PAMANTASAN NG LUNGSOD NG MAYNILA

COST ACCOUNTING LECTURES

REFERENCE COST ACCOUNTING 2013 EDITION
BY GLORIA ARDANIEL RANTE

CHAPTER 1
COST CONCEPTS, CLASSIFICATIONS AND COST ACCOUNTING CYCLE

DEFINITION OF COST ACCOUNTING

Cost accounting is a discipline that focuses on technique or method for

determining the cost of a project, process or services for the purpose of
planning and controlling activities, improving quality and efficiency, and for
making decisions.

According to Horngren, Cost Accounting measures and reports financial and

non-financial information relating to the cost of acquiring or consuming
resources in an organization.

Rayburn states that Cost Accounting identifies, defines, measures, reports,

and analyzes the various elements of direct and indirect costs associated
with producing and marketing goods and services. It also measures the
performance, product quality and productivity.

USES OF COST DATA

Cost accounting information is very useful in determining product and

service costs and in setting prices for the product and the service. Knowing
the costs of a product or service helps the management set the selling price
enough to recover the cost of production, cost of performing a function,
distribution, administration and to provide allowance for reasonable profit.
These costs information also help the management in deciding whether to
maintain, to reduce or to increase the selling price in order to have a fair
competition in the market.
The accumulated costs information are summarized and reported to the
management for effective planning to attain the company’s goal and
objectives.

CLASSIFICATION OF COSTS

I. Product Cost/Inventoriable Cost

This cost is also call the manufacturing cost. This is the sum of the
inputs or resources used in the conversion of raw materials into
finished product. They include costs of direct materials, direct labor
and factory overhead.

Work in Process Account

This is the summarized accumulated cost of direct materials, direct
labor and factory overhead, and is reported also in the Balance Sheet
as current asset if still unfinished at the end of the accounting period.

Finished Goods Inventory Account

This is the transferred cost from work in process account of the
completed goods, and is reported at the Balance Sheet if unsold.

Cost of Goods Sold

This is the finished goods already sold and is reported as an expense
in the Income Statement.

Manufacturing Company normally maintains three (3) inventory

accounts: Finished Goods Inventory, Work in Process Inventory and
Raw Materials Inventory that represent the unused portion of direct
and indirect materials.

Retailing or Merchandising Company product costs include the

purchase price of goods bought for resale plus the transportation
costs and other direct costs incurred in bringing the goods to the
place of the buyer.
 Construction Company Their product costs include the cost of
construction, labor of carpenters and overhead incurred in
constructions like cost of power, light and water, insurance,
hospitalization and other health benefits for workers, maintenance
of construction equipments, compensation of foreman, cost of
constructing temporary house for the workers and for construction
materials, depreciation of equipments, rentals and other expenses
incurred in the construction site.

For service organizations, its product costs are classified either as

direct or indirect costs. Their inventory accounts are usually for
supplies like office supplies for accounting firm or law firms, medical
supplies for hospitals and medical clinics, cleaning supplies for utility
firms and food supplies for restaurants and bars.

ELEMENTS OF PRODUCT COST:

1. MATERIALS include the raw materials and other factory

supplies used in manufacturing operation, classified as:

Direct Materials are those materials traceable to the product

being produced.

Indirect Materials are materials necessary in manufacturing

operations but are not directly included in or not a
significant part of the product.

2. LABOR represents the compensation and other benefits paid

to the workers in the factory, classified as:

Direct Labor represents compensation and benefits paid to

those who physically work on the conversion of
raw materials into finished product and are easily
traceable to a specific process or job order.
 Indirect Labor represents wages of personnel other than the
direct laborers, which are necessary to the
manufacturing process or service but are
not directly related to the actual conversion of raw
materials into a finished product. They include
supervisor’s fee, wages to other workers like janitor,
employees benefits such as the employer’s share in the
mandatory deductions, bonuses, etc.

PRIME COSTS is the sum of direct materials and direct labor.

3. Manufacturing Overhead is an indirect product cost and it

includes productions costs other direct materials and
direct labor that include:

Factory supplies such as oil and other cleaning materials used

in the factory.

Wages of supervisors, factory maintenance personnel, raw

materials handlers and security officers stationed
in the factory premises.

Depreciation of factory plant and equipment.

Insurance and property taxes on factory plant and equipment.

Maintenance and repairs on factory plant and equipment.

Power light and water.

Telephone and mailing costs.

Cost of regulatory compliance such as meeting factory safety

requirements and disposal of waste materials.
 Idle time by factory workers due to machine breakdown or
new set ups which are unavoidable in production
process.

CONVERSION COSTS is the sum of direct labor and factory

overhead.

II. PERIOD COSTS

Period costs are operating expenses that are associated with time
periods, rather than with the production of goods and services. They
are charged directly to expense accounts on the assumption that
their benefit is recognized entirely in the period when the cost is
incurred. They are not manufacturing costs and inventoriable
costs.

They include:

Marketing and Selling Costs They include the costs of getting and
filing orders such as cost customer service, cost of
documentation, salaries and commissions of
sales personnel, advertising costs and other expenses
associated with the sale of goods and services.

Distribution Costs They are costs of warehousing, transporting and

delivering a product or service.

