(16 Cost Accounting Systems)

CHAPTER 16
Cost accounting systems

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

16.1 explain the characteristics and purposes of cost accounting systems
16.2 describe the flow of costs in a job order cost system
16.3 explain a job cost sheet and the accounting entries for a job order cost system
16.4 describe the flow of costs in a process cost system
16.5 prepare the accounting entries for a process cost system
16.6 prepare a production cost report
16.7 recognise the difference between traditional costing and activity-based costing and identify the activity
cost pools and activity drivers used in activity-based cost systems
16.8 understand the benefits and limitations of activity-based costing
16.9 differentiate between value-added and non-value-added activities
16.10 explain just-in-time (JIT) processing.
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Chapter preview
Michael Hill International Limited, jewellery manufacturer and retailer, is an example of a company with a
need for a costing system. Jewellery making is the manufacturing of mixed products: some unique special
orders and other similar or homogeneous pieces. How does a business determine the cost of making its
product and in turn ensure adequate pricing for a profitable business? This chapter discusses how costs
are assigned to products and services. The content and organisation of this chapter are as follows.
Cost accounting systems
Cost accounting Job order Process Activity-based

systems costing costing costing
• Non-manufacturing • Job cost flows • Uses of process • Traditional costing

entities • Job cost sheet costing systems
• Overhead application • Determining overhead • Process cost flow • Activity-based costing
• Job order costing and rates • Accounting procedures (ABC)
process costing • Accounting procedures • Equivalent units • Activity-based costing
• Reporting job cost data • Production cost report in manufacturing
• Under- or overapplied industries
manufacturing • Activity-based costing
overhead in service industries
• Non-manufacturing • Benefits and limitations
entities of activity-based costing
• Value-added vs. non-
value-added activities
• Hierarchy of activity
levels
• Just-in-time processing
(JIT)
16.1 Cost accounting systems

LEARNING OBJECTIVE 16.1 Explain the characteristics and purposes of cost accounting systems.
Cost accounting involves the measuring, recording and reporting of product or service costs. From the
data accumulated, both the total cost and the unit cost of each product are determined.
A product cost accounting system consists of manufacturing cost accounts that are fully integrated
into the general ledger of an entity. An important feature of a product cost accounting system is the use of
a perpetual inventory system that provides information immediately on the cost of a product. For financial
accounting, product costs are needed to value inventory in the statement of financial position and the cost
of sales in the statement of profit or loss.
Recall from chapter 15 that management accounting is primarily concerned with providing economic
and financial information to managers and other internal users for planning, directing and controlling
business activities. As such, cost accounting is an integral part of the management accounting system.
Accurate costing data provide any entity’s management with high quality information for making better
decisions. For example, having access to ingredient costing enables Domino’s Pizza Enterprises Ltd to
set competitive pricing for its fresh pizzas. Likewise, Coca-Cola Amatil needs accurate costing infor-
mation about its diversified lines of products to compete with other food and beverage manufacturers in
the markets.
CHAPTER 16 Cost accounting systems 977

Non-manufacturing entities
Cost accounting was designed mainly to determine product costs for manufacturing businesses. However,
the need for product cost information is also important in other industries such as merchandising, mining,
agricultural products and service industries. Service and non-profit entities do not have inventory but
they still need to know the cost of their services for the purposes of pricing, planning, cost control and
decision making. For example, Qantas management needs to know the cost of flying a proposed route,
the Willoughby City Council can make a better decision about whether to provide library services in a
new area if the cost of providing similar existing services is known, and Vodafone can decide when to
launch new products in Australia if the costs of the new network are known.
In Australia, the service sector is a large and important part of the economy. Approximately 70%
of gross domestic product (GDP) is derived from the service sector. The design of costing systems for
service entities differs from manufacturers in that the service is normally consumed as it is produced
and there is no inventory. However, for services that may take a longer time to complete, costs may be
accumulated and charged at a later date (e.g. a solicitor involved in a complex legal case may accumulate
unbilled labour and incidentals and invoice once a month). The service product is usually heterogeneous
and tailored to meet the customer’s (client’s) needs. As outlined in the previous chapter, product costs are
divided into direct materials, direct labour and manufacturing overhead, and the selling and administrative
costs are period costs. In contrast, in service entities the main costs are direct labour; there are very little,
if any, direct materials and it is often difficult to determine production overhead costs from other indirect
costs. For financial accounting purposes, no special ledger accounts are required to accumulate the costs
of the service provided as the costs are treated as period costs. The costs are recorded in individual
expense accounts such as Salaries and Wages, Telephone and Depreciation. This is because the service
is usually consumed as it is produced.
Overhead application
Whether a service is being provided or a product is being manufactured, establishing the costing sys-
tems for direct materials and direct labour presents a few difficulties. The difficult issue in establishing
the costing systems is the classification of what constitutes overheads that can be assigned as costs to
the products or services. For manufacturing entities, what constitutes manufacturing overheads that can
be inventoried (product cost) is constrained by the requirements of IAS 2/AASB 102 Inventories. This
will be discussed later in this chapter in the discussion of activity-based costing.
Theoretically, overhead costs are accumulated and then assigned to products and services in relation to
the resources consumed, but many indirect costs have differing relationships to the products and services.
Traditionally, many entities use a factory-wide rate such as direct labour hours or machine hours as the
cost driver. A cost driver is any factor or activity that has a direct cause–effect relationship with the
resources consumed. Thus, there should be some correlation between the incurrence of the overhead cost
and the use of the cost driver. For example, the cost of machine maintenance may be driven by the number
of hours each machine is used. The predetermined overhead rate can be applied to the whole factory
where one rate is applied for all production. Some entities may use a two-stage cost allocation, where
each production department is assigned the overhead costs that relate to that department and overheads
are assigned only to products that use that department. A further refinement of the allocation process is the
activity-based costing system. The processes of applying overheads are illustrated throughout this chapter.
Job order costing and process costing

All costing systems track the costs of providing a service or manufacturing a product. When deciding on
a cost accounting system, the nature of the product or service must be considered. Where the product or
service is unique (heterogeneous) with little standardisation (e.g. a tailor-made wedding gown or Flight
Centre booking an itinerary for a customer), costs are assigned to each job. However, where there is a high
978 Financial accounting: Reporting, analysis and decision making

volume, uniform, homogeneous products or services such as Mainland Cheese or bulk mail processing
by Australia Post, then the costing is based on the volume of the standard product or service through
each processing department. There are two basic types of accounting systems: (1) job order costing and
(2) process costing. Although the costing systems differ widely from entity to entity, most are based
on one of these two traditional costing systems. Figure 16.1 provides examples of businesses and the
products or services suited to job order costing and process costing systems.
FIGURE 16.1 Job order costing and process costing businesses
Job order costing Process costing

Business Product Business Product
Snap printing, Printing BMW, Cars

Posh printing Toyota
Mallesons Stephen Legal services Fonterra, Dairy

Jaques, Freelhills Bega Cheese products
Flight Centre, Qantas Travel Fisher & Paykel, Appliances

holiday LGE
bookings
Sigma Healthcare, Patient Shell Australia, Oil
Health Waikato healthcare New Zealand
Refining Company
Under a job order cost system, costs are assigned to each job, such as the manufacture of a high-
speed drilling machine, or to each batch of goods, such as 500 wedding invitations. Jobs or batches
may be completed to fill a specific customer order or to replenish inventory. An important feature of job
order costing is that each job (or batch) has its own distinguishing characteristics. For example, each
travel itinerary is developed to suit the traveller, each motion picture is unique, and each printing job is
different. The objective is to calculate the cost per job. At each point in the manufacturing process, the
job and its associated costs can be identified. A job order cost system measures costs for each completed
job, rather than for set time periods. A job order cost system is illustrated in figure 16.2.
FIGURE 16.2 Job order cost system
Job order cost system

Two jobs: wedding invitations and menus
Black ink $
Typesetting $
225 envelopes $ Red stock $
Typesetting $
Lamination $ 50 copies $
225 invitations $ Vellum stock, blue $
Job no. 9501 Job no. 9502
Each job has distinguishing characteristics and related costs.
A process cost system is used when a series of connected manufacturing processes or departments
produce a large volume of uniform or relatively homogeneous products. Production is continuous to

ensure that adequate inventories of the finished product(s) are on hand. A process cost system is used
in the manufacture of whitegoods, the refining of petroleum, the manufacture of motor vehicles and the
processing of cheese. Process costing accounts for and accumulates product-related costs for a period of
time (such as a week or a month) as opposed to assigning costs to specific products or job orders. In
process costing, the costs are assigned to or accumulated by departments or processes for a set period of
time. A process cost system is illustrated in figure 16.3.
FIGURE 16.3 Process cost system (based on data from Bega Cheese factory)
Process cost system

Cheese making
1. Milk is pasteurised. 2. Bacteria and rennet 3. The curds are cheddared, 4. Cheese is cooled
are added to form milled, salted and mellowed. and stored.
curds and whey.
Rennet The alfomatic
Pasteurisation addition cheddaring machine
Cheese making vat Maturation

cool store
Sweet Block Vacuum
Clarifier Salt silo Salt whey
whey former packer
Relatively similar products are produced over a specified period of time.
A business may use both types of cost systems. For example, BMW uses process cost accounting for
its standard models and job order cost accounting for BMW individual models, which are custom-made
orders with specific designs.
LEARNING REFLECTION AND CONSOLIDATION
Review it
1. What is cost accounting?
2. What is a cost accounting system?
3. How does a job order cost system differ from a process cost system?
16.2 Job order costing

LEARNING OBJECTIVE 16.2 Describe the flow of costs in a job order cost system.
Job cost flows

The flow of costs (direct materials, direct labour and manufacturing overhead) in job order cost account-
ing parallels the physical flow of the materials as they are converted into finished goods. As shown in
figure 16.4, manufacturing costs are assigned to the work in process inventory account. When a job is
completed, the cost of the job is transferred to finished goods inventory. Later when the goods are sold,
their cost is transferred to cost of sales.

FIGURE 16.4 Flow of costs in job order cost accounting
Manufacturing Work in process Finished goods

costs inventory inventory Cost of sales
Assigned
to Completed
d Sold
Raw materials
Factory labour
Manufacturing
overhead
A job order cost system uses the perpetual inventory approach for accumulating costs. Details of costs
are recorded on job cost sheets (subsidiary ledger) and summarised and recorded monthly in the gen-
eral ledger.
A more detailed presentation of the flow of costs is shown in figure 16.5. This figure indicates that there
are two major steps in the flow of costs: (1) accumulating the manufacturing costs incurred and (2) assign-
ing or allocating the accumulated costs to the job done. In step one, manufacturing costs incurred are
accumulated in entries 1–3 by debits to raw materials inventory, factory labour and manufacturing over-
head. No attempt is made when costs are incurred to associate the costs with specific jobs at this stage.
FIGURE 16.5 Job order cost accounting system
Job order cost accounting
Raw materials inventory Work in process inventory Finished goods inventory
(1) Purchases (4) Materials 4 (4) Direct (7) Cost of 7 (7) Cost of (8) Cost of 8
used materials completed completed sales
used jobs jobs
(5) Direct
labour used
(6) Overhead
Factory labour applied
Cost of sales
(2) Factory (5) Factory 5
(8) Cost of
labour labour used
sales
incurred
Manufacturing overhead (net)
Actual overhead (6) Overhead 6 Key to entries:

incurred: applied
Accumulation Assignment
(3) Depreciation,
insurance, 1. Purchase raw materials 4. Raw materials are used
repairs 2. Incur factory labour 5. Factory labour is used
(4) Indirect 3. Incur manufacturing 6. Overhead is applied
materials overhead 7. Completed goods are
used recognised
(5) Indirect 8. Cost of sales is
labour used recognised

The second stage is assigning the accumulated costs to the work done. As raw materials are used, the
costs are transferred to work in process (direct materials) and manufacturing overhead (indirect materials),
as shown in entry 4. Labour is assigned in the same way. Direct labour hours are controlled by a time
sheet that indicates the hours worked, the account/job to be charged and the total labour cost. This is
shown as entry 5. Manufacturing overhead costs are assigned to work in process and to specific jobs on
an estimated basis through the use of a predetermined overhead rate, as shown in entry 6. On completion
of production, the accumulated costs are transferred to finished goods inventory (entry 7), and when the
goods are sold the cost of the finished goods is transferred to cost of sales as shown in entry 8.
The general ledger accounts shown in figure 16.5 are control accounts with corresponding subsidiary
accounts using job cost sheets. The control account and the link to the subsidiary ledger are shown below.
Entries are made in the subsidiary ledgers daily as movement occurs and the entries are summarised and
recorded in the general ledgers usually on a monthly basis.
Control account Subsidiary ledger

Work in process inventory Job cost sheets (incomplete jobs)
Finished goods inventory Job cost sheets (completed jobs)
Cost of sales Job cost sheets (for jobs sold)
16.3 Job cost sheet

LEARNING OBJECTIVE 16.3 Explain a job cost sheet and the accounting entries for a job order cost system.
A job cost sheet or job card is a form used to record the costs chargeable to a specific job and to determine
the total and unit cost of the completed job. Postings to the job cost sheet are made daily directly from
the supporting documentation that shows the cost and job to be charged. A separate job cost sheet is kept
for each job. Job cost sheets constitute the subsidiary ledger for the work in process inventory account.
Each entry to work in process inventory must be accompanied by a corresponding posting to one or more
job cost sheets. Figure 16.6 shows a completed job cost sheet for customer Tanner Ltd. The information
contained on the job cost sheet is explained below.
FIGURE 16.6 Completed job cost sheet
Job cost sheet

Job no. 101 Quantity 1000
Item Magnetic sensors Date ordered 5 March
For Tanner Ltd Date completed 31 March
Date required 5 April
Date Direct materials Direct labour Manufacturing overhead

6/3 $ 2 000
10/3 $18 000 $14 400

12/3 14 000
26/3 8 000
31/3 12 000 9 600
$24 000 $30 000 $24 000
Cost of completed job

Direct materials $24 000
Direct labour 30 000
Manufacturing overhead 24 000
Total cost $78 000
Unit cost ($78 000 ÷ 1000) $ 78.00

Helpful hint: A job cost sheet is a source document detailing the costs associated with each job or
order that a business is working on or has completed.
Each job requires a control number: Tanner’s job is number 101 for 1000 magnetic sensors. It also
shows that the job started on 6 March and was completed on 31 March, five days ahead of the scheduled
required date and time. On 6, 12 and 26 March materials were requisitioned for the job and the direct
labour of $30 000 was assigned from labour sheets. Overheads were allocated on the same date as the
labour, which indicates that the overheads were allocated according to direct labour hours. The bottom
half of the job sheet summarises the costs and calculates a per-unit cost for the job.
DECISION-MAKING TOOLKIT
Tool or technique How to evaluate results

Decision/issue Info needed for analysis to use for decision to make decision
What is the cost Cost of material, labour Job cost sheet Compare costs with those
of a job? and overhead assigned to of previous periods and
a specific job with those of competitors
to ensure that costs are in
line. Compare costs with
expected selling price to
determine overall
profitability.
Determining overhead rates

The predetermined overhead application rate (or budgeted overhead rate) is based on the relation-
ship between estimated annual overhead costs and expected annual operating activity, expressed in terms
of a common activity base. The common activity base may be stated in terms of direct labour costs,
direct labour hours, machine hours or any other measure that will provide an equitable basis for applying
overhead costs to jobs. The predetermined overhead application rate is established by the beginning of
the year. The formula for a predetermined overhead application rate is shown in figure 16.7.
FIGURE 16.7 Formula for predetermined overhead application rate
Predetermined
Estimated annual Expected annual
÷ = overhead
overhead costs operating activity
application rate
The reason for using a predetermined rate to assign overhead costs to jobs is that actual overheads
are generally not known at the time when a job or order is being worked on. For example, the actual
costs of factory overheads such as electricity and water rates are generally not available until the end
of each month when the invoices are received. As jobs are being completed throughout the month, the
time lag for the availability of actual overhead costs means that the information will be too late to be
useful. As an alternative, management accountants estimate how much factory overheads will be and use
a predetermined application rate to assign overhead costs so that the cost for a job can be determined
immediately. Figure 16.8 indicates how manufacturing overhead is applied to work in process.

Helpful hint: In contrast to overhead, actual costs for direct materials and direct labour are used to
assign costs to work in process because the time delay to get materials and labour cost information
is short.
FIGURE 16.8 Using predetermined overhead application rates
Work in process
Activity Predetermined is
× overhead assigned
base
application rate to
Job 1 Job 2 Job 3
For example, if direct labour cost is the activity base, annual overhead costs are expected to be $280 000
and direct labour costs are anticipated to be $350 000, the overhead application rate is 80%, calculated
as follows:
$280 000 ÷ $350 000 = 80%
This means that for every dollar of direct labour, 80 cents of manufacturing overhead will be applied
to a job. The use of a predetermined overhead application rate enables the business to determine the
approximate total cost of each job when the job is completed.
Historically, direct labour costs or direct labour hours have often been used as the activity base because
of the relatively high correlation between direct labour and manufacturing overhead. In recent years,
however, there has been a significant trend towards using machine hours or a combination of other activity
measures as the activity base because of increased reliance on automation in manufacturing operations.
This is discussed in more detail later in the chapter.
Accounting procedures
The following is a brief overview of the recording procedures required in a job order cost system.
Factory material costs
Materials requisitions are made to authorise the release of the raw materials from the materials store. The
requisitions are posted daily to the job cost sheets. Each month the requisitions are sorted, totalled and
costed for entry to the general ledger. Raw materials may be used directly on a job, or they may form
part of the indirect materials costs and are thus part of the overhead. For example, if $36 000 of direct
materials and $3000 of indirect materials are used by Mackenzie Ltd for March, the journal entry is:
(1)
Mar. 31 Work in process inventory 36 000
Manufacturing overhead control 3 000
Raw materials inventory
(To assign materials to jobs and overhead) 39 000
A = L + E
+36 000
+ 3 000
−39 000

Factory labour costs
Factory labour costs are assigned to jobs on the basis of time sheets prepared when the work is performed.
The time sheet should indicate the employee’s name, the hours worked, the account and the job to be
charged, and the total labour cost. The time sheets are sent to the payroll department where the total time
reported for an employee is reconciled for the pay period with the total hours worked. These time sheets
are sorted and summarised for entry in the general ledger. For example, if in March the total factory
labour cost incurred of $48 000 consists of $40 000 of direct labour and $8000 of indirect labour, the
journal entry is:
(2)
Factory labour 48 000
(To assign labour to jobs and overhead)
A = L + E
+40 000
+ 8 000
−48 000
Manufacturing overhead
The manufacturing overhead is applied using a predetermined overhead application rate. If the activity
base is direct labour hours, then the entry is linked to the direct labour hours charged for the month. If the
overhead rate is 80% of direct labour hours, then the entry for the month to apply overhead of $32 000
($40 000 × 80%) is:
(3)
Manufacturing overhead applied 32 000
(To apply overhead to jobs)
A = L + E
+32 000
−32 000
Helpful hint: The manufacturing overhead applied account accumulates the amount of factory over-
head that has been assigned to work in process inventory.
Assigning costs to finished goods inventory

