C0ST

ACCOUNTING &
CONTROL
2019 Edition

GLORIA ARDANIEL RANTE

CPA, DBA
 CHAPTER 1
Cost Concepts, Classifications and
Cost Accounting Cycle

LEARNING OUTCOMES:

After the end of the chapter, the learner will be able to:

Differentiate financial accounting and cost accounting and

explain the uses of cost accounting information
Identify and define the different classification of costs
Understand and remember the raw materials inventory
valuation method
Follow the Flow of costs in recording the activities of a
manufacturing business.
Prepare statement of costs of goods manufactured and
income statement of manufacturing firms.
Identify and describe the three basic elements of product
costs.

Identify the three inventory accounts of a manufacturing

firm

Understand the Cost accounting cycle

Illustrate basic cost accounting procedures using actual and
normal method of accumulating costs.
Compute product costs using actual and normal costing
Journalize acquisition and issuance of raw materials;
incurrence and distribution of factory labor and overhead
 and
Chapter 1 Cost Concepts, Classification Accounting Cycle

ACCOUNTING
WHAT IS COST

Cost Accounting
is defined in many ways but its
main function is to
an object, project
of gervice cost. Costitisaccounting is nto
determine how much
and construction companies but also applicabpe
limited only to manufacturing
businesses,like hospitals, educational institutions, hotels and
service type of professional offices, medical and dentalclinics
tesorts,restaurants,legalandother
and many more.
a discipline focuses
that on techniques or method for
Cost Accounting is
a project, process, or services for the purpose of planning
determining the cost of improving quality efficiency, and
and for making
and controlling activities,
information on a company's cost and may be used for both
decisions. It provides
internal and external purposes.
Accounting measures and reports financial
Horngren, Cost cost of acquiring or consuming
a company's cost and
It provides information on
resources in an organization. purposes.
both internal and external
may be used for
defines, measures, reports,
Cost Accounting identifies,
Rayburn states thatelements of direct and indirect costs associated with
and analyzes the various It also measures the performance,
and ising and marketing goods and services
and
product quality productivity.

USES OF COST DATA

company engages in
important whether
a

ante heurun oort, adr mantise tiring operations. Each of thace

which normally consist of
inad usti
Income temhont
Statement,
the same basic financial statements of Cash flows.
Equity, Balance Sheet and Statement
Statement of Changes Owner' s
and

Cost accounting information

very useful
is in determining product
service. Knowing the
product and the
service costs and in setting prices
for the
the selling price enoughto
costs of a product or service helps the managementset function,distribution,
cost of performing a
recover the cost of production, reasonable profit. These costs
administration and to provide allowance for
information also help themanagement in decidingwhether maintain, reduce
to to in the
or to increase the selling price of the product to have a fair competition
market.

to the
The accumulated
costs information are summarized and reported
Chapter . Cost Concepts, Classification and Accounting Cycle

management for effective planning to attain the company's goal and objectives. In
manufacturing, if the management has sufficient information about the cost data,
it can prepare a detailed production plan, which usually includes the following:

(a) The number of units to be produced

(b) The type of manufacturing operations to be performed
(c) The desired quality of the product
(d) The number of personnel to be utilized (laborers and non-laborers)
(e) The type of materials to be used
(f Thelevel of materials inventory to be maintained in order not to

encounter overstocking or stock - out of materials

(g) The delivery schedules
(h) And other production schedules.

Once production plan has been laid out, it would be easier for the
a

management to perform the function of control where actual results are compared
with expected results set by the management to allow the management
team to

make corrective measures on areas where significant differences are noted. In

controlling, responsibility assigned
is different departments or group of
to
that
workers who has control over and accountable for the costs charged to
department or group. In this manner, the accountability for costs or production
results is easily identified.

