Book Description Learn the basics of practical accounting Featuring the latest information on accounting methods and standards, this guide shows you how to avoid accounting fraud, minimize confusion, maximize profits, and make sense of accounting basics. Big GAAP The internationalization of accounting standards The rise in restatements of previously issued financial reports by public corporations, and how revisions of previously reported earnings impact investors The increasing focus on preventing financial reporting fraud and the expanded role and responsibility of the CPA auditor Accounting problems with stock options The "unaccounted for" cost of employee pensions and retirement health care costs, in both the private and public sectors Expanded coverage of small business accounting Updated resources and websites The information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.
Show and hide more. Table of Contents Product Information. Share from page:. More magazines by this user. Close Flag as Inappropriate. You have already flagged this document. Thank you, for helping us keep this platform clean. Illustration by Wiley, Composition Services Graphics Scattergraphing A scattergraph helps you visualize the relationship between activity level and total cost.
To scattergraph, just follow three steps with explanations for cre- ating the scattergraph in Microsoft Excel : 1. Set up a table that shows production level and total cost by time period. To prepare a scattergraph, you need basic data about the number of units produced and the total costs per time period. Arrange this data by month, week, or some other time period as Figure demonstrates.
Set up a graph with units produced at the bottom axis and total cost in the left axis. Your graph should have the total cost which includes fixed and variable costs on the y-axis and the number of units produced along the x-axis as shown in Figure On this graph, plot each point from the table.
Plot each data point on your graph. Enter the data from Step 1 see Figure into the Excel spread- sheet. Figure shows the resulting scat- tergraph for Xeon Company. Label the axes appropriately. Then use data points from previ- ous months to estimate the total cost. Illustration by Wiley, Composition Services Graphics Using the high-low method The high-low method estimates variable and fixed costs based on the highest and lowest levels of activity during the period.
Just follow three steps: 1. Based on a table of total costs and activity levels, determine the high and low activity levels. Look at the production level and total costs to identify the high and low activity levels. Use the high and low activity levels to compute the variable cost per unit.
Figure out the total fixed cost. Fitting a regression Statistical regression allows you to apply basic statistical techniques to esti- mate cost behavior. Excel or a statistical analysis package can quickly figure this information out for you; the following sections show you how. Enter the data into Excel. Run a regression analysis in Excel. Run a regression on the data in Excel by following these steps: A.
Select an output range on your spreadsheet. Illustration by Wiley, Composition Services Graphics From all the information shown in the output see Figure , you really only need two numbers. Low P-values of the coefficients here, 1.
In other words, this model looks pretty accurate. Outside the relevant range, such as when a plant exceeds its normal capacity or undergoes a shut-down period, the normal patterns of behavior change. Production may go so high that you have to pay workers overtime thereby increasing direct labor rates and variable costs or add a shift increasing fixed overhead costs. Similarly, as production drops, your factory may begin to release workers and turn off the air conditioning.
Outside the relevant range, the normal cost patterns change. This limitation means that you can only make cost predictions within a cer- tain range of activity.
Consider Figure , which shows how wildly costs and production can change outside the relevant range. Figure What happens outside the bounds of the relevant range. I know many managers who probably feel a lot like Atlas because they, too must bear unreasonably disproportionate shares of overhead. Ignoring overhead causes you to underestimate costs of products and processes, which can spell disaster if you underprice based on those figures and lose money.
As factories and processes automate and people get replaced by robots , the direct labor needed to manually produce goods tends to decrease, and the overhead necessary to operate, maintain, and repair the machines tends to increase.
Accordingly, as the overall importance of overhead increases, managers and accountants must pay careful attention to how they allocate overhead to the different products their companies make.
In this chapter, I explain how and why you need to allocate the cost of over- head to individual products. I describe a traditional system for allocating overhead, based on direct labor, as well as a more innovative allocation system known as activity-based costing. For both systems, I explain what to do when you allocate too much or too little overhead to products.
Figure The role of overhead costs in overall product cost. You can often measure exactly how much of the direct costs go into each product. For example, a pencil may contain grams of wood and grams www.
Similarly, if each worker takes an average of one hour to assemble a gadget, the cost of direct labor equals the cost of paying that worker for one hour. Allocating overhead is another story. By definition, overhead is indirect, so understanding how it benefits individual products is difficult. How much elec- tricity cost should be applied to each widget on your assembly line? One way to allocate overhead costs is to use direct labor cost as a guide: the more direct labor cost that goes into a product, the more overhead that goes with it.
