Product Costing Systems and Overhead Allocation

Practice flashcards covering product costing systems, job-order costing, process costing (weighted-average and FIFO methods), absorption versus variable costing, normal and standard costing, overhead allocation, and support department cost reallocation methods.

What three cost elements make up product costs?

Product costs consist of the costs of direct materials, direct labor, and overhead (or indirect costs).

Why do companies adopt a costing method for allocating indirect costs rather than tracing them directly?

Overhead costs are not directly related to the production of products or providing services and, unlike direct costs, are not easily traceable to specific products.

What is a product costing system and what managerial decision-making purposes does it serve?

A product costing system is a costing process by which a firm estimates the costs of producing its products for decisions such as: deciding what to sell, product prices, determining the cost of goods sold, valuation of inventories, and finding potentials for cost reduction.

When does a firm use a job-order costing system?

A firm uses job-order costing when individual products or batches of products are unique, and especially when jobs are being billed directly to specific customers or are expected to be audited by those customers.

Which two source documents are used in job-order costing to track direct materials and employee labor hours for specific jobs?

The materials requisition sheet (to request raw materials for a specific production job) and the time ticket (to indicate the number of hours an employee worked on specific jobs).

What is process costing and what type of production environment uses it?

Process costing is a method where a firm accumulates material, labor, and overhead costs for each department and then allocates the total departmental cost to individual products; it is used by companies with continuous production processes manufacturing large quantities of the same product through multiple cost centers in long production runs.

How is a predetermined manufacturing overhead rate calculated?

It is computed at the beginning of each fiscal period by dividing the estimated manufacturing overhead cost by an allocation base (also known as an activity base or activity driver).

What is the difference between absorption costing and variable costing?

Absorption costing (full costing) includes all manufacturing variable and fixed costs incurred in producing a product, while variable costing only includes variable production costs and excludes any fixed costs.

Which accounting body mandates absorption costing for external reporting by publicly traded companies?

Absorption costing is required under the Generally Accepted Accounting Principles (GAAP), established by the Financial Accounting Standards Board (FASB).

How does variable costing affect cost of goods sold (COGS) and gross profit margin compared to absorption costing?

Variable costing shows a lower cost of goods sold (COGS) and reveals a higher gross profit margin compared to absorption costing, which reports much higher COGS.

What accounting entries are recorded when a job is finished in a job-order costing system?

The accountants remove the job from Work-in-Process (WIP) by debiting the Finished Goods Inventory account and crediting the WIP account.

What is the difference between under-applied and over-applied overhead?

Under-applied overhead occurs when actual overhead costs are greater than applied overhead costs, whereas over-applied overhead occurs when applied overhead costs are greater than actual overhead costs.

How is an insignificant overhead variance disposed of at the end of a fiscal period under normal costing?

It is written off entirely to Cost of Goods Sold (COGS) by debiting COGS for under-applied overhead or crediting COGS for over-applied overhead.

How is a significant overhead variance handled under normal costing?

It is prorated to the cost of goods sold, the work-in-process inventory, and the finished goods inventory relative to the amounts of applied overhead to them.

How does normal costing differ from standard costing in terms of product cost components and variances?

Normal costing uses actual direct materials, actual direct labor, and applied overhead (having only overhead variance), whereas standard costing uses predetermined direct materials, predetermined direct labor, and predetermined overhead (allowing variances for all three cost components).

Why is the Factory Overhead account categorized as a clearing account?

Because all actual factory overhead costs enter this account (debited) and applied overheads exit the account (credited) to other accounts, leaving either an over-applied or under-applied balance to be cleared.

What is the equivalent number of complete units (ENCU or EU) in process costing?

The amount of Work-in-Process (WIP) inventory expressed in terms of the number of complete units.

What is the core difference between the weighted-average method and the FIFO method in process costing?

The weighted-average method averages beginning WIP costs with current period costs uniformly across completed units and ending WIP, whereas the FIFO method assumes units in beginning WIP are completed first and only uses costs added during the current period to compute equivalent unit costs.

What three components make up total equivalent units under the FIFO process costing method?

The equivalent units from beginning WIP completed during the period, the units started and completed in the current period, and the equivalent units remaining in ending WIP.

What is the operational difference between operating departments and service departments?

Operating departments are directly engaged in transforming raw materials, assembling parts, or providing services to clients; service departments do not manufacture goods or directly provide services to clients, but instead render support services to operating departments.

What three main purposes does cost allocation serve?

Cost allocation serves: (1) make decisions, (2) reduce non-value-added costs, and (3) determine pricing.

What are the three disadvantages of using the overhead accumulation method in process costing?

It treats all products as identical, does not allow computation of the cost of goods manufactured until the end of the period, and does not facilitate advance determination of a product's price under cost-plus pricing.

How does the Chartered Institute of Management Accountants (CIMA) define Activity-Based Costing (ABC)?

An approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize cost drivers to attach activity costs to outputs.

What is the difference between a single-stage and a two-stage cost allocation process under Activity-Based Costing?

A single-stage process uses a single plantwide rate to allocate costs, whereas a two-stage process first allocates costs to departments or activities and then allocates costs from departments or activities to products or services.

What is Activity-Based Management (ABM)?

A management approach through which managers identify activities that consume resources and develop strategies to manage costly activities to reduce costs and improve quality.

What is a cost pool?

A grouping of all overhead costs associated with performing a particular task, such as maintenance, warehousing, human resources, security and safety, and physical plant services.

How does the direct method of support cost reallocation allocate service department costs?

It allocates the costs of service departments directly to production departments based on relative usage, completely ignoring any mutual services that service departments provide to one another.

What sequence is followed when using the step-down (sequential) method to allocate service department costs?

It begins by allocating the costs of the service department that provides the highest level of service to other service departments (or the one with greatest total costs) to production and remaining service departments without allocating costs back to already-allocated departments, proceeding sequentially until all service costs are allocated.

Why is the reciprocal method considered the most accurate method for reallocating support department costs?

It fully recognizes the mutual/reciprocal services provided by support departments to other support departments by utilizing simultaneous equations.

What are the five steps of process costing?

Step $1$: Cost Accumulation, Step $2$: Physical Flow of Units, Step $3$: Equivalent Units, Step $4$: Cost per Equivalent Unit, and Step $5$: Assign and Reconcile Costs.