2 Chapter 1 - Cost Concepts, Ch ification and Accounting Cycle [WHATIS COST ACCOUNTING) Cost Accounting is defined in many ways but ils main function is to ow much an object, project or service cost. Cost accounting is not limited only to manufacturing, and construction companies but it is also applicable to service type of businesses, like hospitals, educational institutions, hotels and recorts, restaurants, egal and other professional offices, medical and dental clinics and many more. Cost Accounting is a discipline that focuses on techniques 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, It provides information on a company’s cost and may be used for both internal and external purposes. “According to Homgren, Cost Accounting measures and reports financial and non-financial information relating to the cost of acquiring or consuming resources in an organization. It provides information on a company’s cost and may be used for both internal and external purposes. 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. ‘Accurate cost information is important whether a company engages in service, merchandising or manufacturing operations. Each of these industries has the same basic financial statements which normally consist of Income Statement, Statement of Changes Owner's Equity, Balance Sheet and Statement of Cash flows. 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 of the product to have a fair competition in the market, The accumulated costs information are summarized and reported to the determine h Scanned with CamScanner3 Chapter 1 - Cost Concepts, Classification and Accounting Cycle management for effective planning to attain the company’s goal and objectives. In manufacturing, if the management has sufficient information about the cost data, it can prepare a detailed production plan, which usually includes the following: (a) The number of units to be produced (b) The type of manufacturing operations to be performed (©) The desired quality of the product (d) The number of personnel to be utilized (laborers and non-laborers) (e) The type of materials to be used (0 The level of materials inventory to be maintained in order not to encounter overstocking or stock - out of materials, (g) The delivery schedules (h) And other production schedules, Once a production plan has been laid out, it would be easier for the management to perform the function of control where actual results are compared with expected results set by the management to allow the management team to make corrective measures on areas where significant differences are noted. In controlling, responsibility is assigned to different departments or group of workers who has control over and accountable for the costs charged to that department or group. In this manner, the accountability for costs or production results is easily identified. It relates to the different costing | It relates to the classifying, recording methods and techniques _in | and analyzing of business transactions accumulating the cost of a product, | and events, the end product of which Process, project or service and also the | are financial statements. The books Processes in reducing total costs to | required to maintain are the general improve the profitability of the entity. | journals, general ledgers and special journals, It considers items with no monetary values like units produced or hours | Only items with monetary values are utilized. used in recording and also it deals with actual data. Itdeals with both actual and estimated figures and standards. The users of accounting information are the internal users such as The _users of _cost_accounting | stockholders, officers and employees Scanned with CamScanner4 chapter 1 — Cost Concepts, Classification and Accounting Cycle generally the | and external users such a financial and senior institutions, creditors, suppliers and government regulatory bodies, jon managers Is of the company ] Its objective reflect the correct | financial picture/information of the | entity to the different stakeholders, Fhe main objective is to di Joost to produce a unit, proces | project or cost to deliver a service. The | actual costs incurred is usually | compared with estimates or budgeted costs to guide the management in making relevant decisions, | The reports required by mana The basic financial statements as the end product of financial accounting are (1) Statement of Financial Position The Cost of | or Balance Sheet, (2) Statement of luction Report summarizes the | Comprehensive Income or simply total costs incurred in production like | Income Statement, (3) Statement of the direct materials, direct costs and | Changes in Equity, and (4) Statement overhead. There is no standard format | of Cash Flows. The accountants are in presenting the cost information _| guided by International Financial Reporting Standards in the preparation of financial reports. (Costtepresents any amount paid or incurred in acquiring goods or services. This cost is presented in the Statement of Financial Position as asset. One good example of a cost item is the amount paid for the purchase of equipment. As the equipment is used in the business, an expense is recognized in the form of depreciation and depreciation expense is then reported in the Income Statement. Another example is the cost of producing a product composing of materials, labor and overhead. Upon the completion of the process, the total costs of production is reported in the Finished Goods Inventory account which is an asset. However, if the goods are sold, the cost of goods sold is presented in the Income Statement as expense, Properly classified as Cost of goods sold. Expenseyis any amount paid or incurred in the operation of a business. These expenses are necessary to generate revenue. They are recognized proportionately in the period they are incurred to properly match the