Administrative Costs These are costs association with the general

administration of the organization that cannot be
reasonably assigned to either marketing or production
such as the salaries of the administrative officers and
employees, power and water consumption, transportation and
representation expenses, maintenance cost of office
equipments, depreciation, taxes and licenses, gas and oil
and other expenses in he administrative expenses.
III DIRECT COSTS AND INDIRECT COSTS

Direct Costs are costs that can obviously and physically trace to a
manufacturing process, job or order, business unit, segment or
department. These costs are often described as those that would be
saved if the segment or business unit would be discontinued or if the
product would not be manufactured. Direct costs are not direct
materials and direct labor but it also includes the cost to a run a
business unit, like
a. Salary of auto mechanic in automotive servicing
company.
b. Salary of a binder in a printing company.
c. Oil and lubricants in a trucking business.
d. Steel bars by Construction Company.
e. Bond papers and telephone expenses in a law office.
f. Cost of detergents in a laundry shop.
g. Cost of x-ray, doctor’s fee, laboratory fee and medicine
in a hospital.

Indirect Costs are costs related to a particular cost object but cannot
be traced to that cost object in an economically feasible way. They
are normally incurred for the benefit of several segments within the
organization. In a manufacturing company, these are the overhead
costs incurred in the process of production.

IV COMMON COST AND JOINT COSTS

Common Costs are costs mutually beneficial costs, which occur when
the same resources is used in the output of two or more services or
products, or simply the costs of facilities or services shared by two or
more departments or operations. Example:
a. building repairs and maintenance costs
b. rent of a building occupied by different departments
c. power and utilities costs
 d. salaries and wages of personnel serving two or more
departments
e. real estate taxes for land and building
f. permits and licenses.

Joint Costs are costs incurred in a single process that yields two or
more products. They are production costs (direct materials, direct
labor and factory overhead) incurred up to the point where products
are separately identified.
Example: the cost of dough, labor of baker and overhead incurred
by a bakeshop.

V. OPPORTUNITY COSTS AND SUNK COSTS

Opportunity Costs represents the benefits foregone because one

course of action is chosen over another, as rent revenue forgone if a
company decides to use a part of a building rather than lease it.

Sunk Costs are costs that have already been incurred and will be
changed or avoided by any future decision. They are past costs that
are unavoidable because they cannot be changed no matter what
action is taken by the management.

VI. COMMITTED COSTS AND DISCRETIONARY COST

Committed Costs are costs resulting from an organization’s structure

or use of facilities and its basic organization structure. Examples are:
property taxes, depreciation on buildings and equipments, salaries of
management personnel and cost renting facilities.

Discretionary Costs are costs resulting from management decision to

spend a particular amount of money for a specific purpose. Example:
a. amount of money to spend on research and
development
 b. management development program and contributions to
charitable institutions.
c. advertising and promotions.

VII. CONTROLLABLE AND NON-CONTROLLABLE COSTS

Controllable costs are costs that are primarily subject to the

influence of a given responsibility center manager for a given period
of time, cost of raw materials used in the manufacturing leather
products. The production manager has the ability to control the
materials to be used in the production by selecting materials with
high quality, thus rejecting waste and spoilage.

Non-controllable costs are cost that cannot be controlled or

influenced by a responsibility city manager, like cost of renting
equipment. The owner of the equipment has the control over the
amount of rent nor the production manager.

VIII. OUT OF POCKET COSTS AND BUDGETED COSTS

Out of Pocket Costs are costs refer to the cash outlay required to
complete a proposed project or to extend an activity undertaken.

Budgeted Costs refer to planned or predetermined costs.

IX. CAPITAL EXPENDITURES AND REVENUE EXPENDITURES

Capital Expenditures are expenditures intended to benefit future

periods and are reported as asset in the balance sheet, like cost of
overhauling heavy equipments and cost of replacing worn out wall of
a building.
 Revenue Expenditures are that benefit only the current period and
are reported as expense.

X. FIXED, VARIABLE AND MIXED COSTS

Fixed Costs are costs that are constant in total within the relevant
range of activity but variable on a per unit basis. As the activity level
increases or decreases, total fixed cost remains constant but unit cost
declines or goes up.

Variable Costs are costs that vary in total in direct proportion to

changes in the volume of production. Variable cost is a constant
amount on a per unit basis as activity changes within a relevant
range. As activity changes, total variable costs increases or decreases
proportionally with the activity change but unit variable costs remain
the same.

Mixed costs or semi-variable costs are costs that have both fixed and
variable component like heat, light and water expense.

Relevant range is a limited range of activity within which

expenditures can be accurately classified as fixed cost or variable or
the range over which an assumed cost relationship is valid for the
normal operations of a firm.

SEPARATING MIXED COST

One of the methods of separating mixed cost is called the high-low method,
which it starts from selecting the highest and lowest levels of activity in a
given set of data within the relevant range. Then subtract the lowest range
from the highest range then multiply by the activity level to get the total
variable cost from the mixed cost at either high or low level. Then subtract
the variable cost from the mixed cost to get the fixed cost portion.

FORMULA:
 Cost of high –cost at lowest level (within relevant range)
Highest activity –lowest activity

OR: