Introduction to Cost Accounting & Management
The main and primary objective of accounting
- To provide financial information about an economic entity to
different types of users.
Types of users of financial information
1. Internal users - managers (for planning, controlling, and
decision making).
2. External users - government, those who provide funds to
the entity, those who have various interests in the operations
of the entity.
Cost accounting
- Is the intersection between financial and managerial
accounting.
- Cost accounting information is needed and used by both
financial and managerial accounting.
- It provides product cost information to external parties, such
as stockholders, creditors and various regulatory boards for
credit and investment decisions, and to internal parties such as
managers for planning and controlling.
- It is a field of accounting that measures, records and reports
information about costs.
- It is an expanded phase of general or financial accounting
which informs management promptly with the cost of
rendering a particular service, buying and selling a product,
and producing a product.
- All types of business entities - manufacturing, merchandising,
and service businesses - require information systems which
provide the necessary financial data.
- These financial data are usually documented in information
systems (accounting systems).
- These systems should show what costs were incurred and
where and how these costs were utilized.
- Cost accounting developed originally in manufacturing
business to satisfy management’s need for product cost
information.
Two (2) major areas of accounting:
Financial accounting
- Is the use of accounting information for reporting to external
parties, including investors and creditors.
- The reports prepared under financial accounting focus on the
enterprise as a whole.
- Based on historical data.
- The information may be historical, quantitative, monetary
and verifiable.
- The information provided by financial accounting is usually
presented in the form of financial statements, tax returns, and
other formal reports distributed to various external users. The
same information may also be used internally to provide a
basis for financial analysis by management.
- Required for many firms organized as corporations because
of the requirements of SEC.
- The BIR also requires financial accounting information for
compliance with country’s tax law.
- Financial accounting attempts to present some degree of
precision in reporting historical information while at the same
time emphasizing verifiability and freedom from bias in the
information, relevance to the general user and some degree of
timeliness in reporting which is not as critical in managerial
accounting.
Managerial accounting
- Focuses on the needs of parties within the organization,
rather than interested parties outside the organization.
- Managerial accounting information commonly addresses
individual or divisional concerns rather than those of the
enterprise as a whole.
- The information may be current or forecasted, quantitative
or qualitative, monetary or non-monetary, and most of all,
timely.
- The data are futuristic and some of the costs are not
recognized on the accounting books of the organization.
- Managerial accounting is not separate and distinct from
financial accounting. Financial accounting data are used in
managerial accounting system.
- Management decisions made today will affect the financial
statement of future periods.
- There is no requirement or legislation that mandates the
format or use of managerial accounting.
- The timing of information and its relevance to the decision on
hand has greater significance to the internal decision making.
The measuring bases in managerial accounting does not
necessarily have to be restricted to pesos. It can be in terms of:
1. Economic measure – pesos
2. Physical measure – pounds, gallons, tons, or units
3. Relationship measure – ratios
Merchandising vs manufacturing operations
- Many types of business gather information on costs, but
doing so is especially important in manufacturing.
- A merchandising company normally buys a product that is
ready for resale when it is received. Nothing needs to be done
to the product to make it salable except possibly to prepare a
special package or display.
Cost of goods sold for a merchandising company
Cost of goods sold for a manufacturing company
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.
1. 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 accounting procedures must be designed to permit the
computation of unit costs as well as total product costs.
- For example, if a manufacturer spent P10,000 for labor in a
certain month, the information is insignificant; but if this labor
produced 5,000 finished units, the fact that the cost of labor
was P2 per unit is significant, because this figure can be
compared to the unit labor cost of other periods and the
trends analyzed.
Unit cost information is also useful in making a variety of
important marketing decisions:
Determining the selling price of a product. The selling price
should be high enough to cover the cost of producing the
product and the marketing and administrative expenses and
provide a profit.
Meeting competition. You should be able to have a detailed
knowledge regarding the unit cost to be compared to
competitors and take appropriate action for cost reduction.
Unit cost information is also useful in making a variety of
important marketing decisions:
- Bidding on contracts. Unit cost should be competitive when
entering into government biddings so as to be awarded with
contracts.
- Analyzing profitability. To determine the amount of profit
that each product earns and possibly eliminate those that are
least profitable.
2. Planning and control
- Planning is the process of establishing objectives or goals for
the firm and determining the means by which the firm will
attain them.
- Planning is essential to good management because it
provides a means of coordinating all of the operations of the
firm.
