Friday, August 6, 2010

Operation Costing System or Hybrid Costing System:

Learning Objective:

What is operation costing or hybrid costing system. Explain with examples.
Definition:
Operation costing is a hybrid costing system that employs aspects of both job order and process costing.

Uses of hybrid or operation costing system:
Operation costing system is used in situations where products have some common characteristics and also some individual characteristics. Shoes, for example, have some common characteristics in that all styles involve cutting and sewing that can be done on a repetitive basis, using the same equipment and following the same basic procedure. Shoes also have individual characteristics. Some are made of expensive leathers and others may be made using inexpensive synthetic materials. In a situation such as this, where products have some common characteristics but also must be handled individually to some extent, operation costing may be used to determine product costs.
Products are typically handled in batches when operation costing is in use, with each batch charged for its own specific materials. In this sense, operation costing is similar to job order costing. However, labor and overhead costs are accumulated by operation or by department, and these costs are assigned to units as in process costing.
Examples of other products for which operation costing may be used include electronic equipments (such as semi conductors), textiles, clothing, and jewelry (such as rings, bracelets, and medallions). Products of this type are typically produced in batches, but they can vary considerably from model to model or from style to style in terms of the cost of raw materials inputs. Therefore, an operation costing system is well suited for providing cost data.

Similarities between job order and process costing system:

Learning Objectives:

What are the differences and similarities in process costing and job order costing procedures.
Similarities between job order and process costing systems can be summarized as follows.
Both systems have the same basic purposes-to assign material, labor, and overhead costs to products and to provide mechanism for computing unit product cost.
Both systems use the same basic manufacturing accountants, including manufacturing overhead, Raw materials, Work in process, and Finished Good.
The flow of costs through the manufacturing accounts is basically the same in both systems.

Difference between job order and process costing:

The differences between job order costing and process costing arise from two factors. The first is that the flow of units in a process costing system is more or less continuous, and the second is that these units are indistinguishable from one another. Under process costing it makes no sense to try to identify materials, labor, and overhead costs with a particular order from a customer ( as we do with job order costing ), since each order is just one of many that are filled from a continuous flow of virtually identical units from the production line. Under process costing, we accumulate costs by department rather than by order, assign these costs uniformly to all units that pass through the department during a period.

A further difference between the two costing systems is that the job cost sheet is not used in process costing, since the focal point of process costing is on departments. Instead of using job cost sheet a production report is prepared for each department in which work is done on products. The production report serves several functions. It provides a summary of number of units moving through a department during a period, and it also provides a computation of unit costs. In addition it shows what costs were charged to the department and what disposition was made on these costs. The department production report is a key document in a process costing system.
These differences are summarized below:

Job Order Costing	Process Costing
Many different jobs are worked on during each period, with each job having different production requirements. Costs are accumulated by individual job. Job cost sheet is the key document controlling the accumulation of costs by a job. Unit costs are computed by job on the job cost sheet.	A single product is produced either on continuous basis or for long periods. All units of product are identical. Costs are accumulated by departments. The department production report is the key document showing the accumulation and disposition of costs. Unit costs are computed by department on the department production report.

Discussion Questions and Answers:

Learning Objectives:

Find answers of the general questions about Fist in First Out and Average Method of process costing system.
Questions:
How does the FIFO method differ from the average costing method of process costing system?
Why are units completed and on hand in a processing department included in the department's work in process?
How are equivalent production figure computed when FIFO costing is used?
A certain factory transferred out 8,800 completed units during its second period of operation. The period was begun with 400 units 75% completed and ended with 800 units 50% completed. Assuming that the FIFO method is used, what was the equivalent production for the period?
In another factory, the equivalent production (using the FIFO method) was 7,000 units during a period in which 500 units, 75% complete, were on hand at the start and 600 units,75% complete, were on hand at the end of the period. How many units were full completed?
What are disadvantages of FIFO Costing method?
Enumerate several of the basic difficulties frequently encountered in process costing.
Express on opinion as to the usefulness of data, derived from process costing for the control of cost.
Select the answer which best complete the statement:

a	During 19B, the Novo-Minetto Company had a total manufacturing cost of $180,000. The business completed 14,000 units of product, of which 4,000 units were one half completed in 19A, and started production on an additional 6,000 units that were on half completed at the end of 19B. For 19B, the production cost per unit was:1. $18 2. $16.36 3. $12 4. $9
b	When materials are added in a department subsequent to the first department and additional units result, in affects the unit cost in a cost of production report by causing: 1. an increase in the preceding department's unit cost, which necessitates an adjustment of the transferred-in unit cost; 2. a decrease in the preceding department's unit cost, which necessitates an adjustment of the transferred-in unit cost; 3. an increase in the preceding department's unit cost, but does not necessitates an adjustment of the transferred -in unit cost; 4. a decrease in the preceding department's unit cost, but does not necessitates an adjustment of the transferred-in unit cost
c	Materials are added at the beginning of a process. The beginning work in process inventory was 30% complete as to conversion cost. Using fifo method, the total equivalent units for materials for this process during this period are equal to the: (1) beginning inventory this period (2) units started this period; (3) units started this period plus the beginning inventory; (4) units started this period plus 70% of the beginning inventory.

Answers:

The primary difference between the FIFO method and the average method of process costing lies in the treatment of the cost of beginning work in process inventory. In the FIFO method, the cost of the beginning work in process inventory is kept separate from the cost of production of the current period.

When determining the FIFO cost of unit completed and transferred to next department (process) or to finished goods, the cost of the beginning work in process inventory and the cost necessary to complete the beginning work in process units are added together. The sum of these two costs is the cost assigned to the units in the beginning work in process inventory that are transferred out. Units started and completed during the period are assigned a cost on the basis of costs incurred during the period for the equivalent units produced during the period.

In the FIFO method each department is regarded as a separate accounting unit. Thus, the application of the FIFO method in practice is modified to the extent that subsequent departments usually combine all transferred-in costs into one amount, even though they could identify and separately account for the costs relating preceding department's beginning inventory ant those relating to the preceding department's units started and completed during the period.

The average method of process costing may be simpler to use than the FIFO method, primarily because the beginning work in process inventory is averaged in as a part of the current production. In the average method, the beginning work in process inventory costs are combined with current production costs even though some of the production was begun prior to the current period. When equivalent units are determined, work done on the beginning inventory in a preceding period is regarded as if it were done in the current period. Unit costs are determined by dividing the sum of the beginning work in process and the cost of current production costs by the equivalent units produced, including the units in the department's beginning work in process inventory. The cost of all units transferred out of a department during a period is the product of the number of units completed multiplied by the average cost.
Units completed and on hand in a department must be considered as work in process of that department, because as far as total company inventory is concerned, the units have not been transferred out of the department and therefore, are still work in process. They are still the responsibility of the supervisor of that department.
When FIFO costing is used, equivalent production figures are determined by totaling the number of beginning work in process units restated in terms of units completed during the current period, units started and finished during the period, and ending units in process restated in terms of units completed during the current period.
Transferred out ---------------------------------------------8,800
Less beginning inventory all units ------------------------------400
Started and finished this period --------------(8,800 - 400) = 8,400
Add beginning inventory work this period --------(400 × 25%) = 100
Add ending inventory --------------------------(800 × 50%) = 400
Equivalent production -------------------------------------= 8,900
Equivalent production----------------------------------7,000
Less:
Ending inventory (800 × 75%)----------------------450
Beginning inventory (work this period) (800 × 75%) 200
650
Started and finished this period--------------------------6,350
Add beginning inventory (all units) -----------------------500
Transferred out------------------------------------------6,850
This disadvantages of using the FIFO method in processing costing are those associated with this type of costing in general, and concern the fact that several costs used at the same time require additional computations which can lead involved procedures and often inaccurate calculations.
The basic difficulties encountered in process costing include (a) the determination of production quantities and their stages of completion, (b) materials cost computations frequently requiring considerable analysis, (c) the calculation lost unit costs because units are lost due to many factors and all stages of production, and (d) the fact that many process cost type industries are multiple product operations which necessitate the allocation of cost to various products using different bases, some of which are considered quite unscientific.
Costs computed in a cost of production report are useful in determining inventory costs and in computing the cost of goods sold. However, for cost control purposes, much more information is required than is reported in the cost of production report. Unit costs should be compared with standard unit costs or previous data top determine whether they represent efficient operations. Also, materials, labor, and factory overhead must be reported by item of material used, type of labor operations involved, and overhead in a manner meaningful for cost control purposes. Actual total and unit costs reported in a cost of production report are necessary, but reports must also be designed to assist control of costs.

(a) 3

Units completed	14,000
Less beginning inventory (all units)	4.000
	------
Started and finished during this period	10,000
Add beginning inventory (work this period) - (4,000 × 1/2)	2,000
Add ending inventory (work this period) - (6,000 × 1/2)	3,000
	------
Equivalent production	15,000
	======

$180,000 manufacturing cost / 15,000 equivalent production = $12 per unit

(b) 2

(c) 2

Difficulties Encountered in Process Costing Procedures:

Learning Objectives:

What are the difficulties or Limitations in a process costing procedure.
Certain difficulties likely to be encountered in actual practice should be mentioned with regard to process cost accounting procedures:
The determination of production quantities and their stage of completion presents problem. Every computation is influenced by these figures. Since the data generally come to the cost department from operating personnel often working under circumstances that make a precise count difficult, a certain amount of double counts and unreliable estimates are bound to exist. Yet, the data submitted from the basis for the determination of inventory costs.
Materials cost computations frequently require careful analysis In the illustrations materials are generally considered to the the cost of first department. In certain industries, materials costs are not even entered on production reports. When materials prices are influenced by fluctuating market quotations, the materials cost may be recorded in a separate report designed to facilitate management decisions in relation to the materials market.
The discussion of lost units by shrinkage, spoilage, or evaporation indicates that the time when the loss occurs influences the final cost calculation. Different assumptions concerning the loss would result in departmental unit costs, which, in turn effect inventory costs, the cost of units transferred, and the completed unit cost. Another consideration involves the possibility of treating cost attributable to avoidable loss as an expense of the current period.
Industries using process cost procedures are generally of the multiple product type. Joint processing cost must be allocated the the products resulting from the processes. Weighted unit averages or other bases are used to prorate the joint cost to the several products. If units manufactured are used as a basis for cost allocation, Additional clerical expenses are necessary if the labor hour or machine hour basis is used for charging overhead to work in process. Management must decide whether economy and low operational cost are compatible with increased information based on additional cost computations and procedures.

It should be noted that some companies use both process costing and job order costing procedures for various purposes in different departments. This is particularly true when a parallel or selective cost flow format is required. Each system or method employed by a company must be based on reliable production and performance data which, when combined with output, budget, or standard cost data, will provide the foundation for effective cost control and analysis.

Beginning Work in Process Inventories First In First Out (FIFO) Costing Method:

It is possible to keep beginning work in process inventory costs separate rather than average them in with the additional new costs incurred in the next period. This procedure gives separate unit costs (1) for beginning work in process units completed and (2) for units started and finished in the same period.
Some accountants believe that the beginning work in process costs should be kept in tact, adding only that portion of additional costs required to complete units in the beginning work in process. Under the first in first out (FIFO) costing method, the cost of completing units in process at the beginning of the period is computed first,, followed by the computation of the cost of units started and finished within the period. This procedure leads to at least two different unit costs for work completed within a specific period. The averaging process produces only one completed unit cost.

Example:

The Clonex Corporation
Blending Department
Cost of Production Report - FIFO Costing
For the month of February, 19__

Quantity Schedule:
Units in process at beginning (all materials 1/2 labor and factory overhead FOH)		4,000
Units started in process		40,000	44,000
		-------	=====
Units transferred to next department		38,000
Units completed and on hand		1,000
Units still in process (all materials, 2/3 labor and factory overhead)		3,000
Units lost in process		2,000	44,000
		-------	=====
Cost Charged to the Department:		Total Cost	Unit Cost
Work in process beginning inventory		$4,440	--
Cost added by department:
Materials		$19,480	$0.522
Labor		24,180	0.620
Factory overhead (FOH)		22,580	0.579
		-------	------
Total cost added		$66,600	1.721
		-------	=====
Total cost to be accounted for		$71,040
		======
Cost Accounted for as Follows:
Transferred to next department:
From beginning inventory:
Inventory cost	$4,440
Labor added (4,000 × 1/2 $1.721 × 0.620)	1,240
Factory overhead (4,000 × 1/2 $1.721 × 0.579)	1,158	$6,638
	------
From current production:
Units started and finished (34,000 × $1.721)		58,517*
Work in Process - ending inventory:
Completed and on hand (1,000 × $1.721)		1,721
Materials (3,000 × 0.522)		1,566
Labor (3,000 × 2/3 × 0.620)		1,240
Factory overhead (3,000 × 2/3 $1.721 × 0.579)		1,158	5,685
		-------	-------
			$71,040
			======

* 34,000 units × $1.720 per unit = $58,514. To avoid decimal discrepancy, the cost transferred from current production is computed as follows:
$71,040 - ($6,838 + $5,685) = $58,517

Additional Computations:

Equivalent Production:	Materials	Labor and FOH
Transferred out	38,400	38,400
Less beginning inventory (all units)	4,000	4,000
	---------	---------
Started and finished this period	34,000	34,000
Add beginning inventory (Work this period)	-0-	2,000
Add ending inventory:
Completed and on hand	1,000	1,000
still in production	3,000	2,000
	-------	-------
	38,000 units	39,000 units

Unit cost:

Materials = $19,840 / 38,000 = $0.522 per unit

Labor = $24,180 / 39,000 = $0.620 per unit

Factory overhead = $22,580 / 39,000 = $0.579 per unit

Beginning Work in Process Inventories Average Costing Method:

When beginning work in process inventory costs are merged with costs of the new period, the problem is essentially one of securing representative average costs. Ordinarily, the averaging process is quite simple.

Example:

The Clonex Corporation
Terminal Department (3rd Dept.)
Cost of Production Report
For the Month of January, 19

Quantity Schedule:
Units in process at beginning (1/3 labor and factory overhead)	3,000
Units received from preceding department	38,000	41,000
	-------	=====
Units transferred to next department	36,000
Units still in process (1/4 labor and FOH)	4,000
Units lost in process	1,000	41,000
	--------	=====
Cost Charged To the Department:	Total Cost	unit Cost
	Total Cost	unit Cost
Cost from preceding department:
Work in process - beginning inventory (3000 units)	$5,400	$1.80
Transferred in during this period (38,000 units)	65,360	1.720
	-------	------
Total	$70,760	$1.726
	-------	------
Cost added by the department:
Work in process - Beginning inventory:
Labor	$910
Factory overhead	800
Cost added during period:
Labor	34,050	0.920
Factory Overhead (FOH)	30,018 -------	0.811 -----
Total cost added	$65,778	$1.731
Adjusted units cost for additional units		0.043*
	-------	------
Total cost to be accounted for	$136,538	$3.500
	======	======
Cost Accounted for as Follows:
Transferred to finished goods storeroom (36,000 × $3.50)		$126,000
Work in process - ending inventory:
Adjusted cost from preceding department(4,000 × $1.726 + $0.043)	$7,076
Labor (4,000 × 1/2 × $0.920)	1,840
Factory Overhead (4,000 × 1/2 × $0.811)	1,622 ------	10,538 ------
Total cost accounted for		$136,538
		======

Additional Computations: Unit cost from preceding department: $70,760 / 41,000 = $1.726 Equivalent Production: Labor and factory overhead = 36,000 + 4,000 / 2 = 38,000 units Unit Costs: Labor = $910 + $34,050 = $34,960; $34,960 / 38,000 = $0.920 per unit Factory overhead = $800 + 30,018 = $30,818; $30,818/38,000 = 0.811 per unit Adjustment for Additional Units Method No.1* - $70,760/40,000 =$1.769 - $1.726 = $0.043 Method No.2 - 1,000 units × $1.726 = $1.728; $1.728/40,000 = $0.043 per unit

When additional materials increase the number of units being processed, it is still possible to have lost units. However, should increase and lost units occur, no separate calculation is required for the lost units; only net units added are used. In the example above, 8,000 additional units resulted from added materials. It is quite possible, though, that the materials added should have yielded 10,000 units. The difference between the 8,000 units and the anticipated 10,000 units could be due to the loss of 2,000 units. I this is the case, the effect of the lost units is similar to that of units lost in the first department; that is, the cost is absorbed within the department as an increase in unit costs. However, if 10,000 additional units should have resulted, the effect of losing units can be determined as follows:

Compute the unit cost of work done in preceding departments and the Terminal Department as if no loss had occurred.
Compute the loss by multiplying the unit cost obtained in the preceding computation by the 2,000 lost units.

