Be COST ACCOUNTING DEFINED . yzes, and in- amarizes, ane ead neces- (Cost accounting is a system that records, sum . labor, and ove +erprets the. details of the costs of materials, Sary to produce and sell an article. Cost accounting is usually considered only as it applies to manufacting operations and service organizations as well. Today, it 16 genera me ‘ultiple tinguishable from management accounting because it serves wad pro- purposes. Basically, cost accounting now refers to the gathering ane a viding of information for decision needs of all sorts, rangi" Hecisions management of recurring operations to the making of strategh at it and the formulation of major organizational policies. As in tl © P ste also helps fulfill the legal requirements of reporting to stockholder Sore tors, government agencies, and other external users Cost accounting en, refers to recording, classifying and reporting all costs aspects of com- pany performance during a particular period of time. THE PURPOSE OF COST ACCOUNTING From the above discussion of the concept of cost accounting, it can be gleaned that cost accounting furnishes management with the necessary accounting tools for planning and controlling activities. Specifically, the gathering, presentation, and analysis of cost data will help management in answering the following questions: + Is our plant operating efficiently and economically? + Which of our costs are out of line, and how can they be controlled? + Are our sales prices set realistically in relation to costs? + What is the unit cost of each type of product being manufactured? The answers to such questions require detailed d: Tone that wll pinpoint unit costs of products and recesses Pee of the major functions of cost accounting. Through modern 1S 18 ot cost accounting, it is possible to know how much it cost ‘t systems of manufacture, or sell goods, or to render various servi Ss to construct, ‘make specific and detailed identification and measurem: The ability to ments permits management to reach decisions and rement of cost ele- with greater intelligence. Bidding and budgets whi to evaluate results the next page are examples of how cost accountin, ich are discussed on business. ‘Ng concepts are used inCost Accounting - Basic Concepts and the Job Order Cost Cycle 3 Estimating and Bidding A knowledge of the costs of doing business is needed to estimate a job or to bid for jobs or contracts. The order generally goes to the lowest bidder. Under competitive pressure, the decisive difference in a bid may be as. little as a fraction of a cent per unit. Attempting to bid without detailed cost information can mean losing the job, or it can mean winning the job but having to perform the work at a loss. Either result is undesirable. Planning, Budgets, and Control ‘The cost accounting system also provides vital information needed to plan future operations. Cost data help resolve questions relating to proposed projects or policies, such as the following: + Should we build a new plant or modernize the old one? + How far can we go in lowering prices to increase our volume of sales? + What will be the effect on costs of automating part of our factory operations? Cost accounting is also used in preparing a company's budget. A budget is the overall financial plan for future activities. It is even possible to com- pute flexible budgets that will tell what the costs for any volume of out- put should be. Then actual costs can be compared with a realistic bud- geted amount. Standard cost procedures are helpful in evaluating the results of opera- tions. Unit costs are projected on the basis of standard conditions. These standards are often based on the past experience of the firm or on statis- tics from the industry. Then, as actual costs are incurred, they are com- pared with these standard costs. The differences between the two sets of cost figures can be noted and analyzed while there is still time to take remedial action. From this brief discussion, you can see that cost accounting is one.of the most valuable management tools to control operations. Knowledge of the costs of making and selling the firm's products or services helps manage- ment weigh the various courses of action before any final commitments are made. Once operations begin, cost accounting reveals how efficiently the work.is being done, where the strong and weak spots are, and how to improve performance.. e most The cost of making a product or providing a service '® one of eet infor- critical factors in a firm's ability to meet the competition. YT a. per. mation to support the decisions, management can issue MCS Yo cure form follow-up activities, and obtain the operating results prosperity and growth for the enterprise. MANUFACTURING COSTS CLASSIFIED (Manufacturing is the process of converting materials into finished goods by using labor and incurring other costs, generally called manufacturing overhead. Overhead costs include utilities, supplies, taxes, insurance, an depreciation ‘Onc of the functions of a cost accounting system is to las- sify and record all costs according to category. The three major manufac: _turing-cost classifications — direct materials, direct labor, and manufac- turing overhead — are the basis for all cost accounting procedures. (See ‘the chart of typical costs on page 14.) _ Direct Materials Direct materials, also called xaw materials, are those materials used in the manufacturing process that become a significant part of the finished goods. For example, the metal frame and the lumber used in manufactur- ing a chair and the cloth and buttons used in manufacturing clothing are direct materials. Tt is important to note that what is raw material to one manufacturer is considered finished goods by the supplier of those materials. For example, to the foundry that makes metal chair frames, these frames are finished goods. They are raw materials, however, to the manufacturer who pur- chases the frames to make the chairs. oP The statement of cost of goods manufactured fo: + shown on page 24 had an inventory of raw materia so Printers, Inc., During the month, purchases of raw materials amounted t 86. 10,000. addition of the purchases amount to the beginnin © 86,900. The makes the total of materials available 136,900. On Ji materials inventory was 46,500. This amount i Ur total materials available to get the cost of mare were stom the amount fore, the cost of raw materials after deducting indi: aterials used. There- is 84,600. rect materials of 5,800 ig inventory amount june 30, 2008, the rawCost Accounting ~ Basic Concepts and the Job Order Cost Cycle Direct Labor The employees who work directly with the raw materials in converting. them to finished goods represent direct labor. In a factory that makes chairs, for example, the salaries of workers who cut and sand lumber and of those who assemble the parts into finished chairs are considered di- rect labor costs. In the manufacturing of clothing, the earnings of cutters and sewing machine operators are direct labor costs. The statement of cost of goods manufactured for JenJen Printers, Inc., shows a total direct labor cost of 66,500 for June 2008. Manufacturing Overhead ./ All costs incurred in the factory that cannot be considered direct materi- als or direct labor are classified as manufacturing overhead (sometimes called factory overhead, manufacturing expenses, or factory burden). Manufacturing overhead is usually subdivided into three categories: in- direct materials, indirect labor, and other manufacturing overhead. The manufacturing overhead items of JenJen Printers, Inc., for June 2008 to- taling P53,200 are shown in the statement of cost of goods manufactured on page 24. Indirect Materials /Materials that are used in small amounts in the manufacturing process or that cannot easily be traced to specific products are called indirect materials. The glue used in manufacturing armchairs and the thread used in sewing a suit are indirect materials. This is because only small amounts of glue and thread are used, even though they clearly become part of the finished goods. Records must be kept to show the exact amount of mate- rials used in completing each specific job or group of products. Keeping detailed records for minor materials, however, would require a great deal more time and cost than the results would justify. It is more practical to group all such material together without charging them to specific prod- ucts. Another type of indirect material, sometimes called factory supplies or operating supplies, consist of items that are used in the manufacturing process but do not become a part of the finished goods. Examples of these are cleaning supplies used in the factory, oil used for lubricating the fac- tory machinery, and minor repair parts. JenJen Printers, Inc., shows a total of 5,800 for indirect materials for June 2008.BESS rare ee ee Indirect Labor teri The wages of factory personnel who do not work directly on TaW meeuch als are called indirect labor. For example, the wages and salaries main- factory workers as the storeroom clerks, janitors, superintenden ‘tenJen tenance crew, and factory supervisors are indirect labor costs. Printers, Inc., indirect labor cost for June 2008 is P35,800- Other Manufacturing Overhead on Other manufacturing overhead includes such costs as payroll taxks. bo factory wages; rent, depreciation, taxes, and insurance on factory of ings and machinery; heat, light, and power; repairs and maintendn’! 