Managerial Accounting & Cost Concepts
Managerial vs. Financial Accounting
Same company, same transactions, two completely different reporting jobs. Financial accounting produces reports for people outside the company — investors, creditors, the IRS. Managerial accounting produces reports for people inside the company — the managers who have to plan, control, and decide.
That single difference (who reads it) drives every other difference. Outsiders need reports they can trust and compare across companies, so financial accounting is rule-bound, historical, and covers the whole company. Insiders need reports that help them act, so managerial accounting is flexible, forward-looking, and drills down into segments.
The Comparison You'll Be Tested On
| Dimension | Financial Accounting | Managerial Accounting |
|---|---|---|
| Audience | External — investors, creditors, regulators | Internal — managers, supervisors |
| Purpose | Report on past performance & financial position | Planning, controlling, decision-making |
| Rules | Must follow GAAP / IFRS | No GAAP required — whatever is useful |
| Time orientation | Historical (what happened) | Future-focused (estimates, budgets, forecasts) |
| Scope / detail | Company-wide summary | Segments: products, departments, jobs, customers |
| Timeliness vs. precision | Precision & verifiability emphasized | Timeliness & relevance emphasized (a good estimate now > a perfect number later) |
| Frequency | Quarterly / annual | As often as needed — daily, weekly, on demand |
| Mandatory? | Yes, for public companies | No — purely optional, done because it's useful |
| Audited? | Yes, by independent CPAs | No |
Financial = Foreign eyes, Formal rules, Facts from the past.
Managerial = Managers, Make decisions, Might-happen future.
"Relevance vs. precision" gets flipped constantly. Managerial accounting deliberately sacrifices precision for relevance and speed — a manager would rather have a rough number today than an exact number next month. Financial accounting is the opposite.
Check yourself — which one?
1. A report showing profitability of the Columbus store only, prepared weekly for the regional manager. → Managerial (segment, internal, frequent).
2. An audited balance sheet filed with the SEC. → Financial (external, GAAP, audited).
3. A budget projecting next year's factory utilities. → Managerial (future, internal, not GAAP).
4. Which is legally required? → Financial accounting. Managerial is optional.
Costs for Decision Making: Opportunity, Sunk, Differential
These three exist only because managers make choices. They aren't cost categories on a financial statement — you will never see "Opportunity Cost" as a line item. They're labels that tell you whether a number belongs in your decision at all.
Opportunity Cost
Definition: the potential benefit you give up when you choose one alternative over another. It's the value of the best option you didn't take.
- Example: You work a shift at Sweetbriar earning $120, or you go to a concert. The opportunity cost of the concert is the $120 of wages you gave up.
- Example: A factory uses a machine to make Product A. That same machine could have produced $40,000 of contribution margin on Product B. The $40,000 is the opportunity cost of making Product A.
- Example: Using a warehouse you own to store inventory instead of renting it out for $5,000/month. Opportunity cost = $5,000/month.
Opportunity costs are never recorded in the accounting records — no cash changes hands — but they are always relevant to a decision. If a question asks "should this be considered?", the answer for opportunity cost is yes.
Sunk Cost
Definition: a cost that has already been incurred and cannot be changed by any future decision. It is always irrelevant.
- Example: You paid $400,000 for a machine two years ago. Whether you keep it or scrap it, that $400,000 is gone. Sunk.
- Example: $60,000 already spent on R&D for a product you're deciding whether to launch. Sunk — ignore it.
- Example: The non-refundable $85 you paid for a ticket to a game you no longer want to attend.
Book value of an old asset (original cost minus accumulated depreciation) is a sunk cost — irrelevant to a keep-or-replace decision. The disposal/salvage value you could get for it, however, is relevant, because that amount still depends on what you decide.
Differential / Incremental Cost
Definition: the difference in cost between two alternatives. "Incremental" usually means the increase; "avoidable" means it goes away if you don't do it. Same idea: a cost that changes because of the decision.
- Differential revenue = difference in revenue between alternatives.
- Differential cost = difference in cost between alternatives.
- Differential revenue − differential cost = the net benefit of switching.
