Controllership

WEEK 2
(Class 4)

Prof. Bianca Quirantes Checon

CLASS 4 (AUG 11)
Absorption costing (II): cost flow
WHAT DO YOU REMEMBER FROM
CLASS 3?
Absorption costing system & the
cost flow
Assigning costs to products and services

Assigning costs to products and services: two main

objectives!
1. Planning, organizing and controlling responsibilities → i.e.,
identifying a product’s profitability or estabilishing selling prices

2. Determine the value of ending inventories and cost of goods

sold for external reporting purposes
Assigning costs to products and services

Assigning costs to products and services: two main

objectives!
1. Planning, organizing and controlling responsibilities

2. Determine the value of ending inventories and cost of goods

sold for external reporting purposes

External reporting requirements influence how costs are assigned to

products (Brazil, USA) → ABSORPTION COSTING!
What is ABSORPTION COSTING?

• Absorption costing (GAR, p. 68): “(...) all manufacturing costs,

both fixed and variable, are assigned to units of products”
→ units fully absorb manufacturing costs

What are:
(1) manufacturing costs?
(2) fixed and variables costs?
Manufacturing costs

Manufacturing costs (a) Direct materials

(b) Direct labor
(c) Manufacturing overhead (indirect costs)

Not included
Selling expenses to compute
Nonmanufacturing the unit cost of
Administrative expenses
costs goods
Fixed and variable costs

Varies in direct proportion to changes

Variable costs
in the level of activity.
(e.g., direct materials, direct labor*)

Activity base (GAR's

assumption): total volume of
products and services provided
by the organization

Remains constant (in total) regardless of

Fixed costs changes in the level of activity.
(e.g., depreciation, factory’s buiding
insurance, supervisory salaries)
Fixed and variable costs

Cost behavior using graphs

What is ABSORPTION COSTING?

Costs are added to Direct materials

the product as it is
manufactured!

PRODUCT
(or service)

Direct labor Indirect costs

What is ABSORPTION COSTING?

Direct materials

THE
PRODUCTION
PRODUCT
(or service)
FLOW!
Direct labor Direct materials
The production flow

• Raw materials inventory

• Manufacturing overhead *
• Work in process inventory
• Finished goods inventory e.g. the brigadeiro
production flow!
• Total manufacturing costs
• Cost of goods manufactured
• Cost of goods sold
The production flow in equations

(1) Total manufacturing costs = Direct materials + Direct

labor + Manufacturing overhead

(2) Cost of goods manufactured = Total manufacturing costs +

+ Beginning work in process inventory (-) Ending work in process
inventory

(3) Cost of goods sold = Beginning finished goods inventory + cost

of goods manufactured (-) Ending finished goods inventory
Company A (Exercise 3)

From Company A accounting books, we can extract the following

information:

• Raw materials purchased at the month: $500.000

• Return, at the same month, of 20% of raw materials purchase
• Direct labor: $600.000
• Manufacturing overhead: $300.000

Required:
Estimate the amounts for: Total manufacturing costs, Cost of goods
manufactured, and Cost of Goods Sold, for each one of the
following assumptions.
Company A (Exercise 3)

a) Zero beginning and ending balance for raw materials,

work in process and finished goods inventories.

b) The beginning balance for the raw materials inventory

was $120.000; other inventories have a zero-beginning
and ending balances.

c) The beginning balance for raw materials inventory was

$120.000, and its ending balance was $ 150.000. Other
inventories have a zero-beginning and ending balances.
Company A (Exercise 3)

d) The beginning balance for raw materials inventory was

$120.000. The beginning balance for work in process
inventory was $180.000. The ending balance for finished
goods was $200.000. Other beginning and ending
balances were zero.

e) The ending balance for finished goods inventory was

$300.000. The beginning balance for work in process
inventory was $160.000. The ending balance for work in
process inventory was $200.000. Other beginning and
ending balances were zero.
Company A (Exercise 3)

f) The beginning balance for work in process inventory was

$200.000. The beginning balance for finished goods was
$80.000. The ending balance for work in process inventory was
$220.000. The ending balance for raw materials inventory was
$70.000. Other beginning and ending balances were zero.

g) The beginning balance for raw material inventory was

$150.000, and its ending balance was $220.000. The
beginning balance for work in process inventory was $170.000,
and its ending balance was $230.000. The beginning balance
for finished goods was $130.000, and its ending balance was
$190.000.
For next class (Aug 16)

• Reading
– EM, Ch. 10

• Problems
– Problems #3-7.
Any questions?
 Thank you!
bianca.checon@fgv.br