This approach makes sense because direct labor cost itself seems to cause overhead to increase. The more hours worked, the more direct labor cost and the more money you need to pay for electricity, maintenance, and other overhead costs. The following sections give you the lowdown on the direct labor costing method of allocating overhead.
Rather than allocating overhead based on direct labor costs, managerial accountants may choose to use direct labor hours worked or even machine hours. Calculating overhead allocation Suppose a simple factory makes two products — call them Product A and Product B. The factory needs no direct materials yes, that means it makes products out of thin air; please suspend your disbelief.
This example is relatively simple because each product gets an equal amount of overhead. For example, suppose a similar company plans to make two products, Product J and Product K. Product J requires hours of that direct labor, while Product K requires 40 hours.
Figure illustrates how much overhead goes to each product line in this scenario. Illustration by Wiley, Composition Services Graphics Figure Allocate direct labor according to hours needed to make each product.
Add up total overhead. This step requires adding indirect materials, indirect labor, and all other product costs not included in direct materials and direct labor. Compute the overhead allocation rate by dividing total overhead by the number of direct labor hours. Some accountants and managers refer to the overhead allocation rate as the predetermined overhead allocation rate because it needs to be esti- mated at the beginning of a period. Apply overhead by multiplying the overhead allocation rate by the number of direct labor hours needed to make each product.
Figure illustrates how this process allocates all direct labor and overhead costs to the products made. Illustration by Wiley, Composition Services Graphics Experimenting with direct labor costing Now try an example of how to apply overhead costs, alongside direct materials and direct labor costs, to units produced.
Jackson allocates overhead based on the number of direct labor hours worked. Jackson Company built a specialty widget, model GO. This widget requires pounds of raw direct material and hours of direct labor.
How much does making widget model GO cost Jackson Company? Now use this overall rate to figure out the cost of direct materials for widget model GO. Compute the overhead allocation rate. Jackson allocates overhead based on direct labor hours not the direct labor cost. Therefore, divide total overhead by total direct labor hours. Apply overhead. Widget model GO required hours of direct labor. Figure Total cost of product includes direct mate- rials, direct labor, and overhead.
Illustration by Wiley, Composition Services Graphics Figure provides a more graphical explanation for the example, showing how direct materials, direct labor, and overhead all flow into the cost of the product.
The company will eventually apply all remaining product costs to other products. Figure Compute the cost of widget model GO. The record-keeping for both direct materials and direct labor should mirror whatever happens in the factory. For example, as the factory uses direct materials, their costs should be transferred over to the cost of the products made.
Similarly, as employees work, the cost of their direct labor should go to the products that they work on. However, allocating overhead can get messy. Because the overhead alloca- tion rate needs to be estimated at the beginning of the period based on pre- dictions of total overhead costs and its base such as direct labor cost, direct labor hours, or machine hours , this rate may turn out to be inaccurate.
In this situation, companies apply more overhead to products than the prod- ucts actually require or apply too little overhead, such that a portion of over- head gets left over and not applied to any products. On the other hand, if the company applies too much overhead to products manufactured, the difference reduces cost of goods sold. Debits go to the left, and credits go to the right.
All costs are debits and go to the left. Any reductions of costs are credits, and they go to the right. Figure shows you how this setup works. This assumption made sense in the days before automation, but today completely automated factories operate with little or no direct labor; in these situations, a wide variety of factors can cause overhead to increase.
To gain a better understanding of these factors, managerial accoun- tants use activity-based costing. These activities, each of which are thought to vary with the total costs of each cost pool, are called cost drivers. They drive the costs in each cost pool. For example, instead of using direct labor to allocate overhead, you may split overhead into three different categories: Logistics, Supervision, and Manufacturing.
After some research, you identify a cost driver for each. For Logistics, you set the cost driver as the number of parts in each product. For Supervision, you may use the total number of employees who worked on a product. For Manufacturing, you can use the number of machine hours needed.
Activity-based costing gets around the problem of automated factories that use very little direct labor. It also provides you with valuable insights into how costs behave and can help you reduce the costs and get the manufac- turing process to flow more smoothly. For more on cost drivers and cost behavior, check out Chapter 5. In this section, I take you through the follow- ing steps of activity-based costing: 1.
