AE212 - Module 1 INTRO TO COST ACCTG

MODULE IN
COST ACCOUNTING AND CONTROL

RINCIPLES AND PRACTICES
AE 212
Department of Accountancy
SCHOOL OF ACCOUNTANCY, MANAGEMENT, COMPUTING,

AND INFORMATION STUDIES
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AE 212: COST ACCOUNTING AND CONTROL
Week Topic Learning Outcomes Activities
MODULE 1 – Introduction to Cost Accounting

Week 1 1. Describe the •
environment of cost
accounting from
internal and external
perspectives.
2. Identify the tasks in
which management is
aided by information
provided by the cost
accountant
particularly about
costs and their
benefits.
3. Enumerate the
classification of costs,
define, illustrate and
analyze behavior of
each kind of costs
4. Segregate fixed costs
from variable costs
Do graded activity
MODULE 1:
INTRODUCTION TO COST ACCOUNTING
ACCOUNTING INFORMATION
The primary objective of accounting is to provide information that is useful for decision-making
purposes. From the very start, accounting is not an end, but rather it is a means to an end. The final
product of accounting information is the decision that is enhanced by the use of that information,
whether the decision is made by owners, management, creditors, governmental regulatory bodies,
labor unions, or the many other groups that have an interest in the financial performance of an
enterprise. Sound decisions, based on reliable information, are essential for the efficient distribution
and use of a firm’s scarce resources.
In order to understand and use accounting information in making economic decisions, you need
to understand the following:
• The nature of economic activities that accounting information describes,
• The assumptions and measurement techniques involved in developing accounting
information,
• The information that is most relevant for making various types of decision.
Figure 1-2 illustrates how economic activities flow into the accounting process.
Figure 1-1
The Accounting
Process
Economic Accounting
Activities Information
Decision
makers
Just as there are many types of economic decisions, there are also many types of accounting
information. The terms financial accounting and management accounting often are used in
describing the types of accounting information that are widely used in the business community.
ACCOUNTING SYSTEMS
The accounting information system within an organization has two major subsystems: a financial
accounting system and a management accounting system.
Financial accounting
• refers to information describing the financial resources, obligations, and activities of an
economic entity (either an organization or an individual).
• is designed primarily to assist external users. It includes investors, creditors, owners, employees
or labor unions, government agencies, suppliers, customers, trade associations, and the
general public.
Management accounting
• involves the development and interpretation of accounting information intended
specifically to assist the internal users or management in operating the business.
• Managers use this information in setting the company’s overall goals, evaluating the
performance of departments and individuals, deciding whether to introduce a new line
of products, and making virtually all types of managerial decisions.
• Much management accounting information is financial in nature but is organized in a
manner relating directly to the decision at hand.
The primary differences between these two accounting disciplines are given in figure 1-2.
Figure 1-2
FINANCIAL ACCOUNTING vs. MANAGEMENT ACCOUNTING
FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING
1. As to objective Financial statements are used to To provide information needed

determine the company’s by management in making
operating results for a given period decision
and financial condition at a given
period.
2. As to structure It is a single structure built It varies depending on the use
around one fundamental of information. There are three
equation: Assets = Liabilities + types of accounting: full cost
Capital accounting, differential
accounting and responsibility
accounting. Each with its own set
of principles and application.
3. As to It is always prepared in It is not necessarily in conformity

compliance with accordance with GAAP with GAAP to be able to present
GAAP more useful data.
4. As to basis of Data are historical in nature and Data may be both historical
the reports based on objective facts. and estimates. However, more
emphasis is given to future
estimates.
6. As to timeliness Reports are not easily prepared; Reports are promptly prepared
of reports and submission requires time. and submitted to preserve its
usefulness.
7. As to option of Financial reports are prepared It is optional for its existence and
existence and required not only by function since it depends upon
stockholders, prospective management and its needs.
investors, and creditors but also by
the different regulatory bodies.
COST ACCOUNTING
Cost accounting may be defined as the system that records, summarizes, analyzes and
interprets the details of the costs of a manufactured product or a service. In the planning phase, cost
accounting deals with the future. It helps management to budget the future or predetermined
materials costs, wages and salaries and other costs of manufacturing and marketing products and
services. These costs might be used to assist in setting prices and disclosing the profit that will result,
considering competition and other economic conditions. Cost information is also provided to aid
management with problems such as capital expenditure decisions, expansion of facilities for
increased sales production, make-or-buy decisions or purchase-or-lease decisions. In the control
phase, cost accounting deals with the present, comparing current results with predetermined
standards and budgets. Cost control to be effective, depends upon proper cost planning for each
activity, function and condition. Thru the cost accounting media, management is informed frequently
of those operating functions that fail to contribute their share to the total profit or that perform
inefficiently, thereby leading to profit erosion.
Periodically, generally at the end of the fiscal period, cost accounting deals with past costs for
the purpose of profit determination and thereby with the allocation of historical costs to periods of
time. At this point, cost accounting procedure is particularly concerned with the application of
manufacturing costs to units of products to be capitalized in the ending inventory and transferred to
cost of goods sold as shipments are made.
Cost accounting is an area of accounting concerned with cost determination, cost control and
cost analysis.
• Cost determination refers to the accumulation of cost data by products, processes or services to
be able to arrive at a unit cost or cost per work unit.
• Cost control refers to the comparison of standards set for costs per unit and per work unit with the
figures per actual operations so that remedial measures may be adopted.
• Cost analysis refers to the use of cost data in managerial analysis for decision-making.
It’s objectives include:
1. Creating and executing plans and budgets for operating under expected competitive and
economic conditions
2. Establishing costing methods that permit control of activities, reductions of costs and
improvements of quality
3. Controlling physical quantities of inventory, and determining the cost of each product or service
produced for the purpose of pricing and for evaluating the performance of a product,
department or division
4. Determining company costs and profit for an annual accounting period or a shorter period. This
includes determining the cost of inventory and cost of goods sold according to external reporting
rules.
5. Choosing among two or more short-run or long-run alternatives that might alter revenues or cost.
Cost accounting is a hybrid of financial and management accounting. It provides information

