CHAPTER 3

COST ACCOUNTING CYCLE

1. Explain the cost accounting cycle.

Cost Accounting provides the additional information required by management. It also
provides data necessary for the determination of cost of goods sold on the income statement and the
valuation of inventories on the balance sheet. Cost accounting is the process of accounting for the
classification, analysis, interpretation, and control of cost. It measures the operating efficiency of the
enterprise. The primary objective of cost accounting is to determine the cost of producing a product
or providing service. Cost accounting cycle is a process performed during the accounting period in
recording data, classifying, determining total cost, determining product cost, controlling cost and
decision making [ CITATION IEd21 \l 1033 ].

Steps in Cost Accounting Cycle

1. Cost data recording- The first step in cost accounting is to determine and record the cost
element in order to determine the cost of production.
2. Cost classification- The cost is classified in the second step based on its function, nature,
and behavior.
3. Determining total cost- The cost of goods sold of a product is calculated in this step of
cost accounting. The total cost of goods sold is the sum of all expenditures incurred in the
production of the goods sold.
4. Unit cost- The unit cost is calculated by dividing the cost of goods sold by the total
number of units sold in the fourth step.
5. Selling price- The selling price is calculated by multiplying the cost of sales by a profit
margin.
6. Cost control and decision-making- At the end of the cost accounting process, standard
costing and budget and budgetary control systems are used to control costs and make
decisions.

2. Differentiate service, merchandising and manufacturing entities.

3 Types of Business Entities
1. Service Entity
A service entity does not produce/sell products, instead it provides service. 
2. Merchandising Entity
A merchandising company buys and sells goods known as merchandise. Accounting
inventories for merchandising deals with only one account, the Merchandise
Inventory.
3. Manufacturing Entity
A manufacturing company uses labor and other inputs to transforms raw materials
into finished product and then sells the product. Unlike merchandising, manufacturing
company has three inventory accounts namely Materials Inventory, Work in Process
Inventory and Finished Goods Inventory.
 The major difference between the three types of companies can be found in the cost of goods
sold (services rendered) calculation.

Service Company Merchandising Company Manufacturing Company

Cost of Services Rendered: Cost of Goods Sold: Cost of Goods Manufactured

Primarily labor and overhead Net purchase price Materials

costs
Labor

Factory Overhead

3. Distinguish between and account for direct and indirect materials and labor as they are used
in the production process.

Direct Materials Indirect Materials Direct Labor Indirect Labor

-Cost of materials -Materials that cannot -Cost of labor for -Wages and salaries
that are directly part be readily identified employees who of employees who are
of the product being with any particular directly work on the required for the
manufactured (Raw item manufactured product manufactured manufacturing
Materials) process but do not
work directly on the
-Materials that products being
-Includes materials actually become part manufactured
that can be readily of the finished
identified with a product but whose
certain product cost are relatively
insignificant
4. Make a pro-forma financial statements for a service, merchandising and manufacturing
entities.

Pro-forma Financial Statements for Service Entity

1. Statement of Financial Position

Name of the Company
Statement of Financial Position
As of Period ended

ASSETS
Current Assets
Cash xx
Accounts Receivable xx
Allowance for Bad Debts (xx) xx
Total Current Assets xx

Non – current Assets

Building xx
Acc. Dep. – Building (xx) xx
Long – term Investment xx
Total Non – current Assets xx
Total Assets xx

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities
Accounts Payable xx
Stockholders’ Equity
Capital Stock xx
Retained Earnings xx xx
Total Liabilities and Stockholders’ Equity xx

2. Statement of Comprehensive Income

Name of the Company
Statement of Comprehensive Income
For the month of Period ended

Service Revenue xx
Less: Cost of providing services
Materials xx
Labor xx
Service Overhead xx (xx)
Gross Profit xx
Less: Operating Expenses
Administrative Expense xx
Advertising Expense xx (xx)
Net Income xx
Pro-forma Financial Statements for Merchandising Entity

1. Statement of Financial Position

Name of the Company
Statement of Financial Position
As of Period ended

ASSETS
Current Assets
Cash xx
Accounts Receivable xx
Allowance for Bad Debts (xx) xx
Total Current Assets xx

Non – current Assets

Building xx
Acc. Dep. – Building (xx) xx
Long – term Investment xx
Total Non – current Assets xx
Total Assets xx

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities
Accounts Payable xx
Stockholders’ Equity
Capital Stock xx
Retained Earnings xx xx
Total Liabilities and Stockholders’ Equity xx

2. Statement of Cost of Goods Sold

Name of the Company
Statement of Cost of Goods Sold
For the month of Period ended

Beginning Inventory xx
Add: Net Purchases
Purchases xx
Freight in xx
Less: Purchase Returns and Allowances (xx)
Purchase Discounts (xx) xx
Goods Available for Sale xx
Less: Ending Inventory (xx)
Cost of Goods Sold xx

3. Statement of Comprehensive Income

Name of the Company
Statement of Comprehensive Income
For the month of Period ended
 Net Sales
Sales xx
Less: Sales Returns and Allowances (xx)
Less: Sales Discount (xx) xx
Less: Cost of Goods Sold (xx)
Gross Profit xx
Less: Expenses
Selling and Administrative Expense xx
Freight out xx
Other Expenses xx
Finance Expense xx (xx)
Income Before Tax xx
Less: Income Tax Expense (xx)
Net Income xx

Pro-forma Financial Statements for Manufacturing Entity

1. Statement of Financial Position

Name of the Company
Statement of Financial Position
As of Period ended

ASSETS
 Current Assets
Cash xx
Accounts Receivable xx
Finished Goods xx
Materials xx
Total Current Assets xx

Non – current Assets

Building xx
Acc. Dep. – Building (xx) xx
Long – term Investment xx
Total Non – current Assets xx
Total Assets xx

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities
Accounts Payable xx
Stockholders’ Equity
Capital Stock xx
Retained Earnings xx xx
Total Liabilities and Stockholders’ Equity xx

2. Statement of Cost of Goods Manufactured

Name of the Company
Statement of Cost of Goods Sold
For the month of Period ended

Direct Materials Used:

Materials Inventory, Beginning xx
Add: Net Purchases xx
Total Available for Sale xx
Less: Materials Inventory, Ending (xx) xx
Direct Labor xx
Factory Overhead xx
 Total Manufacturing Cost xx
Add: Work in Process, Beginning xx
Cost of Goods Put into Process xx
Less: Work in Process, Ending (xx)
Cost of Goods Manufactured xx
Add: Finished Goods, Beginning xx
Total Goods Available for Sale xx
Less: Finished Goods, Ending (xx)
Cost of Goods Sold xx

3. Statement of Comprehensive Income

Name of the Company
Statement of Comprehensive Income
For the month of Period ended
Net Sales xx
Less: Cost of Goods Sold (xx)
Gross Profit xx
Expenses
Selling and Administrative Expense xx
Freight out xx
Other Expenses xx
Finance Expense xx (xx)
Income Before Tax xx
Income Tax Expense (xx)
Net Income xx