Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
OVERVIEW
1. Introduction to Cost Accounting
2. Costs – Concepts and Classifications
3. Cost Accounting Cycle
4. Accounting for Materials
5. Accounting for Factory Overhead
6. Accounting for Labor
1 INTRODUCTION TO COST ACCOUNTING
Comparison of Financial, Managerial, and Cost
Accounting
Financial Accounting
• preparing financial statements for external
users (e.g. stockholders, partners,
creditors, etc.)
• output from an accounting system, and
represent the enterprise as a whole
• based on historical transaction data, which
may be historical, quantitative, monetary,
and verifiable
• must be supported by evidence
• requirement of the SEC and BIR
Managerial Accounting
• made to cater to the needs of parties
within the entity
• designed to tackle individual/divisional
concerns
• data may be
a. Current or forecasted
b. Quantitative or qualitative
c. Monetary or non-monetary
d. Futuristic
• data must be timely
• not required
Note: the measuring based in managerial
accounting does not necessarily have to be
restricted to peso.
1. An economic measure such as pesos
2. Physical measure such as pounds, gallons,
tons, or units
3. A relationship measure such as rations
Cost Accounting
• combination of both financial and
management accounting.
Merchandising and Manufacturing Operations
Merchandising
• buying products for immediate resale
• computation of COGS:
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Beginning merchandise inventory
+ Total purchases………………
Cost of goods available for sale
- Ending merchandise inventory
Manufacturing
• buying raw materials, labor, and
overhead for further processing
and subsequent sale
• maintaining three inventory
accounts:
a. Materials inventory
b. Work in process inventory
c. Finished goods inventory
Process:
1. Cost of materials (direct
materials), labor (direct labor), and
overhead (factory overhead) items
are transferred to the Work in
Process account.
2. After production, the cost of
completed units are transferred to
the Finished Goods inventory
account.
3. Once sold, these costs are
transferred to the Cost of Goods Sold
account.
4. Work in Process inventory,
ending will comprise of units that
have been started but not
completed
5. Cost of unused materials for
theperiod comprise the Materials
Inventory, ending balance.
6. Unsold goods comprise the
ending balance of the Finished
Goods inventory.
USES OF COST ACCOUNTING DATA
Determing Product Costs
• computation of unit costs and total
product costs
• unit cost helps in:
a. Determing the selling price of a
product – helps in settling the selling
price.
b. Meeting competition – detailed
information regarding unit costs cam
be used to determine the action to be
taken by the company.
 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
c. Bidding on contracts – must submit • uses several Work in Process Inventory
competitive bids in order to be accounts
awarded manufacturing contracts.
d. Analyzing profitability – enables Major differences between Process and Job
management to determine the order costing
amount of profit.
Process Costing Job Order Costing
For Planning and Control
Homogeneous units Unique jobs are
• Planning: establishing the goals
pass through a series worked on during a
and objectives of the organization of similar processes. time period.
and determining ways to attain
them. Costs are accumulated Costs are accumulated
Three components of Planning: by processing by individual job.
department.
1. Strategic planning - long range goals,
overall direction the company want to go Unit costs are Unit costs are
2. Tactical planning - shorter range goals, computed by dividing determined by
how the company can attain its the individual dividing the total costs
strategicgoals departments’ costs by on the job cost sheet
the equivalent by the number of units
3. Operations planning - day-to-day production. on the job.
implementation of the company’s
settactical plans The cost production The job cost sheet
report provides the provides the details
• Control: monitor the company’s operations detail for the Work in for the Work in
and determining whether the objectives Process account for Process account.
identified in the planning process are each department.
being accomplished.