Total overhead includes indirect materials, indirect labor, and other manufacturing costs. Identify one or more cost drivers. Scrutinize the nature of your overhead to identify different pools of overhead costs and specific measures that affect them. For example, one overhead pool may be storage costs. This pool would be affected by the number of square feet assigned to each department. Ideally, try to identify a single measure that actually causes each overhead pool to increase.
Divide total overhead in each cost pool by its cost driver: 4. It pur- chased ounces this year. The company has budgeted 5, hours of direct labor this year. The cost driver for this pool is the number of units produced. The cost driver for Utilities is direct labor hours. Step 1: Add up total overhead Add up indirect materials, indirect labor, and all other product costs not included in direct materials and direct labor. Illustration by Wiley, Composition Services Graphics Step 2: Identify one or more cost drivers Research the nature of your overhead to try to find measurable factors that affect overhead costs.
Ideally, try to find a measure that actually causes the total overhead pool to increase. If managers decide direct labor hours are a cost driver, that mea- sure can function as part of the activity-based costing system. This process eventually results in breaking total overhead down into several different cost pools and identifying a single cost driver for each. Figure Identifying the cost drivers. Illustration by Wiley, Composition Services Graphics Step 3: Compute the overhead allocation rate for each cost pool Divide total overhead in each cost pool by its cost driver: Figure shows how to document these computations in a straightforward table.
Figure Computing overhead allocation rates under activity- based costing. Remember that Model A uses 0. Now add together all the costs of making one unit of A, as shown in Figure Figure Adding up the total cost of mak- ing A Illustration by Wiley, Composition Services Graphics Figure visually describes how costs flow from direct materials, direct labor, and the overhead pools to the finished product.
Activity-based costing provides useful information to help managers under- stand cost behavior and find new ways to keep costs down. This information may lead managers to examine util- ity costs to reduce inefficiencies. Most people would go no farther than their local drugstore or big-box discount store. There, they can usually choose from a few different colors and sizes in order to find the bear they like.
Drugstore bears are usually manufactured on assembly lines, often in batches of thousands of identical bears. To measure the cost of the products made, companies use process costing, which I cover in Chapter 8. More-discriminating bear aficionados, however, have their teddy bears made to order. They can also choose from a wide selection of clothing or have clothing made to order in any theme they can imagine. When craftspeople sew and assemble these custom bears, they use a system called job order costing to track the exact cost of each bear.
Information about product cost helps managers to set and adjust prices and to decide how to best utilize limited production capacity. In this chapter, I explain how companies accumulate costs in a job order costing system and how they apply overhead to the individual products made. Such goods may include custom teddy bears, made-to-order suits or aircraft, catered affairs, or new feature films; the individual units or batches are called jobs.
In job order costing, an information system traces the exact value of raw materials put into process and the value of direct labor and overhead used to transform those raw materials into finished goods.
This information system ensures that the company accounts for all direct materials, direct labor, and overhead costs and accumulates the cost of each job.
The following sections walk you through the record-keeping documents and process. Getting the records in order Job order costing uses a few specific forms to keep track of the resources that go into an individual job: a job order cost sheet, materials requisition forms, and time tickets.
Job order cost sheet To keep track of jobs, companies typically use a form called a job order cost sheet. As Figure shows, the job order cost sheet accumulates all the direct materials, direct labor, and overhead costs applied to that job. This form is usually kept with the job itself, so that any additional costs incurred can be documented quickly.
Some do, but most businesses actually store their records electronically. Illustration by Wiley, Composition Services Graphics Materials requisition form When factory personnel need raw materials, they complete a materials requi- sition slip. This form, illustrated in Figure , kick-starts the manufacturing process so that the factory can begin to work on the raw materials needed to make the goods.
In this case, storage personnel issued ten cases of plastic pellets, stock number AA45, to the Assembly Department. Figure The materials requisition slip authorizes personnel to issue raw materials. They keep the two forms together, usually with the job itself. Time tickets As employees work, they complete time tickets to indicate how much time they spend working on each job, as shown in Figure This time ticket indi- cates that Jon Garfunkel worked on Job for two hours.