BETWEEN COST ACCOUNTING & FINANCIAL

DIFFERENCE
ACCOUNTING

COST ACCOUNTING FINANCIAL ACCOUNTING

AS TO NATURE
recording
It relates to the different costing It relates to the classifying,
methods and techniques in and analyzing of business transactions
of which
accumulating the cost of a product, and events, the end product
The books
process, project or service and also the are financial statements.
processes in reducing total costs to required to maintain are the general
improve the profitability of the entity. journals, general ledgers and special
journals.
It considers items with no monetary
values like units produced or hours Only items with monetary values are
utilized. used in recording and also it deals
with actual data.
It deals with both actual and estimated
figures and standards. The users of accounting information
are internal users such as
the

The users of cost accounting stockholders, officers and employees

 Classification and Accounting Cycle
Chapter Cost Concepts,

the and external users such as financial

generally
information are
and senior institutions, creditors, suppliers
production managers
and
government regulatory bodies.
officials of the company.
AS TO OBJECTIVE
Its objective is to reflect the correct
objective is to determine the
main
The process or financial picture/information of the
unit,
cost to produce
service. The entity to the different stakeholders.
a

a
project or cost to deliver
incurred is usually
actual costs
anyondwithestimates
costs
os andesin
management
to guide
decisions.
making relevantAS TO REPORTS/FINANCIAL STATEMENTS
by management The basic financial statements as the
The reports required end financial
product of accounting
are the Cost
of Production Report and
are (1) Statement of Financial
Position
Cost of Goods
Statement of
Balance Sheet, (2) Statement of
Manufactured and Sold. The Cost of or

summarizes the Comprehensive Income or simply

Production Report like Income Statement, (3) Statement of
total costs incurred in production Changes in Equity, and (4) Statement
the direct materials, direct costs and
overhead.
There is no standard format of Cash Flows. The accountants
International Financial
are

in presenting the cost information Standards in the

preparation of financial reports.

COST VERSUS EXPENSE

Cost represents any amount paid or incurred in acquiring goods or services. This
cost is presented in the Statement of Financial Position as asset. One good example
of a cost item is the amount paid for the purchase of equipment. As the equipment
is
business, an expense is recognized in the form of depreciation and
used in the

depreciation expense is then reported in the Income Statement. Another example

is the cost of
producing product composing of materials, labor and overhead.
Upon the completion of the process, the total costs of production is reported in the
Finished Goods Inventory account which is an asset. However, if the
goods are
sold, the cost of
goods sold is presented in the Income Statement as expense,
properly classified as Cost of goods sold.
Expense isany amount
paid or incurred in the
expenses are necessary to operation of a business. These
generate revenue.
in the period they
are incurred They are recognized proportionately
to properly match the revenue generated for the
Chapter Cost Concepts, Classification and Accounting Cycle

period. Examples of expenses are: permits and licenses, Salaries and wages, utility
expenses, office supplies used, repairs and maintenance, gas and oil consumed,
representation expenses, rent expense, insurance expense, depreciation expense,
doubtful account expense and many more.

CLASSIFICATION OF COSTS

Cost classification is very essential in summarizing the cost data gathered.

The costs of an object, product, project or service represent the cash or cash
equivalent of resources used in acquiring the goods, manufacturing a product and
performing a function. The classification of costs presented below is in agreement
with the principles of classification of cost under Cost Accounting Standard No.
issued by the council of the Institute of Cost Accountants of India which reads
"Costs shall be classified by the process of grouping the components of cost under
a common designation on the basis of similarities of nature, attributes or

relations". In addition, another classification is added for decision making

purposes.

1. By nature of expense

1.1 Material costs

These are cost of materials used for the purpose of manufacturing a

product or rendering of a service, net of trade discounts, rebates, taxes
and duties refundable that can be quantified with reasonable accuracy.
This may include raw materials, factory supplies, cost of packaging
materials, spare parts, and many more.

1.2 Labor costs (Employee)

Labor costs consist of the compensation and other benefits paid or

payable to permanent, casual or part time employees of the

manufacturing firm.

1.3 Expenses

Expenses include: taxes and licenses, salaries and wages, utility costs,
repairs and maintenance, gasoline & oil consumed, insurance expense,
rent expense, office supplies used, representation expense,
depreciation expense, doubtful account expense, transportation
expenses, and many more.
 • Cost Concepts, Classification and Accounting Cycle
Chapter

2. By nature of
traceability toa cost object
costs
2.1 Direct
costs that can be obviously and physically traced to
These are job order, business unit, segment
process,
manufacturing
or

often described as those that would be saved if

They are
department. businessunit would be discontinued or if the product
or
the segment
would not be manufactured.

