Cost Accounting Module 1

Introduction to Cost Accounting

Learning Objectives:

1. Define what cost accounting is

2. Determine the difference between cost and financial accounting
3. Determine the different concepts used in cost accounting (elements and types of
costs)

What is Cost Accounting?

Cost Accounting analyzes the company’s production costs for its products or services.
A form of management accounting, cost accounting examines all forms of variable
and fixed expenses and is solely for internal purpose. Company and internal
stakeholders use these information to determine the profitability of the products in
a business as well as the price that the company will employ based on the cost of the
product.

In technical terms, cost accounting “is the process of tracking, analyzing and
summarizing all fixed and variable “input” costs related to the production of a
product, acquisition of goods for sale or the delivery of a service. These include
material and labor costs, as well as operating costs associated with a product or
service. Cost accounting helps companies identify areas where they may be able to
better control their costs, and also informs pricing decisions to ensure profitability.”

Cost Accounting vs Financial Accounting

Cost accounting deals with the costs associated with producing or acquiring goods
for sale or in providing a service. Since this is only catered to internal stakeholders,
cost accounting is not mandatory to be performed and is not hold to the same
standards as in financial reporting. The table below sets the differences between the
two types of accounting.
Purpose of Cost Accounting

Cost accounting is an essential aspect of a business to evaluate the costs associated

in producing a product or in providing a service. While this is a tedious and arduous
process, the output insights from this type of accounting can help the company
decide on its operations and its products.

Pertinent areas in which cost accounting can help are:

1. Budget. Cost accounting is an important facet of budget planning. By analyzing

costs, the company can better forecast future and projected fixed and variable costs
and allocate them to product lines.
2. Efficiency. Standard costs is primarily based on the efficient use of material and
labor. Cost accountants and managers will get a better view about the actual and
budgeted amounts of primer and conversion costs.
3. Profit. The use of cost accounting can help mitigate the risk of uncontrolled
expenses that can diminish expected profits.

Elements of Cost Accounting

The concept of cost accounting is based on three elements: material, labor and
overhead.

Material.

Material are inputs to the

production. They are classified as
direct or indirect.

Direct Material

Direct materials are materials that

are used in production and can be
directly reflected into the completed product. Examples are cotton for clothes or
plastic for a phone case.

Indirect Material

These are not directly reflected into the finished product and are treated as
overhead expense. Examples include safety equipment and cleaning supplies. Only
direct materials are shown on the cost sheet.
Labor.

These consist of workers directly involved in production and distribution of goods or

delivery of services that must be paid. Their salaries and labor may include bonuses,
overtime pay, and employee benefits.
Indirect labor costs are also treated as an overhead expense, not as labor expense.

Overhead

These are costs related to the production and distribution of goods, but are not
directly attributable to goods and services of the business. Typical overhead costs
include:

 Equipment set up, such as for factory machinery.

 Utility bills, such as factory electricity, water and sewerage.
 Facilities costs, including rent/mortgage and property taxes.
 Payroll taxes
 Depreciation of fixed assets, such as factory machinery and store equipment.
 Interest payments

Type of Costs

Direct costs are expenses incurred directly in the manufacture, purchase, or

provision of goods or
services. These would
comprise the
components and raw
materials used to create
a finished product, as
well as the labor used to
produce it, for a
manufacturer. These
also go by the name
"product costs."

Operating or Indirect Costs are production-related indirect costs that are not
associated with a particular products or service. The work involved in heating,
lighting, and other expenses is an example of an indirect cost. Purchases of
equipment are also indirect expenses since, despite being employed in
manufacturing, they are not included in the finished product.

When production or demand for a product declines, fixed costs drive up unit costs,
and vice versa. Fixed costs are expenses that don't fluctuate with output and must
be covered regardless of amount of production.

The level of output of a corporation affects variable costs. The expenses of materials,
labor, and overhead are likely to increase and decrease in the spring and summer for
a maker producing skiing equipment. Some expenses are made up of both fixed and
variable expenditures. For instance, the price of energy to power manufacturing
equipment changes depending on consumption, while the price of electricity to heat
and light a building often doesn't, until a business, for instance, adds shifts.

A mixed cost has both a variable and a fixed component. On a per-unit basis, a
mixed cost does not fluctuate proportionately with changes in activity nor does it
remain constant with changes in activity.

A step cost shifts upward or downward when activity changes by a certain interval or
“step.” A step cost can be variable or fi xed. Step variable costs have small steps;
step fixed costs have large steps
 Cost Accounting Module 2
Inventory Costing
Learning Objectives:
1. To define what inventory costing is
2. To determine the difference between cost of goods sold and inventory costs
3. To define and discuss the most common inventory methods

What is Inventory Costing?

Inventory costing aids

organizations in
estimating the worth
of their inventory.

It entails figuring out

the cost of each item in
a company's inventory,
including the cost of
labor, raw materials,
and other inventory
management-related
expenditures including those associated with manufacturing, acquisition, and
carrying. Shipping and handling charges, storage costs like rent or utilities for
warehouse space, insurance, taxes, and any other costs spent to prepare the product
for sale can also be included in inventory costs.

Cost of Goods Sold vs Inventory Costs

Cost of Goods Sold

The term COGS describes the upfront expenses incurred by a business while creating
or acquiring the commodities it sells at a certain point in time. These include the
price of supplies, labor, and other manufacturing-related expenses.

A straightforward method is used to calculate COGS, which involves first adding the
cost of the inventory you had at the start of the period to the total cost of the goods
you bought during this time, then deducting the cost of the items you still have in
stock at the conclusion of the period.

COGS = start inventory + purchases during the period – ending

inventory
Suppose you own a store that sells T-shirts and need to calculate a month’s COGS.

At the beginning of the month, you had 100 shirts in your inventory that you bought
fo P 10 each, making a total of P 1000 start inventory. During the month, you
purchased 200 more for P 12 a piece, bringing your purchases to P 2,400. At the end
of the month, you have 50 left in your inventory, which means P 600 worth of T-
shirts.

Using the COGS formula, you can calculate the cost of the T-shirts you sold during
the month as follows:

COGS = P 1,000 (beginning inventory) + P 2,400 (purchases during the month) – P

600 (ending inventory) = P 2,800

This means that the cost of the T-shirts you sold during the month was P 2,800

Inventory Costs

The expenditures related to keeping and maintaining a company's inventory are

known as inventory costs.

These costs might include all outlays for buying, keeping, and maintaining inventory
as well as any losses from theft or spoiling. Typically, inventory expenses are
determined per unit and are reported as an asset in a company's financial accounts.

Common Inventory Costing Methods

1. First In, First-Out (FIFO)-The FIFO inventory costing approach operates under the
presumption that the first goods bought will also be the first items sold.

The ending inventory is determined using the cost of the newest goods, whereas the
COGS is based on the cost of the inventory's oldest items. Given that the cost of the
oldest things may be less than the cost of the newest products, this technique can
produce a more accurate depiction of the current inventory cost.

2. Last In, First Out (LIFO)- The primary tenet of LIFO is that the most recent
products received should be sold first.

The cost of the newest inventory items is used to determine the COGS value, while
the cost of the oldest inventory items is used to determine the ending inventory. The
greater COGS but lower taxable income that results from this strategy allows firms to
assign the more expensive goods to be sold first.

3. Specific Identification Method- The method of specific identification keeps track

of the exact cost of each individual inventory item.
This approach is frequently employed for goods that are rare, expensive, or with a
limited rate of turnover. For instance, a jewelry store has a P 10,000 diamond
necklace in stock that they bought. If the retailer sells the necklace for P 15,000,
COGS would be P 10,000 and the overall profit would be P 5,000.
4. Weighted Average Cost- COGS is calculated using weighted average cost, which
averages the prices of all the inventory products. Regardless of the purchase date,
this technique gives all items in stock an average cost per unit.

Example of weighted average cost calculation

Let’s say a company has 100 units of a product in inventory. 50 units were purchased
for P 5 each, and the other 50 for P10 each. The weighted average cost per unit
would be calculated as follows:

(50 x P5) + (50 x P10) = P750

P750 / 100 units = P7.50 per unit

This means that COGS for 20 units sold would be:

20 units x P7.50 per unit = $150

 Module 3
Cost Methods
Learning Objectives:

1. To explain the concept of indirect cost and the concept of overhead

2. To explain the different costing methods

What is Costing Methods?

A costing method is a strategy or methodology that organizations use to calculate

the expenses related to creating a product or offering a service. To effectively
determine the overall cost per unit or service, it entails assessing numerous cost
components such raw materials, labor, overhead costs, and other variables.

Indirect Costs

It's simple to concentrate simply on direct expenses like labor and raw materials
when talking about manufacturing costs. However, failing to account for indirect
expenses may result in incorrect pricing. When setting product pricing, businesses
frequently overlook to account for these unaccounted-for costs, especially newer
ones.

All of the expenditures required to keep your firm operating efficiently fall under the
category of indirect costs, even if they are not directly related to the manufacturing
process. Indirect expenses include, for instance:

 Rent or mortgage payments for your facilities

 Utilities such as electricity, water, and gas
 Equipment maintenance and repairs
 Administrative expenses like accounting and HR
 Marketing and advertising costs

A more thorough knowledge of your production costs is provided by accounting for

indirect costs. However, this computation can be difficult and time-consuming. It's
crucial to balance the advantages of precision with the expenses related to devoting
a lot of time and resources.

Calculating Overheads

Manfuacturing overheads are the most difficult to calculate. Overheads are all the
indirect costs incurred in running a business, such as rent, utilities, and insurance.

The five main types of overhead in manufacturing include:

1. Indirect labor — The cost of all the workers who are not directly involved in
manufacturing the product, such as supervisors, office staff, and janitors
2. Indirect materials — Materials used in the production process but are not directly
involved in the production of the final product, such as packaging and labels

3. Utilities — The cost of electricity, water, and gas used in production

4. Physical costs — All the costs related to maintaining your factory, such as rent,
insurance, and property taxes

5. Financial costs — Any legal, accounting, and banking charges

To calculate total cost of overhead, you need to add up all the indirect costs.
Overheads can also be fixed or variable.

 Fixed overheads — Costs that stay the same regardless of how much is
produced, such as rent
 Variable overheads — Costs that change in relation to production, such as
electricity

In order to calculate the overhead cost per unit, you need to divide the total
overhead cost by the number of units produced.

Overhead cost per unit = Total overhead cost / number of units produced

For example, if the total overhead cost is P 100,000 for 2,000 units, the overhead
cost per unit will be P50.

If you’re manufacturing different products, you need to calculate each product’s

overhead cost per unit. This is because each product will have different production
costs, so the overhead cost per unit won’t be the same.

Widely Used Costing Methods

 Standard Costing- Standard costing makes use of fixed prices for labor and
supplies. Due to its simplicity, this kind of pricing is arguably the most often used
technique. The predefined expenses are generated from the company's prior
experience and are adjusted on a regular basis to take into account evolving
circumstances.

This method has the benefit of being the quickest to compute and least time-
consuming. Additionally, it offers a reliable foundation for calculating the product's
price. Standard costing has the drawback that it may be erroneous if conditions have
changed considerably after the firm established the standards. The timely updating
of the standards might sometimes be difficult.
 Job Costing- When each project is unique and the cost of each work fluctuates,
job costing is used to keep track of expenditures. In this approach, both direct
and indirect expenses are included.

You start by adding all of the direct costs to determine the price of a work. Based on
how many resources are used for the assignment, you then distribute a share of the
indirect expenses. For instance, you may allot 50% of the day's rent to a work if it
required 50% of the manufacturing area.

The benefit of this approach is that it takes into account all related expenditures,
which results in a fairly realistic representation of the cost of each work. The
drawback of task costing is that it might take a lot of time since you have to keep
track of and allocate each expense appropriately.

 Process Costing- Mass manufacturers with minor product variations can better
manage costs by using process costing, which refers to a specific step in the
production process. For instance, cutting the cloth may be the first step, and
stitching the garment might be the next.

You sum up all of the direct costs incurred during that particular production step,
including the materials utilized and the salary of your operators, to determine the
cost of a process. Then, based on how extensively the process uses the resources,
you distribute a share of the indirect costs.

 Activity Based Costing- Activity-based costing (ABC), a more complex variation

of job costing, examines the cost of each item from mass production runs
depending on the activities involved in manufacturing it.

Rather of allocating overhead expenses to items, activity-based costing does so. To

do this, indirect expenses are first allocated to cost pools. A cost pool is a collection
of associated expenses incurred when carrying out a specific task.
 Module 4
Cost-Benefit Analysis

Cost Volume Profit- Analysis- a systematic examination of the relationships among

cost, cost driver and profit

ELEMENTS OF A CVP ANALYSIS

1. Sales
a) Selling price
b) Units or volume
2. Total Fixed Costs
3. Variable Costs per unit

APPLICATIONS OF CVP ANALYSIS

1. Type of product to produce and sell

2. Pricing policy to follow
3. Marketing strategy to use
4. Type of facilities to acquire

CONTRIBUTION MARGIN INCOME STATEMENT

 The costs and expenses in the contribution margin income statement are
classified as to behavior (either fixed or variable)
 The amount of contribution margin, which is the difference between sales and
variable costs, is shown. The format are as follows:

CONTRIBUTION MARGIN INCOME STATEMENT

Sales (units x selling price)

Less variable costs (units x variable cost per unit)
Contribution margin
Less total fixed costs
Income before tax

SOME INHERENT ASSUMPTIONS OF CVP ANALYSIS

1. All costs are classifiable as either variable or fixed
2. Selling prices per unit and market conditions remain unchanged
3. Production equals sales, I.e., there is no changes in inventory
4. Technology, as well as productive efficiency, is constant
5. The time value of money is ignored
 BREAK-EVEN ANALYSIS

 Break-even point- the sales volume level (in pesos or in units) where total
revenues equals total costs, that is, there is neither profit nor loss

Formula:
Break-even sales volume = fixed costs / (price − variable costs)
Break-even sales volume = FC / CM
Contribution margin ratio = contribution margin / unit selling price

Components of CVP analysis

The CVP analysis contains different components, which involve various calculations.
These components are:

Fixed costs: These are the costs that don't fluctuate with sales or product production
changes. Examples of fixed costs include rent and advertising.

Variable costs: These are the costs that change as the quantity of products changes.
Examples of variable costs include raw materials and direct labor.

Contribution margin: This is the difference between the total variable costs and a
company's total revenue.

Contribution ratio: This is the contribution margin expressed as a percentage.

Sales volume: This is the number of products that businesses sell during a specific
period.

Break-even point: This is when the total costs and revenue are equal, meaning the
business is neither making a loss nor a profit.

Selling price: This is the amount a customer pays for the product.

Here's an example of how to calculate a cost-volume-profit analysis:

Greg's Socks LLC calculates that its fixed costs are $7,000 every month. The fixed
costs include marketing, rent, insurance, salaries and raw materials. It costs $2.65 to
produce a pair of socks, and each pair sells for $8, earning a profit of $5.35 for each
pair. The company performs a cost-volume-profit analysis:

Break-even sales volume = $7,000 / ($8.00 − $5.35) = 2,641.51

This means that Greg's Socks LLC has to sell a minimum of 2,642 pairs of socks every
month to achieve the break-even point of $7,000.