on a company’s costs and may be used for both external and internal purposes. When cost
accounting is used for financial accounting, it measures the costs of production and sales in
accordance with GAAP. When used for internal purposes, cost accounting information provides the
basis for planning, controlling and decision making.
The following figure on the next page depicts the relationship of cost accounting to the larger
systems of financial and management accounting. None of the three areas should be viewed as a
separate and exclusive type of accounting.
Figure 1-3
RELATIONSHIP OF FINANCIAL, MANAGEMENT AND COS T ACCOUNTIN
FINANCIAL COST MANAGEMENT
ACCOUNTING ACCOUNTING ACCOUNTING
COST CONCEPTS, USES AND CLASSIFICATION

COST
• “Cost is a foregoing, measured in monetary terms, incurred or potentially to be incurred
to achieve a specific objective.” (The Committee on Cost Concepts and Standards of
the American Accounting Association)
• Cost is the cash or cash equivalent value sacrificed for goods and services that are
expected to bring a current or future benefit to the organization.
USES OF COST DATA
1. Planning profit by means of budgets

2. Controlling costs via responsibility accounting
3. Measuring annual or periodic profit, including inventory costing
4. Assisting in establishing selling prices and a pricing policy
5. Furnishing relevant cost data for analytical processes for decision making.
CLASSIFICATIONS OF COST
Cost classification is needed for the development of cost data that are useful to management.
Costs may be classified as follows:
1. Costs to make and sell (Natural classification)

2. Costs in relation to behavior
3. Costs in relation to manufacturing departments
4. Costs in relation to analysis for decision making
5. Costs in relation to timing of charges against revenues
COSTS TO MAKE AND SELL
Product costs or inventoriable costs, are costs that are attached to the product and matched with
revenue in the period in which the product is sold.
In the case of manufactured goods, these costs consist of Direct materials, Direct labor,
Factory/manufacturing overhead.
Prime Costs = Direct materials and direct labor
Conversion = Direct labor and Factory overhead
• Direct materials refer to all materials that form an integral part of the finished product and the
cost of which can be included directly in calculating the cost of the finished product.
• Direct Labor is labor expended directly upon the materials comprising this finished product.
This cost is traceable to the goods or services being produced.
• Factory Overhead or Manufacturing Overhead or Factory Burden may be defined as all

production costs other than direct materials and direct labor. These costs form a substantial
part of the total cost to manufacture that cannot be expediently identified with any particular
unit or batch. The following is a list of costs chargeable to this account:
1. Indirect materials and Factory Supplies
Indirect materials are materials needed for the completion of the product but whose
consumption with regard to the product is either so small or so complex that it would be useless
to treat them as direct materials. This is justified on the basis of cost and convenience. The
cost of the tracing is greater than the benefit of increased accuracy. Glue, thread, nails,
tacks, rivets and other such items usually belong to this category.
Factory Supplies, a form of indirect materials, are generally those materials necessary for
production but that do not become part of the finished product or are not used in providing
a service. Examples are oil used for production equipment, cleaning rags and brushes needed
to maintain the working area and machinery in workable and safe condition, and dishwasher
detergent in a fast-food restaurant.
2. Indirect Labor
Indirect Labor may be defined as that labor expended which does not affect the
construction or the composition of the finished product. The term includes the salaries paid to
foremen, shop clerks, general helpers, cleaners, and those employees engaged in
maintenance work or other service work not directly related to physical production.
3. Factory building maintenance costs, such as rent, taxes, depreciation, light and maintenance
4. Factory machine and equipment depreciation
5. Cost of small tools used in the factory
6. Power used in machine operation
7. Payroll taxes and fringe benefits paid to factory employees
8. Cost of spoilage and rework not chargeable to a particular job
9. Overtime premiums
Period costs refer to the costs that are totally charged against current revenues. Since future benefits
are not subject to objective measurement, no part of a period cost is deferred. Rather, the entire
amount of a period cost is charged to revenue as an expense in the period in which the cost was
incurred.
• Selling Expenses cover the expenses of making sales and delivering products. Examples of
selling costs include the following: salaries and commissions of sales personnel, advertising,
warehousing, shipping and customer service.
• General/ Administrative Expenses include all costs associated with the general administration
of the organization that cannot be reasonably assigned to either marketing or production.
Examples of administrative costs are top-executive salaries, legal fees, printing the annual
report, general accounting, and research and development.
COSTS IN RELATION TO BEHAVIOR
The tendency of costs to change with output must be taken into consideration by the
management for cost control purposes. There are three (3) patterns of behavior that emerge when
costs are classified in relation to volume or activity, namely:
Fixed Costs. These are costs incurred in providing the capacity to do business – the costs of being
in business. The characteristics of fixed costs are:
• Costs tend to remain constant in total amount within the relevant range even the volume
of activity changes
• Cost per unit tend to vary or change in an indirect proportion to volume of activity, that is
fixed cost per unit decreases with increased output or fixed cost per unit increases with
decreased output
A common example of a fixed cost is depreciation of factory machinery. Take note that a
machine has a capacity which defines its relevant range. If a machine can process 12,000 units and
is depreciated at P240,000 annually, then the relevant range is 0-12,000 units. Beyond the relevant
range, the cost of depreciation may be different since the company would need to acquire and
consequently depreciated another machine. This example may be illustrated by the succeeding
graph.
Figure 1-4
FIXED COST BEHAVIOR
Cost
F = P480,000
P480,000
P240,000
4,000 8,000 12,000 16,000 20,000

