6

Fundamentals of Product and Service Costing

Solutions to Review Questions

6-1.
Cost allocation is the assignment of costs in cost pools to cost objects. The cost objects
may be products, services, customers, processes, or anything for which we want to
know the cost. Product costing uses cost allocation to calculate product costs. Product
costing is an application of cost allocation where products are the cost objects.
6-2.
Cost management systems should satisfy the following criteria:

Cost systems should have a decision focus.

Different cost information is used for different purposes.

Cost information for managerial purposes must meet the cost-benefit test.

6-3.
Cost flow diagrams serve two purposes. First, they help describe how a cost
management system works, just like a flow chart helps you understand how a process
works. Second, cost flow diagrams help managers identify and understand quickly the
effect of changes in the system design on reported costs.
6-4.
A job costing accounting system traces costs to individual units or to specific jobs
(typically custom products). A process costing accounting system is used when identical
units are produced through a series of uniform production steps. Operation costing is
used when goods have some common characteristics (process costing) and some
individual characteristics (job costing).
6-5.
The predetermined overhead rate is the value at which overhead is applied to one unit
of the cost allocation base. It is used in product costing to apply the overhead to the
units produced.
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6-6.
Continuous flow processing is used when a single product is mass produced in a
continuing process. Examples would include products such as paint, gasoline, paper, or
any others that are mass produced in a continuing process.
6-7.
The basic cost flow model appears as follows:
Beginning balance + Transfers in Transfers out = Ending balance
Beginning balance is the balance of inventory at the beginning of the period. Transfers
in represent inventory purchased or transferred in from another department (for
example, raw materials would be goods transferred in to work in process) for the period.
Transfers out are goods transferred from one department to another (for example, work
in process would be transferred out to finished goods). Ending balance represents the
amount of inventory in a department at the end of the accounting period.

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Fundamentals of Cost Accounting

Solutions to Critical Analysis and Discussion Questions

6-8.
Although there may be no one correct way to allocate cost, cost allocation can provide
managers with information about the costs of the resources they use. Ignoring costs that
cannot be directly assigned leads to the possibility that managers forget that it is a real
resource that is being used.
6-9.
There are three important points to consider:
1. The cost system should meet the needs of the users (the decision makers).
2. The cost system must provide the appropriate data for its intended purpose.
Different cost information is used for different purposes.
3. Cost information for managerial purposes must meet the cost-benefit test. The costs
of implementing the system should be less than the benefits derived from the system
(i.e. better decisions).
6-10.
The basic cost flow model is as follows:
Beginning balance + Transfers in Transfers out = Ending balance
This model is used for finding one unknown or for comparing perpetual inventory system
output to a physical inventory count. An example of finding one unknown is if the
beginning balance is known (from the previous period ending balance), transfers in are
known, and ending inventory is counted physicallyand we are asked to find the cost of
goods sold for the period (transfers out).
6-11.
It is sometimes difficult (and frustrating) for managers when the cost accountant says
that the cost depends on the decision being made. Many people feel that there is one
cost that is correct. However, as we saw in Chapter 2, costs behave in different ways
and this behavior is affected by the decision being made.

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6-12.
Reasons to agree with approach: If the products are not contributing to company profits,
then the customers should be eliminated. This will increase overall company profits.
Reasons not to agree with approach: The reported product costs and the associated
product profits depend on the allocation of indirect costs. Under a different allocation
process, the results could be very different. In addition, many of the indirect costs are
unavoidable. If the products are eliminated, the costs will be allocated to the remaining
products.
6-13.
The way the products are defined will depend, at least in part, on the decision the
dean is interested in making. They may be defined as degree programs vs. non-degree
programs. They may be the different degree programs. They might be the credit hour
(although it is unlikely you would be able to get much information at this level).
You might ask about the time frame of the analysis (to determine fixed and variable
costs), the source of the data, and how to treat costs that the school does not directly
pay for but where the school consumes the resources (e.g., university buildings).
This is a very difficult analysis in a university setting because of the high proportion of
common costs and the difficulty in defining products.
6-14.
The two most important criteria in determining an allocation base are (1) causality and
(2) measurability. We would like an allocation base that causes costs. This is rarely
possible, but it is a good criterion to use. Second, we need to be able to measure the
allocation base at reasonable cost.
6-15.
The allocation base determines the costs assigned to the cost objects. If these costs are
used to make decisions and if they are based on inappropriate or improper allocation
bases, they could lead the manager to make bad decisions.
6-16.
There are many reasons why two companies may have different cost systems. First,
they may be in different industries. We saw in the chapter that firms in continuous
process industries have different cost systems than those in discrete manufacturing
industries.
Firms may be pursuing different strategies (cost containment versus product
differentiation) and want different information from the cost system. A third reason is that
some firms may be subject to regulations (for example, utilities) and the regulations
dictate the information needed from the cost system.
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Fundamentals of Cost Accounting

