CHAPTER 1 - Introduction To Cost Accounting
CHAPTER 1 - Introduction To Cost Accounting
CHAPTER 1 - Introduction To Cost Accounting
Accounting Cycle
Learning Objectives:
• State the scope and primary objectives of cost accounting;
• Differentiate cost accounting from financial and managerial accounting;
• Explain the different costing methods, techniques, and cost accumulation systems;
• Define terms useful in introducing cost accounting system; and
• Distinguish between job order costing and process costing.
Financial accounting is the branch of accounting that deals with the accumulation and
preparation of financial data for the investors, creditors, regulators and other external users.
Because financial accounting is designed to meet the needs of the external users, it is required to
comply with the Philippines Financial Reporting Standards ( PFRS ).
On the other hand, management accounting is the branch of accounting that involves the
process of accumulating, summarizing, and interpreting economic data about the business
primarily for management and other internal users. It is not required to adhere to the PFRS when
providing information to management for internal use. Management accounting has a subset called
cost accounting that provides product costing information that is necessary for managers to make
their decisions.
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Cost accounting is a branch of managerial accounting that focuses on the flow of cost
of the product and services and development of the systems relating to the cost determination. It
supplements the financial accounting by proving cost date and other relevant information
necessary to accomplish its objectives.
The following summarizes the main differences between cost accounting and financial
accounting:
FINANCIAL ACCOUNTING COST ACCOUNTING MANAGEMENT ACCOUNTING
1. Nature Financial Accounting deals Cost Accounting deals with Management accounting deals with
with recording, classifying, recording, classifying, the collection, analysis, and
summarizing and interpreting summarizing and interpreting the interpretation of information to
in monetary terms, the materials, labor and overhead assist management in their
transactions and events carried cost incurred in manufacturing decision-making and to conduct the
out by an organization. and selling the product, activity business more effectively and
or service. efficiently.
2. Purpose Financial Accounting leads to Cost Accounting leads to the Management Accounting provides
the preparation of the major development of cost of a proud, information to management for
financial statements in activity or service, indicating planning, controlling and decision-
accordance with PFRS. It aims profitability of each product, making. It is concerned about
to provide financial activity, or service when needed. providing financial and non-
information mainly to external It aims to provide information to financial information to
users. management for planning and management in order to manage the
control and decision-making. business effectively and efficiently
and to perform key business
decisions and policies.
3. Primary users External users such as Internal users such as managers. Internal users such as managers.
creditors, shareholders,
investors and regulatory
bodies.
4. Accounting system Double entry system is used May not be based in double entry May not be based in double entry
for recording, classifying and system. system.
summarizing transactions and
events.
5. Accounting PFRS are followed in No specific accounting principles No specific accounting principles
principles recording, measuring and are required because information are required because information is
presenting the financial is mainly provided only to mainly provided only to internal
information. internal users for planning and users for planning and control and
control and decision-making. decision-making
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6. Report timing Financial statements and Cost date provides information Reports are prepared as often as
reports are generally prepared more frequently. However, no needed by the managers for
for a period of one year, but specific period covered is planning and decision making.
can also be prepared at regular required for cost accounting Management is concerned about
intervals such as semi- reports. It depends on the needs timeliness of the information. It
annually or quarterly. of the users for purposes of cannot wait until tomorrow for the
planning, control, cost information that is required for
determination and decision- today’s decision.
making.
3. To control cost.
Cost accounting helps management to control cost through various techniques such
as budgetary control, standard costing and inventory management control in order to
monitor the company’s operation and determine whether the objectives identified in the
planning process are efficiently accomplished.
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Cost Accounting provides timely information necessary for the preparation of the
financial statements and other reports. In order to manage the business and determine its
overall operating efficiency, it is essential for management to review the cost date relating
to procurement, production, sales and operating result of the business. Financial statements
are generally prepared once a year since the value of actual closing inventories is usually
available at the end of the year. However, because cost accounting provides production
report and value of closing stock periodically, it helps in the preparation of the financial
statements at shorter intervals.
2. Budgeting
Budgeting involves the preparation of the company’s plan of operation and
activities, and expressing it in financial terms.
3. Cost Control
Cost control involves the analysis of the cost and comparison with the
predetermined standards set by the company. Any variances are used as gauge to measure
company’s operating efficiency.
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Components of Cost Accounting
Cost of accounting has five components with its subset namely:
I. Costing Method
a. Actual or historical
b. Standard
c. Normal
II. Costing Technique
a. Absorption or Full Costing
b. Variable or Direct Costing
c. Activity- Based Costing
III. Cost Accumulation
a. Job Order Costing
b. Process Costing
c. Backflush Costing
IV. Cost Flow Assumption
a. Specific Identification
b. First in First out (FIFO)
c. Last in First out (LIFO)
d. Average Method
V. Inventory System
a. Perpetual Inventory System
b. Periodic Inventory System
COSTING METHOD
The three costing methods that influence the amount of cost to be assigned to the product are the
following:
1. Actual or historical costing refers to the costing of a product based on the actual historical
costs after they are incurred.