Number of units processed
Other examples are Property taxes, Depreciation, Rent, Salaries of production executives, Patent
amortization, Wages of security guards/janitors, Repairs and maintenance of buildings and grounds,
Insurance on property
Variable Costs. These are costs incurred in utilizing the available capacity and which represents
the cost of doing business as against the costs of being in business. The characteristics of a variable
cost are as follows:
• Costs tend to vary or change in total amount in direct proportion to volume of activity
• Comparatively constant cost per unit in the face of changing volume
• Easy and reasonably accurate assignments to operating departments
• Control of their incurrence and consumption by the responsible department head
To illustrate, a company uses 2 yards of cloth to manufacture 1 unit of T-shirt. The results of the
factory is shown in figure 1-5. As the number of units produced increases, the cost of cloth used in
making T-shirts also increases. Notice also that the unit cost of direct materials is constant.
Figure 1-5
VARIABLE COST PER UNIT COMPUTATION
Cost of Cloth Number of T-shirts Unit Cost
P 240,000 4,000 P 60.00
480,000 8,000 60.00
720,000 12,000 60.00
960,000 16,000 60.00
1,200,000 20,000 60.00
Figure 1-6 graphically illustrates a variable cost.
Figure 1-6
VARIABLE COST BEHAVIOR
Cost
1,200,000 YV = P60 X
960,000
720,000
480,000
240,000
4,000 8,000 12,000 16,000 20,000
Variable cost behavior is represented by a straight line coming out of the origin. Notice that at
zero units processed, total variable cost is zero. However, as units produced increase, the total
variable cost also increases. Here it can be seen that total cost increases in direct proportion to
increases in the number of computers processed (the activity driver); the rate of increase is measured
by the slope of the line. At 12,000 units, the total cost of direct materials is P720,000 (or P60 x 12,000
computers processed), at 16,000 units, the total cost is P960,000.
Mixed Costs. These costs contain both fixed and variable elements. They vary with output but
not in direct proportion to the volume. These costs include an amount that is fixed within a relevant
range of output below which it will not fall and an amount that varies proportionately when output
changes.
For example, sales representatives are often paid a salary plus a commission on sales. Suppose
that a company has ten sales representatives, each earning a salary of P300,000 per year plus a
commission of P500 per unit sold. The activity is selling, and the activity driver is units sold. If 10,000
computers are sold, then the total selling cost (associated with the sales representatives) is P8,000,000
– the sum of the fixed salary cost of P3,000,000 (10 x P300,000) and the variable cost of P5,000,000
(P500 x 10,000 computers). The linear equation for a mixed cost is given by:
For DC Computers, the selling cost is represented by the following equation:
Y = P3,000,000 + P500X Y = Fixed Cost + Total Variable Cost

Y = F + VX
where: Y = Total cost
The following figure shows the selling cost for different levels of sales activity:
Figure 1-7
COST PER UNIT COMPUTATION
Fixed Cost Variable Total Cost Number of Selling

of Selling Cost of Units sold Cost per
Selling Unit
P3,000,000 P2,000,000 P5,000,000 4,000 P 1,250.00
3,000,000 4,000,000 7,000,000 8,000 875.00
3,000,000 6,000,000 9,000,000 12,000 750.00
3,000,000 8,000,000 11,000,000 16,000 687.50
3,000,000 10,000,000 13,000,000 20,000 650.00
The graph for the mixed cost example is given in figure 1-8. The graph assumes that the relevant
range is 0 to 20,000 units. Mixed costs are represented by a line that intercepts the vertical axis (at
P3,000,000 for this example). The intercept corresponds to the fixed cost component, and the slope
of the line gives the variable cost per unit of activity driver (slope is P500 for the example portrayed).
Figure 1-8
MIXED COST BEHAVIOR
13,000,000
11,000,000
C
o 9,000,000 Variable
s Costs
7,000,000
t
5,000,000
3,000,000
Fixed
Costs
4,000 8,000 12,000 16,000 20,000

