chapter6 - Management Accounting | 93 Direct Costing...

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Direct Costing Financial Statements Purpose Accounting has evolved slowly over many centuries. The frst important complete treatise on the principles oF accounting and bookkeeping was a book by Pacoli in the 1490s. The development oF accounting principles and procedures are still continuing to evolve. In the early 1900s, many controversial issues were debated and some were resolved. In the 1950s and 1960s here in the USA, the lack oF standardization in accounting was oF primary concern. One oF controversial areas debated extensively in the 1930s and 1940s was the treatment oF manuFacturing overhead in the costing oF inventory and cost oF goods sold. The controversy was commonly labeled absorption costing versus direct costing. To understand the issues involved, a good understanding oF the principles oF cost accounting is helpFul. The purpose oF this chapter is to provide a conceptual Foundation For understanding the eFFect that absorption costing and direct costing have on net income. In direct costing, fxed manuFacturing overhead is treated as an operating expense (period charge). Absorption costing regards fxed manuFacturing overhead as a manuFacturing cost properly included in inventory and cost oF goods sold. Because oF the diFFerence in the treatment oF fxed manuFacturing overhead, a substantial diFFerence in the measurement oF net income can result. Accounting for Manufacturing Overhead ManuFacturing overhead is one oF the three major manuFacturing costs. ±or the most part, materials and labor are considered direct costs and can be easily associated with a specifc product or job. However, manuFacturing overhead tends to be more intangible and diFfcult to trace to a product or job. ±or example, utility cost such as power and light is necessary to the production process, but it is not easily assignable to a product, job, or department. The main solution to distributing overhead cost has been the use oF overhead rates. Rates are typically determined by dividing estimated overhead cost by some estimated measure oF activity. Consequently, the rates are oFten called predetermined overhead rates. Activity bases For overhead typically used
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94 | CHAPTER SIX Direct Costing Financial Statements are direct labor hours, direct labor cost, machine hours, and units of product. The conventional theory is that direct labor which is easily capable of being measured correlates directly with the amount of overhead being incurred. If product A has labor cost of $100,000 and product B has labor cost of $200,000, then 1/3 of the overhead would be allocated to product A and 2/3 to product B. However, accountants quickly realized that manufacturing overhead varies in nature in that some overhead tends to be Fxed and some tends to be variable. Variable cost was recognized to be caused by activity and to vary directly with changes in activity.
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chapter6 - Management Accounting | 93 Direct Costing...

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