COST ACCOUNTING

Midterm reviewer (BSAC-1A)

CHAPTER 1
Management Advisory Services Management accounting consists of some
– refer to that area of accounting work concerned essential activities:
with providing advice and technical assistance to a. Estimation of cost is one of the basic
help clients improve the use of their resources to
achieve their goals. tasks of management. If it is
estimated, the management will use
Management Consultant
the estimation in control process and
– a person who is qualified by education,
experience, technical ability, and temperament to planning decisions.
advise or assist businessmen on a professional basis b. Controlling the cost is another
in identifying, defining, and solving specific
function of management. Here the
management problems involving the organization,
planning, direction, control, and operation of the cost incurred is compared with task
firm. performed. Corrective measures
should be initiated when costs are
Characteristics of MAS excessive.
 Services are rendered for the management c. Performance evaluation is another

rather than for third parties. part of management accounting.

 Involves problem solving. Managers are often monitored. Their

 Relates to the future. performance should be consistent

with the goals of the organization.
 Broad in scope.
For which, a comprehensive
 Involves varied assignments.
reporting system is required.
 Engagements are usually non-recurring.
d. It supplies information to the
 Engagements require highly qualified staff.
management for planning and
 Human relations play a vital role in each
decision-making.
engagement.

COST AND COST CONCEPTS

Cost - When notified by a term that defines the

- a measurement, in monetary terms, of the purpose, cost becomes operational, e.g., selling
amount of resources used for some purpose. cost, acquisition cost, variable cost, etc.
 Cost object product or providing a service.
- the intermediate and final disposition of cost
pools.
Cost Unit
- Any product, any job order, any division,
anything to which you assign cost - It is a unit of product, service or time in
- Examples : product, job, process, customers, relation to which cost may be ascertained or
departments expressed.
- Why assign costs to cost objects?
- Track Profitability
- Evaluate Managerial
Performance
- Provide info for pricing
decisions
- Control spending
Cost Pool
- an account in which a variety of similar costs
are accumulated prior to allocation to cost
objects it is a group of costs associated with an
activity.
- Example: overhead account; Assembly,
Processing, Support, other

Cost driver
- a factor that causes a change in the cost pool
for a particular activity. It is used as a basis for
cost allocation;
- any factor or activity that has a direct cause-
effect relationship
- Activity that causes cost to occur
- Examples: Machine hours, Direct labor hours,
number of set-ups, etc.
- Changes in activity level ---> Changes in the
amount of cost
- If cost driver decreases, cost decreases. If cost
driver increases, cost increases
Activity
- any event, action, transaction, or work
sequence that incurs costs when producing a

CLASSIFICATIONS OF COSTS

A. As to Function a. Direct Materials – raw materials cost

that becomes integral part of the finished
1. Manufacturing Costs – all costs incurred product and that can be conveniently and
in the factory to convert raw materials into econo-mically assigned to specific units
finished goods. manufactured.
 Examples: Raw materials, semi-finished
parts for assembly, finished parts
b. Direct Labor – all labor costs related to
time spent on products that can be
conveniently and economically assigned
to specific units manufactured.
Example: Factory Payroll/Salaries of
workers (Employee working with the
raw materials)
c. Manufacturing Overhead – all other
costs incurred in the factory aside from
2.
direct materials and direct labor.
Examples: Indirect Labor, Indirect
Materials, Rent, Light & water, taxes &
license, depreciation, repairs, insurance
(all related to manufacturing)
Prime costs – sum of direct materials and
direct labor.
Conversion costs – sum of direct labor and
manufacturing overhead
Concept of Overhead: All material, labor and
expenses, which cannot be identified as direct costs,
are termed as ‘indirect cost’. Overheads are
grouped into three categories:
a. factory (or manufacturing) overheads,
b. office (or administrative) overheads, and
c. selling and distribution overheads
B. As to Timing of Recognition as Expense
1. Product Costs (Inventoriable cost) –
costs that “attach” or cling to the units
that are produced and are reported as
assets until the goods are sold.
Examples: direct materials, direct labor,
and allocated factory overhead.
(Manufacturing costs)
2. Period Costs (Non-inventoriable cost) –
costs that are recognized as expense in
the income statement on the period in
which the cost was incurred. Examples:
Marketing expense, Selling, general
and administrative expenses and CEO
salary. (Non-manufacturing cost or
Operating expenses)
C. As to Traceability to Cost Object
1. Direct Costs – costs that are related to a
particular cost object and can economically
and effectively be traced to the cost object. It
includes Direct Materials and Direct Labor.
Direct Materials: Wood (Chair),
Flour, eggs & Sugar (Bread), Glass
(Window), Clothing and
buttons(dress)
Labor Direct: Salary of workers or
employees who work for the
product/object
Indirect Costs – costs that are related to a cost
object, but cannot practically, economically,
and effectively be traced to that cost object. It
includes Indirect Materials, Indirect Labor and
other Manufacturing Overhead:
Indirect Materials: Glues and adhesives,
oils and lubricants, cleaning supplies,
tapes, needle, thread, fasteners and
fittings, Personal protective equipment
(helmets, gloves, overalls, etc.)
Indirect Labor: Wages and benefits of
security guards, supervisors, and quality
assurance workers in the factory etc.
Other Manufacturing overhead: Rent
expense of the production building,
Property taxes and insurance on
manufacturing facilities and equipment,
repairs expense, Light and water, and
depreciation expense related to
manufacturing.
D. As to Managerial Influence
1. Controllable Costs – costs that are
subject to significant influence by a
particular manager within the time
period under consideration. Examples:
Advertising and marketing budgets,
Bonuses, Direct materials, Direct labor,
overhead costs, Donations, Dues and
subscriptions, Employee compensation,
Office supplies are controlled by
production manager.
2. Noncontrollable Costs – costs over
which a given manager does not have
significant influence.
Examples: depreciation, insurance,
administrative overhead and rent.
E. As to Time-Frame Perspective
 1. Committed Costs – costs that are
inevitable as consequence of a previous
commitment.
2. Discretionary Costs – costs for which
the size or the time of incurrence is a
matter of choice

