BUS 215; Banfield, Ch 3 Week 2 Notes
BUS 215; Banfield, Ch 3 Week 2 Notes BUS 215
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Date Created: 04/18/16
BUS 215 Ch 3 Job Order Costing Inabsorption costing , all manufacturing costs, both fixed and variable, are assigned to units of product—units are said to fully absorb manufacturing costs to determine product costs Most countries—including the United States—require some form of absorption costing for both external financial reports and for tax reports I. JobOrder Costing An Overview ● Under absorption costing, product costs include all manufacturing costs. ○ Some manufacturing costs, such as direct materials, can be directly traced to particular products. Cost of tires directly traced to Toyota camry cars ● But what about manufacturing costs like factory rent? Such costs do not change from month to month. ○ costs remain unchanged from month to month regardless of what products are made, they are clearly not caused by—and cannot be directly traced to—any particular product. ○ these types of costs are assigned to products and services by averaging across time and across products. ○ The type of production process influences how this averaging is done. ● Joborder costing is used in situations where many differe products, each with individual and unique features, are produced each period. ○ EX: Levi Strauss clothing factory would typically make many different types of jeans for both men and women during a month. ○ characterized by diverse outputs. ○ each airline orders a different type of meal from LSG Sky Chefs’ catering service. ● Joborder costing is also used extensively in service industries. ○ EX: hospitals, law firms, movie studios, accounting firms, advertising agencies, and repair shops all use a variation of joborder costing to accumulate costs II. Joborder Costing An Example ● recall from the previous chapter that companies generally classify manufacturing costs into three broad categories: (1) direct materials, (2) direct labor, and (3) manufacturing overhead. A. Measuring Direct Materials Cost ○ a custom product that is being made for the first time, but if this were one of the company’s standard products, it would have an establishedbill of material A bill of materials a document that lists the type and quantity of each type of direct material needed to complete a unit of product. ○ When an agreement has been reached with the customer concerning the quantities, prices, and shipment date for the order, production order is issued. ○ The Production Department then prepares a materials requisition for similar to the form Exhibit 31. The materials requisition form is a document that specifies the type and quantity of materials to be drawn from the storeroom and identifies the job that will be charged for the cost of the materials. ■ used to control the flow of materials into production and also for making entries in the accounting records. B. Job Cost Sheet ○ After a production order has been issued, the Accounting Department’s joborder costing software system automatically generates a job cost sheet like the one presented iExhibit 32 ○ A job cost sheet records the materials, labor, and manufacturing overhead costs charged to that job. ○ After direct materials are issued, the cost of these materials are automatically recorded on the job cost sheet. C. Measuring Direct Labor Cost ○ Direct labor consists of labor charges that are easily traced to a particular job. ■ Labor charges that cannot be easily traced directly to any job are treated as part of manufacturing overhead. ■ As discussed in the previous chapter, this latter category of labor costs isindirect labo and includes tasks such as maintenance, supervision, and cleanup. ○ Most companies rely on computerized systems to maintain employee time ticket A completed time ticket is an hourbyhour summary of the employee’s activities throughout the day. ■ One computerized approach to creating time tickets uses bar codes to capture data. ■ Each employee and each job has a unique bar code. ● The first bar code indicates that a job is being started; the second is the unique bar code on the employee’s identity badge; and the third is the unique bar code of the job itself. D. Computing Predetermined Overhead Rates ○ Assigning manufacturing overhead to a specific job involves some difficulties. There are three reasons for this: ■ 1) Manufacturing overhead is an indirect cos This means that it is either impossible or difficult to trace these costs to a particular product or job. ■ 2) Manufacturing overhead consists of many different types of costs ranging from the grease used in machines to the annual salary of the production manager. ● Some of these costs are variable overhead costs because they vary in direct proportion to changes