Figure Employees use a time ticket to keep track of the jobs they work on. Illustration by Wiley, Composition Services Graphics Allocating overhead Along with direct materials and direct labor, employees add the cost of over- head to the job order cost sheet. As I note in Chapter 6, the process for allo- cating overhead under activity-based costing has four steps: 1.
At the beginning of the period, add up projections of indirect materials, indirect labor, and all product costs not included in direct materials and direct labor. Find measures that drive your overhead. Many companies assume that direct labor drives all overhead. Here, assume that the company uses a single overhead cost pool, with direct labor hours as the cost driver.
Compute the overhead allocation rate for each cost pool. Note that, in this case, employees in the company are projected to work 5, direct labor hours this year. So far, employees worked two hours on Job Completing the job order cost sheet The materials-requisition, time-ticket, and overhead-allocation information all goes on the job order cost sheet. To determine the total cost of the com- pleted job, employees simply add up the job order cost sheet.
Figure tallies the cost of Job Figure Enter infor- mation from materials requisition slips and time tickets onto the job order cost sheet. Because almost all accounts in managerial accounting are either assets or expenses, debits increase most balances and credits decrease balances. There are a few exceptions, which I elaborate on later in this section. Accordingly, a T-account — illustrated in Figure — lists increases in the debit column to the left and decreases in the credit column to the right.
Figure Debits to the left increase, while credits to the right Illustration by Wiley, Composition Services Graphics decrease. Accountants use journal entries to record any changes to these T-accounts. Journal entries record transactions — namely, transfers between different accounts. Therefore, each journal entry affects at least two accounts, and total debits increases to the left must equal total credits decreases to the right.
Figure Journal entries record transactions between different Illustration by Wiley, Composition Services Graphics accounts. Figure How the journal entry in Figure affects the accounts.
Illustration by Wiley, Composition Services Graphics As taught in financial accounting courses, the debit-credit system actually features two different kinds of accounts — so-called debit accounts and credit accounts. So far in this section, you use debits to the left side to increase debit accounts and use credits to the right side to decrease debit accounts.
To increase these accounts, credit them to the right side. To decrease them, you debit them to the left side. This book primarily deals with debit accounts, in which debits increase to the left and credits decrease to the right.
Here I use only two credit accounts: Accounts payable which are moneys owed to suppliers , and Wages pay- able moneys owed to employees. To increase one of these credit accounts, credit it to the right. To decrease it, debit it to the left.
The following sections take you through an example of accounting for the job order costing system. The com- pany makes snow globes in large batches. Each globe features a unique three- dimensional image inside, a custom logo, and one of four different grades of snow. Over this time period, employees worked 2, hours. Figure Journal entries to record direct labor cost.
Paying for overhead Overhead costs are all product costs not included in direct materials and direct labor. They typically encompass indirect materials, indirect labor, property taxes on the factory, depreciation of factory equipment, factory maintenance, and the cost of factory supervision. Figure Journal entries to record payment for overhead.
Illustration by Wiley, Composition Services Graphics Requisitioning raw materials The Work-in-process inventory account accumulates all direct materials, direct labor, and overhead costs that a company puts into production. The factory manager numbered this job BRM Jane then notes receipt of the goods on the job order cost sheet.
Check out Figure and Figure earlier in the chapter for a sample job order cost sheet and materials requisition slip, respectively. Figure Journal entries to record requisition of materials for BRM Jane then notes the cost of hours worked by Amanda on the job order cost sheet. At the end of the day, she completes a time ticket. Figure earlier in the chapter illustrates a sample time ticket. Figure Journal entries to apply direct labor to job BRM Illustration by Wiley, Composition Services Graphics Applying overhead Work through the four steps to apply overhead in this example: 1.
The company evaluated its overhead, identifying two appropriate cost drivers. Management determined that the appropriate cost driver for this cost pool should be the number of setups, estimating that it would have a total of 50 setups during the month.
Divide estimated overhead in each cost pool by its cost driver activity level, as shown in Figure The company also expects to have employees work 2, direct labor hours. Figure Computing overhead allocation rates for National Snow Globe.
Illustration by Wiley, Composition Services Graphics 4. To figure out the overhead assigned to job BRM, measure the activity level of each cost driver and then multiply it by its respective overhead allocation rate, as shown in Figure The journal entry to allocate overhead would debit increase Work-in- process inventory and credit decrease Overhead see Figure This entry effectively moves the overhead cost of the products out of the over- head pools and into the cost of the goods that you make.