- Cost accounting helps in development of plans by providing
historical costs serve as basis for projecting data for planning.
- Management can analyze trends and relationships 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.
Three (3) components of planning:
1. Strategic planning – long range goals and objectives.
2. Tactical planning – short range goals and objectives to
achieve strategic goals.
3. Operational planning – day-to-day implementation of
tactical plans.
Control is the process of monitoring the company’s operations
and determining whether the objectives identified in the
planning process are being accomplished.
Recent developments in cost accounting
- Manual bookkeeping has been reduced because of the use of
computers.
- Changes in production methods have made traditional
applications of cost accounting obsolete in some cases.
Two basic product costing systems
1. Job order costing
- A system for allocating costs to groups of unique product.
- It is applicable 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 order sheet) is needed to keep track
of all unfinished jobs (work-in-process) and finished jobs
(finished goods).
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 production is uniform, each
processing department becomes a cost center.
- The objective of the two systems is the same. They both
provide product unit cost information for pricing, cost control,
inventory valuation, and income statement preparation.
- End-of-period values for cost of goods sold, work-in-process
inventory, and finished goods inventory accounts are
computed using product unit cost data.
Characteristics of job order costing
- A product costing system used by companies making one-of-
a-kind or special products.
- Direct materials, direct labor, and factory overhead costs are
assigned to specific job orders or batches of production.
- In computing unit costs, the total manufacturing costs for
each job order are divided by the number of good units
produced for that order.
- Procedures similar to those used in job order costing are used
in many service industry firms, even if these firms have no
work-in-process or finished good inventories. In a public
accounting firms, for example, costs are assigned to audit
engagements.
Primary characteristics of a job order cost system
a. It collects all manufacturing costs and assigns them to
specific job or batches of product.
b. It measures costs for each completed job rather than for set
time periods.
c. It uses work-in-process inventory control account in the
general ledger. This account is supported by a subsidiary ledger
of job order cost cards or sheets for each job-in-process at any
point of time.
Characteristics of process costing
- A product costing system used by companies that make a
large number of similar products or maintain a continuous
production flow. In these cases, it is more economical to
account for product-related costs for a period of time (a week
or a month) than to try to assign them to specific products or
job orders.
- Unit costs are computed by dividing total manufacturing costs
assigned to a particular department or work center during a
period by the equivalent unit of production.
- If a product is routed through four departments, then four
unit cost amounts are added to find the product’s total unit
cost.
Main characteristics of a process cost system
a. Manufacturing costs are grouped by department or work
center, with little concern for specific job orders.
b. It emphasizes a weekly or monthly time period rather than
the time taken to complete a specific job.
c. It uses several work-in-process accounts – one for each
department or work center in the manufacturing process.
Hybrid costing - The blending of job order costing and process
costing.
The costing system an organization selects will mainly depend
on its underlying production system.
Operation costing - Is a hybrid costing system often used in
repetitive manufacturing where finished products have
common, as well as distinguishing characteristics.
For example, in the manufacture of clothing, basic suits can be
assembled in one operation (process costing). These suits can
then move on to the next operation and have a deluxe lining
added (job order costing). Based on the variations, the 3. Factory overhead
products and the related costs are identified by batches or by B. Non-manufacturing costs/period costs
production runs. 1. Marketing or selling expense
Batch production 2. General or administrative expense
Some companies process large orders or identical units as a II. As to variability
group through the same production sequence. Each of these A. Variable costs
orders is called batch. B. Fixed costs
In batch production, costs are allocated to each batch. C. Mixed costs
Whenever a change in the production line is required to III. As to relation to manufacturing departments
continue production, a new batch is created. A. Direct departmental charges
Generally, job order costing concepts are used to account for B. Indirect departmental charges
batch production and each batch is treated as a job for costing IV. As to their nature as common or joint
purposes. A. Common costs
B. Joint costs
Major differences between process & job order costing V. As to relation to an accounting period
Process costing Job order costing A. Capital expenditures
1. Homogenous units 1. Unique jobs are B. Revenue expenditures
pass through a series of worked on during a VI. Costs for planning, control, and analytical processes
similar process. time period. A. Standard costs
2. Costs are 2. Costs are B. Opportunity costs
accumulated by accumulated by C. Differential costs
processing dept. individual job. D. Relevant costs
3. Unit costs are 3. Unit costs are E. Out-of-pocket costs
computed by dividing determined by dividing
F. Sunk costs
the individual dept.’s the total costs on the
G. Controllable costs
costs by the EUP. job cost sheet by the
no. of units on the job. Manufacturing/product/inventoriable costs
4. The cost of 4. The job cost sheet Direct materials
production report provides the detail for - Are materials that become part of a finished product and can
provides the detail for the WIP account. be conveniently and economically traced to specific product
the WIP account for units.
