Cost Accounting

Chapter 1
Introduction to cost
accounting

 COST ACCOUNTING
MANUFACTURING COST CONCEPT
ALL BUSINESS ENTITIES REQUIRES COST
INFORMATION.
MANUFACTURING PROCESS

USES OF COST
ACCOUNTING DATA
DETERMINING PRODUCT COST AND
PRICING
PLANNING AND CONTROL
ASSIGNING RESPONSIBILITY
PERIODICALLY MEASURING AND
COMPARING RESULTS
TAKING NECESSARY CORRECTIVE
ACTION

 Deal With Firms Which Are

Manufacturers
A Manufacturing A/C Is
Prepared In Addition To
The Trading And Income
Statement Accounts

Comparing Merchandising and

Manufacturing Activities
Merchandisers . . .
Buy finished
goods.
Sell finished
goods.
MegaLoMart

Manufacturers . . .
Buy raw
materials.
Produce and sell
finished goods.

Manufacturing Cost
Concepts

Financial
Accounting
Cost is a measure of
resources used or
given up to achieve a
stated purpose.

Managerial
Accounting
Product costs are the
costs a company
assigns to units
produced.

Comparing Financial
Accounting and Management
Accounting
Financial Accounting
Management Accounting
Provide information about the
Provide information for
Purpose
financial position and
planning, evaluating, and
performance of the company.
rewarding performance.
Balance sheet, income
Types of
statement, and statement of Various, non-standard reports.
Reports
cash flows.
Standards
GAAP
None
Reporting Usually, the company taken
A component of the
Entity
as a whole.
company's value chain.
Time
Usually a year, quarter, or a
Any period.
Periods
month.
Investors, creditors, and other Management, customers, and
Users
external parties.
others in the value chain.

MANAGERIAL
COST CONCEPTS
Manufacturing consists of activities and
processes that convert raw materials into
finished goods.

Direct Costs and

Indirect Costs
Direct costs
Costs that can be
easily and
conveniently traced
to a unit of product
or other cost
objective.
Examples:
Direct material
Direct labor

Indirect costs
Costs cannot be
easily and
conveniently traced
to a unit of product
or other cost object.
Example:
Manufacturing
overhead

Manufacturing costs
Manufacturing costs are usually
classified as follows:
1. Direct materials,
2. Direct labor, and
3. Manufacturing overhead.

Manufacturing Costs
Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

Manufacturing
Manufacturing
Overhead
Overhead

Direct Materials
Raw materials are the basic materials and parts
that are to beused in the manufacturing process.
Raw materials that can be physically and directly
associated with the finished product during the
manufacturing process are called direct
materials.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

Direct Labor
Direct labor is the work of factory employees that can be
physically and directly associated with converting raw
materials into finished goods.

Those labor costs that can be easily traced to individual

units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

Manufacturing/Factory Overheads
Manufacturing costs that cannot be traced directly to specific units
produced.
Manufacturing/factory overhead consists of costs that are
indirectly associated with the manufacture of the finished product.

Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials
Wages paid to employees
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.

Materials used to support

the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.

Overhead
Manufacturing overhead consists of costs that are
indirectly associated with the manufacture of the
finished
product.
These costs may also be manufacturing costs that
cannot be classified as direct materials or direct labor.
Manufacturing overhead includes
1 indirect materials;
2 indirect labor;
3 depreciation on factory buildings and machines
4 insurance, taxes, and maintenance on
factory facilities.

COST OF GOODS SOLD

COMPONENTS

Under a periodic inventory system, the

income statements of a merchandiser and a
manufacturer differ in the cost of goods sold
section.

ILLUSTRATION
COST OF GOODS SOLD
COMPONENTS

Merchandiser
Beginning
Merchandise
Inventory

Cost of Goods
Purchased

Ending
Merchandise
Inventory

=
Cost of
Goods Sold

Manufacturer
Beginning
Finished Goods
Inventory

Cost of Goods
Manufactured

Ending
Finished Goods
Inventory

Nonmanufacturing Costs
a) Administration / Operating costs
b) Marketing and selling costs

ADMINISTRATION
EXPENSES
All executive, organizational,
and clerical costs.
Examples:
- managers salaries
- legal and accountancy
charges
- depreciation of accounting
machinery & secretarial
salaries

SELLING AND DISTRIBUTION

EXPENSES
get

commission

expenses

Costs necessary to
the order and deliver the
product.
Examples:
- Sales staffs
- Salaries &
- Carriage outwards
- Depreciation of
delivery vans
- Advertising

PRODUCT COSTS
Costs that are a necessary and integral part of
producing the finished product.
include each of the manufacturing cost elements
(direct materials, direct labor, and
manufacturing overhead)
These costs are not expensed to cost of goods
sold under the matching principle until the
finished goods inventory is sold.

PRODUCT COSTS (Cont)

Direct materials and direct labor are often
referred to as prime costs due to their direct
association with the manufacturing of the
finished product.

Direct labor and manufacturing overhead are

often referred to as conversion costs since they
are incurred in converting raw materials into
finished goods.

Classifications of Costs
Manufacturing costs are often
combined as follows:
Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

Prime
Cost

Manufacturing
Manufacturing
Overhead
Overhead

Conversion
Cost

PERIOD COSTS

a) are identifiable with a specific time period,

b) relates to nonmanufacturing
non-inventoriable costs, and
c) include selling and administrative expenses.

ILLUSTRATION:
PRODUCT VERSUS PERIOD COSTS
Product Costs

Manufacturing
Costs

Direct Labor
Manufacturing
Overhead
Period Costs

Nonmanufacturing
Costs

Selling Expenses
Administrative
Expenses

{
{

Direct Materials

Prime
Costs
Conversion
Costs

Flow of cost associated with

production

Material
inventory

DM
used

WIP
inventory

Cost of
finished
goods

Finished
goods
INV

DM
purchase
d

DL
used

DL
payable

MOH used

MOH

Product is
sold

COG
S

VARIABLE FACTORY OVERHEADS

Supplies
Fuel
Power
Small tools
Spoilage, salvage and reclamation
expenses
Receiving costs
Hauling within plant
Royalties
Communication costs
Overtime premium

FIXED FACTORY OVERHEADS

Salaries of production executives

Depreciation
Property tax
Patent amortization
Wages of security guards and fire
fighters
Maintenance and repairs of
building and grounds
Insurance- property and liability

SEMI VARIABLE FACTORY

OVERHEADS

Supervision
Inspection
Payroll department services
Personnel department services
Factory office services
Materials and inventory services
Cost department services
Maintenance and repairs of machinery and
equipment
Compensation insurance
Health and accident insurance
Payroll taxes
Industrial relations and employees welfare expenses
Heat, light and power

Controllable and Uncontrollable

costs
Controllable costs:
Costs that can be controlled or heavily influenced
by the manager.

Uncontrollable costs:
Costs that a manager cannot influence significantly.

Manufacturing operations and

Manufacturing Costs
Job Shop:
Low production volume; little standardization; one of
a kind product.

Batch:
Multiple products; low volume

Assembly line:
A few major products; higher volume.
Mass customization:
Higher production volume; many standardized
components ; customized components of
components.

Continuous flow:
Higher production volume; highly standardized
commodity products.

More cost
classifications
Opportunity costs:
Is defined as a benefit that is sacrificed when the choice of
one action preludes taking an alternative course of action.

Out of pocket costs:

Costs that require payment of cash or other assets as a
result of their incurrence.

Sunk costs:
Costs that have been incurred in the past.
They do not affect future costs and cannot be changed by
any current or future action.
Irrelevant to all future decisions.

More cost
classifications

Differential costs:

It is the amount by which the cost differs under two

alternative actions.

Incremental costs:
The increase in cost from one alternative to another.

Marginal costs:
Additional costs incurred when an additional unit is
produced.

Average costs:
It is the total cost for whatever quantity is
manufactured, divided by the number of units
manufactured.

 Standard costs:
Pre determined costs for direct materials, direct
labor and factory overhead.
They are established by using information
accumulated from past experience and data
secured from research studies.