Two Basic Product-Costing Systems

Job order costing
• used in businesses that manufacture or sell
unique products / customer-specified
products
• each job becomes a cost center, and costs
are measured for each completed job
rather than for specific time periods
• to get the unit cost, determine the total
manufacturing costs for each job and
divide it by the number of good units
produced for that job
• uses only one Work in Process Inventory
Control account, supported by a subsidiary
ledger
Process costing
• used by companies that produce large
quantities of similar products, or have a
continuous production flow
• costs are accumulated per period of time
• to get unit cost, determine the total
manufacturing costs per department and
divide it by the equivalent unit of
production. Add all unit costs per
department to get the total unit cost of the
product.
2 COSTS – CONCEPTS AND CLASSIFICATIONS
CLASSIFICATION OF COSTS
COST
• cash or cash equivalent value sacrificed for
goods and services that are expected to
bring a current or future benefit to the
organization.
• are incurred to produce future benefits in a
profit-making firm, future benefits usually
mean revenue.
Expired costs = expenses
Loss – cost that expires without producing any
revenue benefit
As to relation to a product
a. Manufacturing costs
i. Direct materials - raw materials
thatare put into production and
transformed into finished products
ii. Direct labor - wages
paid toworkers engaged
directly in production

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 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
iii. Factory Overhead - all
other costsnot belonging to
DM or DL
PRIME COSTS = direct materials + direct
labor
CONVERSION COSTS = direct labor + factory
overhead
MANUFACTURING COST = prime cost +
factory overhead
b. Non-manufacturing costs
iv. Marketing/selling expense -
all costs spent to secure orders
and getthe product to the
customers
v. General/administrative
expense -executive,
organizational, and clerical
costs not attributable to
marketing or production
As to variability
A. Variable costs - cost per unit
remains constant as volume
increases/decreases
B. Fixed costs - cost per unit decreases
asvolume increases, and vice versa
i. Committed fixed costs - long-
termcommitments
ii. Managed fixed costs - short
term,can be easily modified
C. Mixed costs - have both fixed
andvariable components
i. Semivariable cost - minimum
fee for the service + variable
cost basedon usage
ii. Step costs - costs are acquired
inindivisible portions
As to relation to relation to
manufacturing departments
a. Direct departmental charges -
can beeasily associated with a
particular manufacturing
department, charged immediately.
b. Indirect departmental charges -
costs that indirectly benefited
other departments, later allocated
As to nature
a. Common costs - costs shared by two
or more accounting periods,
operations, commodities, or services;
subject to allocation
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b. Joint costs - manufacturing costs shared by
two or more products produced atthe same
time ; subject to allocation
c. Indirect departmental charges- costs
that indirectly benefited other departments,
later allocated
As to nature
a. Common costs - costs shared by
two or more accounting periods,
operations, commodities, or
services;subject to allocation
b. Joint costs - manufacturing costs
shared by two or more products
produced atthe same time ; subject
to allocation
Costs for planning, control, and
analytical processes
a. Standard costs - predetermined
manufacturing costs based on past
experience, used as a benchmark to
controlexpenditures
b. Opportunity costs - benefit given
up inchoosing another alternative
c. Differential costs - present under
one alternative but absent under
another
i. Incremental cost
ii. Decremental cost
d. Relevant cost - future cost that
variesacross alternatives
e. Out-of-pocket cost - requires
the payment of cash or other
assets
f. Sunk cost - already incurred and
cannotbe recovered
g. Controllable cost - management has
thepower to authorize the expense
Methods of Separating Mixed Cost
• Scattergraph
• High-Low Point
Steps:
1. Identify the highest cost driver (e.g.
direct labor hours) and corresponding
cost.
2. Identify the lowest cost
driver andcorresponding cost.
3. Get the difference between the two
cost drivers, and the two costs
identified.
 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
4. Divide the difference in cost by the Finished goods Inventory
difference in cost driver to get the • total cost incurred in manufacturing but
variablerate per cost driver. still on hand
5. Use either the highest or lowest
data. Subtract the variable Elements of manufacturing cost: (1) direct
proportion (variable rate x cost materials, (2) direct labor, and (3) factory
driver) from the total cost to arrive overhead
at the fixed cost.
Direct materials used
2.9 SUMMARY OF IMPORTANT Materials Inventory, beg xxx
FORMULAS /FORMULAE Add: Purchases xxx

