Chapter 06 – Fundamentals of Product and Service Costing
6-11
determined by the labor activity regardless of the seniority or skills of the employees,
direct labor hours would be the better choice.
• Allocation is inherently arbitrary and imprecise. The goal is to avoid distorting the
product costs “too much.”
======================
Demonstration Problem 2
Capable Golf Cart, Inc. (CGC) manufactures two models of golf cart: LX and EX. The budget
data for next month is available.
LX
EX
Total
Units produced
50
30
80
Direct labor hours
2,000
3,000
5,000
Machine hours
1,500
1,200
2,700
Direct materials
$125,000
$90,000
$215,000
Direct labor
90,000
60,000
150,000
Manufacturing overhead
202,500
Total
$567,500
Required:
1. Compute the reported unit cost for each product if direct labor hours are used as the
allocation base.
2. Compute the reported unit cost for each product if direct labor costs are used as the
allocation base.
3. Compute the reported unit cost for each product if machine hours are used as the
allocation base.
Chapter 06 – Fundamentals of Product and Service Costing
6-12
Solution:
1. Predetermined overhead rate =
$202,500
5,000 direct labor hours
= $40.50 per direct labor hour.
LX
Total
Units produced
50
80
Direct labor hours
2,000
5,000
Direct materials
$125,000
$215,000
Direct labor
90,000
150,000
Manufacturing overhead
(@$40.50 per direct labor hour)
81,000
202,500
Total costs
$296,000
$567,500
Unit cost
$5,920
2. Predetermined overhead rate =
$202,500
$150,000 direct labor cost
= 135% of direct labor cost.
LX
EX
Total
Units produced
50
30
80
Direct materials
$125,000
$90,000
$215,000
Direct labor
90,000
60,000
150,000
Manufacturing overhead
(@135% of direct labor cost)
121,500
81,000
202,500
Total costs
$336,500
$231,000
$567,500
Unit cost
$6,730
$7,700
3. Predetermined overhead rate =
$202,500
2,700 machine hours
= $75 per machine hour.
LX
EX
Total
Units produced
50
30
80
Machine hours
1,500
1,200
2,700
Direct materials
$125,000
$90,000
$215,000
Direct labor
90,000
60,000
150,000
Manufacturing overhead
(@$75 per machine hour)
112,500
90,000
202,500
Total costs
$327,500
$240,000
$567,500
Unit cost
$6,550
$8,000
======================
Chapter 06 – Fundamentals of Product and Service Costing
6-13
LO 6-5 Explain the operation of a two-stage allocation system for product
costing.
♦ A close inspection of the components of manufacturing overhead may reveal that more than
one of the factors are driving the resource consumption during production. If this is the case, two
or more allocation bases can be used to allocate manufacturing overhead to the products.
• Two-stage cost allocation represents the process of first allocating costs to
intermediate cost pools and then to the individual cost objects using different allocation
bases.
• Exhibit 6.8 is a cost flow diagram that shows how this is done. An alternative view is
shown below.
Direct costs:
Direct materials,
Direct labor
Assigned to
Cost
objects:
Products or
services
Indirect costs:
Manufacturing
overhead
First stage
allocation
Cost pools
Second stage
allocation
• The first stage assignment is easy to accomplish if the accounts in the cost accounting
system can be readily distinguished in terms of, say, labor-related costs and machine-
related costs.
• Each cost pool is associated with a suitable allocation base and requires one
predetermined overhead rate.
Example 6 (Continued from Examples 3 and 4): An analysis of Grange Boats’ January
budget data shows that the total machine-related overhead is $72,000 and there are
4,000 machine hours (1,000 machine hours for C-27s and 3,000 machine hours for C-
20s), so the machine-related overhead rate is $18 per machine hour (= $72,000 ÷ 4,000
machine hours).
The total labor-related overhead is $108,000 and the direct labor costs are $150,000
($72,000 for C-27s and $78,000 for C-20s), so the labor-related overhead rate is 72%
of direct labor cost (= $108,000 ÷ $150,000 direct labor cost).
Chapter 06 – Fundamentals of Product and Service Costing
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The machine-related overhead assigned to C-27s and C-20s are $18,000 (= $18 per
machine hour × 1,000 machine hours) and $54,000 (= $18 per machine hour × 3,000
machine hours), respectively.
The labor-related overhead assigned to C-27s and C-20s are $51,840 (= $0.72 per
direct labor dollar × $72,000 direct labor costs) and $56,160 (= $0.72 per direct labor
dollar × $78,000 direct labor costs), respectively.
The unit cost based on the two-stage allocation will be $18,184 (= ($40,000 + $72,000
+ $18,000 + $51,840) ÷ 10 C-27s) for each C-27 and $7,472 (= ($36,000 + $78,000 +
$54,000 + $56,160) ÷ 30 C-20s) for each C-20.
• In a two-stage allocation system, allocation bases still have to be chosen that best reflect
the relation between overhead incurred and activity. A second criterion is the extent to
which the choice of allocation base affects reported product costs.
• Suppose that all direct labor is paid the same hourly wage, then there would be no
difference between using direct labor cost or direct labor hours in the single-stage cost
allocation system.
• Suppose that each direct laborer uses just one machine and that the machine is running
whenever the employee is working, then the amount of machine hours would be the same
as that of labor hours and the two-stage system would result in the same product costs as
would the single-stage system.
LO 6-6 Describe the three basic types of product costing systems: job order,
process, and operations.
♦ Different companies have different production and costing systems.
• The two production processes that sit at the opposite end of the production spectrum can
be described as discrete (such as boat building) and continuous (such as paint
manufacturing), respectively.
• The product costing systems should reflect the differences in the production processes.
• Jobs are units of a product that are easily distinguishable from other units.
Chapter 06 – Fundamentals of Product and Service Costing
6-15
• Job costing is an accounting system that traces costs to individual units or to specific
jobs, contracts, or batches of goods. Companies that generally produce customized
products use job costing methods.
• Continuous flow processing is a system that generally mass-produces a single,
homogeneous output in a continuing process.
• Process costing is an accounting system used when identical units are produced
through a series of uniform production steps. Companies with continuous flow processing
use process costing methods.
• Exhibit 6.10 shows a continuum of production methods ranging from those requiring
job costing to those needing process costing.
• Many companies use job systems for some projects and process systems for others. Yet
other companies use a hybrid of both when, for example, different products with different
materials share a standardized production process.
• Operation is a standardized method or technique of making a product that is
repetitively performed.
• Operations costing is a hybrid costing system often used in manufacturing goods that
have some common characteristics plus some individual characteristics.
======================
Demonstration Problem 3
Jim is a florist who runs Bountiful Flower Shop as a sole owner. During the third week of June,
he received two orders for flower bouquets that required same operations but different
flower/basket combinations. Orders 471 and 472 were for a wedding hall and a business
conference, respectively. The following information was available.
Order 471
Order 472
Total
Number of bouquets
120
90
210
Flowers
$1,800
$1,080
$2,880
Baskets
600
360
960
Supplies
240
90
330
Total costs of materials
$2,640
$1,530
$4,170
Direct labor in operation
$630
Overhead in operation
1,155
Chapter 06 – Fundamentals of Product and Service Costing
6-16
Total costs in operation
$1,785
Required:
Determine the total cost and unit cost for Orders 471 and 472.
Solution:
The costs of materials can be assigned directly to the two orders. Because the time and the
effort required to put together each bouquet is essentially the same, Jim could allocate the
operation costs based on the number of units (bouquets) assembled. That is,
Operation cost per bouquet =
$1,785
210 bouquets
= $8.50 per bouquet.
Order 471’s share of the operation costs was $1,020 (= $8.50 per bouquet × 120 bouquets).
Order 472’s share was $765 (= $8.50 per bouquet × 90 bouquets).
Order 471
Order 472
Number of bouquets
120
90
Flowers
$1,800
$1,080
Baskets
600
360
Supplies
240
90
Total costs of materials
$2,640
$1,530
Operation costs
1,020
765
Total order costs
$3,660
$2,295
Unit cost
$30.50
$25.50
======================
• The design of the cost system is fundamentally the same. All three cost systems (job,
process, and operations) provide managers information about the costs of the products
and services these companies sell. All production costs are allocated to the products
manufactured. The differences reflect differences in the number of products and the
processes used.
Matching
A.
Continuous flow processing
F.
Operation costing
B.
Cost management system
G.
Predetermined overhead rate
C.
Job
H.
Process costing
D.
Job costing
I.
Two-stage cost allocation
E.
Operation