When a job is finished, an entry is made to transfer its total cost to finished goods inventory. Assuming
the costing from the completed job cost sheets for the month totalled $98 000, the entry to record the
finished goods is:
(4)
Mar. 31 Finished goods inventory 98 000
Work in process inventory 98 000
(To record the completion of the jobs for the month)
A = L + E
+98 000
−98 000

Assigning costs to cost of sales
The last entry is the recognition of the cost of goods when the sale is made. Assume Mackenzie Ltd sells,
on account, a job costing $90 000 for $125 000. The entries are:
(5)
Mar. 31 Accounts receivable 125 000
Sales 125 000
(To record the sale of job #842)
Cost of sales 90 000
Finished goods inventory 90 000
(To record the cost of job #842)
A = L + E
+125 000 +125 000
A = L + E
−90 000 −90 000
Reporting job cost data

At the end of a period, financial statements are prepared that present aggregate data on all jobs manufac-
tured and sold. The cost of goods manufactured schedule in job order costing is the same as in chapter 15
with one exception — manufacturing overhead applied, rather than actual overhead costs, is added to
direct materials and direct labour in determining total manufacturing costs. The schedule is prepared
directly from the work in process inventory account. A condensed schedule for Mackenzie Ltd for March
is shown in figure 16.9.
FIGURE 16.9 Cost of goods manufactured schedule
MACKENZIE LTD
Cost of goods manufactured schedule
for the month ended 31 March 2019
Work in process, 1 March $ —
Direct materials used $36 000
Total manufacturing costs for the month 108 000
Total cost of work in process 108 000
Less: Work in process, 31 March (10 000)
Cost of goods manufactured $ 98 000
Helpful hint: Monthly financial statements are usually prepared for management use only.
Note that the cost of goods manufactured ($98 000) agrees with the amount transferred from work in
process inventory to finished goods inventory in journal entry no. 4 above.
The statement of profit or loss and statement of financial position are the same as those that are illus-
trated in chapter 15. For example, the partial statement of profit or loss for Mackenzie Ltd for the month
of March is shown in figure 16.10.
Under- or overapplied manufacturing overhead

As discussed, the predetermined overhead application rate is based on budgeted or estimated overhead
figures. Unless management accountants can estimate the future with 100% accuracy, the actual over-
head incurred will not equal overhead applied. The difference between actual manufacturing overhead

and applied manufacturing overhead is called underapplied manufacturing overhead or overapplied
manufacturing overhead.
FIGURE 16.10 Partial statement of profit or loss
MACKENZIE LTD
Statement of profit or loss (partial)
for the month ended 31 March 2019
Sales $125 000
Cost of sales
Finished goods inventory, 1 March $ —
Cost of goods manufactured (see figure 16.9) 98 000
Cost of goods available for sale 98 000
Finished goods inventory, 31 March 8 000
Less: Total cost of sales (90 000)
Gross profit $ 35 000
When actual overheads exceed applied overheads (i.e. the entity spent more than it had budgeted for),
overhead is said to be underapplied. Underapplied overhead means that the overhead assigned to work in
process is less than the overhead incurred. This means that the cost of the job was underestimated and
needs to be corrected by increasing the overhead application rate for future jobs. Conversely, when actual
overheads are less than applied overheads (i.e. the entity spent less than it had planned for), overhead is
overapplied. In other words, overapplied overhead means that the overhead assigned to work in process
is greater than the overhead incurred. Thus, overapplied overhead overstated the cost of the job and needs
to be adjusted by reducing the overhead application rate.
At the end of the year, any balances in the manufacturing overhead control and manufacturing over-
head Applied accounts are eliminated by an adjusting entry. Usually, under- or overapplied overhead
is considered to be an adjustment to cost of sales. Thus, underapplied overhead is debited to cost of
sales (increasing the cost), and overapplied overhead is credited to cost of sales (reducing the cost). To
illustrate, assume that Mackenzie Ltd has a $100 000 debit balance in manufacturing overhead control,
representing actual overheads incurred; and a $102 500 credit balance in manufacturing overhead applied
at 31 December.
This means that actual overheads were less than anticipated. The adjusting entry for the overapplied
overhead is:
Dec. 31 Manufacturing overhead applied 102 500

Cost of sales 2 500
(To transfer overapplied overhead to cost of goods sold)
A = L + E
+102 500 −2 500

−100 000
After this entry is posted, manufacturing overhead and manufacturing overhead applied will have nil
balances. In preparing a statement of profit or loss for the year, the amount reported for cost of sales will
be the account balance after the adjustment for either under- or overapplied overhead.
Conceptually, it can be argued that under- or overapplied overhead at the end of the year should be
allocated among ending work in process, finished goods and cost of sales. However, most management
accountants do not believe allocation is worth the cost and effort. The bulk of the under- or over-
applied amount will be allocated to cost of sales anyway, because most of the jobs will be sold during
the year.

Non-manufacturing entities
Job order costing is also used in non-manufacturing entities. In these entities the terminology used to
describe each ‘job’ reflects the service being provided. Advertising agencies and consulting firms have
‘contracts’; hospitals, doctors and lawyers have ‘cases’; building companies have ‘projects’; and govern-
ment agencies have ‘programs’. No matter what the terminology, details of the costs associated with the
output still need to be accumulated.
In service entities, fewer direct materials are used. Figure 16.11 illustrates the cost accumulation in a
legal practice, Smithers Partners.
FIGURE 16.11 Overhead budget
SMITHERS PARTNERS
Annual budgeted overhead
Indirect labour (secretarial, clerical) $140 000
Indirect materials 25 000
Rent, telephone, postage, photocopying 200 000
Electricity 5 000
Depreciation 30 000
Library services 40 000
Estimated annual overhead costs $440 000
Budgeted direct professional labour (estimated annual operating activity) $220 000
Overheads are assigned to cases based on professional labour as the activity base.
The formula for a predetermined overhead application rate is applied to Smithers Partners in
figure 16.12.
FIGURE 16.12 Using the predetermined overhead application rate for services
Predetermined
Estimated annual Expected annual
÷ = overhead
overhead costs operating activity
application rate
$440 000 ÷ $220 000 = 200%
If the job used no direct materials and $6000 of direct professional labour, then the cost for the case
will be as shown below.
Direct materials nil

Direct professional labour $ 6 000
Overhead ($6000 × 200%) 12 000
Total cost $18 000
Some entities (e.g. law firms) may keep separate records for secretarial and clerical labour, telephone
and photocopying and charge them directly to the legal case.

Info needed for Tool or technique to How to evaluate results to

Decision/issue analysis use for decision make decision
Has the entity Actual overhead Manufacturing Overapplied overhead occurs
over- or costs and overhead control and when the manufacturing
underapplied overhead applied manufacturing overhead applied exceeds
overhead for overhead applied actual manufacturing
the period? accounts overhead. Underapplied
overhead occurs when actual
manufacturing overhead
exceeds manufacturing
overhead applied.
Review it
1. What source documents are used in assigning manufacturing costs to work in process inventory?
2. What is a job cost sheet, and what is its main purpose?
3. What is the formula for calculating a predetermined overhead application rate?
4. What is the difference between manufacturing and non-manufacturing entities?
5. When are entries made to record the completion of a job and the sale of a job?
6. What costs are included in total manufacturing costs in the cost of goods manufactured schedule?
7. How is under- or overapplied manufacturing overhead reported in monthly financial statements?
Do it
Danielle Ltd is working on two job orders. The job cost sheets show the following: direct materials —
Job 120 $6000, Job 121 $3600; direct labour — Job 120 $4000, Job 121 $2000; and manufacturing
overhead — Job 120 $5000, Job 121 $2500. Prepare the three summary entries to record the assignment
of costs to work in process from the data on the job cost sheets.
Reasoning
Each cost charged to a job must be accompanied by a debit to the control account, work in process
inventory. The credits in the summary entries are the accounts debited when the manufacturing costs
were accumulated. The manufacturing overhead costs are accumulated in the manufacturing overhead
account and, when applied/assigned to jobs, a contra account (manufacturing overhead applied) is cred-
ited. At the end of the period, these two accounts are offset and the balance is transferred to cost of sales.
Solution
The three summary entries are:
Work in process inventory ($6000 + $3600) 9 600

Raw materials inventory 9 600
(To assign materials to jobs)
(To assign labour to jobs)
(To assign overhead to jobs)

Process costing
Uses of process costing
Process cost systems are used to apply costs to similar products that are mass-produced in a continuous
fashion.
BHP Billiton uses process costing in the manufacturing of steel, Fonterra uses process costing for pro-
cessing milk products, Kellogg and Sanitarium use process costing for cereal production, and Dulux uses
process costing for its paint products. At a bottling company like Coca-Cola Amatil, the manufacturing
process begins with the blending of the beverages. Next the beverage is dispensed into bottles that are
moved into position by automated machinery. The bottles are then capped, packaged and forwarded to
the finished goods warehouse. This process is shown in figure 16.13.
FIGURE 16.13 Manufacturing processes
Manufacturing
processes LA
CO
Blending Filling Packaging
For Coca-Cola Amatil, as well as the other entities just mentioned, once the production begins, it
continues until the finished product emerges. Process cost systems are used when a large volume of
uniform or relatively homogeneous products are produced. The major differences between a job order
and process cost system are summarised in figure 16.14.
FIGURE 16.14 Job order versus process cost systems
Features Job order cost system Process cost system
Work in process One for multiple jobs One for each process
accounts
Documents used Job cost sheets Production cost reports
Determination of total Each job Each period

manufacturing costs
Unit-cost Cost of each job Total manufacturing costs ÷

calculations Units produced for the job Units produced during the
period
16.4 Process cost flow

LEARNING OBJECTIVE 16.4 Describe the flow of costs in a process cost system.
Figure 16.15 shows the flow of costs in the process cost system for Tyler Ltd, which manufactures auto-
matic can openers that are sold to retail outlets. Manufacturing consists of two processes: machining and
assembly which are performed in two departments. In the Machining Department (Department A), the

raw materials are shaped, honed and drilled. In the Assembly Department (Department B), the parts are
assembled and packaged.
FIGURE 16.15 Flow of costs in process cost system — Tyler Ltd
Work in process Finished goods inventory

Manufacturing costs
Machining Department A
Raw materials Assigned Costs Cost of
Factory labour to transferred sales
Manufacturing out to
overhead
Cost of sales
Work in process
Assembly Department B
Cost of
completed
work
As the flow of costs indicates, materials, labour and manufacturing overhead can be added in both the
Machining and Assembly departments. When the Machining Department finishes its work, the partially
completed units are transferred to the Assembly Department. In the Assembly Department, with further
processing, the goods are finished and are then transferred to the finished goods inventory. Upon sale, the
goods are removed from the finished goods inventory. Within each department, a similar set of activities
is performed on each unit processed.
16.5 Accounting procedures

LEARNING OBJECTIVE 16.5 Prepare the accounting entries for a process cost system.
Assignment of manufacturing costs — journal entries

As indicated earlier, the accumulation of the costs of materials, labour and manufacturing overhead is
the same in a process cost system as in a job order cost system. All raw materials are debited to raw
materials inventory when the materials are purchased. All factory labour is debited to factory labour
when the labour costs are incurred. And overhead costs are debited to manufacturing overhead as they
are incurred. However, the assignment of the three manufacturing cost elements to work in process in
a process cost system is different from that for a job order cost system. Here we’ll look at how these
manufacturing cost elements are assigned in a process cost system.
Materials costs
All raw materials issued for production are a materials cost to the producing department. Materials
requisition slips may be used in a process cost system, but fewer requisitions are generally required
than in a job order cost system, because the materials are used for processes rather than for specific jobs.
Requisitions are issued less frequently in a process cost system because the requisitions are for larger
quantities.
Materials are usually added to production at the beginning of the first process. However, in subsequent
processes, other materials may be added at various points. For example, in the manufacture of Mars Bars,

the chocolate and other ingredients are added at the beginning of the first process, and the wrappers and
cartons are added at the end of the packaging process. At Tyler Ltd, materials are added at the beginning
of each process. The entry to record the materials used is:
Work in process—machining XXX

Work in process—assembly XXX
Raw materials inventory XXX
(To record materials used)
Factory labour costs

In a process cost system, as in a job order cost system, time tickets may be used in determining the cost of
labour assignable to the production departments. Since labour costs are assigned to a process rather than
a job, the labour cost chargeable to a process can be obtained from the payroll register or departmental
payroll summaries.
All labour costs incurred within a producing department are a cost of processing the raw materials.
Thus, labour costs for the Machining Department will include the wages of employees who shape, hone
and drill the raw materials. The entry to assign these costs for Tyler Ltd is:

Factory labour XXX
(To assign factory labour to production)
Manufacturing overhead costs

The objective in assigning overhead in a process cost system is to allocate the overhead costs to the
production departments on an objective and equitable basis. That basis is the activity that ‘drives’ or
causes the costs. A primary driver of overhead costs in continuous manufacturing operations is machine
time used, not direct labour. Thus, machine hours are widely used in allocating manufacturing overhead
costs. The entry to allocate overhead to the two processes is:

Manufacturing overhead applied XXX
(To apply overhead to production)
Transfer to next department

At the end of the month, an entry is needed to record the cost of the goods transferred out of the depart-
ment. In this case, the transfer is to the Assembly Department, and the following entry is made.

(To record transfer of units to the Assembly Department)
Transfer to finished goods

The units completed in the Assembly Department are transferred to the finished goods warehouse. The
entry for this transfer is as follows:
Finished goods inventory XXX

(To record transfer of units to finished goods)

Transfer to cost of sales
When finished goods are sold, the entry to record the cost of sales is as follows:
Cost of sales XXX

Finished goods inventory XXX
(To record cost of units sold)
Review it
1. What type of manufacturing entities might use a process cost accounting system?
2. What are the main similarities and differences between a job order cost system and a process cost
system?
Do it
Ruth Ltd manufactures ZEBO through two processes: blending and bottling. In June, raw materials used
were blending $18 000 and bottling $4000; factory labour costs were blending $12 000 and bottling $5000;
manufacturing overhead costs were blending $6000 and bottling $2500. Units completed at a cost of
$19 000 in the Blending Department are transferred to the Bottling Department. Units completed at a cost
of $11 000 in the Bottling Department are transferred to finished goods. Journalise the assignment of the
blending and bottling costs to the two processes and the transfer of units as appropriate.
Reasoning
In process cost accounting, separate work in process accounts are kept for each process. Raw materials
are accumulated in the account entitled Raw materials inventory. Factory labour is accumulated in the
account entitled Factory labour. Overhead is accumulated in the account entitled Manufacturing overhead.
These accounts are credited when the costs are assigned to production. When units are completed, they
are transferred to the next process or to finished goods. To assign the costs to production, a contra
account (manufacturing overhead applied) is used (see journal entry no. 3 in section 16.3).
Solution
The entries are:
Work in process—blending 18 000

Work in process—bottling 4 000
Raw materials inventory 22 000
(To record materials used)
(To assign factory labour to production)

(To assign overhead to production)
(To record transfer of units to the Bottling Department)
Finished goods inventory 11 000
(To record transfer of units to finished goods)

Equivalent units
Suppose you were asked to calculate the cost of instruction at your university per full-time equivalent
student. You are given the information in figure 16.16.
FIGURE 16.16 Information for full-time student example
Costs:
Total cost of instruction $900 000
Student population:
Full-time students 900
Part-time students 1 000
Part-time students take 60% of the classes of a full-time student during the year. You will need to
calculate how many full-time students the 1000 part-time students are equivalent to. To work out the
number of full-time equivalent students per year, you would make the calculation shown in figure 16.17.
FIGURE 16.17 Full-time equivalent unit calculation
Full-time Equivalent units Full-time equivalent

+ =
students of part-time students students
900 + (60% × 1000 = 600) = 1500
The cost of instruction per full-time equivalent student is therefore the total cost of instruction
($900 000) divided by the number of full-time equivalent students (1500), which is $600 ($900 000 ÷
1500).
In a process cost system, the same idea, called equivalent units of production, is used. Equivalent
units of production measure the work done during the period, expressed in fully completed units. This
concept is used to determine the cost per unit of completed product, for internal and external reporting.
Weighted-average method
The formula to calculate equivalent units of production is shown in figure 16.18.
FIGURE 16.18 Formula for equivalent units of production
Equivalent units of
Units completed and Equivalent units of
+ ending work in =
transferred out production
process
To better understand this concept of equivalent units, let’s continue with the production processes at
Tyler Ltd.
The Machining Department’s entire output during the period consists of ending work in process of
4000 units which are 60% complete as to materials, labour and overhead. The equivalent units of pro-
duction for the Machining Department are therefore 2400 units (4000 × 60%).
The Assembly Department’s output during the period consists of 10 000 units completed and trans-
ferred out, and 5000 units in ending work in process which are 70% completed. The equivalent units of
production are therefore 13 500 [10 000 + (5000 × 70%)].

This method of calculating equivalent units is referred to as the weighted-average method. It considers
the degree of completion (weighting) of the units completed and transferred out and the ending work in
process. It is the method most widely used in practice.
Refinements on the weighted-average method
Aunt Sally’s Cereals makes muesli cakes. Three departments are used to produce the muesli cakes:
Mixing, Baking and Packaging. In the Mixing Department dry ingredients, including flour, salt and bak-
ing powder, are mixed with liquid ingredients, including eggs and vegetable oil. Information related to
the Mixing Department at the end of June is provided in figure 16.19.
FIGURE 16.19 Information for Mixing Department
Mixing Department
Percentage complete
Physical units Materials Conversion costs
Work in process, 1 June 100 000 100% 70%
Started into production 800 000
Total units 900 000
Units transferred out 700 000
Work in process, 30 June 200 000 100% 60%
Total units 900 000
Figure 16.19 indicates that the beginning work in process is 100% complete as to materials cost and
70% complete as to conversion costs. In other words, both the dry and liquid ingredients (materials)
are added at the beginning of the process to make the muesli cakes. The conversion costs (labour and
overhead) related to the mixing of these ingredients were incurred uniformly and are 70% complete. The
ending work in process is 100% complete as to materials cost and 60% complete as to conversion costs.
We then use the Mixing Department information to determine equivalent units. In calculating equivalent
units, the beginning work in process is not part of the equivalent units of production formula. The units
transferred out to the Baking Department are fully complete as to both materials and conversion costs.
The ending work in process is fully complete as to materials, but only 60% complete as to conversion cost.
Two equivalent unit calculations are therefore necessary: one for materials and the other for conversion
costs. Figure 16.20 shows these calculations.
FIGURE 16.20 Calculation of equivalent units — Mixing Department
Equivalent units
Materials Conversion costs
Units transferred out 700 000 700 000
Work in process, 30 June
200 000 × 100% 200 000
200 000 × 60% 120 000

Total equivalent units 900 000 820 000
Helpful hint: Is it necessary to calculate equivalent units of production if the processing occurs quickly
and is complete at the end of a day’s operating activity?
Answer: No. If the production process does not extend beyond a day’s operation, there is no work in
process at the end of the day. A film processing business is an example; once the film or CD is loaded
to the printing machine, photos are instantly printed and the process is complete — there is no 70%
complete photograph at the end of the day.
The earlier formula in figure 16.18 used to calculate equivalent units of production can be refined to
show the calculations for materials and for conversion costs (figure 16.21).

FIGURE 16.21 Refined equivalent units of production formula
Units completed and Equivalent units of Equivalent units of

transferred out — + ending work in = production —
materials process — materials materials
Equivalent units of
Units completed and Equivalent units of
ending work in
transferred out — + = production —
process —
conversion costs conversion costs
conversion costs
16.6 Production cost report

LEARNING OBJECTIVE 16.6 Prepare a production cost report.
As part of a performance evaluation procedure, a production cost report is prepared for each department
in a process cost system. A production cost report is the key document used by management to under-
stand the activities in a department because it shows the production quantity and cost data related to that
department.
To complete a production cost report, the business must perform four steps.
1. Calculate the physical unit flow.
2. Calculate the equivalent units of production.
3. Calculate unit production costs.
4. Prepare a cost reconciliation schedule.
As a whole, these four steps make up the process cost system.
Production cost reports provide a basis for evaluating the productivity of a department. In addition,
the cost data can be used to assess whether unit costs and total costs are reasonable. When the quantity
and cost data are compared with predetermined goals, top management can also ascertain whether cur-
rent performance is meeting planned objectives. By comparing actual results with budgeted cost data,
management can highlight where variations exist and consider measures to address them.
The following is a brief example showing the calculation of a production cost report for Essence Ltd,
which manufactures a high-quality after-shave lotion, Eternity, using three processes: mixing, filling and
corking. Figure 16.22 provides unit and cost data for the Mixing Department.
FIGURE 16.22 Unit and cost data — Mixing Department

ESSENCE LTD
Mixing Department
UNITS
Work in process, 1 May 1 000
Direct materials: 100% complete
Conversion costs: 70% complete
Units started into production during May 2 000
Units completed and transferred out to Filling Department 2 200
Work in process, 31 May 800
Direct materials: 100% complete
Conversion costs: 50% complete

COSTS
Work in process, 1 May
Direct materials: 100% complete $ 49 100
Conversion costs: 70% complete 7 200
Cost of work in process, 1 May $ 56 300
Costs incurred during production in May
Conversion costs 19 320
Costs incurred in May $119 320
Figure 16.23 illustrates Essence Ltd’s production cost report for the Mixing Department.
FIGURE 16.23 Production cost report
ESSENCE LTD
Mixing Department
Production cost report
for the month ended 31 May 2019
Equivalent units
Physical Conversion
QUANTITIES units Materials costs
Units to be accounted for: 1 2
Work in process, 1 May 1 000
Total units 3 000
Units accounted for:
Transferred out 2 200 2 200 2 200
800 units 50%
Work in process, 31 May 800 800 400
complete
Total units 3 000 3 000 2 600
$49 100 + $100 000
COSTS Conversion
Unit costs: 3 Materials costs Total
Costs in May (a) $149 100 $26 520 $175 620
Equivalent units (b) 3 000 2 600
Unit costs (a) ÷ (b) $ 49.70 $ 10.20 $ 59.90
Costs to be accounted for: $7200 + $19 320
Work in process, 1 May $ 56 300
Total costs $175 620
COST RECONCILIATION SCHEDULE 4
Costs accounted for:
Transferred out (2200 units × $59.90) $131 780
Work in process, 31 May:
Materials (800 × $49.70) $39 760
Conversion costs (400 × $10.20)
4 080 43 840
1zCalculate the physical unit flow. On 1 May, 1000 units were in opening work in process. During May,
2000 more units entered into production, making a total of 3000 units. If 2200 units were transferred
out, then 800 units must be in closing work in process on 31 May.
2zCalculate the equivalent units of production. For materials, equivalent units are the same as the phys-
ical flow because materials are added at the beginning of the process (2200 + 800). Conversion costs
are added as and when needed: 2200 units were completed, and 400 (800 × 50% complete) are in
work in process. Accordingly, there are 2600 equivalent units (2200 + 400).

3zCalculate unit production costs.
(a) Materials are $49 100 (opening) + $100 000 incurred during May = $149 100. The equivalent
units are 3000, so unit production is $149 100 ÷ 3000 = $49.70.
(b) Conversion costs are $7200 (opening) + $19 320 incurred during May = $26 520. The equivalent
units are 2600, so unit production is $26 520 ÷ 2600 = $10.20.
4zPrepare a cost reconciliation schedule. Refer to figure 16.23.

What is the cost Costs of materials, labour Production cost Compare costs with
of a product? and overhead assigned report previous periods and
to processes used to with those of
make the product; selling competitors to ensure
price of the product that costs are in line.
Compare with expected
selling price to determine
overall profitability.
Review it
1. How do physical units differ from equivalent units of production?
2. What are the formulas for calculating unit costs of production?
3. How are costs assigned to units transferred out, and in ending work in process?
4. What are the four sections of a production cost report?
Do it
In March, Reece Manufacturing had the following unit production costs: materials $6 and conversion costs
$9. On 1 March, it had zero work in process. During March, 12 000 units were transferred out, and 800 units
that were 25% completed as to conversion costs and 100% complete as to materials were in ending work
in process at 31 March. Assign the costs to the units transferred out and the units in process at 31 March.
Reasoning
The 12 000 units transferred should be assigned the total manufacturing cost of $16 per unit. The assign-
ment of costs to units in process consists of the materials cost and conversion cost based on equivalent
units of production.
Solution
The assignment of costs is as follows:

Transferred out (12 000 × $15) $180 000
Work in process, 31 March
Materials (800 × $6) $ 4 800
Conversion costs (200∗ × $9) 1 800 6 600
*800 × 25%

16.7 Activity-based costing (ABC)
LEARNING OBJECTIVE 16.7 Recognise the difference between traditional costing and activity-based
costing and identify the activity cost pools and activity drivers used in activity-based cost systems.
Traditional costing systems

The primary aim of a costing system is to provide management with information about the exact cost of a
product or service. Although, realistically, it may be impossible to ascertain the true cost, every effort to
provide management with the best possible cost estimates must be made. The best estimate of costs occurs
when the costs are traceable directly to the product produced or the service rendered. Direct material and
direct labour costs are the easiest to trace directly to the product through the use of material requisition
forms and payroll time sheets. Overhead, however, is an indirect or common cost that generally cannot
be directly traced to individual products or services.
To illustrate, consider the cases of a furniture maker and a charter flight company. The cost of fabric
(direct material) and carpenter time (direct labour) needed to make a desk is easy to calculate. But how
much factory electricity a particular desk consumes is harder to determine. Likewise, gathering the cost
of fuel (direct material) and pilot hour (direct labour) required to fly a chartered plane from the Gold
Coast to Sydney is relatively straightforward. However, assessing how much aircraft maintenance is used
up by a particular flight is more complicated.
As mentioned earlier, despite the difficulty in establishing a direct relationship between overhead and
a product or service, a predetermined application rate is used to allocate overhead costs to each product
or service. When overhead cost allocation systems were first developed, direct labour made up a large
part of total manufacturing cost. It was widely accepted that there was a high correlation between direct
labour and the incurrence of overhead cost. As a result, direct labour became the most popular basis
for overhead allocation. Even in today’s environment, direct labour is often the appropriate basis for
assigning overhead cost to products. It is appropriate when (a) direct labour constitutes a significant part
of total product cost, and (b) a high correlation exists between direct labour and changes in the amount
of overhead costs.

The need for a new costing system
Advances in computerised systems, technological innovation, globalisation and automation have changed
the manufacturing environment drastically. The amount of direct labour used in many industries is now
greatly reduced, and total overhead costs (e.g. depreciation on expensive equipment and machinery,
power, repairs and maintenance) have significantly increased. Entities that continue to use predetermined
overhead rates based on direct labour, where the correlation between direct labour and overhead no longer
exists, experience significant product cost distortions.
Recognising these distortions, many entities now use machine hours as the basis on which to allocate
overhead in an automated manufacturing environment. But even machine hours may not suffice as the sole
basis for allocating all overhead. If the manufacturing process is complex, then only multiple allocation
bases can result in more accurate calculations. In such situations, managers need a new overhead cost
allocation method — activity-based costing.
Activities and cost drivers

Activity-based costing (ABC) allocates overhead to multiple activity cost pools and assigns the activity
cost pools to products by means of cost drivers. In activity-based costing, an activity is any event, action,
transaction or work sequence that causes the incurrence of cost in the production of a product or the
rendering of a service. A cost driver is any factor or activity that has a direct cause–effect relationship
with the resources consumed.
ABC first allocates costs to activities, and then to the products based on each product’s use of those
activities. The reasoning behind ABC cost allocation is simple: products consume activities; activities
consume resources; resources have a cost.
ABC allocates overhead in a two-stage process. In the first stage, overhead is allocated to activity
cost pools, each of which is a distinct type of activity (e.g. ordering materials, setting up machines,
assembling and inspecting), rather than to departments. In the second stage, the overhead allocated to the
activity cost pools is assigned to products using cost drivers that represent and measure the number of
individual activities undertaken or performed (e.g. number of purchase orders, number of set-ups, labour
hours or number of inspections) to produce products or render services. Examples of activities and the
possible cost drivers that measure them are shown in figure 16.24.
As you might imagine, not all products or services share equally in these activities. The more complex a
product’s manufacturing operation, the more activities and cost drivers it is likely to have. If there is little
or no correlation between changes in the cost driver and consumption of the overhead cost, inaccurate
product costs are inevitable. This can lead to incorrect product pricing and production decisions, which
in today’s competitive global environment may mean a loss of potential markets and hence profits.
Activity-based costing in manufacturing industries

The following is an example for Lift Jack Ltd. The design of an activity-based costing system with seven
activity cost pools is graphically shown in figure 16.25 for Lift Jack Ltd. Lift Jack Ltd manufactures two
automotive jacks — a car scissors jack and a truck hydraulic jack, with 200 000 units and 80 000 units
respectively expected to be produced.
Helpful hint: Computers alleviate the problems of huge numbers of activities and promote the platform
of ABC costing, enabling improved product costing.
In some entities the number of activities can be substantial. For example, in the United States, at
Clark-Hurth (a division of Clark Equipment Company), a manufacturer of axles and transmissions, over
170 activities were identified; at the Compumotor Division of Parker Hannifin over 80 activities were
identified in just the purchasing section of its Material Control Department.
Having identified its activity cost pools and the cost drivers for each cost pool, Lift Jack Ltd
accumulated data relative to those activity cost pools and cost drivers shown in figure 16.26.

FIGURE 16.24 Activities and related cost drivers
Purchasing $ Storing $ Machining $ Supervising $
Activities
Number of Amount of Number of Number of

Cost drivers
phone calls square metres machine hours employees
Axles 4200 Steering wheels 8800
Products
Total $/4200 = Cost per axle Total $/8800 = Cost per steering wheel
FIGURE 16.25 ABC system design — Lift Jack Ltd
Activity-based costing system
Overhead costs
Ordering Setting Machining Assembling Inspecting Painting Supervising Activity

and up cost cost and cost cost cost pools
receiving machines pool pool testing pool pool
materials cost cost
cost pool pool
pool
Number Number Number Number Number Direct

Machine Cost
of purchase of of of of labour
hours drivers
orders set-ups parts tests parts hours
Products

FIGURE 16.26 Cost drivers and expected use
LIFT JACK LTD

Expected use of cost
drivers per product
Expected use of cost Scissors Hydraulic
Activity cost pools Cost drivers drivers per activity jacks jacks
Ordering and receiving Purchase orders 2 500 orders 1 000 1 500
Machine set-up Set-ups 1 200 set-ups 500 700
Machining Machine hours 800 000 hours 300 000 500 000
Assembling Parts 3 000 000 parts 1 800 000 1 200 000
Inspecting and testing Inspections 35 000 inspections 20 000 15 000
Painting Parts 3 000 000 parts 1 800 000 1 200 000
Supervising Labour hours 200 000 hours 130 000 70 000
Note that, in assigning overhead costs, it is necessary to know the expected use of the cost driver for
each product.
Calculating overhead rates

The assignment of activity cost pools to products is then calculated using the expected use of the cost
driver and the estimated overhead to give the activity-based overhead rate as shown in figure 16.27.
FIGURE 16.27 Calculation of activity-based overhead rates
LIFT JACK LTD

Estimated Expected use of cost Activity-based
Activity cost pools overhead ÷ drivers per activity = overhead rates
Ordering and receiving $ 200 000 2 500 purchase orders $80 per order
Machine set-up 600 000 1 200 set-ups $500 per set-up
Machining 2 000 000 800 000 machine hours $2.50 per machine hour
Assembling 1 800 000 3 000 000 parts $0.60 per part
Inspecting and testing 700 000 35 000 inspections $20 per inspection
Painting 300 000 3 000 000 parts $0.10 per part
Supervising 1 200 000 200 000 labour hours $6 per labour hour
$6 800 000
FIGURE 16.28 Assignment of activity cost pools to products
LIFT JACK LTD

Scissors jacks Hydraulic jacks

Expected Activity- Expected Activity-
use of cost based use of cost based
Activity cost drivers per overhead Cost drivers per overhead Cost
pools product × rates = assigned product × rates = assigned
Ordering and
receiving 1 000 $80 $ 80 000 1 500 $80 $ 120 000
Machine set-up 500 $500 250 000 700 $500 350 000
Machining 300 000 $2.50 750 000 500 000 $2.50 1 250 000
Assembling 1 800 000 $0.60 1 080 000 1 200 000 $0.60 720 000
Inspecting and
testing 20 000 $20 400 000 15 000 $20 300 000

Expected Activity- Expected Activity-

use of cost based use of cost based
Activity cost drivers per overhead Cost drivers per overhead Cost
pools product × rates = assigned product × rates = assigned
Painting 1 800 000 $0.10 180 000 1 200 000 $0.10 120 000
Supervising 130 000 $6 780 000 70 000 $6 420 000
Total assigned costs $3 520 000 $3 280 000
Total costs assigned $3 520 000 $3 280 000

Total units produced 200 000 80 000
Overhead cost per unit $17.60 $41.00
Assigning overhead costs to products under ABC

Costs for each activity pool are then assigned to each product by multiplying the expected use of each
cost driver by its activity-based overhead rate. The data shown in figure 16.28 show that the total overhead
assigned to 80 000 hydraulic jacks is nearly as great as the overhead assigned to 200 000 scissors jacks.
But the overhead cost per hydraulic jack is $41.00 and per scissors jack is only $17.60.
Comparing traditional and ABC overhead rates

If a traditional costing system based only on output volume is used to allocate overhead cost, what
would be the overhead cost per unit for the two products? Since 200 000 units of scissors jacks and
only 80 000 units of hydraulic jacks were produced, the total overhead of $6 800 000 would be spread
over 280 000 units of jacks. Hence, the unit overhead cost would be $24.30. This is a significantly differ-
ent allocation result compared with the unit overhead cost calculated under ABC, as summarised in the
following table.
Overhead cost per unit based on: Scissors jacks Hydraulic jacks
Traditional costing $24.30 $24.30
Activity-based costing $17.60 $41.00
Effect on cost accuracy Overcosted $6.70/unit (38%) Undercosted $16.70/unit (40%)
If the management of Lift Jack Ltd relied solely on traditional costing data to set its product prices,
scissors jacks would be overpriced and hydraulic jacks would be underpriced. The inaccuracy in costing
would have a significant impact on the business’s bottom line.
Activity-based costing in service industries

Although initially developed and implemented by manufacturing entities that produce products, activity-
based costing has been widely adopted in service industries. ABC has been found to be a useful tool
in such diverse industries as airlines, railroads, hotels, hospitals, banks, insurance companies, telephone
companies and financial services entities. The overall objective of installing ABC in service entities is no
different from that in a manufacturing entity: to identify the key activities that generate costs and to keep
track of how many of those activities are performed for each service that is rendered (by job, service,
contract or customer).
The general approach to identifying activities, activity cost pools and cost drivers is used by a service
entity in the same manner as a manufacturing entity. Also, the labelling of activities as value-added and
non-value-added and the attempt to reduce or eliminate non-value-added activities as much as possible is
just as valid in service industries as in manufacturing operations. And the classification of activities into
unit-level, batch-level, product-level, and facility-level activities also applies to service industries. What
sometimes makes implementation of activity-based costing difficult in service industries is that a larger

proportion of overhead costs are facility-level costs that cannot be directly traced to specific services
rendered by the entity.
To illustrate the application of activity-based costing to a service entity, contrasted with traditional
costing, we use a public accounting practice. This illustration is equally applicable to a law practice,
consulting firm, architect, or any service entity that performs numerous services for a client as part of
a job.
Traditional costing example

Assume that the public accounting practice of Check & Doublecheck prepares the following condensed
annual budget (see figure 16.29).
FIGURE 16.29 Condensed annual budget of a service entity under traditional costing
CHECK & DOUBLECHECK

Annual budget
Revenue $2 000 000
Direct labour $ 600 000
Overhead (expected) 1 200 000
Total costs 1 800 000
Operating profit $ 200 000
Estimated overhead
= Predetermined overhead rate
Direct labour cost
$1 200 000
= 200%
$600 000
Helpful hint: A budget is a quantified statement of planned or forecast activity.

Under traditional costing, the direct professional labour is the service performed and it forms the basis
for overhead application to each audit job. To determine the operating profit earned on any job, overhead
is applied at the rate of 200% of actual direct professional labour cost incurred. For example, assume that
Check & Doublecheck records $70 000 of actual direct professional labour cost during its audit of Plano
Moulding Ltd, which was invoiced an audit fee of $260 000. Under traditional costing, using 200% as
the rate for applying overhead to the job, operating profit related to the Plano Moulding Ltd audit would
be calculated as shown in figure 16.30.
FIGURE 16.30 Overhead applied under traditional costing system
CHECK & DOUBLECHECK

Plano Moulding Ltd audit
Revenue $260 000
Less:
Direct professional labour $ 70 000

Applied overhead (200% × $70 000) 140 000 210 000
Operating profit $ 50 000
In this simple service industry example, under traditional costing only one direct cost item and only
one overhead application rate is used.
Activity-based costing example

Under activity-based costing, Check & Doublecheck’s estimated annual overhead costs of $1 200 000 are
recast and related to several activity cost pools, and cost drivers are identified that relate those costs to
the entity’s audit activities. Figure 16.31 shows an annual overhead budget using an ABC system.

