder is more profitable than the four-inch folder, less profitable than the others The firm is now expecting to use 41,200 machine hours distributed as follows Size Folder Volume Time Required Total Hours Two-inch 44,000 30 13,200 Three-inch 25,000 40 10,000 Four-inch 30,000 60 18,000 Total 41,200 Add hours required for special order (24,000 x 80) Total hours required Practical capacity Required reduction Reduction in number of cartons of four-inch folders (10,400/.6) Contribution margin lost (17,333 x $15) Contribution margin gained ($21 x 24,000) Net gain 19,200 60,400 50,000 10,400 17,333 $259,995 504,000 $244,005 The volume variance will disappear if the six-inch folders were sold, but that is not the critical point The change in contribution is more important Note to the Instructor: Some students will try to calculate the fixed overhead per machine-hour, which is $16 (any of the standard fixed costs divided by the number of hours required per carton), and the total fixed manufacturing costs, $800,000 ($16 x 50,000 hours) These figures are unnecessary, but you may wish to ask for them in order to see if the students understand their derivations An extension of this problem is to ask the value of additional hours of capacity, which is $25 per hour because the only product that can be made and sold is the four-inch folder, which has a contribution margin of $25 per machine-hour The $16 fixed cost per hour is irrelevant 14-41 Review Problem (40-45 minutes) 5,000 units, the top of the relevant range Though relevant range was not discussed specifically in relation to capacity computations, students should be able to see the relationship 3,000 units (2,500 units sold + 500 units of ending inventory) 9,500 yards [(3,000 units produced x yds per unit) + 500 yds of ending inventory] hours (given) $9.00 Material (3 yds x $2) Labor (2 hrs x $0.50) Variable overhead (2 hrs x $1) Total $6.00 1.00 2.00 $9.00 $10 Variable manufacturing cost (from 5) Fixed manufacturing cost ($3,000/3,000) Total 14-31 $ 9.00 1.00 $10.00 $18 [$30 - $9 - 10%($30)] $9, variable manufacturing cost $10 This answer is, for this particular month, the same as the total manufacturing cost using a predetermined overhead rate because the budgeted production for May is equal to normal capacity, upon which the predetermined overhead rate is based Students should be reminded that the two amounts will not always coincide 10 $9, the variable manufacturing cost 11 $12, the variable manufacturing cost plus the variable selling cost of $3 (10% x $30) 12 $.50 per hour ($3,000/6,000 hours) or $1.00 per dress Normal capacity Labor hours per unit Normal capacity, in labor hours 3,000 units 6,000 13 $30,000 [(3,000 x $9) + $3,000] 14 $3,000 + $9X, where X = production 15 $0.30 per hour ($3,000/10,000 hours) or $0.60 per dress Practical capacity Labor hours per unit Practical capacity, in labor hours 5,000 units 10,000 16 The answer here depends on the costing method used costing, income is $36,000, computed as follows: Contribution margin (2,500 units x $18) Fixed costs ($3,000 + $6,000) Income Under variable $45,000 9,000 $36,000 Under absorption costing, income is $36,500, computed as follows: Sales (2,500 x $30) Cost of sales: Variable production costs (3,000 x $9) Fixed production costs applied (3,000 x $1) Less ending inventory (500 x $10) Gross profit Selling and administrative expenses: Variable ($75,000 x 10%) Fixed Income $75,000 $27,000 3,000 30,000 5,000 7,500 6,000 25,000 50,000 13,500 $36,500 The difference in the incomes is equal to the amount of fixed cost in the ending inventory under absorption costing (500 units @ $1) 17 500 units (fixed costs of $9,000/$18 contribution margin per unit) 18 2,000 units (budgeted units of 2,500 - the break-even point of 500 14-32 units) 19 $18, the contribution margin 14-33 14-42 Process Costing Second Department (Continuation of 14-27 and 14-28) (30-40 minutes) Note to the Instructor: This is a very difficult assignment, and we include it only for those of you who wish either to pursue the complications of accumulating costs under FIFO or to challenge students to apply text principles in situations not covered by the text In either case, you might wish to assign this problem to be done in class, so that students won't get too frustrated with their independent efforts And, because the answer depends on the amount of cost transferred from the prior department, it would be helpful to give students the amount of the cost transferred (computed in 14-27 as $51,922) before they attempt to this assignment $0.37 Equivalent production, weighted average, from 14-27 Less equivalent production in beginning inventory, 8,000 x 50% Equals equivalent production, FIFO Divided into current month's costs of Equals cost per equivalent unit 74,000 4,000 70,000 $25,900 $0.37 $73,788 Costs transferred for units in beginning inventory: Prior department costs Conversion costs Costs to