Cost Accounting and Control

CHAPTER 1: Introduction to Cost Accounting

This course will discuss the technical methodologies in the calculation of product and service cost to be
able to properly report items in the financial statements and to make better economic decisions.

Cost Accounting
▪ Branch of accounting that deals with the process of recording and summarizing the amount of
cost that is spent on the company's activities. It includes all costs of process, product, or service
used, provided, and sold.
▪ In summary, cost accounting tackles the amount cost to produce and deliver all product or
services.

NOTE:
Labor intensive – Company uses more skilled laborers in producing products.
Capital intensive – Company uses more machines in producing products.
 The Venn Diagram Overlap

Information about the cost of a product or service is both needed in Financial Accounting for reporting
purposes and Management Accounting for decision making.

To become a cost leader, costs shall be managed well.

In order for costs to be managed well, COST ACCOUNTING information is now of paramount importance
— the entity's cost accountants now play a vital role in the value creation process of the entity.

Steps to Cost Leadership to Add Value to The Entity

1. Properly managed costs
2. Lower costs of production
3. Lower prices
4. Cost leader
5. More people will buy
6. Added value to the entity

Cost Concepts, Terminologies, and Behavior

Cost Terminologies at a Glance

What is a Cost?

Reflects the amount of resources sacrificed in order for the company to achieve a certain objective
such as creation of goods or rendering of services in order to earn revenues.
As to classification in the Financial Statement

PRODUCT COSTS – Costs identified and incurred by an entity to manufacture a product. It includes all raw
materials used, labor costs incurred, and all other indirect costs.

o Materials – All raw materials and other supplies used in the manufacturing process.
▪ Direct Materials: e.g., Cost of glass in lightbulb manufacturing
▪ Indirect Materials: e.g., Cost of glue, lubricating oils, nails, screws, and the like.

o Labor – Salaries and other benefits provided to all workers.

▪ Direct Labor: e.g., Cost of salaries paid to laborers of furniture associated directly in the
process.
▪ Indirect Labor: e.g., Salaries paid to all other factory personnel necessary in the
manufacturing process but is not directly related in the conversion process.

o Overhead – All indirect costs necessary for product conversion that are not direct materials and
direct labor. E.g., Indirect materials, Indirect labor, Depreciation of equipment in the factory,
Insurance of factory plant, Maintenance and repairs of equipment, Factory Utilities.

Components of Product Costs

1. Direct Materials
2. Direct Labor
3. Overhead

Always Remember:
Prime Cost + Overhead = Total Manufacturing Cost
Direct Materials + Conversion Cost = Total Manufacturing Cost
Direct Materials + Direct Labor + Manufacturing Overhead = Total Manufacturing Cost
PERIOD COSTS – The entity’s operating expenses. They are called as such since they are much more
associated with time periods rather than manufacturing process. They are all other expenses not related
to manufacturing.

o Marketing and Advertising – Expenses incurred in promoting the entity’s products and services.
o Selling and Distribution – They include salaries of sales personnel and delivery expenses.
o Administrative Expenses – They include Office Utilities, Depreciation of office Property, Plant and
Equipment (PPE), Repairs and Maintenance of office PPE, and all other expenses in the office

NOTE:
If the utilities are utilized and spent in factory, then, it is Manufacturing Overhead. If the utilities
are utilized and spent in office, then, it is Administrative Expenses.

A Manufacturing Overhead is an expense used and spent inside the factory. An Operating Expense
is an expense that is used and spent inside the office.

As to behavior

VARIABLE COSTS – Costs that change as the quantity of the goods produced changes. Total amount of
variable cost is dependent to the level of production.
o Constant on a per-unit basis.
o Varies when presented as a total.
o When the number of unit increase, then total variable cost will increase. When the number of
units decrease, then the total variable cost will decrease.

Examples:
▪ Cost of Materials
▪ Cost of direct labor computed per piece

FIXED COSTS – At whatever level of production within the relevant range, this cost does not change. It is
independent to the level of production.
o Incurs same amount.
o Constant when presented as a total.
o Varies on a per unit basis.

Examples:
▪ Rent of facilities
▪ Depreciation equipment
NOTE:
▪ If the production is low, the fixed cost per unit is high.
▪ If the number of units is high, expect that the fixed cost per unit is low.
▪ Relevant Range – Usual capacity of a company to produce.

COST EQUATION
y = a + bx
y = total cost of the product
a = total fixed cost of the product
b = variable cost per unit
x = volume of activity

STEP COST – Costs that are constant on a certain level of activity but increases on another certain level of
activity. E.g., Salaries and commission of agents that goes higher with different ranges of activity. e.g.,
people served.

MIXED COST – Refers to costs that has both variable and fixed components. E.g., Utilities, since these are
charged with a base amount and goes higher with any usage over the base amount.
SEPARATING MIXED COSTS:
In separating mixed costs, there can be two methods to be used:

1. High-Low Method

Step 1. Determine the highest and lowest activity and the cost associated thereunto.

Activity Machine Hours Maintenance Cost

Highest 9,000 24,800
Lowest 3,000 9,800

Step 2. Obtain the variable cost per unit by dividing the change in cost over the change in activity.
Step 3. Obtain the total fixed costs by removing the variable cost component in the total costs.

2. Least Squares Regression Method

Step 1. Prepare a table calculating x (activity), y (total cost), xy, and x 2

Step 2. Substitute the computed amounts in the following equation to get VC/Unit.
Step 3. Substitute b to any equation to get a (fixed cost).

NOTE:
The computation is correct if the value/total fixed cost is not far from each other.

OTHER COST TERMINOLOGIES

Opportunity Cost – Benefits foregone in choosing one action over another.

Sunk Cost – Cost incurred that will not affect a future decision.
Committed Cost – Costs resulting from organizational structure or use of facilities.
Discretionary Cost – Costs arising from managerial decisions.
Controllable Cost – Costs that are able to be influenced on how much shall be spent.
Noncontrollable Cost – Costs that cannot be controlled or influenced.

Accounting Cycle for a Manufacturing Company

(Journal Entries and Statement of Cost of Goods Manufactured and Sold)

Three Kinds of Inventories

Paragraph 6 of IAS 2 defines an inventory as follows:

Inventories are assets:
a. held for sale in the ordinary course of business;
b. in the process of production for such sale; or
c. in the form of materials or supplies to be consumed in the production process or in the rendering
of services.
In a manufacturing perspective…

▪ Raw materials inventory are the materials or supplies to be consumed in the production process
to be transformed as completed goods.

▪ Work-in-process inventory are items that are currently in the process of production.

▪ Finished goods inventory are items that completed the production process and are held for sale
in the ordinary course of business.

Components of Product Costs

New Account Titles

 CHAPTER 2: Elements of Product Cost

Accounting for Materials 1 - Forms, entries, and recording systems

Materials
▪ All raw materials and other supplies used in the manufacturing process.
▪ All materials and ingredients transform to become finished goods.
Accounting for Materials 2 – Economic Order Quantity (EOQ) and Just-in-time Inventory System (JIT)
 Accounting for Labor 1 – General Principles of Factory Labor

Labor
▪ The physical or mental effort exerted by individuals in the creation of a product. This also includes
all salaries earned by employees in the factory.
Accounting for Labor 2 – Payroll Workshop
 Accounting for Manufacturing Overhead

Manufacturing Overhead
▪ Includes all costs incurred in the production process which are no direct materials or direct labor,
not directly traceable to the products completed but are still necessary to be incurred to convert
raw materials to finished goods.
▪
CHAPTER 3: Job Order Costing System
Standard Costing System