When a question gives you a fixed cost and a variable cost and asks what the incremental cost of producing more units is, the answer is the variable cost. Total fixed cost doesn't change within the relevant range, so it contributes zero to the incremental cost of one more unit. The incremental cost of n extra units = variable cost per unit × n.
A company currently makes 10,000 units. Variable cost is $6 per unit and total fixed cost is $80,000. What is the incremental cost of producing 6,000 more units?
Show solution
Fixed cost contributed nothing to the incremental amount. That's the entire point of the question.
Direct vs. Indirect Costs
Before you can call a cost direct or indirect, you have to name the cost object — the thing you're measuring the cost of. A cost object can be a product, a job, a department, a store, a customer, anything. The same cost can be direct to one object and indirect to another.
| Type | Definition | Examples |
|---|---|---|
| Direct cost | Can be easily and conveniently traced to a specific cost object. | Wood in a table (object = the table); wages of the worker assembling Job 214 (object = Job 214); salary of the Columbus store manager (object = Columbus store) |
| Indirect cost | Cannot be easily and conveniently traced to the cost object; must be allocated using some reasonable base. | Factory rent, factory utilities, factory insurance, the plant supervisor's salary, glue and screws, depreciation on factory equipment |
| Common cost | A specific kind of indirect cost: one cost that supports several cost objects at once and can't be traced to any one of them individually. | The factory building's rent shared by three product lines; a CEO's salary shared by all divisions |
"Easily and conveniently." It's not about whether tracing is possible — you could theoretically count the exact drops of glue in one chair. It's about whether it's worth the effort. If tracing costs more than the information is worth, it's indirect.
The factory supervisor's salary:
- Cost object = one individual product → indirect (she supervises everything, can't trace to one unit)
- Cost object = the manufacturing department → direct (she works only for that department)
Always read what the cost object is before answering.
Check yourself — direct or indirect?
Cost object = one bicycle made by a bike manufacturer.
- Steel tubing for the frame → Direct (traceable material)
- Wages of the assembler who builds it → Direct (traceable labor)
- Lubricant used on all machines → Indirect (not worth tracing — indirect material)
- Factory janitor's wages → Indirect (indirect labor)
- Depreciation on the frame-welding machine → Indirect (allocated across all bikes)
- Salary of the bike company's CFO → Indirect to the bike — and it's a period cost, not manufacturing at all
Product Costs vs. Period Costs
This classification answers one question: when does the cost hit the income statement?
The Three Product Costs (memorize this list)
| Component | What it is | Examples |
|---|---|---|
| Direct Materials (DM) | Raw materials that become an integral part of the finished product and can be easily traced to it | Steel in a car, flour in bread, fabric in a shirt, the circuit board in a laptop |
| Direct Labor (DL) | Labor costs that can be easily traced to individual units — "touch labor" | Assembly-line worker wages, machine operator wages, carpenter building the cabinet |
| Manufacturing Overhead (MOH) | All other manufacturing costs — everything that happens inside the factory that isn't DM or DL | Indirect materials, indirect labor, factory rent/utilities/insurance/depreciation, factory supervisor salary, factory maintenance |
Ask: "Did this cost happen inside the factory?" If yes, and it isn't DM or DL, it's MOH. If it happened in the office or in sales, it's a period cost — it never enters inventory.
Same Cost, Different Answer — the classic trap pairs
| Cost | Classification |
|---|---|
| Depreciation on factory equipment | Product cost → MOH |
| Depreciation on office equipment | Period cost → Administrative |
| Factory utilities / rent / insurance | Product cost → MOH |
| Office or showroom utilities / rent / insurance | Period cost |
| Production supervisor's salary | Product cost → MOH (indirect labor) |
| Sales manager's salary | Period cost → Selling |
| Wages of assembly-line workers | Product cost → Direct labor |
| Wages of the factory janitor / security guard / materials handler | Product cost → MOH (indirect labor) |
| Sales commissions, advertising, delivery to customers | Period cost → Selling |
| Glue, screws, lubricants, sandpaper | Product cost → MOH (indirect materials) |
Product costs are also called inventoriable costs. They can sit on the balance sheet for months. If a company makes 1,000 units but sells only 700, the product costs of the 300 unsold units stay in Finished Goods Inventory — they are not expensed. All period costs for the year, however, are expensed this year regardless of what sold.
