Topic 11 - Costing

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This article is a topic within the subject Accounting 1B.


Required Reading

Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning, pp. Management Accounting, Supplementary Text, Trotman.


Management accounting is information for internal users who plan, control, direct/motivate and evaluate. Costing is used for pricing, decision making & inventory valuation.

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Job Order Costing – Distinct, Identifiable Goods And Services

Information in the costing system involves capturing information on a 1 to 1 basis. Generally used by firms who produce a variety products/jobs that are distinct from each other e.g. construction, printing. Manufacturing costs accumulated by job. Unit Costs = Total Job Costs / Units Produced on Job.



Process Costing – Mass Production, Assembly Line



Process costing is used for firms in process industries that mass produce large quantities of homogenous goods e.g. food, cement, petroleum. The cost of 1 product must be identical to the cost of another. Accumulate costs by process or department for a given period of time. Unit Costs = Total Process Costs / Units Produced

Cost Classifications



  • Cost - the value sacrificed for goods &services that are expected to bring current or future benefits to the firm then expire as expenses once revenue is generated
  • Types of Costs
    • Differential – alternative projects (the difference between the costs)
    • Out of Pocket – involves an initial cash outlay
    • Controllable – heavily influenced by a manager, all costs are controllable at some management level
    • Direct & Indirect costs – traceable to single or multiple cost objects
  • Selling & Admin Costs - costs of marketing & distributing a G/S (order-getting/filling costs)
  • Manufacturing Costs - incurred in the process of converting raw materials into finished goods
    • Direct – costs that are traceable to a cost object (any item/activity) e.g. RM for a product or direct labour
    • Indirect – linked to many cost objects, e.g. indirect materials/labour, Overhead that needs to be allocated
    • Manufacturing Overhead (M.O or MO.H) – indirect product costs (depreciation of machinery)
  • Prime Costs – Direct Materials (DM or Raw Materials - RM) & Direct Labour (DL)
  • Conversion Costs – Direct Labour & Manufacturing Overheads (M.OH)
  • Product Costs – DM + DL + M.OH (for the product)
  • Non-Manufacturing Costs - Selling, General & Administrative (SG&A) costs (Period Costs)
    • Marketing/Selling Costs – Salaries for sales personnel, advertising, shipping

Cost Measurement - Normal

  • Actual Costing – doesn’t provide accurate unit cost info on a timely basis for throughout the year decision making
    • Non uniform production levels & fluctuations in overhead costs (difficulty with overhead averaging over short term)
  • Normal Costing – measure OH on a predetermined basis & uses actual rates for raw materials & direct labour



Overhead Application And Overhead Rate

  • Activity Level - Identify a production activity measure (cause & effect – cost driver) & predict ‘level
    • Production Activity Measures – units produced, direct labour hours/dollars, machine hours, direct materials
    • Levels – expected (this year), normal (LT avg, less volatility), theoretical (max), practical (efficient & imperfect)

Produce 10,000 of 2 products & 1 machine produces (costs 20,000) units of production won’t be accurate if the 1 product takes 4 times longer (in machine hours) to produce. It should bear more of the costs. Use Mach hours.


For example, Bell ltd produces a cordless & regular telephone. Budgeted overhead is $360,000, normal activity in direct labour hours is 120,000. Actual activity was 100,000 & actual overhead was $320,000.

The predetermined overhead rate is $3/DLH, giving an applied overhead of $300,000.

If we were to assume that 40% of the actual direct labour hours produced 80,000 cordless phones & 60% produces 90,000 regular phones, we can work out the per unit overhead costs.

