Chapter 2
Cost Concepts and the Cost Accounting Information System
Discussion Questions
1) (a) Cost is the current monetary value of economic
resources given up or to be given up in obtaining
goods and services. Economic resources may be
given up by transferring cash or other property,
issuing capital stock, performing services, or
incurring liabilities. Costs are classified as unexpired
or expired. Unexpired costs are assets and apply to
the production of future revenues. Examples of
unexpired costs are inventories, prepaid expenses,
plant and equipment, and investments. Expired costs,
which most costs become eventually, are those that
are not applicable to the production of future
revenues and are deducted from current revenues or
charged against retained earnings. Expense in its
broadest sense includes all expired costs; i.e., costs
which do not have any potential future economic
benefit. A more precise definition limits the use of
the term “expense” to the expired costs arising from
using or consuming goods and services in the process
of obtaining revenues; e.g., cost of goods sold and
marketing and administrative expenses.
(b) (1) Cost of goods sold is an expired cost and may
be referred to as an expense in the broad sense of the
term. On the income statement, it is most often
identified as a cost. Inventory held for sale which is
destroyed by an abnormal casualty should be
classified as a loss. (2) Uncollectible accounts
expense is usually classified as an expense. However,
some authorities believe that it is more desirable to
classify uncollectible accounts as a direct reduction
of sales revenue (an offset to revenue). An
uncollectible account which was not provided for in
the annual adjustment, such as bankruptcy of a major
debtor, may be classified as a loss. (3) Depreciation
expense for plant machinery is a component of
factory overhead and represents the reclassification
of a portion of the machinery cost to product cost
(inventory). When the product is sold, the
depreciation becomes a part of the cost of goods sold
which is an expense.
Depreciation of plant machinery during an unplanned
and unproductive period of idleness, such as during a
strike, should be classified as a loss. The term
“expense” should preferably be avoided when
making reference to production costs. (4)
Organization costs are those costs that benefit the
firm for its entire period of existence and are most
appropriately classified as a noncurrent asset. When
there is initial evidence that a firm’s life is limited,
the organization costs should be allocated over the
firm’s life as an expense or should be amortized as a
loss when a going concern foresees termination. In
practice, however, organization costs are often
written off in the early years of a firm’s existence. (5)
Spoiled goods resulting from normal manufacturing
processing should be treated as a cost of the product
manufactured.
When the product is sold, the cost becomes an
expense. Spoiled goods resulting from an abnormal
occurrence should be classified as a loss.
2) Cost objects are units for which an arrangement is
made to accumulate and measure cost. They are
important because of the need for multiple
dimensions of data (e.g., by product, contract, or
department) to accomplish the various purposes of
cost accounting, including cost finding, planning, and
control.
3) A cost system is a combination of procedures and
records designed to provide the various types of
information required in the conduct of the enterprise;
including cost finding, planning, and control.
4) A good information system requires the
establishment of (a) long-range objectives; (b) an
organization plan showing delegated responsibilities
in detail; (c) detailed plans for future operations, both
long- and short-term; and (d) procedures for
implementing and controlling these plans.
5) A chart of accounts is necessary to classify
accounting data, so that the data may be uniformly
recorded in journals and posted to the ledger
accounts.
6) Advantages of the electronic data processing
system for record keeping are: speed, larger storage,
single entry of multiple transactions, automatic
control features, and flexibility in report formats.
7) Costs are most commonly classified based on their
relationship to (a) the product (a single batch, lot, or
unit of the good or service); (b) the volume of
activity; (c) the manufacturing departments,
processes, cost centers, or other subdivisions; (d) the
accounting period; (e) a proposed decision, action, or
evaluation.
8) Indirect materials are those materials needed for
the completion of the product but whose consumption
is either so small or so complex that their treatment
as direct materials would not be feasible. For