6-17.
A firm can have a two-stage system and use the same allocation base to allocate costs
in the second stage. There will be different costs reported if the allocation base (direct
labor, say) is used differently by the products in the second stage cost pools.

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Solutions to Exercises
6-18. (20 min.) Basic Cost Flow Model: Office Mart.
a. $300,000 (see item 5)
b. $1,240,000 = $1,200,000 + $40,000 (see items 2 & 3)
c. $200,000 (see item 5)
d. $1,340,000. BB + TI TO = EB
$300,000 + $1,240,000 X = $200,000
X = $300,000 + $1,240,000 $200,000
X = $1,340,000

6-19. (20 min.) Basic Cost Flow Model: General Electric

a. $67 million = $16 million + $27 million + (.8 x $30 million)
b. $50.25 million = .75 x $67 million
c. BB + TI TO = EB
0 + $67 million $50.25 million = EB
EB = $16.75 million
6-20. (20 min.) Basic Cost Flow Model.
Based on the basic formula:
BB
+
TI

a. $51,000 + $48,000
b.

$28,400 +

c.

$67,000 + $170,000

TO
$57,000
X
$88,000
X
X
X
X
X

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=
=
=
=
=
=
=
=
=

EB
X
$42,000
$24,800
$24,800 $28,400 + $88,000
$84,400
$56,000
$67,000 + $170,000 $56,000
$181,000

Fundamentals of Cost Accounting

6-21. (20 min.) Basic Cost Flow Model.

Based on the basic formula:
BB
+
TI

TO
A. $250,000 + $260,000 $270,000
X
B. $7,100 +
X
$22,000
X
X
C. $156,000 + $280,000
X
X
X

=
=
=
=
=
=
=
=
=

EB
X
$240,000
$6,200
$6,200 $7,100 + $22,000
$21,100
$128,000
$156,000 + $280,000 $128,000
$308,000

6-22. (20 min.) Basic Cost Flow Model.

Based on the basic formula:
BB
+
TI

TO
A. $14,000 + $12,000 $18,000
X
B. $90,000 +
X
$330,000
X
X
C. $65,000 + $230,000
X
X
X

Solutions Manual, Chapter 6

=
=
=
=
=
=
=
=
=

EB
X
$8,000
$93,000
$93,000 $90,000 + $330,000
$333,000
$30,000
$65,000 + $230,000 $30,000
$265,000

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6-23. (10 min.) Basic Product Costing: Enviro Corporation.

Materials............................................
Labor.................................................
Manufacturing overhead....................
Total cost......................................
Gallons produced ...........................
= Cost per gallon ...............................

$595,000
51,000
204,000
$850,000
1,700,000
$0.50

6-24. (10 min.) Basic Product Costing: Big City Bank.

Labor..................................................
Manufacturing overhead.....................
Total ..............................................
Checks processed...........................
= Cost per check ................................

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$ 17,000
67,000
$ 84,000
1,400,000
$0.06

Fundamentals of Cost Accounting

6-25. (20 min.) Basic Cost Flow Model: Kim and Smith Refiners
a.

Total
Production:
Gallons .........................................
Percentage complete...................
Equivalent gallons .......................
Costs:
Materials ......................................
Labor ..........................................
Manufacturing overhead ..............
Total cost incurred .......................
Cost per equivalent barrel...............
Cost assigned to product ................