F. For Decision Making

1. Relevant Costs – future costs that will

differ under alternative courses of action.
2. Differential Costs – difference in costs
between any two alternative courses of
action.
3. Opportunity Costs – income or benefit
given up when one alternative is selected
over another.
4. Sunk Costs – costs already incurred and
cannot be changed by any decision made
now or to be made in the future.

G. Cost Behavior

- Describes how cost behaves or changes as the amount of cost driver changes.
Total cost

Fixed cost Variable cost

1. Fixed Cost
- not immediately affected by cost driver activity
- in total; constant within the relevant range as activity output changes
- per unit; changes as activity level changes. Indirectly proportional to cost driver
activity or activity level.
Example: rental lease payments, equipment administrative salaries, insurance,
property taxes, interest expenses, depreciation, and potentially some utilities
2. Variable Cost
- Affected by cost driver activity
- In total; varies in direct proportion to changes in activity output;
- Per unit; remains constant
Example: sales commissions, direct labor costs, cost of raw materials used in
production, and utility costs
3. Mixed Cost
- Has both fixed and variable components
- A mixed cost is expressed by the algebraic formula y = a + bx, where: y is the total
cost, a is the fixed cost per period, b is the variable rate per unit of activity.
ASSUMPTIONS 2. Time Period Assumption
- The cost behavior patterns identified are true only
over a specified period of time. Beyond this, the
1. Relevant Range Assumption
cost may show a different behavior.
- Relevant range refers to the band of activity within
3. Linearity Assumption
which the identified cost behavior patterns are valid.
Any level of activity outside this range may have a - Within the relevant range, there is a strict linear
different cost behavior pattern. relationship between the cost and cost driver. Costs
may therefore be shown graphically as straight
- Outlier - behaviors in the cost that is outside of the
lines.
relevant range and should never be used in
estimating costs as they may either overstate or The Total Cost Function:
understate the estimation. However, the
Y = a + bx
determination of outliers are circumstantial and will
depend on the professional judgment. where: Y = total cost
a = total fixed cost
b = variable cost per cost driver
x = activity level or cost driver
SEGREGATION OF FIXED AND VARIABLE ELEMENTS OF MIXED COSTS:
1. High-Low Points Method – the fixed and depending on the production (variable) or not
variable elements of the mixed costs are computed (fixed).
from two data points (period) –the high and low
6. Method of Least Squares (Regression Analysis)
periods as to activity level or cost driver.
– mathematically determines a line of best fit of a
2. Statistical Scattergraph Method – various costs linear regression line through a set of plotted points
(the dependent variable) are ploted on a vertical so that the sum of the squared deviations of each
lime (y-axis) and measurement figures (cost drivers actual plotted point from the point directly above or
or activity levels) are plotted on a horizontal line (x- below it on the regression line is at minimum. This
axis). A straight line is drawn through the points method uses the following equations in computing
and, using this line, the rate of variability and the for the values
fixed cost are computed.
3. Account Analysis Method - an account is
Multiple Regression Analysis - is a statistical
classified as either variable or fixed based on the
method of separating fixed and variable cost which
analyst’s prior knowledge of how the cost in the
is used when the dependent variable (cost) is caused
account behaves. The total fixed cost is the sum of
by more than one factor/independent variable.
the costs for the accounts that have been classified
as fixed. The estimated variable cost per unit is
estimated by dividing the sum of the costs for the
accounts that have been classified as variable by the
total activity.
4. Engineering Approach - involves a detailed
analysis of what cost behavior should be based on
the industrial engineer’s evaluation of the
production methods to be used, the materials
specifications, labor requirements, equipment usage,
production efficiency, power consumption, and so
on.
5. Conference Method - each representative of
different departments is convened to discuss the
estimated costs that the departments will incur
during the year and to be sorted out as to either
MODULE 1 FORMULA

