Product Costs for External Reporting

Many cases you will study in your MBA program will present you with product costs that have been developed for external reporting. These costs do not approximate marginal costs, so you have to modify the product costs to arrive at the values you need. First, consider how an accountant develops the unit cost used for external reporting.
Developing a Unit Cost for External Reporting

Labor Cost

Assume an accountant wants to develop a unit cost for external reporting for the paint sprayer illustrated above. First, the accountant must estimate the amount of labor cost for the product. A product routing shows every step a product goes through in the manufacturing process, and these routings usually include labor times for each step. So the accountant can use these labor times from the routing to estimate the labor time required to make the product.

Assume in this case the total labor time equals 10 hours to make the paint sprayer. Next the accountant reviews payroll records to estimate the labor cost per hour and finds workers usually make $12 per hour; in addition, the company pays a variety of fringe benefits that amount to 30% of the hourly wage. Total company cost for an hour of labor, then, equals $15.60 ($12 + (30% x $12). The total labor cost for a paint sprayer for external reporting then equals $156 (10 hours x $15.60).

Overhead Cost

Overhead cost consists of numerous types of expenses ranging from depreciation and taxes to various kinds of supplies. Because it is such a miscellaneous collection of costs, accountants spread this total lump of costs across products made to assign a portion of overhead costs to each unit produced.

In companies that run their cost systems primarily to generate unit costs for external reporting, accountants must estimate the total annual overhead at the start of the year. Usually they divide this total estimated overhead by the estimated number of labor hours the company will use during the year. The resulting value is called an overhead rate per labor hour, and accountants multiply this rate by the number of labor hours in a product to assign overhead cost to the product. Remember, accountants perform this calculation only because financial reporting rules require them to do so. This has no relevance for decision making.

Assume in the paint spraying example that accountants estimated at the start of the year that total overhead would equal $820,000 and that the company would use 100,000 labor hours. This provides an overhead rate of $8.20 per labor hour. Putting the material, labor and overhead costs together provides a unit cost for external reporting of $548. This $548 value appears in the balance sheet and income statement issued to creditors, investors and taxing authorities.



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