Management Accounting Consultancy Report


Chapter 4 Product Costing Systems

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For this topic you should be able to:

Explain the role of product costing systems in decision-making

Understand the flow of costs through the various manufacturing accounts

Use basic techniques to allocate manufacturing overhead costs to products

Distinguish between different types of product costing systems and understand what types of contexts each are most applicable to

Estimate product costs using a basic process or job costing system, and prepare journal entries to record costs

Product Costing Systems

Accumulate product-related costs and use procedures to assign them to the organisation’s final products

Can include both manufacturing costs and upstream and downstream costs








Loading Machine

Operating Machine




Product Cost

Cost Allocation

For Example: Activity-Based Costing

We will come back to this in Week 7!

Why Do We Need Product Costing Systems?

GAAP requires the determination of the cost of goods sold or services performed for financial reporting

Many important strategic decisions are made at the product-line level – for example, product profitability helps guide product portfolio or pricing decisions (Week 8 topic)

Can help in cost and operational control


Different Product Costs for Different Purposes

We need different measures of product costs for different management decisions.

Only manufacturing costs are included in product costs for external reporting purposes (e.g. inventory valuation)

For managerial decisions, product costs may include different combinations of upstream, manufacturing and downstream costs


Scope of Product Costs

The types of costs to be included in product costs for managerial decisions depends on:

The type of managerial decision to be made

Whether the decision has short-term or long-term implications

Managers’ personal preferences


When Choosing a Product Costing System…

Cost and benefits of providing various types of cost estimates must be assessed

Some organisations will use product costs developed for external reporting due to the high cost

of developing more relevant cost

estimates for managerial decision


When Designing a Product Costing System…


External Financial Reporting….

Does not require a high level of accuracy or relevance for product costing - the method simply needs to be systematic and reasonable

Only manufacturing costs are assigned to products for the purposes of inventory valuation - as required by Australian accounting standards

Upstream and downstream costs are expensed in the period in which they are incurred – Internally, these may be included in product costs where relevant to managers’ decision making


Direct Materials

from suppliers


Direct Labour

Manufacturing overhead consumed

factory rent


indirect labour


Direct Materials store

Finished Goods Warehouse

Work in Progress

in the factory



Physical Flows in Manufacturing

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Second level

Third level

Fourth level

Fifth level


Flow of Costs in Manufacturing Businesses

Manufacturing costs flow through several ledger accounts:

Raw materials inventory

Work in process inventory

Finished goods inventory

Cost of goods sold expense

Profit and loss account


Allocating Overhead Costs to Products

To estimate the cost of a product we need to identify the cost of resources used to produce the product

Some resources are consumed directly by products and are traced directly to each product

Direct material and direct labour

Overhead costs are essential to production but as they have no observable relationship with the product they need to be allocated to products

These cost are indirect costs to the product

Inspection costs

Quality Training

Data Storage

Salaries of IT




Council Rates

Quality Control




or department


Steps in Allocating OH Costs to Products

Aggregate overhead costs into cost pools

Identify the overhead cost driver

the factor that causes the cost to be incurred (remember from last week?!)

Calculate a predetermined (or budgeted) overhead rate per unit of cost driver

Eg. If annual OH budget = $ 7.5M

Annual labour budget = 50K hours (and labour hours is the cost driver)

then budgeted OH rate = $150/hour

Apply manufacturing overhead costs to products at the budgeted (or predetermined) overhead rate, multiplied by the actual quantity of cost driver consumed by the product

- E.g. if producing a product required 10 labour hours

$1500 of overhead would be applied to the product ($150 x 10)


Accounting for Manufacturing Overhead

Two types of manufacturing overhead are recorded :

Applied manufacturing overhead

Estimate of manufacturing overhead used to manufacture a product

Applied to products using a predetermined OH rate

Credited to the manufacturing overhead account

Actual manufacturing overhead

Actual manufacturing overhead costs incurred throughout the accounting period

Might be different to applied manufacturing overhead

Debited to the manufacturing overhead account


Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith

Prepared by Kim Langfield-Smith

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Second level

Third level

Fourth level

Fifth level


At the end of an accounting period, total actual manufacturing overhead may not equal total applied manufacturing overhead

Disposing of underapplied or overapplied overhead at the end of the accounting period. Two options:

Close the underapplied or overapplied overhead to cost of goods sold


Prorate the underapplied or overapplied overhead to cost of goods sold, work in process inventory and finished goods inventory

Accounting for Manufacturing Overhead

Illustration 1

The following data relate to Fine Furniture Pty Ltd for the year 2017:


1.Calculate predetermined MOH rate using:

a) Machine Hours b) DL Hrs c) DL Dollars

2. Calculate over/under-applied MOH using each of the cost drivers

3. Prepare journal entries in relation to MOH costs for the year (charge any under-/over-applied MOH to COGS)

Budgeted machine hours 20,000
Budgeted DL hours 40,000
Budgeted DL rate $25.00 /hr
Budgeted MOH costs $800,000
Actual MOH costs $820,000
Actual machine hours 22,000
Actual DL hours 35,000
Actual DL rate $26.00 /hr




Types of Product Costing Systems

Conventional product costing systems range from job costing to process costing

Depends on the type of product being produced and the production environment


Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Management Accounting: Information for managing and creating value 6e

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Next week!

Production costs traced to process/department and averaged across all units produced

Mass production or repetitive processes environment

Used in petrol production, processed food, chemical and plastics manufacturers

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Management Accounting: Information for managing and creating value 6e

Slides prepared by Kim Langfield-Smith

Process Costing

Used in areas where there are repetitive services such as routine processing of cheques by banks, handling of licence applications by government departments

Process Costing

Steps in determining product cost:

Estimate the cost of production processes

2. Calculate the average cost per unit by dividing the cost of the process by the number of units produced

Where there are sequential processes or departments, costs are transferred from one department to the next at an average unit cost for the department

Raw material  Cleaning & mixing dept  Packaging dept  Finished goods

No work-in-process inventory

# units produced (i.e. number of boxes of cereal): 80,000

Cereal Manufacturer

Required: Calculate the product cost for June.

Simple Process Costing in a Manufacturer

Cleaning & Mixing cost / unit… $250,000 / 80,000 = $3.125 /unit

Packaging cost / unit .………….$150,000 / 80,000 = $1.875 /unit

Total product cost……………… $ 5.00 /unit

Note also: The value of completed units = 80,000 x $5 = $400,000

June period Cleaning & mixing Packaging
Direct materials $ 130,000 $ 20,000
Direct labour $ 40,000 $ 30,000
Mfg Overhead $ 80,000 $ 100,000
Total $ 250,000 $ 150,000


To Think About…2 Issues

What if there was work-in-process inventory? For example, some units are 20% finished, some 70% finished

What would the product cost for June be given that not all manufacturing processes (and therefore costs) have been completed?

What if more than one type of cereal was produced?

What if some of the cereal products required complex manufacturing processes in some of the production department but not others?

How would we figure out how much cost should apply to different production departments and hence, cereal products that pass through them?

Hint: We have to come up with a better allocation method than the one on the previous slide

Stay tuned over the next week to find out more!


Job Costing Systems

Manufacturing costs traced to individual jobs

Products produced are significantly different and may be produced in distinct jobs/batches

Used by printers, furniture manufacturers, machinery manufacturers

Use in service firms such as lawyers, accountants, consulting engineers


Purchase of materials Debit Credit

Raw material inventory xxxx

Account payable/Cash xxxx

Transferring direct material to jobs

Work in process inventory xxxx

Raw material inventory xxxx

Journal Entries (Job Costing)

If purchased on credit

Charging direct labour to jobs Debit Credit

Work in process inventory xxxx

Wages payable/Cash xxxx

Accounting for indirect labour

Manufacturing overhead xxxx

Wages payable xxxx

Accounting for manufacturing costs

Manufacturing overhead xxxx

Prepaid rent xxxx

Depreciation on equipment xxxx



Application of manufacturing overhead

Work in process inventory xxxx

Manufacturing overhead xxxx

Completion of production job

Finished goods inventory xxxx

Work in process inventory xxxx

Accumulated cost of the job (DM, DL + MOH)

Sale of goods

Accounts receivable xxxx

Sales revenue xxxx

Cost of goods sold xxxx

Finished goods inventory xxxx

Underapplied overhead Debit Credit

Cost of goods sold xxxx

Manufacturing overhead xxxx

Or the reverse entry if overhead is overapplied

Don’t forget!!!! Always THREE journal entries for manufacturing overhead:

1) Actual amount

2) Applied amount

3) Underapplied/overapplied amounts

Illustration 2

Aberat Pty Ltd manufactures custom made furniture and uses a job costing system. The following information relates to February.

 1. Manufacturing supplies opening inventory $1,000

2. Direct material (plastic) opening inventory $4,500

3. WIP inventory (Job 101 (Chairs), started on Jan 10):

Direct materials (plastic) $1,000

Direct labor: 50 DLHs x $8 400

Manufacturing overhead: 50 DLHs x $6 300 $1,700

4. Finished goods opening inventory $0


5. Feb, 4: Purchase of direct materials (plastic): $2,000


6. During February, the following materials were issued to production:

Direct materials (plastic)

Job 101 (Chairs, started on Jan 10) $1,000

Job 102 (50 coffee tables, started on Feb 5) 1,100 $2,100

Indirect materials 200 $2,300


Illustration 2 (Cont’d)

7. The payroll summary showed the following totals for February:

Job 101 – 100 hrs @ $4.50 $450

Job 102 – 45 hrs @ $8.00 360 $ 810

Indirect labour 400 $1,210


8. Other indirect manufacturing costs incurred during February: $400


9. On 20 February, Job 101 was completed, and all of the 100 chairs were transferred to finished goods inventory. The manufacturing overhead costs were added to the job cost sheet using the predetermined manufacturing overhead rate of $6.00 per direct labour hour.


10. Fifty (50) of the 100 chairs completed on Job 101 were shipped to the customer. The chairs were sold for $80 per unit.


11. Job 102 remained incomplete at the end of February. Manufacturing overhead costs were applied to Job 102.

Required: Complete the following ledger accounts to reflect the transactions for February.


Ledger Transactions

Manufacturing Supplies Inventory Work in progress Inventory Finished Goods Inventory
Direct Materials Inventory Cost of Goods Sold
Manufacturing Overhead Wages Payable Sales Revenue
Accounts payable Accounts receivable (various accounts)



Presentation title


Journal Entries: Job vs. Process Costing

The journal entries in process costing are basically similar to those made in job costing systems

The main difference is that, in process costing, there is often more than one work-in-process account –– one for each process

In contrast, job costing has just one work-in-process account



Some slides contained in this presentation were adapted from: