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Module 1 Introduction To Cost System
Module 1 Introduction To Cost System
Introduction
Management needs prompt cost information in the decision making process. In any type of organization, be it business,
political, religious or civic, it is imperative for management to be aware not only of its total costs and expenses, but also of
the specific product, department or activity for which they are incurred, costs per unit and per work unit of its products
and services, respectively, and of whether the amounts incurred are in accordance with the financial plans and standards.
COST DEFINED
- The cash or cash equivalent value sacrificed for goods and services that are expected to bring a current or future
benefit to the organization.
- Expired costs are called expenses. In each period, expenses are deducted from revenues in the income statement
to determine the period’’s profit.
- Loss – a cost that expires without producing any revenue benefit.
• Cost determination. This refers to accumulation of cost data by products, processes or services to be able to
arrive at unit cost or cost per work unit.
• Cost control. Standards are set for costs per unit and per work unit and are subsequently compared with the
figures per actual operations so that remedial measures may be adopted.
Cost accounting facilitates the performance by management of its planning and control functions. Cost standards are
established for materials, labor and factory overhead based on product design, time and motion studies, and analysis of
factory overhead. These standards subsequently serve as bases in measuring performance and as deterrents to pilferages
and unnecessary wastages of materials and inefficiency of manpower.
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Cost Accounting, Financial Accounting and Management Accounting
One of the most important functions of cost accounting is the development of information which can be used by
management in planning and controlling operations.
- Planning
o the process of establishing objectives or goals for the firm and determining the means by which the firm
will attain them.
o Cost accounting helps in the development of plans by providing historical costs that serve as basis for
projecting data for planning. Management can analyze trends and relationship among such data as an aid
in estimating future costs and operating results and in making decisions regarding the acquisition of
additional facilities, changes in marketing strategies, and obtaining additional capital.
- Control
o The process of monitoring the company’s operations and determining whether the objectives identified in
the planning process are being accomplished.
The recording of the costs of a product or a service is part of financial accounting. The use of cost for valuation of
inventory and cost of goods sold for external reporting is also financial accounting. The use of cost data in choosing
between two or more alternatives is part of managerial accounting. Differential cost analysis is considered by others as a
form of applied microeconomics. Cost accounting provides data for use in decision models for finance, operations
management, and marketing. Cost accounting is also related to motivation and behaviour because it is used in planning
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and performance evaluation. Finally, tools from statistics, mathematics, and computer sciences are used to perform cost
analysis.
CLASSIFICATION OF COSTS
1. Costs classified as to relation to a product
a. Manufacturing costs/ product costs
i. Direct materials
- materials that become part of a finished product and can be conveniently and economically traced
to specific product units.
- Examples:
Iron ore for steel
Sheet steel for automobiles
Flour for bread
- The way a company buys, stores, and uses materials is important.
Timely purchasing is important because if the company runs out of materials, the manufacturing
process will be forced to shut down. Shutting down production results in no products, unhappy
customers, and loss of sales and profits.
- Buying too many direct materials, on the other hand, can lead to high storage costs.
ii. Direct labor costs
- Wages of machine operators and other workers involved in actually shaping the product.
- Include all labor costs for specific work performed on products that can be conveniently and
economically traced to end products.
- Indirect labor costs
- Labor costs for production related activities that cannot be conveniently and economically
traced to end products
- accounted for as part of factory overhead costs
- include the wages and salaries of
Machine helpers
Supervisors
Other support personnel
iii. Factory overhead
- A catchall for all the manufacturing costs that cannot be classified as direct materials or direct labor
costs.
- A varied collection of production – related costs that cannot be practically or conveniently traced
directly to end products.
- Also called
Manufacturing overhead
Factory burden
Indirect manufacturing costs
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- Costs of facilities or services employed in two or more accounting periods, operations, commodities
or services.
- Subject to allocation.
b. Joint cost
- Costs of materials, labor and overhead incurred in the manufacture of two or more products at the
same time.