Check yourself — classify these
- Cost of the leather in a sofa → Product / DM
- Thread used in the sofa (tiny cost, not traced) → Product / MOH (indirect materials)
- Wages of the sofa upholsterer → Product / DL
- Property taxes on the factory → Product / MOH
- Property taxes on the corporate headquarters → Period / Admin
- Shipping the finished sofa to the customer → Period / Selling
- Shipping raw leather in to the factory → Product / DM (freight-in becomes part of materials cost)
Prime Cost vs. Conversion Cost
These are just two ways of grouping the three product costs. Nothing new gets added — you're re-slicing DM, DL, and MOH.
DL appears in prime cost and conversion cost. That means Prime + Conversion ≠ Total Product Cost — you'd be double-counting direct labor. If a problem gives you prime and conversion and asks for total product cost:
PRIME = the PRIMary, traceable stuff (materials + the hands that touch it).
CONVERSION = what it takes to convert material into product (labor + the factory around it). Materials aren't part of converting — they're the thing being converted.
A company reports: Direct materials $85,000 · Direct labor $60,000 · Manufacturing overhead $95,000.
Compute prime cost, conversion cost, and total product cost. Then: if prime cost is $145,000 and conversion cost is $155,000, what is MOH?
Show solution
Variable, Fixed, and Mixed Costs
Cost behavior means: what happens to this cost when activity goes up? Activity could be units produced, machine-hours, direct labor-hours, miles driven, patients seen. Every cost behavior question has two halves — in total and per unit — and they almost always behave oppositely.
Variable Cost
Definition: total cost changes in direct proportion to activity. Per unit, it stays constant.
Examples: direct materials, direct labor (when paid per unit), sales commissions, shipping costs per package, cups and lids at a coffee shop, electricity to run production machines.
Fixed Cost
Definition: total cost stays constant regardless of activity (within the relevant range). Per unit, it decreases as activity rises, because you're spreading the same dollars over more units.
Examples: factory rent, straight-line depreciation, the plant manager's salary, property taxes, insurance, an annual software license.
Relevant range: the band of activity over which the fixed-cost assumption actually holds. Make 10× more units and you'd need a second building — rent would jump. Fixed means fixed inside the relevant range only.
Mixed (Semi-Variable) Cost
Definition: contains both a fixed component and a variable component. Total cost rises as activity rises, but not proportionally — the line starts above zero.
Examples: a utility bill with a $2,500 base charge plus $0.35 per machine-hour; a cell plan with a flat fee plus per-GB overage; a salesperson paid a base salary plus commission; equipment rental with a flat fee plus per-hour charge; maintenance costs.
The Behavior Table — the single most-tested thing in Ch. 1
| Cost type | TOTAL cost as activity ↑ | PER-UNIT cost as activity ↑ |
|---|---|---|
| Variable | Increases proportionally | Stays constant |
| Fixed | Stays constant | Decreases |
| Mixed | Increases, but not proportionally | Decreases (because of the fixed piece) |
Variable and fixed are mirror images. Draw an X:
Variable: total moves ↗, per unit flat →
Fixed: total flat →, per unit moves ↘
Whatever is constant in total is variable per unit, and vice versa.
"Fixed cost per unit" is the most dangerous number in managerial accounting. It looks like a per-unit cost you can multiply, but it changes every time volume changes. Never use average fixed cost per unit to predict the cost of extra units — the extra units cost you only the variable amount.
Y = a + bX, and the Cost-Per-Unit Computations
Every mixed cost can be written as a straight line. This one equation runs through the whole course — you'll use it again in Ch. 2 to estimate total manufacturing overhead.
If a problem says "Utilities cost $2,500 per month plus $0.35 per machine-hour," then a = $2,500 and b = $0.35, so Y = 2,500 + 0.35X. At 20,000 machine-hours: Y = 2,500 + 0.35(20,000) = 2,500 + 7,000 = $9,500. Of that, $2,500 is fixed and $7,000 is variable.