Examples:
Direct materials. directly identifiableas part of the final
2.1.1
raw materials of tables and
These are wood used in production
product. For example, construction company,leather used
by
chairs, steel bars used shoes,bags and wallets and many more
in the manufacturing
of

labor directly engaged

2.1.2 Direct
are paid to
the factory workers who are product from
finished
These materials to
a
of raw
the conversion Department
assembly department to Finishing
in

costs include:
Other examples of direct
layout of a particular job
designs and company
Cost of drawings, automotive servicing
a.
mechanics in fees of particular job
b. Salary of auto consultation
surveyors and other
c. Architects,
or work.
in printing company
d Salary of a binder in a
printing company
Cost of paper used
Oil and lubricants
in a trucking company
f.
construction company
Steel bars used by a
h. Cost of detergents in a
laundry shop
1 Salary of laundry shop employees and medical supplies
in a
laboratory fee
Cost of x-ray, doctor' s fee,
in a
k.
hospital
Cost of professional development
activities for the doctors
hospital
L. Office supplies in law office
en. Royalties
payable on use of patents copyrights
Chapter 1 - Cost Concepts, Classification and Accounting Cycle

2.2 Indirect costs

These are costs related to a particular cost object but cannot be traced
to that cost objectan economically feasible way. They are normally
in

incurred for the benefit of several segments within the organization. In

a manufacturing company, these are the overhead costs incurred in the
process of production which includes:

Indirect materials - consumable small parts and tools, threads and

buttons used in stitching clothes, lubricants used in maintenance of
plant and machinery, cotton waste used in cleaning the machinery and
other factory supplies.

Indirect labor - salaries and wages paid to raw materials warehouse

control, production
keepers, supervisors, timekeepers, quality
managers, clerical staff, These indirect labor costs cannot be identified
cost center.
with any particular job, process, cost unit or

Indirect expenses like rent, taxes, insurance, light and water,

telephone, postage and telegrams, depreciation, repairs and

maintenance, cost of regulatory compliance, janitorial and security fee
and many more.

3. By function

3.1 Production/Project costs.

The elements of product costs in a manufacturing business are the

following:

the raw materials and other factory

1. Materials. Materials include classified as:
supplies used in manufacturing operation. They are
(a) Direct Materials. Direct materials are those materials traccable
wood, lumber and
to the Product being produced. Examples: steel,
vinyl in the manufacture of furniture; galvanized iron and
vehicles;
the manufacture of
rubber, aluminum and glass in

leather in the manufacture

of bags, belts, wallets and shoes;
of shirts, dresses, coats and other
fabrics in the manufacture
and butter in the
related gents and ladies apparels; flour, sugar
manufacture of bread and other pastries and many more.
 Concepts,Classification and Accounting Cycle
Chapter - Cost

(b) Indirect
Materials. These are materials
necessary in
manufacturing operations but are not directly included in or not
a significant part of the product. They fall under manufacturing
overhead. They include cleaning supplies, disposable
in the factory such
tools,
factory supplies used as nails, screws,
washers, glue, sand paper, lubricating oil, grease, cleaning
materials and other materials needed to maintain the working
area and plant equipment in a usable and safe condition. The
costs of indirect materials are relatively small in relation to the
cost of all other raw materials.

2. Labor. Labor represents the compensation and other benefits paid or

workers in the factory. They are classified as:
payable to the
(a) Direct labor. Direct labor represents compensation and
benefits paid to those who physically work on the conversion of
raw materials into a finished product and are easily traceable to
a specific process or job order. They include the
basic pay, cost

of living allowance, 13th month pay and cash equivalents of non-

cash incentives given on a regular basis.

(b) Indirect Labor. Indirect labor represents wages of personnel

other than the direct laborers, which are necessary to the
manufacturing process or service but are not directly related to
the actual conversion of raw materials into a finished product.
They include supervisor's fee, wages paid to other workers such
as janitors, inventory control clerks, guards, and other personnel
in the factory, employee benefits such as employer's share in SSS,
Philhealth and Pag-ibig, vacation and holiday pay, health
insurance of workers, educational benefits, overtime and night
premium, costs of housing and accommodation for stay-in
workers, and performance bonuses for deserving worker.
Most manufacturing companies find it more convenient to treat
employee benefit costs accruing to direct labor workers.

Prime costs - is the sum of direct materials and direct labor.