FIGURE 16.31 Condensed annual budget of a service entity under ABC
CHECK & DOUBLECHECK

Annual overhead budget
Expected
use of cost
Estimated drivers per Activity-based
Activity cost pools Cost drivers overhead ÷ activity = overhead rates
Secretarial support Direct professional hours $ 210 000 30 000 $7 per hour
Direct labour fringe benefits Direct labour cost 240 000 $600 000 $0.40 per $1 labour cost
Printing and photocopying Working paper pages 20 000 20 000 $1 per page
Computer support CPU minutes 200 000 50 000 $4 per minute
Telephone and postage None (traced directly) 71 000 $71 000 Based on usage
Legal support Hours used 129 000 860 $150 per hour
Insurance (professional
liability etc.) Revenue invoiced 120 000 $2 000 000 $0.06 per $1 revenue
Recruiting and training Direct professional hours 210 000 30 000 $7 per hour
$1 200 000
Note that some of the overhead can be directly assigned (see telephone and postage). The assignment
of the individual overhead activity rates to the actual number of activities used in the performance of the
Plano Moulding audit results in total overhead assigned of $165 100 as shown in figure 16.32.
FIGURE 16.32 Assignment of overhead in a service entity
CHECK & DOUBLECHECK

Assignment of overheads for Plano Moulding Ltd audit
Activity-
based
Actual use overhead Costs
Activity cost pools Cost drivers of drivers rates assigned
Secretarial support Direct professional hours 3 800 $7.00 $ 26 600
Direct labour fringe benefits Direct labour cost $70 000 $0.40 28 000
Printing and photocopying Working paper pages 1 800 $1.00 1 800
Computer support CPU minutes 8 600 $4.00 34 400
Telephone and postage None (traced directly) 8 700
Legal support Hours used 156 $150.00 23 400
Insurance (professional liability etc.) Revenue invoiced $260 000 $0.06 15 600
Recruiting and training Direct professional hours 3 800 $7.00 26 600
$165 100
Under activity-based costing, overhead of $165 100 is assigned to the Plano Moulding Ltd audit, com-
pared with $140 000 under traditional costing. A comparison of total costs and operating margins is shown
in figure 16.33.
The comparison shows that the assignment of overhead costs under traditional costing is distorted. The
total cost assigned to performing the audit of Plano Moulding Ltd is greater under activity-based costing
by $25 100, or 18% higher, and the profit margin is only half as great. Traditional costing gives the false
impression of an operating profit of $50 000, more than double what it really is at $24 900.

FIGURE 16.33 Comparison of traditional costing with ABC in a service entity
CHECK & DOUBLECHECK

Plano Moulding Ltd audit
Traditional costing ABC
Revenue $260 000 $260 000
Expenses:
Direct professional labour $ 70 000 $ 70 000
Applied overhead 140 000 165 100
Total expenses 210 000 235 100
Operating profit $ 50 000 $ 24 900
Profit margin 19.2% 9.6%
16.8 Benefits and limitations of activity-based costing

LEARNING OBJECTIVE 16.8 Understand the benefits and limitations of activity-based costing.
As the use of activity-based costing has grown, both its practical benefits and its limitations have now
become apparent.
Benefits of ABC
The main benefit of ABC is more accurate product costing because of the following.
1. ABC leads to more cost pools used to assign overhead costs to products. Instead of one factory-wide
pool (or even departmental pools) and a single cost driver, numerous activity cost pools with more
relevant cost drivers are used. Costs are assigned more directly on a basis of the portion of multiple
cost-driven activities that can be traced to each product.
2. ABC leads to enhanced control of overhead costs. Under ABC, many overhead costs can be traced
directly to activities — some indirect costs become direct costs. Thus, managers become more aware
of their responsibility to control the activities that generate those costs.
3. ABC leads to better management decisions. More accurate product costing should contribute to setting
selling prices that will achieve desired product profitability levels. In addition, the more accurate cost
data should be helpful in deciding whether to make or buy a product, part or component.
Activity-based costing does not, in itself, change the amount of overhead costs, but it does in certain
circumstances allocate those costs in a more accurate manner. And if the score-keeping is more realistic,
more accurate and better understood, managers should be able to better understand cost behaviour and
overall profitability.
Limitations of ABC
Although ABC systems often provide better product cost data than traditional volume-based systems,
there are limitations.

1. ABC can be expensive to use. Many entities are discouraged from using ABC by the higher cost of
identifying multiple activities and applying numerous cost drivers. Activity-based costing systems are
more complex than traditional costing systems — sometimes significantly more complex. Is the cost
of implementation greater than the benefits of greater accuracy? For some entities there may be no
need to consider ABC at all because their existing system is sufficient, or because the costs of ABC
outweigh the benefits.
2. Some arbitrary allocations continue. Even though more overhead costs can be assigned directly to
products through multiple activity cost pools, certain overhead costs remain to be allocated by means
of some arbitrary volume-based cost driver such as labour or machine hours.

3. IAS 2/AASB 102 Inventories specifically prohibit administrative overheads unrelated to production,
selling and distribution costs from being included in conversion costs. Thus the cost allocation achieved
by ABC cannot be used for external reporting purposes.
When to switch to ABC

Activity-based costing is a useful tool and under certain conditions is the appropriate costing system to
use. The presence of one or more of the following factors indicates that ABC would be the superior
costing system.
1. Product lines differ greatly in volume and manufacturing complexity.
2. Product lines are numerous and diverse, and require differing degrees of support services.
3. Overhead costs constitute a significant portion of total costs.
4. The manufacturing process or the number of products has changed significantly — for example, from
labour-intensive to automated.
5. Production or marketing managers are ignoring data provided by the existing system and are using
other data when pricing or making other product decisions.
The redesign and installation of a new product costing system is a significant decision that requires
considerable cost and a major effort to accomplish. Therefore, financial managers need to be very cautious
and deliberative when initiating changes in costing systems.

When should we Knowledge of the A detailed and accurate Compare the results under
switch to ABC? products or product lines, cost accounting both costing systems. If
the manufacturing system, cooperation managers are better able to
process, overhead costs between accountants understand and control
and the needs of and operating their operations using ABC,
managers for accurate managers and the costs are not
cost information prohibitive, the switch
would be beneficial.
Review it
1. What are the benefits of activity-based costing (ABC)?
2. What are the limitations of ABC?

3. What factors indicate the applicability of ABC as the superior costing system?
16.9 Value-added vs. non-value-added activities

LEARNING OBJECTIVE 16.9 Differentiate between value-added and non-value-added activities.
Some entities that have experienced the benefits of activity-based costing have applied it to a broader
range of management activities. Activity-based management (ABM) is an extension of ABC from a
product costing system to a management function that focuses on reducing costs and improving processes

and decision making. A refinement of activity-based costing used in ABM is the classification of activities
as either value-added or non-value-added.
Value-added activities are the functions of actually manufacturing a product or performing a service.
They increase the worth of a product or service to customers. Value-added activities involve resource
usage and related costs that customers are willing to pay for. Examples of value-added activities in a
manufacturing operation are engineering design, machining, assembly, painting and packaging.
Non-value-added activities are production- or service-related activities that simply add cost to, or
increase the time spent on, a product or service without increasing its market value. Examples typical
of a manufacturing operation include the repair of machines; the storage of inventory; the moving of
raw materials, assemblies and finished product; building maintenance; inspections; and inventory control.
Examples of non-value-added activities in service businesses might include taking appointments, recep-
tion, bookkeeping, invoicing, travelling, ordering supplies, advertising, cleaning and computer repair.
Identifying and labelling activities as value-added or non-value-added is part of the analysis of opera-
tions, the first step, in an ABC system. Figure 16.34 is an activity flowchart. Activity flowcharts are often
used to help identify the activities that will be used in ABC costing. In the top part of this flowchart,
activities are identified as value-added or non-value-added. The value-added activities are highlighted in
red, and the non-value-added activities are highlighted in blue.
FIGURE 16.34 Flowchart showing value-added and non-value-added activities
HEARTLAND MANUFACTURING
Activity flowchart
Activities
NVA NVA NVA NVA VA NVA NVA VA NVA NVA NVA VA
Receive Move
Move Machining: Move Inspect Move Store
and materials to Set up Package
and store Inspect and Assembly and to finished
inspect production machines and ship
materials Drill Lathe wait test storage goods
materials and wait
Current
days 1 12 2.5 1.5 2 1 0.2 6 2 0.3 0.5 14 1
Total current average time = 44 days
Proposed
days 1 4 1.5 1.5 2 1 0.2 2 2 0.3 0.5 10 1
Total proposed average time = 27 days
Proposed reduction in non-value-added time = 17 days
VA = Value-added NVA = Non-value-added
Note that in the lower part of the flowchart there are two rows showing the number of days spent on each
activity. The first row shows the number of days spent on each activity under the current manufacturing
process. The second row shows the number of days spent on each activity under management’s proposed
re-engineered manufacturing process. The proposed changes would reduce time spent on non-value-added
activities by 17 days. This 17-day improvement is entirely due to moving inventory more quickly through
the processes — that is, by reducing inventory time in moving, storage and waiting.
Not all activities labelled non-value-added are totally wasteful, nor can they be totally eliminated.
For example, although inspection time is a non-value-added activity from a customer’s perspective, few
entities would eliminate their quality control functions. Similarly, moving and waiting time is non-value-
added, but it would be impossible to completely eliminate. Nevertheless, because managers recognise
the non-value-added characteristic of these activities, they are motivated to minimise them as much as

possible. Attention to such matters is part of the growing practice of activity-based management which
helps managers concentrate on continuous improvement of operations and activities.
Info needed Tool or technique How to evaluate results

Decision/issue for analysis to use for decision to make decision
How can ABC Activities classified The activity analysis flowchart The flowchart should
help managers as value-added and extended to identify each motivate managers to
manage the non-value-added; activity as value-added or minimise non-value-added
business? activities and costs non-value-added; activities activities. Managers should
classified by level of and related costs classified as better understand the
performance or unit-level, batch-level, relationship between
incurrence product-level or facility-level activities and the resources
they consume.
Hierarchy of activity levels

Traditional costing systems are volume-driven — driven by units of output. Some activity costs are
strictly variable and are caused by the production or acquisition of a single unit of product or the per-
formance of a single unit of service. However, the recognition that other activity costs are not driven by
output units has led to the development of a hierarchy of ABC activities, consisting of four levels. The
four levels of activities are classified and defined as follows.
1. Unit-level activities. These are performed for each unit of production.
2. Batch-level activities. These are performed for each batch of products rather than each unit.
3. Product-level activities. These are performed in support of an entire product line, but are not always
performed every time a new unit or batch of products is produced.
4. Facility-level activities. These are required to support or sustain an entire production process.
Greater accuracy in overhead cost allocation may be achieved by recognising these four different lev-
els of activities and, from them, developing specific activity cost pools and their related cost drivers.
Figure 16.35 graphically displays this four-level activity hierarchy, along with the types of activities and
examples of costs traceable to those activities at each level.
This hierarchy provides managers and accountants with a structured way of thinking about the rela-
tionships between activities and the resources they consume. In contrast, traditional volume-based costing
recognises only unit-level costs. Failure to recognise this hierarchy of activities is one of the reasons that
volume-based cost allocation causes distortions in product costing.
As indicated earlier, allocating all overhead costs by bases that measure change in units produced can
send false signals to managers — dividing batch-, product- or facility-level costs by the number of units
produced gives the mistaken impression that these costs vary with the number of units. The resources
consumed by batch-, product- and facility-level supporting activities do not vary at the unit level, nor
can they be controlled at the unit level. The number of activities performed at the batch level goes up
as the number of batches rises — not as the number of units within the batches changes. For example,
machine set-up costs are incurred for each batch regardless of the number of units in the batch. Similarly,
what product-level activities are performed depends on the number of different products — not on how
many units or batches are produced. And facility-sustaining activity costs do not depend on the number
of products, batches or units produced. Batch-, product- and facility-level costs can be controlled only by
modifying batch-, product- and facility-level activities.

FIGURE 16.35 Hierarchy of activity levels
Four levels Types of activities Examples of costs

Unit-level activities
Machine-related: Direct materials
drilling, cutting, milling, Depreciation of machine
trimming, pressing Power costs
Machine maintenance
Labour-related: Direct labour
assembling, painting Employee entitlements
sanding, sewing Payroll tax
Batch-level activities
Equipment set-ups Labour set-up costs

Purchase ordering Purchasing clerical costs
Inspection Quality control costs
Materials handling Materials handling costs
Product-level activities
Product design Design costs

Engineering changes Product engineering costs
Inventory management Inventory carrying costs
Facility-level activities
Factory management Building depreciation

Personnel administration Heating, airconditioning
Training Rates and taxes
Security Insurance
16.10 Just-in-time processing (JIT)

LEARNING OBJECTIVE 16.10 Explain just-in-time (JIT) processing.
The benefit of classifying activities as value-added and non-value-added is that managers know which
activities to eliminate or minimise in order to reduce costs without affecting production efficiency or
product quality. The activity analysis flowchart shown in figure 16.34 revealed lots of inventory storage
and waiting time at several places in the operation. These are non-value-added activities. One way to
minimise inventory storage and waiting time is to implement a just-in-time (JIT) processing system.
Traditionally, continuous process manufacturing has been based on a just-in-case philosophy: Invento-
ries of raw materials are maintained just in case some items are of poor quality or a key supplier is shut
down by a strike. Similarly, sub-assembly parts are manufactured and stored just in case they are needed
later in the manufacturing process. Finished goods are completed and stored just in case unexpected and
rush customer orders are received. This philosophy often results in a push approach in which raw mat-
erials and sub-assembly parts are pushed through each process. Traditional processing often results in the
build-up of extensive manufacturing inventories.

Many entities have switched to just-in-time (JIT) processing primarily in response to cost reduction.
JIT manufacturing is dedicated to having the right amount of materials, products, or parts at the time
they are needed. Under JIT processing, raw materials are received just in time for use in production, sub-
assembly parts are completed just in time for use in finished goods, and finished goods are completed
just in time to be sold. Figure 16.36 shows the sequence of activities in just-in-time processing.
Helpful hint: Just-in-time processing is easier said than done. JIT requires a total commitment by
management and employees, a complete change in philosophy and significant changes in the way pro-
duction is organised. JIT takes time to implement.
Objective of JIT processing

A primary objective of JIT is to eliminate all manufacturing inventories. Inventories are considered to
have an adverse effect on profit because they tie up funds and storage space that could be made available
for more productive purposes. JIT strives to eliminate inventories by using a demand–pull approach in
manufacturing. This approach begins with the customer placing an order with the entity. This order,
which indicates product demand, starts the process of pulling the product through the manufacturing
process. A signal is sent via a computer to the next preceding work station indicating the exact materials
(parts and sub-assemblies) needed for a time period, such as an 8-hour shift, to complete the production
of a specified product. The preceding process, in turn, sends its signal to other preceding processes.
The goal is a smooth continuous flow in the manufacturing process, with no build-up of inventories at
any point.
JIT processing has grown in importance in many supply chain management programs. For example,
Fonterra has developed a ‘do it once, do it right first time’ structure and culture to eliminate unnecessary
duplications in functions and costs.

FIGURE 16.36 Just-in-time processing
‘100 pairs ‘Send rubber &

of soccer shoe laces directly to the
shoes... got it.’ factory.’
Sales order received
Goods manufactured Goods shipped to customer
Elements of JIT processing

There are three important elements in JIT processing.
1. An entity must have dependable suppliers who are willing to deliver on short notice exact quantities of
raw materials according to precise quality specifications. (This may even include multiple deliveries
within the same day.) Suppliers must also be willing to deliver the raw materials at specified work
stations rather than at a central receiving department. This type of purchasing requires constant and
direct communication with suppliers, which is facilitated by an online computer linkage between the
entity and its suppliers.
2. A multiskilled workforce must be developed. Under JIT, machines are often strategically grouped
into work cells or centres and much of the work is automated. As a result, one worker may have the
responsibility to operate and maintain several different types of machines.
3. A total quality control system must be established through the manufacturing operations. Total quality
control means no defects. Since only required quantities are signalled by the demand–pull approach,
any defects at a work station will shut down operations at subsequent work stations. Total quality
control requires continuous monitoring by both employees and supervisors at each work station.
Benefits of JIT processing

The major benefits of implementing JIT processing are as follows.
1. Manufacturing inventories are significantly reduced or eliminated.
2. Product quality is enhanced.
3. Rework costs and inventory storage costs (i.e. rent and labour costs) are reduced or eliminated.
4. Production cost savings are realised from the improved flow of goods through the processes.
One of the major accounting benefits of JIT is the elimination of separate inventory accounts for
raw materials and work in process. These accounts are replaced by one account called Raw and
In-Process Inventory. All materials and conversion costs are charged to this account. Due to the reduction
(or elimination) of in-process inventories, the calculation of equivalent units of production is simplified.

Helpful hint: Without its emphasis on quality control, JIT would be impractical or even impossible. In
JIT, quality is engineered into the production process.

Can we benefit from Amounts of raw materials, Establish that we have JIT should reduce or nearly
installation and work in process, and dependable suppliers, eliminate inventories,
implementation of finished goods inventory; a multiskilled storage and waiting time,
JIT processing? days that inventory is in workforce, and a total and should minimise waste
storage or waiting to be quality control system. and defects. Inventory
processed or sold should be pulled rather than
pushed through each
production process.
Review it
1. Of what benefit is classifying activities as value-added and non-value-added?
2. Of what importance to managers is the differentiation of activities into unit-level, batch-level, product-
level and facility-level?
3. What are the major ‘benefits’ of implementing JIT?
Do it
Morgan Toy Ltd manufactures six main product lines in its factory. As a result of an activity analysis, the
accounting department has identified eight activity cost pools. Each of the toy products is produced in
large batches, with the whole factory devoted to one product at a time. Classify each of the following
activities as either unit-level, batch-level, product-level or facility-level: (a) engineering design, (b) machine
set-up, (c) inventory management, (d) cafeteria, (e) inspections after each set-up, (f) polishing parts,
(g) assembling parts, (h) health and safety.
Reasoning
Unit-, batch-, product- and facility-level costs can be controlled only by modifying unit-, batch-, product-
and facility-level activities. This hierarchy provides managers and accountants a structured way of thinking
about the relationship between activities and the resources they consume.
Solution
(a) Product-level, (b) batch-level, (c) product-level, (d) facility-level, (e) batch-level, (f) unit-level, (g) unit-
level, (h) facility-level.
USING THE DECISION-MAKING TOOLKIT
Speedy Ltd manufactures a line of up-market exercise equipment of commercial quality. The chief account-
ant has proposed changing from a traditional costing system to an activity-based costing system. The
financial director is not convinced of making the changes, so she requests that the next large order for
equipment be costed under both systems for purposes of comparison and analysis. An order from Slim-
Way Salons for 150 low-impact treadmills is received and identified as the order to be subjected to dual
costing. The following cost data relate to the Slim-Way order.

Data relevant to both costing systems
Direct labour hours 820
Direct labour rate per hour $18
Data relevant to the traditional costing system
Predetermined overhead rate is 300% of direct labour cost.
Data relevant to the activity-based costing system

Activity-based Expected use of cost
Activity cost pools Cost drivers overhead rate drivers per treadmill
Engineering design Engineering hours $30 per hour 330 hours
Machine set-up Set-ups $200 per set-up 22 set-ups
Machining Machine hours $25 per hour 732 hours
Assembly Number of subassemblies $8 per subassembly 1450 subassemblies
Packaging and shipping Packaging/shipping hours $15 per hour 152 hours
Building occupancy Machine hours $6 per hour 732 hours
Required
Calculate the total cost of the Slim-Way Salons order under (a) the traditional costing system and (b) the
activity-based costing system. (c) As a result of this comparison, which costing system is Speedy likely
to adopt? Why?
Solution
(a) Traditional costing system:
Direct materials $ 55 500

Direct labour (820 × $18) 14 760
Overhead assigned ($14 760 × 300%) 44 280
Total costs assigned to Slim-Way order $114 540
Number of low-impact treadmills 150
Cost per unit $ 763.60
(b) Activity-based costing system:

Direct labour (820 × $18) 14 760
Overhead activities costs:
Engineering design (330 hours @ $30) 9 900
Machine set-up (22 set-ups @ $200) 4 400
Machining (732 machine hours @ $25) 18 300
Assembly (1450 subassemblies @ $8) 11 600
Packaging and shipping (152 hours @ $15) 2 280
Building occupancy (732 hours @ $6) 4 392 50 872

Total costs assigned to Slim-Way order $121 132
Number of low-impact treadmills 150
Cost per unit $ 807.55
(c) Speedy Ltd is likely to adopt ABC because of the differences in the cost per unit. More importantly,
ABC provides greater insight into the sources and causes of the cost per unit. Managers are given
greater insight into which activities to control in order to reduce costs.