revenue generated for the Scanned with CamScanner5 Chapter 1 ~ Cost Concepts, Classification and Accounting Cycle period, Examples of expenses are: permits and licenses, Salaries and wages, utility expenses, office supplies used, repairs and maintenance, gas and oil consumed, representation expenses, rent expense, insurance expense, depreciation expense, doubéful account expense and many more. (CLASSIFICATION OF COSTS Cost classification is very essential in summarizing the cost data gathered. The costs of an object, product, project or service represent the cash or cash equivalent of resources used in acquiring the goods, manufacturing a product and performing a function. The classification of costs presented below is in agreement with the principles of classification of cost und issued by the council of the Institute of Cost Accountants of India which reads \dded for d These are cost of materials used for the purpose of manufacturing a product or rendering of a service, net of trade discounts, rebates, taxes and duties refundable that can be quantified with reasonable accuracy. This may include EERE SSRSSTSROM aeiSaee, 5, Spare parts, and many more; 1.2 (Gaboreosts (Employee) Labor costs consist of the ompénsation and (other|benefits” paid or payable to permanent, casual or part time employees of the manufacturing firm. 1.3 Expenses? Expenses include: and. Scanned with CamScanner6 Chapter 1 - Cost Concepts, Classification and Accounting Cycle 2 ‘By ature of traceability to a cost object » 2.1 (Directcosts These are costs that are often described as those that would be saved i uld be discontinued or if the product . They e segment or business unit wo would not be manufactured. Examples: 211 Direct materials. These are raw materials For example, wood used in production of tables ee pars used by a construction company, leather used in the manufacturing of shoes, bags and wallets and many more 21.2 These are assembly department to Finishing Department Cost of drawings, designs and layout of a particular job a b. Salary of auto mechanics in automotive servicing company ‘Architects, surveyors and other consultation fees of particular job or work, Salary of a binder in a printing company ._ Cost of paper used in a printing company Oil and lubricants in a trucking company Steel bars used by a construction company Cost of detergents in a laundry shop i, Salary of laundry shop employees Cost of x-ray, doctor’s fee, laboratory fee and medical supplies ina hospital Cost of professional development activities for the doctors in a hospital Office supplies in a law office .. Royalties payable on use of patents copyrights gr Scanned with CamScanner1 Chapter 1 - Cost Concepts, fication and Accounting Cycle 2.2UthetiFeEt Cowes» incurred for the benefit of gments within the organi a manufacturing company, these are the overhead costs Incurred In the Process of production which include: ~consunnbe al pats a 100s, teats and buttons used in stitching clothes, lubricants used In maintenance of plant and machinery, cotton waste used in cleaning the machinery and other factory supplies. areca elarisand wages aid oraw materials warehouse keepers, supervisors, imekeepers, quality control, managers, clerical staff, These indirect labor costs. 3. (By function) 3.1 (Prodlietion/ Project coats.” The elements of product.costs. in.a. manufacturing, business are the following: 1 (MaleFials. Materials are classified as: @ Direct materials are those materia Examples: wood, ne an manufacture o} ture; galvanized iron and steel, tubber, aluminum and glass in the manufacture of vehicles; leather in the manufacture of bags, belts, wallets and shoes; fabrics in the manufacture of shirts, dresses, coats and other related gents and ladies apparels; flour, sugar and butter in the manufacture of bread and other pastries and many more. Scanned with CamScannerChapter 1 - Cost Concepts, Classification and Accounting Cycle : 2 pa 2, (b) Indirect Materials. These are materials Necessary in manufacturing operations but are not directly included in or not a significant part of the product. They fall under manufactur overhead. “They include cleaning supplies, disposable tole factory supplies used in the factory such as nails, screw., washers, glue, sand paper, lubricating oil, grease, leaning materials and other materials needed to maintain the working area and plant equipment in a usable and safe condition. The costs of indirect materials are relatively small in relation to the cost of all other raw materials, Labor: Labor represents the compensation and other benefits paid or yable to the workers in the factory. They are classified as: (@) ‘Direct labor.’ Direct labor represents compensation and benefits paid to those who physically work on the conversion of raw materials into a finished product and are easily traceable to a specific process or job order. They include the basic pay, cost of living allowance, 13% month pay and cash equivalents of non- cash incentives given on a regular basis. (©) (idiveet* Labor, 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 paid to other workers such as janitors, inventory control clerks, guards, and other personnel in the factory, employee benefits such as. employer's share in SSS, Philhealth and Pag-ibig, vacation and holiday pay, health insurance of workers, educational benefits, overtime and night Premium, costs of housing and accommodation for stay-in workers, and performance bonuses for deserving worker. Most manufacturing companies find it more convenient to treat employee benefit costs accruing to direct labor workers. (Primejeosts - is the sum of direct materials and direct labor. Manufacturing overhead is an indirect product cost and it includes productions costs other than direct materials and direct labor. They include: (a) Factory supplies such as oil and other cleaning materials used in the