Chapter One Overview

Meaning and Scope of Cost Accounting

Cost accounting is the process of determining and accumulating the cost of product or activity. It
is a process of accounting for the incurrence and the control of cost. It also covers classification,
analysis, and interpretation of cost. In other words, it is a system of accounting, which provides
the information about the ascertainment, and control of costs of products, or services. It measures
the operating efficiency of the enterprise. It is an internal aspect of the organization.

Cost Accounting is accounting for cost aimed at providing cost data, statement and reports for
the purpose of managerial decision making. Cost accounting is the process of accounting from
the point at which expenditure is incurred or committed to the establishment of its ultimate
relationship with cost centers and cost units.

In the widest usage, it embraces the preparation of statistical data, application of cost control
methods and the ascertainment of profitability of activities carried out or planned. Costing
includes “the techniques and processes of ascertaining costs.” The ‘Technique’ refers to
principles which are applied for ascertaining costs of products, jobs, processes and services. The
'Process’ refers to day to day routine of determining costs within the method of costing adopted
by a business enterprise.

Costing involves “the classifying, recording and appropriate allocation of expenditure for the
determination of costs of products or services; the relation of these costs to sales value; and the
ascertainment of profitability”.

Scope of Cost Accounting

The terms ‘costing’ and ‘cost accounting’ are many times used interchangeably. However, the
scope of cost accounting is broader than that of costing. Following functional activities are
included in the scope of cost accounting:
1. Cost book-keeping: It involves maintaining complete record of all costs incurred from their
incurrence to their charge to departments, products and services. Such recording is preferably
done on the basis of double entry system.
2. Cost system: Systems and procedures are devised for proper accounting for costs.
3. Cost ascertainment: Ascertaining cost of products, processes, jobs, services, etc., is the
important function of cost accounting. Cost ascertainment becomes the basis of managerial
decision making such as pricing, planning and control.
4. Cost Analysis: It involves the process of finding out the causal factors of actual costs varying
from the budgeted costs and fixation of responsibility for cost increases.
5. Cost comparisons: Cost accounting also includes comparisons between cost from alternative
courses of action such as use of technology for production, cost of making different products
and activities, and cost of same product/service over a period of time.
6. Cost Control: Cost accounting is the utilization of cost information for exercising control. It
involves a detailed examination of each cost in the light of benefit derived from the
incurrence of the cost. Thus, we can state that cost is analyzed to know whether the current
level of costs is satisfactory in the light of standards set in advance.

1
7. Cost Reports: Presentation of cost is the ultimate function of cost accounting. These reports
are primarily for use by the management at different levels. Cost Reports form the basis for
planning and control, performance appraisal and managerial decision making.

Objectives of Cost Accounting

There is a relationship among information needs of management, cost accounting objectives, and
techniques and tools used for analysis in cost accounting. Cost accounting has the following
main objectives to serve:
 Determining selling price,
 Controlling cost,
 Providing information for decision-making,
 Ascertaining costing profit,
 Facilitating preparation of financial and other statements.

Determining selling price - The objective of determining the cost of products is of main
importance in cost accounting. The total product cost and cost per unit of product are important
in deciding selling price of product. Cost accounting provides information regarding the cost to
make and sell product or services. Other factors such as the quality of product, the condition of
the market, the area of distribution, the quantity which can be supplied etc., are also to be given
consideration by the management before deciding the selling price, but the cost of product plays
a major role.

Controlling cost - Cost accounting helps in attaining aim of controlling cost by using various
techniques such as Budgetary Control, Standard costing, and inventory control. Each item of cost
[viz. material, labor, and expense] is budgeted at the beginning of the period and actual expenses
incurred are compared with the budget. This increases the efficiency of the enterprise.

Providing information for decision-making - Cost accounting helps the management in

providing information for managerial decisions for formulating operative policies. These policies
relate to the following matters:
(i) Determination of cost-volume-profit relationship.
(ii) Make or buy a component
(iii)Shut down or continue operation at a loss
(iv) Continuing with the existing machinery or replacing them by improved and economical
machines.

Ascertaining costing profit - Cost accounting helps in ascertaining the costing profit or loss of
any activity on an objective basis by matching cost with the revenue of the activity.

Facilitating preparation of financial and other statements - Cost accounting helps to produce
statements at short intervals as the management may require. The financial statements are
prepared generally once a year or half year to meet the needs of the management. In order to
operate the business at high efficiency, it is essential for management to have a review of
production, sales and operating results. Cost accounting provides daily, weekly or monthly
statements of units produced, accumulated cost with analysis. Cost accounting system provides

2
immediate information regarding stock of raw material, semi-finished and finished goods. This
helps in preparation of financial statements.

Purpose of Accounting System

As you may recall from your earlier accounting courses, there is no single official definition of
accounting. However, most authors use the following wording: - Accounting is the process of
identifying, measuring, and communicating financial information about an entity to permit
informed judgments and decisions by users of the information. It is a system of gathering
financial information about a business and reporting this information to users.
There are six major steps in accounting process:
1. Data gathering and analyzing - analyzing is looking at events that have taken place and
thinking about how they affect the business. Such an economic events or conditions that
directly changes an entity’s financial condition or results of operation are known as business
transactions in accounting.
2. Recording - is entering financial information about events in to the accounting system. This
can be done manually or using computer, this day's most business use computers to perform
routine record-keeping operations.
3. Classifying - is sorting and grouping similar items and /or events rather than merely keeping
numerous items and/or events all together.
4. Summarizing - is bringing the various items of information together to determine a result.
5. Reporting - is telling the results.
6. Interpreting -is deciding the meaning and importance of the information in various reports.
This may include percentage analysis and the use of ratios to help explain how pieces of
information relate to one another.

Users of Accounting Information

Who is the user of accounting information?
In the earlier section, we have said that, accounting is a system of gathering financial information
about a business and reporting this information to decision makers to help make informed
decisions. Strictly speaking everyone in a society is engaged in decision making, from the very
minor and personal ones to a very complex and that are overall organizational or even country
level or above that. In most decisions accounting information is primarily used hence we can say
that everyone in a society is user of accounting information. However, with respect to particular
entity, users of accounting information fall in to two categories: Internal Users and External
Users.

Internal Users: - These are managers of the entity who use the information
a. For making short-term planning and controlling routine operations
b. For making non-routine decisions and formulating overall policies and long-range plans.

External Users: - These include parties which are external to the organization, do not involve in
the day-to-day operation of the organization, but which have interest in the financial information

3
of the organization. Examples include: government, customers, suppliers, creditors, financial
analysts, owners, investors, etc.

Both internal parties (managers) and external parties use accounting information, but the ways in
which they use it differ, the types of accounting information they demand may also differ.

Difference between Financial, Cost and Management Accounting

Management accounting refers to accounting information developed for managers. It is the
process of gathering; communicating and interpreting information that helps managers fulfill
organizational objectives. In contrast financial accounting refers to accounting information
developed for use of external parties. It measures and records business transactions and provides
financial statements that are based on GAAP.

Cost accounting provides information for both management accounting and financial accounting.
It measures, analyzes and reports, financial and non-financial information relating to the cost of
acquiring or using resources in an organization. For example, calculating the cost of a product is
a cost accounting function that answers financial accountings inventory valuation needs and
management accountings decision-making need such as pricing decision. Modern cost
accounting takes the perspective that collecting cost information is a function of management
accountant. Thus, the distinction between management accounting and cost accounting is not
clear-cut and different authors use these terms interchangeably.

What Is Management Accounting?

In defining management accounting a logical start is to examine the words “Management” and
“Accounting” separately. Unfortunately, neither of these words has a single, universally agreed
meaning. Management may be seen to encompass the entire range of activities involved in
running an organization. On the other hand Accounting may be seen to encompass any of the
activities that attempt to gauge the performance of the organization or to plan for an
organization’s performances. Additionally it may be seen to encompass the traditional
accounting roles of stewardship control, and audit. A layman might think of accounting as being
concerned only with those activities with financial measurements undertaken by those with the
title “accountant” and of management as being concerned with those activities undertaken by
those with the title “managers” neither is the case in the real world.

So far you may think as if there is a clear cut between “Accounting” and “management”, but in a
competitive business environment, and with in a public sector that is increasingly focused up on
effectiveness, value for money and best practice, all organizational participants take on a
responsibility of both management and accounting. The actions of each individual within an
organization have, after all ‘a trickle-down’ effects on other parts of the organization and an
“upward” effect on the eventual results of the organization as a whole. Here are major
distinctions between Management and Financial Accounting:

4
Table 1.1 Major distinctions between Management Accounting and Financial Accounting
Basis Management Accounting Financial Accounting
(i) Primary Organization managers at different level Outside parties such as investors
users government, and also organization
managers
(ii) Freedom of No constraints other than costs in relation Constrained by generally accepted
choice to benefits of improved decisions accounting principles (GAAP).
(iii) Behavioral Concern about how measurements and Concern about how to measure and
implication reports will influence manager’s daily communicate economic phenomena.
behavior Behavioral considerations are
secondary
(iv) Time Focus Future orientation: Formal use of budgets Past orientation historical evaluation.
all well as historical records
(v) Time Span Flexible, varying from hourly to 10 to 15 Less flexible, usually 1-year or 1
years quarter.
(vi) Reports Detailed Reports concern about details of Summary reports: concern primarily
parts of the entity, products, departments with entity as a whole
territories, etc
(vii) Delineation Field is less sharply defined. Field is more sharply defined. Lighter
of activities Heavier use of Economics, decision use of related disciplines
science ,and behavioral sciences

Thus, what is management accounting? Well in a nutshell management accounting is accounting

for management. "Management Accounting is the process of identifying measuring, analyzing,
preparing, interpreting and communicating information that managers use to fulfill
organizational objectives".

In this sense, management accounting includes the production of information useful in running
the organization, such information may be:
 Financial or non-financial,
 Accurate or broadly correct,
 Actual (certain) or estimated (uncertain),
 Based in the past or the future,
 Detailed, or highly aggregated form,
 Presented in any of a variety of spoken or written forms, such as tables and graphs.
 Related to profits (losses), costs (revenues), volumes, quality indicators, trends, etc.
Thus, in many senses, an average person might not consider many of the areas of management
accounting as accounting at all.

What Is Financial Accounting?

Financial accounting (or financial accountancy) is the field of accountancy concerned with the
preparation of financial statements for decision makers, such as stockholders, suppliers, banks,
employees, government agencies, owners and other stakeholders. Financial capital maintenance
can be measured in either nominal monetary units or units of constant purchasing power. The
central need for financial accounting is to reduce the various principal-agent problems, by

5
measuring and monitoring the agents' performance and thereafter reporting the results to
interested users.

Financial accountancy is used to prepare accountancy data for people outside the organization or
for those, who are not involved in the mundane administration of the company. Management
accounting, provides accounting information to help managers make decisions to manage and
enhance the business. In short, financial accounting is the process of summarizing financial data,
which is taken from an organization's accounting records and publishing it in the form of annual,
semi- annual, quarterly or monthly reports, for the benefit of people outside the organization.
Financial accountancy is governed not only by local standards but also by international
accounting standard.

DIFFERENCE BETWEEN FINANCIAL AND COST ACCOUNTING

After studying financial accounting and cost accounting, you can understand the difference
between these two accounting systems. Therefore, difference between financial accounting and
cost accounting is as follows:

Table 1.2 Differences between Financial Accounting and Cost Accounting

Basis Financial Accounting Cost accounting
(i) Objective It provides information about the It provides information of
financial performance and financial ascertainment of cost to control cost
position of the business. and for decision making about the cost.
(ii) Nature It classifies records, presents and It classifies, records, presents, and
interprets transactions in terms of interprets in a significant manner the
money. material, labor and overheads cost.
(iii) Recording of It records Historical data. It also records and presents the
data estimated/budgeted data. It makes use
of both the historical costs and pre-
determined costs.
(iv) Users of The users of financial accounting The cost accounting information is
information statements are shareholders, used by internal management at
creditors, financial analysts and different levels.
government and its agencies, etc.
(v) Analysis of It shows the profit/loss of the It provides the details of cost and profit
costs and profits organization. of each product, process, job, contracts,
etc.
(vi) Time period Financial Statements are prepared Its reports and statements are prepared
for a definite period, usually a year. as and when required.
(vii) Presentation A set format is used for presenting There are not any set formats for
of information financial information. presenting cost information.

In spite of the above differences, both financial and cost accounting are in agreement regarding
actual cost data and product costing analysis. Values of stock and cost of goods produced and
sold are the main examples. For the preparation of the position statement, financial accountant
receives the necessary data from the cost accountant.

6
Importance of Cost accounting
The limitation of financial accounting has made the management to realize the importance of
cost accounting. The importances of cost accounting are as follows:

1. Importance to Management
Cost accounting provides invaluable help to management. It is difficult to indicate where the
work of cost accountant ends and managerial control begins. The advantages are as follows:

Helps in ascertainment of cost - Cost accounting helps the management in the ascertainment of
cost of process, product, Job, contract, activity, etc., by using different techniques such as Job
costing and Process costing.

Aids in Price fixation - By using demand and supply, activities of competitors, market condition
to a great extent, also determine the price of product and cost to the producer does play an
important role. The producer can take necessary help from his costing records.

Helps in Cost reduction - Cost can be reduced in the long-run when cost reduction programme
and improved methods are tried to reduce costs.

Elimination of wastage - As it is possible to know the cost of product at every stage, it becomes
possible to check the forms of waste, such as time and expenses etc., are in the use of machine
equipment and material.

Helps in identifying unprofitable activities -With the help of cost accounting the unprofitable
activities are identified, so that the necessary correct action may be taken.

2. Importance to Employees
Worker and employees have an interest in which they are employed. An efficient costing system
benefits employees through incentives plan in their enterprise, etc. As a result both the
productivity and earning capacity increases.

3. Cost accounting and creditors

Suppliers, investor’s financial institution and other moneylenders have a stake in the success of
the business concern and therefore are benefited by installation of an efficient costing system.
They can base their judgment about the profitability and prospects of the enterprise upon the
studies and reports submitted by the cost accountant.

4. Importance to National Economy

An efficient costing system benefits national economy by stepping up the government revenue
by achieving higher production. The overall economic developments of a country take place due
to efficiency of production.

5. Data Base for operating policy

Cost Accounting offers a thoroughly analyzed cost data which forms the basis of formulating
policy regarding day to day business, such as:
(a) Whether to make or buy decisions from outside?

7
 (b) Whether to shut down or continue producing and selling at below cost?
(c) Whether to repair an old plant or to replace it?

LIMITATIONS OF COST ACCOUNTING

Like other branches of accounting, cost accounting is not an exact science but is an art which has
developed through theories and accounting practices based on reasoning and common sense.
These practices are not static but changing with time. Cost accounting lacks a uniform procedure.
There is no stereotyped system of cost accounting applicable to all industries. There are widely
recognized cost concepts but understood and applied differently by different industries. Cost
accounting can be used only by big enterprises. The limitations of cost accounting are as follows:
 It is expensive because analysis, allocation and absorption of overheads require considerable
amount of additional work.
 The results shown by cost accounts differ from those shown by financial accounts.
Preparation of reconciliation statements frequently is necessary to verify their accuracy.
This leads to unnecessary increase in workload.
 It is unnecessary because it involves duplication of work. Some industrial units are
functioning efficiently without any costing system.
 Costing system itself does not control costs. If the management is alert and efficient, it can
control cost without the help of the cost accounting. Therefore it is unnecessary.

Distinguish B/n the Planning and Control Decisions of Managers

The Nature of Planning and Control
The management process is a series of activities in a cycle of planning and control. Decision-
making, which is the purposeful choice from among a set of alternative courses of action
designed to achieve some objective is the core of management process. Decisions within an
organization are often divided in to two types: Planning Decisions and Control Decisions. In
practice, planning and control are so intertwined that it seems artificial to separate them.

Planning - is setting goals, predicting results and deciding to attain goals.

Control - is deciding and taking actions, it is deciding on performance evaluation and feedback.
Budgets - are quantitative expressions of proposed plan of actions. Budgets aid in the
coordination and implementation of the plan.
Performance Reports - are reports that compare actual results with budgeted amounts.

Example of performance Report:

BS Shop, Jan 2010
Budget Actual Variance
Revenues 59,000 60,000 1,000 F
Cost of goods sold 42,000 43,400 1,400U
Wages Expense 6,700 7,000 3,000U
General Expense 1,300 900 400F
Fixed Costs 5,000 5,000 0
Operating Income 4,000 3,700 300U

8
The accounting system supports planning and controlling function and is a key source for
performance reports. Accounting formalizes control as performance report, which provides
feedback by comparing results with plans and by highlighting variances, which are deviations
from plans. Based on their evaluation, managers would make corrections and revisions to their
plans. Performance reports are used to judge decisions and the productivity of organizational
units and manager. By comparing actual results to budgets performance report motivate manager
to achieve budgeted objectives.

Performance reports spur investigation of exceptions-items for which actual amounts differ
significantly from budgeted amounts. Operations are then made to conform to the plans, or the
plans are revised. This is often called management by exception, which means concentrating on
areas that deviate from the plan and ignoring areas that are presumed to be running smoothly.
Thus, the management-by-exception approach frees managers from needless concern with those
phases of operations that are adhering to plans. However, well-conceived plans should
incorporate enough discretion or flexibility so that the manager may feel free to peruse any
unforeseen opportunities. In other words, control should not be a straight jacket. When
authorized in the plan, managers should be able to take these actions.

Line and Staff Authority

Line authority is authority which is exerted downward over subordinates. Staff authority is
authority to advise but not command. It may be exerted downward, laterally, or upward. The top
accounting officer of an organization is often called the controller or respectably in a
government organization a comptroller. The controller position varies in nature and duties from
organization to organization. In some firms, the controller is confined to compiling data,
primary for external reporting purposes. In others, the controller is a key executive who aids
managerial planning and control throughout the company’s subdivisions. In most firms,
controllers have a status somewhere between these two extremes.

Although controllers have a staff role, they are generally empowered by the firm’s president to
approve, install, and oversee, the organization’s accounting system to ensure uniform accounting
and reporting methods. In theory, controllers have no line authority except over the accounting
department. Yet by reporting and interpreting relevant data, controllers do exert a force or
influence that leads management toward logical decisions that are consistent with the
organization’s objective. Many people confuse the office of controller and treasurer, as can be
seen from the partial organization chart these are both functions which report to financial vice
president, i.e., they boot are at equal level in the organization chart.