SUMMARY
16.1 Explain the characteristics and purposes of cost accounting systems.
Cost accounting involves the procedures for measuring, recording and reporting product costs. From the
data accumulated, the total cost and the unit cost of each product are determined.
16.2 Describe the flow of costs in a job order cost system.
In job order cost accounting, manufacturing costs are first accumulated in three accounts: Raw materials
inventory, Factory labour, and Manufacturing overhead. The accumulated costs are then assigned to work
in process inventory and eventually to finished goods inventory and cost of sales.
16.3 Explain a job cost sheet and the accounting entries for a job order cost system.
A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total
and unit cost of the completed job. Job cost sheets constitute the subsidiary ledger for the work in process
inventory control account. Costs are assigned to production and controlled via the job cost sheet. While
jobs are in progress, the costs are accumulated in the work in process account. When jobs are completed,
the cost is debited to finished goods inventory and credited to work in process inventory. When a job is
sold, cost of sales is debited and finished goods inventory is credited for the cost of the goods.
16.4 Describe the flow of costs in a process cost system.
Manufacturing costs for raw materials, labour and overhead are assigned to work in process accounts for
various departments or manufacturing processes, and the costs of units completed in a department are
transferred from one department to another as those units move through the manufacturing process. The
costs of completed work are transferred to finished goods inventory. When inventory is sold, costs are
transferred to cost of sales.
16.5 Prepare the accounting entries for a process cost system.
The raw materials, labour and direct overhead are debited to the raw materials inventory, factory labour
and manufacturing overhead accounts. Entries to assign the costs of raw materials, labour and overhead
consist of a credit to raw materials inventory, factory labour and manufacturing overhead applied, and a
debit to work in process for each of the departments doing the processing. Entries to record the cost of
goods transferred to another department are a credit to work in process for the department whose work
is finished and a debit to the department to which the goods are transferred. The entry to record units
completed and transferred to the warehouse is a credit for the department whose work is finished and
a debit to finished goods inventory. Finally, the entry to record the sale of goods is a credit to finished
goods inventory and a debit to cost of sales.
16.6 Prepare a production cost report.
The production cost report contains both quantity and cost data for a production department. There are
four sections in the report: (a) number of physical units, (b) equivalent units determination, (c) unit costs
and (d) cost reconciliation schedule.
16.7 Recognise the difference between traditional costing and activity-based costing and identify
the activity cost pools and activity drivers used in activity-based cost systems.
A traditional costing system allocates overhead to products on the basis of predetermined factory-wide or
department-wide volume of output rates such as direct labour or machine hours. An ABC system allocates
overhead to identified activity cost pools which are then assigned to products using related cost drivers
that measure the activities (resources) consumed.
To identify activity cost pools, an entity must perform an analysis of each operation or process, docu-
menting and timing every task, action or transaction. Cost drivers identified for assigning activity cost
pools must reflect the actual consumption of the activity by the various products.

16.8 Understand the benefits and limitations of activity-based costing.
What makes ABC a more accurate product costing system is (1) the increased number of cost pools
used to assign overhead, (2) the enhanced control over overhead costs and (3) the better management
decisions. The limitations of ABC are (1) the higher analysis and measurement costs that accompany
multiple activity centres and cost drivers, (2) the necessity still to allocate some costs arbitrarily, and
(3) the preclusion of its use in external reports by IAS 2/AASB 102.
16.9 Differentiate between value-added and non-value-added activities.
Value-added activities increase the worth of a product or service, for which the customer is willing to
pay. Non-value-added activities simply add cost to, or increase the time spent on, a product or service
without increasing its market value. Awareness of these classifications encourages managers to reduce
or eliminate the time spent on the non-value-added activities. Related to eliminating non-value-added
activities is the implementation of just-in-time inventory management.
16.10 Explain just-in-time (JIT) processing.
JIT is a processing system that is dedicated to having on hand the right materials and products at the time
they are needed, thereby reducing the amount of inventory and the time inventory is held. One of the
principal accounting effects is that one account, Raw and In-Process Inventory, replaces both inventory
accounts for raw materials and work in process.
DECISION-MAKING TOOLKIT — A SUMMARY


What is the cost Cost of material, labour Job cost sheet Compare costs with those of
of a job? and overhead assigned to previous periods and with
a specific job those of competitors to ensure
that costs are in line. Compare
costs with expected selling
price to determine overall
profitability.
Has the entity Actual overhead costs Manufacturing Overapplied overhead occurs
over- or and overhead applied overhead and when the manufacturing
underapplied manufacturing overhead applied exceeds
overhead for the overhead applied actual manufacturing
period? accounts overhead. Underapplied
overhead occurs when actual
manufacturing overhead
exceeds manufacturing
overhead applied.
What is the cost Costs of materials, labour Production cost Compare costs with previous
of a product? and overhead assigned to report periods and with those of
processes used to make competitors to ensure that
the product; selling price costs are in line. Compare with
of the product expected selling price to
determine overall profitability.

When should we Knowledge of the A detailed and accurate Compare the results under
switch to ABC? products or product lines, cost accounting both costing systems. If
the manufacturing system, cooperation managers are better able to
process, overhead costs between accountants understand and control their
and the needs of and operating operations using ABC, and the
managers for accurate managers costs are not prohibitive, the
cost information switch would be beneficial.
How can ABC help Activities classified as The activity analysis The flowchart should motivate
managers manage value-added and flowchart extended to managers to minimise
the business? non-value-added; identify each activity as non-value-added activities.
activities and costs value-added or Managers should better
classified by level of non-value-added; understand the relationship
performance or activities and related between activities and the
incurrence costs classified as resources they consume.
unit-level, batch-level,
product-level or
facility-level
Can we benefit from Amounts of raw Establish that we have JIT should reduce or nearly
installation and materials, work in dependable suppliers, eliminate inventories, storage
implementation of process, and finished a multiskilled and waiting time, and should
JIT processing? goods inventory; days workforce, and a total minimise waste and defects.
that inventory is in quality control system Inventory should be pulled
storage or waiting to be rather than pushed through
processed or sold each production process.
KEY TERMS
activity Any event, action, transaction or work sequence that causes incurrence of cost in producing a
product or rendering a service.
activity cost pool The overhead cost allocated to a distinct type of activity or related activities.
activity-based costing (ABC) An overhead cost allocation system that allocates overhead to multiple
activity cost pools and assigns the activity cost pools to products or services by means of cost drivers.
activity-based management (ABM) A management tool that focuses on determining the entity’s
activities and associated costs, and assessing if the costs can be reduced or eliminated.
batch-level activities Activities performed for each batch of products.
cost accounting An area of accounting that involves the measuring, recording and reporting of product
or service costs.
cost accounting system Manufacturing cost accounts that are fully integrated into the general ledger of
an entity.
cost driver Any factor or activity that has a direct cause–effect relationship with the resources
consumed. In ABC, cost drivers are used to assign activity cost pools to products or services.
equivalent units of production A measure of the work done during the period, expressed in fully
completed units.
facility-level activities Activities required to support or sustain an entire production process and not
dependent on number of products, batches or units produced.
job cost sheet A form used to record the costs chargeable to a job and to determine the total and unit
cost of the completed job.

job order cost system A cost accounting system in which costs are assigned to each job or batch.
just-in-time (JIT) processing system A processing system dedicated to having the right amount of
materials, products or parts arrive as they are needed, thereby reducing the amount of inventory.
materials requisition slip A document authorising the issue of raw materials from the storeroom
to production.
non-value-added activity An activity that adds cost to, or increases the time spent on, a product or
service without increasing its market value.
overapplied manufacturing overhead A situation in which overhead assigned to work in process is
greater than the overhead incurred.
predetermined overhead application rate or budgeted overhead rate A rate based on the
relationship between estimated annual overhead costs and expected annual operating activity,
expressed in terms of a common activity base.
process cost system A system of accounting used by entities that manufacture a large volume of
uniform or relatively homogeneous products through a series of continuous processes or operations.
product-level activities Activities performed for and identifiable with an entire product line.
production cost report An internal report for management that shows both production quantity and
cost data for a production department.
time sheet A document that indicates the employee, the hours worked, the account and job to be
charged, and the total labour cost.
underapplied manufacturing overhead A situation in which overhead assigned to work in process is
less than the overhead incurred.
unit-level activities Activities performed for each unit of production.
value-added activity An activity that increases the worth of a product or service to customers.
weighted-average method Method used to calculate equivalent units of production which considers
the degree of completion (weighting) of the units completed and transferred out and the ending work
in process.
DEMONSTRATION PROBLEM
Spreadwell Paint manufactures two high-quality base paints — an oil-based paint and a latex paint. Both
paints are manufactured in neutral white colour only. The white base paints are sold to franchised retail
paint and decorating stores where pigments are added to tint (colour) the paint as desired by the customer.
The oil-based paint is made from, thinned, and cleaned with organic solvents (petroleum products) such as
mineral spirits or turpentine. The latex paint is made from, thinned, and cleaned with water; synthetic resin
particles are suspended in the water and dry and harden when exposed to the air. Both paints are house
paints. Spreadwell uses the same processing equipment to produce both paints in differing production
runs. Between batches, the vats and other processing equipment must be washed and cleaned.
After analysing the entire operations, Spreadwell’s accountants and production managers have identi-
fied activity cost pools and accumulated annual budgeted overhead costs by pool as follows:
Estimated
Activity cost pools overhead
Purchasing $ 240 000
Processing (weighing and mixing, grinding,
thinning and drying, straining) 1 400 000
Packaging ( 12 litre, 5 litres and 25 litres) 580 000
Testing 240 000
Storage and inventory control 180 000
Washing and cleaning equipment 560 000
Total annual budgeted overhead $3 200 000

Following further analysis, activity cost drivers were identified and their expected use by product and
activity were scheduled as follows:
Expected use of drivers

Expected cost drivers per product
Activity cost pool Cost drivers per activity Oil-based Latex
Purchasing Purchase orders 1 500 orders 800 700
Processing Litres processed 1 000 000 litres 400 000 600 000
Packaging Containers filled 400 000 containers 180 000 220 000
Testing Number of tests 4 000 tests 2 100 1 900
Storing Avg. litres on hand 18 000 litres 10 400 7 600
Washing Number of batches 800 batches 350 450
Spreadwell has budgeted 400 000 litres of oil-based paint and 600 000 litres of latex paint for processing
during the year.
Required
(a) Prepare a schedule showing the calculations of the activity-based overhead rates.
(b) Prepare a schedule assigning each activity’s overhead cost pool to each product.
(c) Calculate the overhead cost per unit for each product.
(d) Classify each activity cost pool as value-added or non-value-added.
PROBLEM-SOLVING STRATEGIES
1. Identify the major activities that pertain to the manufacture of specific products and allocate manufac-
turing overhead costs to activity cost pools.
2. (a) Identify the cost drivers that accurately measure each activity’s contribution to the finished product.
(b) Calculate the activity-based overhead costs.
3. Assign manufacturing overhead costs for each activity cost pool to products, using the activity-based
overhead rates.
SOLUTION TO DEMONSTRATION PROBLEM
(a) Calculations of activity-based overhead rates:
SPREADWELL PAINT
Activity cost Estimated Expected use of Activity-based

pools overhead ÷ cost drivers = overhead rates
Purchasing $ 240 000 1 500 orders $160 per order
Processing 1 400 000 1 000 000 litres $1.40 per litre
Packaging 580 000 400 000 containers $1.45 per container
Testing 240 000 4 000 tests $60 per test
Storing 180 000 18 000 litres $10 per litre
Washing 560 000 800 batches $700 per batch
$3 200 000
(b) Assignment of activity cost pools to products:
SPREADWELL PAINT
Oil-based paint Latex paint

Activity cost Expected use Overhead Cost Expected use Overhead Cost
pools of drivers rates assigned of drivers rates assigned
Purchasing 800 $160 $ 128 000 700 $160 $ 112 000
Processing 400 000 $1.40 560 000 600 000 $1.40 840 000

Oil-based paint Latex paint
Activity cost Expected use Overhead Cost Expected use Overhead Cost
pools of drivers rates assigned of drivers rates assigned
Packaging 180 000 $1.45 261 000 220 000 $1.45 319 000
Testing 2 100 $60 126 000 1 900 $60 114 000
Storing 10 400 $10 104 000 7 600 $10 76 000
Washing 350 $700 245 000 450 $700 315 000
Total overhead assigned $1 424 000 $1 776 000
(c) Calculation of overhead cost assigned per unit:
Oil-based Latex
paint paint
Total overhead cost assigned $1 424 000 $1 776 000
Total litres produced 400 000 600 000
Overhead cost per litre $ 3.56 $ 2.96
(d) Value-added activities: processing and packaging.

Non-value-added activities: purchasing, testing, storing and washing.
SELF-STUDY QUESTIONS
16.1 Cost accounting involves the measuring, recording and reporting of: LO1
(a) product costs.
(b) future costs.
(c) manufacturing processes.
(d) managerial accounting decisions.
16.2 When incurred, factory labour costs are debited to: LO2
(a) work in process.
(b) factory wages expense.
(c) factory labour.
(d) factory wages payable.
16.3 A job cost sheet: LO3
(a) is used in process costing.
(b) is the subsidiary ledger record for work in process.
(c) records direct material requisitions only.
(d) is used to record a factory employee’s total hours worked.
16.4 In Styler Manufacturing, the predetermined overhead rate is 80% of direct labour cost. During
the month, $210 000 of factory labour costs are incurred, of which $180 000 is direct labour and
$30 000 is indirect labour. Actual overheads incurred was $200 000. The amount of overhead
debited to work in process inventory should be: LO3
(a) $120 000.
(b) $200 000.
(c) $144 000.
(d) $168 000.
16.5 In a process cost system, costs are assigned only to: LO4
(a) one work in process account.
(b) work in process and finished goods inventory.
(c) work in process, finished goods and cost of sales.
(d) work in process accounts.

16.6 In making the journal entry to assign raw materials costs in a process costing system the: LO5
(a) debit is to finished goods inventory.
(b) debit is often to two or more work in process accounts.
(c) credit is generally to two or more work in process accounts.
(d) credit is to finished goods inventory.
16.7 The Mixing Department’s output during the period consists of 20 000 units completed and trans-
ferred out, and 5000 units in ending work in process 60% complete as to materials and conversion
costs. Beginning work in process is 1000 units, 40% complete as to materials and conversion costs.
The equivalent units of production are: LO5
(a) 25 000.
(b) 22 600.
(c) 24 000.
(d) 23 000.
16.8 Lister Ltd has a unit cost of $10 for materials and $30 for conversion costs. If there are 2500 units
in ending work in process, 40% complete as to conversion, and fully complete as to materials cost,
the total cost assignable to ending work in process inventory is: LO6
(a) $40 000.
(b) $55 000.
(c) $70 000.
(d) $10 000.
16.9 A production cost report: LO6
(a) is an external report.
(b) shows costs charged to department and costs accounted for.
(c) shows equivalent units of production but not physical units.
(d) contains six sections.
16.10 Activity-based costing: LO7
(a) is the initial phase of converting to a just-in-time operating environment.
(b) can be used only in a job order cost system.
(c) is a two-phase overhead cost allocation system that identifies activity cost pools and cost
drivers.
(d) uses direct labour as its main cost driver.
16.11 Crawford Ltd has identified an activity cost pool to which it has allocated estimated overhead of
$1 500 000 and determined the expected use of cost drivers per that activity to be 200 000 inspec-
tions. Widgets require 40 000 inspections, gadgets 60 000 inspections, and targets 100 000 inspec-
tions. The overhead assigned to each product is: LO7
(a) widgets $40 000, gadgets $60 000, targets $100 000.
(b) widgets $80 000, gadgets $80 000, targets $200 000.
(c) widgets $450 000, gadgets $300 000, targets $750 000.
(d) widgets $300 000, gadgets $450 000, targets $750 000.
16.12 Any activity that causes resources to be consumed is called a: LO7

(a) just-in-time activity.
(b) facility-level activity.
(c) cost driver.
(d) non-value-added activity.
16.13 Activity-based costing would be likely to be most beneficial to companies with: LO8
(a) a single product.
(b) few products, each of which consumes about the same amount of resources.
(c) many products, each of which consumes about the same amount of resources.
(d) many products, each of which consumes different amounts of resources.

16.14 Which activities are value-added? LO9
(a) Storage of raw materials.
(b) Moving parts from machine to machine.
(c) Turning a piece of metal on a lathe.
(d) All of the above.
16.15 Just-in-time processing requires all of the following except: LO10
(a) increasing operational efficiencies.
(b) eliminating inventories.
(c) basing production on future demand for the product.
(d) controlling quality.
QUESTIONS
16.1 (a) Your friend is not sure about the differences between cost accounting and a cost accounting
system. Explain the differences.
(b) What is an important feature of a cost accounting system?
16.2 Your classmate asks for your help in understanding the major steps in the flow of costs in a job
order cost system. Identify the steps.
16.3 What is the purpose of a job cost sheet?
16.4 Ron is confused about under- and overapplied manufacturing overhead. Define the terms for Ron
and indicate the action that should be taken at the end of the year for under- or overapplied
overhead.
16.5 A friend is confused about the features of process cost accounting. Identify and explain the dis-
tinctive features.
16.6 What steps are involved in developing an activity-based costing system?
16.7 (a) What are the main differences between activity-based costing (ABC) and traditional product
costing?
(b) What assumptions must be met for ABC costing to be useful?
16.8 Of what benefit is classifying activities as value-added and non-value-added?
16.9 (a) Describe the philosophy and approach of just-in-time processing.
(b) Identify the major elements of JIT processing.
16.10 In what ways is the application of ABC to service entities the same as its application to manufac-
turing entities?
BRIEF EXERCISES
BE16.1 Distinguish between job and process costing. LO1
Indicate whether job costing or process costing would be more appropriate for each of the
following products:
(a) Antique chairs.
(b) Office chairs.
(c) Mobile phones.
(d) Aircraft.
(e) Volleyballs.
BE16.2 Prepare a flowchart of a job order cost accounting system, and identify transactions. LO2
Diamond Tool & Die Pty Ltd begins operations on 1 January. Because all work is done to
customer specifications, the entity decides to use a job cost accounting system. Prepare a
flowchart of a typical job order system with arrows showing the flow of costs. Identify the eight
transactions.

BE16.3 Calculate equivalent units of production. LO6
Burrough Manufacturing has the following production data for selected months:
Ending work in process

Beginning work Units % complete as to
Month in process transferred out Units conversion cost
January — 7 000 2 000 60
March — 12 000 3 000 30
May — 16 000 4 000 80
July — 10 000 15 000 40
(a) Calculate the physical units for each month.