Total variable costs = variable cost per Total available for use xxx
unit x total output
Less:Materials Inventory, end xxx xxx
Total cost = total variable cost + total fixed
cost Direct labor xxx
Variable rate = highest point cost – lowest Factory overhead xxx
point cost highest output – lowest output Total Manufacturing costs xxx
Fixed cost = total cost at highest – (variable
rate x output at highest point) Add: Work in Process, beg xxx
Fixed cost = total cost at lowest – (variable
Total Cost of goods put into process xxx
rate x output at lowest point)
Least square method variable cost Less: Work in Process, end xxx

- Formula for projecting total cost: Total cost of goods manufactures xxx
Y = FC + VX Add: Finished goods, beginning xxx
Total goods available for sale xxx
Where:
Y = Total cost COST OF GOODS SOLD xxx
V = Variable rate per unit X = Level of
activity
FC = Fixed cost ILLUSTRATION 1 COST ACCUMULATION

❖ Method of least square Equations The following data are available for three
companies at the end of their fiscal years:
to be used:
1. Y = a + bx Company Alpha:
2. ∑Y = na + b∑x
Finished goods, April 1 400,000
3. ∑XY = ∑xa + b∑x2
Cost of goods manufactured 2,600,000
Sales 3,500,000
Where:
Gross profit on sales 35%
X = Cost driver data Y = Cost data
Finished goods inventory, April
30 ?

3 COSTS ACCOUNTING CYCLE Company Chi:

Gross profit 264,000
Materials Inventory Cost of goods manufactured 612,000
• cost of all materials purchased and on Finished goods, January 1 34,000
hand Finished goods, December 31 26,000
Work in process, January 1 18,000
Work in process Inventory
Work in process, December 31 12,000
• costs for goods in production but not yet
completed Sales ?

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 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
Required: Determine the amounts indicated by the 3. Two-bin method – used for materials that
question marks. are considered inexpensive and/or nonessential.
First bin. Used between the time an order
ILLUSTRATION 2 COST ACCUMULATION is received and the next order is placed
Second bin. Used between the ordering
Cost of Goods Manufactured; Prime and and delivery, plus additional units of safety
Conversion Costs. Wyoming Company's stock
purchases of materials during June totaled
4. Automatic order system – an order is
$25,000, and the cost of goods sold for June was
$130,000. Factory overhead was 200% of direct automatically placed when the level of inventory
labor cost. Other information pertaining to reaches a predetermined order point quantity.
Wyoming Company's inventories and production 5. ABC plan – method used by companies
for June is as follows: with a large number of materials, each one having
different value.

Inventories Beginning Ending MATERIAL CONTROL

Finished goods P42,500 P39,000
Work in process 15,500 17,000
Materials 5,000 8,500
4 ACCOUNTING FOR MATERIALS
ACCOUNTING BY THE PERIODIC
INVENTORY SYSTEM
Purchases of Direct and indirect Materials
• “Purchases” account if there is beginning
balance “Materials Inventory - Beginning”
• Added to the materials inventory -
beginning = to materials available for use.
ACCOUNTING BY THE PERPETUAL INVENTORY
SYSTEM
Purchases of Direct and indirect Materials
• “Materials Inventory”
• The beginning materials inventory is the
balance of the materials inventory at the
end of the previous period.
o Credit Materials Inventory for the
cost of direct materials, and Debit
to Work in Process Inventory
• Issuance of Indirect materials, debited to
the Factory Overhead Control account
COMMONLY USED CONTROL PROCEDURES
1. Order cycling – method where materials on
hand are reviewed on a regular or periodic
cycle.
2. Min-max method – based on the assumption
that materials inventory have minimum and
maximum levels.
1. Physical Control of Materials
• Limited Access
• Segregation of Duties
• Accuracy in recording
2.Control of the Investment in Materials
• Order Point
a. Usage – anticipated rate at which the
materials will be used
b. Lead time – estimated time interval
between the placement of an order and
receipt of the material
c. Safety stock – estimated minimum
level of inventory needed to protect
against running out of stock
• Economic Order Quantity – Optimal
quantity to order at one time. To
determine this, the cost of placing an
order (order costs) and the cost of
carrying inventory in stock (carrying
costs) should be considered.
EOQ =
where: C= cost of placing an order
N= no. of units required annually
K= annual carrying cost per unit of
inventory
Ordering Cost=
where: C= cost of placing an order
EOQ= economic order quantity
N= no. of units required annually
OC= Ordering cost