40% of DLH = 40,000 hours = $120,000, which gives a $1.50 per unit cost 60% of DLH = 60,000 hours = $180,000, which gives a $2 per unit cost

Under Applied And Over Applied Overhead - Variance

Overhead Variance = Actual Overhead – Applied Overhead. If it is positive, overhead has been under applied. If it is negative, it has been over applied. Bell ltd under applied overhead by $20,000

Disposition of Overhead Variance

  1. Allocate all overhead variance to COGS
    • Only if the variance is immaterial
    • We add to COGS if we under applied, we deduct if we over applied
    • Bell ltd would increase COGS by $20,000
  2. Allocate overhead variance among WIP, FG & COGS i.e. allocated to the periods production
    • If the variance is material
    • Prorate the overhead variance based on the ending applied overhead balances in each account
    • Bell ltd – WIP = $60,000 (20%), FG = $90,000 (30%), COGS = $150,000 (50%)
      • Allocate $4,000 to WIP, $6,000 to FG & $10,000 to COGS

Single Vs. Multiple Overhead Rates

Single overhead rates may result in unfair cost assignments (particularly if departments differ in labour/machine intensity see page 85 chap 17 of supplementary textbook). Department overhead rates can be employed that are related to the cost drivers that reflect the overhead consumed by the individual jobs.

Limitations of Overhead Product Costing

  • Assumes all overhead costs are caused by the cost driver
    • Many overhead costs are not caused by unit based cost drivers e.g. quantity produces, labour/mach hours
      • E.g. set up & inspection costs are a function of ‘# of runs’
  • Greater failure when a greater proportion of overhead is non-unit-related & if there is great product diversity.
    • Distortion when the quantity of unit based inputs does not vary in direct proportion to non unit based inputs

Power-Pooch Case Study: a special order for 2 batches (job order costing)


  1. Charge the client cost plus 60%
  2. $11,000 of Raw Materials purchased at the start of December
  3. Overhead
    • Expected Overhead of $45,500 Based on 50 Machine Hours
    • Cost Driver - Machine Hours (910 per hour)
  4. Job 1 (Dec end)
    • Used: $6,750 RM, 14 Labour Hours ($45), 20 Machine Hours
  5. Job 2 (Dec end)
    • Used: $3350 RM, 9 Labour Hours ($45), 15 Machine Hours
  6. Following Costs Actually Incurred
    • Overhead = $30,945
      • Rent Payable $10,000, Electricity Payable $220, Depreciation (equip) $6,725, Wages Payable ($14,000)
    • SG&A = $1520
      • Advertising $85, Sales Commission $600, Office Salaries $775, Depreciation Office $60

Journal Entries

  • Purchase RM on Credit - DR Raw Materials 11,000, CR Accounts Payable 11,000
  • Use of RM for J1 & J2 - DR WIP 10,100, CR Raw Materials 10,100 (6750 WIP J1, 3350 WIP J2)
  • Direct Labour Costs Incurred (45*23) - DR WIP 1,035, CR Wages Payable 1,035 (630-J1, 405-J2)
  • Application of Overhead (35*910) - DR WIP 31,850, CR MOH Control 31,850
    • Affects WIP valuation
  • Actual Overheads Incurred - DR MOH Control 30,945, CR Payables (Rent/10k , Electricity/220, Dep/6,725, Wages/14k)
    • Does not affect WIP valuation but is part of the adjustment process of COGS

Overhead Variance

Applied Overhead = $31,850, Actual Overhead = $30,945 - Over Applied Overhead $905 (we need to reduce costs)

  • Since immaterial - DR MOH Control 905, CR COGS 905 (Adjustment)

Job 1 – Finished Goods

  • Direct Material = $6,750
  • Direct Labour = $630
  • Allocated OH = $18200
  • Total = $25,580

Job 2 – WIP

  • Direct Material = $3350
  • Direct Labour = $405
  • Allocated OH = $13,650
  • Total = $17,405




This is the end of this topic. Click Accounting 1B to go back to the main subject page for Accounting 1B


Textbook refers to Trotman, K. and Gibbins, M. (2009) Financial Accounting: An Integrated Approach, 4th edition, Nelson Thomson Learning

  1. ASB, UNSW
  2. Trotman, Management Accounting Supplementary Text
  3. ASB, UNSW
  4. ASB, UNSW
  5. ASB, UNSW
  6. ASB, UNSW
  7. ASB, UNSW
  8. ASB, UNSW
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