Cost Concepts and Classifications

● Cost Accounting - It is a discipline that focuses on techniques or methods for

determining the cost of a product and services.
○ It measures and reports both financial and non-financial information relating to
the cost of acquiring or consuming resources in an organization.
○ It identifies, defines, measures, reports, and analyzes the various elements of
costs associated with producing and marketing goods and services.
● Functions of Cost Accounting
○ It focuses primarily on the determination of the cost of making products or
performing services.
○ It determines the cost of products or services by direct measurement, arbitrary
assignment, and systematic or rational allocation of such cost.
○ It integrates with financial accounting by providing product costing information
for financial statements, and with management accounting by providing
quantitative, cost-based information that managers need to perform their
functions.
● Financial Accounting VS Cost Accounting

Basis Financial Cost

It relates to the classifying,

It relates to the different costing
recording, and analyzing of
methods and techniques in
Nature business transactions and
accumulating the cost of
events to produce financial
products or services.
statements.

It considers both items with

It considers only items with
monetary and non-monetary
monetary values.
values.

Users Both internal and external users Internal users

To determine the cost of

To reflect the correct financial
Objective producing a product or rendering
information of the company
service

Reports Financial Statements Management reports

● Cost VS Expense
○ Cost – represents any amount paid or incurred in acquiring goods or services.
It is presented in the statement of financial position as an asset (example:
amount paid in purchasing equipment).
○ Expense – represents aby amount paid or incurred in the operation of a
business. It is necessary to generate revenue. It is presented in the income
statement (example: depreciation of equipment).
● Classification of Costs
○ As to functional areas of an organization
■ Manufacturing Cost – is the cost incurred in the production of the
product or service.
● Direct Materials – are raw materials directly
identifiable as part of the final product
● Direct Labor – are amounts paid to the factory
workers who are directly engaged in the
conversion of raw materials to finished product.
● Manufacturing Overhead – are costs related to a
particular cost object but cannot be traced to that
cost object in an economically feasible way.
■ Non-Manufacturing Cost – is the cost incurred in administering the
operation of the business and commercializing the product or service.
○ As to traceability
■ Direct Cost – is the cost that can be traced to a particular unit or
department.
■ Indirect Cost – is the cost that is not directly traceable to a particular unit
or department.
○ As to controllability
■ Controllable Cost – is the cost that the manager can significantly or
heavily influence its incurrence.
■ Uncontrollable Cost – is the cost that the manager cannot significantly
influence its incurrence.
○ As to timing of charges to revenue
■ Product Cost – is the cost assigned to goods or services until sold.
■ Period Cost – is the cost matched against revenues in the same time
period in which it is incurred.
○ As to avoidance
■ Avoidable Cost – is the cost that can be avoided by making one choice
over the other.
■ Unavoidable Cost – is the cost that cannot be changed in the future
when choosing one decision over the other.
○ As to decision making
■ Opportunity Cost – it is the benefit sacrificed when choosing one action
over the other.
■ Differential Cost – it is the amount by which the cost differs under two
alternative actions.
■ Relevant Cost – it is the cost incurred in one alternative but will not be
incurred in another alternative.
■ Marginal Cost – it is the extra cost incurred when one additional unit is
produced.
■ Average Cost – it is the result if the total cost to produce the product is
divided by the number of units manufactured or produced.
■ Sunk Cost – it is the cost that has been paid or incurred.
■ Out-of-Pocket Cost – it is the cost that requires the payment of cash or
other assets in the future as a result of its incurrence.
 ○ As to activity and its behavior
■ Fixed Costs – are costs that are constant in total within the relevant
range of activity but variable on a per unit basis.
■ Variable Costs – are costs that vary in total in direct proportion to
changes in the volume of production. These are constant on a per unit
basis as activity changes within the relevant range.
■ Mixed Costs – are costs that have both fixed and variable component.
● Separating Mixed Cost - When cost is classified as mixed, it is appropriate to
separate the fixed cost from the variable cost.
○ High-Low Method
■ Select the highest and lowest levels of activity and costs (within relevant
range).
■ Compute the variable cost element. Variable cost per unit is computed as:

𝐶𝑜𝑠𝑡 𝑎𝑡 𝐻𝑖𝑔ℎ 𝐿𝑒𝑣𝑒𝑙 − 𝐶𝑜𝑠𝑡 𝑎𝑡 𝐿𝑜𝑤 𝐿𝑒𝑣𝑒𝑙 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡𝑠

𝐻𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 −𝐿𝑜𝑤𝑒𝑠𝑡 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦
or 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐿𝑒𝑣𝑒𝑙