The Four Computations
Buckeye Co. has variable costs of $6.00 per unit and total fixed costs of $80,000. Fill in the grid at 10,000 units and at 16,000 units, and explain each movement.
Show solution
| Measure | 10,000 units | 16,000 units | Direction |
|---|---|---|---|
| Total variable cost | $60,000 | $96,000 | ↑ Increases proportionally |
| Average variable cost / unit | $6.00 | $6.00 | → Constant |
| Total fixed cost | $80,000 | $80,000 | → Constant |
| Average fixed cost / unit | $8.00 | $5.00 | ↓ Decreases |
| Total cost (Y) | $140,000 | $176,000 | ↑ Increases, not proportionally |
| Average total cost / unit | $14.00 | $11.00 | ↓ Decreases |
Why average total cost fell $3.00: entirely from fixed cost spreading ($8.00 → $5.00). The variable piece never moved. That's the whole lesson.
If you're given total cost at one volume and asked for total cost at another, do not scale the whole thing. Break it into fixed and variable first, scale only the variable piece, then add the fixed back. Scaling $140,000 by 1.6 gives $224,000 — wrong by $48,000.
Traditional vs. Contribution Format Income Statement
Two income statements, same company, same period, same bottom line. The only difference is how the costs are grouped on the way down.
| Traditional Format | Contribution Format |
|---|---|
| Organized by function: production vs. selling & admin | Organized by behavior: variable vs. fixed |
| Required for external reporting (GAAP) | Used internally for management decisions |
| Key subtotal: Gross Margin | Key subtotal: Contribution Margin |
| Can't tell how costs will change with volume | Built for CVP analysis, break-even, what-if decisions |
CM = the dollars left after covering variable costs. Those dollars go first to cover fixed costs; anything past that is profit. That's why it's called "contribution" — it's what each sale contributes toward fixed costs and profit.
CM per unit = Selling price per unit − Variable cost per unit.
Scarlet Co. sold 10,000 units at $25. Manufacturing costs: variable $100,000, fixed $40,000. Selling & administrative: variable $20,000, fixed $50,000. Prepare both formats.
Show solution
Traditional format (group by function):
| Sales (10,000 × $25) | $250,000 |
| Cost of goods sold ($100,000 variable + $40,000 fixed mfg) | 140,000 |
| Gross margin | 110,000 |
| Selling & administrative ($20,000 variable + $50,000 fixed) | 70,000 |
| Net operating income | $40,000 |
Contribution format (group by behavior):
| Sales | $250,000 |
| Variable expenses ($100,000 mfg + $20,000 S&A) | 120,000 |
| Contribution margin | 130,000 |
| Fixed expenses ($40,000 mfg + $50,000 S&A) | 90,000 |
| Net operating income | $40,000 |
Gross margin ≠ contribution margin. Gross margin subtracts all manufacturing costs (variable and fixed). Contribution margin subtracts all variable costs (manufacturing and selling/admin). They're slicing the same pile along different lines.
Job-Order Costing: Calculating Unit Product Costs
What Costs Get Applied as MOH — and Why We Estimate
In job-order costing, DM and DL are traced directly to each job — you know exactly how much steel and how many labor-hours went into Job 214. Manufacturing overhead can't be traced, so it must be applied using a rate.
What Goes Into MOH
All indirect manufacturing costs — everything in the factory that isn't direct materials or direct labor:
| Category | Examples |
|---|---|
| Indirect materials | Glue, screws, solder, lubricants, sandpaper, cleaning supplies, small parts not worth tracing |
| Indirect labor | Factory supervisors, janitors, security guards, maintenance techs, materials handlers, quality inspectors, idle time, overtime premium |
| Factory facility costs | Factory rent, factory utilities, factory property taxes, factory insurance |
| Factory equipment | Depreciation on factory buildings & machinery, equipment repairs and maintenance |
These are period costs and never enter manufacturing overhead, no matter how tempting:
- Sales commissions and salaries
- Advertising
- Administrative / executive salaries
- Depreciation on office equipment or the sales showroom
- Office rent, office utilities, office supplies
- Shipping finished goods to customers
A problem will hand you a list of 12 costs and expect you to pick out only the factory ones. Sort every line with the question: factory floor, or office?