2. Manufacturing overhead. Manufacturing overhead is an indirect

product cost and it includes productions costs other than direct
materials and direct labor. They include:

(a) Factory supplies such as oil and other cleaning materials

used in the factory.
Chapter 1 - Cost Concepts, Classification and Accounting Cycle

(b) Wages of supervisors, factory maintenance personnel,

raw materials handlers and security officers stationed in
the factory premises.
(c) Depreciation of factory plant and equipment
(d) Insurance and property taxes on factory plant and
equipment.
(e) Maintenance and repairs on factory plant and equipment
(f) Power, light and water
(g) Telephone and mailing costs
(h) Cost of regulatory compliance such as meeting factory
safety requirements and disposal of waste materials.
(i) Idle time by factory workers due to machine breakdowns
or new set ups which are unavoidable in production
process. During their idle time, the workers are not
productive therefore the cost is spread over the entire
production not to a specific product.

Conversion costs = Direct labor + Manufacturing

Overhead

Project Costs

For a construction company, a company engaged in constructing

buildings, bridges and other related structures, the project costs
include the cost of construction materials, labor of carpenters,
professional fees of the project engineers, and overhead incurred
in construction like power, light & water, insurance,
cost of

hospitalization and other health benefits for workers,

maintenance of construction equipment, compensation of

foremen, cost of constructing temporary house for the workers

and for construction materials, depreciation of equipment, rentals
and other expenses incurred in the construction site.

For a retailing or merchandising company (a company engaged

in buying goods ready for sale), product costs include the

purchase price of goods bought for resale plus the transportation

costs and other direct costs incurred in bringing the goods to the
place of the buyer.

3.2 General and Administrative costs

These are costs associated with the general administration of the

organization that cannot be reasonably assigned to either marketing or
 10

Chapter 1 - Cost Concepts, Classification and Accounting Cycle

production such as salaries and wages of administrative officers and

employees, power and water consumption, transportation and
representation expenses, maintenance cost of office equipment,
depreciation of office furniture and equipment,
taxes and
licenses, gas
the administrative offices.
and oil expenses and other expenses in

3.3 Selling/marketing/distribution costs

These are the costs of getting and filling orders such as cost of customer
service, cost of documentation, salaries and commissions of sales
expenses associated with the
personnel, advertising costs and other Distribution costs are cost of
sale of the goods and services.
warehousing transporting and delivering of products or services.
General and administrative costs, selling and distribution costs are also
called Period costs.
Period costs are operating expenses that are
associated with time periods, rather than with the production of goods
and services. Period costs
are charged directly to expense accounts on
the assumption that their benefit is recognized entirely
in the
period
when the cost is incurred. They are non-manufacturing costs and
non

inventoriable costs.

4. By nature of production or operation process

41 Joint costs

These are costs incurred in a single process that yields two or more

products. They are production costs (direct materials, direct labor

and

factory overhead) incurred up to the point where products are

labor of
separately identified. Example of joint costs: Cost of dough,
baker, and overhead incurred by a bakeshop.

4.2 Contract costs

Cost of a contract agreed upon between the contractee and the

contractor.

4.3 Batch costs

Batch Cost shall be the aggregate cost related to a cost unit that consists
of a group of similar articles or services which maintain its identity
throughout one or more stages of production oroperation.
 11

Chapter 1 - Cost Concepts, Classification and Accounting Cycle

4.4 Operation costs

Operation Cost shall be the cost of a specific operation involved in the

production of goods or rendering of services.

4.5 Process costs

Process cost shall be the cost of production or operation process where

of
goods produced or services rendered from a sequence
are

continuous or repetitive operations or processes during period.

5. For Decision-making purposes

5.1 Controllable costs

Controllable costs are costs that are primarily subject to the influence of a
given responsibility center manager for a given period of time. Examples
are:

The cost of raw materials used in manufacturing leather products.

The production manager has the ability to control the materials to
be used in production by selecting only materials with high quality,
thus, reducing waste and spoilage.

Cost of food in the factory canteen. The canteen manager has the

ability to control losses in terms of spoilage and theft by canteen

personnel.

