Introduction to Managerial Accounting and Job Order Cost Systems (Part B)
by
Charles Lamson
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Manufacturing Cost Terms Managers rely on managerial accountants to provide useful cost information to support decision-making. What is a cost? A cost is a payment of cash or its equivalent or the commitment to pay cash in the future for the purpose of generating revenues. A cost provides a benefit that is used immediately or deferred to a future period of time. If the benefit is used immediately, then the cost is an expense, such as salary expense. If the benefit is deferred, then the cost is an asset, such as equipment. As the asset is used, an expense, such as depreciation expense, is recognized. In this section we will illustrate manufacturing costs for Goodwell Printers, a manufacturing firm. A manufacturing business converts materials into a finished product through the use of machinery and labor. Goodwell Printers prints textbooks. The Printing Department feeds large rolls of paper into printing presses. The printing presses use electricity and ink. From the Printing Department, the printed pages are stacked and moved to the Binding Department. In the Binding Department, the pages are cut, separated, stacked, and bound to book covers. A finished book is the final output of the Binding Department. Materials The cost of materials that are an integral part of the product is classified as direct material cost. For example, the direct materials cost for Goodwell Printers would include paper and book covers. As a practical matter, direct materials cost must not only be an integral part of the finished product, but it must also be a significant portion of the total cost of the product. Other examples of direct materials are the electronic components for a TV manufacturer and tires for an automobile manufacturer.  The costs of materials that are not a significant portion of the total product cost are termed indirect materials. Indirect materials are considered a part of factory overhead, which we discuss later. For Goodwell Printers, the costs of ink and binding glue are classified as indirect materials. Factory Labor The cost of wages of employees who are directly involved in converting materials into the manufactured product is classified as direct labor cost. The direct labor cost of Goodwell Printers includes the wages of the employees who operate the printing presses. Other examples of direct labor costs are carpenters' wages for a construction contractor, mechanics' wages in an automotive repair shop, machine operators' wages in a tool manufacturing plant, and assemblers' wages in a microcomputer assembly plant. As a practical matter, a direct materials cost must not only be an integral part of the finished product, but it must also be a significant portion of the total cost of the product. For Goodwell Printers, the printing press operators' wages are a significant portion of the total cost of each book. Labor costs that do not enter directly into the manufacture of a product are termed indirect labor and are recorded as factory overhead. Indirect labor for Goodwell Printers might include the salaries of maintenance, plant management, and quality control personnel. Factory Overhead Cost Costs other than direct materials cost and direct labor cost incurred in the manufacturing process are classified as factory overhead cost. Factory overhead is sometimes called manufacturing overhead or factory burden. Examples of factory overhead costs, in addition to indirect materials and indirect labor, are machine depreciation, factory utilities, factory supplies, and factory insurance. In addition, payments to employees for overtime and nonproductive time (such as idle time) are considered factory overhead. For many industries, factory overhead costs are becoming a larger portion of the costs of a product as manufacturing processes become more automated.  The direct materials, direct labor, and factory overhead costs are considered product costs, because they are associated with making a product. The costs of converting the materials into finished products consist of direct labor and factory costs, which are commonly called conversion costs. Cost Accounting System Overview An objective of a cost accounting system is to accumulate product costs. Product cost information is used by managers to establish product prices, control operations, and develop financial statements. In addition, the cost accounting system improves control by supplying data on the costs incurred by each manufacturing department or process. There are two main types of cost accounting systems for manufacturing operations: job order cost systems and process cost systems. Each of the two systems is widely used, and any one manufacturer may use more than one type. In the next several posts, the job order cost system will be illustrated. After that, the process cost system will be illustrated. A job order cost system provides a separate record for the cost of each quantity of product that passes through the factory. A particular quantity of product is termed a job. A job order cost system is best suited to industries that manufacture custom goods to fill special orders from customers or that produce a high variety of products for stock. Manufacturers that use a job order cost system are sometimes called job shops. An example of a job shop would be an apparel manufacturer, such as Levi Strauss.  Many service firms also use job order cost systems to accumulate the costs associated with providing client services. For example, an accounting firm will accumulate all of the costs associated with a particular client engagement, such as accountant time, copying charges, and travel costs. Recording costs in this manner helps the accounting firm control costs during a client engagement and determine client billing and profitability. Under a process cost system, costs are accumulated for each of the departments or processes within the factory. A process system is best suited for manufacturers of units of product that are not distinguishable from each other during a continuous production process. Examples would be oil refineries, paper producers, chemical processors, aluminum smelters, and food processors.  *WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 740-742* end |
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