COSTS IN RELATION TO MANUFACTURING DEPARTMENTS
The departments of a factory fall into two categories: [1] Producing departments and [2] Service
departments.
Producing department is one whose costs may be charged to the product because they have
contributed directly to its production, such as the machining, forming, upholstering, or assembling
departments.
Service department is one that is not directly engaged in production but renders a particular type
of service for the benefit of other departments. In some instances these services benefit other service
departments as well as the producing departments. The costs incurred in the operation of service
departments represent a part of the total factory overhead that must be absorbed in the cost of the
product by means of the factory overhead rate. Some service departments common to many
manufacturing concerns are receiving, inspection, storeroom maintenance, timekeeping, payroll,
cost accounting, factory office, cafeteria and plant protection.
Direct departmental cost - cost is directly traceable to the product that pass the department
Indirect or common costs - those expenses, the benefits from which may be shared with the other
departments For indirect and common costs, allocation has to be made proportionately to the
departments receiving the benefits.
Joint cost occurs when two or more products are manufactured at the same time such as those
coming from the same raw materials. Meat-packing, lumber and liquor industries are examples where
production costs have to be allocated to the different products manufactured. In such industries,
joint costs can be allocated to joint products only by arbitrary calculations.
COSTS IN RELATION TO ANALYSES FOR DECISION MAKING
Relevant costs - The cost is said to be relevant when the same can be changed or influenced by
a decision. Relevant costs have two basic characteristics, namely: [1] they are future costs, and [2]
they are different between decision alternatives.
Irrelevant costs. Irrelevant costs are those that will not be changed by a decision. A cost is
irrelevant if, though it is different under each alternative yet it is not a future cost.
• Differential Cost refers to the difference between any two alternative courses of action. If
the difference in cost of the alternatives is an increase, the differential cost is appropriately
termed as Incremental cost while a decrease is properly called as Decremental cost.
Generally speaking, a differential cost is a relevant cost for decision making purposes. It
is interesting to note that a cost to be relevant it must be both relating to the future and
differential.
• Avoidable cost are costs that can be eliminated by virtue of an alternative. In form,
avoidable costs are cost savings arising from a decision to discontinue an undertaking.
Thus, a particular cost that cannot be eliminated by a decision is said to be an
unavoidable cost. One form of an unavoidable cost is committed cost. This cost is a result
of a long-run decision such as the acquisition of equipments subject to periodic
depreciation or a long-term lease contract that will bring about periodic rental charges
for a definite period of time.
• Postponable costs are costs that may be deferred or shifted to a future date or period of
time without adversely affecting current operations.
• Out-of-pocket cost are future outlay of financial resources as a consequence of a

decision. A decision to acquire equipment involves cost. Such cost is a typical example
of out-of-pocket cost.
• Opportunity cost refers to the income or benefit sacrificed or foregone when an

alternative is selected over another. Though cost generally looked upon as outlays of
resources either in the present or in the future, it also includes sacrifices made by refusing
an alternative. To illustrate, assume the existence of an opportunity to produce only one
product out of two different product lines. Product A is estimated to contribute P35,000 a
year to profit while product B will generate P30,000 a year. Naturally, product A should be
selected and the opportunity cost for selecting product A is the sacrifice of P30,000 that
could be earned by producing product B. Opportunity cost is not entered in the
accounting records. However, for decision making purposes, these costs are usually
considered relevant.
• Imputed costs are assumed or hypothetical costs representing the cost or value of a
resource that is utilized for a specific purpose. This cost does not involve actual outlay of
cash but is considered as a relevant factor in decision making. Although it may not be
recorded in the books of accounts, the importance and relevance of the rental value of
company-owned facilities and the salaries of owner-operator of a single proprietorship
cannot be overlooked. Also, the equivalent interest for a borrowed capital that could
have been invested somewhere else constitute an imputed cost.
• Sunk cost is a cost that has already been incurred and that cannot be changed by any
decision made now or in the future. Therefore, sunk cost is irrelevant in decision making
processes.
• Quality cost is cost associated with conforming to standards. It refers to the costs incurred
to prevent, or the costs arising as a result of, producing a low-quality product. Quality is a
managerial concern on two general levels. First, the quality of the product or service as it
is perceived by the consumer is an important consideration. On another level, managers
are concerned about the quality of the production process. There are two basic
categories of quality costs: [1] the cost of control or compliance with standards and [2]
the cost of failure to control or non-compliance with standards. The cost of control
includes prevention cost and appraisal cost. The second category of quality costs is failure
costs, which may be internal or external.
Prevention cost has for its purpose the improvement of quality by preventing product defects
resulting from dysfunctional processing. Companies employ many techniques to prevent defects
including statistical process control, quality engineering, training, and a variety of tools from Total
Quality Management (TQM). A company can increase its product and service quality by investing in
prevention costs. Amounts spent on improved production equipment, training, and engineering and
modeling are considered as prevention costs.
Appraisal cost represents quality control costs incurred for monitoring since some mistakes are not
eliminated through prevention activities. These are sometimes called inspection costs that are
incurred to identify defective products before the products are shipped to customers. Appraisal cost
complements prevention cost. Both of these costs can be expected to cause a reduction in another
group of costs known as failure costs.
Failure cost may be internal loss such as scrap or rework, or it may also be an external loss, such
as warranty cost, or cost of recalling defective product. Internal failure costs result from identification
of defects before they are shipped to customers. These costs include scrap, rejected products,
reworking of defective products, and downtime caused by quality problems. External failure costs
result when a defective product is delivered to customers. These costs include warranty repairs and
replacements, product recalls, liability arising from legal action against a company, and lost sales
arising from a reputation for poor quality. Such cost can reduce profits.
COSTS IN RELATION TO TIMING OF CHARGES AGAINST REVENUES
Capital expenditures relate to use of resources for future benefits – the benefits extending over two
or more accounting periods. These are recorded as assets. These are the costs paid in relation to the
acquisition of plant, property and equipment which are capitalized or added in the related asset
account. Any costs incurred during the purchase, installation and dry-run are capitalized. Since these
will benefit several accounting periods, they are treated as assets. Examples of capital expenditures
are building, equipment, machinery, and patent, purchased for the operation of the business.
Revenue expenditures are costs that will benefit only the current period. They are not material in
amount, thus, they are recorded under the expense accounts. Examples of revenue expenditures are
depreciation on most of the capital expenditures, repairs and maintenance, amortization of
intangibles, insurance. All non-manufacturing costs are revenue expenditures.
ESTIMATING AND CONTROLLING COSTS
Cost studies are made continuously inasmuch as cost behavior may change over time as
conditions change. Management is constantly examining cost behavior in an effort to prepare better
budgets through more accurate cost prediction. The costs of projects or departments may be
estimated or predicted by a combination of two approaches:
1. Engineering estimates of materials and work requirements
2. An examination of past cost behavior
Engineers who are familiar with the technical requirements will estimate the quantities of
materials that are needed for production and the labor or machine hours required for various
operations. Prices and rates are applied to the physical measurements to obtain cost estimates.
Past cost behavior is also studied as a guide in predicting costs. The future is seldom a
duplication of the past, yet a study of past cost behavior can be effectively utilized in the overall
problem of cost allocation.
COST SEGREGATION
Costs are segregated for the purpose of determining the rate of past cost variability. After the
variable cost is determined, the estimated fixed cost can be established. Three methods are often
employed in cost segregation the: [a] high-low point method; [b] least squares method; [c] visual fit
method.
HIGH-LOW POINT METHOD
In the high-low point method, the observed costs for various hours of activity are listed in order
from the highest number of hours in the range to the lowest. The difference in hours between the
highest level of activity and the lowest is divided into the difference in cost for the corresponding hours
to arrive at a rate of variable cost per hour. For example, repair costs for various hours of operation
have been incurred in the past as follows:
Hours of Activity Repair Cost
High 80,000 P 246,000.00
70,000 216,000.00
60,000 186,000.00
50,000 156,000.00
40,000 126,000.00
Low 30,000 96,000.00
The difference in hours is 50,000 (80,000 – 30,000), and the difference in cost is P150,000
(P246,000 – P96,000). The variable repair cost is computed below:
Difference in cost P150,000
-------------------------- = ------------- = P3.00 vc/hr
Difference in hours 50,000
The fixed cost can be estimated at any level (assuming a uniform rate of variability) by
subtracting the variable cost portion from the total cost. At 80,000 hours, for example, the total cost is
P246,000; and the total variable cost is P240,000 (80,000 hours x P3.00 variable cost per hour). Hence,
the fixed cost is P6,000 (P246,000 – P240,000). In this example, it was assumed that a constant rate of
variability existed over the entire range. For every increase of 10,000 hours, there was a P30,000
increase in cost. In some cases, however, the rate of variability may change, and this possibility must
be considered in cost analysis.
LEAST SQUARES METHOD
When cost characteristics are such that they do not always vary at a constant rate for each
hour of activity, the most frequently used alternative to the high-low point method is the line of
regression method wherein an average rate of variability is computed. The costs for the various
numbers of hours may be plotted on a graph, and by visual inspection a line of average that
represents the costs for the various hours can be fitted to the data. The line of average for costs that
are influenced by a factor such as hours of activity is called the line of regression. The variable cost
per hour is indicated by the slope of the line, and the fixed cost is measured where the line begins at
zero hours of activity.
For purposes of illustration, it is assumed that a record of maintenance cost has been kept for
various hours of operation as follows:
Hours Maintenance Cost