5.2 Non-controllable costs

These are costs that cannot be controlled or influenced by a

responsibility center manager. Examples are: Cost of renting

equipment

5.3 Opportunity costs

These are benefits foregone because one course of action is chosen over
another, expressed in other words, these are future cash inflow that will
be sacrificed as a result of particular management decision. Examples
are:

a) Salary foregone if a student decides to be a full time student

rather than a working student
b) Rent revenue if a company decides to use part of the building
Chapter 1 - Cost Concepts, Classifcation and Accounting ycle.
12

rather than leasing it.

costs
5.4 Sunk costs or past

These are costs

that have already been incurred in the past and will not
decision in the future. It is not relevant
be changed or avoided by any
in decision making. Examples are:

a) Acquisition cost of an equipment

costs of finished goods on hand.
b) Manufacturing
Research and development costs for new product
a
c)

cost.
5.5 Relevant

This refers to costs that change with each decision that a company
makes. It includes incremental, opportunity and avoidable costs.
Examples are: Future cash flows, avoidable costs,
5.6 Incremental costs.

Where different alternatives are being considered, relevant cost is the

incremental or differential cost between the various alternatives being
considered.

5.7 Period Cost

operating expenses that are associated with

time
Period costs are
of goods and services.
periods, rather than with the production the
Period costs are charged directly to expense accounts on
is recognized entirely in the period
assumption that their benefit
when the cost is incurred. They are non-manufacturing costs and
non inventoriable costs. They include:

These are the costs of

a) Marketing and Selling Costs.
cost of customer
getting and filling orders such
as

salaries and
service, cost of documentation,
commissions of sales personnel, advertising
costs

and other expenses associated with the sale of the

goods and services.

b) Distribution costs. These are costs of warehousing,

transporting and delivering : product or service.
 13

Chapter Cost Concepts, Classification and Accounting Cycle

c) Administrative Costs. These are costs associated

with the general administration of the organization
that cannot be reasonably assigned to either
marketing or production such as salaries and
wages of administrative officers and employees,
power and water consumption, transportation and
representation expenses, maintenance cost of office
equipment, depreciation of office furniture and
equipment, taxes and licenses, gas and oil expenses
and other expenses in the administrative offices.

5.8 Product cost

The product costs include costs of direct materials, direct labor and
factory overhead. The accumulated cost of direct materials, direct labor
and factory overhead is summarized in a work in process account. At
the end of a period, the cost of completed goods is transferred to the

finished goods account. The sold portion of the finished goods is

reported as expense in the Income Statement, as Cost of Goods Sold,
while the unsold goods are reported in the balance sheet as finished
goods. The cost of unfinished goods is left in the Work in Process
account which is also reported in the balance sheet as current assets.

5.9 Avoidable

Avoidable costs are those costs that are avoided by making one choice
over another.

5.10 Unavoidable costs

These are the costs not change in the future when a manager makes one
decision versus another. They are costs that will continue to happen.

6. By nature of behavior

6.1 Fixed costs

These are costs that are constant in total within the relevant range of activity
but variable on a per unit basis. As the activity level increases or decreases,
total fixed cost remains constant but unit cost declines or goes up.

Examples are:

(a) Depreciation using the straight line method

 14
Classification and Accounting Cycle
Chapter 1 - Cost Concepts,

(b) Factory Rent & factory taxes

(c) Factory insurance
(d) Supervision Fee
(e) Wages of indirect laborers

6.2 Variable costs

These are costs that vary in total in direct proportion to changes in the
Variable cost is a constant amount on a per unit
volume of production.
basis as activity changes withini relevant range. As activity changes, total
variable costs increases or decrease proportionately with the activity
change, but unit variable costs remain the same. Examples are:

a. Direct materials and direct labor

b.Fuel and other factory supplies
C. Overtime premium
d. Materials handling costs
e. Maintenance costs

6.3 Mixed costs

These are costs that have both fixed and variable components like heat,
light, and water expense.

Illustration 1. Fixed costs

Assume the following:

P100,000
Total fixed cost for the period
Production in units:
8,000
Case 1
Case 2
9,000
Case 3
9,500

Relevant Range 8,000-10,000 units

Case 2 Case 3
Case :
 15

Chapter - Cost Concepts, Classification and Accounting Cycle

Illustration 2. Variable costs

Assume the following:

Variable cost per unit:

Direct materials P5.00

Direct labor 6.00

Overhead 3.00

Total variable costs P14.00

Case A Case B Case C

Production in units 8,000 9,000 9,500
Variable cost per unit 14.00 14.00 14.00

Total variable costs P112,000 P126,000 P133,000

The variable cost per unit is constant at P14.00 per unit, but as production
increases, total variable costs also increase.