0 machinery and equipment. Many of these relate to the physica’ Patt (building, machinery, and equipment). Other manufacturing overhead 16 a growing part of the total cost of production because of the increasing use of labor-saving equipment such as computers and robots in. many manufacturing processes. The use of automated equipment results in more costly maintenance, greater insurance and depreciation charges, and in- creased utility costs. Prime and Conversion Costs In cost accounting, the term for the sum of direct materials and direct labor is-‘prime cost. Prime cost reflects the primary sources of costs for units in production. The total of direct labor and manufacturing over- head is often called the conversion cost. Conversion cost indicates the costs required to convert the raw materials into finished products. (See the chart of costs on page 8.) INVENTORIES FOR A MANUFACTURING COMPANY A manufacturing company has three distinct inventory accounts: Raw Materials Inventory, Work In Process Inventory, and Finished Goods In- ventory. At the end of the fiscal period, the balance of each of the three accounts will appear in the Current Assets section of the balance sheet. Raw Materials Inventory The Raw Materials Inventory account reflects th: and factory supplies that will be used in the man direct materials are removed from the storeroo; e cost of raw materials ufacturing process. Once m for use in the manufac-‘Cost Accounting - Basic Concepts and the Job Order Cost Cycle turing process, their costs are no longer part of the raw materials inven- tory. Instead, these costs are then classified as part of work in process. In the same way, the costs of factory supplies that have been removed from the storeroom and applied in the manufacturing process are charged to manufacturing overhead. Some manufacturing firms may use a separate Supplies Inventory account if the quantities or value of supplies normally kept on hand are significant enough to justify the additional account. Work in Process Inventory The Work in Process Inventory account reflects the cost of raw mater! direct labor, and manufacturing overhead of goods on which manufact ing has begun-but has not been completed at the end of the-fiscal period. /Finished Goods Inventory The Finished Goods Inventory account reflects the costs of goods that have been completed and are ready for sale. This account corresponds to the Merchandise Inventory account of a merchandising business. Any changes in the Finished Goods Inventory account are reflected in the Cost of Goods, Sold section of the income statement. SYSTEM OF COST ACCUMULATION The basic objective of cost accounting is the determination or accumula- tion of a product's cost for inventory valuation and income determina- tion. The following systems maybe used in accumulating a product's cost. 1. Actual Cost System (Historical). Under this system, direct materials, direct labor and factory overhead costs are deter- mined as they occur simultaneously with the manufacturing operation but the total of these costs is known only after the. operation has been completed. An actual cost system collects the actual amounts of direct material, direct labor and factory overhead that are incurred for each product. This system will be used throughout this chapter.7809 worsiaaue | soueansuy 9800) atlite] souvansuy sosuoayy 9 Sox, | sasuaor] 7 SOxE], sayddng sopeg souvansuy aowemsuy, yearyy, worworunmuod suedoy worvorunum0) quay sauepeg woreardag wonepardag uoreperdag SrayIom Areayjoq | | sasuaovy yp saxvy, Buyjquiassy oy quay yaavay, sayeday yonay,| | soyegy 9p 1USrT siaeg poystury sayddng say3Q sajduug NO pue ouyosey quay, sueg sqyoueg | | sorrejeg s,ajdoadsojeg, wonvperdeg| speuoqepy s0upuy poystuyruiag 2g woHsuaduio Suisnieapy ang qareag| | soqey yoaupuy] | orkeg rojo speuaqeyy wey DEM ELZCG) RuAtteL aching taRcety iif aa s3sog Biol ehcncta ratte shed Pate ACL LGC C6 § Brvohaceiecuia i ANVdWOO ONIYALOVANNVA V UOd SLSOD 40 LUVHOCost Accounting ~ Basic Concepts and the Job Order Cost Cycle Z 2. Standard Cost System (Predetermined). Under this system, costs are determined in advance from analysis and forecasts made before the actual production begins. In a standard cost system, standard unit costs are computed for the direct materi- als, direct labor and factory overhead; these amounts, rather than the actual costs, are carried to Finished Goods inventory. This will be discussed in Volume 2. 