AEC 105 COST ACCOUNTING AND CONTROL

Cost Concepts and Objectives

Functions of Management:
1) Planning – involves establishing a basic strategy, selecting a course of action,
and specifying how the action will be implemented.
2) Directing and Motivating – involve mobilizing people to carry out plans and run
routine operations.
3) Controlling – involves ensuring that the plan is actually carried out and is
appropriately modified as circumstances change.
4) Decision-making opportunities appear in daily activities ranging from
adding/dropping business divisions or mergers and acquisitions to remuneration
adjustments for employees.

Role of Cost Accounting and its Relationship to Management and Financial

Accounting
1) Cost accounting is a set of discipline that focuses on techniques or methods for
determining the cost of a project, process, or thing through direct measurement,
arbitrary assignment, or systematic and rational allocation.
2) Financial accounting focuses on external users, and as such, must comply with
the generally accepted accounting principles (the PFRS and the PAS). Financial
accounting information is:
a) typically historical, verifiable, quantifiable, and monetary;
b) usually quite aggregated and related to the organization as a whole;
c) often a business essential because it is necessary for obtaining loans,
preparing tax returns, and understanding how well or how poorly the
business is performing.
3) Management accounting focuses on the information needs of a firm’s internal
managers that are related to their planning, controlling and decision-making
functions.
a) Some management needs are satisfied by historical, monetary information
based on generally accepted accounting principles.
b) Other needs require forecasted, qualitative and frequently nonfinancial
information that has been developed and computed for their specific
decision purposes.

1
 c) A company’s business intelligence system is a formal process for
gathering and analyzing information and producing intelligence to meet
decision-making needs.

The Role of Cost Accounting

● Cost accounting includes defining costs and valuing inventories to help
managers to run businesses.
● Management accounting, on the other hand, relates to the provision of
appropriate information, including cost information for decision-making, planning,
control, and performance evaluation.
● Cost accounting and management accounting are sometimes interchangeable,
and their functions are to help companies make better decisions. The close
relationship between cost and management accounting intertwines them.

Classification of Costs
The term cost is used in many different ways. The reason is that there are many types
of costs, and these costs are classified differently according to the immediate needs of
management. This notion of different costs for different purposes is a critically important
aspect of managerial accounting.

Cost classifications for manufacturing companies

1) Manufacturing costs:
a) Direct materials – are those materials that become an integral part of the
finished product and whose costs can be conveniently traced to the
finished product. For example, wood used to make tables or electronic
chips to manufacture motherboards for computers.

b) Direct labor consists of labor costs that can be easily (physically and
conveniently) traced to individual units of product. Examples of direct labor
include carpenters working at furniture factories and electronic engineers
developing the chips.

2
 c) Manufacturing overhead – includes all manufacturing costs except direct
materials and direct labor. Manufacturing overhead can be classified into
three categories: (a) indirect materials, (b) indirect labor, and (c) others.
● indirect materials – are small items of material such as glue
and nails that may be an integral part of a finished product,
but whose costs cannot be easily or conveniently traced to it.
● indirect labor – refer to the salaries of janitors, supervisors,
materials handlers and other factory workers that cannot be
conveniently traced to particular products.
● Depreciation on factory machinery, factory rent expense,
factory utilities cost, factor insurance expense and other
costs relating to manufacturing activities comprise the
“others” category.
2) Nonmanufacturing costs
a) Selling costs – include all costs that are incurred to secure customer
orders and get the finished products to the customer. Examples of selling
costs or expenses include advertising, shipping, sales travel, sales
commissions, sales salaries, and costs of finished goods warehouses.
b) Administrative costs – include all costs associated with the general
management of an entity rather than with manufacturing or selling.
Examples of administrative costs include executive compensation. general
accounting, secretarial, public relations, and similar costs involved in the
overall, general administration of the organization as a whole.

Cost classifications for preparing financial statements

1) Product costs – include all costs involved in acquiring or making a product. In the
case of manufactured goods, these costs consist of direct materials, direct labor,
and manufacturing (or factory) overhead. Product costs are initially assigned to
an inventory account on the statement of financial position. When the goods are
sold, the costs are released from inventory as expenses (typically called cost of
goods sold) and matched against sales revenue. Because product costs are
initially assigned to inventories, they are also known as inventoriable costs.
2) Period costs – are all the costs that are not product costs. For example, sales
commissions and the rental costs of administrative offices are period costs.
Period costs are not included as part of the cost of either purchased or
manufactured goods; instead, period costs are expensed on the income

3
 statement in the period in which they are incurred using the usual rules of accrual
accounting.
3) Prime costs and conversion costs
a) Prime cost is the sum of direct materials cost and direct labor cost.
Prime cost = direct materials cost + direct labor cost
b) Conversion cost is the sum of direct labor cost and factory overhead cost.
Conversion cost = direct labor cost + factory overhead cost
Summary of Cost Terms