Chapter 4

Costing Methods:
The costing of resource
outputs
1
• Costing is the process and techniques of
determining the costs.
• In manufacturing and many service
companies there are two commonly used
costing systems:
–Job-order costing and
–Process costing systems.

2
 A Job-Order Costing System
• Is used in situations where many different
products are produced each period.
• It is used by the company that make large, unique,
or special order products such as customized
publications, specially built cabinets, custom
printing business etc.
• For example, Furniture factory, Garment factory
3
 Process Costing System
Is used in situations where the company
produces many units of a single product for
long periods.
Examples: MOHA Soft Drinks, Hamaresa
Edible oil Share Company and so on.
All these industries produce essentially
homogeneous product that flows through the
production process on a continuous basis.
4
 Operational Costing System:
This typical product costing system combines
parts of both job order costing and process costing
to create a hybrid system.
– An example of a company that would use an
operational cost system is an automobile
manufacturer.
– An automobile maker may use process costing to treat
the costs of manufacturing basic car and then use job
order costing to track the costs of customized features.
5
Differences between Job-Order and Process Costing System
Job-Order Costing System Process Costing System
1. Many different jobs are worked during 1. A single product is produced on a
each period, with each job having continuous basis for long periods of
different production requirements. time. All units of product are identical.
2. Costs are accumulated by identical job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the
controlling the accumulation of costs key document showing the
by a job. accumulation of costs by a department.
4. Unit costs are computed by department
4. Unit costs are computed by job on the on the department production report.
job cost sheet.

6
Accounting treatment and Cost Flow in Job Order Costing
The physical flow of production is the sequence of
operating activity that begins with the decision to
order direct materials and ends with finished
product being sold to customers.
The intervening steps may vary from firm to firm,
but they share a common thrend.
The following may show the steps of the physical
flow of production.
7
1. Purchase Requisition
– Is a request sent internally within a company to obtain
purchased goods and services.
– After the form is duly filled, it will be sent to the purchasing
department. Sample purchase requisition form:
Sol Furniture Factory
Date January 5, 2018 Requisition no. 121
Purchase requisition form
Prepared by:
Quantity Description Date needed
1,000.00 board ft Lumber (eucalyptus) January 15, 2018
5 gallons Glue January 15, 2018
50 boxes Nails January 15, 2018

– No journal entry is required when a purchase requisition8 is

2. Purchase Order: is a document that authorizes the supplier to ship
the specified merchandise ordered.
– A sample purchase order looks the following:
Sol Furniture Factory
Purchase order form
Date January 6, 2018 Purchase No. 496
Vendor
Gentle lumber processing
Harar, near to stadium
F.O.B point Ship Via Terms Delivery date Requisition
no.
Factory site Harar Transport 2/10, n/30 Jan. 15, 2018 121
PLC
Item no. Quantity Description Unit price Total
1. 1,000 board ft. Lumber (eucalyptus) 20 20,000.00

– No journal entry is required when a purchase order is filled.

9
3. Receiving Report: when the ordered materials are
received, the receiving department prepares a receiving
report, which lists the description, and quantities of
goods received.
– The purchase of the material in the above example, for
instance, would be as follows:
Dr. Cr.
January 15, 2018 Direct Material 20,000
Account Payable 20,000

10
4. Production Order: a manufacturer can produce in response to
a customer order or just for stock.
– A sample production order is presented here below:
Sol Furniture Factory
Production Order
Date: January 19, 2018 Job
No. 365
Manufactured for: Stock
Date needed: March 20, 2018
Quantity Model number Description
150 F. 4152 Coffee table
Authorized by: Name of manager in charge

– No journal entries are required on the company’s books when the

production order is issued. 11
5. Material Requisition: to commence production, evidently the
production department needs direct materials.
– The material requisition form should contain specific description of
the direct and indirect materials required for production.
• A sample material requisition form is shown below:
Material requisition No. 906 Date: January 28, 2018
Job No. to be charged: 365
Quantity Description Unit cost Total cost Classification
500 board ft. Lumber 20 10,000.00 Direct
1 box Nail 22 22 Indirect
1 Gallon Glue 30 30 Indirect
10,052.00
sign Direct materials ------------10,000.00
Authorized signature Indirect materials ----------52.00 12
 At the time the materials are issued from the storeroom, the
following entry is made:
Jan. 28, 2018 Work in process 10,000.00
Manufacturing overhead 52.00
Raw materials 10,052.00

Direct materials that are sent for manufacturing process are no more
direct materials since they are soon to be processed to become finished
goods.
Thus, the cost is charged to work in process account, while indirect
material costs are charged to Manufacturing Overhead.