Addition of Materials - Increase in Units and Change in Unit Cost:

Learning Objective:

What is the effect on the calculation in the cost of production report when materials are added in a department subsequent to the first and as a result number of units increase and unit cost is decreased?

When additional materials result in additional units, different computations are necessary. The greater number of units causes a decrease in unit cost which necessitates an adjustment of the preceding department's unit cost, since the increased number of units will absorb the same total cost transferred from the preceding department.

Example:

To illustrate the situation of additional units resulting from the addition of materials, assume that the Terminal department of the Clonex Corporation cost for labor and factory overhead of $32,400 and 19,800, respectively, an additional materials cost of $17,020, and an increase of 8,000 units as the result of added materials. The effect of these assumptions on the Terminal Department's cost of production report is shown below:

The Clonex Corporation
Terminal Department (3rd Dept.)
Cost of Production Report
For the Month of January, 19

Quantity Schedule:
Units received from the preceding department	40,000
Additional units put into process	8,000	48,000
	-------	=====
Units transferred to finished goods storeroom	44,000
Units still in process (1/4 labor and FOH)	4,000	48,000
		=====
Cost Charged To the Department:	Total Cost	unit Cost
	Total Cost	unit Cost
Cost from preceding department:
Transferred in during the month (40,000 units)	$140,400	$3.51
Cost added by the department:
Materials	$17,020	$0.37
Labor	32,400	0.72
Factory Overhead (FOH)	19,800 -------	0.44 -----
Total cost added	$69,220	$1.53
Adjusted units cost for additional units		2.925*
	-------	------
Total cost to be accounted for	$209,620	$4.455
	======	======
Cost Accounted for as Follows:
Transferred to finished goods storeroom (44,000 × $4.455)		$196,020
Work in process - ending inventory:
Adjusted cost from preceding department(4,000 × $2.925)	$11,700
Materials (4,000 × 1/2 × $0.37)	740
Labor (4,000 × 1/4 × $0.72)	720
Factory Overhead (4,000 × 1/4 × $0.44)	440 ------	16,770 ------
Total cost accounted for		$209,620
		======

Additional Computations: Equivalent Production: materials = 44,000 + 4,000 / 2 = 46,000 units Labor and factory overhead = 44,000 + 4,000 / 4 = 45,000 units Unit Costs: Materials = $17,020 / 46,000 = $0.37 Labor = $32,400 / 45,000 = $0.720 per unit Factory overhead = $19,800 / 45,000 = 0.44 per unit Adjustment for Additional Units Formula:* Cost from preceding department / (Units received from preceding department + Units added) $140,400 / 48,000 = 2.925 per unit

When additional materials increase the number o units being processed, it is still possible to have lost units. However, should increase and lost units occur, no separate calculation is required for the lost units; only net units added are used. In the example above, 8,000 additional units resulted from added materials. It is quite possible, though, that the materials added should have yielded 10,000 units. The difference between the 8,000 units and the anticipated 10,000 units could be due to the loss of 2,000 units. I this is the case, the effect of the lost units is similar to that of units lost in the first department; that is, the cost is absorbed within the department as an increase in unit costs. However, if 10,000 additional units should have resulted, the effect of losing units can be determined as follows:

Compute the unit cost of work done in preceding departments and the Terminal Department as if no loss had occurred.
Compute the loss by multiplying the unit cost obtained in the preceding computation by the 2,000 lost units.

Friday, August 6, 2010

Definition:

Uses of hybrid or operation costing system:

Difference between job order and process costing:

Questions:

Answers:

Example:

Example:

Example: