S_Session 05 - Product Costing - Post Class.pdf

# E not material it can all be closed or written off to

• Notes
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If the amount is small (i.e., not material), it can all be closed (or written off) to COGS. over-applied subtract off from COGS under-applied add to COGS Alternatively, the amount can be prorated (or divided) among the relevant inventory accounts and COGS. One method uses ending balances before taking variances into account: Ending WIP balance before proration = \$ 11,200 ( 5.33%) Ending FG Inventory before proration = \$ 8,800 ( 4.19%) COGS before proration = \$190,000 (90.48%) This amount must be closed at the end of the period. Which is to say, all differences need to be reconciled. From the preceding example, Overhead Variance (Under-applied) = 84,000 80,000 = 4,000 (unfavorable)

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25 Based on these percentages, these accounts would be increased by (since overhead were under-applied): Ending Work-in-Process: \$4,000 x 5.33% = \$213 Ending Finished Goods: \$4,000 x 4.19% = \$168 Cost of Goods Sold: \$4,000 x 90.48% = \$3,619 How would net income be affected by this proration? As an analyst or investor, do you care about how companies set their predetermined rates or how they close their variances? TREATMENT OF UNDER- OR OVER-APPLIED OVERHEAD
26 STANDARD COSTING Standard costing systems apply all product costs (direct material, direct labor, and manufacturing overhead) to inventory using standard or predetermined rates. The standard rate for direct labor is the estimated or budgeted labor rate (e.g., \$/hour) and for direct material is the budgeted material cost (e.g., \$/pound, \$/foot or \$/part). Under normal costing , only overhead costs can be over- or under-applied. Under standard costing , each cost category can be over- or under-applied. The resulting variances must be closed at the end of the period.

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Some Terminology ACTUAL OUTPUT (AO) is the actual number of units produced. (This can be different than the number sold.) INPUT is the amount of a resource needed for each unit made. Examples: Hours or minutes per unit for direct labor Liters or pounds per unit for direct material For overhead, input is the amount of the allocation base per unit (if overhead is allocated using machine hours, it is machine hours per unit; if allocated using direct labor hours, it is direct labor hour per unit) Actual input (AI) is the actual amount of the resource used per unit made Standard input (SI) is the standard or budgeted amount of the resource (to be) used per unit made 27
Some Terminology PRICE is the cost (or price) per unit of resource (NOT per unit of product or service sold). Examples: Hourly wage rate for direct labor Cost per liters or pound of direct material The price of overhead is the overhead rate (if overhead is allocated using machine hours, it is dollars per machine hour) Actual price (AP) is the actual price per unit of the resource used or the actual overhead rate Standard price (SP) is the standard or budgeted price per unit of the resource used or the standard overhead rate Actual Cost per unit of output = Actual resource input per unit x actual price of resource Standard Cost per unit of output = Standard resource input per unit x standard price of resource 28

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