example, nails used to make the product are indirect
materials.
9) Indirect labor, in contrast to direct labor, is labor
expended that does not affect the construction or the
composition of the finished product. For example, the
labor of custodians is indirect labor.
10) (a) A service department is one that is not
directly engaged in production, but renders a
particular type of service for the benefit of other
departments. Examples of service departments are
receiving, storerooms, maintenance, timekeeping,
payroll, and cafeteria. (b) Producing departments
classify their share of service department expenses as
indirect overhead expenses.
11) (a) Capital expenditures are intended to benefit
more than one accounting period.
The expenditures should therefore be recorded by a
charge to an asset account for allocation to the
periods benefited. Revenue expenditures benefit the
operations of the current period only.
They should be recorded by charges to the
appropriate expense accounts. (b) If a capital
expenditure is improperly classified as an expense,
assets, retained earnings, and income for the period
will be understated. In future periods, income will be
overstated by any amount that would have been
amortized had the expenditure been properly
capitalized. Assets and retained earnings will be
understated on future balance sheets by successively
smaller amounts until the error has been fully
counterbalanced. If revenue expenditure is
improperly capitalized, assets, retained earnings, and
income for the period will be overstated. Income will
be understated in subsequent periods as the
improperly capitalized item is charged to the
operations of those periods. Assets and retained
earnings will continue to be overstated in subsequent
balance sheets by successively smaller amounts until
the improperly capitalized item has been completely
written off. (c) The basic criterion for classifying
outlays as revenue or capital expenditures is the
period of benefit. The amount of detail necessary to
maintain subsidiary records, the materiality of the
expenditures, and the consistency with which various
expenditures recur from period to period are other
criteria generally considered in establishing a
capitalization policy. Firms frequently establish an
arbitrary amount below which all expenditures are
expensed, irrespective of their period of benefit. The
level at which this amount is set is determined by its
materiality in relation to the size of the firm. The
objective of such a policy is to avoid the expense of
maintaining excessively detailed subsidiary records.
Expenditures for items that fall below the set amount
but are material in the aggregate should be
capitalized, if total expenditures for these items vary
significantly from period to period. A capitalization
policy that reasonably applies these criteria, although
it disregards the period of benefit and is therefore
lacking in theoretical justification, will not
significantly misstate periodic income.
12) The five parts are:
 Direct material
 Direct labor
 Factory overhead
 Work in process inventories
 Finished goods inventories
13) The balance sheet is a statement of financial
position, whereas income stamen is a stamen of
activities. The income statement is a complementary
to the balance sheet, accounting in particular for the
change in the equity as a result of operations during
the year. In that respect, the income statement s
essentially nothing more than a major section of the
retained earnings account, therefore the revenue and
expenses account in the income statement have been
termed “explanatory” accounts, explaining the ebb
and flow of revenues and expenses that lead to the
new income (loss) and to the new retained earnings
balance in the balance sheet.
14) The ordinary balance sheet and income statement
are intended to provide information as to financial
position and results of operations of a business in
accordance with several assumptions which are made
in preparing the statements. From the standpoint of
the criticism made, the most important of these
assumptions are that cost less appropriate
amortization of cost measures unexpired cost, and
that a business may be assumed may be going to
continue operations indefinitely into the future.
Accounting statements are usually prepared on the
theory that a sale or some other definite event is
essential before revenue is recognized. Basically the
asset side of balance sheet contains a presentation of
the amount of cost incurred which can be presumed
to benefit future periods. An income statement
presents the amount of revenue recognized as having
been realized during the period, less the portion of all
costs incurred which does not appear to be fairly
deferrable to future periods.
 Exercises