3. Normal Cost System. This system is a combination of the ac- tual cost system and the standard cost system. This system ac- cumulates only the actual amounts of direct material and direct labor costs. Factory overhead costs are accumulated on the ba- sis of a predetermined rate. This system will be used in the next chapter. A comparison of the alternative product costing system is presented be- low. Product Costs Actual Costing Standard Costing Normal Costing Direct Materials Actual Standard Actual Direct Labor Actual Standard Actual Factory Overhead Actual Standard Predetermined TYPES OF COST SYSTEMS One type of accounting system is needed to accumulate costs of goods manufactured when products are produced in jobs or lots of varying quan- tities and types. A different type of system is used when there is a con- tinuous flow of goods of identical or similar characteristics throughout the manufacturing process. The job order cost system has been devel- oped for the first type of operation, and the process cost system for the second. . Job Order Cost System The job order cost system accumulates costs applicable to each specified job order or lot of similar goods manufactured on a specific order for stock or for a customer. When production on a job begins, the job is assigned a number, and a form called a job cost sheet is set up. As direct materials are—SPler is, 2 5 eet. Similarly, direct labor he job cost”, When the job is-com, ed on tl ° e ar ded pent ), manufacturing overheag . cor eer a job are FeO”, * worked on) : costs incurred oe ally as the job is ved ‘and entered on the job cost sheet, pleted (or pe to the job are estima the total costs of the completeg costs applicable mows Tet fhe cna Tho job cost shoot we nen be obtained by dividing ach je ost per uni 1 tain woh by the number of units comple the j used by manufacturers, such as a furnj. n je is ofte: ‘The job order cost ore produce a variety of products, because auch Pro- duce ante keg track of each specific order to ensure cor < assign. ducers te als ihe actual costs shown on the job cost sheets may be ment of eosts. Also, hich the sales prices were based, WwW! red with the estimated costs on ; Any discrepancies or significant variations between estimated costs and actual costs to manufacture are analyzed, and necessary cormective 0 tions are taken to ensure that adequate profit margins are maintained. used, their costs are e _ Process Cost System The process cost system accumulates costs without attempting to allo- cate them during the accounting period to specific units of goods being manufactured. At the end of the fiscal period, the average cost per unit is determined by dividing the total number of units produced into the total cost accumulated. Because of this technique, process costing is often re- ferred to as average costing. If the Process cost system is used, the goods . manufactured must be similar in nature so that an average cost will be 2 meaningful. The process cost system is commonly used in such manufac- turing operations as cement plants and flour mills, in which the produc- tion process is standardized and conti . nti i sentially the same from day to day. fous and the product remains es-Dual Systems Some manufacturers use both the job order cost system and the process cost system. A dual system is often used when a company makes standard parts or subassemblies continuously and then incorporates them into fin- ished goods built to customer specifications. The cost of the parts is accu: mulated and determined under a process cost system, and the cost of each.customer's order for finished goods is computed under a job order cost system. The job order cost system is outlined in Chapter 2 and dis- cussed in detail in the remaining chapters. The process cost system is covered in Volume Two. INTRODUCTION TO THE JOB ORDER COST CYCLE - NORMAL COSTING As discussed earlier, total manufacturing cost cosists of three elements: direct materials, direct labor, and manufacturing overhead. The flow of these costs through the accounting system parallels the flow of products through the manufacturing operations. _/WORK FLOW The steps in a typical cycle of operations of a firm using Job Order Cost System are outlined below: 1. Procurement: Materials and supplies needed for manufacturing are ordered, received, and stored. Direct and indirect factory labor and services are obtained. 2. Production: Materials are transferred from the storeroom to the fac- tory. Labor tools, machines, power, and other costs are applied to complete the product. 3. Warehousing: Finished goods are moved from the factory to the ware- house to be held until they are sold. 4. Selling: Customers are found. Merchandise is shipped from the ware- house. Sales to customers are recorded. The cost accountant's job is to design a system in which all cost elements are recorded as incurred and then charged to production as the work flows through the operating cycle.