CHAPTER 1 gathering and providing of information for decision

needs of all sorts, ranging from the management of

COST ACCOUNTING –
recurring operations to the making of strategic decisions
BASIC CONCEPTS AND THE and the formulation of major organizational policies. As
in the past, it also helps fulfill the legal requirements of
JOB ORDER COST CYCLE reporting to stockholders, creditors, government
agencies, and other external users. Cost accounting then,
refers to recording, classifying and reporting all costs
BASIC CONCEPTS aspects of company performance during a particular
period of time.
The accounting system is the major quantitative
information system in al- most every organization. It
provides information for (1) Internal reporting to
managers, for use in planning and controlling operations; THE PURPOSE OF COST ACCOUNTING
(2) Internal reporting to managers, for use in formulating From the above discussion of the concept of cost
plans and policies; (3) Ex- ternal reporting to accounting, it can be gleaned that cost accounting
stockholders, government, and other outside parties. furnishes management with the necessary accounting
tools for planning and controlling activities. Specifically,
the gathering, presentation, and analysis of cost data will
In as much as internal reporting caters to management help management in answering the following questions:
needs and purposes, it is known as management
accounting. On the other hand, external reporting is
known as financial accounting because it is principally  Is our plant operating efficiently and
concerned with the historical and stewardship aspects of economically?
accounting.  Which of our costs are out of line, and how can
they be controlled?
 Are our sales prices set realistically in relation to
Where does "cost accounting" fit within the framework? costs?
In its broadest sense, cost accounting has the same three  What is the unit cost of each type of product
major purposes as those described above. However, the being manufactured?
third purpose simultaneously deals with costing of
products for inventory valuation and income
determination. It therefore fulfills the demands of The answers to such questions require detailed data
outsiders and those of management for such information. based on computations that will pinpoint unit costs of
When viewed in this way, cost accounting is products and processes. This is one of the major
management accounting, plus a small part of financial functions of cost accounting. Through modern systems
accounting to the extent that its product costing function of cost accounting, it is possible to know how much it
satisfies the needs of external reporting. costs to construct, manufacture, or sell goods, or to
render various services. The ability to make specific and
detailed identification and measurement of cost elements
permits management to reach decisions and to evaluate
COST ACCOUNTING DEFINED
results with greater intelligence. Bidding and budgets
Cost accounting is a system that records, summarizes, which are discussed on the next page are examples of
analyzes, and interprets the details of the costs of how cost accounting concepts are used in business.
materials, labor, and overhead necesary to produce and
sell an article.
Estimating and Bidding
A knowledge of the costs of doing business is needed to
Cost accounting is usually considered only as it applies
estimate a job or to bid for jobs or contracts. The order
to manufacturing operations and service organizations as
generally goes to the lowest bidder. Under competitive
well. Today, it is generally indistinguishable from
pressure, the decisive difference in a bid may be as little
management accounting because it serves multiple
as a fraction of a cent per unit. Attempting to bid without
purposes. Basically, cost accounting now refers to the
detailed cost information can mean losing the job, or it follow-up activities, and obtain the operating results that
can mean winning the job but having to perform the ensure prosperity and growth for the enterprise.
work at a loss. Either result is undesirable.

MANUFACTURING COSTS CLASSIFIED

Planning, Budgets, and Control
Manufacturing is the process of converting materials into
The cost accounting system also provides vital finished goods by using labor and incurring other costs,
information needed to plan future operations. Cost data generally called manufacturing overhead. Overhead
help resolve questions relating to proposed projects or costs include utilities, supplies, taxes, insurance, and
policies, such as the following: depreciation. One of the functions of a cost accounting
system is to classify and record all costs according to
 Should we build a new plant or modernize the
category. The three major manufacturing cost
old one?
classifications - direct materials, direct labor, and
 How far can we go in lowering prices to increase
manufacturing overhead - are the basis for all cost
our volume of sales?
accounting procedures. (See the chart of typical costs on
 What will be the effect on costs of automating
page 14.)
part of our factory operations?

