1|CHAPTER 1-INTRODUCTION TO COST ACCOUNTING

PRIMARY OBJECTIVE OF ACCOUNTING • Primarily concerned with financial statements for external use
by those who supply funds to entity and other persons who may
• To provide financial information about an economic entity to have vested interest in the financial operations of the firm.
different types of users. • The supplier of funds:
TYPES OF USERS 1. Stockholders (the owners of the corporation)
2. Partners (the owners of partnership)
A. Internal Users – managers for planning, controlling, and decision 3. Sole Proprietors
making. • Financial statements are the output from an accounting
B. External Users – the government, those who provide funds, and system.
those who have various interests in the operations. • Financial accounting is based on historical transaction data.
COST ACCOUNTING • The information may be historical, quantitative, monetary,
and verifiable.
• An expanded phase of general or financial accounting which • The information usually presented in the form of financial
informs management promptly with the cost of rendering a statements, taw returns, and other formal reports distributed to
particular service, buying and selling a product, and producing various external users.
a product. • It is required for many firms organized as corporations because
• It is the field of accounting that measures, records, and reports of the requirements of the Securities and Exchange
information about costs. Commissions (SEC).
• Recognized as being essential to efficient cooperation of • It attempts to present some degree of precision in reporting
business and industry. historical information while at the same time emphasizing
verifiability and freedom from bias in the information, relevance
SIMILAR ACTIVITIES OF MANUFACTURING ORGANIZATIONS AND to the general user and some degree of timeliness in reporting
MERCHANDIZING BUSINESS
which is not as critical in managerial accounting.
• Concerned with purchasing, storing, and selling goods. B. Managerial Accounting – focuses on the needs of parties within
• Must have efficient management and adequate sources of the organization, rather than interested parties outside the
capital. organization.
• May employ hundreds or thousands of workers. • Commonly addresses individual or divisional concerns rather
than those of the enterprise as a whole.
MANUFACTURING PROCESS • The information may be current or forecasted, quantitative
or qualitative, monetary or non-monetary, and most of all
• Involves the conversion of raw materials into finished goods futuristic.
through the application of labor and the incurrence of various
• It is not separate and distinct from financial accounting.
factory expenses.
• Financial accounting data are used in the managerial
COMPARISON OF FINANCIAL, MANAGERIAL, AND COST accounting system.
ACCOUNTING • Management decisions made today will affect the financial
statement of future periods.
A. Financial Accounting – the use of accounting information for • There is no requirement or legislation that mandates the format
reporting to external parties, including investors and creditors. or use of managerial accounting.
2|CHAPTER 1-INTRODUCTION TO COST ACCOUNTING

• It is more concerned on the timeliness of the information so • Manufacturer maintains three inventory accounts:
management cannot wait until tomorrow for the information that 1. Materials Inventory – purchased materials unused during
is required for today’s decision. the production process make up the ending material
• Measurements in managerial accounting: inventory balance.
1. An economic measure such as pesos 2. Work in Process Inventory – account when the
2. A physical measure such as pounds, gallons, tons, or materials, labor services, and overhead items are used in
units the production process. The cost of materials used plus the
3. A relationship measure such as ratios costs of labor services and factory overhead are
C. Cost Accounting – the intersection between financial and transferred in this inventory.
managerial accounting. ✓ Factory Overhead includes such items as indirect
• Cost accounting information is needed and used by both materials, indirect labor, utility costs, depreciation of
financial and managerial accounting. factory machinery, depreciation of factory building,
• Provides product cost information to external parties, such as and supplies.
stockholders, creditors, and various boards for credit and ✓ The three types of costs mentioned are often called
investment decisions. Direct Materials (DM), Direct Labor (DL), Factory
• Provides product cost information also to internal parties such Overhead (FO).
as managers for planning and controlling. 3. Finished Goods Inventory – when a batch or order is
completed, all manufacturing costs assigned to the
MERCHANDIZING VERSUS MANUFACTURING OPERATIONS completed units are moved in this inventory.
A. Merchandizing Company – normally buys a product that is ready USES OF COST ACCOUNTING DATA
for resale when it is received. Nothing needs to be done to the
product to make it salable except possibly to prepare a special A. Determining Product Costs – cost accounting procedures help
package or display. management in gathering the data needed to determine product
• Total Beginning Merchandise Inventory + Purchases = Basis costs and thus generate meaningful financial statements and other
for computing both Cost of Goods Sold and Ending reports.
Merchandise Inventory balances. • Cost procedures must be designed to permit the computation
• Costs assigned to unsold items make up the ending inventory of unit costs as well as total product costs.
balance. • Unit cost information is also useful in making a variety of
• The difference between the cost of goods available for sale and important marketing decisions.
the ending inventory amount is the cost of goods sold during 1. Determining the Selling Price of a Product – a
the period. knowledge of the cost of manufacturing a unit of a product
• Formula: helps in setting price, which should be high enough to
Beginning merchandise inventory cover the cost of production, pay a portion of marketing
Plus: Total purchases and administrative expenses and provide a profit.
Cost of goods available for sale 2. Meeting Competition – if a competitor is selling the
Less: Ending merchandise inventory product at a low price, detailed information regarding unit
Cost of goods sold costs can be used to determine the action to be taken by
B. Manufacturing Company – computing the cost of goods sold for a the company.
manufacturing company is more complex.
3|CHAPTER 1-INTRODUCTION TO COST ACCOUNTING