factory. Scanned with CamScannerChapter 1 - Cost Concepts, Classification and Accounting Cycle (b) Wages of supervisors, factory maintenance personnel, raw materials handlers and security officers stationed in the factory premises. (©) Depreciation of factory plant and equipment (d) Insurance and property taxes on factory plant and equipment. (e) Maintenance and repairs on factory plant and equipment (©) Power, light and water (g) Telephone and mailing costs (h) Cost of regulatory compliance such as meeting factory safety requirements and disposal of waste materials. () Idle time by factory workers due to machine breakdowns or new set ups which are unavoidable in production Process. During their idle time, the workers are not productive therefore the cost is spread over the entire Production not to a specific product. Conversion costs = Direct labor + Manufacturing Overhead For a construction company, a company engaged in constructing buildings, bridges and other related structures, the project costs include the cost of construction materials, labor of carpenters, professional fees of the project engineers, and overhead incurred in construction like cost of power, light & water, insurance, hospitalization and other health benefits for workers, maintenance of construction equipment, compensation of foremen, cost of constructing temporary house for the workers and for construction materials, depreciation of equipment, rentals and other expenses incurred in the construction site. For a retailing or merchandising company (a company engaged in buying goods ready for sale), 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. 3.2\General and Administrative costs” These are costs associated with the general administration of the organization that cannot be reasonably assigned to either marketing or Scanned with CamScannerChapter 1 ~ Cost Concepts, Classification and Accounting Cycle e production such as salaries and wages of administrative officers and employees, power and water consumption, transportation and representation expenses, maintenance cost of office equipment, depreciation of office furniture and equipment, taxes and licenses, gas and oil expenses and other expenses in the administrative offices. 3.3 Selling/marketing/ distribution costs These are the costs of getting and filling orders such as cost of customer service, cost of documentation, salaries and commissions of sales personnel, advertising costs and other expenses associated with the sale of the goods and services. Distribution costs are cost of warehousing, transporting and delivering of products or services. General and administrative costs, selling and distribution costs are also called Period costs. Period costs are operating expenses that are associated with time periods, rather than with the production of goods and services. Period costs 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 non-manufacturing costs and non. inventoriable costs. 4. (Byinatii¥e of production or operation process 4.1 Joint costs ‘These 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 of joint costs: Cost of dough, labor of baker, and overhead incurred by a bakeshop. 4.2 Contract costs» Cost of a contract agreed upon between the contractee and the contractor. 43 Batehicosts) Batch Cost shall be the aggregate cost related to a cost unit that consists of a group of similar articles or services which maintain its identity throughout one or more stages of production or operation. Scanned with CamScanner" Chapter 1 - Cost Concepts, Classification and Accounting Cycle 44 Operation(ebsts” Operation Cost shall be the cost of a specific operation involved in the production of goods or rendering of services. 4.5 Process costs) Process cost shall be the cost of production or operation process where goods are produced or services rendered from a sequence of continuous or repetitive operations or processes during a period. 5. ‘For Decision-making purposes) 5.1 (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. Examples are: The cost of raw materials used in manufacturing leather products. The production manager has the ability to control the materials to be used in production by selecting only materials with high quality, thus, reducing waste and spoilage. Cost of food in the factory canteen, The canteen manager has the ability to control losses in terms of spoilage and theft by canteen personnel, 5.2\Non-controllable costs These are costs that cannot be controlled or influenced by a responsibility center manager. Examples are; Cost of renting equipment 5.3 Opportunity costs ” ‘These are benefits foregone because one course of action is chosen over another, expressed in other words, these are future cash inflow that will be sacrificed as a result of a particular management decision. Examples. are: a) Salary foregone if a student decides to be a full time student rather than a working student b) Rent revenue if a company decides to use part of the building Scanned with CamScannerCost Concepts, Classification and Accounting cle Chapter, rather than leasing it. 5.4 (Sunk coats or pasticosts These are costs that have be changed or avoided by in decision making. Examples are: already been incurred in the past and will not any decision in the future. Itis not relevant a) Acquisition cost of an equipment b) Manufacturing costs of finished goods on hand. ) Research and development costs for a new product 5.5 Relevant'cost This refers to costs that change with makes. It includes incremental, oppor! Examples are: Future cash flows, avoidable costs, 5.6 Incremental costs? Where different alternatives are being considered, relevant cost is the incremental or differential cost between the various alternatives being considered. 