Relevant Range is defined as a limited range of activity within

which expenditures can be accurately classified as fixed cost
or variable or the range over which an assumed cost

relationship is valid for the normal operations of a firm.

SEPARATING MIXED COSTS

When cost is classified as mixed, it is appropriate to separate the fixed cost from
the variable cost. One of the methods in separating mixed costs is the high-low
method. The procedure starts from selecting the highest and lowest levels
of
determine the
activity in a given set of data within the relevant range. Then,
changes in activity and cost by subtracting low values from high values. These
in the mixed cost The
changes are used to calculate the variable unit cost contained
fixed portion of the mixed cost is calculated by subtracting total variable cost from
total mixed costs.

Variable cost per unit is computed as:

Cost at high level cost at lowest level (within relevant range)

Highest activity - lowest activity

Or: Change in total costs / Change in activity level = VC per unit

 16
Cost Concepts, Classification and Accounting Cycle
Chapter 1

Illustration: Separating mixed cost

Machine hours and electricity costs for DKNY Industriesfor the current year were
as follows:

Machine Hours Utility Costs

Month
2,500 P36,800
January
2,900 42,000
February
1,900 27,000
March
3,100 46,000
April 56,500
3,800
May 3,300 44,000
June 49,500
4,100
July 45,500
3,500
August 31,000
2,000
September 3,700 P52,000
October
4,700 62,000
November
4,200 55,500
December

Procedures:
(within relevant range)
1. Select the highest and lowest levels of activity and costs
Machine Hours Utility costs
4,700 P62,000
Highest 1,900 27,000
Lowest
2,800 35,000
Difference

element
2. Compute the variable cost
machine hours
VC per unit = Change in costs/Change
in

L P35,000 / 2,800

- P12.50 per machine hour

Compute the variable cost at the highest and lowest level of activity.
Highest level - 4,700 x 12.50 = P58,750
Lowest level = 1,900 x 12.50 = P23,750

Determine the fixed cost at each level of activity.

Highest level = P62,000 - 58,750 = P3,250
Lowest level - P27,000 - 23,750 = P3,250
 17
Chapter Cost Concepts, Classification and Accounting Cycle

INVENTORY ACCOUNTS

Manufacturing companies maintain three inventory accounts, namely:

Raw Materials Inventory. This account shows the raw materials available for use
in the manufacturing process. It serves as a controlling account if the company
maintains only one account for its direct and indirect materials. However, if the
company maintains a separate account for its direct and indirect materials or
supplies, the account may be changed to Direct Materials Inventory which is meant
to include only direct materials. Factory Supplies Inventory account includes
indirect materials such supplies to be used in the production including janitorial,
operating, and repairs supplies intended for use in the factory.

Work In Process Inventory. This account represents the costs of partially

completed goods on which production activities have been started but not yet
completed as of a certain period.

Finished Goods Inventory. This account summarizes the costs of completed

jobs stored in the warehouse ready for delivery to the customers.

INVENTORY SYSTEMS

Perpetual inventory system. Under this system, purchases of raw materials are
directly debited to the Raw Materials Inventory account. The expenses related to
the purchase like freight, insurance, and other expenses are also debited to the
Inventory account. When raw materials are issued to production, the raw
materials inventory account is credited. This system provides a running balance
of the raw materials available for use and this is reflected in the stock card
maintains for each type of material. The balance of the inventory account at the

end of an accounting period shows the cost of raw materials inventory on hand.
To determine the accuracy of this balance, a physical count is periodically made
usually once a year. If a difference is found between the balance in the inventory
account and a physical count, it is corrected by making a suitable journal entry.
The common reasons for the said difference include inaccurate record-keeping,
normal shrinkage, shoplifting, etc.

Pro-forma Journal Entries:

a. When raw materials are purchased on account or cash

Raw Materials Inventory 000
Accounts Payable/cash 000
Chapter I - Cost Concepts, Classification and Accounting Cycle
18

b. When expenses are paid like freight

Raw Materials Inventory 000

Cash 000

When goods are returned to supplier

Accounts Payable/Cash 000

Raw Materials Inventory 000

d. When materials are issued to production

OH 000
Work in process or Manufacturing
Raw Materials inventory 000

When excess materials

are returned to warehouse
e.
000
Raw materials
Work in process or Manufacturing OH 000

Under periodic inventory system, the entity

Periodic Inventory system.
mintains temporary accounts like purchases, purchase returns and freight in. It
will not record inventory additions directly to invnentory accounts but instead
of raw materials is debited to purchases account.
purchase
to the purchases, the amount is debited to
For the transportation expenses related
Freight In
account and returns to suppliers is credited to purchases returns and
allowances account. Thysical inventory count (also called stock taking) at the end
of the period is mandatory. Without such count, cost of raw materials used cannot
be determined therefore manufacturing companies have to conduct this activity at
least once a year or at every period end

Pro-forma Journal Entries:

When raw materials are purchased on account or cash

Purchases 000
000
Accounts Payable/cash

b. When expenses are paid like freight

000
Freight In
000
Cash

c. When goods are returned to supplier

Accounts Payable/Cash 000
000
Purchased Returns

Take note that the raw materials issued is not journalized. This is determined only
after
taking a physical count of the unused raw materials at the end
of given
 19

Chapter Cost Concepts, Classification and Accounting Cycle

period. On the other hand, the Raw Materials Inventory, End is reflected in the
Balance Sheet as part of the assets.

To determine the cost of raw materials used:

Raw Materials, beg inventory 100,000

Add: Purchases P2,000,000
Freight In 50,000
Gross purchases P2,050,000
Less: Purchase Returns 20,000
Net purchases P2,030,000
Raw materials available for use 2,130,000
Less: Raw materials inventory, end 200,000
Raw materials used P1,930,000

INVENTORY COSTING/VALUATION METHODS

First-In, First-Out (FIFO)

With first-in, first-out, the oldest cost (i.e., the first in) is issued first to production
and assigned to the cost of raw materials used. Conversely, the most recent
purchases are assigned to units in ending inventory. Example:

Inventory, Net Purchases Issuances of Raw Materials Inventory,

Beg. End

300 @20 200@22 500@25 400@24 1st 350 2nd 350 3rd 400 300@24

Inventory stock card:

In (Purchases) Out (Issuances) Balance (Inventory)

Units Amt Units Amt Units Amt

300 20 6,000
Beg
1st 200 22 4,400 200 22 4,400
300 20 6,000
50 22 1,100 150 22 3,300
2nd 500 25 12,500 500 25 12,500

2nd 150 22 3,300

200 25 5,000 300 25 7,500
3rd 400 9,600 400 24 9,600
3rd 300 25 7,500
100 24 2,400 300 24 7,200
1,100 26,500 1,100 25,300
Beg 300 6,000
Total 1,400 32,500 1,100 25,300 300 7,200
 Accounting Cycle 20
Chapter 1 - Cost Concepts, Classification and

Amount
Units
300 20 P6,000
Inventory, beg 200 22 4,400
Purchases
500 25 12,500

400 24 9,600

1,400 P32,500
RM available
1,100 25,300
Less: RM issued 7,200
300
Inventory, end

THE FLOW OF MANUFACTURING

COSTS
Cost Accounting cycle

The activities in a manufacturing business also start from verification and

general ledger and
preparation of source documents, journalizing,
of nominalposting
to

accounts, and preparation of

subsidiary ledgers, adjusting, closing
subsidia Statements." Control accounts are used in recording Work Process, in

mention a few,
Raw Materials, Finished Goods, and Factory Overhead Control, to
outlined below together with the
is
The flow of costs of a manufacturing company
Pro-forma entries to record each transaction.

(A) Purchase of Raw Materials

from the time raw materials
are

The manufacturing process starts

perpetual inventory
purchased. Most manufacturing companies
use a

pustens fin a perpetual inventory system, purchases and issuance of raw

Inventory
account
materials are recorded directly in the Raw MaterialsThe manufacturing
is not used.
as they occur. A purchases account materials inventory
companies maintain a subsidiary ledger of raw the journal entry is
for each type of
raw material. When
accounts, one
posted to the general ledger account, the individual inventory accounts
in the subsidiary ledger are
also updated. Normally, the cost of raw
materials includes the invoice costs plus
transportation costs to bring the
materials to the place of the buyer.