in the level of production (e.g., indirect materials, supplies, and power) and some are fixed overhead costs because they remain constant as the level of production fluctuates (e.g., heat and light, property taxes, and insurance). ■ 3) Because of the fixed costs in manufacturing overhead, total manufacturing overhead costs tend to remain relatively constant from one period to the next even though the number of units produced can fluctuate widely. Consequently, the average cost per unit will vary from one period to the next. EX 33 ○ ○ Given these problems, allocation is used to assign overhead costs to products. Allocation is accomplished by selecting aallocation bas that is common to all of the company’s products and services. ■ An allocation baseis a measure such as direct laborhours (DLH) or machinehours (MH) that is used to assign overhead costs to products and services. ■ The most widely used allocation bases in manufacturing are ● direct laborhours, ● direct labor cost, ● Machinehours, ● and (where a company has only a single product) units of product. ○ Manufacturing overhead is commonly assigned to products usina predetermined overhead rate. ■ The predetermined overhead rate is computed by dividing the total estimated manufacturing overhead cost for the period by the estimated total amount of the allocation base as follows: ■ The predetermined overhead rate is computed before the period begins using a fourstep process. ● The first step is to estimate the total amount of the allocation base (the denominator) that will be required for next period’s estimated level of production. ● The second step is to estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. ● The third step is to use the cost formula shown below to estimate the total manufacturing overhead cost (the numerator) for the coming period: ○ Y = The estimated total manufacturing overhead cost ○ a = The estimated total fixed manufacturing overhead cost ○ b = The estimated variable manufacturing overhead cost per unit of the allocation base ○ X = The estimated total amount of the allocation base ● The fourth step is to compute the predetermined overhead rate. ○ Notice, the estimated amount of the allocation base is determined before estimating the total manufacturing overhead cost. This needs to be done because total manufacturing overhead cost includes variable overhead costs that depend on the amount of the allocation base. E. Applying Manufacturing Overhead ○ To repeat, the predetermined overhead rate is computbefore the period begins. ○ The predetermined overhead rate is then used to apply overhead cost to jobs throughout the period. The process of assigning overhead cost to jobs is coverhead application. ■ The formula for determining the amount of overhead cost to apply to a particular job is: ■ For example, if the predetermined overhead rate is $8 per direct laborhour, then $8 of overhead cost isapplied to a job for each direct laborhour incurred on the job. When the allocation base is direct laborhours, the formula becomes: F. Manufacturing Overhead A Closer Look ○ let’s return to Yost Precision Machining and make the following assumptions. ■ In step one, the company estimated that 40,000 direct laborhours would be required to support the production planned for the year. ■ In step two, it estimated $220,000 of total fixed manufacturing overhead cost for the coming year and $2.50 of variable manufacturing overhead cost per direct laborhour. ■ Given these assumptions, in step three the company used the cost formula shown below to estimate its total manufacturing overhead cost for the year: ■ In step four, Yost Precision Machining computed its predetermined overhead rate for the year of $8 per direct laborhour as shown below: ● The job cost sheet inExhibit 34 indicates tha27 direct laborhours (i.e., DLHs) were charged to Job 2B47. Therefore, a total o$216 of manufacturing overhead cost would be applied to the job: ● This amount of overhead has been entered on the job cost sheet iExhibit 34. Note that this inot the actual amount of overhead caused by the job. ○ Actual overhead costs arenot assigned to jobs—if that could be done, the costs would be direct costs, not overhead. ○ The overhead assigned to the job is simply a share of the total overhead that was estimated at the beginning of the year. ○ A normal cost system , which we have been describing, applies overhead to jobs by multiplying a predetermined overhead rate by the actual amount of the allocation base incurred by the jobs. G. The Need for a Predetermined Rate ○ If an actual rate is computed monthly or quarterly, seasonal factors in overhead costs or in the allocation base can produce fluctuations in the overhead rate. ■ For example, the costs of heating and cooling a factory in Illinois will be highest in the winter and summer months and lowest in the spring and fall. If the overhead rate is recomputed at the end of each month or each quarter based on actual costs and activity, the overhead rate would go up in the winter and summer and down in the spring and fall. As a result, two identical jobs, one completed in the winter and one completed in the spring, would be assigned different manufacturing overhead costs. ● These fluctuations in product costs serve no useful purpose. ● To avoid such fluctuations, actual overhead rates could be computed on an annual or lessfrequent basis. ○ However, if the overhead rate is computed annually based on the actual costs and activity for the year, the manufacturing overhead assigned to any particular job would not be known until the end of the year ■ For these reasons, most companies use predetermined overhead rates rather than actual overhead rates in their cost accounting systems. H. Choice of an Allocation Base for Overhead Cost ○ Ideally, the allocation base in the predetermined overhead rate shodrivethe overhead cost ○ A cost driver is a factor, such as machinehours, beds occupied, computer time, or flighthours, that causes overhead costs. If the base in the predetermined overhead rate does not “drive” overhead costs, product costs will be distorted. ■ Most companies use direct laborhours or direct labor cost as the allocation base for manufacturing overhead. ○ In companies where direct labor and overhead costs have been moving in opposite directions, it would be difficult to argue that direct labor “drives” overhead costs ■ Accordingly, managers in some companies use activitybased costin principles to redesign their cost accounting systems. Activitybased costing is designed to more accurately reflect the demands that products, customers, and other cost objects make on overhead resources. ○ Although direct labor may not be an appropriate allocation base in some industries, in others it continues to be a significant driver of manufacturing overhead. ■ most manufacturing companies in the United States continue to use direct labor as the primary or secondary allocation base for manufacturing overhead ■ The key point is that the allocation base used by the company should really drive, or cause, overhead costs, and direct labor is not always the most appropriate allocation base I. Computation of Unit Costs ○ With the application of Yost Precision Machining $216 of manufacturing overhead to the job cost sheet in Exhibit 34, the job cost sheet is complete except for two final steps. ○ The unit production cost is an average cost and should not be interpreted as the cost thaw ould actually be incurred if another unit were produced. ○ The Incremental cost of an additional unit is something less than the average unit of $900 because much of the actual ovehead cost would not change if another unit were produced III. Job Order Costing The Flow of Costs ● Exhibit 35 provides a conceptual overview of these cost flows. It highlights the fproduct costs flow through inventories on the balance sheet and then on to cost of goods sold in the income statement. More specifically, raw materials purchases are recorded in thRaw Materials inventory account. ● Raw materials include any materials that go into the final product. When raw materials are used in production, their costs are transferred to tWork in Process inventory account as direct materials. ● Work in process consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer. ○ direct labor costs are added directly to Work in Process—they do not flow through Raw Materials inventory. ○ Manufacturing overhead costs are applied to Work in Process by multiplying the predetermined overhead rate by the actual quantity of the allocation base consumed by each job. ● When goods are completed, their costs are transferred from Work in Process Finished Goods. Finished goods consist of completed units of product that have not yet been sold to customers. ● The amount transferred from Work in Process to Finished Goods is referred to as cost of goods manufactured. The cost of goods manufactured includes the manufacturing costs associated with the goods that were finished during the period. ● As goods are sold, their costs are transferred from Finished Goods to Cost of Goods Sold. ○ At this point, the various costs required to make the product are finally recorded as an expense. ● Until that point, these costs are in inventory accounts on the balance sheet. Period costs (or selling and administrative expenses) do not flow through inventories on the balance sheet. ○ They are recorded as expenses on the income statement in the period incurred. ○ EXHIBIT 35 Cost Flows and Classifications in a Manufacturing Company ○ A. The Purchase and Issue of Materials ● On April 1, Ruger Corporation had $7,000 in raw materials on hand. During the month, the company purchased on account an additional $60,000 in raw materials. The purchase is recorded in journal entry (1) below: ○ Remember that Raw Materials is an asset account. Thus, when raw materials are purchased, they are initially recorded as an asset—not as an expense. ● Issue and Direct and Indirect Materials ○ During April, $52,000 in raw materials were requisitioned from the storeroom for use in production. These raw materials included $50,000 of direct and $2,000 of indirect materials. Entry (2) records issuing the materials to the production departments. ○ Materials charged to Work in Process represent direct materials for specific jobs. ○ costs are also recorded on the appropriate job cost sheets. This point is illustExhibit 3, where $28,000 of th$50,000 in direct materials is charged to Job A’s cost sheet and the rema$22,000 is charged to Job B’s cost sheet. (In this example, all data are presented in summary form and the job cost sheet is abbreviated. ○ EXHIBIT 36 Raw Materials Cost Flows ○ ○ The purpose of the Manufacturing Overhead account is to accumulate all manufacturing overhead costs as they are incurred during a period. ■ Before leaving Exhibit 36, we need to point out one additional thing. Notice from the exhibit that the job cost sheet for Job A contains a beginning balance of$30,000. We stated earlier that this balance represents the cost of work done during March that has been carried forward to April. ■ Also note that the Work in Process account contains the same $30,000 balance. ■ Thus, the Work in Process account summarizes all of the costs appearing on the job cost sheets of the jobs that are in process. B. Labor Cost ● In April, the employee time tickets included $60,000 recorded for direct labor and $15,000 for indirect labor. The following entry summarizes these costs: ● ● direct labor costs are added to Work in Process, they are also added to the individual job cost sheets, as shown in Exhibit 37. ○ The labor costs charged to Manufacturing Overhead ( $15,000) represent the indirect labor costs of the period, such as supervision, janitorial work, and maintenance. C. Manufacturing Overhead Costs ● Recall that all manufacturing costs other than direct materials and direct labor are classified as manufacturing overhead costs. These costs are entered directly into the Manufacturing Overhead account as they are incurred. ● To illustrate, assume that Ruger Corporation incurred the following general factory costs during April: ○ The following entry records the incurrence of these costs: ● assume that during April, Ruger Corporation recognized $13,000 in accrued property taxes and that $7,000 in prepaid insurance expired on factory buildings and equipment. The following entry records these items: ● Finally, assume that the company recognized $18,000 in depreciation on factory equipment during April. The following entry records the accrual of this depreciation ● In short, all actual manufacturing overhead costs are debited to the Manufacturing Overhead account as they are incurred. D. Applying Manufacturing Overhead ● how are manufacturing overhead costs assigned to Work in Process? ○ by means of the predetermined overhead rate. ○ predetermined overhead rate is established at the beginning of each year. The rate is calculated by dividing the estimated total manufacturing overhead cost for the year by the estimated total amount of the allocation base (measured in machinehours, direct laborhours, or some other base). ○ The predetermined overhead rate is then used to apply overhead costs to jobs. ■ For example, if machinehours is the allocation base, overhead cost is applied to each job by multiplying the predetermined overhead rate by the number of machinehours charged to the job. ● To illustrate, assume that Ruger Corporation’s predetermined overhead rate is $6 per machinehour. ○ Also assume that during April, 10,000 machinehours were worked on Job A and 5,000 machinehours were worked on Job B (a total of 15,000 machinehours). Thus, $90,000 in overhead cost ($6 per machinehour × 15,000 machinehours = $90,000) would be applied to Work in Process. ○ The following entry records the application of Manufacturing Overhead to Work in Process ○ The flow of costs through the Manufacturing Overhead account is shown iExhibit 38. The actual overhead costs on the debit side in the Manufacturing Overhead account Exhibit 38 are the costs that were added to the account in entries (2)–(6). ● The Concept of Clearing ○ The Manufacturing Overhead account operates as a clearing account. ○ When a job is completed (or at the end of an accounting period), overhead cost is applied to the job using the predetermined overhead rate, and Work in Process is debited and Manufacturing