Why a PREDETERMINED Rate? (three reasons)
- Actual overhead isn't known until year-end. Managers need job costs now — for bidding, pricing, decisions.
- Actual overhead is incurred unevenly. Heating bills spike in January; a big repair hits in March. A job finished in January shouldn't be charged more overhead than an identical job in July.
- Actual output varies month to month. A slow month would spread fixed overhead over few units and make the same product look wildly more expensive.
The fix: set one rate before the year begins, based on estimates, and use it all year long. That's the predetermined overhead rate.
This approach is called normal costing: actual direct materials + actual direct labor + applied overhead (estimated rate × actual activity). Two of the three pieces are actual; only overhead is estimated.
Estimating Total MOH (a Mixed Cost) & the Predetermined Rate
Total manufacturing overhead is itself a mixed cost — part of it is fixed (rent, depreciation, supervisor salary) and part varies with activity (utilities to run machines, indirect materials). So you estimate it with the same equation from Module 07.
- Every number in the POHR formula is an ESTIMATE. Nothing actual goes in the rate.
- The rate is computed before the period begins and used for the whole period.
- The allocation base (X) should be whatever drives overhead — direct labor-hours in a labor-heavy shop, machine-hours in an automated one.
- The same X appears in both steps: you use estimated activity to estimate the cost, then divide by that same estimated activity.
Buckeye Machining estimates fixed manufacturing overhead of $120,000 for the year, plus variable manufacturing overhead of $3.00 per direct labor-hour. It expects to work 40,000 direct labor-hours. Compute estimated total MOH and the predetermined overhead rate.
Show solution
Don't forget to multiply the variable rate by the estimated activity before adding the fixed piece. Students routinely compute $120,000 + $3.00 = $120,003 or just divide $120,000 by 40,000 and stop. Write out Y = a + bX every single time.
If the question gives you variable overhead per unit of product but the allocation base is machine-hours, convert first. Everything in the equation must be in the same activity unit.
Applying Overhead: The Plantwide (Factory-Wide) Rate
Once you have the rate, applying overhead is one multiplication — but notice which number is estimated and which is actual.
The RATE is estimated. The ACTIVITY is actual. Estimated activity is used only to build the rate — it is never used again after that. Once the rate exists, every application uses actual hours/units.
A "Plantwide" or "Factory-Wide" Rate
One single rate for the entire factory. You add up estimated overhead from every department, divide by estimated activity from every department, and get one rate that every job pays regardless of which department it passes through.
Buckeye Machining's POHR is $6.00 per DLH (from Module 10). During the year the factory actually worked 38,000 direct labor-hours. How much overhead was applied for the year?
Show solution
Plantwide Rate Across Two Departments
Here's the version your review sheet calls out. Buckeye has two departments, but still uses one factory-wide rate. You sum both departments' estimates to build the rate, then apply it to a job using that job's total activity across both departments.
Buckeye Machining has two departments. Estimates for the year:
| Department | Est. MOH | Est. DLH | Est. Machine-Hours |
|---|---|---|---|
| Molding | $180,000 | 25,000 | 30,000 |
| Assembly | $60,000 | 15,000 | 5,000 |
| Total | $240,000 | 40,000 | 35,000 |
Job 214 actually used: Molding — 20 DLH and 60 machine-hours; Assembly — 40 DLH and 2 machine-hours.
Using a single plantwide rate based on direct labor-hours, how much overhead is applied to Job 214?
Show solution
Why this matters: Molding is machine-intensive but only uses 25,000 of the 40,000 labor-hours. A plantwide DLH rate charges Molding jobs based on labor they barely use — so machine-heavy jobs get undercosted and labor-heavy jobs get overcosted. That's the setup for Module 12.