Cost accounting is also used in preparing a company's Direct Materials

budget. A budget is the overall financial plan for future
Direct materials, also called raw materials, are those
activities. It is even possible to compute flexible budgets
materials used in the manufacturing process that become
that will tell what the costs for any volume of out- put
a significant part of the finished goods. For example, the
should be. Then actual costs can be compared with a
metal frame and the lumber used in manufacturing a
realistic budgeted amount.
chair and the cloth and buttons used in manufacturing
clothing are direct materials.
Standard cost procedures are helpful in evaluating the
results of operations. Unit costs are projected on the
It is important to note that what is raw material to one
basis of standard conditions. These standards are often
manufacturer is considered finished goods by the
based on the past experience of the firm or on statis- tics
supplier of those materials. For example, to the foundry
from the industry. Then, as actual costs are incurred, they
that makes metal chair frames, these frames are finished
are com- pared with these standard costs. The differences
goods. They are raw materials, however, to the
between the two sets of cost figures can be noted and
manufacturer who pur- chases the frames to make the
analyzed while there is still time to take remedial action.
chairs.
From this brief discussion, you can see that cost
The statement of cost of goods manufactured for JenJen
accounting is one of the most valuable management
Printers, Inc., shown on page 24 had an inventory of raw
tools to control operations. Knowledge of the costs of
materials on hand of 50,000. During the month,
making and selling the firm's products or services helps
purchases of raw materials amounted to 86,900. The
management weigh the various courses of action before
addition of the purchases amount to the beginning
any final commitments are made. Once operations begin,
inventory amount makes the total of materials available
cost accounting reveals how efficiently the work is being
136,900. On June 30, 2008, the raw materials inventory
done, where the strong and weak spots are, and how to
was 46,500. This amount is deducted from the amount of
improve performance.
total materials available to get the cost of raw materials
used. There- fore, the cost of raw materials after
deducting indirect materials of 5,800 is 84,600.
The cost of making a product or providing a service is
one of the most critical factors in a firm's ability to meet
the competition. With cost information to support the
Direct Labor
decisions, management can issue directives, per- form
The employees who work directly with the raw materials Indirect Labor
in converting them to finished goods represent direct
The wages of factory personnel who do not work
labor. In a factory that makes chairs, for example, the
directly on raw materials are called indirect labor. For
salaries of workers who cut and sand lumber and of
example, the wages and salaries of such factory workers
those who assemble the parts into finished chairs are
as the storeroom clerks, janitors, superintendent,
considered direct labor costs. In the manufacturing of
maintenance crew, and factory supervisors are indirect
clothing, the earnings of cutters and sewing machine
labor costs. JenJen Printers, Inc., indirect labor cost for
operators are direct labor costs. The statement of cost of
June 2008 is P35,800.
goods manufactured for JenJen Printers, Inc., shows a
total direct labor cost of 66,500 for June 2008. Other Manufacturing Overhead
Other manufacturing overhead includes such costs as
payroll taxes on factory wages; rent, depreciation, taxes,
Manufacturing Overhead
and insurance on factory buildings and machinery; heat,
All costs incurred in the factory that cannot be light, and power; repairs and maintenance of machinery
considered direct materials or direct labor are classified and equipment. Many of these relate to the physical
as manufacturing overhead (sometimes called factory plant (building, machinery, and equipment). Other
overhead, manufacturing expenses, or factory burden). manufacturing overhead is a growing part of the total
Manufacturing overhead is usually subdivided into three cost of production because of the increasing use of labor-
categories: in- direct materials, indirect labor, and other saving equipment such as computers and robots in many
manufacturing overhead. The manufacturing overhead manufacturing processes. The use of automated
items of JenJen Printers, Inc., for June 2008 totaling equipment results in more costly maintenance, greater
P53,200 are shown in the statement of cost of goods insurance and depreciation charges, and increased utility
manufactured on page 24. costs.
Indirect Materials
Materials that are used in small amounts in the Prime and Conversion Costs
manufacturing process or that cannot easily be traced to
In cost accounting, the term for the sum of direct
specific products are called indirect materials. The glue
materials and direct labor is prime cost. Prime cost
used in manufacturing armchairs and the thread used in
reflects the primary sources of costs for units in
sewing a suit are indirect materials. This is because only
production. The total of direct labor and manufacturing
small amounts of glue and thread are used, even though
over- head is often called the conversion cost.
they clearly become part of the finished goods. Records
Conversion cost indicates the costs required to convert
must be kept to show the exact amount of mate- rials
the raw materials into finished products. (See the chart
used in completing each specific job or group of
of costs on page 8.)
products. Keeping detailed records for minor materials,
however, would require a great deal more time and cost
than the results would justify. It is more practical to
group all such material together without charging them INVENTORIES FOR A MANUFACTURING
to specific products. COMPANY
A manufacturing company has three distinct inventory
accounts: Raw Materials Inventory, Work In Process
Another type of indirect material, sometimes called Inventory, and Finished Goods Inventory. At the end of
factory supplies or operating supplies, consist of items the fiscal period, the balance of each of the three
that are used in the manufacturing process but do not accounts will appear in the Current Assets section of the
become a part of the finished goods. Examples of these balance sheet.
are cleaning supplies used in the factory, oil used for
lubricating the fac- tory machinery, and minor repair
parts. JenJen Printers, Inc., shows a total of 5,800 for Raw Materials Inventory
indirect materials for June 2008.
The Raw Materials Inventory account reflects the cost of
raw materials and factory supplies that will be used in
the manufacturing process. Once direct materials are following systems maybe used in accumulating a
removed from the storeroom for use in the product's cost.
manufacturing process, their costs are no longer part of
the raw materials inventory. Instead, these costs are then
classified as part of work in process. In the same way, 1. Actual Cost System (Historical). Under this
the costs of factory supplies that have been removed system, direct materials, direct labor and factory
from the storeroom and applied in the manufacturing overhead costs are deter- mined as they occur
process are charged to manufacturing overhead. Some simultaneously with the manufacturing
manufacturing firms may use a separate Supplies operation but the total of these costs is known
Inventory account if the quantities or value of supplies only after the operation has been completed. An
normally kept on hand are significant enough to justify actual cost system collects the actual amounts of
the additional account. direct material, direct labor and factory overhead
that are incurred for each product. This system
will be used throughout this chapter.
Work in Process Inventory
The Work in Process Inventory account reflects the cost
2. Standard Cost System (Predetermined).
of raw materials, direct labor, and manufacturing
Under this system, costs are determined in
overhead of goods on which manufacturing has begun
advance from analysis and forecasts made before
but has not been completed at the end of the fiscal
the actual production begins. In a standard cost
period.
system, standard unit costs are computed for the
direct materials, direct labor and factory
overhead; these amounts, rather than the actual
Finished Goods Inventory
costs, are carried to Finished Goods inventory.
The Finished Goods Inventory account reflects the costs This will be discussed in Volume 2.
of goods that have been completed and are ready for
sale. This account corresponds to the Merchandise 3. Normal Cost System. This system is a
Inventory account of a merchandising business. Any combination of the actual cost system and the
changes in the Finished Goods Inventory account are standard cost system. This system ac- cumulates
reflected in the Cost of Goods Sold section of the only the actual amounts of direct material and
income statement. direct labor costs. Factory overhead costs are
accumulated on the ba- sis of a predetermined
rate. This system will be used in the next
chapter.

A comparison of the alternative product costing system

is presented below.

TYPES OF COST SYSTEMS

One type of accounting system is needed to accumulate
costs of goods manufactured when products are
produced in jobs or lots of varying quantities and types.
SYSTEM OF COST ACCUMULATION A different type of system is used when there is a
continuous flow of goods of identical or similar
The basic objective of cost accounting is the characteristics throughout the manufacturing process.
determination or accumulation of a product's cost for The job order cost system has been developed for the
inventory valuation and income determination. The
first type of operation, and the process cost system for distinct operations or processes. Usually, each process is
the second. carried out in a different department. A unit cost may be
computed for each process or department. This
Job Order Cost System
departmental unit cost may be a useful tool in measuring
The job order cost system accumulates costs applicable and controlling efficiency. The total cost of production is
to each specified job order or lot of similar goods determined by adding up the departmental costs.
manufactured on a specific order for stock or for a
Dual Systems
customer. When production on a job begins, the job is
assigned a number, and a form called a job cost sheet is Some manufacturers use both the job order cost system
set up. As direct materials are used, their costs are and the process cost system. A dual system is often used
entered on the job cost sheet. Similarly, direct labor costs when a company makes standard parts or subassemblies
incurred on a job are recorded periodically. When the job continuously and then incorporates them into finished
is completed (or periodically as the job is worked on), goods built to customer specifications. The cost of the
manufacturing overhead costs applicable to the job are parts is accumulated and determined under a process
estimated and entered on the job cost sheet. The job cost cost system, and the cost of each customer's order for
sheet, when complete, shows the total costs of the finished goods is computed under a job order cost'
completed job. The cost per unit may then be obtained system. The job order cost system is outlined in Chapter
by dividing the total cost of the job by the number of 2 and dis- cussed in detail in the remaining chapters. The
units completed. process cost system is covered in Volume Two.
The job order cost system is often used by INTRODUCTION TO THE JOB ORDER COST
manufacturers, such as a furniture manufacturer, who CYCLE - NORMAL COSTING
produce a variety of products, because such producers
As discussed earlier, total manufacturing cost consists of
need to keep track of each specific order to ensure
three elements: direct materials, direct labor, and
correct assignment of costs. Also, the actual costs shown
manufacturing overhead. The flow of these costs through
on the job cost sheets may be compared with the
the accounting system parallels the flow of products
estimated costs on which the sales prices were based.
through the manufacturing operations.
Any discrepancies or significant variations between
estimated costs and actual costs to manufacture are WORK FLOW
analyzed, and necessary corrective actions are taken to
ensure that adequate profit margins are maintained. The steps in a typical cycle of operations of a firm using
Job Order Cost System are outlined below:
Process Cost System
The process cost system accumulates costs without
attempting to allocate them during the accounting period 1. Procurement: Materials and supplies needed for
to specific units of goods being manufactured. At the end manufacturing are ordered, received, and stored.
of the fiscal period, the average cost per unit is Direct and indirect factory labor and services are
determined by dividing the total number of units obtained.
produced into the total cost accumulated. Because of this
technique, process costing is often referred to as average 2. Production: Materials are transferred from the
costing. If the process cost system is used, the goods storeroom to the fac- tory. Labor tools,
manufactured must be similar in nature so that an machines, power, and other costs are applied to
average cost will be meaningful. The process cost complete the product.
system is commonly used in such manufacturing
operations as cement plants and flour mills, in which the 3. Warehousing: Finished goods are moved from
production process is standardized and continuous and the factory to the warehouse to be held until they
the product remains essentially the same from day to are sold.
day.
4. Selling: Customers are found. Merchandise is
shipped from the ware- house. Sales to
customers are recorded.
In many types of businesses that use process costing,
manufacturing con- sists of a progressive series of
The cost accountant's job is to design a system in which MATCHING COST FLOW AND WORK FLOW
all cost elements are recorded as incurred and then
The provision for special cost accounts sets the stage of
charged to production as the work flows through the
charging costs in accordance with the flow of work. The
operating cycle.
process can best be understood if analyzed step by step
RECORDING COSTS AS INCURRED as follows:
As each cost is incurred, it must be recorded in an 1. Procurement: Purchases of materials, labor, and
appropriate general ledger account. Different accounts overhead are re- corded as debits to Materials,
are needed at different points in the operating cycle. The Factory Payroll and Manufacturing Overhead
following information includes usual account titles and Control. As these costs are used, or applied, in
numbers: factory operations, they are credited to these
accounts and transferred to production.
1. Procurement: Accounts must be provided to
2. Production: Costs of materials, labor, and
record the purchase of materials, labor, and
overhead transferred into production are debited
overhead. These costs will later be charged to
to Work in Process. As goods are finished and
production. Typical general ledger account titles
moved from the factory, their total cost is
and numbers used for this purpose are Materials
removed from the Work in Process account by a
121, Factory Payroll 500, and Manufacturing
credit entry and charged (debited) to Finished
Overhead Control 501.
Goods.
2. Production: An account is required to gather
3. Warehousing: The cost of finished goods
procurement costs as they become chargeable to
transferred from Work in Process is recorded as
manufacturing operations. This account is Work
a debit to Finished Goods. The cost of
in Process 122.
merchandise shipped from the warehouse to
3. Warehousing: An account must be set up to
customers is credited to Finished Goods and
record the cost of goods that have completed
charged (debited) to Cost of Goods Sold.
manufacturing process. This account is Finished
4. Selling: As indicated above, as finished goods
Goods 126.
are sold and shipped from the warehouse, their
4. Selling: The cost of the completed goods that
cost is debited to Cost of Goods Sold. At the end
have been sold must be recorded. An account,
of the accounting period, this account is closed
Cost of Goods Sold 415, is provided in the
by crediting Cost of Goods Sold and debiting
general ledger for this purpose. Other general
Income Summary 399.
ledger accounts, Ac- counts Receivable 111 and
Sales 401, are used for recording the sale to the
customer and the credit to income at the selling The matching of cost and work flow is shown below.
price.
The following examination of the Cost Flow of JenJen
Printer’s, Inc. for June 2014 will show how the Cost
The Flow Chart below shows the relationship of these Flow matched the Work Flow.
accounts to the steps in the operating cycle.