50 P120
30 110
10 60
50 150
40 100
30 80
20 70
60 150
40 110
20 50
If the maintenance costs are to be plotted on a graph, and a line of regression will be fitted
to the data, the line is drawn so that the sum of the distances from the line to all points above the line
is equal to the sum of the distances form the line to all points below it, as shown below. The average
(defined as an arithmetic mean) is the point at which the sum of the deviations above that point is
equal to the sum of the deviations below that point. The line of regression represents a continuous
series of average points and thus is the line of averages.
Figure 1-10
160
140
120
100
80
60
40
20
0
0 10 20 30 40 50 60 70
The line of regression begins at P30 and rises P20 for each increase of 10 hours. Therefore the
estimated fixed cost is P30, and the variable cost is an average rate of P2 per hour (P20 ÷ 10 hours).
A line of regression can be fitted to a large quantity of data more precisely by the least squares
method. The line of regression is derived by simultaneous equations, with the equation for a straight
line serving as a foundation for the computations. The equation for the determination of a point on a
line is given below:
Y = a + bX
This equation states that the value of Y is equal to a point (a) plus a percentage (b) of the
change in X. in the last example, a is the P30 value of fixed cost. The percentage (b) was the change
in Y in relation to the change in X. In the example, Y increased by P20 for each increase of 10 hours.
Hence, the percentage of change was 200 percent (20/10)
Then,
Y = P30 + 200% X
If X is assigned a value of 10, Y is equal to 50,
Y = P30 + 2(10). Y = P50
By substituting various values for X, a line is formed on a graph.
The equation for a point on a line is Y = a + bX, and the equation for a line is the equation for
a set of connected points, ∑Y = Na + b∑X. N represents the number of items of data.
Assume that maintenance costs for various hours of operation have been recorded and that
computations have been made as shown below:
Hours Maintenance
X Cost Y X2 XY
20 200 400 4,000
50 500 2,500 25,000
30 450 900 13,500
20 250 400 5,000
10 150 100 1,500
60 650 3,600 39,000
30 250 900 7,500
40 500 1,600 20,000
60 550 3,600 33,000
50 600 2,500 30,000
40 200 1,600 8,000
10 200 100 2,000
∑X=420 ∑Y=4,500 ∑X2=18,200 ∑XY=188,500
The first step in obtaining a line of regression is to set up an equation for a line that will represent all of
the data.
Equation (1) ∑Y = Na + b∑X
Another equation [Equation (2)] is formed by multiplying each point that constitutes Equation (1) by
∑X. Note that Equation (1) is not merely multiplied by ∑X. Instead, each point (Y = a + bX) is multiplied
by ∑X.
Equation (2) ∑XY = ∑Xa + b∑X2
Referring to the data listed above, substitute values and by simultaneous equations, solve for either a
or b.
Equation (1) 4,500 = 12a + 420b
Equation (2) 188,500 = 420a + 18,200b
To solve for b multiply Equation (1) BY 35 (420 ÷ 12) to provide:
Equation (3) 157,500 = 420a +14,700b.
Subtract Equation (3) from Equation (2); the a values will cancel out to yield:
31,000 = 3,500b b = P8,857 the rate of variable maintenance cost/hour.
Substitute the value of b in Equation (1) and solve for a.
4,500 = 12a + 3,719.94

12a = 780.06
a = P65 the estimated fixed maintenance cost (approximately).
VISUAL-FIT METHOD
When a cost has been classified as semi-variable, or when the analysts has no clear idea about
the behavior of a cost item, it is helpful to use the visual fit method (also known as scattergraph
method) to plot recent observations of the cost at various activity levels. The resulting scatter diagram
helps the analyst to visualize the relationship between cost and the level of activity (or cost driver).
To illustrate, the controller of a business establishment compiled the following historical data for the
company’s utility costs.
Month Units Delivered Cost of Delivery
for the Month
January 1,500 P 24,000
February 1,800 33,000
March 2,500 39,000
April 1,200 23,400
May 3,000 43,000
June 2,100 33,000
July 4,000 54,000
August 800 22,000
September 3,600 47,000
October 2,600 35,000
November 3,300 49,000
December 4,600 57,000
The scatter diagram of these data is shown in the graph below. The vertical axis is the cost while the
horizontal axis represents the units. The cost analyst can visually fit a line to these data by laying a ruler
on the plotted points. The line is positioned so that a roughly equal number of plotted points lie above
and below the line. It is not a general rule but a good in drawing the line would be to let it pass through
at least two points. Using this method, the controller visually fit the line shown in the graph.
Figure 1-11
60000
50000
40000
30000
20000
10000
0
0 1000 2000 3000 4000 5000
What does the graph show?
• utilities cost is a semi-variable cost within the relevant range

• visually fit cost line in the graph intercepts the vertical axis at P10,000. Thus P10,000 is
the estimate of the fixed-cost component in the semi-variable cost approximation. To
determine the variable cost per unit, subtract the fixed cost from the total cost at any
activity level that passes along the line. The remainder is the total variable cost for that
activity level. For example, the total variable cost for an activity level of 4,000 deliveries
is P44,000 (total cost of P54,000 minus fixed cost of P10,000). This yields a variable cost
of P11 per unit (P44,000 ÷ 4,000 = 11).
• enables the cost analyst to quickly spot outliers in the data, in this case, there are no
outliers. An outlier is a data point that falls far away from the other points in the scatter
diagram and is not representative of the data.
The primary drawback of the visual fit method is its lack of objectivity. Two cost analysts
may draw two different visually fit cost lines.
DISCUSSION QUESTIONS:
1. What is the relationship among financial accounting, management accounting and cost
accounting?
2. Define cost accounting. What are its objectives?
3. Enumerate the various classifications of costs.
4. State the principal elements that make up the following: [a] prime cost; [b] factory cost; [c]
operating expenses; [d] total cost
5. What is the difference between a variable and a mixed cost, given that each changes in total
with changes in activity levels?
6. What is the major disadvantage of the high low method?
7. What is meant by the term least squares regression?
8. Give at least two advantages of using the scattergraph
Exercise 1-1. TRUE OR FALSE. Write letter “T” if you believe the statement is true, the letter “F” if the
statement is false.
__1. Cost accounting is applicable only to businesses engaged in manufacturing operations.

