Cost Allocations

...

and COGS is common. Uses of end of year balances as the

basis

• Re‐computing rates is most accurate. Easy if system is computerized

B&S 9

Comparison of disposition methods

10

•Write off all to COGS is least accurate

• Proration is better

• Correcting rates is most accurate

WIP

Inventory FG Inventory COGS

Write off to COGS X

Proration (allocation) X X X

Actual rates (assignment) X X X

 Ramji Balakrishnan

7/28/2015

6

Regardless of method, the effect is the same

11

• Under‐applied overhead

• We charged jobs too little for overhead (Actual > Applied)

• We correct by charging under‐applied amount

• Will increase COGS  (and therefore lower net income)

• Will increase inventory values (under proration)

• Over‐applied overhead

• Works in the opposite direction

• As a manager, which would you rather have at year end?

• How can you increase the chance of being at the desired spot?

Job order costing example

12

Machining Assembly Total

Budgeted Mfg. overhead $4,000,000 $3,080,000 $7,080,000

Actual Mfg. overhead $4,260,000 $3,050,000 $7,310,000

Budgeted direct labor cost $1,500,000 $5,600,000 $7,100,000

Actual direct labor cost $1,450,000 $5,780,000 $7,230,000

Budgeted machine hours 400,000 100,000 500,000

Actual machine hours 425,000 110,000 535,000

B&S

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Pictorial representation

B&S 13

Resource costs

Product A Product B

Pool 1 Pool 2

From financial

records

Costs traced /

allocated to

pools.

Costs allocated

to products

Choose a driver

Calculate total

Compute rate

Product cost of A = Inventoriable cost =

Direct materials + Direct labor + Allocated

overhead (sum over all pools)

Application to example

B&S 14

Resource costs

$7,080,000

Product A

Est. cost:

Product B

Est. cost:

Machining

$4,000,000

Assembly

$3,080,000

Driver: Labor cost

Denominator: $5.60 MM

Driver: Machine hours

Denominator: 400K hours

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Job order costing example

• Predetermined overhead rate (machining) =

• Predetermined overhead rate (assembly) =

• We can use these rates to value

• A new or an existing product

• A specific job / contract

• Inventories (in the aggregate)

15

$10 / machine hr. =

$4,000,000 / 400,000 hrs.

55% of labor cost =

$3,080,000 / $5,600,000

B&S

Using OH rates to value inventory

16

Machining Assembly Total

Direct materials $24,500 $6,700 $31,200

Direct labor 27,900 58,600 86,500

Machine hours 360 150

B&S

Suppose we have following data on ending WIP.  What is its value in

the balance sheet? (i.e., after allocating overhead?)

Machining Assembly Total

Direct materials $24,500 $6,700 $31,200

Direct labor 27,900 58,600 86,500

Overhead 3,600 32,230 35,830

Total value $153,530

Solution:

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Job order costing example

• Overhead under‐applied or over‐applied in machining?

• Overhead under‐applied or over‐applied in assembly?

17

Applied overhead $10 / m. hr * 425,000