5.7 Petiod Cost Period costs are operating expenses that are associated with time periods, rather than with the production of goods and services. Period costs 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 non-manufacturing costs and non inventoriable costs. They include: each decision that a company tunity and avoidable costs, a) These are the costs of getting and filling orders such as cost of customer service, cost of documentation, salaries and commissions of sales personnel, advertising costs and other expenses associated with the sale of the goods and services. b) 4 lese are costs of warehousing, transporting and delivering a product or service. Scanned with CamScanner13 Chapter 1 ~ Cost Concepts, Classification and Accounting Cyde ©) WAidministratige "Costs: These are costs associated with the general administration of the organization that cannot be reasonably assigned to either marketing or production such as salaries and wages of administrative officers and employees, power and water consumption, transportation and representation expenses, maintenance cost of office equipment, depreciation of office furniture and equipment, taxes and licenses, gas and oil expenses and other expenses in the administrative offices. 5.8 Productos The product costs include costs of direct materials, direct labor and factory overhead. The accumulated cost of direct materials, direct labor and factory overhead is summarized in a work in process account. At the end of a period, the cost of completed goods is transferred to the finished goods account. The sold portion of the finished goods is teported as expense in the Income Statement, as Cost of Goods Sold, while the unsold goods are reported in the balance sheet as finished goods. The cost of unfinished goods is left in the Work in Process account which is also reported in the balance sheet as current assets. 5.9 (Avoidable) Avoidable costs are those costs that are avoided by making one choice over another. 5.10 Unavoidablecostsy These are the costs not change in the future when a manager makes one decision versus another. They are costs that will continue to happen. 6. (Byinature of behavior 6.1 \Bixedlicosts) ‘These 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. Examples are: (@) Depreciation using the straight line method Scanned with CamScannerChapter 1 - Cost Concepts, Classification and Accounting Cycle = (b) Factory Rent & factory taxes (©) Factory insurance (4) Supervision Fee (©) Wages of indirect laborers 6.2,Variable costs) ‘These 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 decrease proportionately with the activity change, but unit variable costs remain the same. Examples are: a. Direct materials and direct labor b. Fuel and other factory supplies c. Overtime premium d. Materials handling costs . Maintenance costs 6.3 Mixed costs) ‘These are costs that have both fixed and variable components like heat, light, and water expense. Mustration 1. Fixed costs ‘Assume the following: Total fixed cost for the period 100,000 Production in units: Case 1 8,000 Case 2 9,000 Case 3 9,500 Relevant Range 8,000-10,000 units Case 1 Case 2 Case 3 Production 8,000 9,000 4500 Total FC # 100,000 100,000 # 100,000 FC per unit 12.50 Hl 10.53 Take note that the total fixed costs rensia the same but the fixed unit decreases as production feces vac by 7 al me Scanned with CamScanner15 Chapter 1 - Cost Concepts, Classification and Accounting Cycle Illustration 2. Variable costs Assume the following: Variable cost per unit: Direct materials P5.00 Direct labor 6.00 Overhead 3.00 Total variable costs P14.00 CaseA CaseB Case Production in units 8,000 9,000 9500 Variable cost per unit 14.00 14.00 14.00 Total variable costs P112,000 P 126,000 P133,000 The variable cost per unit is constant at P14.00 per unit, but as production increases, total variable costs also increase. Relevant Range is defined as 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 COSTS When cost is classified as mixed, it is appropriate to separate the fixed cost from the variable cost. One of the methods in separating mixed costs is the high-low method. The procedure starts from selecting the highest and lowest levels of activity in a given set of data within the relevant range. Then, determine the changes in activity and cost by subtracting low values from high values. These changes are used to calculate the variable unit cost contained in the mixed cost The fixed portion of the mixed cost is calculated by subtracting total variable cost from total mixed costs. Variable cost per unit is computed as: Cost at high level - cost at lowest level (within relevant range) Highest activity - lowest activity Or: Change in total costs / Change in activity level = VC per unit Scanned with CamScannerq a Chapter 1 ~ Cost Concepts, Classification and Accounting Cycle b. When expenses are paid like freight Rew Materials Inventory 900 Cash oe When goods are returned to supplier Accounts Payable/Cash 000 aa Revo Materials Inventory d. When materials are issued to production Work in process or Manufacturing OH 000 on Raw Materials inventory e. When excess materials are returned to warehouse ‘Raw materials 000 Work in process or Manufacturing OH 000 Periodic Inventory system. Under periodic inventory system, the entity maintains temporary accounts like purchases, purchase returns and freight in. It to invnentory accounts but instead will not record inventory additions directly purchase of raw materials is debited to purchases account purchases, the amount is debited to For the transportation expenses related to the Freight In account and returns to suppliers is credited to purchases returns and allowances account. Physical inventory count (also called stock taking) at the end of the period is mandatory. Without such count, cost of raw materials used cannot be determined therefore manufacturing companies have to conduct this activity at least once a year or at every period end Pro-forma Journal Entries: a, When raw materials are purchased on