__2. The cost accountant is concerned with internal reporting to management and external
reporting to the public and to the government
__3. Progress reports are provided by accounting to management to enable the latter to determine
how much have been achieved to attain its goals for a given period.
__4. Managerial accounting draws heavily on economics, statistics, operations research and other
disciplines as necessary in providing accounting and financial information.
__5. Management accounting is primarily intended for external reporting purposes.
__6. Receiving, inspection, storeroom, maintenance and timekeeping are examples of producing
departments.
__7. Under a process cost system, the focal point in costing are the various departments or processes.
__8. It is possible that a lower actual cost compared to budgeted cost may prove to be detrimental
to the firm.
__9. Variable costs are fixed per unit and fixed costs are variable per unit.
__10. Costs that tend to remain relatively constant per unit of output at different production levels
are known as variable costs.
__11. Relevant costs are future costs that will differ across alternative courses of action.
__12. Past costs and revenues are irrelevant, but they may be used as a basis to predict or estimate
the costs and revenues associated with alternative courses of future action.
__13. A differential cost may either be incremental or decremental cost.
__14. A sunk cost has relevance to a decision while opportunity cost does not.
__15. A difference in cost between one course of action and another is an opportunity cost.
__16. Factory overhead is incurred when a company is engaged in manufacturing rather than in
trading.
__17. Some materials, although an integral part of the finished product are not classified as direct
materials.
__18. Certain expenses such as insurance, property taxes, and salaries of executives may be classified
partly as factory overhead and partly as general or selling expenses of the company.
__19. Under the normal cost system, factory overhead is allocated to products on a predetermined
basis rather on an actual basis.
__20. When cost of goods sold exceeds cost of goods manufactured, finished goods inventory
decreases.
__21. In the least-squares regression method, total cost is considered to be “Y”, the dependent
variable.
__22. The visual fit method is not often used by managers for cost segregation because it is not very
accurate.
__23. The scattergraph do not give any insight on a company’s costs.
__24. The high-low method is the most accurate method of segregating costs.
__25. In the high-low method, the focus is the highest cost rather than the highest activity level.
Exercise 1-2. COST CLASSIFICATIONS.

A. Classify each cost as either variable or fixed with respect to the volume of goods or services
produced and sold by the organization.
B. Classify each cost as period or product cost.
C. If the cost is a product cost, classify further as to whether it is direct material, direct labor, or
factory overhead.
Use the following column headings and put “X” on the appropriate column. Item number 1 is done
for you.
Item Fixed Variable Mixed Period Product Direct Direct Factory

No. material Labor Overhead
1. X X X
1. Cost of microchips in cellphones

2. Factory airconditioning costs
3. Maintenance costs of factory machinery
4. Training costs of sales personnel
5. Travel costs of the company’s CEO
6. Salaries of factory workers
7. SSS premiums for employees in the human resource department
8. Costs of shipping products to customers
9. Depreciation of factory equipment
10. Supplies used in the factory
11. Cost of cloth in making Tshirts
12. Production manager’s salary
13. Metal sheets used in car production.
14. Cost of electricity used in the showroom
15. Advertising costs
16. Philhealth premiums for bakers in a bakeshop
17. Rent for the administrative building.
18. Property tax for the plant.
19. Salaries of the security guards in the factory.
20. Depreciation of computers in the accounting department.
21. Insurance of factory building.
22. Nails used in furniture making.
23. Costs paid to Cleaners Inc. by SM mall.
24. Secretary’s salary in a doctor’s clinic.
25. Repairs cost on the delivery equipment.
26. Interest expense on notes payable.
27. External auditors’ fee
28. Cost of disposing the factory’s hazardous waste
29. Depreciation of an ECG machine in a hospital.
30. Salary of the principal in an elementary school.
Exercise 1-3. COST CLASSIFICATIONS (MERCHANDISING).
Chu Stores reported sales revenue of P1,950,000 for the current year. Inventory at the beginning
of the year was P195,000. Purchases during the year amounted to P1,140,000. At the end of the year
inventory on hand was P142,500. Various operating expenses for the year are listed as follows: Supplies
– P99,000; Salaries – P171,000; Communication – P30,000; Advertising – P69,000; Utilities – P19,500; Taxes
and Insurance – P25,500; Depreciation – P18,000, Insurance – P45,000.
Required: Prepare an income statement for the company.
Exercise 1-4. COST COMPUTATIONS (MANUFACTURING).
Golden Manufacturers provides you with the following data: Cost of goods sold, ₱ 3,600,000;
Raw materials used, P1,500,000; Labor cost, P1,000,000; Factory overhead, P1,000,000. Ending
inventory of work in process and beginning inventory of finished goods inventories are 50% and 83
1/3% of beginning inventory of work in process, respectively. Finished goods inventory, end is 140% of
finished goods inventory, beginning.
Required:
Compute for the following: 1.Prime cost; 2. Conversion cost; 3. Cost of goods manufactured
Exercise 1-5 COST BEHAVIOR.

Orange Inc. manufactures a product line that requires materials costing P35 for each unit of
product. Four units of product are produced each labor hour at a labor rate of P40 per hour. Variable
manufacturing overhead has been budgeted at P8 per hour and fixed manufacturing overhead has
been budgeted at P600,000 for the year. In a good year, the company can produce and sell 60,000
units or product. Normally only 50,000 units are produced and sold each year. If the market is weak,
the company may produce and sell only 40,000 units.
Required: Compute for the following:
1. Product unit cost if 50,000 units are to be manufactured each year.
4. Compute for the gross profit per unit under the three activity levels assuming that the product is
sold at P100 per unit.
Exercise 1-6. COST BEHAVIOR