finish beginning inventory this month, $0.37 x 8,000 x 50% Total cost transferred for units in beginning inventory Costs transferred for units started and completed Prior department's costs: Costs transferred this month (14-27) $51,922 Divided by no of units transferred in 75,000 Equals prior department's cost per unit $0.6923 Times units started and completed this month, 68,000 - 8,000 in beginning inventory 60,000 Equals prior department's cost $41,538 Conversion costs (60,000 x $0.37) 22,200 Total costs transferred to finished goods $ 6,350 2,220 1,480 10,050 63,738 $73,788 Work in Process Inventory Boiling | Beginning balance $ 8,570 | Transferred in (14-27) 51,922 | $73,788 Transferred out Conversion costs 25,900 | 86,392 | 73,788 Ending balance $12,604 Verification of ending balance: Prior department costs (15,000 x 100% x $0.6923) Conversion costs (15,000 x 40% x $0.37) Total ending inventory 14-43 Review of Chapters 11, 12, 13, and 14 Variances, 20X3 14-34 (40 minutes) $10,384 2,220 $12,604 Materials Actual Cost at Actual Quantity $1,425,000 Actual Quantity at Standard Price $1,400,000 $25,000 U price variance (7,000,000 lbs x $.20) Actual Quantity Used at Standard Price Standard Cost 6,450,000 x $0.20 260,000 x 25 x $0.20 $1,290,000 $1,300,000 $10,000 F use variance Direct Labor Actual Cost for Actual Quantity Actual Quantity Used at Standard Price Standard Cost 53,000 x $10 $530,000 $520,000 260,000 x 20 x $10 $520,000 $10,000 U efficiency variance $10,000 F rate variance Variable Overhead Actual Cost for Actual Quantity Actual Quantity Used at Standard Price 53,000 x $5 $265,000 $270,000 $5,000 U spending variance Fixed Overhead = $1,500,000/250,000 Budgeted Overhead $1,480,000 260,000 x 20 x $5 $260,000 $5,000 U efficiency variance Standard rate = $6 Actual Overhead Standard Cost $1,500,000 $20,000 F budget variance units Applied Overhead 260,000 x $6 $1,560,000 $60,000 F volume variance (Note that the above variances relate only to the income statement using absorption costing.) Summary of Variances Material price variance Material use variance Labor rate variance Labor efficiency variance Variable overhead spending variance Variable overhead efficiency variance 14-35 Variable Costing $25,000 10,000 10,000 10,000 5,000 5,000 U F F U U U Absorption Costing $25,000 U 10,000 F 10,000 F 10,000 U 5,000 U 5,000 U Fixed overhead budget variance Fixed overhead volume variance Total Income Statements 20,000 F 20,000 F 60,000 F $55,000 F $ 5,000 U ARC Industries Income Statements for 20X3 Variable Costing $4,600,000 Sales (230,000 x $20) $4,600,000 Cost of sales at standard: Beginning inventory Variable production costs (260,000 x $8) 2,080,000 Fixed production costs (260,000 x $6) 1,560,000 Available for sale 3,640,000 Ending inventory: 30,000 x $8 30,000 x $14 ($8 + $6 = $14) 420,000 Cost of sales at standards of $8 and $14 3,220,000 Standard gross profit 1,380,000 Variances (unfavorable) 55,000 Actual gross profit 1,435,000 Selling and administrative expenses 800,000 Fixed production costs budgeted Total other costs 800,000 Profit 635,000 Absorption Costing 2,080,000 2,080,000 240,000 1,840,000 2,760,000 (5,000) 2,755,000 800,000 1,500,000 2,300,000 $ 455,000 $ It is also possible to short-cut the income statements because standard cost of sales under either method is standard unit cost times the 230,000 rolls sold Some students might ask about the format of our solution, where the fixed production cost budget variance is shown as part of the calculation of actual gross profit An alternative is to show it as a separate item along with budgeted fixed production costs We showed it this way because the problem states that there should be a single figure for variances on each statement The important point for students to get is that the format of the income statement is largely a matter of choice Aside from some "unacceptable" practices, the selection of format depends on the managers' preferences regarding what they want highlighted and what sequence they want 14-44 Review of Chapters 11, 12, 13, and 14 (Extension of 14-43) minutes) Material price $30,000F Material use $20,000F (40 $1,240,000 budget for 6,200,000 lbs 1,210,000 actual cost $ 30,000F $1,200,000 1,180,000 14-36 standard for 240,000 rolls at $5 budget for 5,900,000 lbs at $0.20 $ Labor rate $5,000U Labor efficiency Variable overhead spending 20,000F $475,000 actual cost 470,000 budget for 47,000 hours at $10 $ 5,000U $10,000F $480,000 standard for 240,000 rolls at $2 470,000 budget for 47,000 hours $ 10,000F $240,000 actual cost 235,000 budget for 47,000 hours at $5 $ 5,000U $5,000U Variable overhead efficiency $5,000F standard for 240,000 rolls at $1 budget for 47,000 hours Fixed overhead budget actual cost budgeted cost Fixed overhead volume $240,000 235,000 $ 5,000F $10,000U $1,510,000 1,500,000 $ 10,000U $60,000U $1,500,000 budgeted cost 1,440,000 applied at $6 x 240,000 rolls $ 60,000U