High-Low Method: Direct materials, end (XXXX)

Variable cost per unit = Direct Materials used PXXXX
Highest Activity Cost −Lowest Activity Cost
Direct Labor XXXX
Highest Activity Level−Lowest Activity Level
Factory Overhead XXXX
Total Manufacturing PXXXX
Fixed cost = Highest Activity Cost – (Variable cost
per unit x Highest Activity units) Cost
Work in Process, beg. XXXX
Total Work put into PXXXX
Fixed cost = Lowest Activity Cost – (Variable cost
per unit x Lowest Activity units) Process
Work in Process, end (XXXX)
Method of Least Squares (Regression Analysis: Total Goods PXXXX

Equation 1: ∑Y = na + b∑x Manufactured

Equation 2: ∑xy = a∑x + b∑x2 Finished Goods, beg. XXXX

Total Goods Available PXXXX

Alternative: For Sale

Finished Goods, end (XXXX)
b = (n∑xy - ∑x∑y) / (n∑x2 – (∑x)2)
Cost of Goods Sold PXXXX
a = (∑y - b∑x) / n

Beginning Inventory PXXXX

COST FORMULE: y = a + bx
Net Purchases or Total XXXX
Y = total cost
Goods Manufactured
x = activity level
Ending inventory (XXXX)
a = fixed cost
Cost of Goods Sold PXXXX
b = variable cost

Prime Cost = Direct Materials + Direct Labor

Conversion Cost = Direct Labor + MOH

Manufacturing Cost Formula:

MC = Direct Materials + Direct Labor + MOH
MC = Prime cost + MOH
MC = Conversion cost + Direct Materials
MC = Prime cost + Conversion cost – Direct Labor

Cost of Goods Sold:

Direct materials, beg. PXXXX
Purchases XXXX
CHAPTER 2
Activity Based-Costing (ABC system)
Objective:
 Accurately allocate cost to the products
 To better assign overhead costs to product
Basic Assumption:
 activities cause costs and that cost objects
create the demand for activities.
Broad Averaging or “Peanut-butter costing”
– describes a costing approach that uses broad
averages for assigning (or spreading, as in
spreading peanut butter) the cost of resources
uniformly to cost objects when the individual
products or services, in fact, use those resources in
non-uniform ways.
Product undercosting – a product consumes high
level of resources but is reported to have a low cost
per unit.
Product overcosting – a product consumes a low
level of resources but is reported to have a high cost
per unit.
Product-cost cross-subsidization – if a company
undercosts one of its products, it will overcost at
least one of its other products.
Costing System Refinement
– making changes to a simple costing system that
reduces the use of broad averages for assigning the
cost of resources to cost objects and provides better
measurement of the costs of overhead resources
used by different cost objects.
Activity-based Approach
- refines a costing system by focusing on
individual activities as the fundamental cost
objects.
- It uses the cost of these activities as the basis
for assigning costs to other cost objects such as
products or services.
Activity Based Costing (ABC) System
– allocates overhead to multiple activity cost pools
and assigns the activity cost pools to products by
means of cost drivers.
– a costing approach that first assigns costs to
activities and then to products.
Cost driver – a factor that causes a change in the
cost pool for a particular activity. It is used as a
basis for cost allocation; any factor or activity that
has a direct cause-effect relationship
Activity – any event, action, transaction, or work
sequence that incurs cost when producing a product
or providing a service.
Activity Cost Pool – a “bucket” in which costs are
accumulated that relate to a single activity measure
in the ABC system
Value-adding activities – activities that are
necessary (non-eliminable) to produce that products
Non-value adding activities – activities that do not
make the product or service more valuable to the
customer.
BENEFITS OF ABC
1. ABC leads to more cost pools
2. ABC leads to enhanced control over overhead
costs
3. ABC leads to better management decisions
FOUR DECISIONS FOR WHICH ABC
INFORMATION IS USEFUL:
1. Pricing and product mix decisions
2. Cost reduction and process improvement
decisions,
3. Product design decisions, and
4. Decisions for planning and managing activities.
LIMITATIONS OF ABC
1. ABC can be expensive
2. Some arbitrary allocations continue
3. ABC will be of limited benefit if the overhead
costs are primarily volume related or if the overhead
is a small proportion of the overall cost.
4. If it is impossible to allocate all overhead costs to
specific activities.
5. The choice of both activities and cost drivers
might be inappropriate.
WHEN TO SWITCH TO ABC
– The presence of one or more of the following
factors indicates ABC as the superior costing
system:
1. Product lines differ greatly in volume and
manufacturing complexity.
2. Product lines are numerous, diverse, and require
differing degrees of support services.
3. Overhead costs constitute a significant portion of
total costs
4. The manufacturing process or the number of
products has changed significantly
5. Production or marketing managers are ignoring
data provided by the existing system
HIERARCHY OF ACTIVITY LEVELS
1. Unit-level Activities
– are performed each time a unit is produced.
Examples: creating mold, direct materials for test
quantity to judge conformity to design
specifications, costs of direct materials, direct
labor, and machine maintenance.
2. Batch-level Activities
– performed each time a batch is handled or
processed, regardless of how many units are in the
batch.
Examples: setup, receiving and inspection,
material-handling, packaging, shipping, and
quality assurance, inspecting test quantity
3. Product-level Activities
– relate to specific products and typically must be
carried out regardless of how many batches are run
for units of product are produced or sold.
Examples: engineering costs, product
development, consultation with equipment
manufacturer on design specifications,
engineering design of mold, preparing design
specification changes based on test molds
4. Customer-level activities
– relate to specific customers
Examples: sales calls, catalog mailings, and
general technical support (that are not tied to
any specific product)
5. Organization-sustaining activities
– carried out regardless of which customers are
served, which products are produced, how many
batches are run, or how many units are made
Examples: Depreciating manufacturing
building, plant maintenance, insurance ,
property taxes, plant management
STEPS FOR IMPLEMENTING ACTIVITY-
BASED COSTING:
1. Define activities, activity cost pools, and activity
measures.
2. Assign overhead costs to activity cost pools.
3. Calculate activity rates.
4. Assign overhead costs to cost objects using the
activity rates and activity measure.
5. Prepare management reports.
[The following information about ABC System
aren’t included from the Chapter 2 reference
given to us, but this might help for further
understanding of the theories from the topic.]
• ABC's philosophy is to accumulate
homogeneous cost pools, so that the cost elements
in a pool should be consumed by cost objects in
proportion to the same driver.
• In a homogeneous cost pool, all costs should have
the same or a similar cause-and-effect relationship
with the cost driver or cost allocation base.
• Process value analysis
- is a comprehensive understanding of how an
organization generates its output.
- It involves that determination of which
activities are value-adding or non-value adding
and how the latter may be reduced or
eliminated.
- It is a key component of ABC Management
that links product costing and continuous
improvement.
• Activity-based Management
- integrates Activity-based Costing (ABC) with
other concepts such as Total Quality
Management (TQM), and target costing to
produce a management system that strives for
excellence through cost reduction, continuous
process improvement, and productivity gains.
• One best reason for using activity-based costing is:
to better assign overhead costs to products.
•Activity-based Costing System
- is one means of avoiding what has been called
peanut-butter costing.
- Inaccurately, averaging or spreading cost like
peanut butter over products or service units
that use different amounts of resources results
in cross-subsidization of product costs.
• Cross-subsidization
- describes the condition in which the
miscosting of one product causes the
miscosting of other products.
• In allocating variable costs to products, a
volume-based cost driver should be used.
• Traditional overhead allocation results in:
Overhead costs are assigned as period costs to
manufacturing operations.
• Traditionally, overhead has been assigned based
on direct labor hours and machine hours. The effect
of this on the cost of high-volume product is: it
over-costs the product.
• Relative to traditional product costing, ABC
differs in the way costs are allocated.
• In allocating fixed cost to products in activity-
based costing, a cost driver that is not volume
related should be used.
Youtube tutorial Links:
MAS cost concepts -
https://www.youtube.com/watch?v=jtRzSAjkVNc
High-low method and regression analysis –
https://www.youtube.com/watch?
v=PLMcLKUgq_I&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=4
https://www.youtube.com/watch?
v=YGrlsCPIKkw&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=3
https://www.youtube.com/watch?v=YqPy-
gvewK0&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=7
https://www.youtube.com/watch?
v=yC_Dxp1vSSU&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=5
Relevant range –
https://www.youtube.com/watch?v=KCpRAgs-
yMw&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=11
Activity-based costing and Traditional costing:
https://www.youtube.com/watch?
v=NXwq2oVOovU&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=13
https://www.youtube.com/watch?
v=iihGkCEjyqo&list=PLHSb2Y2RG6U-
mf5xj3ucKk_N1r0g7m5nJ&index=14
https://www.youtube.com/watch?v=aDycx2hJ6tg