Accounting Business Reporting for Decision Making

CHAPTER 11 Costing and pricing in an entity 481

Indirect costs are allocated on a departmental basis. Actual costs and relevant cost driver information
for each department follows.

Production

Department A

Production

Department B

Indirect costs

Cost driver

Usage of cost driver

$60 000

Machine hours

60 000 machine hours

$62 500

Labour hours

10 000 labour hours

To recognise the increased complexity in the process, the manufacturing section has now been
separated into two departments: Department A, where the soaps and candles are moulded; and
Department B, where the products are finished and wrapped. The use of departmental cost pools recog-
nises that different cost drivers cause resource consumption in each department. Department A is
machine intensive, so the use of machine hours has been identified as the appropriate cost driver; while
in Department B, the process is labour intensive, with labour hours being the appropriate cost driver. To
illustrate the job costing system, we will now calculate the inventoriable product cost for each product.

Step 1: Understand the structure of the costing system
The first step is to understand the job costing system. Figure 11.10 outlines how costs are to be allo-
cated to the individual products — soaps and candles. The manufacturing operation has been divided
into two departments — Department A and Department B. All costs incurred by both departments are
direct costs of those departments and of the manufacturing operation. Remember that the costs can be
classified as direct to the manufacturing operation because there have been no costs allocated from the
non-manufacturing departments.

Soaps

Production department B

Cost driver: labour hours

Candles

Direct labour Direct material Direct labour Direct material

Production department A

Cost driver: machine hours

F I G U R E 11.10 Structure of the costing system

There are two direct cost pools — direct labour and direct material — which can be directly traced to
the individual products. Indirect costs will be allocated based on the products’ use of the cost drivers
identified as causing resource consumption in Department A and Department B. The next step is to
determine the indirect cost rates.

Step 2: Determine the departmental indirect cost rates
The products consume indirect costs differently, so there is more than one indirect cost pool to capture
the difference in resource consumption.