With a plantwide rate and two departments, add the job's hours across departments and multiply once. Don't compute a separate rate per department — that's a different question (Module 12). Read carefully whether the problem says "plantwide/factory-wide" or "departmental/multiple rates."
Multiple Predetermined Overhead Rates (Departmental)
A plantwide rate assumes one activity drives all the overhead in the whole factory. That's usually false. A multiple predetermined overhead rate system gives each department its own rate, with its own allocation base — machine-hours where machines drive costs, labor-hours where people do. More accurate, more work.
- Compute a separate rate for each department using that department's own estimates and that department's own base.
- Multiply each rate by the job's actual activity in that department.
- Add the department amounts together for the job's total applied overhead.
Same Buckeye data, but now each department gets its own rate. Molding allocates overhead on machine-hours; Assembly allocates on direct labor-hours.
| Department | Est. MOH | Allocation base | Est. base activity |
|---|---|---|---|
| Molding | $180,000 | Machine-hours | 30,000 MH |
| Assembly | $60,000 | Direct labor-hours | 15,000 DLH |
Job 214 actually used: Molding — 60 machine-hours; Assembly — 40 direct labor-hours.
Show solution
| Method | OH applied to Job 214 |
|---|---|
| Plantwide rate ($6.00/DLH × 60 DLH) | $360 |
| Departmental rates ($360 + $160) | $520 |
| Difference | $160 |
Job 214 is machine-heavy in Molding. The plantwide DLH rate undercosted it by $160. If Buckeye priced this job off the plantwide number, it under-bid by $160 of real cost on every unit batch — that's the practical argument for departmental rates.
Each department's rate must be divided by its own base — don't accidentally divide Molding's overhead by total factory hours. And when applying, use the job's hours in that department only, measured in that department's base. Molding's 20 DLH are irrelevant if Molding allocates on machine-hours.
Plantwide and departmental rates give the same total overhead for the factory as a whole, but different amounts per job. The split changes; the pie doesn't.
Total Job Cost, Unit Product Cost, and Sales Price
This is the payoff of the whole chapter — and it's usually the last part of a multi-part problem, so getting the rate right earlier is what earns these points.
Problems often give you direct labor hours and a wage rate separately. Direct labor cost = hours × wage rate. Then those same hours may also be the allocation base for overhead. One number, two jobs — don't mix up the labor cost with the overhead applied.
Job 214 at Buckeye Machining (plantwide rate, $6.00 per DLH):
- Direct materials requisitioned: $1,200
- Direct labor: 60 hours at $22.00 per hour
- Job produced 40 units
- Company prices jobs at cost plus a 60% markup
Compute total job cost, unit product cost, and sales price per unit.
Show solution
| Direct materials | $1,200.00 |
| Direct labor (60 hrs × $22.00) | 1,320.00 |
| Applied overhead (60 DLH × $6.00) | 360.00 |
| Total job cost | $2,880.00 |
Same job under departmental rates (overhead $520 instead of $360):
"Cost plus 60% markup" means multiply cost by 1.60. It does not mean the price is such that profit is 60% of the price. If a question instead says "a 60% gross margin" or "markup on sales price," that's price = cost ÷ (1 − 0.60). Read the wording.
Never put selling or administrative costs into a job cost. Only DM, DL, and applied MOH. Sales commission on the job? Period cost. Excluded.
Job-Order Costing: Cost Flows & External Reporting
The Flow of Costs and the Type of Each Account
Manufacturing costs move through three inventory accounts in a strict order, then become an expense. Draw this on your scratch paper the second the exam starts.
Account Types
| Account | Type | What sits in it / normal balance |
|---|---|---|
| Raw Materials | Asset (inventory) | Materials purchased but not yet used. Debit balance. Balance sheet. |
| Work in Process (WIP) | Asset (inventory) | Jobs started but not finished — holds their DM + DL + applied MOH. Debit balance. Balance sheet. |
| Finished Goods | Asset (inventory) | Completed jobs not yet sold. Debit balance. Balance sheet. |
| Manufacturing Overhead | Clearing / temporary | Not a real asset or expense. Debited for ACTUAL overhead, credited for APPLIED overhead. Closed to zero at year-end. |
| Cost of Goods Sold | Expense | Cost of units actually sold. Debit balance. Income statement. |
| Selling & Admin Expense | Expense | Period costs, expensed immediately. Never goes through inventory. |
Selling and administrative costs never enter Raw Materials, WIP, Finished Goods, or MOH. They go straight to expense. When a problem lists "depreciation, $80,000 — of which 75% is factory and 25% is office," only the factory 75% is debited to MOH. The office 25% is debited to Depreciation Expense.