- Major difficulty inherent to joint cost – they are invisible and they are not specifically identifiable
with any of the products being simultaneously produced.
- Subject to allocation.
5. Costs classified as to relation to an accounting period
a. Capital expenditures
- Expenditure intended to benefit more than one accounting period and is recorded as an asset.
- The allocation of the cost to the different periods is
a. Depreciation for fixed tangible assets
b. Amortization for intangible assets
c. Depletion for wasting assets
b. Revenue expenditures
- Expenditure that will benefit current period only and is recorded as expense
6. Costs for planning, control and analytical processes
a. Standard costs
- Predetermined costs for direct materials, direct labor, and factory overhead.
- Established by using information accumulated from past experience and data secured from research
studies.
b. Opportunity costs
- The benefit given up when one alternative is chosen over another.
- Not usually recorded in the accounting system.
- However, it is considered when evaluating alternatives for decision-making.
- If an asset can be used to perform only one function and cannot be sold or used in other ways, the
opportunity cost of that asset is zero.
c. Differential costs
- Cost that is present under one alternative but is absent in whole or in part under another alternative.
- Encompasses both cost increases and cost decreases between alternatives.
d. Relevant costs
- A future cost that change across the alternatives.
- Examples:
a. Cost of goods sold c. Commissions
b. Advertising d. Warehouse depreciation
e. Out-of-pocket cost
- Cost that requires the payment of money (or other assets) as a result of their incurrence.
f. Sunk cost
- A cost for which an outlay has already been made and it cannot be changed by present or future
decision.
g. Controllable cost
- A cost is considered to be a controllable cost at a particular level of management if that level has
power to authorize the cost.
- Example:
a. Entertainment expense would be controllable by a sales manager if he or she had power
to authorize the amount and type of entertainment for customers.
b. On the other hand, depreciation of warehouse facilities would not be controllable by the
sales manager since he or she would have no power to authorize warehouse
construction.
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THE COST SYSTEM
- One wherein flow of costs is accounted for in detail so that unit costs and inventory costs can be promptly
determined.
- It is effective when it ensures that the company benefits from all its expenditures, that is, costs incurred contribute
to the production of the desired quantity of goods and services.
- May be designed to accumulate costs by products or by departments or processes.
- Perpetual inventory method is used – involves the use of perpetual records showing the flow of costs or resources.
o For a manufacturing firm, cost of raw materials used, cost of completed units and cost of goods sold can
be readily determined and responsibility for inventories can be pinpointed based on records kept.
o The controlling accounts and the corresponding subsidiary records are as follows:
Materials
Materials purchases Purchase returns
Freight in Purchase discounts
Returns of materials previously issued Materials issued
Work in Process
Materials, labor and factory overhead Cost of goods manufactured
charged to production
Finished Goods
Cost of goods manufactured Cost of goods sold
Cost of returned goods which were Goods returned to factory
previously sold for reprocessing
Flow of cost as reflected by postings to both controlling accounts and subsidiary records – Next page
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USE OF CONTROLLING AND SUBSIDIARY ACCOUNTS (JOB ORDER) COST SYSTEM
Materials Work in Process Finished Goods
Purchase
Balances, beg xx returns xx Balance, beg. xx Cost of goods Balance, beg. xx Cost of goods sold xx
Purchases Cost of goods
xx Issuance: Direct materials xx manufactured xx manufactured xx Cost of goods
Returns of excess mat. xx Direct mat. xx Direct labor xx Cost of goods returned xx returned to factory xx
Applied factory
Indirect mat. xx overhead xx
Per materials ledger cards: Per job order cost sheets Per finished goods ledger cards
Direct Labor
Received Issued Balance Direct Mat. Cost Cost FOH Applied Received Issued Balance
xx xx xx xx xx
xx xx xx xx xx xx xx
(xx) xx xx xx xx xx (xx) xx xx
(xx) xx (xx) xx
Summary
Direct mat. Cost P xx
Payroll Direct labor cost xx
Gross earnings xx Direct labor xx FOH applied xx
Indirect labor xx P xx
Factory overhead
Indirect materials xx Charged to
Indirect labor xx production xx
Others xx
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Other controlling accounts
- They may be used under both periodic and perpetual inventory methods because they do not affect the
inventories. They are:
o Factory overhead control
o Selling expenses control
o General and Administrative Expenses Control
o These are supported by subsidiary records or analysis sheets.
Example: The company pays for the following: Factory supplies – P 600; factory repairs – P 500; store supplies – P 300;
and office supplies – P 200.
The journal entry and the corresponding postings to be made on subsidiary records would be as follows:
The footings per subsidiary records must tally with the balances per controlling accounts in the general ledger.
- Similar to that under the non-cost system with the exception of the account titles affecting cost of goods
manufactured and cost of goods sold.
- The chart of accounts as given under the non-cost system is revised and is shown below.
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Selling Expenses (400-499) 603 Rental Income
401 Selling Expenses Control 604 Commission Income
402 Salaries – Sales Supervision 605 Miscellaneous Income
403 Salaries – Salesgirls
404 Salaries – Clerical Help Other Expense (620-629)
405 Sales Commissions 621 Interest Expense
411 Delivery Expense
416 SSS Contributions Income Deductions (630-639)
417 Medicare Contributions 631 Provisions for Income Tax
418 Pagibig Contributions
419 Employees’ Compensation Premiums Temporary Account
425 Telephone and Telegraph 700 Payroll
426 Light, Power and Water
- When transactions are voluminous and/or the factory is far from the main office, manufacturing transactions are
preferably recorded in a factory journal and posted to the factory ledger.
o This requires the use of reciprocal accounts General Ledger (for the factory) and Factory Ledger (for the
main office) when a transaction affects accounts found in both books.
- Factory Ledger – refers to the book of final entry for manufacturing operations, or
o the account title used by main office in recording transactions affecting accounts found in both the books
of the factory and the main office.
- The accounts carried on factory books are those used in recording manufacturing operations.
- Factory fixed asset accounts – may either be in the books of the factory or the main office.
o If the problem is silent, they are assumed to be on factory books.
o The accounts that must be on books of the factory are:
▪ Materials ▪ Plant, Property and Equipment ▪ Factory Overhead Control
▪ Work in Process ▪ Accumulated Depreciation ▪ Factory Overhead Variance
▪ Finished Goods ▪ Applied Factory Overhead ▪ General ledger
o The factory may have its own petty cash fund so that this account may also be found on its books
- All functions other than manufacturing are taken care of by main office so that
o Disbursements
o collections
o sales and the corresponding expenses
involved are recorded on the main office books.
Transfer Voucher
- an intra-company form used to inform the factory when transactions are entered into by the main office but the
same affect manufacturing accounts
- Example
o The main office buys machinery for the factory for P 30,000. Factory fixed assets are carried on factory
books.
▪ a transfer voucher is prepared by the main office informing the latter of the transaction and to the effect
that the factory ledger is debited by the main office for P 30,000.
▪ Based on this, the entries on both books are:
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▪ Factory issues a transfer voucher informing the main office of such delivery and debits the account
general ledger.
▪ Entries would be as follows:
Nature of products:
Heterogeneous Homogeneous
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Cost accumulation:
By job orders By departments or processes
Reporting
By job orders By departments or processes
When is unit cost computed:
Upon completion End of costing period (usually a month)
Unit cost computation:
Production costs per job Departmental costs
Number of units Equivalent units of production
Subsidiary record for work in process:
Job order cost sheets Cost of production reports (or departmental cost sheets)
Elements of product cost – materials cost, labor cost and factory overhead.
For job order costing, materials and labor costs refer to direct materials cost and direct labor cost, respectively.
Direct materials cost – refers to those items that form part of the finished product and which can be measured and
directly charged to the product
• Examples: leather for shoes, lumber for furniture and metal parts for automobiles
Direct labor cost – refers to cost of labor expended in the manufacture of a product and which can be directly
charged to the product
Factory overhead – also known as manufacturing expenses or burden.
- Refers to the indirect element of cost
- Includes all manufacturing cost not classified as direct materials or as direct labor
- Examples:
o Indirect materials – those needed for the completion of the product but the consumption
of which with regard to the product is either so small or allocation would be too
complex so that for convenience, it is treated as an indirect product cost.
▪ Examples: glue, tacks and polish in the manufacture of shoes
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o Indirect labor – refers to cost of manpower which cannot be identified as pertaining to a
particular product.
▪ Examples: salaries and wages of forement, timekeepers and utility men.
o Factory supplies
o Depreciation of factory building
o Factory insurance
Note: Distinctions between direct and indirect materials and between direct and indirect labor are not observed in process
costing inasmuch as under the latter, costs accumulation is by departments or processes and not by products or jobs.
a. These records accumulate product costs of specific units or small batches of units for both product
costing and control purposes.
b. The file of job order cost sheets for uncompleted jobs serves as a perpetual book inventory and the
subsidiary ledger for Work in Process Control.
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Example of a Job order cost sheet:
Direct Labor
Date Time Card No. Hours Rate Cost
Factory Overhead
Date Activity Base Quantity Application Rate Cost
Cost Summary
Direct Materials
Direct Labor
Factory Overhead
Total Cost
Location in
Description Storeroom
Maximum Minimum Stores Ledger Acct. No.
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MATERIALS REQUISITION
Date No.
To
Approved by Issued by
Received by
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basis for the materials to be issued. The job order number is shown on the materials requisition together
with the specifics on type and quantity of materials required by each job. The quantity, unit cost, and total
cost of each of the materials are entered on the issued section of the stock card.
MATERIALS
Inventory beginning Cost of direct materials issued
Purchase of materials Cost of indirect materials issued
Freight-in Cost of materials returned to supplier
Cost of excess materials returned from factory
- The balance of the Materials account represents the Materials inventory at the end of the period under
consideration.
- The amount should be equal to the total of the balances of all the material stock cards.
Time tickets
- Prepared for each worker to determine the time spent for each job as basis in determining the amount to be
charged to direct labor cost and indirect labor cost.
- For various jobs, they are sorted, priced and summarized , and the time ticket hours should be reconciled with the
clock card hours.
• At regular intervals, usually daily or weekly, the labor time and labor cost for each job are entered on the
job order cost sheets. For each payroll period – weekly, every two weeks, or monthly – the summary of
employees’ earnings and the liability for payment is journalized and posted to the general ledger.
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- Entry: Payment of Payroll
- The Work in Process account is used to charge the jobs with the direct labor cost.
- Factory overhead control is charged for the indirect labor cost incurred.
- Tax withheld is computed based on the table provided by the Bureau of Internal Revenue.
- For the SSS Premiums and Medicare Contributions, the table is provided by the Social Security System.
- The clearing account for the total wages due to the factory personnel is the payroll account summarized as
follows:
PAYROLL
Total wages and salaries earned by factory personnel Total payroll during the payroll period at the same time
during the payroll period debiting work in process for direct labor and overhead for
indirect labor
- The account used to accumulate the liability for payroll or factory overhead is the Accrued Factory Payroll
summarized as follows:
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FACTORY OVERHEAD CONTROL
Cost of indirect materials and supplies issued from the Total debit footing at the end of the accounting
warehouse at the same time crediting materials period when closing the books
Cost of indirect labor at the same time crediting payroll
Cost of indirect expense purchased from outsiders
Cost of other indirect expense incurred by the company
Factory overhead applied – account used for accumulating the total overhead charged to production during period.
Over / under applied overhead – the difference between the actual overhead incurred and the applied overhead.
- Accumulation of factory overhead incurred (or actual factory overhead) takes time especially in cases wherein
adjustments are done on an annual basis.
- Instead of charging actual factory overhead to production, the practice of charging overhead based on
predetermined rates is adopted.
o Account used may either be Applied Factory Overhead or Factory Overhead.
o At the end of the period, both applied factory overhead and factory overhead control are closed and the
difference is called the factory overhead variance which may be overapplied (credit) or underapplied
(debit).
▪ Example: Factory Overhead Charged to production is P 25,760 and factory overhead incurred amounts to
P 26,000. The entries would be as follows:
• To charge overhead to production:
Work in Process P 25,760
Applied Factory Overhead P 25,760
• To take up factory overhead incurred:
Factory Overhead Control P 26,000
Sundry credits P 26,000
• To close Applied factory overhead to Factory Overhead Control
Applied Factory Overhead P 25,760
Factory Overhead Control P 25,760
After this entry, Factory overhead control shall have a debit balance of P 240, the factory overhead variance. This is set up
in the following entry:
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Factory Overhead Variance P 240
Factory Overhead Control P 240
• In the given example, Actual Factory overhead exceeds applied overhead so that the variance
is a debit ( underapplied, underabsorbed, or unfavourable).
• When Actual Overhead is more than Applied overhead, the variance must be a debit
(underapplied, underabsorbed or unfavourable).
• When Actual Overhead is less than Applied overhead, the variance must be a credit
(overapplied, overabsorbed or favourable).
• Factory Overhead Variance- preferably used so that both overapplied and underapplied
variances may be posted to the same ledger page.
• Instead of crediting “Applied Factory Overhead” in charging overhead to production, the
credit may be to “Factory Overhead Control”. This practice eliminates the need to close the
former to the latter.
o Disposition of Factory Overhead Variances.
▪ Factory overhead, in general, is treated as a period cost and is closed to cost of goods sold or to income
and expense summary.
• However, when it is significant in amount, it implies an error in costing or that a wrong
overhead rate was used. In this case, the variance is treated as an adjustment to cost of goods
sold and the inventories of finished goods and work in process.
▪ In the example given in the preceding section, the variance is closed to cost of goods sold as follows:
Cost of Goods Sold P 240
Factory Overhead Variance P 240
▪ Based on the given entry, an unfavourable variance increases cost of goods sold and a favourable variance
reduces the same.
Manufacturing costs:
Direct materials cost P 75,000
Direct labor cost 55,000
Factory overhead applied 55,000 P 185,000
Work in process, Jan. 1 33,000
Work in process, Dec. 31 (45,000)
Cost of Goods Manufactured P 173,000
Finished Goods, Jan. 1 29,000
Finished Goods, Dec. 31 (22,000)
Cost of goods sold, normal P 180,000
Underapplied factory overhead 240
Cost of goods sold, actual 180,240
Gross profit on sales 69,760
Less: Operating expenses 55,000
Net income 14,760
In the foregoing illustration, cost of goods sold prior to adjustment for factory overhead variance is described as
normal, that is, based on what has been estimated or planned.
Work in process - a controlling account used to record the flow of the elements of cost through the factory during a
given period
- Used to accumulate during the month the total cost of materials placed in process, labor used and factory
overhead applied.
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- Amounts entered on the cost sheet should equal the amounts debited to the work in process account during the
month.
- As jobs are completed, the cost sheets for the corresponding jobs are totalled and the amount is now transferred to
the finished goods account.
Entry: Transfer from Work in process to Finished Goods account
Finished Goods xxx
Work in process xxx
,
WORK IN PROCESS
- Cost of beginning inventory - Cost of materials, labor and factory overhead applied
- Cost of direct materials issued to production at the to jobs completed during the period at the same time
same time crediting materials debiting finished good
- Cost of direct labor applied to production during the - Cost of direct materials returned to the warehouse at
period at the same time crediting the payroll account the same time debiting materials
- Amount of overhead applied to production at the same
time crediting applied overhead
FINISHED GOODS
- Cost of inventory at the beginning - Cost of finished goods sold during the period at
the same tie debiting cost of goods sold
- Factory cost of job order completed at the same
time crediting work in process
- Cost of goods returned by the customer at the
same time crediting cost of goods sold
Cost of Goods Sold – an account used to accumulate he cost of finished goods disposed through sale to customers.
