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Learning Activity Sheet No. 1

Topic : INTRODUCTION TO COST

ACCOUNTING

Learning Objectives: After reading this Learning Activity Sheet, YOU

MUST be able:
1. To explain the meaning of cost accounting;
2. To distinguish between financial, managerial, and cost accounting;
3. To distinguish between merchandising and manufacturing
operations;
4. To identify the uses of cost accounting data; and
5. To distinguish between job order costing and process costing.

INTRODUCTION

The primary objective of accounting is to provide financial information

about an economic entity to different types of users. First, we have internal users
– managers for planning, controlling, and decision making. Then second, we have
external users – investors, creditors, government, and those who have various
interests in the operations of the entity.

Cost accounting is the subfield of accounting records, measures, and

reports information about costs. When costs are used by internal users to
evaluate the performance of operations or personnel, or as a basis for decision
making, we say costs are used for managerial accounting purposes. When costs
are used by external users to evaluate the performance of top management and
make investment decisions about the organization, we say costs are used for
financial accounting purposes.

All types of business entities – service, merchandising, and manufacturing

– require information systems that provide the necessary data. Due to the nature
of the manufacturing process, the information systems of manufacturing entities
must be designed to accumulate detailed cost data relating to the production
process. These systems should show what costs were incurred and where and
how these costs were utilized.

COMPARISON OF FINANCIAL AND MANAGEMENT ACCOUNTING

There are two (2) major areas of accounting – financial accounting and
management accounting.

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022

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Financial Accounting Management Accounting

It deals with the theoretical Involves the application of

framework covering accounting appropriate techniques and
principles and concepts relative concepts to economic data to
to measurement and valuation as assist management in
1. Definition applied to assets, liabilities, establishing plans for
equity, income, and expense reasonable objectives and in
accounts in relation to the the making of rational
preparation and presentation of decisions to achieve these
financial statements. objectives.
2. User of Exclusively for internal users
Primarily for external users
information (management)
3. Guiding Generally Accepted Accounting
Management wants and needs
principles Principles (GAAP)
4. Optional /
Mandatory Discretionary or optional
Mandatory
5. Type of Primarily monetary (financial) in
Monetary and non-monetary
information nature
6. Emphasis of
Reliability (precision of data) Relevance (timeliness of data)
reports
7. Purpose / Financial reporting and
Decision-making
End result compliance
8. Source of From the company’s (internal) From internal and external
data information system sources
9. Amount of
Compressed and simplified Extensive and detailed
detail
10. Focus of Focus mainly on business as a Focus on segments and
information whole business as a whole

11. Frequency Periodic (annually, quarterly) As frequent as the need arises

12. Time Future-oriented using current

Mainly historical (past) data
orientation and past data
13. Unifying
Assets = Liabilities + Equity No unifying model or equation
model

RELATIONSHIP OF FINANCIAL, MANAGEMENT, AND COST ACCOUNTING

Financial Cost Management

Accounting Accounting Accounting

Figure 1

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022

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Figure 1 shows the relationship between financial, management, and cost

accounting. It can be seen that Cost accounting is the subset of financial and
managerial accounting. Cost accounting provides product cost information to
external users for credit and investment decisions. Also, cost accounting
provides product cost information to internal users for planning and controlling.

MERCHANDISING BUSINESS

Inventories are asset items that a company holds for sale in the ordinary
course of business, or goods that it will use or consume in the production of
goods to be sold.

A merchandising concern usually purchases its merchandise in a form

ready for sale. It reports the cost assigned to unsold units left on hand as
inventory. Only one inventory account, “Merchandise Inventory”, appears in the
financial statements.

The computation of cost of goods sold in merchandising business is as

follows:

Merchandise Inventory, beginning xx

Add: Net Purchases:
Purchases xx
Add: Freight-In xx
Total xx
Less: Purchase Returns and Allowances (xx)
Purchase Discounts (xx)
Cost of Goods Available for Sale xx
Less: Merchandise Inventory, ending (xx)
Cost of Goods Sold xx

Inventory Cost Flow of Merchandising Business

Companies that sell goods report inventory and the cost of goods sold at
the end of each accounting period. The flow of costs for a merchandising
company is as follows:

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022

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Beginning Inventory
Cost of Goods
(Unsold Units, previous
Purchased
period)

Cost of Goods
Available for Sale

Ending Inventory
Cost of Goods Sold
(Unsold Units, current
(Expense)
period)

Figure 2: Inventory Cost Flow of Merchandising Business

Beginning inventory plus the cost of goods purchased is the cost of goods
available for sale. As goods are sold, they are assigned to the cost of goods sold.
Those goods that are not sold by the end of the accounting period represent
ending inventory.