180,000

Sold

b.
Work-inProcess,
March 31

176,000

160,000
100%
160,000

20,000
80%
16,000

$ 94,000
24,200
49,000
$167,200
$0.95a
$167,200

$152,000b

$15,200c

a $0.95

= $167,200 176,000 equivalent units.

$152,000 = 160,000 equivalent units x $0.95.
c $15,200 = 16,000 equivalent units x $0.95.
b

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6-26. (20 min.) Basic Cost Flow ModelEthical Issues: Old Tyme Soda
a. and b.
a.

Production:
Barrels..............................................
Percentage complete ......................
Equivalent barrels............................
Costs:
Materials..........................................
Manufacturing overhead..................
Total cost incurred...........................
Cost per equivalent barrel ..................
Cost assigned to product....................

b.
Work-inProcess,
November 30

Total

Sold

10,000

8,800
100%
8,800

1,200
30%
360

$36,960b

$1,512c

9,160
$18,072
20,400
$38,472
$4.20a
$38,472

$4.20 = $38,472 9,160 equivalent units.

$36,960 = 8,800 equivalent units x $4.20.
c $1,512 = 360 equivalent units x $4.20.
b

c. (1) The change in the estimate will cause more cost to be assigned to work-inprocess inventory and less to finished goods. As the finished goods are sold, cost of
goods will be lower and income higher.
(2) Unless the production supervisors estimates are incorrect, the controller should
not change the estimates. He or she has an ethical (and legal) obligation to ensure
that the estimates reflect fairly the results of operations.

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Fundamentals of Cost Accounting

6-27. (15 min.) Process Costing: Van Goe.

a. and b.

Total
Production:
Gallons .........................................
Percentage complete...................
Equivalent gallons .......................
Costs:
Materials ......................................
Conversion costs .........................
Total cost incurred .......................
Cost per equivalent barrel...............
Cost assigned to product ................

100,000

a.
Transferred
to Finished
Goods

b.
Work-inProcess,
January 31

96,000

80,000
100%
80,000

20,000
80%
16,000

$219,200
280,000
$499,200
$5.20a
$499,200

$416,000b

$83,200c

a $5.20

= $499,200 96,000 equivalent units.

$416,000 = 80,000 equivalent units x $5.20.
c $83,200 = 16,000 equivalent units x $5.20.
b

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6-28. (15 min.) Process Costing: Opech, Inc.

a. and b.
a.

Total
Production:
Barrels (millions)..........................
Percentage complete...................
Equivalent barrels (millions).........
Costs:
Materials (millions).......................
Conversion costs (millions)..........
Total cost incurred (millions)........
Cost per equivalent barrel...............
Cost assigned to product ................

200

Shipped

b.
Work-inProcess,
May 31

194

180
100%
180

20
70%
14

$2,500
3,320
$5,820
$30a
$5,820

$5,400b

$420c

a $30

= $5,820 194 equivalent units.

$5,400 = 180 equivalent units x $30.
c $420 = 14 equivalent units x $30.
b

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Fundamentals of Cost Accounting

6-29. (15 min.) Process Costing: Oholics, Ltd.

a. and b.
a.

Total
Production:
Pounds ........................................
Percentage complete...................
Equivalent pounds .......................
Costs:
Materials ......................................
Conversion costs .........................
Total cost incurred .......................
Cost per equivalent pound..............
Cost assigned to product ................

40,000

Sold

b.
Work-inProcess,
April 30

39,200

38,000
100%
38,000

2,000
60%
1,200

$44,000
54,000
$98,000
$2.50a
$98,000

$95,000b

$3,000c

a $2.50

= $98,000 39,200 equivalent units.

$95,000 = 38,000 equivalent units x $2.50.
c $3,000 = 1,200 equivalent units x $2.50.
b

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6-30. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings

Predetermined overhead rate = $34.82 per direct labor hour.

Units produced ......................

Machine-hours.......................
Direct labor-hours..................
Direct materials .....................
Direct labor............................
Manufacturing overhead........
Total Costs ............................

Basic
1,000
4,000
3,000
$10,000
64,500

Burden Rate: .........................

Total overhead ..................
Direct labor-hours............

Dominator
250
2,000
2,000
$3,750
35,500

$174,100
5,000

Total
1,250
6,000
5,000
$13,750
100,000
174,100
$287,850

= $34.82

6-31. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings

Predetermined overhead rate = 174.1% of direct labor cost.

Units produced ......................

Machine-hours.......................
Direct labor-hours..................
Direct materials .....................
Direct labor............................
Manufacturing overhead........
Total Costs ............................
Burden Rate: .........................
Total overhead ..................
Direct labor cost ..............

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Basic
1,000
4,000
3,000
$10,000
64,500

Dominator
250
2,000
2,000
$3,750
35,500

$174,100
$100,000

Total
1,250
6,000
5,000
$13,750
100,000
174,100
$287,850

=174.1%

Fundamentals of Cost Accounting

6-32. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings

Predetermined overhead rate = $29.0167 per machine-hour (rounded).

Units produced ..................

Machine-hours...................
Direct labor-hours..............
Direct materials .................
Direct labor........................
Manufacturing Overhead...
Total Costs ........................
Burden Rate: .....................
Total overhead ..............
Machine-hours.............

Basic
1,000
4,000
3,000
$10,000
64,500

Dominator
250
2,000
2,000
$3,750
35,500

$174,100
6,000

Total
1,250
6,000
5,000
$13,750
100,000
174,100
$287,850

=$29.0167

6-33. (20 Minutes) Cost Flow Diagram: Tiger Furnishings

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6-34. (30 Minutes) Operation Costing: Howrey-David, Inc.

The unit costs are:
Fatboy:............
Screamer: .......

$3,700
$4,700

Number of units .........................

Materials cost per unit ...............
Costs .........................................
Operation costs:
Direct Labor..........................
Indirect materials ..................
Other overhead ....................
Total operation cost.........

Fatboy
1,000
$2,000
$2,000,000

Screamer
2,000
$3,000
$6,000,000

Total
3,000
$ 8,000,000
$ 3,000,000
800,000
1,300,000
$ 5,100,000

Cost per unit in plant ................. ($5,100,000 3,000 units) = $1,700 per unit.
Operation cost
(@ $1,700 per unit) ................... $1,700,000a
Material cost.............................. 2,000,000
Total cost................................... $3,700,000
Number of units .........................
1,000
Unit cost ....................................
$3,700
a

$1,700,000 = 1,000 units x $1,700 per unit.

$3,400,000 = 2,000 units x $1,700 per unit.

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$3,400,000b
6,000,000
$9,400,000
2,000
$4,700

$5,100,000

Fundamentals of Cost Accounting

6-35. (30 Minutes) Operation Costing: Organic Grounds.

The unit costs are:
Star: ................
$8.96
Bucks: .............
$10.96
Number of units .........................
Materials cost per unit ...............
Costs .........................................
Operation costs:
Direct Labor..........................
Indirect materials ..................
Other overhead ....................
Total operation cost.........

Star
10,000
$5.00
$50,000

Bucks
40,000
$7.00
$280,000

Total
50,000
$ 330,000
$ 60,000
17,000
121,000
$198,000

Cost per unit in plant ................. ($198,000 50,000 units) = $3.96 per pound.
Operation cost
(@ $3.96 per unit) .....................
Material cost..............................
Total cost...................................
Number of units .........................
Unit cost ....................................

$39,600a
50,000
$89,600
10,000
$8.96

$39,600 = 10,000 units x $3.96 per unit.

$158,400 = 40,000 units x $3.96 per unit.

Solutions Manual, Chapter 6

$158,400b
280,000
$438,400
40,000
$10.96

$198,000

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Solutions to Problems
6-36. (30 Minutes) Product Costing: Tiger Furnishings
The unit costs are: Basic: $186.79 and Dominator: $404.22
Basic Dominator
Total
Direct materials ............................................................
$10,000
$3,750 $13,750
Direct labor...................................................................64,500
35,500 100,000
Manufacturing overhead
a
(@174.1% of Direct labor cost) ..................................
112,295
61,806 174,100b
Total costs....................................................................
$186,795 $101,056 $287,850b
Units produced ............................................................. 1,000
250
Unit cost .......................................................................
$186.795 $404.22
a

174.1% = $174,100 $100,000.