3. Bidding on Contracts – many manufacturing firms must RECENT DEVELOPMENTS IN COST ACCOUNTING
submit competitive bids in order to be awarded
manufacturing contracts by the government or private • Cost accounting is experiencing dramatic changes. Manual
firms. bookkeeping has been reduced because of the use of
4. Analyzing Profitability – unit cost information enables computers. Changes in production methods have made
management to determine the amount of profit that each traditional applications of cost accounting obsolete in some
product earns and possibly eliminate those that are least cases.
profitable, thereby concentrating efforts on those items that • Increasing emphasis on control is seen now in hospitals, in
are most profitable. industries facing stiff foreign competition and in many
• Costs are said to be used for managerial accounting purposes organizations that have traditionally not focused on cost
when costs are used inside the organization by managers to control.
evaluate the performance of operations or personnel, or as a • The use of accounting data for decision making and
basis for decision making. performance evaluation has gained importance in recent years.
B. Planning and Control COST ACCOUNTING AND OTHER FIELDS OF STUDY
• One of the most important functions of cost accounting is the
development of information which can be used by the • The recording of the costs of a product or a service is part of
management in planning and controlling operations. financial accounting.
1. Planning – the process of establishing objectives or goals • The use of cost for valuation of inventory and cost of goods sold
for the firming and determining the means by which the firm for external reporting is also financial accounting.
will attain them. It is essential to good management • The use of cost data in choosing between two or more
because it provides a means of coordinating all of the alternatives is part of managerial accounting.
operations of firm. Planning can be divided into three • Differential Cost Analysis is considered by others as a form of
components: applied microeconomics.
a. Strategic Planning – concerned with setting long • Cost accounting provides data for use in decision models for
range goals and objectives to determine the overall finance, operations management, and marketing.
direction of the company. • Cost accounting is also related to motivation and behavior
b. Tactical Planning – concerned with plans for a because it is used in planning and performance evaluation.
shorter range (or time period) and emphasizes plans • Tools from statistics mathematics, and computer sciences are
to achieve the strategic goals. used to perform cost analysis.
c. Operations Planning – relates to the day to day
implementation of tactical plans. It emphasizes the TWO BASIC PRODUCT-COSTING SYSTEMS
coordination of the major factors of production
(materials, labor, and facilities). A. Job Order Costing - a system for allocating costs to groups of
2. Controlling – the process of monitoring the company’s unique product. It is applicable to the production of customer
operations and determining whether the objectives specified products such as the manufacture of special machines.
identified in the planning process are being accomplished. • Each job becomes a cost center for which costs are
accumulated.
• A subsidiary record (job cost sheet) is needed to keep track of
all unfinished jobs (work in process) and finished jobs (finished
goods).
4|CHAPTER 1-INTRODUCTION TO COST ACCOUNTING

