MIDTERM TOPICS

Differential Cost and Revenue

Differential cost or (Incremental/Decremental Costs) - A future cost that differs between any two
alternatives
Differential revenue - Future revenue that differs between any two alternatives.

To illustrate, assume that Natural Cosmetics, Inc., is thinking about changing its marketing method from
distribution through retailers to distribution by a network of neighborhood sales representatives. Present costs
and revenues are compared to projected costs and revenues in the following table:

How much is the Differential Revenue?

How much is the total Differential Costs?
How much is the Differential Net Operating Income?

Sunk Cost and Opportunity Cost

 Sunk Costs - a cost that has already been incurred and that cannot be changed by any decision made
now or in the future.
 Opportunity cost - the potential benefit that is given up when one alternative is selected over another.

The Traditional Format Income Statement

- This type of income statement organizes costs into two categories—cost of goods sold and selling and
administrative expenses.
- Sales minus cost of goods sold equals the gross margin.
- The gross margin minus selling and administrative expenses equals net operating income.
- useful for external reporting purposes
- It does not distinguish between fixed and variable costs
- Computation of cost of goods sold is as follows:

The Contribution Format Income Statement

- it provides managers with an income statement that clearly distinguishes between fixed and variable
costs and therefore aids planning, controlling, and decision making.
- The contribution margin is the amount remaining from sales revenues after all variable expenses have
been deducted.
PROBLEM I:
JOB-ORDER COSTING

Absorption Costing - all manufacturing costs, both fixed and variable, are assigned to units of product—units
are said to fully absorb manufacturing costs. Conversely, all nonmanufacturing costs are treated as period costs
and they are not assigned to units of product.

Job-order costing - used in situations where many different products, each with individual and unique features, are
produced each period.
- In a job-order costing system, costs are traced and allocated to jobs and then the costs of the job are divided
by the number of units in the job to arrive at an average cost per unit. This average cost per unit is also referred
to as the unit product cost.

Measuring Direct Materials Cost

o Bill of Materials - a document that lists the quantity of each type of direct material needed to complete a unit
of product.
o Production Order – issued when an agreement has been reached with the customer concerning the
quantities, prices, and shipment date for the order.
o Materials requisition form - document that specifies the type and quantity of materials to be drawn from the
storeroom and identifies the job that will be charged for the cost of the materials. The form is used to control
the flow of materials into production and also for making journal entries in the accounting records.

o Job Cost Sheet - records the materials, labor, and manufacturing overhead costs charged to that job. After
direct materials are issued, the cost of these materials are automatically recorded on the job cost sheet.
Measuring Direct Labor Cost

 Direct labor consists of labor charges that are easily traced to a particular job.
 Most companies rely on computerized systems to maintain employee time tickets
 A completed time ticket is an hour-by-hour summary of the employee’s activities throughout the day.

Computing Predetermined Overhead Rates

 An allocation base is a measure such as direct labor hours (DLH) or machine-hours (MH) that is used to
assign overhead costs to products and services.
 The predetermined overhead rate is computed by dividing the total estimated manufacturing overhead cost
for the period by the estimated total amount of the allocation base as follows:

Applying Manufacturing Overhead

 The process of assigning overhead cost to jobs is called overhead application.

 The formula for determining the amount of overhead cost to apply to a particular job is:
REVIEW PROBLEM:

Redhawk Company has two manufacturing departments—Assembly and Fabrication. The company considers
all of its manufacturing overhead costs to be fixed costs. The first set of data shown below is based on
estimates that were made at the beginning of the year for the expected total output. The second set of data
relates to one particular job completed during the year—Job A200.

Required:
 1. If Redhawk uses a predetermined plantwide overhead rate with direct labor-hours as the allocation base,
how much manufacturing overhead would be applied to Job A200?

2. If Redhawk uses predetermined departmental overhead rates with direct labor-hours as the allocation
base in Assembly and machine-hours as the allocation base in Fabrication, hoW much total manufacturing
overhead cost would be applied to Job A200?

3. Assume that Redhawk uses the departmental overhead rates mentioned in requirement 2 and that Job
A200 includes 50 units. What is the unit product cost for Job A200?

EXERCISE I
Newhard Company assigns overhead cost to jobs on the basis of 125% of direct labor cost. The job cost sheet for Job
313 includes $10,000 in direct materials cost and $12,000 in direct labor cost. A total of 1,000 units were produced in Job
313.

Required:
What is the total manufacturing cost assigned to Job 313? What is the unit product cost for Job 313?

EXERCISE 2
Sigma Corporation applies overhead cost to jobs on the basis of direct labor cost. Job V, which was started and
completed during the current period, shows charges of $5,000 for direct materials, $8,000 for direct labor, and $6,000
for overhead on its job cost sheet. Job W, which is still in process at year-end, shows charges of $2,500 for direct
materials and $4,000 for direct labor.

Required:
1. Should any overhead cost be applied to Job W at year-end? If so, how much? Explain.
2. How will the costs included in Job W’s job cost sheet be reported within Sigma Corporation’s financial statements
at the end of the year?

JOB-ORDER COSTING: COST FLOWS AND EXTERNAL REPORTING

 Raw materials include any materials that go into the final product.
 Work in process consists of units of product that are only partially complete and will require further work
before they are ready for sale to the customer.
 Finished goods consist of completed units of product that have not yet been sold to customers.
 The cost of goods manufactured includes the manufacturing costs associated with units of product that
were finished during the period.
Schedules of Cost of Goods Manufactured and Cost of Goods Sold

The schedule of cost of goods manufactured contains three elements of product costs—direct materials, direct
labor, and manufacturing overhead—and it summarizes the portions of those costs that remain in ending Work
in Process inventory and that are transferred out of Work in Process into Finished Goods.

Computing Underapplied and Overapplied Overhead

REVIEW PROBLEM
Required:

1. What is the Ending balance in Raw Materials?

2. What is the total amount of manufacturing overhead applied to production during the year?
3. What is the total manufacturing cost added to Work in Process during the year?
4. What is the ending balance in Work in Process?
5. What is the total amount of actual manufacturing overhead cost incurred during the year?
6. What is the cost of goods available for sale during the year?
7. What is the ending balance in Finished Goods?
8. What is the gross margin for the year?
9. What is the net operating income for the year?

EXERCISE I

Required:
1. Prepare a schedule of cost of goods manufactured for the month.
2. Prepare a schedule of cost of goods sold for the month.