Below are Pro-forma journal entries under the perpetual inventory

system.

The entry would be:

000
Raw Materials (invoice cost + freight) 000
Accounts Payable or cash
 21

Chapter - Cost Concepts, Classification and Accounting Cycle

If the company maintains two separate accounts for raw materials, Direct
Materials account is debited for the invoice and freight cost of direct
materials while Factory Supplies account is debited for the invoice and
freight cost allocated to indirect materials.

(B) Issuance of Raw Materials

Raw materials are issued to production on the basis of a material

requisition slip properly accomplished and approved by the

production manager. The cost of raw materials issued is then

transferred to a Work in Process and Manufacturing Overhead

Account. The pro-forma entry is:

Work in Process 000

Manufacturing overhead 000

Raw Materials 000

The Work in Process account is debited for the cost of direct materials
issued while Manufacturing Overhead account is debited for the cost
of indirect materials issued to production.

(C) Return of Excess Materials to Storeroom

If materials issued to the production department are in excess of the

requirements, the unused materials are returned to the storeroom.

The pro-forma entry to record the return is:

Raw Materials 000

Work in Process 000
000
Manufacturing Overhead

The costs of unused direct materials and factory supplies are reverted
back to Raw Materials account, while the Work in Process is reduced
by the cost of unused direct materials while the Manufacturing
Overhead is reduced by the cost of unused factory supplies.
 22
Chapter Cost Concepts, Classification and Accounting Cycle

living allowance, performance bonuses, and other

form of
compensation given on a regular basis. The entry to record the
incurrence of factory labor is:

Factory Payroll (gross) 0000

Accrued wages payable or cash (net) 000

WHT Payable 000
SSS Premium Payable 000
Philhealth Payable 000

(E) Distribution of Factory Labor

After sorting the time tickets of the workers in the factory, the
accountant will make an entry to segregate the direct labor and
indirect labor costs. The salary of direct laborers or factory workers is
debited to Work in Process account while the salary of indirect
laborers like the production manager, supervisor or foreman, raw
materials inventory clerk and maintenance personnel is debited to
manufacturing overhead. The entry to distribute the factory payroll
is:

Work in process 000

Manufacturing overhead 000

Factory Payroll 000

(F) Manufacturing Overhead Incurred

The actual overhead cost in production is charged to a Manufacturing

Overhead account at the time it is incurred. Other manufacturing
costs such
as expired insurance and depreciation of factory plant and
equipment are charged to manufacturing overhead account only at
year end when adjusting entry is prepared. The debit side of this
account is used
to accumulate actual overhead incurred (whether paid
or not)

Examples of manufacturing overhead are:

a. Repairs and maintenance
b. Depreciation of Factory plant and equipment
C. Insurance

d. Property taxes
e. Indirect labor
f. Indirect materials
g. Factory utilities (light, power, water and telephone)
 23

Chapter 1 -
Cost Concepts, Classification and Accounting Cycle

h. Factory rent
i. Employers' share of SSS, Philhealth and Pag-ibig

The entry to record actual overhead incurred is:

Manufacturing Overhead (total) 000

Accumulated depreciation 000

Prepaid Insurance 000

Cash 000
000
Accounts payable (if not paid)

(G) Actual Factory Overhead Charged to the Job

At the end of a given period, the actual overhead is transferred to the

Work in Process account if a company adopts the actual costing system
of accumulating costs. The entry to transfer the total overhead costs

to production is:

Work in Process 000

000
Manufacturing Overhead

(H) Completion of the Job

On completion of the production process, the accumulated cost of

production summarized in a Work in Process account is transferred to
the Finished Goods account. The entry to record the cost of goods
completed is:

Finished Goods 000

Work in Process 000

After this entry has been posted, any balance remaining in the Work
in Process account represents the cost of uncompleted jobs during the
period.

(I) Sale of the Completed Job

The most common method of setting price for the job completed is the
Cost-Plus Pricing method. Cost in this mean only
sense does not

production costs but also includes administrative and selling costs.

Normally, entrepreneurs or managers simply consider the cost as the
floor based at which the price of the product cannot be lower than the