Figure Journal entry to allocate overhead. Illustration by Wiley, Composition Services Graphics To record that you finished making the goods, transfer this cost from Work- in-process inventory to Finished goods inventory by debiting increasing Finished goods inventory and crediting decreasing Work-in-process inven- tory.
Note how transactions in the books reflect what happens in the factory. As the goods are moved off the assembly line and into the finished goods warehouse, the accountants take their cost out of the account Work-in- process inventory and into the account Finished goods inventory. See Figure for the journal entry to record this transfer. Figure provides a job order cost sheet for BRM It illustrates how the company keeps track of direct materials, direct labor, and overhead costs throughout the production process.
Figure illustrates the journal entry used to reflect this shift; it debits increases Cost of goods sold and credits decreases Finished goods inventory. Figure Journal entry to record the sale of inventory.
Mass producing automobiles dramatically reduced their cost and price, making them afford- able for most families. However, standardized production goes back much farther than Henry Ford. At the end of the s, Eli Whitney started to manufacture standardized parts to make firearms, reducing costs and simplifying production. Workers no longer needed to spend time custom-fitting every part to work in each unit.
In modern mass production, a system called process costing keeps track of what was produced and how much it cost. In this chapter, I explain how companies accumulate costs in a process costing system and how they apply overhead to individual products made. Others mass-produce large numbers of similar or identical items, such as soft drinks, sheets of paper, and boxes of cereal. To mass-produce products at a minimal cost, assembly lines move materials and partially finished goods from one station or department to the next until they get completed into finished goods.
Process costing handles the same types of manufacturing costs as job order costing, which I explain in Chapter 7. Both systems deal with tracking how manufacturing costs such as direct materials, direct labor, and overhead flow through work-in-process to finished goods and finally, when the goods are sold, to cost of goods sold.
As Chapter 7 describes, job order costing accumulates costs by job, using job order cost sheets that stay with the inventory as it flows through the pro- duction process.
Process costing, on the other hand, accumulates costs by department. Although job order costing measures the cost of each individual job, process costing mea- sures the cost of work actually done on WIP during a period. Unlike job order costing, which sends costs directly to individual jobs, process costing uses a two-step method: 1. Sending direct materials, direct labor, and overhead costs to departments 2.
Sending the department costs to the units produced Figure illustrates the flow of this process. Illustration by Wiley, Composition Services Graphics Keeping Process Costing Books Before getting into the nitty-gritty of process costing, you may benefit from reviewing a few basics — namely, how to use debits and credits, how to keep track of the costs of goods that you make and sell, and how goods and their costs move through a typical production line.
Debiting and crediting Remember that when costing goods, almost all accounts are either assets or expenses, such that in most cases, debits increase balances and credits decrease balances.
Accordingly, when using T-accounts, increases go in the www. Note that liabilities, such as Accounts payable and Wages payable, go in the opposite direction. Debits decrease these accounts, and credits increase them. Figure Debits to the left increase, and credits to the right Illustration by Wiley, Composition Services Graphics decrease.
Chapter 7 explains this process in greater detail. Direct labor for making peanut butter sandwiches includes the cost of paying employees for the five minutes they take on average to prepare a single sandwich. For peanut butter sandwiches, overhead includes the costs of running the kitchen, including utilities and cleaning. Accountants need to first accumulate costs and then assign them to individ- ual departments.
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Over time, income tax rules change, the company goes into new lines of business, the company adopts new employee benefit plans, and so on. Furthermore, accountants have to interpret the rules as they apply GAAP in actual situations. Also, I present a helpful glossary at the end of the book that can assist you on your accounting safari. Bookkeeping — the record-keeping part of accounting — must be done well to ensure that the financial information of a business is timely, complete, accurate, and reliable — especially the numbers reported in its financial statements and tax returns. The late Kenneth Boulding, a well-known economist, once quipped that accountants would rather be precisely wrong than approximately correct. Joan kept a steady hand on the tiller as we sailed through the choppy waters of the revisions. Or the company may have settled a long-standing lawsuit, and the amount of damages needs to be recorded. Menu Search for. Following the rules and bending the rules An often repeated accounting story concerns three persons interviewing for an important accounting position. Not so fast!