account or cash Purchases 000 ‘Accounts Payable/cash 000 b, When expenses are paid like freight Freight In 000 Cash 000 c. When goods are returned to supplier Accounts Payable/Cash 000 Purchased Returns 000 Take note that the raw materials issued is not journalized. This is determined only after taking a physical count of the unused raw materials at the end of a given Scanned with CamScannerChapter 1 - Cost Concepts, Classification and Accounting Cycle 19 period. On the other hand, the Raw Materials Inventory, End is reflected in the Balance Sheet as part of the assets. To determine the cost of raw materials used: Raw Materials, beg inventory irchases Add: Pur Freight In Gross purchases Less: Purchase Returns Net purchases Raw materials available for use Less: Raw materials inventory, end Raw materials used 100,000 2,000,000 50,000 2,050,000 20,000 P2,030,000 2,130,000 200,000 1,930,000 [INVENTORY COSTING/VALUATION METHODS; First-In, First-Out (FIFO) With first-in, first-out, the oldest cost (ie,, the first in) is issued first to production and assigned to the cost of raw materials used. Conversely, the most recent purchases are assigned to units in ending inventory. Example: Inventory, Net Purchases Issuances of Raw Materials | Inventory, Beg. End 30020 | 200022 [500025 [400024 | 1st 350__[ 2nd 350 | 3rd 400 [300824 Inventory stock card: Tn (Purchases) Out (issuances) | Balance (Inventory) | Units [| UC | Amt | Units | UC Units | UC | Amt Beg 300 | 20 | 6,000 Ist 20 [22 [4400 20 [22 | 4400 Ist '300_[ 20 | 6,000 50 2_|[_1100| 150 [2 [3300 2nd B00 [5 | 12500 500 | 25 | 12,500) 2nd is0_ [2 | 3300 200_| 25 | 5,000 { 300 | 25 | 7500 3rd 400 | 24 | 9,600 4o0_| 24 | 9,600 3rd 300_| 35 | _ 7,500 100_|__24 2400300 | 24 | 7,200 1,100 26,500_|_ 1,100 25,300 Beg, 300 | 6,000 Total |" 1400 32,500_| 1,100 25, 300 7,200 Scanned with CamScannerq 2 Chapter 1 - Cost Concepts, Classification and Accounting cyde_ Units uC ‘Amount Inventory, beg 300 20 P6,000 Purchases 200 22. 4,400 500 25 12,500 400 24 9,600. RMavailable 7400 P32,500 Less: RM issued 1,100 25,300 Inventory, end 300 7,200 HE! ‘OF MANUFACTURING COSTS! Cost Accounting cycle The activities in a manufacturing business also start from verification and preparation of source documents, journalizing, posting to general ledger and inal accounts, and preparation of subsidiary ledgers, adjusting, closing of nomii Snancal raternents ‘Conte a are used in recording Work in Process, Raw Materials, Finished Goods, and Factory Overhead Control, to mention a few. The flow of costs of a manufacturing company is outlined below together with the Pro-forma entries to record each transaction. (A) Purchase of Raw Materials The manufacturing process starts from the time raw materials are purchased. Most manufacturing companies use a perpetual inventory system. Ina perpetual inventory system, purchases and issuance of raw materials are recorded directly in the Raw Materials Inventory account as they occur, A purchases account is not used. The manufacturing companies maintain a subsidiary ledger of raw materials inventory accounts, one for each type of raw material. When the journal entry is posted to the general ledger account, the individual inventory accounts in the subsidiary ledger are also updated. Normally, the cost of raw materials includes the invoice costs plus transportation costs to bring the materials to the place of the buyer. Below are Pro-forma journal entries under the perpetual inventory system. The entry would be: Raw Materials (invoice cost + freight) 000 ‘Accounts Payable or cash 000 Scanned with CamScannera Chapter 1 - Cost Concepts, Classification and Accounting Cycle Ifthe company maintains two separate accounts for raw materials, Direct Materials account is debited for the invoice and freight cost of direct materials while Factory Supplies account is debited for the invoice and freight cost allocated to indirect materials. @) Issuance of Raw Materials Raw materials are issued to production on the basis of a material requisition slip properly accomplished and approved by the Production manager. The cost of raw materials issued is then transferred to a Work in Process and Manufacturing Overhead Account. The pro-forma entry is: Work in Process 000 Manufacturing overhead 000 Raw Materials 000 The Work in Process account is debited for the cost of direct materials issued while Manufacturing Overhead account is debited for the cost of indirect materials issued to production. (C) Return of Excess Materials to Storeroom If materials issued to the production department are in excess of the requirements, the unused materials are returned to the storeroom. The pro-forma entry to record the return is: Raw Materials 000 Work in Process 000 Manufacturing Overhead 000 The costs of unused direct materials and factory supplies are reverted back to Raw Materials account, while the Work in Process is reduced by the cost of unused direct materials while the Manufacturing Overhead is reduced by the cost of unused factory supplies. Scanned with CamScannerChapter 1 ~ Cost Concepts, Classification and Accounting Cycle 2 living allowance, performance bonuses, and other form of compensation given on a regular basis. The entry to record the incurrence of factory labor is: Factory Payroll (gross) 0000 Accrued wages payable or cash (net) 000 WHT Payable 000 SSS Premium Payable 000 000 Philhealth Payable (E) Distribution of Factory Labor After sorting the time tickets of the workers in the factory, the accountant will make an entry to segregate the direct labor and indirect labor costs. The salary of direct laborers or factory workers is debited to Work in Process account while the salary of indirect laborers like the production manager, supervisor or foreman, raw materials inventory clerk and maintenance personnel is debited to manufacturing overhead. The entry to distribute the factory