9
Basic distinction between controller and Treasurer
Table 1.3- Distinguishing roles of controller and Treasurer
Controller Treasurer
1. Planning for control 1. Provision of capital
2. Reporting and Interpreting 2. Investor relation
3. Evaluating and Consulting 3. Short-term financing
4. Banking and Custody
4. Tax administration
5. Credit and Collection
5. Government Reporting 6. Investments
6. Protection of assets 7. Risk management (Insurance)
7. Economic appraisal

As you can observe from the table above treasurer is concerned mainly with the company’s
financial matters, where as the controller with the operating matters. The exact division of
accounting and financial duties varies from company to company, in a small organizations; the
same person might be both treasurer and controller.

10
 CHAPTER TWO
COST CONCEPTS AND CLASSIFICATION
Managers need to understand costs in order to interpret and act on accounting reports. Managers
who understand cost concepts and terms are best able to use the information provided and can
avoid misusing it. A common understanding of cost concepts and terms helps communication
among managers and management accountants. In this chapter, we will discuss cost concepts
and terms that are the basis for accounting information used for internal and external reporting.

Cost and Cost Object

Cost is a resource sacrificed or forgone to achieve specific objective while cost object is
anything for which a separate measurement of cost is desired.

How do accountants relate activities to resource costs in a way that make cost control possible?
Accountants first identify the activities in their organization and determine measures of output
for each activity. They then relate each output measures to the resources that are necessary to
produce it. Any output measure that causes cost (that is, causes the use of costly resources) is
called a cost driver. Look at the following Exhibit.

Value Chain Functions and Examples of Costs R&D Example of Cost Driver
 Salaries of marketing research personnel, costs of  Number of new proposal
market survey
 Salaries of product and process engineers  Complexity of proposed products
Design of products, services and processes
 Salaries of product and process engineers  Number of engineering hour.
 Cost of computer-aided design equipment  Number of parts per product
Production
 Labor wages  Labor hour
 Supervisory salaries  Number of people supervised
 Maintenance wages  Number of machine hour
 Depreciation of plant asset  Kilowatt hour
 Energy
Marketing
 Cost of advertisements  Number of advertisement
 Salaries of marketing personnel  Sales birr
Distribution
 Wages of shipping personnel  Labor –hour
 Transportation costs  Weight of item delivered
Customer service
 Salaries of service personnel  Hours spent serving products
 Costs of supplies, travel costs  Number of service calls
Table 2:1 Examples of value chain functions, costs and cost drivers

General Classifications of Costs

An organization has many cost drivers across its value chain. How well the accountant does at
identifying the most appropriate cost drivers determines how well managers understand cost
behavior and how well costs are controlled.

11
 (A) Direct and Indirect Costs
A costing system typically accounts for costs in two basic stages: accumulation followed by
assignment. Cost accumulation is the collection of cost data in some organized way by means
of an accounting system. Cost assignment is a general term that encompasses both: (1) tracing
accumulated costs that have a direct relationship to the cost object and (2) allocating
accumulated costs that have an indirect relationship to a cost object.

Direct costs of a cost object - are related to a particular cost object and can be traced to it in an
economically feasible (cost-effective) way. Thus, the term cost tracing is used to describe the
assignment of direct costs to a particular cost object.
Indirect costs of cost object- are related to the particular cost object but cannot be traced to it in
an economically feasible (cost-effective) way. The term cost-allocation is used to describe the
assignment of indirect costs to a particular cost object.

Cost Accumulation Cost Assignment Cost objects

Direct costs Cost tracing Cost object 1

Indirect costs Cost Allocation Cost object 2

Cost object 3
Exhibit 2:1 Cost Accumulation and Cost Assignment

Factors Affecting Direct/Indirect Cost Classification

Several factors affect the classification of a cost as direct or indirect. The following factors are
the major ones.
Materiality of the cost in question- the smaller the amount of a cost, that is the more immaterial
the cost is-the less likely that it is economically feasible to trace that cost to particular cost
object.
Available information gathering technology - Improvements in information gathering
technology make it possible to consider more and more costs as direct costs.
Design of operations -Classifying a cost as direct is easier if a company’s facility (or some part
of it) is used exclusively for a specific cost object, such as specific product or a particular
customer.
At this point, be aware that a specific cost may be both direct cost of one cost object and indirect
cost of another cost object. That is, the direct indirect classification depends on the choice of the
cost object.

(B) Fixed and Variable Costs

Costing systems record the cost of resources acquired, such as materials, labor, and equipment,
and track how those resources are used to produce and sell products or services. Recording the
costs of resources acquired and used allows managers to see how costs behave.

Knowing how costs vary by identifying the drives of costs and by distinguishing fixed from
variable costs is frequently the key in making management decision. In fact, much management
functions, such as planning and control, rely on how costs behave. For example, consider

12
questions, what price should we charge? Should we make the component part or buy it? What
effect will a 40% increase in units sold have on operating income? Knowledge of cost behavior
is a key input in answering these questions. The following paragraphs will discuss how costs
change in relation to changes in activity levels such as units of products produced, and so on,
which is often called costs behavior pattern in accounting.

Variable Cost- A variable cost is a cost, which changes in total in proportion to changes in the
related level of total activity or volume.
Fixed Cost - A fixed cost remains unchanged in total for a given time period despite wide
changes in the related level of total activity or volume.
NB - Costs are defined as variable or fixed with respect to a specific activity and for a given
time period.

A particular cost item could be variable with respect to one level of activity and fixed with
respect to another. Some costs have both fixed and variable elements and are called mixed or
semi variable costs. Therefore, don’t assume that individual cost items are inherently variable or
fixed.

Cost Derivers
A cost driver is variable such as level of activity or volume that causally affects costs over a
given time span. That is, there is a cause-effect relationship between a change in the level of
activity or volume and a change in the level of total costs. For example as discussed in the
previous section, the product-discussed in the previous section, the product-design costs changes
with the number of parts in a product, thus, the number of parts is a cost driver of product-design
costs. The cost driver of a variable cost is the level of activity or volume whose change causes
proportionate changes in the variable cost. Costs that are fixed in the short run have no cost
driver in the short run but may have a cost driver in the long run.

Relevant Range
Relevant range is the boundary of normal activity level or volume in which there is a specific
relationship between the level of activity or volume and the cost in question. For example, a
fixed cost is fixed only in relation to a given wide range of total activity or volume at which the
company is expected to operate and only for a given time span.
The basic assumption of the relevant range also applies to variable costs. That is, outside the
relevant range, variable costs, such as direct materials, may to change proportionally with
changes in production volume. For example, above certain volume, direct material costs may
increase at lower rate because of price discounts on purchases of large quantities.