B. Process Costing - a system applicable to a continuous process of • Unit costs are computed by dividing total manufacturing costs
production of the same or similar goods, e.g., oil refining and assigned to a particular department or work center during a
chemical production. period by the equivalent unit of production.
• Since there is no need to determine the costs of different • The main characteristics of a process cost accounting systems:
groups of products because the product is uniform, each 1. Manufacturing costs are grouped by department or work
processing department becomes a cost center. center, with little concern for specific job orders.
2. It emphasizes a weekly or monthly time period rather than
CHARACTERISTICS OF JOB ORDER COSTING the time taken to complete a specific order.
• Job Order Cost Accounting System is a product costing 3. It uses several Works in Process Inventory accounts – one
system used by companies making one-of-a-kind or special- for each department or work center in the manufacturing
order products. process.
• In such a system, direct materials, direct labor, and factory • Many manufacturing firms have production systems which are
overhead costs arc assigned to specific job orders or batches not suited for strictly job-order costing or process costing, but
of production. instead require a costing system which incorporates ideas from
• In computing unit costs the total manufacturing costs for each both. This blending of idea is knowing as Hybrid Costing.
job order are divided by the number of good units produced for • Operation Costing is a hybrid costing system often used in
that order. repetitive manufacturing where finished products have
• Industries that use a job order cost accounting system include common, as well as distinguishing characteristics.
those that make ships, airplanes large machines, and special • Based on the variations, the products and the related costs are
orders identified by batches or by production runs. A television
• The primary characteristics of a job order cost system are: assembly plant, which produces a basic chassis and
1. It collects all manufacturing costs and assigns them to component system, but which varies options such as remote
specific job or batches of product. control and cabinetry would be a logical user of operation
2. It measures costs for each completed job, rather than for costing.
set time periods. • Some companies process large orders of identical units as a
3. It uses just one Work in Process Inventory Control account group through the same production sequence. Each of these
in the general ledger. This account is supported by a orders is called a batch. In batch production, costs are
subsidiary ledger of job order cost cards or sheets for each allocated to each batch.
job in process at any point of time. • Generally, job costing concepts are used to account for batch
production and each batch is treated as a job for costing
CHARACTERISTICS OF PROCESS COSTING purposes.
• A process Cost Accounting System is a product costing MAJOR DIFFERENCES BETWEEN PROCESS AND JOB ORDER
system used by companies that make a large number of similar
products or maintain a continuous production flow. Process Costing Job Order Costing
• In these cases, it is more economical to account for product- 1. Homogenous units pass 1. Unique jobs are worked
related costs for a period of time (a week or a month) that is to through a series of similar on during a time period.
try to assign them to specific products or job orders. processes.
2. Costs are accumulated by 2. Costs are accumulated
processing department. by individual job.
5|CHAPTER 1-INTRODUCTION TO COST ACCOUNTING

3. Unit costs are computed by 3. Unit costs are

dividing the individual determined by dividing
departments’ costs by the the total costs on the
equivalent production. job sheet by the number
of units on the job.
4. The cost of production report 4. The job cost sheet
provides the detail for the provides the details for
Work in Process account for the Work in Process
each department. account.

• In job costing, costs are accumulated for each job or batch

produced costing, costs are accumulated by department for an
accounting period (for example a month).
• Process costing has less detailed recordkeeping, hence, if a
company was choosing between job and process costing, it
would generally find that recordkeeping costs are lower under
process costing.
• Process costing does not provide as much information as job
costing because records of the cost of each unit produced are
not kept using process costing.
• The choice of process versus job costing systems involves a
comparison of the costs and benefits of each system.
• As a general rule, job systems are usually more costly than
process systems.
• So, if managers and accountants must decide whether to use
job costing or process costing, recordkeeping costs must be
compared with additional benefits that will be derived from
knowing the actual cost of each unit.
• If recordkeeping costs were equal under job and process
systems, for the units in a product line, then the job costing
systems are better because they provide all of the data that
process systems do.