payroll is: Work in process 000 Manufacturing overhead 000 Factory Payroll 000 (F) Manufacturing Overhead Incurred The actual overhead cost in production is charged to a Manufacturing Overhead account at the time it is incurred. Other manufacturing costs stich as expired insurance and depreciation of factory plant and equipment are charged to manufacturing overhead account only at year end when adjusting entry is prepared. The debit side of this account is used to accumulate actual overhead incurred (whether paid or not) Examples of manufacturing overhead are: a. Repairs and maintenance b. Depreciation of Factory plant and equipment c. Insurance d. Property taxes e. Indirect labor f. Indirect materials 8 Factory utilities (light, power, water and telephone) Scanned with CamScannerB Chapter 1 - Cost Concepts, Classification and Accounting Cycle h. Factory rent i, Employers’ share of SSS, Phithealth and Pag.ibig The entry to record actual overhead incurred is: Manufacturing Overhead (total) 000 ‘Accumulated depreciation Prepaid Insurance Cash Accounts payable (if not paid) 38388 (G) Actual Factory Overhead Charged to the Job At the end of a given period, the actual overhead is transferred to the Work in Process account if a company adopts the actual costing system of accumulating costs. The entry to transfer the total overhead costs to production is: Work in Process 000 Manufacturing Overhead 000 (H) Completion of the Job (On completion of the production process, the accumulated cost of production summarized ina Work in Process account is transferred to the Finished Goods account. The entry to record the cost of goods completed is: Finished Goods 000 Work in Process 000 After this entry has been posted, any balance remaining in the Work in Process account represents the cost of uncompleted jobs during the period. ) Sale of the Completed Job The most common method of setting price for the job completed is the Cost-Plus Pricing method. Cost in this sense does not mean only production costs but also includes administrative and selling costs. Normally, entrepreneurs or managers simply consider the cost as the floor based at which the price of the product cannot be lower than the Scanned with CamScannerw Chapter 1 ~ Cost Concepts, Classification and Accounting Cycle cost, Other factors to be considered are the desired profit and prices of competitors. The entry to record the sale is: Accounts Receivable or Cash 000 Sales 900 Accounts Receivable is debited if the buyer did not pay in cash upon This account represents the selling price of the delivery of the goods. sell oft goods. If the perpetual inventory method of handling inventories is adopted by the company, another entry is made to remove the costs of goods sold from the Finished Goods Inventory account. The entry is: Cost of Sales 000 000 Finished Goods Inventory Figure 1. The Flow of Costs Purchase of Materials Materials Inventory Pay direct laborers To summarize the flow of costs through the three inventory accounts of a manufacturing company, let's take a look at the following presentation: Scanned with CamScannerChapter 1 - Cost Concepts, Classification and Accounting Cycle Direct Materials | Workin Process Finished Goods | Inventory | Inventory Inventory ‘| alan 000__| Beg balance .000_| = a {00 | 000 \ { 000 es of goods sold Lo ee ON Manufactured |) In addition to the two basic financial statements, the Balance Sheet and the Income Statement, manufacturing companies are required to prepare a Statement of Cost of Goods Manufactured. This statement summarizes the total production cost, the direct labor and the overhead that transform the materials into work in process inventory. When the work in process inventory is completed, it becomes finished goods inventory. The finished goods inventory is the only inventory that is ready to sell. The costs of the finished goods inventory become Cost of Goods Sold on the income statement. A pro-forma statement of Costs of Goods Manufactured and Sold is given on the other page: Scanned with CamScanner6 Chapter 1 - Cost Concepts, Classification and Accounting Cycl Name of Company Statement of Cost of Goods Manufactured and Sold Period Direct Materials used: Direct Material, beginning P000 Add: Purchases 000 Freight In 000 Gross Purchases 000 Less: Purchase Discounts 000 Net Purchases a Direct Materials Available wo Less: DM inventory, end 0 Direct Materials used F000 (®) Direct Labor 000 (() Manufacturing overhead 000 (d) Total Manufacturing costs P000 ‘Add: Work in Process, beg 000 (©) Total cost of goods placed into process 000 Less: Work in Process, End 000 () Costs of goods manufactured P000 Add: Finished Goods, beginning 000 (g) Total goods available for sale ‘OOO Less: Finished Goods, end 000 P000 (h) Cost of goods sold Actual Costing System. Very few companies adopt this method of costing because the overhead costs cannot be traced easily to individual jobs. This method requires that all production overhead must be available before any cost allocation Scanned with CamScanner2 Chapter 1 - Cost Concepts, Classification and Accounting Cycle can be made to the jobs in process. Under this system, the actual costs of direct materials used, direct labor and manufacturing overhead incurred in production are charged to the job. Cost accounting cycle: Actual Costing Method High Street Manufacturing Company has the following account balances at the beginning of the current year: Raw materials inventory 50,000 Work in process inventory 150,000 Finished Goods 120,000 Below is the summary of transactions for the month of January: (@) Purchased of Raw Materials: On account, P200,000; Cash, P80,000 (&) Issuance of Raw Materials to the production department, P180,000 of which 10% is indirect materials. (©) Company payroll for the month: Factory payroll consisted of P120,000 for direct labor and 25,000 for indirect laborers; Marketing and Administrative payroll amounts to P40,000 and P80,000, respectively. (Use Marketing Expense control and Administrative expense control for marketing and administrative expenses) (d) The following were accrued at the end of the month: (a) Electricity costs, 22,000; (b) Rent, P10,000 and (c) Taxes and permits, P5,000. Of the given expenses, 50% is allocated to factory, 20% to marketing and 30% to administrative. (©) Depreciation for the month: Factory plant and equipment, P7,500; Office furniture and equipment, P7,500 Expired insurance, P10,000, allocated in the same manner as in (4). (g) Overhead is applied to production. (h) At the end of the month, unfinished jobs totaled P75,000 and unsold finished goods amounted to P90,000. () High Street Manufacturing Company uses the actual cost system in accumulating cost and perpetual inventory system in accounting for its Scanned with CamScannerRequired: aR Classification and Accounting Cycle Chapter 1 ~ Cost Concep! ig Cy inventory. The company’s mark-up on cost is maintained at 40% for the past two years all on a 30 days term. A. Journalize the transactions B. Post to selected accounts C. Determine the following: ~PeEnausenn . Raw materials inventory on January 31 .. Direct materials charged to the job . Total prime costs for the period Amount of overhead charged to the job Cost of Goods manufactured Cost of goods sold Selling price of the goods sold . Total administrative and marketing costs ). Net income for the period D. Prepare a Statement of Cost of Goods Manufactured and Sold. Solutions: A. Journal Entries 1. Purchase of Raw Materials 2. Issuance of RM 3. Company payroll 4. Accrual of other expenses 5. Depreciation Rew Materials Accounts Payable Cash Work in process ‘Manufacturing Overhead ‘Raww Materials Work in Process Factory overhead Marketing exp ~ control Administrative exp-control Accrued payroll ‘Manufacturing overhead Marketing exp-control Administrative exp.control Accrued exp payable ‘Manufacturing OH Administrative exp-control Accum. Dep'n-factory 280,000 200,000 80,000 162,000 18,000 180,000 120,000 25,000 40,000 80,000 265,000 18,500 7,400 11,100 37,000 7,500 7,500 7,500 Scanned with CamScanner29 Chapter 1 - Cost Concepts, Classification and Accounting Cycle Accum.Depn- office 7,500 6. Insurance exp Manufacturing overhead 5,000 Marketing exp ~ control 2,000 Administrative exp ~ control 3,000 Prepaid insurance 10,000 7. OH applied to Work in process 74,000 production Manufacturing OH 74,000 8. Good completed Finished goods 431,000 Work in process 431,000 9. Salesonaccount Accounts Receivable 645,400 Sales 645,400 Cost of sales 461,000 Finished goods 461,000 B. Post to selected accounts: Raw Materials 1/3 50,000 2) 180,000 1) 280,000 1/31 150,000 Work in Process 1/3 150,000 8) 431,000 2) 162,000 3) 120,000 1/31 75,000 7) 74,000 ‘Manufacturing Overhead Scanned with CamScannerChapter Requirement C. a) Q) @) ® ©) ©) Raw Materials Inventory, Jan. 31: RM inventory, Jan. 1 Purchases Raw materials available Less: RM issued. Raw materials inventory, Jan. 31 Raw materials issued Less: Indirect materials, 10% Direct materials used Direct labor Direct materials Total prime costs Overhead charged to the job: Indirect materials Indirect labor Electricity Rent Taxes & permits Depreciation Insurance Total OH charged to the job Direct materials used Direct labor Overhead Total manufacturing costs Add: Work in process, Jan. 1 Total costs put into process Less: Work in process, Jan. 31 Cost of goods manufactured Finished Goods, Jan. 1 Add: Goods manufactured Total goods available for sale Less: Finished Goods, Jan. 31 Cost of goods sold Cost Concepts, Classification and Accountin, ‘cle 162,000 120,000 74,000 356,000 150,000 ‘506,000 75,000 431,000 P120,000 431,000 P551,000 90,000, 461,000 Scanned with CamScannerun Chapter 1 - Cost Concepts, Classification and Accounting Cycle (7) Cost of goods sold ‘P461,000 Multiply by 140% Selling price ‘P645,400 (8) Administrative & marketing costs: Administrative Marketing, Flectricity P6,600 ‘P4400 Rent 3,000 2,000 Taxes 1,500 1,000 Depreciation 7,500 Insurance 3,000 2,000 Salaries 80,000 40,000 Total P101,600 P49A00 Sales ‘645,400 Cost of Sales 461,000 Gross Profit P184,400 Less: Administrative expenses P101,600 Marketing costs 49,400 151,000 (9) Net Income P33,400 Requirement D. The statement of cost of goods manufactured is found on the other page. Scanned with CamScannerChapter 1 - Cost Concepts, Classification and Accounting Cycle 2 High Street Manufacturing Company Statement of Cost of Goods Manufactured and Sold 31, 2019 ——— _—___January 51, 20° —~ T__P50,000 | J 280,000 CL ~__P330,000 | LL : ory, Jan. 31__ [TT indirect materials used 168,000 | _F162,000 [Direct Labor ; ae) | Manufacturing overhead: __[ Indirect material P18,000 | [Indirect labor _ a Depreciation | Others — . 2 | Total Manufacturing costs i P356,000 | Add: Work in process, Jan. 1 150,000 [Total costs of work put into process | P506,000 Less: Work in process, Jan. 31 | [75,000 Cost of goods manufactured _ ‘P431,000 | Add: Finished Goods, Jan.1__- 120,000 | Goods avail ___| P551,000 | Less: Finishes _ 90,000 Cost of Goods sold 461,000 Normal Costing System. Under this system, the actual costs of direct materials and direct labor are charged to the job. The manufacturing overhead applied to production differs from actual costing in the sense that a pre-determined overhead rate is used in computing for the amount of overhead charged to the job. The predetermined overhead rate is the ratio of estimated total overhead to the estimated total of cost driver selected. A company can use one rate (plant-wide) or several rates (departmental rates). If several rates are used, the budgeted manufacturing overhead is actually divided into several cost pools and uses each the predetermined overhead rate. driver as the denominator in computing for Scanned with CamScanner3 Chapter 1 - Cost Concepts, Classification and Accounting Cycle Cost Accounting cycle: Normal costing system Transactions Entries 1. Purchase Raw Materials 5,000 units @ 20,50, on Raw Materials 102,500 account. ‘Accounts Payable 102,500 if one control account for all materials (direct and indirect materials) is maintained, the raw materials purchased is debited to Raw Materials account. 5. Transportation cost Raw materials Inventory or freight for the Cash 10,000 purchase, P10,000 10,000 Before updating the inventory card, the unit cost of the raw materials purchased is adjusted to include the freight. The freight in this example is apportioned equally to the number of units purchased, Invoice price per unit P2050 Freight costs (10,000/5,000) __2.00 Adjusted unit costs P2250 6. Returned 200 units Accts Payable(inooice cost) 4,100 to the supplier due Manufacturing OH (freight) 400 to defective quality. Raw Materials 4,500 Take note that the accounts payable is decreased by the invoice cost of the returned merchandise and the freight associated with the 200 Scanned with CamScannerChapter 1 ~ Cast Concepts, Classification and Accounti units is charged to manufacturing overhead. 200 x 20.50 = 4,100 200x200 = 400 Tseuance of Raw Work in process Materials: 2.800 Raw materials 2,800°22.50 units, 8. Return of — excess Raw Materials materials to Work in process storeroom, 200 units 200 x 22.50 9. Factory Payroll Factory Payroll Gross 125,000 SSS Payable SSS Payable (4,800) Philhealth payable Philhealth (1,200) Pag-ibig payable WHT Payable (9,600) WHT payable Pag-ibig Pay —_(1,200) Cash or Wages Payable Net payroll 108,200 10. Distribution of factory payroll: Work in process 80% - direct laborers Manufacturing overhead 20% - indirect laborers Factory payroll 11. Utility expenses, Manufacturing overhead 20,000 Cash or Accts Payable 12. Maintenance of Manufacturing overhead factory machineries, Cash 5,000 13. Year-end adjustments for: a.expired insurance Manufacturing overhead P1,200 Prepaid insurance b, Depreciation of plant Manufacturing overhead assets, P15,000 Accumulated dep'n 1 Actual Overhead Work in process applied to the job, Manufacturing OH 125,000 100,000 25,000 20,000 5,000 1,200 15,000 66,200 63,000 4,500 4,800 1,200 1,200 9,600 108,200 125,000 20,000 5,000 1,200 15,000 66,200 Scanned with CamScanner35 Chapter 1 - Cost Concepts, Classification and Accounting Cycle Indirect labor 25,000 Utility 20,000 Maintenance 5,000 Insurance 1,200 Depreciation 15,000_ Total 66,200 14. Completion of the Finished Goods 224,700 Process Work in process 224,700 Total costs: Direct mat 58,500 Direct labor 100,000 Overhead 66,200 Total 224,700 15. Sold the manufactured goods at cost plus 40% Accounts Receivable 314,580 mark-up. Sales : 314,580 Total costs 224,700 Mark up 40% 89,880. Cost of sales 224,700 Sales price _ 314580 Finished goods 224,700 Another illustration: Normal costing method Triple A Manufacturing Company submitted the following summary of transactions for its first year of operation, a) Raw materials purchased, P1,350,000 b) Factory payroll - Indirect labor, P150,000 - Direct labor, P1,500,000 ©) Material requisition for the period ~ Indirect materials, P190,000 - Direct materials, P1,200,000 4) Overhead is applied to production at 75% of direct labor costs. Budgeted overhead for the year amounted to P1,200,000 while actual overhead amounted to P1,150,000. Scanned with CamScannerChapter 1 — Cost Concepts, Classification and Accounting Cycle ©) Goods completed for the period equal to 80% of goods put into proces, {) 75% of total production was sold at 40% mark-up on cost. 8) Close overhead variance to cost of sales. Required: Journal exttries following the flow of cost. Solutions: [Transactions Journal Entries Dr Gu] a, Purchase ofRM — Raw Materials 1,350,000 Accts. Payable or cash 1,350,000 b. Factory payroll — Workin process 1,500,000 Manufacturing overhead 1,500,000 cc. Issuance of RM — Workin process 1,200,000 Manufacturing Overhead 190,000 Raw Materials 1,390,000 d. OH applied to Workin process 1,125,000 production Manufacturing OH 1,125,000 Actual overhead — Manufacturing OH 1,150,000 Various 1,150,000 Goods put into process Direct materials 1,200,000 : Direct labor 1,500,000 MOH 1,125,000 Total costs of goods put into process 3,825,000 Portion completed 80% Goods manufactured 3,060,000 e. Completion Finished Goods 3,060,000 Work in process 3,060,000 £ Sale Accounts Receivable 3,213,000 Sales 3,213,000 (3,060,000*75%) Cost of sales 2,295,000 Finished Goods 2,295,000 Scanned with CamScannerChapter 1 ~ Cost Concepts, Classification and Accounting Cycle 8 Over/under applied OH Cost of sales Manufacturing OH x” 25,000 25,000 Actual overhead - 1,150,000 Applied overhead - 1,125,000 Under applied OH - 25,000 (ALTERNATIVE COMPUTATION OF DIRECT MATERIALS USED’ If only one account is maintained for the direct and indirect materials, the Raw Materials account is used instead of Direct Materials account. The direct materials used are computed as follows: Raw Material, beginning 00,000 Add: Purchases 000,000 Freight In 000 Gross Purchases 000,000 Less: Purchase Discounts 000 Net Purchases 000,000 Raw Materials Available 000,000 Less: Raw Materials, end 000 Indirect materials 000 000 used Direct Materials used P00,000 After studying the different types of businesses, service, merchandising and manufacturing, let us now take a close look at how cost of goods sold is computed in each type of business: jnished _ Goods No cost of goods sold 100 | Inventory, beg __| 000 because they don’t sell + Purchases 000 | + Cost of goods 000 merchandise but service. [000] Manufactured 4 i 000 | Goods for sale | 000 | | 000 | “Finished | 000 | The counterpart of cost | ventory, end Inventory, end | of goods sold is Cost of | Cost of goods sold | 000 | Cost of goods sold | 000 | pe Scanned with CamScanner