each dept. - The costs of these materials are direct costs. In some cases,
however, even though a material becomes part of a finished
- Process costing has less detailed recordkeeping. product, the expense of actually tracing the cost of a specific
- The choice of process versus job order costing systems material is too great. These minor materials and other
involve a comparison of the costs and benefits of each system. production supplies that cannot be conveniently or
- If recordkeeping costs were equal under job and process economically traced to specific products are accounted for as
systems, for the units in a product line, then the job order indirect materials. Indirect material costs are part of factory
costing systems are better because they provide all the data overhead costs.
that process systems do. Direct labor
- Include all labor costs for specific work performed on
CHAPTER 2 products that can be conveniently and economically traced to
- Costs are associated with all types of organizations - business, end products.
non-business, service, retail and manufacturing. - Labor costs for production-related activities that cannot be
- Generally, the kinds of costs that are incurred and the way in conveniently and economically traced to end products are
which these costs are classified will depend on the type of called indirect labor costs. These are accounted for as factory
organization involved. overhead costs.
- Payroll related costs, such as payroll taxes, group insurance,
sick pay, vacation and holiday pay, and other fringe benefits
can be considered as part of direct labor costs, but are usually
Cost included as factory overhead.
- Is the cash or cash equivalent value sacrificed for goods and Factory overhead
services that are expected to bring a current or future benefit - Are a varied collection of production-related costs that
to the organization. cannot be practically and economically traced directly to end
- Costs are incurred to produce future benefits in a profit products.
making firm, future benefits usually mean revenue. - Manufacturing overhead, factory burden, and indirect
- As costs are used up in the production or revenues, they are manufacturing costs.
said to expire. Expired costs are called expenses. - Examples: indirect materials and supplies (nails, rivets,
- A loss is a cost that expires without producing any revenue lubricants, and small tools)
benefit. - Examples: indirect labor costs (lift truck driver’s wages,
maintenance and inspection labor, engineering labor, machine
Classification of costs helpers, and supervisors)
I. As to relation to a product - Examples: others (building maintenance, machinery and tool
A. Manufacturing costs/product costs maintenance, property taxes, property insurance, pension
1. Direct materials costs, depreciation on plant and equipment, rent expense, and
2. Direct labor utility expense)

Non-manufacturing/period costs
Marketing or selling expenses
- Include all costs necessary to secure customer orders and get
the finished product or service into the hands of the
customers.
- Order-getting and order-filling costs.
Administrative or general expenses
- Include all executive, organizational, and clerical expenses
that cannot be logically be included under either production or
marketing.
- All organizations have administrative expenses.
Costs classified as to variability
- Costs that change in relation to changes in the activity of the
organization.
- Activity refers to a measure of the organization’s output of
product or services.
- In specifying cost behavior, the managerial accountant often
limits the description to a specific range of activity. This is
called the relevant range.
Fixed costs
- Items of cost which remain constant in total, irrespective of
the volume of production.
- Not related to activity within the relevant range. Thus, if
activity increases or decreases, total fixed cost remains the
same. However, fixed cost per unit decreases as volume
increases, and increases as volume decreases.
- Fixed costs are assignable to departments based on different
allocation methods.
Classification of fixed costs depending on the ability of
management to influence the levels of these costs in the short-
term:
Committed fixed costs - represent relatively long-term
commitments on the part of management as a result of a past
decision. (ex. depreciation)
Managed fixed costs (discretionary, programmed or planned)
- incurred on a short-term basis and can be more easily
modified in response to changes in management objectives.
(ex. Advertising, R & D, and cost of employee training
programs).
Variable costs
- Items of cost which vary directly, in total, in relation to
volume of production.
- Cost per unit remains constant as volume changes within a
relevant range.
Mixed costs
- Items of cost with fixed and variable components.
- Vary with the level of production, though not in direct
relation to it. Probably because part of the cost is fixed while
the rest is variable.
Two types of mixed cost:
1. Semi-variable cost - the fixed portion of a semi-variable cost
usually represents a minimum fee for making a particular item
or service available. The variable portion is the cost charged for
actually using the service.
2. Step cost - the fixed part of step cost changed abruptly at
various activity levels because these costs are acquired in
indivisible portions. A step cost is similar to a fixed cost within
a very small relevant range.
