Costing System-Case Study:
On December 31, 19A, after
closing, the ledgers of the Vilas-LaMesa Company contained these accounts
|Work in process*
in the factory ledger
Details of the three inventories are:
Finished goods inventory: Item X--1,000
units @ $12.50
Item Y--2,000 units @ $10.00
in process inventory:
500 units of A @ $5.00
200 units of B @ $3.00
500 hours @ $4.00
200 hours @ $5.00
Factory overhead applied @ $2.00/hour
Materials A-2,000 units @ $5.00
Materials B-4,000 units @ $3.00
During January, 19B, these transactions were
- Purchase on account: Materials A, 10,000
units @ $5.20; Materials B, 12,000 units @ $3.75; indirect materials,
- Payroll totaling $110,000 was paid. Of the
total payroll, $20,000 was for marketing and administrative salaries.
Payroll deductions consisted of $15,500 for employees' income tax and 6.5%
for FICA tax.
- Payroll to be distributed as follows: Job
101, 5,000 direct labor hours @ $4.00; Job 102, 8,000 direct labor hours @
$5.00; Job 103, 6000 direct labor hours @ $3.00; indirect labor, $12,000;
marketing and administrative salaries, $20,000. Employers payroll taxes
are: FICA, 6.5%; state unemployment, 2.7%; federal unemployment, 0.7%.
- Materials were issued on a first in first
out (FIFO) basis as follows: Materials A, 10,000 units (charged to Job
101); Materials B, 12,000 units (charged to Job 102); Materials A, 1,000
units, and Materials B, 2,500 units (charged to Job 103). (Note:
Transactions are to be taken in consecutive order.) Indirect materials
amounting to $7,520 were issued.
- Factory overhead was applied to jobs 101,
102, and 103 based on the rate of $2.00 per direct labor hour.
- Jobs 101 and 102 were completed and sold
on account for $120,000 and $135,000, respectively.
- After allowing a 5% cash discount, a net
amount of $247,000 was collected on account receivable.
- Marketing and administrative expenses
(other than salaries) paid during the month amounted to $15,000.
Miscellaneous factory overhead of $10,800 was paid and transferred to the
factory. Depreciation on machinery was $2,000.
- Payment on account, other than payroll
paid, amounted to $85,000.
- The over- or underapplied factory overhead
is to be closed to the cost of goods sold account.
- Trial balances of the general ledger and
of the factory ledger as of January 1, 19B.
- General ledger and factory ledger accounts
opened and balances recorded from the January 1 trial balances.
- Journal entries to record the January
- The posting of January transactions to the
general ledger, factory ledger, and subsidiary ledgers for materials, work
in process, finished goods and factory overhead incurred.
- Trial balances of the general ledger and
the factory ledger as of January 31, 19B, reconciliation control accounts
with subsidiary ledgers.
- A statement of cost of goods sold for
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The presented of the Nola Cola Company has
heard rumblings of dissatisfaction among board of directors about the
relatively low net earnings of the company. Several directors are not
satisfied with the accounting reports being issued.
They believe, it appears, that the shipping
and delivery expenses are responsible, that advertising is in line, and that
administrative expenses, although possibly somewhat above normal, are not
out of control. Their primary criticism seems leveled at manufacturing
Consequently, a meeting of the board of
directors has been called in order to examine critically the accounting
system is use for determining manufacturing costs; that is, the cost of a
Nola Cola bottle ready for delivery as it comes from the last operation of
the bottling process.
Sensing some of the problems involved, the
president has adopted a recognized technique of executive strategy. Before
having the controller explain the accounting system in use, the president
has decided to ask for an opinion as to what item should be included in the
proper determination of the cost of a bottle of Nola Cola. For example, the
president believes there is mutual agreement that such items as syrup,
water, carbonation, and bottle caps are properly part of manufacturing
Required: A list of other items
that should be included, and to what extent.
A number of specific items may be mentioned:
- Direct labor cost.
- Wear and breaking of bottles and cases.
- A share of manufacturing expenses other
than direct materials ad direct labor, i.e., factory overhead.
As these specific items are mentioned, the
discussion should be channeled into a consideration of several "general"
problems of cost accounting:
- The problem of setting up an equitable and
economical cost determination system.
- The need for the system also to provide
devices and information for control and decision-making purposes.
- The problem of measurement and assignment
of overhead costs to work completed.
- The fact that cost figures are, at best,
estimates. Yet, although we may never know what the exact cost is, we can
obtain useful information at a reasonable price.
An examination of costing methods and
procedures in the Franklin Printing Company reveals the following:
- Costing formulas and ratios prepared a
long time ago are still being used by estimators even though prices for
materials have increased, overhead is higher, and new machinery has been
- An estimator in the production department
and a cost clerk in the cost department prepare estimates
independently from one another, resulting in widely divergent cost
- A profit per individual job or order can
never be determined.
- Each job or order is sold with a definite
markup. Yet, instead of a profit of $100,000 as the president hopped for,
the chief accountant prepared an income statement showing only a $48,000
- Determining departmental efficiency and
control over expenses is not possible.
Required: A statement
A. Possible causes of the existing conditions.
B. Possible steps to remedy the situation.
Possible causes of the existing conditions:
- The printing industry makes use of
predetermined rates and pricing tables. At times advancement of materials
labor costs is not incorporated quickly enough. The installation of new
machinery requires individual attention to the cost situation.
- This situation is unusual. estimator, in
many firms, operates with future costs and prices while the cost
department bases its calculations on present or experienced costs. Often
the situation is particularly critical with regard to the overhead rates
used by the two parties.