13
 Job Cost Sheet
• Right after the materials are received from store, a
job cost sheet will be prepared.
• The job cost sheet is used to accumulate the
manufacturing costs incurred in producing that
particular job.
• After being notified that the production order had
been issued, the Accounting Department prepares
a job cost sheet.
14
1. Job Time Ticket:
–The second cost category of manufacturing firms
is the direct labor employed.
–A job time ticket is used to record how much
time is spent on a particular job.
–When a particular job is started, the employee
fills the time the job is started on the job time
ticket, and fills the time he stopped when he left
the job.
15
Example:
Suppose analysis of the job time ticket showed direct
labor of $9,600.00 and indirect labor of $4,800.00, the
journal entry to record the cost of direct and indirect labor
looks like the following:
Jan. 28, 2018 Work in Process 9,600.00
Manufacturing Overhead 4,800.00
Wages Payable 14,400.00

16
2. Manufacturing Overhead: are costs other than direct material
and direct labor that are necessary to transform the raw
materials into finished goods.
– The total overhead costs can’t be known exactly until the end
of the year.
– Thus, organizations should wait up to the end of the year if
they are to charge the actual amount.
– Thus, preparation of interim financial statements is
impossible which in turn affect managerial decisions.
– A predetermined overhead rate is determined to allocate
such costs to individual jobs, which is found by dividing
estimated overhead cost to the estimated amount of
allocation base. 17
• The allocation base is assumed to be a cost driver of
manufacturing overhead costs.
• 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 allocation base is used to compute the
predetermined overhead rate:

18
Example: assume that the estimated overhead cost for the
coming year is Birr 80,000.00, and the direct labor hour is
estimated to be 4,000 hours, the predetermined overhead
rate can thus be calculated as follows:

If we assume that the direct labor hours spent on a

specific job are 90, the manufacturing overhead applied
will, therefore, be

19
 The entry to record the manufacturing overhead
applied is as follows:
March 18, 2018 Work in Process Br 1,800.00
MOH Applied Br 1,800.00

Although actual manufacturing overhead costs are not

assigned, they should be recorded as incurred.
Example: Assume that factory rent, utilities, and other
manufacturing costs totaled Birr 22,000.00.
March 20, 2018 Manufacturing Overhead 22,000.00
Accounts Payable (Rent, Utilities & Other) 22,000.00

20
 Finished Goods Inventory Ledger Card: when work in
process is completed and transferred to the finished good
inventory warehouse.
Example: assume the total cost of goods produced is Birr 21,400,
the following journal entry is made:
March 20, 2018 Finished Goods 21,400
Work in Process 21,400

21
 Cost of Goods Sold: two records are maintained when
sale is made under the perpetual inventory system:
one for sales and the other for cost of goods sold.
Example: Assume that the total units produced are 150,
and half of the units produced (75) are sold for Birr 180
each on with a 40% down payment. The entry to record
the sales
April is as follows:
10, 2018 Cash 5,400.00
Account Receivable 8,100.00
Sales 13,500.00

Thus,
• The cost of the 75 units that are sold = 22
The following entry is necessary to record the cost of goods sold
April 10, 2018 Cost of Goods Sold 10,700.00
Finished Goods 10,700.00

23
 Disposition of Over and Under Applied Overhead
• If the amount of the predetermined manufacturing
overhead is less than the actual amount, the difference is
said under applied overhead or under absorbed
overhead.
• When the reverse is true, the difference is said over
applied overhead or over absorbed overhead.
• Under and over applied overhead at the end of one
fiscal year should not be carried to the coming periods;
rather they should be disposed-off in the year the
difference occurs. 24
• The disposition of under and over applied overhead
costs can take one of the following two ways.
1.Closed out to Cost of Goods Sold
2.Allocated between
– Work in Process
– Finished Goods, and
– Cost of Goods Sold
– In proportion to the overhead applied during the current
period in the ending balances of these accounts.

25
 The Process and Operation or service costing methods
• A process costing System is most commonly used in
industries that produce essentially homogeneous
products on a continuous basis.
• Process costing system fits among others to: paint
manufacturers, oil refineries, sugar refineries, and salt
producers.

26
 Process Costing Methods
• The two methods of accounting for cost flows in process
costing are
– Weighted average (WA) and
– First-in, first-out (FIFO)
• Use of these methods for costing a manufacturing firm’s
production is similar to their use by a retailer.

01:36 PM 27
─ The weighted average method computes a single average cost
per unit of the combined beginning WIP Inventory and
current period production.
─ The first-in, first-out method separates beginning WIP
Inventory and current period production as well as their costs
so that a current period cost per unit can be calculated.