- Ideally, for both planning purposes and for making certain
types of decisions, all costs would be classified as either fixed
or variable, with semi-variable costs being separated into their
fixed and variable components.
- One of the most important steps in estimating the variable
and fixed components of a mixed cost is to examine the cause
and effect relationships between activities that affect costs.
Three different methods of separating mixed costs into their
fixed and variable components:
1. High-low point method
2. Method of least square
3. Scatter graph or visual fit
High-low point method
- It is a quantitative approach that starts with the collection of
data pertaining to the cost to be analyzed. It can be on a
weekly, monthly or annual basis.
- Under this method, the assumption is whatever is the
difference in cost is due to the changes in activity levels
reflecting the effect of the variable cost per unit.
- Despite of its ease of application, there are problems with the
high-low method, particularly, its disregard of the information
contained in all of the data other than the low and the high
points and the low and high levels of activity tend to be
unusual.
Least square method/Least square regression analysis - This
is an averaging method which can be treated as an expansion
of the high-low method. It is used to measure the average
amount of change in a dependent variable that is associated
with unit increases in the amounts of one or more
independent variables. Unlike the high-low method which only
considers two data points, regression analysis uses all available
data to estimate the cost function.
Two types:
Simple regression method - estimates the relationship
between the dependent variable and one independent
variable.
Multiple regression method - estimates the relationship
between the dependent variable and multiple independent
variables.
Scatter graph or visual fit
- The cost analyst visually fits a straight line through a plot of
all the available data, not just between the high point and the
low point, making it more reliable than the high-low method.
- The process will start with plotting the different data points
collected and drawing a line that will “visually fit” the direction
of the data points.
- After drawing the line, determine the fixed cost which is equal
to the y-intercept. This is due to the fact that if x=0, the total
cost (y) will be equal to a. Then, selecting a particular x and y
coordinates, substitute all the data gathered to solve for b.
- One of the disadvantages of the visual fit method is that it
could be very subjective on how the cost analyst would see the
data points’ pattern. This would mean that different people
will draw different lines with different slopes, giving different
cost estimates.
Common costs - costs of facilities or services employed in two
or more accounting periods, operations, commodities or
services. Just like indirect costs, these costs are subject to
allocation.
Joint costs - costs of materials, labor and overhead incurred in
the manufacture of two or more products at the same time. A
major difficulty inherent to joint costs is that they are invisible
and they are not specifically identifiable with any of the
products being simultaneously produced. These costs are also
subject to allocation.
Capital expenditure - 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 - depreciation
for fixed tangible assets, amortization for intangible assets and
depletion for wasting assets.
Revenue expenditure - expenditure that will benefit current
period only and is recorded as an expense.
Direct departmental charges - costs that are immediately
charged to the particular manufacturing department(s) that
incurred the costs since the costs can be conveniently
identified or associated with the department(s) that benefited
from said costs.
Indirect departmental charges - costs that are originally
charged to some other manufacturing department(s) or
account(s) but are later allocated or transferred to another
department(s) that indirectly benefited from said costs.
Standard costs - predetermined costs for direct materials,
direct labor and factory overhead. They are established by
using information accumulated from past experience and data
secured from research studies. In essence, a standard cost is a
budget for the production of one unit of product or service. It
is the cost chosen by the managerial accountant to serve as the
benchmark in the budgetary control system.
Opportunity cost - the benefit given up when one alternative
is chosen over another. However, opportunity costs should be
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.
Differential cost - cost that is present under one alternative
but is absent in whole or in part under another alternative. It
can either be fixed or variable.
Incremental cost - an increase in cost from one alternative to
another.
Decremental cost - a decrease in cost from one alternative to
another.
Marginal revenue - the revenue that can be obtained from
selling one more unit of product.
Marginal cost - the cost involved in producing one more unit
of product.

Costs for planning, control and analytical processes

Relevant cost - a future cost that changes across the
alternatives.
Out-of-pocket cost - cost that requires the payment of money
(or other assets) as a result of their incurrence.
Sunk cost - a cost for which an outlay has already been made
and it cannot be changed by present or future decision. Since
sunk cost cannot be changed by any present or future decision,
it should be used in analyzing courses of action.
Controllable cost - a cost that a particular level of management
has the power to authorize the cost.
- In some situations, there is a time dimension to
controllability. Costs that are controllable over the long-run
may not be controllable over the short-run.