(b) Calculate equivalent units of production for materials and conversion costs for each month,
assuming materials are entered at the beginning of the process.
BE16.4 Calculate equivalent units of production. LO6
The Smelting Department of Clark Manufacturing has the following production and cost data
for March. Beginning work in process 3000 units that are 100% complete as to materials and
20% complete as to conversion costs; units transferred out 11 000 units; and ending work in
process 2000 units that are 100% complete as to materials and 60% complete as to conversion
costs. Calculate the equivalent units of production for (a) materials and (b) conversion costs for
the month of March.
BE16.5 Calculate activity-based overhead rates. LO7
Smyth Ltd identifies three activities in its manufacturing process: machine set-ups, machin-
ing, and inspections. Estimated annual overhead cost for each activity is $180 000, $325 000
and $70 000, respectively. The cost driver for each activity and the expected annual usage are:
number of set-ups 2000, machine hours 25 000 and number of inspections 1750. Calculate the
overhead rate for each activity.
BE16.6 Classify activities as value-added or non-value-added. LO9
Dewey Novelty Pty Ltd identified the following activities in its production and support opera-
tions. Classify each of these activities as either value-added or non-value-added.
1. Purchasing.
2. Receiving.
3. Design engineering.
4. Storing inventory.
5. Cost accounting.
6. Moving work-in-process.
7. Inspecting and testing.
8. Painting and packing.
BE16.7 Classify activities according to level. LO9
Elburn Plastics Ltd operates 20 injection moulding machines in the production of fishing tackle
boxes of four different sizes: the minnow, the bass, the mackerel, and the shark. Classify each
of the following costs as unit-level, batch-level, product-level or facility-level.
(a) First shift supervisor’s salary.
(b) Powdered raw plastic.
(c) Dies for casting plastic components.
(d) Depreciation on injection moulding machines.
(e) Changing dies on machines.
(f) Moving components to assembly department.
(g) Engineering design.
(h) Workers compensation insurance.

EXERCISES
E16.1 Analyse a job cost sheet and prepare entries for manufacturing costs. LO2, 3
A job order cost sheet for Standish Ltd is shown below.
Job no. 92 For 2000 units

Direct Direct Manufacturing
Date materials labour overhead
Beg. bal. Jan. 1 7 000 8 000 5 200
8 5 000
12 7 000 4 900
25 4 000
27 5 000 3 500
16 000 20 000 13 600
Cost of completed job:
Manufacturing overhead 13 600
Total cost $49 600
Unit cost ($49 600 ÷ 2000) $ 24.80
Required
(a) Answer the following questions using the job order cost sheet above:
1. What are the source documents for direct materials, direct labour and manufacturing over-
head costs assigned to this job?
2. What was the balance in work in process inventory on 1 January if this was the only
unfinished job?
3. If manufacturing overhead is applied on the basis of direct labour cost, what overhead
rate was used in each year?
(b) Prepare summary entries at 31 January to record the current year’s transactions pertaining to
job no. 92.
E16.2 Analyse costs of manufacturing and determine missing amounts. LO2, 3
Manufacturing cost data for Kang Pty Ltd, which uses a job order cost system, are presented
below:
Case A Case B Case C

Direct materials (a) $83 000 $63 150
Direct labour used $50 000 90 000 (h)
Manufacturing overhead applied 42 500 (d) (i)
Total manufacturing costs 185 650 (e) 287 000

Work in process, 1/1/19 (b) 15 500 18 000
Total cost of work in process 203 100 (f) (j)
Work in process, 31/12/19 (c) 11 800 (k)
Cost of goods manufactured 193 700 (g) 262 000
Required
Indicate the missing amount for each letter. Assume that in all cases manufacturing overhead is
applied on the basis of direct labour cost and the rate is the same.

E16.3 Recognise a variety of cost accounting systems. LO2, 3, 7, 9, 10
Complete the following statements with one of the terms listed below:
Job costing Non-valued-added

Just-in-time processing Underapplied
Overhead Activity-based costing
(a) is an approach to manufacturing which results in reduced inventory, stream-

lined production processes and quality control.
(b) A design firm creates custom-made interior design plans for clients. The company would use
a system.
(c) is a strategy for allocating factory overhead costs to activity cost pools based
on appropriate cost drivers.
(d) Reworking and fixing defective parts is an example of activity.
(e) The key difference between activity-based costing and traditional costing systems is the allo-
cation of costs.
(f) Overhead is considered if overhead incurred exceeds applied overhead.
E16.4 Prepare entries for manufacturing costs. LO3
Berg Printing Ltd uses a job order cost system. The following data summarise the operations
related to the first quarter’s production.
1. Materials purchased on account $172 000, and factory wages incurred $87 300.
2. Materials requisitioned and factory labour used by job:
Factory
Job number Materials labour
A20 $ 32 240 $18 000
A21 42 920 26 000
A22 36 100 15 000
A23 39 270 25 000
General factory use 4 470 3 300
$155 000 $87 300
3. Manufacturing overhead costs incurred on account $39 500.

4. Depreciation on machinery and equipment $14 550.
5. Manufacturing overhead rate is 75% of direct labour cost.
6. Jobs completed during the quarter: A20, A21, and A23.
Required
Prepare entries to record the operations summarised above. (Prepare a schedule showing the
individual cost elements and total cost for each job in item 6.)
E16.5 Determine equivalent units, unit costs and assignment of costs. LO5, 6
The Blending Department of Kohler Ltd has the following cost and production data for the month
of July:
COSTS
Work in process, 1 July
Direct materials: 100% complete $ 100 000
Conversion costs: 20% complete 70 000
Cost of work in process, 1 July $ 170 000
Costs incurred during production in July
Conversion costs 350 000
Costs incurred in July $1 150 000

Units transferred out 8000; ending work in process 1000 units that are 100% complete as to
materials and 40% complete as to conversion costs.
Required
(a) Calculate the equivalent units of production for (1) materials and (2) conversion costs for the
month of July.
(b) Calculate the unit costs for the month.
(c) Determine the costs to be assigned to the units transferred out and in ending work in process.
E16.6 Prepare a production cost report. LO6
The Welding Department of Nagano Manufacturing has the following production and manufac-
turing cost data for February 2019. All materials are added at the beginning of the process.
Manufacturing costs Production data

Beginning work in process Beginning work in process 15 000 units
Materials $18 000 1/10 complete
Conversion costs 14 175 32 175 Units transferred out 49 000
Materials 180 000 Units started 60 000
Labour 35 100 Ending work in process 26 000
Overhead 64 545 1/5 complete
Required
Prepare a production cost report for the Welding Department for the month of February.
E16.7 Journalise transactions for two processes. LO5
Henderson Manufacturing has two production departments: Cutting and Assembly. 1 July inven-
tories are Raw materials $4200, Work in process—Cutting $2900, Work in process—Assembly
$10 600; and Finished goods $31 000. During July, the following transactions occurred:
1. Purchased $35 600 of raw materials on account.
2. Incurred $56 000 of factory labour (credit wages payable).
3. Incurred $70 000 of manufacturing overhead; $42 000 was paid and the remainder is unpaid.
4. Requisitioned materials for Cutting $15 700 and Assembly $8900.
5. Used factory labour for Cutting $29 000 and Assembly $27 000.
6. Applied overhead at the rate of $20 per machine hour. Machine hours were Cutting 1740 and
Assembly 1620.
7. Transferred goods costing $67 700 from the Cutting Department to the Assembly Department.
8. Transferred goods costing $134 900 from Assembly to finished goods.
9. Sold goods costing $130 000 for $200 000 on account.
Required
Journalise the transactions (narrations are not required).
E16.8 Explain the production cost report. LO6
Larry Lair has recently been promoted to production manager, and so he has just started to receive
various management reports. One of the reports he has received is the production cost report that
you prepared. It showed that his department had 1000 equivalent units in ending inventory. His
department has had a history of not keeping enough inventory on hand to meet demand. He has
come to you, very angry, and wants to know why you credited him with only 1000 units when
he knows he had at least twice that many on hand.
Required
Explain to him why his production cost report showed only 1000 equivalent units in ending
inventory. Write an informal memo. Be kind and explain very clearly why he is mistaken.
E16.9 Calculate activity-based overhead rates. LO7
Robina Jam Factory produces two types of jam: blueberry and raspberry. Planned production for
August is 4500 bottles of blueberry jam and 13 500 bottles of raspberry jam. Estimated overhead

for August is $53 750. The following data summarises activities, overhead cost pools and cost
drivers for August:
Expected use Expected use

Activity cost Estimated Expected use of cost driver of cost driver
pools Cost driver overhead of cost drivers by blueberry by raspberry
Purchasing Orders $12 000 500 200 300
Blending Litres 35 000 9 800 2 400 7 400
Packaging Cartons 6 750 540 180 360
Required
(a) Calculate the overhead allocation rate for each overhead cost pool.
(b) Calculate the total overhead costs allocated to each product.
E16.10 Identify activity cost drivers and classify activities as value-added or non-value-added. LO7, 9
Valliance Vineyards produces three varieties of wine: Merlot, Shiraz and Pinot Noir. The wine
master, Sue, has identified the following activities as cost pools for accumulating overhead and
assigning it to products:
1. Culling and replanting — dead or overcrowded vines are culled and new vines are planted
or relocated. (Separate vineyards by variety.)
2. Trimming — at the end of the harvest the vines are cut and trimmed back in preparation for
the next season.
3. Tying — the posts and wires are reset and vines are tied to the wires for the dormant season.
4. Spraying — the vines are sprayed with chemicals for protection against insects and fungi.
5. Harvesting — the grapes are hand-picked, placed in carts and transported to the crushers.
6. Stemming and crushing — cartfuls of bunches of grapes of each variety are separately
loaded into machines that remove stems and gently crush the grapes.
7. Pressing and filtering — the crushed grapes are transferred to presses that mechanically
remove the juices and filter out bulk and impurities.
8. Fermentation — the grape juice, by variety, is fermented in either stainless-steel tanks or
oak barrels.
9. Ageing — the wines are aged in either stainless-steel tanks or oak barrels for 1 to 3 years
depending on variety.
10. Bottling and corking — bottles are machine-filled and corked.
11. Labelling and boxing — each bottle and each 9-bottle case is labelled with the name of the
vintner, vintage and variety.
12. Storing — packaged and boxed bottles are stored awaiting shipment.
13. Shipping — the wine is shipped to distributors and private retailers.
14. Maintenance of buildings and equipment — printing, repairs, replacements and general
maintenance are performed in the off-season.
15. Heating and air conditioning of plant and offices.
Required
(a) For each of Valliance’s 15 activity cost pools, identify a probable cost driver that might be
used to assign overhead costs to its three wine varieties.
(b) In an effort to expand the usefulness of its activity-based costing system, the vineyard uses
activity-based management techniques. One of these ABM techniques is qualifying its activi-
ties as either value-added or non-value-added. Using the list of 15 activity cost pools, classify
each of the activities as either value-added or non-value-added.
E16.11 Calculate overhead rates and assign overhead using ABC. LO7, 8
Amend Instrument Ltd manufactures two products: missile range instruments and space pres-
sure gauges. During January, 50 range instruments and 300 pressure gauges were produced, and

overhead costs of $89 000 were incurred. An analysis of overhead costs reveals the following
activities:
Activity Cost driver Total cost

1. Materials handling Number of requisitions $35 000
2. Machine set-ups Number of set-ups 27 000
3. Quality inspections Number of inspections 27 000
The cost driver volume for each product was as follows:
Cost driver Instruments Gauges Total

Number of requisitions 400 600 1 000
Number of set-ups 200 300 500
Number of inspections 200 400 600
Required
(a) Determine the overhead rate for each activity.
(b) Assign the manufacturing overhead costs for January to the two products using activity-based
costing.
(c) Write a memorandum to the CEO of Amend Instrument Ltd explaining the benefits of
activity-based costing.
E16.12 Assign overhead using traditional costing and ABC; classify activities as value- or non-value-
added and by level. LO7, 9
Stylish Clothing Ltd manufactures its own designed and labelled sports attire and sells its pro-
ducts through catalogue sales and retail outlets. While Stylish has for years used activity-based
costing in its manufacturing activities, it has always used traditional costing in assigning its
selling costs to its product lines. Selling costs have traditionally been assigned to Stylish’s pro-
duct lines at a rate of 60% of direct material costs. Stylish’s direct material costs for the month
of March for its ‘high intensity’ line of attire are $400 000. The entity has decided to extend
activity-based costing to its selling costs. Data relating to the ‘high intensity’ line of products for
the month of March are as follows:
Number of cost
drivers used
Activity cost pool Cost driver Overhead rates per activity
Sales commissions Dollar sales $0.05 per dollar sales $930 000
Advertising (TV/radio) Minutes $300 per minute 250
Advertising (newspaper) Column cm $10 per column cm 3 000
Catalogues Catalogues mailed $2.50 per catalogue 60 000
Cost of catalogue sales Catalogue orders $1 per catalogue order 8 500
Credit and collection Dollar sales $0.03 per dollar sales $930 000
Required
(a) Calculate the selling costs to be assigned to the ‘high-intensity’ line of attire for the month
of March: (1) using the traditional product costing system (direct material cost is the cost
driver), and (2) using activity-based costing.
(b) By what amount does the traditional product costing system undercost or overcost the ‘high-
intensity’ product line?
(c) Classify each of the activities as value-added or non-value-added.
E16.13 Classify activities as value-added or non-value-added. LO9
Groat and Groat is a law firm that is initiating an activity-based costing system. Jim Groat,
the senior partner and a strong supporter of ABC, has prepared the following list of activities
performed by a typical solicitor in a day at the firm.

Activity Hours
Writing contracts and letters 1.0
Attending staff meetings 0.5
Taking depositions 1.5
Doing research 1.0
Travelling to/from court 1.0
Contemplating legal strategy 1.5
Eating lunch 1.0
Instructing barristers 2.5
Entertaining a prospective client 1.5
Required
Classify each of the activities listed by Jim Groat as value-added or non-value-added; be able
to defend your classification. How much was value-added time and how much was non-value-
added?
PROBLEM SET A
PSA16.1 Prepare entries in a job cost system and cost of goods manufactured schedule. LO2, 3
Mercury Ltd is a construction company specialising in custom patios. The patios are con-
structed of concrete, brick, fibreglass and timber, depending upon customer preference. On
1 June 2019, the general ledger for Mercury Ltd contains the following data:
Raw materials inventory $4 200 Manufacturing overhead applied $32 640

Work in process inventory $5 900 Manufacturing overhead incurred $31 650
Subsidiary data for work in process inventory on 1 June are as follows:
Job cost sheets

Customer job
Cost element Rockford Aurora Moline
Direct materials $ 600 $ 800 $ 900
Direct labour 320 540 580
Manufacturing overhead 480 810 870
$1 400 $2 150 $2 350
A summary of materials requisition slips and time sheets for June shows the following.
Customer job Materials requisition slips Time sheets

Rockford $ 800 $ 450
Elgin 2 000 800
Aurora 500 360

Moline 1 300 800
Rockford 300 250
4 900 2 660
General use 1 500 1 200
$6 400 $3 860
During June, raw materials purchased on account were $3900, and all wages were paid.
Additional overhead costs consisted of depreciation on equipment $700 and miscellaneous
costs of $400 incurred on account. Overhead was charged to jobs at the same rate that was
used in May. The patios for customers Rockford, Aurora and Moline were completed during
June and sold for a total of $18 900. Each customer paid in full.

Required
(a) Journalise the June transactions.
(b) Post the entries to work in process inventory.
(c) Reconcile the balance in work in process inventory with the costs of unfinished jobs.
(d) Prepare a cost of goods manufactured schedule for June.
PSA16.2 Calculate predetermined overhead rate, apply overhead, and indicate statement presentation
of under- or overapplied overhead. LO3
Urbana Manufacturing Ltd uses a job order cost system in each of its three manufacturing
departments. Manufacturing overhead is applied to jobs on the basis of direct labour cost in
Department D, direct labour hours in Department E, and machine hours in Department K.
In establishing the predetermined overhead rates for 2018 the following estimates were
made for the year:
Department
D E K
Manufacturing overhead $1 170 000 $1 500 000 $1 248 000
Direct labour costs $1 500 000 $1 250 000 $ 585 000
Direct labour hours 100 000 120 000 52 000
Machine hours 400 000 500 000 156 000
During January, the job cost sheets showed the following costs and production data:
Department
D E K
Direct materials used $140 000 $126 000 $93 600
Direct labour costs $120 000 $110 000 $45 000
Manufacturing overhead incurred $ 98 000 $129 000 $96 000
Direct labour hours 8 000 11 000 4 200
Machinery hours 34 000 45 000 12 480
Required
(a) Calculate the predetermined overhead rate for each department.
(b) Calculate the total manufacturing costs assigned to jobs in January in each department.
(c) Calculate the under- or overapplied overhead for each department at 31 January.
(d) Indicate the statement presentation of the under- or overapplied overhead in the financial
statements.
PSA16.3 Journalise transactions. LO5
Vargas Ltd manufactures its product, Vitadrink, through two manufacturing processes: Mixing
and Packaging. All materials are entered at the beginning of each process. On 1 October
2018, inventories consisted of Raw materials $26 000, Work in process—Mixing $0, Work
in process—Packaging $250 000, and Finished goods $89 000. The beginning inventory for
Packaging consisted of 10 000 units that were 50% complete as to conversion costs and fully
complete as to materials. During October, 50 000 units were started into production in the
Mixing Department and the following transactions were completed.
2. Issued raw materials for production: Mixing $210 000 and Packaging $45 000.
3. Incurred labour costs of $238 900.
4. Used factory labour: Mixing $182 500 and Packaging $56 400.
5. Incurred $790 000 of manufacturing overhead on account.
6. Applied manufacturing overhead on the basis of $25 per machine hour. Machine hours
were 28 000 in Mixing and 7000 in Packaging.