E-1

1- Identify the conversion cost per unit

Conversion cost = Direct labor + factory Over head
= 20 + (15+6) = 41 /- units
2- Identify the prime cost
Prime cost= direct material + Direct labor
= 32 + 20 = 52 /-units
3- Determine the estimated total variable cost per unit
= 32+20+15+3 = $70
4- Total cost for production 12,000 units and sale 8,000 units:
(($32 + $20 +$15 + $6 + $4) × 12,000) + ($3 × 8,000)
= $924,000 + $24,000
= $948000
E-2

Determine Mercado Company’s expected operating income or loss for 19B.

Sale decease to 15% Rs

19950,000 × 15%

1950,000 – 2992500 16957500

Less: cost of goods sold

Fixed cost 7623000

Variable cost (W) 9835350 1745835

Net loss (500850)

(w) Variable cost varies with sales

VC Sales

19A 11571000 1950,000

19B x 16957500

1950,000 x = (1157100) (1695750)

x = 9835350
E- 3:

Crockett Company

Cost of Goods Sold Statement

For The Year Ended On Dec, 31B

Rs. Rs.

Direct Material

Material Opening 176000

Add: purchases (Net) 2400,000

Add: Freight in 32000 2432000

Material available for use 2608000

Less: Material Ending 196000

Direct Material used 2412000

Add: Direct Labor 3204000

Add: Factory Overhead 188560O

Total current manufacturing cost 7501600

Add: Work - in – process opening 129800

Cost of goods available for manufacturing 7631400

Less: Work - in – process ending 136800

Cost of goods manufactured 7494600

Add: Finished goods opening 620,000

Cost of goods available for sale 8114600

Less: Finished goods ending 567400

Cost of goods sold 7547200

E- 4 Prepare journal entries for above transactions.

JOURNAL Dr. Rs. Cr. Rs.

1- Work - in – process 24500

Factory overhead 4500
Material 29000
_____________________________
2- Payroll 44000
Accrued payroll 33700
Income tax withheld 7000
FICA tax at 7.5% 33000
Accrued payroll 33700
Cash 33700
___________________________
3- Work- in – process 30,000
Factory Overhead 6000
Marketing expenses 8000
Payroll 44000

Factory overhead 4932

Marketing expenses 1096
Unemployment Insurance 2376
Federal unemployment 352
FICA Tax payable 3500
Working
Total cost =2376+352+3500 = 6028
FOH (direct & indirect labour)
=6028+36000/44000 = 4932
Marketing expenses
=6028×8000/44000= 1096
4- Factory overhead 7500
Voucher payable 7500
____________________________________
5- Work - in – process 22932
Factory overhead applied 22932
____________________________________
6- Finished goods 60,000
Work - in – process 60,000
 ____________________________________
7- Material 50,000
Voucher P/A 50,000
____________________________________
8- Cost of goods sold 20,000
Finished goods 20,000

Account Receivable 26000

Sales 26000

_____________________________________
 E-5 Dr Cr

Date Particulars Rs. Rs.

(a) Material 120,000

Account payable 120,000

(b) Payroll 90,000

FICA Tax payable 6750

Income Tax payable 15750

Accrued payroll 675000

Work in process 45,000

Factory overhead 9,000

Marketing expenses 15,000

Administrative expenses 21,000

Payroll 90,000

(c) Material 26250

Account payable 26250

(d) Factory overhead 6156

Marketing expenses 1710

Administrative expenses 2394

State unemployment 2790

Federal unemployment 720

FIACA Tax 6750

 (working)

Total cost = 10260

W.I.P = 10260×(54000)/90,000

=6156

Mark. Exp = 10260×(15000)/90,000

=1710

Admin exp = 1026×(21000)/90,000

=2394

(e) Work in process 60,000

Factory overhead 15,000

Marketing expenses 4,500 79500

Material

(f) Account payable 900

Material 900

(g) Account payable 75000

Accrued payroll 67500

Cash 142500

(h) Factory overhead 1000

Accumulated Depreciation -Machinery 1000

(i) Factory overhead 9600

Account payable 9600

(j) Finished goods 126000

Work in process 126000

(k) Cost of goods sold 96000

Finished goods 96000

Account receivable 150,000

Sales 150,000

(l) Factory over head 38056

Account payable 38056

E-6 Dr Cr

Date Particulars Rs. Rs.

(a) Work in process 18500

Factory overhead 2800

Material 21300

(b) Finished goods 51000

Work- in- process 51000

(c) Material 32000

Account payable 32000

(d) Payroll 50,000

FICA Tax payable 3750

Federal Income Tax payable 8750

State Income Tax payable 2500

Accrued payroll 35000

 (working)

Let total payroll = 100

Accrued payroll = 100- 7.5- 17.5-5

=70%

Accrued payroll 35,000

Cash 35000

(e) Work- in- process 27500

Factory over head 9000

Marketing expenses 8500

Administrative expenses 5,000

Payroll 50,000

(f) Factory over head 5000

Marketing expenses 1165

Administrative expenses 685

FICA tax payable 3750

Federal unemployment tax p/a 400

State unemployment tax p/a 2700

 (working)

Total = 6850

F-O-H = 6850×36500/50,000

=5,000

Marketing exp = 6850×8500/50,000

= 1165

Admin exp = 6850×5,000/50,000

= 685

(g) Factory overhead 11300

Accumulated Depreciation-Equip 9450

Prepaid insurance 600

Account payable 1250

(h) Work in process 28100.50

Factory overhead applied 28100.50

(i) Account receivable 92120

Sales 92120

(j) Cost of goods sold 65800

(92120×100/140)Finished goods 65800

Cash A/C 76000

Account receivable 76000

E-7

Tuornton Company

Cost of goods manufactured statement

For the month of October, 19A

Direct Material Rs. Rs.

Opening Inventory 16200

Add: purchases 29,000

Cost of material available 36200

Less: closing Inventory 17000

Cost of material used 19200

Add: Direct labour 16500

Prime cost 35700

Add: Factory overhead 8580

Current manufacturing cost 44280

Add: Work –in- process Opening 3600

Cost of goods to be manufactured 47880

Less: Work-in-process closing 7120

Cost of goods manufactured 40760

 E-8

Pensacola Corporation

Cost goods sold statement

For the year ended…….

Direct material Rs. Rs.

Opening inventory 88,000

Add: Net purchases 366,000

Add: Direct expenses 6,600

Cost of material available 460,600

Add: closing inventory 64,000

Cost of material used 396600

Add: Direct labour 523600

Prime cost 920200

Add: Factory overhead (468,400+104,400) 572800

Current Manufacturing cost 149300

Work in process

Add: Opening inventory 29800

Cost of goods to be manufactured 1522800

Less: closing inventory 38800

Cost of goods manufactured 1484000

Finished goods

Add: opening inventory 54200

Cost of goods available for sale 1538200

Less: closing inventory 66000

Cost of goods sold 1472200
 Problems

P-1

Mat. Company

Cost of goods manufactured statement

For the month of March,

Direct Material Rs. Rs.

Opening inventory 20,000

Add: purchases 110,000

Cost of material available for use 130,000

Less: closing inventory 26,000

Direct material used 104,000

Direct Labour:

Add: Direct Labour cost 160,000

Prime cost 264,000

Factory overhead:

Add: Factory Overhead 80,000

Current manufacturing cost 344,000

Work in process:

Add: Opening inventory 40,000

Cost of goods to be manufactured 384,000

Less: closing inventory 36,000

Cost of goods manufactured 348,000

Finished good:

Add: Opening inventory 102,000

Cost of goods available for sale 450,000

Less: closing inventory 105,000

Cost of goods sold 345000

(Working)

F-O-H = 50% of direct labour

= direct labour×50/100

Current manufacturing cost = Direct material + direct labor + factory Overhead

344,000 = 104,000+ x +(x × 50/1000)

344,000 – 104,000 = x + 50x/100

240,000 = 100x + 50x/100

240,000 × 100/150 = x

160,000 = x

(a) cost of goods manufactured = 348,000

(b) prime cost = 264,000
(c) conversion cost = direct labour + F-O-H
= 160,000 + 80,000
= 240,000
P-2

Company - A

Rs.

Cost of goods manufactured 380000

Finished goods:

Add: opening inventory 600,000

Cost of goods available for sale 4400,000

Less: closing inventory 1200,000

Cost of goods sold 3200,000

(Working)

Cost of goods sold = sale -- G.P

= $ 4000,000 -- (40, 00,000 ×20/100)

= $ 320,000

Company-B

Rs.

Cost of goods available for sale 1490,000

Less: Finished goods closing 190,000

Cost of goods sold 13, 00,000

P – 2 (cont.)

Company-C

Rs.