MANUFACTURING BUSINESS

Inventories are asset items that a company holds for sale in the ordinary
course of business, or goods that it will use or consume in the production of
goods to be sold.

A manufacturing company has three (3) distinct inventory accounts such

as raw materials inventory, work in process inventory, and finished goods
inventory. At the end of the accounting period, the balance of each of the three
(3) accounts will appear in the Current Asset section of the balance sheet.

Raw Materials Inventory

Also called as Materials Inventory account or Materials Inventory Control

account. This account reflects the cost of raw materials and factory supplies that
will be used in the manufacturing process.

Work in Process Inventory

The Work in Process Inventory account reflects the cost of raw materials,
direct labor, and manufacturing overhead of goods on which manufacturing has
begun but has not been completed at the end of the accounting period.

Finished Goods Inventory

The Finished Goods Inventory account reflects the costs of goods that have
been completed and are ready for sale. This account corresponds to the
Merchandise Inventory account of a merchandising business. Any changes in the

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022

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Finished Goods Inventory account are reflected in the “Cost of Goods Sold”
section of the income statement.

Formula for cost of goods sold under manufacturing concern:

Raw Materials, beginning P xx

Add: Net Purchases* xx
Total Materials Available for Use P xx
Less: Raw Materials, ending (xx)
Raw Materials Used P xx
Less: Indirect Materials Used (xx)
Direct Materials Used P xx
Direct Labor xx
Manufacturing Overhead xx
Total Manufacturing Cost P xx
Add: Work in Process, beginning xx
Total Costs of Goods Put into Process P xx
Less: Work in Process, ending (xx)
Costs of Goods Manufactured P xx
Add: Finished Goods Inventory, beginning xx
Total Goods Available for Sale P xx
Less: Finished Goods Inventory, ending (xx)
Costs of Goods Sold P xx

Inventory Cost Flow of Manufacturing Business

Companies that manufacture goods report inventory and the cost of goods
sold at the end of each accounting period. The flow of costs for a manufacturing
company is as follows:

Beginning Inventory
Cost of Goods
(Unsold Units, previous
Manufactured
period)

Cost of Goods
Available for Sale

Ending Inventory
Cost of Goods Sold
(Unsold Units, current
(Expense)
period)

Figure 3: Inventory Cost Flow of Manufacturing Business

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022

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USES OF COST ACCOUNTING DATA

The information produced by a cost accounting system provides a basis

for determining product cost and aids management in planning and controlling
operations.

Determining Product Costs

Cost accounting procedures help management in gathering the data

needed to determine product costs and thus generate meaningful financial
statements and other reports. Cost procedures must be designed to permit the
computation of unit costs and total product costs.

Unit cost information is also useful in making a variety of important

marketing decisions.

1. Determining the selling price of a product

2. Meeting competition
3. Bidding on contracts
4. Analyzing profitability

Planning and Control

Planning is the process of establishing objectives or goals for the firm and
determining how the firm will attain them.

Three (3) components in planning:

1. Strategic planning – concerned with setting long-range goals and

objectives to determine the overall direction of the company.

2. Tactical planning – concerned with plans for a shorter range or time

period and emphasizes plans to achieve the strategic goals.

3. Operations planning – relates to the day-to-day implementation of

tactical plans. It emphasizes the coordination of the major factors of
production (materials, labor, and facilities).

Control is the process of monitoring the company’s operations and

determining whether the objectives identified in the planning process are being
accomplished.

TWO BASIC PRODUCT-COSTING SYSTEMS

1. Job order costing – a system for allocating costs to groups of unique

products. It applies to the production of customer-specified products such
as the manufacture of special machines. Each job becomes a cost center
for which costs are accumulated. A subsidiary record (job cost sheet) is
needed to keep track of all unfinished jobs (work in process) and finished
jobs (finished goods).

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022

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2. Process costing – a system applicable to a continuous process of
production of the same or similar goods, e.g., oil refining and chemical
production. Since there is no need to determine the costs of different
groups of products because the product is uniform, each processing
department becomes a cost center.

Wrap-Up Exercise No. 1

Review Questions:

1. Define cost accounting.

2. Differentiate financial accounting and management accounting.
3. Discuss the relationships between financial, management, and cost
accounting.
4. What is the formula to compute the cost of goods sold in merchandising
business? How about in the manufacturing business?
5. Discuss the three (3) inventory accounts in manufacturing.
6. In your understanding, what are the uses of cost accounting data?
7. Differentiate job order costing and process costing.

PREPARED BY: MR. RODEL E. CAHILIG, MSA | Updated: January, 2022