01:36 PM 28
 Illustration of Process Costing
• Flame 'N Scent is used to demonstrate the steps involved in
the computation of EUP and cost assignment for both
methods of process costing. Assume Flame 'N Scent makes a
7-inch unscented pillar candle.
• The company manufactures this product in one department
with a single direct material: wax. Costs of wicks and coloring
are insignificant and are considered indirect materials and
part of overhead.
• Candles are shipped in reusable containers to a central
warehouse.
01:36 PM 29
• From there, candles are distributed to wholesalers and
retailers.
• Because wax is added at the start of processing, inventory is
100 percent complete as to this material as soon as processing
begins.
• Labor and overhead are assumed to be at the same degree of
completion throughout the production process.
• Actual overhead is assigned to production at the end of each
period.

01:36 PM 30
The following data below presents April 2010 information regarding Flame 'N Scent’s inventories and
costs.
– Candles in beginning WIP Inventory ------------------------------------------------ 10,000
(40% complete as to labor and overhead or conversion)
– Candles started during current period ---------------------------------------- 401,400
– Candles completed and transferred to FG Inventory -------------------------- 406,000
– Candles in ending WIP Inventory -------------------------------------------------- 5,400
(80% complete as to labor and overhead or conversion)
– Costs of beginning WIP Inventory
• Direct material ------------------ Br 11,886
• Direct labor ---------------------- 5,658
• Overhead ------------------------- 19,858 Br 37,402
– Current period costs
• Direct material ------------------- Br 642,240
• Direct labor ----------------------- 122,638
• Overhead ------------------------- 385,262 1,150,140
• Total
01:36 PMcost to account for ----------------------------------------------------- Br 1,187,542 31
 Weighted Average (WA) Method
Step 1: Calculate the Total Physical Units to Account For
Candles in beginning WIP Inventory ---------------------- 10,000
Candles started during current period --------------------- 401,400
Candles to account for ------------------------------------- 411,400
Step 2: Calculate the Physical Units Accounted For
Candles completed and transferred to FG Inventory --- 406,000
Candles in ending WIP Inventory ---------------------------- 5,400
Candles accounted for ---------------------------------------
411,400
01:36 PM 32
Step 3: Calculate the Equivalent Units of Production
Units S & C = Units Completed During Period - Units in Beg WIP Inventory

Units S & C = 406,000 – 10,000 = 396,000

Or

Units S & C = Units Started During Period - Units in End WIP Inv

Units S & C = 401,400 - 5,400 = 396,000

01:36 PM 33
 Equivalent Units of Production
DM CC
Candles in beginning WIP Inventory (actual units) 10,000 10,000
Candles started and completed 396,000 396,000
Ending WIP Inventory (Candles X % complete) 5,400 4,320
Equivalent units of production ----------------------------411,400 410,320

01:36 PM 34
Step 4: Calculate the Total Cost to Account For
• Total cost to account for equals:
Beginning WIP Inventory Cost + Current Period Costs
• For Flame 'N Scent, the total cost to account for is:
Br 1,187,542 = Br 37,402 + Br 1,150,140

01:36 PM 35
 DM DL OH Total
Beginning WIP
– Inventory costs Br 11,886 Br 5,658 Br 19,858 Br 37,402
– Current period costs 642,240 122,638 385,262 1,150,140

Total cost to account for ……Br 654,126 Br 128,296 Br 405,120 Br 1,187,542

01:36 PM 36
Step 5: Calculate the Cost per Equivalent Unit of Production

Unit Cost = Total Cost Incurred

Total Equivalent Units of Production

= (Beginning WIP Inventory Cost + Current Period Cost)

WA EUP

01:36 PM 37
 Total DM CC
Beginning WIP Inventory costs Br 37,402 Br 11,886 Br 25,516
Current period costs 1,150,140 642,240 507,900
Total cost to account for Br 1,187,542 Br 654,126 Br 533,416
Divided by EUP (step 3) ÷ 411,400 ÷ 410,320
Cost per EUP Br 2.89 Br 1.59 Br 1.30

01:36 PM 38
Step 6: Assign Costs to Inventories
This step assigns total production costs to units of product by
determining the cost of
(1) Goods completed & transferred out during the period &
(2) units in the ending WIP Inventory.
Total cost transferred = 406,000 units X Br 2.89 = Br 1,173,340
Ending WIP Inventory
Direct material (5,400 X Br 1.59) Br 8,586
Conversion (4,320 X Br 1.30) 5,616
Total cost of ending WIP Inventory Br 14,202