Sales 429,000

Less: cost of goods sold 333,000

Gross profit 96,000

(Working)

Cost of goods manufactured 340,000

Add: Finished goods opening 45,000

Cost of goods available for sale 385,000

Less: Finished goods closing 52,000

Cost of goods sold 333,000

P-3

(1)

Material A/C

Bal. b/d 20,000 W-I-P(Bal) 70,000

A/P 65,000

Bal. c/d 15,000

85,000 85,000

Material issue to production = 70,000

(2)

Payroll A/C

Accrued payroll 6000 W-I-P 6000

6000 6000

Direct labour cost = 6000

(3)

F-O-H A/C

Supplies exp 20000 W-I-P (Bal) 100,000

Ind lab exp 55000

Acc: Dep 10000

Prep Ins 2000

Misc: exp 13000

100,000 100,000

Total F-O-H = 100,000

(4)

W-I-P A/C

Bal. b/d 7000 Fin goods 172,000

Material 70000

Payroll(lab) 6000

F-O-H 100,000 Bal. c/d 11000

183000 183000

Cost of goods manufactured = 172000

(5)

Finished goods A/C

Bal. b/d 34000 C.GS 176000

W-I-P 172000

Bal. c/d 30,000

206,000 206,000

Cost of goods sold = 176000

(6)

A/P A/C

Cash 77000 Bal. b/d 18000

Bal. c/d 6000 Material 65000

83000 83000

Payment of A/P = 77000

(7)

A/R A/C

Bal. b/d 54000 Cash 532000

Sales 500,000

Bal. c/d 22000

554000 554000

Amount collected from account receivable = 548000

(8)

Accrued payroll A/C

Cash 10,000 Bal. b/d 13000

Bal. c/d 9000 Payment A/C 6000

19000 19000

Payment to A/P = 10,000

P-4

Water Lux Company

1- For Purchase Of Material Dr. Rs Cr. Rs

Material 91,000
Account payable 91,000
______________________________________
2- For Use Of Material
Work- in- process 84,000
Material 84,000
___________________________________
3- For Direct Labour
Work in process 50,000
Payroll 50,000
________________________________
4- For Factory Overhead
Factory overhead 25,000
Account payable 25,000
________________________________
5- For Finished Goods
Finished goods 157,000
Work in process 157,000
_____________________________
6- For Cost Of Goods Sold
Cost of goods sold 140,000
Finished Goods 140,000
_____________________________
P – 4 (Working)
Calculation of purchase, use of material, direct labour, FOH, Finished goods, cost of goods
sold.
Direct Material Rs.
Opening inventory 17000
Add: purchases 91,000
Cost of material available 108,000

Less: Closing inventory 24,000

Cost of material used 84,000

Direct Labour
+Direct labour cost 50,000
Prime cost 134000
Factory overhead
+F-O-H 25000
Current Material cost 150,000
W-I-P
+ Opening inventory 12000
Cost of goods to be manufactured 1, 71,000
-- Closing inventory 141000
Cost of goods manufactured 1, 57,000
Finished Goods
+opening inventory 29,000
Cost of goods available for sale 185,000
-- Closing inventory 45,000
Cost of goods sold 140,000
____________________________________________________
P-5

Prepare T accounts with January 1 Balance.

1-
Cash

Bal b/d 20,000 Accrued payroll 74820

A/P A/C 179379 A/P A/C 104000

Bal c/d 20559

199379 199379

2-
Account Receivable

Bal b/d 25000 Cash A/C 179379

Sales A/C 228800 Discount A/C 3661
Bal c/d 70760
253800 253800

3-
Finished Goods
Bal b/d 9500 CGS 176000
W/P 188000
Bal c/d 21500
197500 197500
4-
W-I-P
Bal b/d 4500 F. goods 188000
Payroll 60500
Material 82500
FOH applied 47330 Bal. c/d 6830
194830 194830

5-
A/P
Cash 104000 Bal b/d 15500
Material 92000
FOH A/C 18500
Mark exp 18000
Bal c/d 160000 Admin exp 120000
264000 264000

6-
Material

Bal b/d 10,000 A/P W/P 82500

A/C 92000 FOH 8300

Bal c/d 11200

102000 102000
7-

Accrued payroll

Cash 74820 Bal b/d 2250

Bal c/d 2250 Payroll 74820

77070 77070

8-

Machinery

Bal b/d 40,000

Bal c/d 40,000

40,000 40,000

9-

Depreciation

Bal b/d 10,000

Bal c/d 10,000

10,000 10,000
10-

Common stock

Bal b/d 60,000

Bal c/d 60,000

60,000 60,000

11-

Retained Earnings

Bal b/d 21250

Bal c/d 21250

21250 21250

12-

With Holding

Payroll A/C 8170

Bal c/d 8170

8170 8170

13-

State unemployment

Payroll 2322

Bal c/d 2322

2322 2322
14-

F-O-H

A/P A/C 18500

Payroll 12500

FIAC Tax 5475

Material 8300 Bal c/d 44775

44775 44775

15-

Marketing expense

Payroll 8000

FIAC tax 600

A/P A/C 18000 Bal c/d 26600

26600 26600

16-

Admin expense

Payroll 5000

FIAC Tax 375

A/P A/C 120,000 Bal c/d 125375

125375 125375
17-

FIAC Tax

FOH 5475

Mark exp 600

Bal c/d 6450 Admin exp 375

6450 6450

18-

F-O-H Applied

W/P 47330

Bal c/d 47330

47330 47330

19-

C.G.S

FG 176000

Bal c/d 176000

176000 176000
20-

Sales

Account receivable 228800

Bal c/d 228800

228800 228800

21-

Discount

A/R A/C 3661

Bal c/d 3661

3661 3661

22-

Payroll

W.H.Tax 8170 W/P 60500

State unemp tax 2322 FOH 12500

Federal unemp tax 688 Mark exp 8000

Accrued payroll 74820 Admin exp 5000

86000 86000
P – 5 (cont.)

TRAIL BALANCE

SR# A/C TITLE Dr Cr

1- Cash 20559

2- A/R A/C 70760

3- F G A/C 21500

4- W/P A/C 6830

5- A/P A/C 160,000

6- Material A/C 11200

7- Accrued payroll A/C 2250

8- Machinery A/C 40,000

9- A/C Depreciation A/C 10,000

10- Common stock 60,000

11- R.E A/C 21250

12- W.E Tax A/C 8170

13- State unemp tax 2322

14- Fedral unemp tax 688

15- Marketing exp 26600

16- Admin exp 125375

17- FICA Tax 6450

18- FOH Applied A/C 47330

19- C.G.S 176000

20- Sales A/C 28800

21- Discount A/C 3661

22- Payroll A/C _ _

23- FOH A/C 44775

547260 547260
P- 5 (cont.)

JOURNAL ENTRIES

Rs Rs

A. Material 93,000
A/P
93,000

B. F-O-H 18500
A/P
18500

C. Payroll 86000
Withholding tax
8170
State un employment tax 2322

Federal un employment tax 688

74820
Accrued payroll

Accrued payroll 74820

Cash
74820

W-I-P 60500

12500
F-O-H
8000
Marketing expenses
Payroll 86000

F-O-H 5475

600
Marketing expenses
FICA Tax 6450
D. Work -in -process 82500

8300
F-O-H
Material 90800

E. W-I-P 47330
F-O-H Applied
47330

F. Finished goods 188000

W-I-P 188000

G. Cost of goods sold 176000

176000
Finished goods

A/R 228800

228800
Sales A/C

H. Cash A/C 179379

3661
Discount (183040×2%)
A/R (228800×80%) 183040

I. Marketing expenses 18000

120,000
Admin expenses
A/P 300,000

J. A/P 104000
Cash
104000
P-6

MANDMENEYER COMPANY

COST OF GOODS SOLD STATEMENT

FOR THE YEARB ENDED ON 30-11-19B

Direct Material $ $

Opening inventory 4000

+purchases 1, 80,000

Cost of material available 22,000

-- Closing inventory 4250

Direct material used 17750

Direct Labour

+Direct labour 7500

Prime cost 225250

F-O-H

+F-O-H Applied 5000

Current manufacturing cost 30250

W-I-P

+Opening inventory 4000

Cost of goods to be manufactured 34250

-- Closing inventory 7500

Cost of goods manufactured 26750

Finished Goods

+Opening inventory 3500

Cost of goods available for sale 30250

-- Closing inventory 5700

Cost of goods sold 25150

________________________________________

P -6 (cont.)

MANDMEYER COMPANY

INCOME STATEMENT

FOR THE YEAR ENDED 30-11-19B

Rs Rs

Net sales 56000

Less: cost of goods sold (25150)

Gross Profit 30850

Less: Opening expenses

Marketing expenses 2800

56000×2%

Administration expenses 1120 (3920)

56000×2%

Operating Income 26,930

Less: Other expenses (560)

56000 ×1%

NET INCOME 26,370