7. Transferred 45 000 units from Mixing to Packaging at a cost of $999 000.
8. Transferred 53 000 units from Packaging to finished goods at a cost of $1 455 000.
9. Sold goods costing $1 540 000 for $2 500 000 on account.
Required
Journalise the October transactions.
PSA16.4 Complete four steps necessary to prepare a production cost report. LO6
Freedo Ltd manufactures in separate processes refrigerators and freezers for homes. In each
process, materials are entered at the beginning and conversion costs are incurred uniformly.
Production and cost data for the first process in making two products in two different manu-
facturing plants are as follows:
Stamping department
Plant A Plant B
Production data — June R12 refrigerators F24 freezers
Work in process units, 1 June 0 0
Units started into production 20 000 20 000
Work in process units, 30 June 2 000 2 500
Work in process percent complete 75% 60%
Cost data — June
Work in process, 1 June $ 0 $ 0
Materials 840 000 700 000
Labour 223 500 251 000
Overhead 420 000 319 000
Total $1 483 500 $1 270 000
Required
(a) For each plant:
1. Calculate the physical units of production.
2. Calculate equivalent units of production for materials and for conversion costs.
3. Determine the unit costs of production.
4. Show the assignment of costs to units transferred out and in process.
(b) Prepare the production cost report for Plant A for June 2019.
PSA16.5 Calculate equivalent units and complete production cost report. LO6
Taylor Processing Ltd uses a weighted-average process costing system and manufactures a
single product — a premium rug shampoo and cleaner. The manufacturing activity for the
month of October has just been completed. A partially completed production cost report for
the month of October for the Mixing and Blending Department is shown below.
TAYLOR PROCESSING LTD

Mixing and Blending Department
for the month ended 31 October

Equivalent units
Physical Conversion
units Materials costs
QUANTITIES
Units to be accounted for:
Work in process, 1 October (all materials,
70% conversion costs) 20 000
Total units 180 000

Equivalent units
Physical Conversion
Transferred out 140 000 ? ?
Work in process, 31 October (50%
materials, 25% conversion costs) 40 000 ? ?
Total units accounted for 180 000 ? ?
Conversion
Materials costs Total
COSTS
Unit costs
Costs in October $240 000 $90 000 $330 000
Equivalent units ? ?
Unit costs $ ? ? $ ?
Costs to be accounted for:
Work in process, 1 October $ 30 000
COST RECONCILIATION SCHEDULE
Transferred out $ ?
Work in process, 31 October:
Materials $ ?
Conversion costs ? ?
Total costs $ ?
Required
Complete the production cost report for Taylor Processing Ltd.
PSA16.6 Assign overhead using traditional costing and ABC. LO7
Chris at Burleigh Ltd specialises in making two types of surfboards: short boards and long
boards. The profitability in the last two years has deteriorated. Chris consulted Luke, who
is a CPA, to help improve his business’s bottom line. Luke analysed the profitability of the
two products, firstly by investigating how overheads were allocated to each product line. The
following information relates to overhead:
Short Long
boards boards
Production units 200 150
Material moves per product line 300 200
Purchase orders per product line 450 350
Direct labour hours per product line 700 1 300
Annual material-handling costs $120 000
Annual purchasing activity costs 45 600
Required
(a) Currently, a traditional costing system is in place. It assigns overhead on the basis of direct
labour hours. Under this system:
1. What material handling costs are assigned to each unit of short board and long board?
2. What purchasing activity costs are assigned to each unit of short board and long board?
(b) Luke suggested adopting an activity-based costing (ABC) to allocate overheads. Under
ABC:
1. What material handling costs are assigned to each unit of short board and long board?
2. What purchasing activity costs are assigned to each unit of short board and long board?

(c) After reviewing the costing from parts (a) and (b), what advice can Luke offer to Chris
about improving the profitability of the two product lines?
PSA16.7 Assign overhead using traditional costing and ABC; compute unit costs; classify activities as
value- or non-value-added. LO7, 9
Curly-Soo Ltd manufactures hair curlers and hair-dryers. The handheld hair curler is
Curly-Soo’s high-volume product (80 000 units annually). It is a ‘large barrel’, triple-heat
appliance designed to appeal to the teenage market segment with its glow-in-the-dark handle.
The handheld hair-dryer is Curly-Soo’s lower-volume product (40 000 units annually). It is a
three-speed appliance with a ‘cool setting’ and a removable filter. It also is designed for the
teen market.
Both products require one hour of direct labour for completion. Therefore, total annual
direct labour hours are 120 000 (80 000 + 40 000). Expected annual manufacturing overhead
is $441 600. Thus, the predetermined overhead rate is $3.68 per direct labour hour. The direct
materials cost per unit is $5.25 for the hair curler and $9.75 for the hair-dryer. The direct
labour cost is $8.00 per unit for the hair curler and the hair-dryer.
Curly-Soo purchases most of the parts from suppliers and assembles the finished product
at its Brisbane factory. It recently adopted activity-based costing, which after this year-end
will totally replace its traditional direct labour-based cost accounting system. Curly-Soo has
identified the following six activity cost pools and related cost drivers and has assembled the
following information:
Expected use of
cost drivers per
Estimated Expected use product
Activity cost pool Cost driver overhead of cost drivers Curlers Dryers
Purchasing Orders $ 57 500 500 170 330
Receiving Kilograms 42 000 168 000 70 000 98 000
Assembling Parts 169 600 848 000 424 000 424 000
Testing Tests 52 000 130 000 82 000 48 000
Finishing Units 60 000 120 000 80 000 40 000
Packing and shipping Cartons 60 500 12 100 8 040 4 060
$441 600
Required
(a) Under traditional product costing, calculate the total unit cost of both products. Prepare a
simple comparative schedule of the individual costs by product.
(b) Under ABC, prepare a schedule showing the calculations of the activity-based overhead
rates (per cost driver), using the information above.
(c) Prepare a schedule assigning each activity’s overhead cost pool to each product based on
the use of cost drivers. (Include a calculation of overhead cost per unit, rounding to the
nearest cent.)
(d) Calculate total cost per unit for each product under ABC.
(e) Classify each of the activities as a value-added activity or a non-value-added activity.
(f) Comment on (1) the comparative overhead cost per unit for the two products under ABC,
and (2) the comparative total costs per unit under traditional costing and ABC.
PSA16.8 Assign overhead costs using traditional costing and ABC; compare results; identify benefits
and limitations of ABC. LO7, 8
Castro Cabinets Company Ltd designs and builds upscale kitchen cabinets for luxury homes.
Many of the kitchen cabinet and counter arrangements are customer made, but occasionally

the entity does mass production on order. Its budgeted manufacturing overhead costs for the
year 2018 are as follows:
Estimated
Overhead cost pools overhead
Purchasing $ 114 400
Handling materials 164 320
Production (cutting, milling, finishing) 400 000
Setting up machines 174 480
Inspecting 184 800
Inventory control (raw materials and finished goods) 252 000
Power 360 000
Total budget overhead costs $1 650 000
For the last 3 years, Castro Cabinets has been charging overhead to products on the basis
of machine hours. For the year 2018, 100 000 machine hours are budgeted.
Michael Castro, owner-manager of Castro, recently directed his accountant, John Kandy, to
implement the activity-based costing system he has repeatedly proposed. At Michael’s request,
John and the production foreman identify the following cost drivers and their usage for the
previously budgeted overhead cost pools:
Total
Overhead cost pools Activity cost drivers drivers
Purchasing Number of orders 650
Handling materials Number of moves 8 000
Production (cutting, milling, finishing) Direct labour hours 100 000
Setting up machines Number of set-ups 1 200
Inspecting Number of inspections 6 000
Inventory control (raw materials and finished goods) Number of components 36 000
Power Square metres occupied 90 000
Kathy Lawson, sales manager, has received an order for 50 kitchen cabinet arrangements
from Bob the Builder. At Kathy’s request, John prepares cost estimates for producing compo-
nents for 50 cabinet arrangements so Kathy can submit a contract price per kitchen arrange-
ment to Bob the Builder. He accumulates the following data for the production of 50 kitchen
cabinet arrangements.

Direct labour $200 000
Machine hours 15 000
Direct labour hours 12 000
Number of purchase orders 50
Number of material moves 800

Number of machine set-ups 100
Number of inspections 450
Number of components (cabinets and accessories) 3 000
Number of square metres occupied 8 000
Required
(a) Calculate the predetermined overhead rate using traditional costing with machine hours
as the basis. (Round to the nearest cent.)
(b) What is the manufacturing cost per complete kitchen arrangement under traditional
costing?

(c) What is the manufacturing cost per kitchen arrangement under the proposed activity-based
costing? (Prepare all of the necessary schedules.)
(d) Which of the two costing systems is preferable in pricing decisions and why?
PSA16.9 Assign overhead to products using ABC and evaluate decision. LO7
Jackson Electronics manufactures two large-screen television models: the Royale which sells
for $1600, and a new model, the Majestic, which sells for $1300. The production cost calcu-
lated per unit under traditional costing for each model in 2019 was as follows:
Traditional costing Royale Majestic

Direct materials $ 700 $420
Direct labour ($20 per hour) 120 100
Manufacturing overhead ($38 per DLH) 228 190
Total per unit cost $1 048 $710
In 2019, Jackson manufactured 25 000 units of the Royale and 10 000 units of the Majestic.
The overhead rate of $38 per direct labour hour was determined by dividing total expected
manufacturing overhead of $7 600 000 by the total direct labour hours (200 000) for the
two models.
Under traditional costing, the gross profit on the models was: Royale $552 or
($1600 − $1048), and Majestic $590 or ($1300 − $710). Because of this difference, manage-
ment is considering phasing out the Royale model and increasing the production of the
Majestic model.
Before finalising its decision, management asks Jackson’s accountant to prepare an analysis
using activity-based costing (ABC). The accountant accumulates the following information
about overhead for the year ended 31 December 2019:
Estimated Expected use Activity-based

Activity Cost driver overhead of cost drivers overhead rate
Purchasing Number of orders $1 200 000 40 000 $30
Machine set-ups Number of set-ups 900 000 18 000 50
Machining Machine hours 4 800 000 120 000 40
Quality control Number of inspections 700 000 28 000 25
The cost drivers used for each product were:
Cost driver Royale Majestic Total

Purchase orders 15 000 25 000 40 000
Machine set-ups 6 000 12 000 18 000
Machine hours 75 000 45 000 120 000
Inspections 8 000 20 000 28 000
Required
(a) Assign the total 2019 manufacturing overhead costs to the two products using activity-
based costing (ABC).
(b) What was the cost per unit and gross profit of each model using ABC costing?
(c) Are management’s future plans for the two models sound? Explain.
PSA16.10 Assign overhead costs to services using traditional costing and ABC; calculate overhead rates
and unit costs; compare results. LO7
Horses and Dogs Veterinary Clinic is a small-town partnership that offers two primary ser-
vices, farm animal services and pet care services. Providing veterinary care to farm animals
requires travel to the farm animal (house calls), while veterinary care to pets generally requires

that the pet be brought into the clinic. As part of an investigation to determine the contribu-
tion that each of these two types of services makes to overall profit, one partner argues for
allocating overhead using activity-based costing while the other partner argues for a more
simple overhead cost allocation on the basis of direct labour hours. The partners agree to use
next year’s budgeted data, as prepared by their public accountant, for analysis and comparison
purposes. The following overhead data are collected to develop the comparison:
Expected use of
Total drivers by service
Estimated expected Farm
Activity cost pool Cost driver overhead cost drivers animals Pets
Drug treatment Treatments $ 64 000 4 000 1 800 2 200
Surgery Operations 65 000 800 200 600
Travel Mileage 28 000 28 000 26 000 2 000
Consultation Appointment/calls 33 000 3 000 600 2 400
Accounting/office Direct labour hours 30 000 5 000 2 000 3 000
Boarding and grooming 100% pets 40 000
$260 000
Required
(a) Using traditional product costing as proposed by the one partner, calculate the total over-
head cost assigned to both services of Horses and Dogs Veterinary Clinic.
(b) 1. Using activity-based costing, prepare a schedule showing the calculations of the
activity-based overhead rates (per cost driver).
2. Prepare a schedule assigning each activity’s overhead cost pool to each service based
on the use of the cost drivers.
(c) Classify each of the activities as a value-added activity or a non-value-added activity.
(d) Comment on the comparative overhead cost assigned to the two services under both
traditional costing and ABC.
PROBLEM SET B
PSB16.1 Prepare entries in a job cost system and partial statement of profit or loss. LO2, 3
For the year ended 31 December 2019, the job cost sheets of Asticio Manufacturing contained
the following data.
Job Direct Direct Manufacturing Total

number Explanation materials labour overhead costs
7650 Balance 1/1 $18 000 $20 000 $25 000 $ 63 000
Current year’s costs 22 000 30 000 37 500 89 500
7651 Balance 1/1 12 000 18 000 22 500 52 500

Current year’s costs 28 000 40 000 50 000 118 000
7652 Current year’s costs 40 000 60 000 75 000 175 000
Additional information:
1. Raw materials inventory totalled $20 000 on 1 January. During the year, $100 000 of raw
materials were purchased on account.
2. Finished goods on 1 January consisted of job no. 7648 for $98 000 and job no. 7649 for
$62 000.
3. Job no. 7650 and job no. 7651 were completed during the year.
4. Job nos. 7648, 7649 and 7650 were sold on account for $390 000.

5. Manufacturing overhead incurred on account totalled $120 000.
6. Other manufacturing overhead consisted of indirect materials $12 000, indirect labour
$18 000, and depreciation on factory machinery $6000.
Required
(a) Prove the agreement of work in process inventory with job cost sheets pertaining to unfin-
ished work.
(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated
entirely to cost of sales.
(c) Determine the gross profit to be reported for 2019.
PSB16.2 Prepare entries in a job cost system and job cost sheets. LO3
Han Wu Manufacturing uses a job order cost system and applies overhead to production on
the basis of direct labour hours. On 1 January 2019, job no. 50 was the only job in process.
The costs incurred prior to 1 January on this job were as follows: direct materials $10 000,
direct labour $6000, and manufacturing overhead $10 500. As of 1 January, job no. 49 had
been completed at a cost of $45 000 and was part of finished goods inventory. There was a
$5000 balance in the raw materials inventory account.
During the month of January, Han Wu Manufacturing began production on jobs 51 and
52, and completed jobs 50 and 51. Jobs 49 and 50 were sold on account during the month for
$67 000 and $74 000, respectively. The following additional events occurred during the month.
1. Purchased additional raw materials of $45 000 on account.
2. Incurred factory labour costs of $31 500. Of this amount $6500 related to employer payroll
taxes.
3. Incurred manufacturing overhead costs as follows: indirect materials $10 000; indirect
labour $7500; depreciation expense $1250; and various other manufacturing overhead costs
on account $15 000.
4. Assigned direct materials and direct labour to jobs as follows:
Job no. Direct materials Direct labour

50 $ 5 000 $ 3 000
51 20 000 12 000
52 15 000 9 000
5. The company uses direct labour hours as the activity base to assign overhead. Direct
labour hours incurred on each job were as follows: Job no. 50, 200; Job no. 51, 800; and
Job no. 52, 600.
Required
(a) Calculate the predetermined overhead rate for 2019, assuming Han Wu Manufacturing
estimates total manufacturing overhead costs of $500 000, direct labour costs of $300 000
and direct labour hours of 20 000 for the year.
(b) Open job cost sheets for jobs 50, 51 and 52. Enter the 1 January balances on the job cost
sheet for job no. 50.

(c) Prepare the journal entries to record the purchase of raw materials, the factory labour costs
incurred, and the manufacturing overhead costs incurred during the month of January.
(d) Prepare the journal entries to record the assignment of direct materials, direct labour,
and manufacturing overhead costs to production. In assigning manufacturing overhead
costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as
necessary.
(e) Total the job cost sheets for any job(s) completed during the month. Prepare the journal
entry (or entries) to record the completion of any job(s) during the month.

(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month.
(g) What is the balance in the finished goods inventory account at the end of the month? What
does this balance consist of?
(h) What is the amount of over- or underapplied overhead for the month? How would this be
reported in the financial statements for the month of January?
PSB16.3 Complete four steps necessary to prepare a production cost report. LO6
Buehler Skis manufactures water-skis through two processes: moulding and packaging. In
the Moulding Department, fibreglass is heated and shaped into the form of a ski. In the
Packaging Department, the skis are placed in cartons and sent to the finished goods ware-
house. Materials are entered at the beginning of both processes. Labour and manufacturing
overhead are incurred uniformly throughout each process. Production and cost data for the
Moulding Department for June 2019 are presented below.
Production data June

Beginning work in process units —
Units commenced 35 200
Ending work in process units 4 000
Per cent complete — ending inventory 65%
Cost data
Materials $400 400
Labour 159 600
Overhead 191 520
Total $751 520
Required
(a) Calculate the physical units of production.
(b) Determine the equivalent units of production for materials and conversion costs.
(c) Calculate the unit costs of production.
(d) Determine the costs to be assigned to the units transferred out and in process.
(e) Prepare a production cost report for the Moulding Department for the month of June.
PSB16.4 Journalise transactions. LO5
Pickard Pty Ltd manufactures a nutrient, Everlife, through two manufacturing processes:
blending and packaging. All materials are entered at the beginning of each process. On
1 August 2019 inventories consisted of Raw materials $5000, Work in process—Blending $0,
Work in process—Packaging $3945 and Finished goods $7500. The beginning inventory for
Packaging consisted of 500 units, two-fifths complete as to conversion costs and fully com-
plete as to materials. During August, 9000 units were started into production in Blending and
the following transactions were completed:
2. Issued raw materials for production: Blending $16 930 and Packaging $7140.
3. Incurred labour costs of $18 770.

4. Used factory labour: Blending $13 320 and Packaging $5450.
5. Incurred $41 500 of manufacturing overhead on account.
6. Applied manufacturing overhead at the rate of $35 per machine hour. Machine hours were
Blending 900 and Packaging 300.
7. Transferred 8200 units from Blending to Packaging at a cost of $54 940.
8. Transferred 8600 units from Packaging to finished goods at a cost of $74 490.
9. Sold goods costing $62 000 for $90 000 on account.
Required
Journalise the August transactions.

PSB16.5 Calculate equivalent units and complete production cost report. LO5, 6
Fluid Cleaners uses a weighted-average process cost system and manufactures a single pro-
duct — an all-purpose liquid cleaner. The manufacturing activity for the month of March has
just been completed. A partially completed production cost report for the month of March for
the mixing and blending department is shown below.
FLUID CLEANERS
Mixing and blending department
for the month ended 31 March
Equivalent units
Physical Conversion
QUANTITIES
Units to be accounted for:
Work in process, 1 March (40%
materials, 20% conversion costs) 10 000
Total units 110 000
Transferred out 95 000 ? ?
Work in process, 31 March (60%
materials, 20% conversion costs) 15 000 ? ?
Total units 110 000 ? ?
Conversion
Materials costs Total
COSTS
Unit costs
Costs in March $156 000 $98 000 $254 000
Equivalent units ? ?
Unit costs $ ? ? $ ?
Costs to be accounted for:
Work in process, 1 March $ 8 700
COST RECONCILIATION SCHEDULE
Transferred out $ ?
Work in process, 31 March:
Materials ?
Conversion costs ? ?
Total costs $ ?
Required
Complete the production cost report for Fluid Cleaners.
PSB16.6 Assign overhead using traditional costing and ABC. LO7
Prince Boat Ltd specialises in making two types of boat: sail boats and power boats. Profit-
ability has deteriorated in the last few years. Owner, Scott, consulted his accountant, Jeff,
who is a CPA to help improve his business’s bottom line. Jeff analysed the profitability of the
two products, firstly by investigating how overheads were allocated to each product line. The
following information relates to overhead.

Sail Power
boats boats
Production units 50 30
Material moves per product line 20 80
Purchase orders per product line 80 120
Direct labour hours per product line 175 285
Annual material-handling costs $245 000
Annual purchasing activity costs 69 800
Required
(a) Currently a traditional costing system is in place. It assigns overhead on the basis of
direct-labour hours. Under this system:
1. What material handling costs are assigned to each unit of sail boat and power boat?
2. What purchasing activity costs are assigned to each unit of sail boat and power boat?
(b) Jeff suggested adopting activity-based costing (ABC) to allocate overheads. Under ABC:
1. What material handling costs are assigned to each unit of sail boat and power boat?
2. What purchasing activity costs are assigned to each unit of sail boat and power boat?
(c) After reviewing the costing from parts (a) and (b), what advice can Jeff offer to Scott
about improving the profitability of the two product lines?
PSB16.7 Assign overhead using traditional costing and ABC; calculate unit costs; classify activities as
value-added or non-value-added. LO7, 9
Spartan Safety manufactures steel cylinders and nozzles for two models of fire extinguishers:
(1) a home fire extinguisher and (2) a commercial fire extinguisher. The home model is
a high-volume (54 000 units) 2-litre cylinder that holds 1 kilogram of multipurpose dry
chemical at 480 PSI. The commercial model is a low-volume (10 200 units) 8-litre cylin-
der that holds 4 kilograms of multipurpose dry chemical at 390 PSI. Both products require
1.5 hours of direct labour for completion. Therefore, total annual direct labour hours are
96 300 [1.5 h × (54 000 + 10 200)]. Expected annual manufacturing overhead is $1 492 780.
Thus, the predetermined overhead rate is $15.50 ($1 492 780 ÷ 96 300) per direct labour hour.
The direct materials cost per unit is $18.50 for the home model and $26.50 for the commercial
model. The direct labour cost is $19 per unit for both the home and the commercial models.
Spartan Safety’s managers identified six activity cost pools and related cost drivers and
accumulated overhead by cost pool as follows:
Expected use of
Estimated Expected use drivers by product
Activity cost pool Cost driver overhead of cost drivers Home Commercial
Receiving Kilograms $ 70 350 335 000 215 000 120 000
Forming Machine hours 150 500 35 000 27 000 8 000
Assembling Number of parts 381 600 212 000 162 000 50 000
Testing Number of tests 51 000 25 500 15 500 10 000
Painting Litres 52 080 6 510 4 510 2 000

Packing and shipping Kilograms 787 250 335 000 215 000 120 000
$1 492 780
Required
(a) Under traditional product costing, calculate the total unit cost of both products using
the information above. Prepare a simple comparative schedule of the individual costs by
product.
(b) Under ABC, prepare a schedule showing the calculations of the activity-based overhead
rates (per cost driver), using the information above.

(c) Prepare a schedule assigning each activity’s overhead cost pool to each product based on
the use of cost drivers (include a calculation of overhead cost per unit, rounding to the
nearest cent).
(d) Calculate the total cost per unit for each product under ABC.
(e) Classify each of the activities as a value-added activity or a non-value-added activity.
(f) Comment on (1) the comparative overhead cost per unit for the two products under ABC
and (2) the comparative total costs per unit under traditional costing and ABC.
PSB16.8 Assign overhead costs using traditional costing and ABC; compare results. LO7
Designed Stairs designs and builds factory-made premium timber stairs for homes. The manu-
factured stair components (spindles, risers, hangers, hand rails) permit installation of stairs of
varying lengths and widths, but all are of cedar timber. Its budgeted manufacturing overhead
costs for the year 2018 are as follows:
Overhead cost pools Amount
Purchasing $ 57 000
Handling materials 82 000
Production (cutting, milling, finishing) 200 000
Setting up machines 84 840
Inspecting 90 000
Inventory control (raw materials and finished goods) 126 000
Power 180 000
Total budget overhead costs $819 840
For the last four years, Designed Stairs has been charging overhead to products on the basis
of machine hours. For the year 2018, 100 000 machine hours are budgeted.
Larry Morris, owner-manager of Designed Stairs, recently directed his accountant, Denise
Cheung, to implement the activity-based costing system that she has repeatedly proposed. At
Larry’s request, Denise and the production foreman identify the following cost drivers and
their usage for the previously budgeted overhead cost pools:
Expected use
Overhead cost pools Activity cost drivers of cost drivers
Purchasing Number of orders 600
Handling materials Number of moves 8 000
Production (cutting, milling, finishing) Direct labour hours 100 000
Setting up machines Number of set-ups 1 200
Inspecting Number of inspections 6 000
Inventory control (raw materials and finished goods) Number of components 168 000
Power Square metres occupied 90 000
Richard Way, sales manager, has received an order for 280 stairs from Acme Builders, a
large housing development contractor. At Richard’s request, Denise prepares cost estimates
for producing components for 280 stairs so Richard can submit a contract price per stair to
Acme Builders. She accumulates the following data for the production of 280 stairways.
Direct labour $112 000
Machine hours 14 500
Direct labour hours 5 000
Number of purchase orders 60
Number of material moves 800
Number of machine set-ups 100
Number of inspections 450
Number of components 16 000
Number of square metres occupied 8 000

Required
(a) Calculate the predetermined overhead rate using traditional costing with machine hours
as the basis.
(b) What is the manufacturing cost per stairway under traditional costing?
(c) What is the manufacturing cost per stairway under the proposed activity-based costing?
(Prepare all of the necessary schedules.)
(d) Which of the two costing systems is preferable in pricing decisions and why?
PSB16.9 Assign overhead to products using ABC and evaluate decision. LO7
Leto Plastics manufactures two plastic icebox containers at its plastics moulding facility. Its
large container, called the Ice House, has a volume of 25 litres, side carrying handles, a snap-
down lid, and a side drain and plug. Its smaller container, called the Cool Chest, has a volume
of 10 litres and a carrying handle which is part of a tilting lid. Both containers and their parts
are made entirely of hard-moulded plastic. The Ice House sells for $35.00 and the Cool Chest
sells for $24.00. The production costs calculated per unit under traditional costing for each
model in 2018 were as follows:
Ice Cool
Traditional costing House Chest
Direct materials $ 9.50 $ 6.00
Direct labour ($10 per hour) 8.00 5.00
Manufacturing overhead ($17.20 per direct labour hour) 13.76 8.60
Total per unit cost $31.26 $19.60
In 2018, Leto Plastics manufactured 50 000 units of the Ice House and 20 000 units of the
Cool Chest. The overhead rate of $17.20 per direct labour hour was determined by dividing
total expected manufacturing overhead of $860 000 by the total direct labour hours (50 000)
for the 2 models.
Under traditional costing, the gross profit on the two containers was Ice House $3.74
($35 − $31.26) and Cool Chest $4.40 ($24 − $19.60). The gross margins on cost are Ice House
12% ($3.74 ÷ $31.26) and Cool Chest 22% ($4.40 ÷ $19.60). Because Leto can earn a gross
margin nearly twice as great with less investment in inventory and labour costs, management
is urging the sales staff to put its efforts into selling the Cool Chest over the Ice House.
Before finalising its decision, management asks the controller, Janet Plote, to prepare a
product costing analysis using activity-based costing (ABC). Plote accumulates the following
information about overhead for the year ended 31 December 2018:
Total
Estimated expected Activity-based
Activity Cost driver overhead cost drivers overhead rate
Purchasing Number of orders $180 000 4 500 $40 per order
Machine set-ups Number of set-ups 200 000 800 $250 per set-up
Extruding Machine hours 320 000 80 000 $4 per machine hour
Quality control Tests and inspections 160 000 8 000 $20 per test
The cost drivers used for each product were:
Cost driver Ice House Cool Chest Total

Purchase orders 2 500 2 000 4 500
Machine set-ups 500 300 800
Machine hours 60 000 20 000 80 000
Tests and inspections 5 000 3 000 8 000

Required
(a) Assign the total 2018 manufacturing overhead costs to the two products using activity-
based costing (ABC).
(b) What was the cost per unit and gross profit of each model using ABC costing?
(c) Are management’s future plans for the two models sound?
PSB16.10 Assign overhead costs to services using traditional costing and ABC; calculate overhead rates
and unit costs; compare results. LO7
Wise and Otherwise is a public accounting firm that offers two main services, auditing and tax
return preparation. A controversy has developed between the partners of the two service lines
as to who is contributing the greater amount to the bottom line. The contentious area is the
assignment of overhead. The tax partners argue for assigning overhead on the basis of 40%
of direct labour dollars and the audit partners argue for implementing activity-based costing.
The partners agree to use next year’s budgeted data for purposes of analysis and comparison.
The following overhead data are collected to develop the comparison:
Expected Expected use of cost

Estimated use of cost drivers per service
Activity cost pool Cost driver overhead drivers Audit Tax
Employee training Direct labour dollars $209 000 $1 900 000 $1 000 000 $900 000
Typing and secretarial Number of reports/forms 76 200 2 500 600 1 900
Computing Number of minutes 204 000 60 000 25 000 35 000
Facility rental Number of employees 142 500 38 20 18
Travel Per expense reports 128 300 Direct 86 800 41 500
$760 000
Required
(a) Using traditional product costing as proposed by the tax partners, calculate the total cost
of both services (audit and tax) of Wise and Otherwise.
(b) 1. Using activity-based costing, prepare a schedule showing the calculations of the
activity-based overhead rates (per cost driver).
2. Prepare a schedule assigning each activity’s overhead cost pool to each service based
on the use of the cost drivers.
3. Calculate the overhead cost per unit for each product under ABC.
(c) Classify each of the activities as a value-added activity or a non-value-added activity.
(d) Comment on the comparative overhead cost per unit for the two products under both
traditional costing and ABC.
BUILDING BUSINESS SKILLS

FINANCIAL REPORTING AND ANALYSIS
Managerial analysis
BBS16.1 Davidson Furniture manufactures living-room furniture through two departments: Framing
and Upholstering. Materials are entered at the beginning of each process. For May, the fol-
lowing cost data are obtained from the two work-in-process accounts:
Framing Upholstering
Work in process, 1 May $ — $ ?
Materials 420 000 ?
Conversion costs 210 000 330 000
Costs transferred in — 550 000
Costs transferred out 550 000 ?
Work in process, 31 May 80 000 ?

Required
Answer the following questions:
(a) If 3000 sofas were started into production on 1 May and 2500 sofas were transferred to
Upholstering, what was the unit cost of materials for May in the Framing department?
(b) Using the data in (a) above, what was the per-unit conversion cost of the sofas transferred
to Upholstering?
(c) Continuing the assumptions in (a) above, what is the percentage of completion of the units
in process at 31 May in the Framing department?
BBS16.2 New Tech Pharmaceuticals, Brisbane, has supported a Research and Development (R&D)
department that has for many years been the sole contributor to New Tech’s new cancer drug.
The R&D activity is an overhead cost centre that provides services only to in-house manu-
facturing departments (four different product lines), all of which produce pharmaceutical pro-
ducts. The department has never sold its services outside, but because of its long history of
success, larger manufacturers of pharmaceutical products have approached New Tech to hire
its R&D department for special projects. Because the costs of operating the R&D department
have been spiralling uncontrollably, New Tech’s management is considering entertaining these
outside approaches to absorb the increasing costs. But (1) management doesn’t have any cost
basis for charging R&D services to outsiders and (2) it needs to gain control of its R&D costs.
Management decides to implement an activity-based costing system in order to determine the
charges for both outsiders and the in-house users of the department’s services.
R&D activities fall into four pools with the following annual costs:
Market analysis $1 050 000

Product design 2 280 000
Product development 3 600 000
Prototype testing 1 400 000
Activity analysis determines that the appropriate cost drivers and their usage for the four
activities are:
Total estimated
Activity Cost drivers drivers
Market analysis Hours of analysis 15 000 hours
Product design Number of designs 2 500 designs
Product development Number of products 90 products
Prototype testing Number of redesigns 700 redesigns
Required
(a) Calculate the activity-based overhead rate for each activity cost pool.
(b) How much cost would be charged to an in-house manufacturing department that con-
sumed 1800 hours of market analysis time, was provided with 280 designs relating to
10 products, and requested 92 engineering redesigns?

(c) How much cost would serve as the basis for pricing an R&D bid with an outside entity
on a contract that would consume 800 hours of analysis time, require 178 designs relating
to 3 products, and result in 70 engineering redesigns?
(d) What is the benefit to New Tech of applying activity-based costing to its R&D activity
for both in-house and outside charging purposes?
Surfing the net
BBS16.3 Search the internet and find the web sites of two manufacturers that you think are likely to
use process costing. Are there any specifics included in their web sites that confirm the use of
process costing for each of these entities? (Hint: Go to the ASX web site, www.asx.com.au,
and search by company name.)

CRITICAL THINKING
Group decision cases
BBS16.4 Costello Products uses a job order cost system. For a number of months there has been
an ongoing rift between the sales department and the production department concerning a
special-order product, TC-1. TC-1 is a seasonal product that is manufactured in batches of
1000 units. TC-1 is sold at cost plus a mark-up of 40% of cost.
The sales department is unhappy because fluctuating unit production costs significantly
affect selling prices. Sales personnel complain that this has caused excessive customer com-
plaints and the loss of considerable orders for TC-1.
The production department maintains that each job order must be fully costed on the basis
of the costs incurred during the period in which the goods are produced. Production personnel
maintain that the only real solution to the problem is for the sales department to increase sales
in the slack periods.
Linda Smart, the manager, asks you as the accountant to collect quarterly data for the past
year on TC-1. From the cost accounting system, you accumulate the following production
quantity and cost data:
Quarter
Costs 1 2 3 4
Direct materials $150 000 $330 000 $120 000 $300 000
Direct labour 90 000 198 000 72 000 180 000
Manufacturing overhead 157 500 184 000 146 000 187 500
Total $397 500 $712 000 $338 000 $667 500
Production in batches 5 11 4 10
Unit cost (per batch) $ 79 500 $ 64 727 $ 84 500 $ 66 750
Required
With the class divided into groups, answer the following questions:
(a) What manufacturing cost element is responsible for the fluctuating unit costs? Why?
(b) What is your recommended solution to the problem of fluctuating unit cost?
(c) Restate the quarterly data on the basis of your recommended solution.
BBS16.5 Mendoza Ltd manufactures suntan lotion, called Surtan, in 50 mL plastic bottles. Surtan is
sold in a competitive market. As a result, management is very cost-conscious. Surtan is manu-
factured through two processes: mixing and filling. Materials are entered at the beginning
of each process, and labour and manufacturing overhead occur uniformly throughout each
process. Unit costs are based on the cost per litre of Surtan using the weighted-average costing
approach.
On 30 June 2019, Sue Noller, the chief accountant for the past 20 years, opted to take early
retirement. Her replacement, Jeff Mura, had extensive accounting experience with motels in
the area but only limited contact with manufacturing accounting.
During July, Jeff correctly accumulated the following production quantity and cost data for
the Mixing Department:

Production quantities: Work in process, 1 July, 8000 litres 75% complete; started into pro-
duction 100 000 litres; work in process, 31 July, 5000 litres 20% complete. Materials are
added at the beginning of the process.
Production costs: Beginning work in process $88 000, comprising $21 000 of materials
costs and $67 000 of conversion costs; incurred in July: materials $600 000, conversion costs
$785 800.
Jeff then prepared a production cost report on the basis of physical units started into pro-
duction. His report showed a production cost of $14.738 per litre of Surtan. Management was
surprised at the high unit cost. The CEO comes to you, as Sue’s top assistant, to review Jeff’s
report and prepare a correct report if necessary.

Required
With the class divided into groups, answer the following questions:
(a) Show how Jeff arrived at the unit cost of $14.738 per litre of Surtan.
(b) What error(s) did Jeff make in preparing his production cost report?
(c) Prepare a correct production cost report for July.
Communication activity
BBS16.6 Sue Smithers was a good friend of yours in high school. While you chose to major in account-
ing when you both went to university, she majored in marketing and management. You have
recently been promoted to accounting manager for the Furniture Division of Easy Relax, and
your friend was promoted to regional sales manager for the same division. Sue recently tele-
phoned you. She explained that she was familiar with job cost sheets, which had been used by
the Special Projects division where she had formerly worked. She was, however, very uncom-
fortable with the production cost reports prepared by your division. She emailed you a list of
her particular questions. These included the following:
1. Since Easy Relax occasionally prepares furniture for special orders in the Furniture
Division, why don’t we track costs of the orders separately?
2. What is an equivalent unit?
3. Why am I getting four production cost reports? Isn’t there only one work in process
account?
Required
Prepare a memorandum to Sue. Answer her questions and include any additional information
you think would be helpful. You may write informally, but be careful to use proper grammar
and punctuation.
BBS16.7 The following is an extract from Bega Cheese Limited’s web site, www.begacheese.com.au:
Bega Cheese is committed to improving its sustainability and reducing the environmental
impact of the business. Bega Cheese focuses on two core areas; Farm Sustainability and
Factory Sustainability.
Required
1. What is meant by the term ‘sustainability’?
2. Access Bega Cheese’s latest sustainability information and complete the following.
(a) Outline Bega Cheese’s approach to sustainability and why it is important for the
business.
(b) Summarise Bega Cheese’s achievements, and include a discussion of goals and how
these achievements are measured in farming and factory sustainability.
ANSWERS
Answers to self-study questions
16.1 (a) 16.2 (c) 16.3 (b) 16.4 (c) 16.5 (c) 16.6 (b) 16.7 (d) 16.8 (b) 16.9 (b) 16.10 (c) 16.11 (d)
16.12 (c) 16.13 (d) 16.14 (c) 16.15 (c)
ACKNOWLEDGEMENTS
Photo: © Zadorozhnyi Viktor / Shutterstock.com
Photo: © Hero Images / Getty Images
Photo: © Monkey Business Images / Shutterstock.com

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CHAPTER 16

Cost accounting systems

After studying this chapter, you should be able to:

Cost accounting systems

Cost accounting Job order Process Activity-based

• Non-manufacturing • Job cost flows • Uses of process • Traditional costing

16.1 Cost accounting systems

CHAPTER 16 Cost accounting systems 977

Job order costing and process costing

978 Financial accounting: Reporting, analysis and decision making

FIGURE 16.1 Job order costing and process costing businesses

Job order costing Process costing

Snap printing, Printing BMW, Cars

Mallesons Stephen Legal services Fonterra, Dairy

Flight Centre, Qantas Travel Fisher & Paykel, Appliances

FIGURE 16.2 Job order cost system

Job order cost system

Job no. 9501 Job no. 9502

Each job has distinguishing characteristics and related costs.

CHAPTER 16 Cost accounting systems 979

Process cost system

Cheese making vat Maturation

Relatively similar products are produced over a speciﬁed period of time.

LEARNING REFLECTION AND CONSOLIDATION

16.2 Job order costing

Job cost ﬂows

980 Financial accounting: Reporting, analysis and decision making

Manufacturing Work in process Finished goods

FIGURE 16.5 Job order cost accounting system

Job order cost accounting

Raw materials inventory Work in process inventory Finished goods inventory

Manufacturing overhead (net)

Actual overhead (6) Overhead 6 Key to entries:

CHAPTER 16 Cost accounting systems 981

Control account Subsidiary ledger

16.3 Job cost sheet

FIGURE 16.6 Completed job cost sheet

Job cost sheet

Date Direct materials Direct labour Manufacturing overhead

10/3 $18 000 $14 400

Cost of completed job

982 Financial accounting: Reporting, analysis and decision making

Tool or technique How to evaluate results

Determining overhead rates

FIGURE 16.7 Formula for predetermined overhead application rate

CHAPTER 16 Cost accounting systems 983

FIGURE 16.8 Using predetermined overhead application rates

Job 1 Job 2 Job 3

984 Financial accounting: Reporting, analysis and decision making

Assigning costs to ﬁnished goods inventory

CHAPTER 16 Cost accounting systems 985

Reporting job cost data

FIGURE 16.9 Cost of goods manufactured schedule

Under- or overapplied manufacturing overhead

986 Financial accounting: Reporting, analysis and decision making

FIGURE 16.10 Partial statement of profit or loss

Dec. 31 Manufacturing overhead applied 102 500

+102 500 −2 500

CHAPTER 16 Cost accounting systems 987

FIGURE 16.11 Overhead budget

$440 000 ÷ $220 000 = 200%

Direct materials nil

988 Financial accounting: Reporting, analysis and decision making