For each unit of product, Heavy Company has the following costs: Direct materials, P100;
Direct labor, P280; Variable overhead, P70. The company has a monthly normal capacity of 1,500
units where it incurs fixed production costs of P75,000.
Required: Compute for the total production cost and the cost per unit of product if the company is
able to produce
1. 1,200 units.
2. 1,500 units.
3. 100 units.
Exercise 1-7. QUALITY COSTS

Ealsy Company's quality cost report is to be based on the following data:
Maintenance of test equipment P95,000
Cost of field servicing and handling complaints 17,000
Statistical process control activities 77,000
Net cost of scrap 62,000
Downtime caused by quality problems 23,000
Technical support provided to supplier 93,000
Depreciation of test equipment 81,000
Supplies used in testing and inspection 33,000
Warranty repairs and replacements 24,000
Required:
1. What would be the total prevention cost appearing on the quality cost report?
2. What would be the total appraisal cost appearing on the quality cost report?
3. What would be the total internal failure cost appearing on the quality cost report?
4. What would be the total external failure cost appearing on the quality cost report?
Exercise 1-8. COST SEGREGATION

Donna Company would like to estimate the variable and fixed components of its maintenance
costs and has compiled the following data for the last five months of operations:
Labor Hours Maintenance Cost
January 190 P677
February 120 P593
March 170 P646
April 110 P623
May 100 P582
Required:
[a] Using the high-low method of analysis
[a1] how much is the estimated variable cost per labor hour for maintenance?
[a2] how much is the estimated total fixed cost per month?
[a3] compute for the expected maintenance cost for June if expected labor hrs is 150 hrs.
[b] Using the least-squares regression method,
[b1] how much is the estimated variable cost per labor hour for maintenance?
[b2] how much is the estimated total fixed cost per month for maintenance?
[b3] compute for the expected maintenance cost for June if expected labor hrs is 150 hrs.
[b4] where is the total maintenance cost for March located with respect to the regression
line?
Exercise 1-8. COST SEGREGATION (Needs Graphing paper)

The owner of the Queensland Restaurant would like to determine the fixed and variable
components of the restaurant's utility expenses. The owner believes that the variable component of
the utilities cost is driven by the number of meals served.
Meals Utilities
served Cost
January 3,600 P1,560
February 2,000 P1,060
March 2,900 P1,350
April 3,500 P1,500
May 3,900 P1,580
June 2,100 P1,250
July 1,900 P1,100
August 1,000 P 850
September 1,250 P 990
October 1,400 P 880
November 2,600 P1,180
Required:
[a] Plot the data on a graphing paper.
[b] Using the scattergraph method, derive a cost formula for utilities cost.
[c] Use your cost formula to predict the utilities cost if 5,200 meals are served.

AE212 - Module 1 INTRO TO COST ACCTG

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MODULE IN

COST ACCOUNTING AND CONTROL

SCHOOL OF ACCOUNTANCY, MANAGEMENT, COMPUTING,

MODULE 1 – Introduction to Cost Accounting

1. As to objective Financial statements are used to To provide information needed

3. As to It is always prepared in It is not necessarily in conformity

It’s objectives include:

Cost accounting is a hybrid of financial and management accounting. It provides information

RELATIONSHIP OF FINANCIAL, MANAGEMENT AND COS T ACCOUNTIN

FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTING ACCOUNTING

COST CONCEPTS, USES AND CLASSIFICATION

USES OF COST DATA

1. Planning profit by means of budgets

1. Costs to make and sell (Natural classification)

COSTS TO MAKE AND SELL

• Factory Overhead or Manufacturing Overhead or Factory Burden may be defined as all

COSTS IN RELATION TO BEHAVIOR

4,000 8,000 12,000 16,000 20,000

Figure 1-6 graphically illustrates a variable cost.

4,000 8,000 12,000 16,000 20,000

Number of units processed

Y = P3,000,000 + P500X Y = Fixed Cost + Total Variable Cost

Fixed Cost Variable Total Cost Number of Selling

4,000 8,000 12,000 16,000 20,000

COSTS IN RELATION TO MANUFACTURING DEPARTMENTS

• Out-of-pocket cost are future outlay of financial resources as a consequence of a

• Opportunity cost refers to the income or benefit sacrificed or foregone when an

COSTS IN RELATION TO TIMING OF CHARGES AGAINST REVENUES

ESTIMATING AND CONTROLLING COSTS

HIGH-LOW POINT METHOD

LEAST SQUARES METHOD

Hours Maintenance Cost

Equation (1) ∑Y = Na + b∑X

To solve for b multiply Equation (1) BY 35 (420 ÷ 12) to provide:

Equation (3) 157,500 = 420a +14,700b.

31,000 = 3,500b b = P8,857 the rate of variable maintenance cost/hour.

Substitute the value of b in Equation (1) and solve for a.

4,500 = 12a + 3,719.94

What does the graph show?

• utilities cost is a semi-variable cost within the relevant range

__1. Cost accounting is applicable only to businesses engaged in manufacturing operations.

Exercise 1-2. COST CLASSIFICATIONS.

Item Fixed Variable Mixed Period Product Direct Direct Factory

1. Cost of microchips in cellphones

Exercise 1-4. COST COMPUTATIONS (MANUFACTURING).

Exercise 1-5 COST BEHAVIOR.

Exercise 1-6. COST BEHAVIOR

Exercise 1-7. QUALITY COSTS

Exercise 1-8. COST SEGREGATION

Exercise 1-8. COST SEGREGATION (Needs Graphing paper)

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