Summary of Variances: Variable Costing Material price variance Material use variance Labor rate variance Labor efficiency variance Variable overhead spending variance Variable overhead efficiency variance Fixed overhead budget variance Fixed overhead volume variance Total $30,000 20,000 5,000 10,000 5,000 5,000 10,000 F F U F U F U $45,000 F ARC Industries Income Statements for 20X4 Variable Costing $5,000,000 Sales (250,000 x $20) Cost of sales at standard: Beginning inventory (14-42) Variable production costs (240,000 x Fixed production costs (240,000 x $6) Available for sale Ending inventory: 20,000 x $8 20,000 x $14 Cost of sales at standard of $8 and $14 Standard gross profit Variances (unfavorable) Actual gross profit Selling and administrative expenses Budgeted fixed production costs Total other costs Profit 14-37 $8) 240,000 1,920,000 2,160,000 160,000 2,000,000 3,000,000 45,000 3,045,000 810,000 1,500,000 2,310,000 $ 735,000 Absorption Costing $30,000 20,000 5,000 10,000 5,000 5,000 10,000 60,000 $15,000 F F U F U F U U U Absorption Costing $5,000,000 $ 420,000 1,920,000 1,440,000 3,780,000 280,000 3,500,000 1,500,000 (15,000) 1,485,000 810,000 $ 810,000 675,000 Again, we could prepare much shorter income statements by taking advantage of the relationship that standard cost of sales is the unit standard cost times the number of units sold The reconciliation of incomes in 20X4 is: Income under variable costing Less fixed costs in beginning inventory (30,000 x $6) Subtotal Plus fixed costs in ending inventory (20,000 x $6) Income under absorption costing 14-45 Unit Costs $735,000 180,000 555,000 120,000 $675,000 (30 minutes) The major difficulty with this problem might be identifying the components for which unit costs must be calculated The text does not cover the possibility of different percentages of completion for different materials Equivalent units Quilted Wrap 30,000 10,000 40,000 Complete beginning WIP inventory Started and completed Ending WIP inventory Equivalent units of production Cost per equivalent unit October Costs Quilted Wrap $80,000 Boxes $50,000 Conversion costs $88,000 Equivalent unit cost Prior department cost Total unit cost Boxes 10,000 30,000 10,000 50,000 Equivalent Units 40,000 50,000 44,000 Conversion Costs 6,000 30,000 8,000 44,000 Unit Costs $2.00 1.00 2.00 $5.00 3.00 $8.00 If $5,000 is considered immaterial, the additional overhead incurred would be charged to the cost of goods sold for the month of October If the amount is material, the underapplied overhead should be prorated among the cost of goods sold, work in Process inventory, and finished goods inventory 14-46 Cost of Rejected Units Students will either get requirement or not get it, so we have no time estimate Chapter 16 discusses quality costs in much greater depth, but you might still want to pursue some aspects of quality cost For instance, does the $58,000 cost of rejects capture the cost of poor quality If some poor units go to customers and fail in the field, the costs are much higher than $58,000 because of future lost sales 19,000, which is any of the three figures divided by the related per unit amount $418,000/$22 = 19,000, $684,000/$36 = 19,000, $1,102,000/$58 = 19,000 The solution is to calculate the standard cost of total production (20,000 units here) to determine efficiency or inefficiency, and calculate the standard cost of the 1,000 rejected units as quality cost Actual Cost Standard Cost for Total Output 14-38 Standard Cost for Good Output Materials $451,000 $440,000 $418,000 $11,000 U use variance $22,000 U rejected units $33,000 U total variance Conversion $712,000 $720,000 $8,000 F efficiency variance $28,000 U total variance $684,000 $36,000 U rejected units The picture we get now is clearer because the $58,000 (1,000 x $58) standard cost of rejected units is separated from the $3,000 ($11,000 U $8,000 F) variances related to efficiency It is possible for the plant to be efficient, but to produce poor product, and it is important to distinguish between two causes of high costs inefficiency and making defective units Cost accountants might use the term "spoilage" to refer to our rejected units variance We not wish to discuss normal and abnormal spoilage, nor ways to account for either, but to focus on the cost of poor quality 14-39 ... production/sale process A single product factory could probably operate a standard costing or process costing system cheaply as well The cost of the accounting system depends partly on the complexity of the. .. unit times the change in volume of production, and standard gross profit by the selling price minus standard cost times the change in volume Hence, while standard cost of sales will rise, the volume... work with the difference between absorption costing and variable costing incomes Absorption costing income Increase in inventory (24,000 produced - 20,000 sold) Fixed cost per unit Fixed cost carried