Adjusted for rounding error.

6-37. (30 Minutes) Product Costing: Tiger Furnishings

The unit costs are: Basic: $190.57 and Dominator: $389.13
Basic
Dominator
Direct materials ......................................................
$ 10,000
$3,750
Direct labor.............................................................64,500
35,500
Manufacturing overhead
a
(@29.0167 per machine-hour) ............................
116,067b
58,033c
Total costs..............................................................
$ 190,567
$97,283
Units produced ....................................................... 1,000
250
Unit cost .................................................................
$ 190.57
$389.13
a

$29.0167 per machine-hour = $174,100 6,000 machine-hours.

$116,067 = 4,000 machine-hours x $29.0167 per machine-hour.

$58,033 = 2,000 machine-hours x $29.0167 per machine-hour.

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Total
$13,750
100,000
174,100
$287,850

Fundamentals of Cost Accounting

6-38. (30 Minutes) Product CostingEthical Issues: Tiger Furnishings

a. The unit costs are different because the two products use the machine hours and
direct labor costs in different proportions. The Basic model is more machine
intensive (it uses relatively more machine hours than labor compared to the
Dominator model). This means that when the company moves to machine hours to
allocate costs, the Basic model will be assigned more overhead costs resulting in
higher reported product costs.
b. Without knowing more about the production process at Tiger Furnishings, it is not
possible to say which of these is better. Because you get different results, it may pay
to use a two stage system to split overhead between that which is driven more by
machine hours and that driven more by direct labor.
c. The allocation base should be chosen on the basis of how overhead is related to
cost. Income is the result of this decision and not the basis for the decision.

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6-39. (30 Minutes) Two-Stage Allocation and Product Costing: Mets Products
a. The overhead rates are $9 per machine hour and 30% of direct-materials cost.

Account
Utilities . .................
Supplies ....................................................
Machine depreciation and maintenance ...
Purchasing and storing materials .............
Miscellaneous............................................
Total overhead ........................................
Total machine hours ...............................
Total materials cost ................................
Overhead rate ...........................................

Machine-Hour
Related
$ 4,000

Materials
Related
$2,800

8,800
3,400
$ 16,200
1,800 hours
$9 / hour

3,200
__________________________
$ 6,000
$20,000
30%

b.
Baseball
Caps
Machine hours used...........................................
1,000

T-shirts
800

Total
1,800

$8,000
2,400

$20,000
6,400

7,200
2,400
$20,000
5,000
$4.00

16,200
6,000
$48,600
15,000

Direct materials costs .

$12,000
Direct labor costs
4,000
Manufacturing overhead costs .
a
Machine-hour related overhead ......................
9,000
b
Materials-related overhead .............................
3,600
Total cost ...........................................................
$28,600
Units produced ..
10,000
Cost per unit.......................................................
$2.86
a

$9,000 = 1,000 machine hours x $9 per machine hour;

$7,200 = 800 machine hours x $9 per machine hour.

$3,600 = $12,000 materials cost x 30%;

$2,400 = $8,000 materials cost x 30%.

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Fundamentals of Cost Accounting

6-40. (30 Minutes) Two-Stage Allocation and Product Costing: Owl-eye

Radiologists
a. The overhead rates are $46 per equipment hour and $50 per direct labor hour.

Account
Utilities . ....................
Supplies .......................................................
Indirect labor and supervision ......................
Equipment depreciation and maintenance ...
Miscellaneous...............................................
Total overhead ...........................................
Total equipment hours ...............................
Total labor hours........................................
Overhead rate ..............................................

EquipmentHour Related
$ 4,800

Direct-Labor
Hour Related
$12,600
20,400

8,400
3,360
$ 16,560
360 hours
$46 per hour

__________________________
$ 33,000
660 hours
$50 per hour

b.

