Module 2 – Application and Analysis: Direct and Indirect Costs in a Real-World Business

Module 2 – Application and Analysis: Direct and Indirect Costs in a Real-World Business

Objective: To enhance your understanding of direct and indirect costs and their impact on business decision-making, you are to analyze a real-world business scenario. This assignment will require you to identify and classify costs, and discuss how these costs influence business decisions.

Instructions:

Introduction:

Begin with a brief introduction that outlines the importance of understanding direct and indirect costs in business operations and decision-making.

Identify a Real-World Business:

Choose a real-world business or organization. This can be one you are familiar with, one from your research, or even a hypothetical scenario that you construct based on realistic business models.

Provide a brief description of the business, including its industry, size, and primary products or services.

Classification of Costs:

1. Identify and describe at least 3 direct costs and 3 indirect costs associated with the chosen business.

Explain why each cost is classified as direct or indirect.

Impact on Decision Making:

• Analyze how the identification and management of these costs influence business decisions.

1. Consider aspects such as pricing, budgeting, cost control, and profitability.

Provide specific examples or scenarios where direct and indirect costs play a critical role in decision-making

Conclusion:

• Summarize the key points discussed in your assignment.
• Reflect on the importance of accurately classifying and managing direct and indirect costs in achieving business success.

1. Research and Resources:

Conduct independent research to support your analysis. Use at least 2 credible sources, in addition to your textbook.

Module 2: Notes 1 – Costing Systems
Costing Systems
This week builds on several cost related terms learned in week one. It is recommended that you go
back to week one and review Module Notes 2 “Cost Terminology” and Module Notes 3 “External
Reporting of Costs”. This review will refresh your memory on cost objects, cost assignment, cost
classification, etc.
Now, we are ready to introduce two basic types of costing systems:
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Job Costing
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Process Costing
Job Costing System
Job costing systems are used for products or services that are distinct. Examples include movies,
custom designed jewelry, and legal representation. In job costing systems, the cost object is the job,
so costs are accumulated separately for each job.
A job is often a single product or service. In this case, the total costs assigned to the job to also be
the per-unit cost. However, a job may be multiple units of the same distinct product or service.
When there are multiple units, the total costs assigned to the job are spread evenly to each unit in
the job to arrive at the per-unit cost.
Process Costing System
Process costing systems are used for products or services that are homogeneous and mass
produced. Examples include bags of potato chips, bottles of water, and most clothing. In process
costing systems, the cost object is a specific process for a specific period of time.
The total costs assigned to the process for the time period are spread evenly across all units
produced resulting in an average per-unit cost.
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Work well in cross-functional teams.
Promote fact-based analysis and make hard critical judgments.
Lead and motivate people to change and be innovative.
Communicate clearly, openly and candidly.
Module 2: Notes 2 – Job Costing
Job Costing
One of the two basic types of costing systems used by management accountants is the job costing
system wherein the cost object is a unit or multiple units of a distinct product or service called a job.
You will be introduced to the elements that comprise the job costing process in this lesson,
including the flow of costs, allocation of manufacturing overhead, and adjustments of under/over
cost allocations.
Cost Assignment
In week one, you learned:
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A cost object is anything for which a measurement of cost is desired.
Product costs are all manufacturing costs – direct materials, direct labor and manufacturing
overhead.
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Direct costs (i.e., direct materials and direct labor) are traced to a cost object.
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Indirect costs (i.e., manufacturing overhead) are allocated to a cost object.
In a job costing system, the cost object is each job so product costs are assigned to each job. Direct
materials and direct labor are traced to each job. Manufacturing overhead are allocated to each job.
Manufacturing Overhead
Manufacturing overhead are indirect costs which cannot be traced to a single job so these costs must
be allocated to each job. The allocation process divides the manufacturing overhead among all these
jobs produced during the year by using a predetermined manufacturing overhead rate.
The predetermined MOH rate is calculated before the beginning of the year. First, the company
estimates the amount of total manufacturing overhead cost expected for the year. Second, the
company selects an allocation base and estimates the total amount expected for the year. The
allocation base should be primary factor that causes a cost. Direct labor hours, direct labor costs or
machine hours are examples of typical allocation bases.
The predetermined MOH rate is the estimated total manufacturing overhead divided by the
estimated allocation base.
Under-Allocated and Over-Allocated Overhead
At the end of the period, the allocated manufacturing overhead which is calculated using estimates
is unlikely to equal the actual manufacturing overhead incurred. The difference between is referred
to as under-allocated or over-allocated overhead. This under/over-allocated amount must be
adjusted at the end of the period.
Write-off to costs of goods sold approach adjusts the under/over-allocated overhead fully to the
current year’s cost of goods sold. This approach is acceptable if the under/over-allocated amount is
immaterial.
Proration approach spreads under/over-allocated overhead among ending work-in-process
inventory, ending finished goods inventory, and cost of goods sold. This approach is used if the
under/over-allocated amount is large.