Note that, costs may simultaneously be:

Direct
 Direct and Variable
 Direct and Fixed
 Indirect and Variable
Variable Fixed
 Indirect and Fixed

Exhibit 2:2 Direct/Indirect & Variable/Fixed Cost

Indirect

13
 (C) Total Cost and Unit Cost
Unit Cost: Generally, the decision maker should think in terms of total costs rather than in unit
costs. In many decision contexts, however, calculating a unit cost is essential. For example:
consider the chairman of social committee of your organization or any organization you know,
who is trying to decide whether to rent a hall and pay some to the author and show a movie for
upcoming party to be held on next Christmas. He estimated the total cost of hall rent and a
payment for author is let say Br 2000. This knowledge is helpful for the decision, but it is not
enough. Before a decision can be reached, the chairman must predict the number of people who
will attend. Without the knowledge of the total cost and number of attendees, he cannot make
informed decision on a possible admission price to recover the cost of the party or even whether
to have a party at all. So he computes the unit cost by dividing the total cost (Br 2000) by the
expected number of people who will attend. If 2000 people attend, the unit cost is Br 10 per
person, and If 1000 people attend the unit is Br 2 per person.

Thus, in such situation unless the total cost is “unitized” (that is, averaged with respect to the
level of activity or volume), the Br 2000 cost is difficult to interpret. The unit cost combines the
total cost and the level of activity or volume in a handy, communicative way. Accounting
systems typically report both total cost amounts and average-cost-per unit amounts. A unit cost,
also called an average cost is computed by dividing total cost by the number of units. The units
might be expressed in various ways. Unit costs are found in all areas of the value chain for
example unit cost of product designs, of sales visits, and of customer-service calls. By summing
unit costs throughout the value chain, managers calculate the unit cost of the different products
or services they deliver and determine the profitability each product or service. Managers use
this information, for example, to decide which products they should emphasize and the prices
they should charge

Use of Unit Costs Cautiously

Although unit costs are regularly in financial reports and for marketing product mix and pricing
decisions, managers should think in terms of total costs rather than unit costs for many decisions.
It is better to illustrate this point through example:

Illustration: Assume a Bicycle Assembly Company buys a handle bar at Br 52 for each of its
bicycles and pays an annual fixed cost of Br 94,500 for the lease of its plants. Assume that the
leasing cost is fixed and remain at the same amount for a volume range of 1000 to 5000 bicycles.
What is the unit cost (leasing and handle bars) when 1000 Bicycles are assembled?
Total Fixed Cost------------------------Br 94,500
+ Total variable cost (1000 x 52) -------- 52,000
Total cost-------------------------------- Br 146,500
Therefore, Unit cost = 146,500/1000 = Br 146.50

Assume that bicycle management uses a unit cost of Br 146.50. And if management is using the
unit cost for budgeting costs for levels of production, what is the budgeted cost for estimated
production of 2,000 bicycles, 2,600 bicycles, and 3,500 bicycles?
2000 x 146.50 = Br 293,000
2600 x 146.50 = Br 380,900
3500 x 146.50 = Br 512,750

14
Pretty student do you accept the above total budgeted costs? You should not.
What should be the budgeted cost for the estimated production levels (2,000 bicycles, 2,600
bicycles and 3,500 bicycles)?

Since all these production levels are within the relevant range, the total fixed cost (the leasing
cost) remains constant and hence the appropriate budgeted cost for the estimated production
level should be as follow:

Bicycles: 2,000 2,600 3,500

Total Variable Cost (2600 x52, 3500x 52, 2000 x52) 104,000 135,200 182,000
Total Fixed Cost 94,500 94,500 94,500
Total cost 198,500 229,700 276,500
Unit cost 99.25 88.35 79

As the above example shows, for decision making, managers should think in terms of total
variable costs, total fixed costs, and total costs rather than unit cost.

(D)Product and Period Costs

Before we discuss about product costs and period costs, let us see different business sectors with
example in each sector.

Manufacturing sector companies - These are companies, which purchase materials and
components and convert them into various finished goods. Examples include: Textile
companies, Food processing companies, automotive companies, etc.
Merchandising sector companies- These purchase and then sell tangible products without
changing their basic form. These companies include retail business, distributing business, or
whole sellers.
Service sector companies - Provide services (intangible products) for example legal advice,
audit, financial analysis, etc, to their customers. Examples include: Law firms, Accounting
firms, banks, Insurance companies, Hospitals, etc.

The distinction between product (inventorible) costs and period costs is necessary for financial
reporting for both manufacturing and merchandising sector of the economy. Service –sector
companies as mentioned above, provided only services or intangible products. Thus, they don’t
hold inventories of tangible products for sale, hence, the concept of inventorible costs and period
costs do not apply to service –sector companies.

Let us first look at the different types of inventory that companies hold and some commonly used
classification of manufacturing costs.

15
Types of Inventory
As mentioned earlier, manufacturing-sector companies purchase materials and components and
convert them in to various finished goods. These companies typically have one or more of the
following three types of inventory.
(a) Direct materials inventory- Direct materials in stock and awaiting use in manufacturing
process, For example: Wood need to manufacture different furniture’s by wood worker
company.
(b) Work-in-process inventory- Goods partially worked but not yet completed. This is also
called work-in-progress inventory.
(c) Finished goods inventory- Goods completed but not yet sold – these are finished goods a
waiting for sale. Example: Table, Bed, etc- completed product by the wood worker, which
is waiting for sale.

Merchandising sector companies purchase tangible products and then sell them without changing
their basic form. They hold only one type of inventory, which is products in their original
purchased form, known as merchandise inventory.

Classification of Manufacturing Costs:

Three terms commonly used when describing manufacturing costs are direct material costs,
direct labor costs, and indirect manufacturing costs.
(a) Direct material costs- are the acquisition costs of all materials that eventually become part of
the cost object (Work-in-process and then finished goods) and that can be traced to the cost
object in an economically feasible way. Acquisition costs of direct material include freight-
in (inward delivery) charges, sales taxes and custom duties.
(b) Direct manufacturing labor costs- includes the compensation of all manufacturing labor that
can be traced to the cost object (work in process and then to finished goods) in an
economically feasible way. Examples include wages paid to machine operator, and assembly
line workers who convert direct material purchased to finished good.
(c) Indirect manufacturing costs- are all manufacturing costs that are related to the cost object
(work in process and then finished goods) in an economically feasible way. This cost
category is also known as or various names are used for indirect manufacturing cost, such as
manufacturing overhead, factory overhead, or factory burden. All of these terms are
synonyms for indirect manufacturing cost.

It is the third element of manufacturing cost, includes all costs of manufacturing except direct
materials and direct labor. Manufacturing overhead includes items such as indirect materials;
supplies, maintenance and repairs on production equipment, heat and light, lubricants, property
taxes, depreciation, and insurance on manufacturing facilities; indirect manufacturing labor such
as the compensation for plant managers. A company also incurs costs for heat and light, property
taxes, insurance, depreciation, and so forth, associated with its selling and administrative

16
functions, but these costs are not included as part of manufacturing overhead. Only those costs
associated with operating the factory are included in manufacturing overhead. Across large
numbers of manufacturing companies, manufacturing overhead averages about 16% of sales
revenues.

Product costs or Inventorible costs

These are all costs of product that are considered as assets in the balance sheet when they are
introduced and that become cost of goods sold only when the product is sold. For manufacturing
sector companies, all manufacturing costs (Direct material, Direct manufacturing labor and
Manufacturing overhead) are inventorible costs. Hence manufacturing costs are included in
work-in-process inventory and in finished goods inventory (they are “inventoried”) to
accumulate the costs of creating these turning them is matched against the revenues from sale.
The cost of goods sold includes all manufacturing costs incurred to produce them.

Thus, product (inventorible) costs are assets because they have value as long as the company
owns them. When the inventory (finished goods) is sold, its cost is transferred from the balance
sheet to the income statement as cost of goods sold.

For merchandising-sector companies, inventorible costs are the costs of purchasing the goods
that are resold in their same form. These costs comprise the costs of the goods themselves plus
any incoming transportation costs.

Period Costs
Period costs are all costs in the income statement other than costs of goods sold. Period costs are
treated as expenses of the accounting period in which they are incurred because they are
expected to benefit revenues in that period and are not expected to benefit revenues in the future
period-there is no sufficient evidence to conclude that such future benefit exists.
 For manufacturing-sector companies, period costs in the income statement are non-
manufacturing costs (for example, design costs and distribution costs).
 For merchandising-sector companies, period costs in the income statement are all costs not
related to the cost of goods purchased for resale. Examples of these period costs are labor
costs of sales personnel, advertising costs and general administrative costs.

(E) Prime Cost and Conversion Cost

Two more cost categories are often used in discussions of manufacturing costs- prime cost and
conversion cost. Prime cost is the sum of direct materials cost and direct labor cost. Conversion
cost is the sum of direct labor cost and manufacturing overhead cost.
The term conversion cost is used to describe direct labor and manufacturing overhead because
these costs are incurred to convert materials into the finished product. Exhibit 2.3 contains a
summary of the cost terms that we have introduced so far.

17
 Manufacturing Costs
(Also called Product Costs
or Inventoriable Costs)

Direct Materials
Materials that can be
conveniently traced to a
product (such as wood in a table).
Direct Labor
Labor cost that can be physically
and conveniently traced to a product
(such as assembly-line workers in a
plant). Direct labor is sometimes
called touch labor.
Manufacturing Overhead
All costs of manufacturing a product
other than direct materials and direct
labor (such as indirect materials,
indirect labor, factory utilities, and
depreciation of factory buildings and
equipment).

Prime Cost Conversion Cost

Nonmanufacturing Costs
(Also called Period Costs or
Selling and Administrative Costs)

Selling Costs Administrative Costs

All costs necessary to secure All costs associated with the general
customer orders and get the management of the company as a
finished product or service to whole (such as executive
the customer (such as sales compensation, executive travel costs,
commissions, advertising, and secretarial salaries, and depreciation of
depreciation of delivery equipment office buildings and equipment).
and finished goods warehouses).

Flow of Inventorible and Period Costs

In this section, the illustration of the flow of inventorible costs and period costs through the
income statement of a manufacturing company are presented, for which the distinction between
inventorible costs and period costs is most detailed.

(A) Suppose a manufacturer had Br 50,000 of direct material inventory at beginning of the
period. Purchases of raw material during the period amounted to Br 180,000 and ending
inventory was Br 30,000. How much direct materials were used during the period?
Solution:
Cost of Material Used = Beginning inventory + Purchase – Ending inventory
= 50,000+ 180,000-30,000
= Br 200,000
(B) Suppose direct labor costs incurred during the period were Br 105,500 and indirect
manufacturing costs were Br 194,500, what were the total manufacturing costs incurred?
Solution:
Total Manufacturing = Direct Material + Direct Labor + Ind. Manufacturing
Costs Used Cost Costs
Direct material used---------------------------------------- 200,000
+ Direct labor cost ------------------------------------------- 105,500
+ Indirect manufacturing cost--------------------------------194,500
Total manufacturing cost-------------------------- Br 500, 000

18
(C) Assume that the work in process inventory at beginning of the period was Br 30,000 and Br
35,000 at the end of the period. What is the cost of goods manufactured?
Solution:
Cost Of goods = Beginning work + Total manufacturing - Ending Work
Manufactured in process Inventory Cost In process Inventory
= 30,000 + 500,000-35000
= Br 495,000
(D)Assume that the finished goods inventory at the beginning of the period was 10,000 birr and
15,000 birr at the end of the period. What is the cost of goods sold?
Solution:
Cost of Beginning Finished Cost of goods Ending Finished goods
= + -
goods sold goods inventory manufactured inventory
= 10,000+ 495,000 – 15000
= Br 490,000
The above illustration shows the flow of costs in manufacturing sector companies. This flow is
depicted as follow:
Work-in-process Finished Goods
Beg. Bal. Br 30,000 495,000 Beg. Bal. Br 10,000 490,000 Cost of goods Sold
DM Used 200,000 495,000 490,000
DL 105,500 Ending bal. Br 15,000
FOH 194,500
Ending bal. Br 35,000

Balance Sheet Income statement

Revenues
Materials Inventory Finished goods When Deduct
Inventory sale
occurs
Cost of goods Sold
Work-in-process Equals gross margin
Inventory
Deduct

Period costs
Exhibit 2:3 Flow of costs in manufacturing companies

Merchandise Merchandise Cost of goods Sold

Purchases Inventory

Period costs
Balance sheet Income statement
Exhibit 2:4 Flow of costs in merchandising business

19
Schedule of Cost of Goods Manufactured and Income Statement - Illustration
The following information has been taken from the accounting records of KS Corporation for
last year:
Selling expenses.......................................... $140,000
Raw materials inventory, January 1............ 90,000
Raw materials inventory, December 31...... 60,000
Direct labor cost.......................................... 150,000
Purchases of raw materials.......................... 750,000
Sales............................................................ 2,500,000
Administrative expenses.............................. 270,000
Manufacturing overhead.............................. 640,000
Work in process inventory, January 1.......... 180,000
Work in process inventory, December 31.... 100,000
Finished goods inventory, January 1........... 260,000
Finished goods inventory, December 31..... 210,000
Management wants these data organized in a better format so that financial statements can be
prepared for the year.
Required:
a) Prepare a schedule of cost of goods manufactured. Assume raw materials consist entirely of
direct materials.
b) Compute the cost of goods sold and Prepare an income statement.
Solution:
KS Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials inventory, January 1 $ 90,000
Add: Purchases of raw materials 750,000
Raw materials available for use 840,000
Deduct: Raw materials inventory, December 31 60,000
Raw materials used in production $780,000
Direct labor 150,000
Manufacturing overhead 640,000
Total manufacturing cost 1,570,000
Add: Work in process inventory, January 1 180,000
1,750,000
Deduct: Work in process inventory, December 31 100,000
Cost of goods manufactured $1,650,000

The cost of goods sold would be computed as follows:

Finished goods inventory, January 1 $ 260,000
Add: Cost of goods manufactured 1,650,000
Goods available for sale 1,910,000
Deduct: Finished goods inventory, December 31 210,000
Cost of goods sold $1,700,000

20
 KS Corporation
Income Statement
For the Year Ended December 31
Sales $2,500,000
Cost of goods sold (above) 1,700,000
Gross profit 800,000
Selling and administrative expenses:
Selling expenses $140,000
Administrative expenses 270,000 410,000
Net operating income $ 390,000
Absorption Costing and Variable Costing
In the previous section, we have discussed that inventory cost (product cost) is the sum of direct
material used, direct labor cost and manufacturing overhead costs. In this section, two
alternative ways of product (inventory) costing in manufacturing companies are introduced:

Absorption Costing- under this inventory valuation procedure all manufacturing costs are
assigned to inventory cost (all manufacturing costs: Direct material used, direct labor cost,
variable manufacturing overhead, and Fixed manufacturing overhead-are inventorible costs).
This is also known as full costing or traditional costing approach. It is used in general purpose
financial statements prepared for external users in accordance with generally accepted
accounting principles.

Variable (Direct) Costing

This is an inventory valuation procedure that assigns only variable manufacturing (Direct
material used, Direct manufacturing labor cost, and variable manufacturing overhead) to units
produced. All other costs including fixed manufacturing overhead are treated as period costs.
Look at the following Exhibit.

Absorption Variable/direct
costing costing
DM used
Product cost
DL cost
Product cost
Variable FOH

Fixed FOH

Variable Selling & Admin. Exp. Period cost

Period cost
Fixed Selling & Admin. Exp.
Exhibit 2:5 Absorption Costing and Variable Costing

21
Note- the difference between absorption costing and direct costing as you can see from Exhibit
2:5 the treatment of fixed manufacturing overhead which is considered as Product cost under
absorption costing and period cost under variable costing approach.

Income Effect of Alternative Product Costing (Absorption versus Variable Costing

Approaches)
In the previous section, we have discussed that under absorption costing, all production costs are
absorbed into products and the unsold stock is measured at total cost of production, whereas,
invariable costing only variable costs of production are allocated to products and the unsold
stock (inventory) is measured at variable cost of production. Fixed production costs are treated
as a cost of the period in which they are incurred. In this section, the income effect of the two
costing approach, before you proceed reading with this section be aware of the general income
statement under the two approaches:

Absorption Variable
Revenues xx Revenues xx
Less: CGS (xx) Less: Variable costs (CGS&VC) (xx)
Gross Margin xx Contribution Margin xx
Less: S&A Exp (V&F) (xx) Less: Fixed Costs (xx)
Operating Income xx Operating Income xx

The income statements prepared based on the two costing methods differs in their treatment of
fixed manufacturing costs and the classification and presentation of costs on the income
statement. On the traditional (absorption) costing method income statement, costs are classified
on the basis of functions: Manufacturing, Selling, Administrative, etc. Whereas on a variable
(direct) costing method income statement costs are classified on the basis of behaviour pattern:
Fixed and Variable.

ILLUSTRATION 1
In 2011, ABC Company began producing a product that has the following selling price, variable
costs, and contribution margin.
Unit Selling Price Br 25
Unit variable costs:
Direct Material 4
Direct Labor 7
Manufacturing overhead 2
Selling and Administrative 2
Total unit variable cost 15
Unit contribution margin Br 10
Annual fixed costs of ABC Company include:
Fixed Manufacturing overhead Br 120, 000
Selling and Administrative 80, 000

Now, if the company produced and sold 30,000 units of products during the year, what is
operating income under the two approaches?

22
At a production volume of 30,000 units costs per unit under the two approaches is computed as
follow:
Cost per unit
Cost items Absorption approach Variable approach
Direct Material 4 4
Direct Labor 7 7
Variable manufacturing overhead 2 2
Fixes manufacturing overhead 4 0
Total cost per unit 17 13

Absorption Costing Approaches Income Statement:

ABC Company
Income Statement
For Year ended, Dec. 31, 2011
Sales (30,000units x 25) Br 750,000
Less: Cost of goods sold (30,000 x 17) 510,000
Gross Margin Br 240,000
Less: Selling and Administrative Expenses:
Variable (30,000 x 2) Br 60,000
Fixed 80,000 140,000
Operating income Br 100, 000

Direct Costing Approach Income Statement:

ABC Company
Income Statement
For Year ended Dec. 31, 2011
Sales (30,000 x 25) Br 750,000
Less: variable costs:
Cost of goods sold (30,000 x 13) Br 390,000
Variable Selling and administrative (30,000 x2) 60,000 450,000
Contribution margin 300,000
Less: Fixed costs:
Fixed manufacturing costs Br 120, 000
Fixed selling and Administrative costs 80, 000 200,000
Operating income Br 100, 000

You may inquire, so where is the income effect of the two costing methods; the income
statement prepared under the two approaches shows the same operating income. Yes, you are
right, but this is if there is no change in the inventory level, i.e., when productions units equals
with sales units, during the period. However, when there is change in inventory level during the
period the operating income under the two approaches is different as the following examples,
which are continuation of the previous illustration shows.

23
ILLUSTRATION 2
Consider illustration 1 above except that out of the 30,000 units of products produced only
20,000 units were sold during the period. Look at the income statements under the two
approaches.

Absorption Costing Approach

ABC Company
Income statement
For the year ended, Dec. 31, 2011
Sales (20,000 x 25) Br 500,000
Less: Cost of goods sold (20,000 x 17) 340,000
Gross margin 160,000
Less: Selling and Administrative Expenses:
Variable selling and Admin. (20,000 x 2) Br 40,000
Fixed selling and Admin. 80,000 120,000
Operating income Br 40, 000

Direct Costing Approach

ABC Company
Income Statement
For the Year ended, Dec. 31, 2011
Sales (20,000 x 25) Br 500,000
Less: Variable Expenses:
Cost of goods sold (20,000 x 13) Br 260,000
Selling and Administrative (20,000 x 2) 40,000 300,000
Contribution margin 200, 000
Less: Fixed Costs:
Fixed manufacturing overhead Br 120, 000
Fixed selling and Administrative 80, 000 200,000
Operating income Br 0

Practice Exercise -1
Consider illustration 2 above and the company produced 30,000 units during 2012 and sold
40,000 units, the other information’s remaining the same; prepare (determine) income statement
under the two approaches.

Now, you see the income effect of the two costing methods, when there is change in inventory
level. The difference in operating income under both illustration 2 and exercise above is
explained by the amount of fixed manufacturing overhead assignment in “inventory” by
absorption costing, where as immediately expensing the amount in the period incurred.

Sunk Cost
A sunk cost is a cost that has already been incurred and that cannot be changed by any decision
made now or in the future. Because sunk costs cannot be changed by any decision, they are not
differential costs. And because only differential costs are relevant in a decision, sunk costs can
and should be ignored.

24
To illustrate a sunk cost, assume that a company paid $50,000 several years ago for a special-
purpose machine. The machine was used to make a product that is now obsolete and is no longer
being sold. Even though in hindsight purchasing the machine may have been unwise, the
$50,000 cost has already been incurred and cannot be undone. And it would be folly to continue
making the obsolete product in a misguided attempt to “recover” the original cost of the
machine. In short, the $50,000 originally paid for the machine is a sunk cost that should be
ignored in current decisions.

Opportunity cost is the potential benefit that is given up when one alternative is selected over
another. To illustrate this important concept, consider the following examples:

Example 1: Mr. Ahmed has a part-time job that pays $200 per week while attending college. He
would like to spend a week at the beach during spring break, and his employer has agreed to give
his the time off, but without pay. The $200 in lost wages would be an opportunity cost of taking
the week off to be at the beach.
Example 2: Suppose that Neiman is considering investing a large sum of money in land that
may be a site for a future store. Rather than invest the funds in land, the company could invest
the funds in high-grade securities. The opportunity cost of buying the land is the investment
income that could have been realized by purchasing the securities instead.

Differential Cost and Revenue

Decisions involve choosing between alternatives. In business decisions, each alternative will
have costs and benefits that must be compared to the costs and benefits of the other available
alternatives. A difference in costs between any two alternatives is known as a differential cost.
A difference in revenues between any two alternatives is known as differential revenue.

A differential cost is also known as an incremental cost, although technically an incremental

cost should refer only to an increase in cost from one alternative to another; decreases in cost
should be referred to as decremental costs. Differential cost is a broader term, encompassing
both cost increases (incremental costs) and cost decreases (decremental costs) between
alternatives.

The accountant’s differential cost concept can be compared to the economist’s marginal cost
concept. In speaking of changes in cost and revenue, the economist uses the terms marginal cost
and marginal revenue. The revenue that can be obtained from selling one more unit of product is
called marginal revenue, and the cost involved in producing one more unit of product is called
marginal cost. The economist’s marginal concept is basically the same as the accountant’s
differential concept applied to a single unit of output. Differential costs can be either fixed or
variable.

Practice Exercise -2
(1) Many new cost terms have been introduced in this chapter. It will take you some time to learn what
each term means and how to properly classify costs in an organization. Consider the following
example: Unique Corporation manufactures furniture, including tables. Selected costs are given
below:
(a) The tables are made of wood that costs $100 per table.

25
(b) The tables are assembled by workers, at a wage cost of $40 per table.
(c) Workers making the tables are supervised by a factory supervisor who is paid $38,000 per year.
(d) Electrical costs are $2 per machine-hour. Four machine-hours are required to produce a table.
(e) The depreciation on the machines used to make the tables totals $10,000 per year. The machines have
no resale value and do not wear out through use.
(f) The salary of the president of the company is $100,000 per year.
(g) The company spends $250,000 per year to advertise its products.
(h) Salespersons are paid a commission of $30 for each table sold.
(i) Instead of producing the tables, the company could rent its factory space for $50,000 per year.
Required: Classify these costs according to the various cost terms used in the chapter. Carefully study the
classification of each cost. If you don’t understand why a particular cost is classified the way it is, reread
the section of the chapter discussing the particular cost term. The terms variable cost and fixed cost refer
to how costs behave with respect to the number of tables produced in a year.
(2) LOIN Manufacturing Co. manufactures a variety of products in its factory. Data for the most recent
month’s operations appear below:
Beginning raw materials inventory............... $60,000
Purchases of raw materials.......................... 690,000
Ending raw materials inventory.................... 45,000
Direct labor................................................... 135,000
Manufacturing overhead.............................. 370,000
Beginning work in process inventory........... 120,000
Ending work in process inventory................ 130,000
Required: Prepare a schedule of cost of goods manufactured for the company for the month.
(3) The following cost and inventory data are taken from the accounting records of Mason Company for
the year just completed:
Costs incurred:
Direct labor cost.......................................... $70,000
Purchases of raw materials......................... 118,000
Manufacturing overhead............................. 80,000
Advertising expense.................................... 90,000
Sales salaries.............................................. 50,000
Depreciation, office equipment.................... 3,000
Inventories: Beginning of the Year End of the Year
Raw materials.................... $7,000 $15,000
Work in process................. 10,000 5,000
Finished goods................... 20,000 35,000
Required:
(a) Prepare a schedule of cost of goods manufactured.
(b) Prepare the cost of goods sold section of Mason Company’s income statement for the year.

26