Overhead is credited. ○ the predetermined overhead rate is based entirely on estimates of what the level of activity and overhead costs areexpected to be, and it is established before the year begins. ○ As a result, the overhead cost applied during a year will almost certainly turn out to be more or less than the actual overhead cost incurred ○ For the moment, we can conclude from Exhibit 38 that the cost of a completed job consists of the actual direct materials cost of the job, the actual direct labor cost of the job, and the manufacturing overhead cost applied to the job. Pay particular attention to the following subtle but important point: ○ Actual overhead costs are not charged to jobs; actual overhead costs do not appear on the job cost sheet nor do they appear in the Work in Process account. Only the applied overhead cost, based on the predetermined overhead rate, appears on the job cost sheet and in the Work in Process account. E. Nonmanufacturing Costs ● companies also incur selling and administrative costs ● costs should be treated as period expenses and charged directly to the income statemenNonmanufacturing costs should not go into the Manufacturing Overhead account. ● The following entry summarizes the accrual of those salaries: ● Assume that depreciation on office equipment during April was $7,000. The entry is as follows: ● ○ depreciation on factory equipment was debited to Manufacturing Overhead and is therefore a product cost ○ In journal entry (9) above, depreciation on office equipment is debited to Depreciation Expense. Depreciation on office equipment is a period expense rather than a product cost. ● Finally, assume that advertising was $42,000 and that other selling and administrative expenses in April totaled $8,000. The following entry records these items: ○ The amounts in entries (8) through (10) are recorded directly into expense accounts—they have no effect on product costs. F. Cost of Goods Manufactured ● , When a job has been completed, the finished output is transferred from the production departments to the finished goods warehouse. ● A transfer of costs is made within the costing system tparallel the physical transfer of goods to the finished goods warehouse. ○ The costs of the completed job are transferred out of the Work in Process account and into the Finished Goods account. ○ The sum of all amounts transferred between these two accounts represents the cost of goods manufactured for the period. ○ In the case of Ruger Corporation, assume that Job A was completed during April. The following entry transfers the cost of Job A from Work in Process to Finished Goods: ■ The $158,000 represents the completed cost of Job A, as shown on the job cost sheet iExhibit 38. Because Job A was the only job completed during April, the $158,000 also represents the cost of goods manufactured for the month. ■ Job B was not completed by the end of the month, so its cost will remain in the Work in Process account and carry over to the next month G. Cost of Goods Sold ● As finished goods are shipped to customers, their accumulated costs are transferred from the Finished Goods account to the Cost of Goods Sold account. ● In most cases, however, only a portion of the units involved in a particular job will be immediately sold. In these situations, the unit product cost must be used to determine how much product cost should be removed from Finished Goods and charged to Cost of Goods Sold. ● For Ruger Corporation, we will assume 750 of the 1,000 gold medallions in Job A were shipped to customers by the end of the month for total sales revenue of $225,000. Because 1,000 units were produced and the total cost of the job from the job cost sheet was $158,000, the unit product cost was $158. The following journal entries would record the sale (all sales were on account): ● Entry (13) completes the flow of costs through the joborder costing system. To pull the entire Ruger Corporation example together, journal entries (1) through (13) are summarized in Exhibit 39. The flow of costs through the accounts is presented in Taccount form in Exhibit 310. ● EXH 39 Summary of Journal Entries Rugar Corp ● EXH 10 IV. Schedules of Cost of Goods Manufactured and Cost of Goods Sold ● The schedule of cost of goods manufactured contains three elements of product costs—direct materials, direct labor, and manufacturing overhead—and it summarizes the portions of those costs that remain in ending Work in Process inventory and that are transferred out of Work in Process into Finished Goods. ● The schedule of cost of goods sold also contains three elements of product costs—direct materials, direct labor, and manufacturing overhead—and it summarizes the portions of those costs that remain in ending Finished Goods inventory and that are transferred out of Finished Goods into Cost of Goods Sold. ● Exhibit 311 presents Ruger Corporation’s schedules of cost of goods manufactured and cost of goods sold. We want to draw your attention to three equations that are embedded within the schedule of cost of goods manufactured. ○ First, thraw materials used in productio are computed using the following equation ○ For Ruger Corporation, the beginning raw materials inventory of $7,000 plus the purchases of raw materials of $60,000 minus the ending raw materials inventory of $15,000 equals the raw materials used in production of $52,000. ○ Second, the total manufacturing costs are computed using the following equation: ■ The direct materials used in production will usually differ from the amount of raw material purchases when the raw materials inventory balance changes or indirect materials are withdrawn from raw materials inventory. ■ this equation includes manufacturing overhead applied to work in process rather than actual manufacturing overhead costs. ■ its manufacturing overhead applied to work in process of $90,000 is computed by multiplying the predetermined overhead rate of $6 per machinehour by the actual amount of the allocation base recorded on all jobs, or 15,000 machinehours. ● the actual manufacturing overhead costs incurred during the period are not added to the Work in Process account. ○ The third equation included in the schedule of cost of goods manufactured relates to computing the cost of goods manufactured: ○ ■ For Ruger, the total manufacturing costs of $200,000 plus the beginning work in process inventory of $30,000 minus the ending work in process inventory of $72,000 equals the cost of goods manufactured of $158,000. The cost of goods manufactured represents the cost of the goods completed during the period and transferred from Work in Process to Finished Goods. ■ The schedule of cost of goods sold shown in Exhibit 311 relies on the following equation to compute the unadjusted cost of goods sold: ■ ■ The beginning finished goods inventory ($10,000) plus the cost of goods manufactured ($158,000) equals the cost of goods available for sale ($168,000). The cost of goods available for sale ($168,000) minus the ending finished goods inventory ($49,500) equals the unadjusted cost of goods sold ($118,500). Finally, the unadjusted cost of goods sold ($118,500) plus the underapplied overhead ($5,000) equals adjusted cost of goods sold ($123,500). ○ Exhibit 312 presents Ruger Corporation’s income statement for April. Observe that the cost of goods sold on this statement is carried over froExhibit 311. The selling and administrative expenses (which total $87,000) did not flow through the schedules of cost of goods manufactured and cost of goods sold. Journal entries 8–10 (pages 98–99) show that these items were immediately debited to expense accounts rather than being debited to inventory accounts. ○ EXHIBIT 312 Income Statement V. Underapplied and Overapplied Overhead A closer look A. Computing Underapplied and OVerapplied ● the overhead cost applied to Work in Process will generally differ from the amount of overhead cost actually incurred. ○ In the case of Ruger Corporation, for example, the predetermined overhead rate of $6 per hour was used to apply $90,000 of overhead cost to Work in Process, whereas actual overhead costs for April proved to be $95,000 (sexhibit 38). ○ the difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is called eitunderapplied oroverapplied overhead . ○ Ruger Corporation, overhead was underapplied by $5,000 because the applied cost ($90,000) was $5,000 less than the actual cost ($95,000). If the situation had been reversed and the company had applied $95,000 in overhead cost to Work in Process while incurring actual overhead costs of only $90,000, then the overhead would have been overapplied. ● What is the cause of underapplied or overapplied overhead? ○ the method of applying overhead to jobs using a predetermined overhead rate assumes that actual overhead costs will be proportional to the actual amount of the allocation base incurred during the period. ○ If, for example, the predetermined overhead rate is $6 per machinehour, then it is assumed that actual overhead costs incurred will be $6 for every machinehour that is actually worked. ○ There are at least two reasons why this may not be true. ■ First, much of the overhead often consists of fixed costs that do not change as the number of machinehours incurred goes up or down. ■ Second, spending on overhead items may or may not be under control. If individuals who are responsible for overhead costs do a good job, those costs should be less than were expected at the beginning of the period. If they do a poor job, those costs will be more than expected. ○ To illustrate these concepts, suppose that two companies—Turbo Crafters and Black & Howell—have prepared the following estimated data for the coming year: ○ ■ When dollars are divided by dollars, the result is a percentage. ● Now assume that because of unexpected changes in overhead spending and in demand for the companies’ products, the actua overhead cost and the actual activity recorded during the year in each company are as follows: ● For each company, note that the actual data for both cost and the allocation base differ from the estimates used in computing the predetermined overhead rate. This results in underapplied and overapplied overhead as follows: ● EXHIBIT 313 Summary of Overhead Concepts ○ B. Disposition of Underapplied or Overapplied Overhead Balances ● Remember that debit entries to the account represent actual overhead costs incurred, whereas credit entries represent overhead costs applied to jobs. ● the actual overhead costs incurred exceeded the overhead costs applied to jobs by $5,000—hence, the debit balance of $5,000 ● the overhead costs applied ($90,000), and that the difference is called underapplied overhead. ● If there isdebi balance in the Manufacturing Overhead account of X dollars, then the overhead is underapplied by X dollars. On the other hand, if therecredit balance in the Manufacturing Overhead account of Y dollars, then the overhead overapplied by Y dollars. ● What do we do with the balance in the Manufacturing Overhead account at the end of the accounting period? ○ The underapplied or overapplied balance remaining in the Manufacturing Overhead account at the end of a period is treated in one of two ways: ■ Closed out to Cost of Goods Sold. ■ Allocated among the Work in Process, Finished Goods, and Cost of Goods Sold accounts in proportion to the overhead applied during the current period in ending balances. ● Closed OUt to Cost of Goods Sold ○ In the Ruger Corporation example, the entry to close the $5,000 of underapplied overhead to Cost of Goods Sold is: ○ Note that because the Manufacturing Overhead account has a debit balance, Manufacturing Overhead must be credited to close out the account. This has the effect of increasing Cost of Goods Sold for April to $123,500: ■ Note that this adjustment makes sense. The unadjusted cost of goods sold is based on the amount of manufacturing overhead applied to jobs, not the manufacturing overhead costs actually incurred. ■ Because overhead was underapplied, not enough cost was applied to jobs. ■ Hence, the cost of goods sold was understated. Adding the underapplied overhead to the cost of goods sold corrects this understatement. ● Allocated Between Accounts ○ Allocation of underapplied or overapplied overhead between Work in Process, Finished Goods, and Cost of Goods Sold is more accurate than closing the entire balance into Cost of Goods Sold. ○ allocation assigns overhead costs to where they would have gone had the estimates included in the predetermined overhead rate matched the actual amounts. ○ Had Ruger Corporation chosen to allocate the underapplied overhead among the inventory accounts and Cost of Goods Sold, it would first be necessary to determine the amount of overhead that had been applied during April to each of the accounts. The computations would have been as follows: ■ ■ Based on the above percentages, the underapplied overhead (i.e., the debit balance in Manufacturing Overhead) would be allocated as shown in the following journal entry: ■ ■ If overhead had been overapplied, the entry above would have been just the reverse, because a credit balance would have existed in the Manufacturing Overhead account. ● A General Model of Product Cost Flows ○ Exhibit 31 presents a Taccount model of the flow of costs in a product costing system. ○ ● Multiple Predetermined Overhead Rates ○ Our discussion in this chapter has assumed that there is a single predetermined overhead rate for an entire factory callelantwide overhead rate. ■ This is a fairly common practice—particularly in smaller companies. But in larger companies, multiple predetermined overhead rate are often used. ○ In amultiple predetermined overhead rate system each production department may have its own predetermined overhead rate. Such a system, while more complex, is more accurate because it can reflect differences across departments in how overhead costs are incurred. ■ For example, in departments that are relatively labor intensive overhead might be allocated based on direct laborhours and in departments that are relatively machine intensive overhead might be allocated based on machinehours. ■ When multiple predetermined overhead rates are used, overhead is applied in each department according to its own overhead rate as jobs proceed through the department. VI. Summary VOCAB
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