- This situation is also typical of the
printing industry. Generally, a printer has many jobs: some require only a
very short time, others continue over several weeks. Cost determination
becomes a job of averaging costs over the time. Therefore, an individual
profit per job can rarely be calculated on the basis of the books and
- This result can be traced to the fact that
cost estimates are based on erroneous and outdated costs and percentages.
It could also be caused by a steady increase of fixed costs that consume
the imaginary profit calculated in the estimates. Overhead rates might be
out of line with actual experience.
- The company's management might never have
considered the delegation of authority and responsibility to supervisors.
With costs so for out of line it may be that no manager has been asked to
contribute ideas and prepare cost estimates for a better performance in
his or her department.
B. Possible steps to remedy the
- Check industry rates and prices with
company's costs. Revise and keep up to date, so that estimates can be
based on realistic figures.
- Let estimator prepare bids and estimates,
but costs and prices used should be set in collaboration with the cost
department. Differences should be explainable and, if possible, brought
- The determination of profit per job or
order depends greatly upon the revisions suggested in (1) and (2). Also, a
job order cost accumulation of actual costs may be practical. Many factors
might still prevent a completely accurate profit determination; however,
basing the estimates on realistic data and company overhead rates and
modifying these estimates as circumstances change will result in a more
satisfactory job cost and profit picture.
- Here, too, rates and costs must be
examined in the light of present conditions. It is important to examine
fixed costs that have entered into the cost situation unnoticed. The
preparation of a budget with a continuous reporting scheme would assist in
avoiding the difficulty of this unpleasant report regarding the final
- The steps needed in (4) are also part of
this answer. Departmental budgets will permit (1) the calculation of
overhead rates and (2) a close watch over actual expenses by supervisors.
Weekly or monthly reports will assist the supervisors in keeping the costs
within the budget limits; that is, within the predetermined profit range.
A textile manufacturer asks advice concerning
the installation of a cost system. The manufacturer explains briefly that
many different cloths are produced, starting with scoured wool that passes
through the following processing before becoming finished cloth: picking and
blending, carding, spinning, weaving, finishing, and dyeing. The company's
sales representatives take orders considerably in advice of the actual
production of the cloth, using samples produced during a special period set
aside each season for the manufacture of samples. Competition is keen and
the profit margin is low. The financing is received through bank loans.
- The principle advantages of installing a
- The principle additions or alterations
necessary to operate a cost system. (The present accounting system is
designated for the purpose preparing annual financial statements.)
- An explanation of how matters can be
arranged in order to find the cost of the principle stages of manufacture,
such as carding, spinning, weaving, etc. (The carding machines operate
three shifts per day; the spinning machines, two shifts; and the weaving
machines, one shift.)
A: The principle advantages of
installing a cost system are:
- The ascertainment of unit costs of the
various products. Unit costs are variable in determining minimum sales
prices and in eliminating unprofitable lines.
- Improvement in efficiency by comparison of
cost details at regular intervals.
- More adequate information, which is
available for inventory costing.
- Establishing control over production
B: To operate a cost system, it would
be necessary to amplify the accounting procedure by providing for:
- More detailed analysis of disbursements.
- Perpetual inventory records.
- Monthly accumulation of detailed figures
relating to costs of each operation and product.
C: Divide the factory into departments
for cost accumulating purposes corresponding to the
natural divisions, such as Carding Department, Spring Department, and
Weaving Department. Break down the analysis of
factory overhead according to these department departments. This
automatically takes care of the differences in operating shifts.
A client has asked advice as to a
satisfactory system of factory costs for a factory that is divided into two
- Machine Shop: This division makes steel
molds used in the manufacture to plastic articles. These molds require
careful precision work; and frequently, one person is employed at
machining one mold for several weeks. The finished molds are used by the
Plastic Division of the company. In addition, some other machine work is
done for customers, although this forms the smaller portion of the shop's
- Plastic Division: This division
manufactures plastic articles including ash trays, buttons, knobs, etc.
The process of manufacture consists of placing chemical powders in a mold,
which is then placed under a steam press where pressure is applied for a
few minutes. The chemical powders are the only materials used and are not
processed before being placed in the mold. After being processed, a
certain amount of finishing and inspection labor is necessary to complete
It is ascertained that:
- The company has had no previous cost
- Production in both divisions is controlled
by job order tickets.
- Materials are kept in one place, but no
record has been kept of withdrawals.
- Labor is paid at hourly rates, and a time
clock at the factory entrance is used for determining the hours worked in
- Employees have been preparing satisfactory
time tickets showing the hours worked on each job and, in the case of the
plastics division, the number of units produced; but this record has never
been balanced against the wages paid nor the record of production.
- Spoilage is a substantial factor in both
- The machine shop and the plastic division
are in separate parts of the one building.
- The company has a satisfactory system of
general ledger accounting.
Required: A method or methods
for obtaining factory costs, explaining why they are considered the most
satisfactory under the circumstances.
Regardless of what cost system is installed,
three changes should be made in the company's methods:
- A control should be established over
materials. Requisitions should be used.
- Factory overhead should be segregated
between the two divisions. Direct departmental charges should be made as
much as possible. Common costs should be apportioned to each department on
an equitable basis.
- Clock cards should be balanced with
employees' time sheets.
If these matters are resolved satisfactorily,
the costs might be obtained as follows:
Machine Shop. The product seems to be
custom item so that job costing seems appropriate. Overhead should be
charged to the product on some predetermined basis.
Plastic Division. It seems that job
order costing system is also possible here. The overhead might be charged to
the product on different bases if the machine used would suggest
different rates. This might make possible the creation of cost centers.
General. Any cost system should permit
comparison with estimated figures.