Say it out loud. DA-CA. Actual overhead costs flow in on the debit side; applied overhead flows out to WIP on the credit side. Every MOH question is answered by knowing which side a number belongs on.
The Full Set of Journal Entries
Nine entries cover the entire manufacturing cycle. Learn them in order — each one is just the flow diagram written as a debit and a credit.
| # | Event | Journal Entry |
|---|---|---|
| 1 | Purchase raw materials | DR Raw Materials |
| 2 | Issue materials to production | DR Work in Process (direct materials) |
| 3 | Record factory labor | DR Work in Process (direct labor) |
| 4 | Incur other actual factory overhead | DR Manufacturing Overhead |
| 5 | Apply overhead to jobs | DR Work in Processamount = POHR × actual activity |
| 6 | Incur selling & admin costs | DR Selling Expense / Admin ExpenseNOT overhead — never touches WIP |
| 7 | Jobs completed | DR Finished Goodsamount = Cost of Goods Manufactured |
| 8 | Goods sold (two entries) | DR Accounts Receivable / CashDR Cost of Goods Sold |
| 9 | Close under/overapplied overhead | If UNDERapplied:DR Cost of Goods SoldIf OVERapplied: DR Manufacturing Overhead |
Entry 4 (actual overhead) debits MOH. Entry 5 (applied overhead) credits MOH. They are separate entries, made at different times, for different amounts. Applying overhead never touches Cash or Payables — it only moves a number from the MOH clearing account into WIP.
Recording a sale requires both the revenue entry (at selling price) and the cost entry (at cost). Losing the second entry is one of the most common points lost on this exam.
Scarlet Fabrication for the year: purchased raw materials $145,000 on account; requisitioned $141,000 of materials, of which $9,000 was indirect; incurred factory labor of $190,000 ($155,000 direct, $35,000 indirect); incurred factory utilities $28,000 (on account) and recorded factory equipment depreciation $62,000; applied overhead of $144,000; incurred sales commissions of $50,000 in cash. Write the entries.
Show solution
The Schedules & Under/Overapplied Overhead
The schedules are just the T-accounts written vertically. Every one of them follows the identical pattern: Beginning + Additions − Ending = What left the account.
Under- vs. Overapplied Overhead
UNDER = ADD. OVER = SUBTRACT. Under-applied means you under-charged your jobs, so costs are too low — add the shortfall back. Over-applied means you over-charged, so costs are too high — take it out.
Or think about the direction of the entry: underapplied leaves a debit balance in MOH, so you close it with a debit to COGS (COGS goes up). Overapplied leaves a credit balance, closed with a credit to COGS (COGS goes down).
If a question asks about the effect: underapplied overhead increases COGS, which decreases gross margin and decreases net operating income. Overapplied does the reverse — decreases COGS, increases net operating income. And yes, a journal entry is required; MOH must be closed to zero.
Scarlet Fabrication, for the year just ended. POHR is $6.00 per machine-hour; actual machine-hours were 24,000.
| Item | Beginning | Ending |
|---|---|---|
| Raw materials inventory | $18,000 | $22,000 |
| Work in process inventory | $30,000 | $25,000 |
| Finished goods inventory | $40,000 | $36,000 |
During the year: raw material purchases $145,000; indirect materials used $9,000; direct labor $155,000; indirect labor $35,000; factory utilities $28,000; factory equipment depreciation $62,000; factory insurance $18,000. Also: sales commissions $50,000, administrative salaries $70,000, office equipment depreciation $12,000, advertising $25,000.