Hospital
Patients
Equipment hours used .......................................240
Direct labor-hours...............................................480

Other
Patients
120
180

Total
360
660

Direct labor costs

$38,400
Overhead costs .
a
Equipment-hour related overhead ..................
11,040
b
Direct labor-hours related overhead ...............
24,000
Total cost ...........................................................
$73,440
Patients ..
640
Cost per patient..................................................
$114.75

$10,800

$49,200

5,520
9,000
$25,320
860
$29.44

16,560
33,000
$98,760
1,500

$11,040 = 240 equipment hours x $46 per equipment hour;

$5,520 = 120 equipment hours x $46 per equipment hour.

$24,000 = 480 direct labor-hours x $50 per direct labor-hour;

$9,000 = 180 direct labor-hours x $50 per direct labor-hour.

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6-41. (40 Minutes) Operation Costing: Vermont Instruments

The unit costs are:
Fin-X: .......
Sci-X: .......

$23
$28

Number of units .........................

Parts cost per unit .....................
Costs .........................................
Operation costs:
Direct Labor..........................
Parts.....................................
Overhead .............................
Total operation cost.........
Cost per unit in plant .................
Operation cost (@ $3 per unit) ..
Material cost..............................
Total cost...................................
Number of units .........................
Unit cost ....................................

Fin-X
10,000
$20
$200,000

Total
50,000
$ 1,200,000
62,000
17,500
70,500
$ 150,000

($150,000 50,000 units) = $3 per unit.

$ 30,000a $ 120,000b
200,000
1,000,000
$ 230,000 $1,120,000
10,000
40,000
$23
$28

$30,000 = 10,000 units x $3 per unit.

$120,000 = 40,000 units x $3 per unit.

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Sci-X
40,000
$25
$1,000,000

$150,000

Fundamentals of Cost Accounting

6-42. (45 Minutes) Accounts Analysis, Two-Stage Allocation, and Product

Costing: Tiger Furnishings
a. Cost Flow Diagram

Overhead

First Stage

Machine-Related
Overhead

Second Stage

Machine Hours

Basic

Solutions Manual, Chapter 6

Direct Labor Cost

Related
Overhead
Direct Labor Cost

Dominator

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6-42 (continued)
b.
Basic
Dominator

$188.00
$400.00

Units Produced...........................................
Machine hours............................................
Direct labor hours.......................................

Basic
1,000
4,000
3,000

Direct materials ..........................................

Direct labor.................................................

$10,000
64,500

Manufacturing Overhead
Utilities...................................................
Supplies ................................................
Training .................................................
Supervision ...........................................
Machine depreciation ............................
Plant depreciation..................................
Miscellaneous .......................................
Total .................................................
Total Costs .................................................
Burden Rates
Machine hour rate .................................
Direct labor cost rate .............................

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Dominator
250
2,000
2,000

Total
1,250
6,000
5,000

$3,750 $ 13,750
35,500 100,000

Machine-hour Direct labor

related
cost related
$1,800
$0
0
5,000
0
10,000
0
25,800
32,000
0
14,200
0
0
85,300
$48,000
$126,100

($48,000 6,000 hours =)

($126,100 $100,000) =

$1,800
5,000
10,000
25,800
32,000
14,200
85,300
174,100
$287,850
$8.00
126.1%

Fundamentals of Cost Accounting

6-42 (continued)
Product Costing
Direct material .........................................
$ 10,000
Direct labor..............................................
64,500
Overhead
Machine-related (@$8 per machine-hour)...... 32,000a
Labor-related (@126.1% direct labor cost)
81,335c
Total overhead .......................................
$113,335
Total cost....................................................
$187,835
Units produced ........................................
1,000
= Unit cost .................................................
= $188
a

$32,000 = 4,000 machine-hours x $8 per machine-hour.

$16,000 = 2,000 machine-hours x $8 per machine-hour.

$81,335 = $64,500 x 126.1% direct labor cost.

$44,766 = $35,500 x 126.1% direct labor cost

Solutions Manual, Chapter 6

$ 3,750
35,500

$ 13,750
100,000

16,000b
48,000
d
44,766
126,100
$60,766 $174,100
$100,016 $287,850
250
1,250
= $400

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The McGraw-Hill Companies, Inc., 2008

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Fundamentals of Cost Accounting