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1 3-2: Costing Methods <Author name> <Institutional affiliation> <Course number and name> <Instructor name> January 26, 2024

2 3-2: Costing Methods The clothing company The Gap, Inc. is an American multinational retail organization. Gap, along with its subsidiaries Old Navy, Banana Republic, and Athleta, sell apparel, shoes, accessories, and fragrances for women, men, children, toddlers, and infants. They are best known for their athletic wear, shirts, denim items, fleece, and active apparel for all age groups and lifestyles. Gap is a merchandising organization that has been around for more than five decades, and in that time, has expanded into several brands and positioned itself as a champion of global diversity, equity, inclusivity, and sustainability. The company is built upon its ethical and protective manufacturing practices that does right by its customers, the community, and the natural environment (The Gap, Inc).. A job order cost system details the product cost for each unit of product that is manufactured. It is typically used for custom products or jobs like the units that Gap, Inc. sells. When a company utilizes a job order cost system, account ledgers are used less compared to the process cost system. The job order system, on the other hand, lists and summarizes the costs for manufacturing by describing them as “jobs” instead of other categories or classifications. Gap mass produces its products to sell to a wide range of people in several places worldwide, including in stores and online. The company does this instead of individualized custom orders for each buyer. If Gap, Inc. did take this route, all of its materials, labor, and overhead costs associated with manufacturing would increase and would have their places at the beginning of the process. Each individual job would have a time sheet for each employee that would define how long they spent on a specific task, which would be the direct labor hours. Upon completion of the task, it would be tallied in the finished goods category; the total of these products can be used to determine the total cost of goods sold. Gap produces large amounts of identical and similar items that are differentiated by size, measurements, fabric choice, labor, and overhead; all this is within the process cost system. The process cost system also provides product costs for each of a company’s manufacturing departments or processes (Taylor, 2018), which is well suited for Gap and similar businesses. Without the process cost system, for example, Gap could produce 50 blue shirts. For this, the direct labor, direct materials, and manufacturing overhead for each department would be separately segmented and defined, e.g. assembly, packaging, and packing for orders. Within these are individual “work-in-process” and “factory overhead cost” ledgers that detail each department’s costs. Upon finishing, the units are collectively moved to finished goods which, again, will be used to find the total for the goods and calculate a sales margin. Both the job costing and process costing systems allocate expenses including direct labor, materials, and overhead, differently when producing the end products. What separates the two is that job costing is better suited for companies that produce more unique and small goods, whereas the process costing system works better in a large and industrial manufacturing environment with similar, if not identical products (Weygandt et al., 2020). Factor overhead costs cover the necessary materials for production while eliminating the costs associated with manual labor and direct materials. They are encompassed in the factory overhead, alongside indirect materials and labor, facility rent payments, the required insurance, and facility maintenance costs. In Gap’s case, those overhead costs much also involve payroll and total compensation for employees including benefits, the supplies to maintain the facilities, and all costs associated with maintaining each location. The three primary methods of allocating

3 factory overhead costs are the activity-based costing (ABC) method, multiple production department rate method, and the single plantwide rate method. The ABC method identifies the required activities and associated costs, then allocates those costs to the products based on activity drivers or bases. An activity is defined as the type of work within a manufacturing process, e.g., design, inspection, or assembly. Unlike the multiple production department method, Gap breaks its work up into different activities in this method, attributing a certain cost to each company function. Depending on the product, it also estimates the number of units or processes within the system. To find the activity rates, divide the budgeted cost by the total activity base usage. For example, there are $40,000 for design, $50,000 for setup, $60,000 for assembly, and $30,000 for inspection and 50 designs, 200 setups, 400 units, and 10 inspections. For the design element, it would be $800 per design, $2,500 per setup, $150 per assembly, and $3,000 per inspection. The multiple production department method uses different rates for each production department to allocate the factory overhead costs to the products manufactured. There are varying departments in this method that are assigned different overhead budgets to abide by when manufacturing Gap merchandise. An example of a procedure under this method is dividing assembly and sorting to account for overhead. If the budget is $450,000, of which $200,000 is given to assembly and the remainder to sorting, it comes out to the total allotted. For a jacket, ten hours of labor are in assembly and two hours are in sorting. The factory overhead cost for each jacket is $320. Unlike the ABC method and single plantwide rate method, the multiple production department method takes each department and considers its intricate operations rather than standardizing costs across the company. Finally, the single plantwide rate method allocates factory overhead costs to products with a single flat rate across all departments. This is best for consistent manufacturing businesses as it assumes that all factory overhead costs will be used the same way, namely for companies with simple and inexpensive goods. For example, Gap sells shirts and shoes. If the factory overhead costs are $300,000 for the budget and the budgeted hours for labor are 20,000, meaning 500 units that required 20 hours for each shirt and 500 units that require 20 hours for each pair of shoes. In the single plantwide rate method, divide the total budget for factory overhead -- $300,000 – by the total budget for the plantwide allocation. This equals $15 per direct labor hour. Then, multiply this by the required labor hours: 20. In conclusion, $300 is the factory overhead cost unit for both products. After evaluating each method to calculate and account for all sets of factory overhead costs, the ABC method would most benefit Gap, Inc. It is a varied company with several deparments, functions and capabilities for its wide array of products. It appears to be the most accurate in determining the actual costs of production. Its products are too different across the spectrum to apply a flat plantwide rate for accounting and the multiple production department method may be too rigid for Gap’s operations. If Gap chose either of the other methods, it opens the company up to the potential for reconciling accounts because of inequities in production, pricing, etc., which could mean less revenue for the company or a change in public perception of the brand that leads to a decrease in demand for products. The ABC method can also help Gap change the cost of a product and compare price differences in other areas.

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4 References Cornick, M., Cooper, W. D., & Wilson, S. B. (1988). How do companies analyze overhead?. Strategic Finance , 69 (12), 41. Tayler, W. B., & Warren, C. S. (2018). Managerial accounting , 15e. Boston: Cengage Learning, Inc. The Gap, Inc. (GPS) company Profile & Facts. (2022, January 23). Retrieved January 26, 2024, from https://finance.yahoo.com/quote/GPS/profile?p=GPS Weygandt, J. J., Kimmel, P. D., & Aly, I. M. (2020). Managerial accounting: tools for business decision-making . John Wiley & Sons.