Required: (a) direct materials used, (b) actual total MOH, (c) applied MOH and whether over/underapplied, (d) COGM, (e) unadjusted COGS, (f) adjusted COGS, (g) the closing journal entry.
Show solution
(a) Materials used in production
(b) Actual manufacturing overhead — factory costs only
(c) Applied overhead & the variance
(d) Cost of goods manufactured
(e) Unadjusted cost of goods sold
(f) Adjusted cost of goods sold
(g) Closing journal entry
- Using actual MOH in the COGM schedule. It's always applied. Actual overhead only shows up when you compute the over/under variance.
- Forgetting to subtract indirect materials. "Raw materials used" includes both direct and indirect. Only the direct portion goes into COGM; the indirect portion goes to MOH.
- Flipping the beginning/ending signs. Beginning inventory is always ADDED, ending inventory is always SUBTRACTED, in all three schedules. No exceptions.
Problems love to give you COGM and ask for ending WIP, or give you COGS and ask for beginning FG. Every schedule is a four-variable equation — write out the whole schedule with a blank in the unknown spot and solve. Never try to do it in your head.
Formula Sheet
Chapter 1 — Cost Concepts & Behavior
Chapter 2 — Job-Order Costing
Chapter 3 — Cost Flows
Flashcards
One-Page Cheat Sheet
Managerial vs. Financial
- Internal vs. external users
- No GAAP vs. GAAP required
- Future vs. past
- Segments vs. whole company
- Relevance/timeliness vs. precision
- Optional vs. mandatory & audited
Decision Costs
- Opportunity = benefit given up; never recorded; always relevant
- Sunk = already spent; always irrelevant (book value is sunk)
- Differential/incremental = the change between alternatives = the variable cost
Direct vs. Indirect
- Direct = easily and conveniently traced to the cost object
- Indirect = must be allocated
- Common cost = indirect cost shared by several objects
- Answer depends on the cost object — read it first
Product vs. Period
- Product = DM + DL + MOH → inventory → COGS when sold
- Period = selling + admin → expensed now
- Test: factory floor or office?
- Prime = DM + DL · Conversion = DL + MOH
- DL is in both — don't double count
Cost Behavior (memorize)
- Variable: total ↑ proportional · per unit constant
- Fixed: total constant · per unit ↓
- Mixed: total ↑ not proportional · per unit ↓
- Y = a + bX → a = total FC, b = VC/unit, X = activity, bX = total VC
Income Statements
- Traditional: by function → Gross Margin
- Contribution: by behavior → Contribution Margin
- Same net operating income both ways
- GM subtracts all mfg; CM subtracts all variable
The POHR
- Est. total MOH ÷ Est. total activity
- All estimates, computed before the year
- Est. MOH is mixed → Y = a + bX
- Applied = rate × ACTUAL activity
- Plantwide: one rate, sum the job's hours across depts
- Departmental: each dept's own rate & base, then add
Job Costing Math
- Total job cost = DM + DL + applied MOH
- Unit cost = total job cost ÷ units
- Price = unit cost × (1 + markup)
- No selling/admin in a job cost, ever
The Flow
- RM → WIP → FG → COGS
- RM, WIP, FG = assets · COGS = expense
- MOH = clearing account, closed to zero
- Debit actual, credit applied
- S&A costs never enter the flow
Key Journal Entries
- Issue materials: DR WIP + DR MOH / CR RM
- Labor: DR WIP + DR MOH / CR Wages Payable
- Apply OH: DR WIP / CR MOH
- Complete: DR FG / CR WIP
- Sell: DR A/R / CR Sales and DR COGS / CR FG
The Schedules
- Pattern: Beg + Additions − End
- RM used = Beg RM + Purch − End RM
- DM = RM used − indirect materials
- COGM = DM + DL + applied MOH + Beg WIP − End WIP
- COGS = Beg FG + COGM − End FG
Over / Under Applied
- Actual − Applied
- UNDER = ADD to COGS · DR COGS, CR MOH · NOI ↓
- OVER = SUBTRACT from COGS · DR MOH, CR COGS · NOI ↑
- A JE is always required — MOH must end at zero