COST OF GOODS SOLD
- Cost of finished goods disposed through sale to - Cost of finished goods returned by customers at
customers at the same time crediting finished the same time debiting the finished goods
goods account
- Adjustment for under applied factory overhead - Adjustment of over applied factory overhead
- Balance of the account at the end of the period at
the same time debiting income summary
ILLUSTRATION:
The following information is provided by Bacolor Corp. For 2014:
2014
a. Direct materials issued:
Job order No. 14 ................................................ P 9,000
15 ................................................. 12,000
16 ................................................. 8,000
P 29,000
b. Direct labor costs:
Job order No. 14 ................................................ P 3,500
15 ............................................... 5,400
16 ............................................... 3,300
P 12,200
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c. Factory overhead is charged to production at 60% of direct labor cost.
d. Job orders nos. 14 and 15 are completed.
The entries and corresponding postings to the work in process account and the cost sheets would be as follows:
a. Work in Process P 29,0000
Materials P 29,000
Direct materials issued.
b. Work in Process 12,200
Payroll 12,200
Direct labor costs
c. Work in Process 7,320
Applied Factory Overhead 7,320
Overhead charged at 60% of direct labor costs
d. Finished Goods 35,240
Work in Process 35,240
Jobs 14 and 15 completed
Per general ledger; the work in process account should have the following postings:
Work In Process
Direct materials 29,000 Cost of completed jobs 14 and 15 35,240
Direct labor 12,200
Factory overhead applied 7,320
- The ending balance of work in process is P 13,280 (or P 48,520 minus P 35,240). This must be the accumulated
cost of Job No. 16. However, per cost sheet for said job, the total is only P 11,300 (that is, P 8,000 + 3,300)
because of the non-application yet of factory overhead of P 1,980 (or 60% x P 3,300).
- Assuming that job order no. 16 is completed during the next period (or in 2015) after incurring additional direct
materials and direct labor costs of P 4,000 and P 2,000, respectively, the total factory cost of the job would be as
follows:
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ILLUSTRATION OF ENTRIES UNDER COST AND NON-COST
SYSTEM
The following transactions are journalized under both the cost and the non-cost systems:
Work in process 25,000.00 Labor cost (Factory Salaries and wages) 30,200.00
Factory Overehead control 5,200.00 Selling expenses control 10,000.00
Selling expenses control 10,000.00 Gen and adm. Expenses control 9,800.00
Gen and adm. Expenses control 9,800.00 Payroll 50,000.00
Payroll 50,000.00
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e. Rentals (factory, sales and office, 50:30: 20), P 12,000.
Factory Overhead Control 6,000.00 same entry
Selling Expenses Control 3,600.00
General and Adm. Expenses control 2,400.00
Vouchers Payable 12,000.00
h. Incurred the following: factory repairs - P 3,500; store supplies - P 600; office supplies - P 900; light power and water (factory, sales and office, 60:30:10), P 4,200.
i. Remittance of payroll deductions including counterpart contribuutions and workmen' compensation premiums amounting to P 2,000
(factory - P 1,000; sales - P 600; office - P 400)
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Vouchers Payable 5,800.00 same entry
Cash 5,800.00
n. Provision for depreciation: factory machinery and equipment - P 5,500; factory office furniture - P 3,000; store furniture - P 2,800; and,
office furniture and equipment, P 2,000.
Closing Entries:
The factory overhead variance is set up
Applied Factory Overhead 30,000.00 The closing entries, as taken up in Chapter 1, are made by setting up the closing
Factory Overhead Variance 380.00 inventories and closing the beginning inventories and nominal accounts.
Factory Overhead Control 29,620.00
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