01:36 PM 39
 Flame 'N Scent’s Cost of Production Report for the Month Ended April 30, 2010
(Weighted Average Method)
Equivalent Units
of Production
Production Data Actual Units Direct Material Conversion
Beginning WIP Inventory 10,000
Candles started 401,400
Candles to account for 411,400
Beginning WIP Inventory (completed) 10,000 10,000 10,000
Started and completed 396,000 396,000 396,000
Candles completed 406,000
Ending WIP Inventory 5,400 5,400 4,320
Candles accounted for 411,400 411,400 410,320
Cost Data Total Costs Direct Material Conversion
Costs in beginning WIP Inventory Br 37,402 Br 11,886 Br 25,516
Current period costs 1,150,140 642,240 507,900
Total cost to account for Br 1,187,542 Br 654,126 Br 533,416
Divided by EUP ÷ 411,400 ÷ 410,320
Cost per EUP Br 2.89 Br 1.59 Br 1.30
Cost Assignment
Transferred out (406,000 X Br 2.89) Br 1,173,340
Ending WIP Inventory
Direct material (5,400 X Br 1.59) Br 8,586
Conversion (5,400 X 80% X Br 1.30) 5,616 14,202
Total
01:36cost
PM accounted for Br 1,187,542 40
2) FIFO Method
– Steps 1 and 2 are the same for the FIFO and WA methods
• Step 3: Calculate the Equivalent Units of Production
• Using the FIFO method, the work performed last period is not commingled with
work of the current period. Only the work performed on the beginning WIP
Inventory during the current period is shown in the EUP schedule; this work
equals the actual units in the beginning WIP Inventory times (1 - percentage of
work done in the prior period).
• No additional material is needed in April to complete the 10,000 candles in the
beginning WIP Inventory. Because the beginning WIP Inventory was 40 percent
complete as to labor and overhead, the company will do 60 percent of the
conversion work on those goods in the current period or the equivalent of 6,000
01:36 PM 41
candles (10,000 X 60%).
The EUP schedule for the FIFO method is:
DM Conversion
Candles in beginning WIP Inventory
completed in the current period 0 6,000
Candles started and completed 396,000 396,000
Ending WIP Inventory (candles X % complete) 5,400 4,320
Equivalent units of production 401,400 406,320

01:36 PM 42
Step 4: Calculate the Total Cost to Account For
This step is the same as it was for the WA method; the total cost
to account for is Br 1,187,542
Step 5: Calculate the Cost per Equivalent Unit of Production
Total DM CC
Current period costs Br 1,150,140 Br 642,240 Br 507,900
Divided by EUP (step 3) ÷ 401,400 ÷ 406,320
Cost per EUP Br 2.85 Br 1.60 Br 1.25

01:36 PM 43
Step 6: Assign Costs to Inventories
• The FIFO method assumes that the units in beginning
WIP Inventory are the first units completed during
the current period and, thus, are the first units
transferred out.
• The remaining units transferred out during the period
were both started and completed in the current
period.
• This cost assignment process for Flame 'N Scent is as
follows:
01:36 PM 44
Transferred out
(1) Beginning inventory (prior period costs) Br 37,402
Completion of beginning inventory
Direct material (0 X Br 1.60) 0
Conversion (10,000 X 60% X Br 1.25) 7,500
Total cost of beginning inventory transferred Br 44,902
(2) Candles started and completed (396,000 X Br 2.85) 1,128,600
Total cost transferred Br
1,173,502

01:36 PM 45
Flame 'N Scent’s Cost of Production Report for the Month Ended April 30, 2010 (FIFO Method)
EQUIVALENT UNITS OF
____PRODUCTION_____
Production Data Actual Units Direct Material Conversion
Beginning WIP Inventory 10,000
Candles started 401,400
Candles to account for 411,400
Beginning WIP Inventory (completed) 10,000 0 6,000
Started and completed 396,000 396,000 396,000
Candles completed 406,000
Ending WIP Inventory 5,400 5,400 4,320
Candles accounted for 411,400 401,400 406,320
Cost Data Total Costs Direct Material Conversion
Costs in beginning WIP Inventory Br 37,402
Current period costs 1,150,140 Br 642,240 Br 507,900
Total cost to account for Br1,187,542
Divided by EUP ÷ 401,400 ÷ 406,320
Cost per EUP Br 2.85 Br 1.60 Br 1.25
Cost Assignment
Transferred out
Beginning WIP Inventory costs Br 37,402
Cost to complete
Conversion (10,000 X 60% X Br 1.25) 7,500 Br 44,902
Started & completed (396,000 X Br 2.85) 1,128,600
Total cost transferred Br 1,173,502
Ending WIP Inventory
Direct material (5,400 X Br 1.60) Br 8,640
Conversion (5,400 X 80% X Br 1.25) 5,400 14,040
Total cost
01:36 PM accounted for Br 1,187,542 46
 END OF
CHAPTER
3 47