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Standard costs are used to determine the cost of a product activity, or service, and then compared
with the actual cost to determine the extent of the variances for investigations and management
actions.
3. Normal costing refers to the setting of the cost of a product based on actual costs except
for the overhead which is based on pre-determined rate.
The overhead application rate is charged per unit of activity during the given period.
The summary of the three costing methods is presented below:
Actual Standard Normal
Direct materials Actual Standard Actual
( actual price X actual ( standard price X standard ( actual price X actual
quantity of input used ) quantity of input allowed quantity of input used )
for actual output achieved
)
Direct labor Actual Standard Actual
( actual price X actual ( standard price X standard ( actual price X actual
quantity of input used ) quantity of input allowed quantity of input used )
for actual output achieved
)
Overhead Actual Standard Budget
( actual OH rate X actual ( standard OH rate X ( predetermined OH rate X
quantity of cost allocation standard quantity of cost actual quantity of cost
based used ) allocation base allowed for allocation base used )
actual output achieved )
COSTING TECHNIQUE
There are three costing techniques that are commonly used in cost accounting:
1. Absorption or full costing is traditional costing technique where all manufacturing costs,
whether fixed or variable, are treated as product costs.
2. Variable or direct costing refers to the costing technique were all variable manufacturing costs
(direct materials, direct labor and variable factory overhead) are considered product costs
while fixed factory overhead cost is considered as period cost.
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3. Activity-based costing (ABC) is a costing technique which assumes that cost objects consume
activities. It assigns overhead costs to the activities that are real cause of the overhead and
subsequently assigns the cost of those activities only to the products that demand such
activities.
1. Job order costing is It is a product costing system used by companies making one—of-a kind
or special-order products. The cost of a product is tracked by individual job orders.
2. Process costing is used when homogenous or very similar products are produced in large
volumes. Manufacturing cost incurred are allocated to the proper functions or departments
within the process, rather than to specific products or job orders.
3. Backflush costing focuses mainly on the output of the business and then works backwards to
allocate the product cost between cost of goods sold and inventories. This costing was
developed for just-in-time operations.
2. First in First Out (FIFO) is a cost flow assumption where the goods which were purchased
first are assumed to have been sold first, thus, the ending inventory is comprised of items from
the most recent purchases.
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3. Last-in, First-out (LIFO) is based on the assumption that the latest items purchased are sold
first, leaving the oldest items in the ending inventory. It is not permitted in the Philippines.
4. Average Method is used when same cost is applied to all units in the inventory. The weighted-
average unit cost is determined by dividing the cost of goods available for sale by the number
of units available for sale. At the end of the accounting period, the remaining units on hand
are then multiplied by the weighted average price per unit to determine cost of ending
inventory.
INVENTORY SYSTEM
The two types of inventory system are:
1. Perpetual inventory system. Under this system, the purchase of direct and indirect materials
is recorded in an account “Inventory”. The “inventory” account is updated immediately after
every purchase and sale based on the stock ledger card that is used to control the inventory
quantities.
2. Periodic inventory system. Under this system, the purchase of direct and indirect materials is
recorded in an account “Purchases”. Under this method, the cost of materials is not directly
determined. It is indirectly computed by deducting the remaining inventory on hand from the
total available for use (materials beginning plus net purchases).
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Cost classification refers to the process of grouping cost according to their common characteristics
or features. While cost classification is determined for planning and control, it is also performed
to obtain proper matching of cost and benefits on the income statement.
1. Cost Classified as to relation to the product
A. Manufacturing or product costs
▪ Direct Materials
▪ Direct Labor
▪ Factory Overhead
B. Non-manufacturing or period costs
▪ Marketing or selling expense
▪ General or administrative expense
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D. Relevant
E. Out of pocket cost
F. Sunk
Direct Labor
Labor represents the amount paid for the salaries and wages of the employees for their
services. Direct Labor costs include all labor costs for specific work performed on products that
can be conveniently and economically traced to end products.
Examples are salary of machine operators, salary of employee cutting woo
Factory Overhead
Factory overhead costs are varied collection of product-related costs that cannot be
practically or conveniently traced directly to end products. These include manufacturing costs that
cannot be classified as either direct materials or direct labor costs.
Examples are:
Indirect materials: nails, rivets, lubricants, and small tools
Indirect labor: Salary of supervisor, inspector, machine helpers, and maintenance workers
Other Costs: Building maintenance, factory utilities expense, machinery and tool
maintenance, factory taxes and insurance, depreciation of factory building, plant and equipment,
factory rental expense, and other indirect factory costs.