Carrying Cost=

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 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
where: K= annual carrying cost per unit of 1. If the scrap recovered can be traced to a
inventory specific job
Scrap/Scrap materials xxx
Work in process xxx
SPOILED UNITS, DEFECTIVE UNITS, SCRAP
MATERIAL, AND WASTE MATERIAL IN A JOB 2. If the scrap recovered are not traceable
ORDER COST SYSTEM to a specific job
Spoiled unites – units that do not meet Scrap/Scrap materials xxx
production standards and are either sold for their Miscellaneous Income xxx
salvage value or discarded.
FOR WASTE MATERIAL
Defective units – do not meet production 1. If the cost of disposing is allocated to all jobs
standards and must be processed further in order Factory overhead control xxx
to be salable as good units or as irregulars. Accounts payable xxx
Scrap material – left over from the production
2. If the cost of disposing is allocated to specific
process that cannot be put back into production
for the same purpose, but may usable for a job
different purpose. Work In process inventory – (Job #) xxx
Accounts payable xxx
Waste materials – left over from the production
process that has no further use or resale value and
may require cost for their disposal. ILLUSTRATION 3 ACCOUNTING FOR MATERIALS

Warner Co. uses 6,000 units of material per year

FOR SPOILED MATERIALS at a cost of P4 per unit. Carrying costs are
1. Charged to the specific job estimated to be P1.125 per unit per year, and
order costs amount to P60 per order. As an
incentive to its customers, Warner will extend
Spoiled goods xxx quantity discounts according to the following
Work in process xxx schedule:
2. Charged to all production Minimum List Net
Order Price Discount Price
Spoiled goods (invty @SV) xxx 500 P4 2% P3.92
Factory overhead control (loss) xxx 1,000 4 4 3.84
Work in process xxx 2,000 4 6 3.76
Required:
FOR DEFECTIVE MATERIALS
1. Charged to the specific job a. Determine the economic order quantity
(ignoring quantity discounts) and the total
Work in process xxx annual order cost, carrying cost, and
Materials xxx materials costs at EOQ (considering quantity
Payroll xxx discounts).
Factory overhead applied xxx
b. Compute the annual order cost, carrying
2. Charged to all production cost, materials cost, and total cost at each
discount level. (Round to the nearest dollar.)
Factory overhead control xxx
c. Identify the order size, choosing from one
Materials xxx
of the three discount levels, that will
Payroll xxx
minimize the total cost
Factory overhead applied xxx

FOR SCRAP MATERIAL

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 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
ILLUSTRATION 4 ACCOUNTING FOR MATERIALS Budgeting Factory Overhead cost – are
management operating plans expressed in
Jefferson & Sons Inc. would like to determine the quantitative terms, such as units of production
safety stock to maintain for a product so that the and related cost
lowest combination of stock out cost and carrying
cost would result. Each stock out will cost P100; FACTORS TO BE CONSIDERED IN COMPUTING
the carrying cost for each safety stock unit will be FACTORY OVERHEAD RATE
P2; the product will be ordered ten times a year.
The following probabilities of running out of stock 1. BASE AMOUNT TO BE USED
during an order period are associated with
various safety stock levels: a. The simplest base is Physical Count or
Units of Production.
Safety Stock Probability of Stock out
Level
FOH Rate = Factory Overhead
Estimated Direct Labor Hours
25 50%
50 25% b. Direct Materials Cost – it is
75 10% commonly used as a base or
100 5% denominator in the computation of
predetermined factory overhead
rate.
Required: Determine the combined stock out and
safety stock carrying cost associated with each
level and the recommended level of safety stock. FOH RATE = Estimated Factory Overhead
x 100
Estimated Direct Materials
5 ACCOUNTING FOR FACTORY OVERHEAD Cost

FACTORY OVERHEAD c. Direct Labor Cost – if it can establish that

• all costs that are incurred and not Direct there is a direct relationship between labor cost
Materials and Direct Labor. and factory overhead. This base is more reliable
than Material Cost
Example:
Estimated Factory Overhead
FOH Rate = Percentage of Direct Materials Cost FOH Rate = x 100
Estimated Direct Labor Cost
Indirect Materials and Indirect Labour, Heat,
Light and Power for the Factory, Rent on Facility
Building, Dep’n of Factory Building and Factory Estimated Factory Overhead
Equipment, and Maintenance of the Latter. FOH Rate = x 100
Estimated Direct Labor Cost
They are divided in Three Categories as to their
behaviour in production
d. Machine Hours – it occurs in a company
1. Variable Overhead – cost that varies in that is automated so that the majority of the
direct proportion to the level of production. overhead cost consists of depreciation on
Variable cost per unit remains constant as the factory equipment.
production either increases or decreases.

2. Fixed overhead – remains constant with Estimated Factory Overhead

the relevant range regardless of the level of FOH Rate =
production. The greater the number of units Estimated Machine Hours
produced the lower the fixed cost per unit.

3. Mixed overhead – it is neither wholly, fixed Estimated Factory Overhead

or variable in nature but has the FOH Rate =
characteristics of both. Mixed cost must Machine Hours
ultimately separate if it is variable or mixed.

e. Direct Material Cost – in this case direct

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 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
materials are a very large part of the total
cost. It is not appropriate when more than
one product is manufactured by a company.
Estimated Factory Overhead
FOH Rate =
Estimated Unit of Production
Estimated Factory Overhead
FOH Rate =
Unit of Production
2. METHODS OF ALLOCATING SERVICE
DEPARTMENT COST TO PRODUCING
DEPARTMENTS
a. Direct Method – The most commonly
used method. It allocates each service
department's total cost directly to the
producing department. It ignores
services rendered by one service
department to another.
b. Step Method – it is also called a
sequential method. This method
recognizes the services rendered by
one service department to another. It
is more complicated because it
requires a sequence of allocation. It
typically starts with the department
that has the greater service rendered
and ends with the one with the least
services rendered. Once a services
department’s costs are allocated, no
subsequent services are allocated to
it.
c. Algebraic Method – it is called the
reciprocal method. It allocates cost by
explicitly including the mutual
services rendered among all
departments.
CAPACITY PRODUCTION
Theoretical, Maximum or ideal capacity
• it is a capacity that can produce at full
speed without interruptions.
• gives no allowance for human capacity
to achieve the maximum nor due
allowance for any circumstances that
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might result in a stoppage of
production within or not within the
control of the management.
• functions 24 hours a day, 7 days a
week, 52 weeks a year.
Practical Capacity
• provides allowance for circumstances
that might result in stoppage of
production.
Expected actual capacity
• a capacity concept based on a short-
range outlook which is only feasible for
firms with products that are seasonal.
Normal Capacity
• consider the utilization of the plant
facilities to meet commercial demands
served over a period long enough to level
out the peaks and valleys which come in
seasonal and cyclical variations.
• commonly used in the computation of
Overhead rates.
METHODS OF ACCUMULATION OF FACTORY
OVERHEAD COST
Non-Controlling account system – it is an
account for which each kind of overhead to their
nature is opened in the general ledger and
charges to which account are made upon the
incurrence of the expense.
Controlling Account System – An “Overhead
Control” account is opened in a general ledger
wherein the overhead incurred are charged; a
subsidiary ledger is maintained to show detail
the nature and account of the expense.
FACTORY OVERHEAD VARIANCE
The difference between the actual factory
overhead and the applied factory overhead.
• Under-applied Overhead – Actual
FOH is more than Applied FOH
• Over-applied Overhead – actual is less
than applied.
 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
ACCOUNTING FOR OVERHEAD
FORMULAS:
VARIANCE
SPENDING VARIANCE
a. Variance should be deferred rather than
disposed of immediately. Actual FOH xxx
b. If variance is immaterial, it is closed to Less Budgeted allowance
COGS : based on capacity
used xxx
c. If variance is material, it is distributed to COGS,
Fixed FOH xxx
FG inventory, WIP inventory. Variable FOH xxx xxx
Spending Variance xxx
CAUSES OF VARIANCE

• Spending Variance – due to expense IDLE CAPACITY VARIANCE

factor.
Budgeted allowance based on
• Idle Capacity or Volume Variance – due capacity used xxx
to the difference in volume and activity Less:
factors FOH applied xxx

Idle Capacity Variance xxx

ACTIVITY BASED COSTING
• Also known as “transaction costing”
• Overhead costs that are caused by
activities are raced to individual product units
on the basis of frequency of consumption of
overhead resources by each product.
• Simple concept which can provide
accurate information about a particular
product's consumption of overhead resources.
• Approximation of user’s fee.
User’s Fee – refers to the process of charging for
services consumed by users of the service.
APPLIED FOH
FOH = Actual x Estimated FOH/Estimated Base
6 ACCOUNTING FOR LABOR
Labor
• the physical or mental effort expended
in manufacturing a product labor cost is
the price paid for using human resources
Factory labor – the compensation paid to
employees who engage in production
related activities

Wages – Principal labor cost paid to production

FIVE STEPS IN APPLYING ACTIVITY BASED
COSTING (ABC)
1. Assemble similar actions into activity
centers.
2. Classify cost by activity center and by
type of expense
3. Select cost drivers
4. Compute a cost function to associate costs
and cost drivers with resource use.
5. Assign cost to the cost objectives.
workers; Payments are made on an
hourly/daily/piecework basis
Salaries – Are fixed payments made regularly
for managerial or clerical services
TWO DIVISIONS OF FACTORY PAYROLL
COSTS
DIRECT LABOR: Represents payroll costs that
are allocated directly to the product
WIP xxx
PAYROLL xxx

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 Junior Philippine Institute of Accountants and Auditors – United
Cost Accounting and Control
INDIRECT LABOR: labor costs that are
either considered "too remote" or "too
insignificant" to be charged directly to the
product.
FOH -C. xxx
PAYROLL xxx
WAGE PLANS
HOURLY-RATE PLAN
• Rate per hour x number of hours used
• does not provide incentive for the
employee to produce more or a high level
of productivity
• employees are paid for merely being on
the job
PECE RATE PLAN: (QTY PRODUCED x
RATE PER PIECE)
• provides incentives for employees to
produce more
• might sacrifice the quality of the product
MODIFIED WAGE PLAN
• Minimum hourly wage + (Qty
exceeding quota x Rate per piece)
• combined feature of hourly rate and
piece rate plan
CONTROLLING LABOR COST
Time Keeping Department: Accounts for the
time spent by the employer in the factory
Clock Cards: Determine the time spent in the
company
Time Ticker: Determine the distribution of hours
Production Reports: Report the number of
products produced
Payroll Department: compute each employee's
gross earnings, deduction, and net earnings to
be paid by employees
Payroll Records: Reports the labor cost
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Employees Earning Records: Includes historical
and current record
Payroll Summaries: Summarizes payroll
obligations
ALLOCATION OF LABOR HOURS
Regular time - charged to WIP
Overtime pay - normally part of FOH but can be
charged as direct labor if the job is rushed
Overtime premium - always charged to FOH
CLASSIFICATION FOR LABOR
1. Direct Labor - represents payroll costs that
are traceable to individual jobs worked on during
the period. Direct labor costs are debited to the
Work in Process account.
Examples: machine operators, painters,
assemblers, factory workers
2. Indirect Labor - cost of work not directly
traceable to the production of the product but is
still related to the production process. Indirect
labor costs are charged to factory overhead.
Examples: janitors, production supervisor,
inventory clerks, cost accountant
3. Labor Overhead
• Waiting Time or Idle Time – cost of non-
productive direct labor hours due to a lack
of work, delayed materials due to
scheduling, machine malfunction, and
machine set-up.
• Make-up Pay - "piecework" rate;
additional pay to minimum wage
employees if they produced more.
• Overtime Premium – represents amount
paid when a worker works beyond normal
working hours.
• Shift Premium - extra pay to work during
less desirable evening shift (2 p.m. to 10
p.m.) or night shift (10 p.m. to 6 a.m.)