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Marketing or selling expense
It includes all costs necessary to secure customer orders and get the finished product or
service into the hands of the customer.
Examples are advertising, shipping, sales travel, sales commission, sales salaries, and other
expenses associated with selling.
Fixed Costs
These are items of cost which remain constant in total, irrespective of the volume of
production. Cost per unit is inversely proportional to the activity level. As activity level increases,
fixed cost per unit decreases, and vice versa. Examples of these costs are salaries of production
executives, depreciation of equipment computed on a straight line basis, periodic rent and
insurance payment.
Mixed Cost
These are items of costs with fixed and variable components. Example includes utilities
where there is a fixed charge for the minimum rate and variable charge per unit for actual excess
usage.
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Cost Classified as to Controllability
• Controllable cost. These costs are subject to the discretion of a manager or can be controlled
to keep within pre-defined limits.
• Noncontrollable cost. These costs are outside the control of a manager or cannot be
influenced at a given level of managerial supervision.
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• Opportunity Cost is the value of the alternative foregone by adopting or pursuing a
particular strategy or certain action.
• Sunk costs are historical costs that were incurred in the past and are not relevant to the
particular decision-making problem being considered.
• Out of pocket cost requires the payment of money (or other assets) as a result of their
incurrence.
(2) Incurrence of direct and indirect materials Work in Process Inventory xxx
to production Factory Overhead Control xxx
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Raw Materials Inventory xxx
(9) Transfer of finished goods to cost of goods sold Cost of Goods Sold xxx
Finished Goods xxx
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Materials 50,000
Journal Entries
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*to record issuance of materials
2 Factory Overhead Control 37,800
Accounts Payable 37,800 7 Work in Process 112,000
*to record incurrence of factory overhead Factory Overhead Applied 112,000
*to record application of factory overhead
3 210,000
Payroll
Withholding Tax Payable 18,520 8 Finished Goods 412,000
SSS Premiums Payable 8,400 Work in Process 412,000
Phil health Cont. Payable 1,125 *to record transfer of cost of goods manufactured into
Pag-ibig Cont. Payable 6,300 Finished Goods
Accrued Salaries 175,655
*to record accrual of payroll for the month 9 Accounts Receivable 560,000
Sales 56,000
Work in Process 140,000 *to record sales
Factory Overhead Control 30,000
Selling Expenses 25,000 Cost of Goods Sold 400,000
Administrative Expenses 15,000 Finished Goods 400,000
Payroll 210,000 *to record the cost of goods sold
*to record distribution of payroll
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4 Accrued Salaries 175,000 Accounts Receivable 415,000
Cash 175,000 *to record collection
*to record payment of payroll for the month
11 Accounts Payable 240,000
5 Factory Overhead Control 14,200 Cash 240,000
Selling Expenses 2,375 *to record payment
Administrative Expenses 1,350
SSS Premiums Payable 10,500
Philhealth Cont. Payable 1,125
Pag-ibig Cont. Payable 6,300
*to accrue the employer's contribution
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The T- Accounts for the transactions are presented below:
Cash Accounts Payable Common Stock
beg 150,000 150,000 beg 145,000
10 415,000 175,000 4 250,000 1
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Brave Company Brave Company
Cost of Goods Sold Statement Statement of Financial Position
January 30, 2021 January 30, 2021
ASSETS
Raw Materials, beginning 50,000 Cash 150,000
Add: Purchases 250,000 Accounts Receivable 205,000
Materials Available for Use 300,000 Finished Goods Inventory 67,000
Less: Ending Materials 60,000 Work in Process Inventory 70,000
Indirect Materials 30,000 Raw Materials Inventory 60,000
Direct Materials Used 210,000 TOTAL ASSETS 552,000
Direct Labor 140,000
Factory Overhead 112,000
Total Manufacturing Costs 462,000 LIABILITIES AND CAPITAL
Add: Work in Process, beg 20,000 Accounts Payable 22,800
Cost of Goods Put into
Process 482,000 Accrued Salaries 8,655
Less: Work in Process, end 70,000 Withholding Tax Payable 18,520
Cost of Goods Manufactured 412,000 SSS Prem. Cont. Payable 18,900
Add: Finished Goods, beg 55,000 Philhealth Cont. Payable 2,250
Cost of Goods Available for
Sale 467,000 Pag-ibig Cont. Payable 12,600
Less: Finished Goods, end 67,000 Total Liabilities 83,725
Cost of Goods Sold 400,000
Common Stock 320,000
Brave Company Retained Earnings 148,275
Income Statement Total Capital 468,275
January 30, 2018
Total Liabilities & Capital 552,000
Sales 560,000
Cost of Goods Sold 400,000
Gross Profit 160,000
Expenses 43,725
Net Income 116,275
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