■ Compute the variable cost at the highest and lowest level of activity.
■ Determine the fixed cost at each level of activity.
○ Scatter Graph Method
■ A visual technique used in accounting for separating the fixed and
variable elements of a mixed cost.
■ It uses a horizontal x-axis that represents a production activity and a
vertical y-axis that represents its cost.
■ Data are plotted as points on the graph, and a regression line that runs
through the dots represents the best fit of the relationship between the
variables.
○ Least Squares Method
■ A mathematical regression analysis used to determine the line of best fit
for a set of data, providing a visual demonstration of the relationship
between the data points.
■ Each point of data represents the relationship between a known
independent variable and an unknown dependent variable.
■ Set of data points are plotted on an x- and y-axis graph to determine the
line of best fit that explains the potential relationship between
independent and dependent variables.
● Inventory Accounts
○ In a manufacturing setting, there are three inventory accounts:
■ Raw Materials Inventory – it shows the raw materials available for use
in the manufacturing process.
■ Work in Process Inventory – it represents the costs of partially
completed goods that have been started but not yet completed as of a
certain period.
■ Finished Goods Inventory – it summarizes the costs of completed
goods stored in the warehouse ready for delivery to customers.
● Inventory Systems
○ Perpetual Inventory System
■ It keeps track of inventory balances continuously with updates made
automatically whenever a product is received or sold.
■ It is best suited to small businesses due to the expense of acquiring the
technology and staff to support a perpetual system or businesses selling
high value items such as car dealership or art gallery.
■ Merchandise Account
○ Periodic Inventory System
■ It uses an occasional physical count to measure the level of inventory
and the cost of goods sold.
■ It is best suited to businesses with high sales volume and multiple retail
outlets like grocery stores or pharmacies.
■ Purchase Account
● The Flow of Manufacturing Costs
● Methods of Accumulating Product Costs
○ Actual Costing System
■ It requires that all production overhead must be available before any cost
allocation can be made to the jobs in process.

○ Normal Costing System

■ The manufacturing overhead is applied to the production using a
predetermined overhead rate (plant-wide or departmental).
■ Predetermined overhead rate is the ratio of estimated total overhead to
the estimated total of cost driver selected.

● Disposition Overhead Variance

○ Under the normal costing, actual and applied overhead are usually not equal.
○ The two are compared at the end of the period to evaluate the
appropriateness of predetermined overhead rate used:
■ if actual > applied = underapplied (unfavorable)
■ if actual < applied = overapplied (favorable)
○ If the variance is insignificant, it is closed to Cost of Goods Sold:

○ If the variance is significant, it is closed to all accounts with overhead

element:
 Accounting For Materials

● Product Cost Elements

○ Direct Materials – are raw materials directly identifiable as part of the final
product.
○ Direct Labor – are amounts paid to the factory workers who are directly
engaged in the conversion of raw materials to finished product.
○ Manufacturing Overhead – are costs related to a particular cost object but
cannot be traced to that cost object in an economically feasible way.
● Materials - these are materials used for the purpose of manufacturing a product or
rendering of a service.
○ These are recorded in the books 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.
● Stock Card - it is used to record the movement of the inventory.
○ Entries are made in chronological order (according to date of occurrence).
○ It shows the balance of the inventory in units and in peso values at a given
period.

● Materials Requisition - it serves as the basis of recording the issuance of raw

materials.
○ It is used as a control mechanism to make sure that issuance is authorized
and approved by the department head requesting the materials
● Purchase Order - it is a source document that is issued by a purchasing
department when placing an order with its vendors or suppliers.
○ It indicates the details on the items that are to be purchased, such as the
types of goods, quantity, and price.
● Basic Transactions

● Inventory Valuation Methods

○ FIFO (first in, first out) - raw materials inventory is reported at latest cost
while the Cost of Goods Sold is reported at earliest cost.
○ Simple Average - the total unit cost is divided by the total items to arrive at
the simple average unit cost. This procedure is repeated every time raw
materials are acquired.
○ Weighted Average - divide the total costs of raw materials available by the
number of units to arrive at the weighted average per unit.
● Economic Order Quantity (EOQ)
○ It is the order size for an inventory item that results in the lowest total
inventory cost:
■ Carrying Cost – includes cost of storage, insurance, taxes,
obsolescence, spoilage and pilferage, opportunity costs, and handling
costs.
■ Ordering Cost – includes costs of placing and receiving orders like
processing documents, insurance for shipment, and unloading costs.
○ It answers two questions: how many units should be ordered and when
should these units be ordered?
● Reorder Point, Stock Outs and Safety Stocks
○ Stock Outs – occurs when a company does not have materials to issue when
needed and this will result to disruption of production schedules and loss of
customers.
○ Reorder Point – is the point in time a new order should be placed.

RP = Daily Usage x Lead Time or

RP = Daily Usage x Lead Time + Safety Stock

○ Lead Time - the time span from placing an order to date of

actual receipt
○ Safety Stocks – is an additional quantity of an item held in inventory to
reduce the risk that the item will be out of stock.

SS = (Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage x

Average Lead Time)

● Just in Time System

○ It requires no inventory on hand.
○ Materials arrive just in time when production needs them.
○ Finished goods are delivered to customers in time when they are needed.
○ It conforms to the manufacturing philosophy “the lower the level of inventory,
the more efficient the production system is”
○ It results to:
■ lower investment in inventory
■ reduced inventory cost and carrying costs
■ reduce costs of obsolescence
■ lower investment in space for inventories
■ reduced total manufacturing costs
● Backflush Accounting
○ It omits some of the journal entries relating to the stages from purchasing of
raw materials to sale of the goods.
○ When materials are purchased, Raw and in Process Inventory account is
maintained which includes only the raw materials purchased.
○ Conversion costs incurred (labor and overhead) are summarized in a
Conversion Costs Control account. It is then charged immediately to Cost of
Sales.
○ There is no work in process or materials inventory accounts.
● Scrap Materials
○ These are defective materials or leftover materials in production:
■ fillings or excessive trimmings of materials after the manufacturing
operations
■ defective materials not suitable for manufacturing operations
■ broken parts of materials as a result of employee error or machine
breakdown.
○ Methods of accounting for scrap materials:
■ reduction of the cost of specific products which were produced
■ reduction of the cost of production in general
■ recognize as other revenue for the market value of the scrap
■ recognizing as sales revenue for the market value of the scrap
 Accounting For Factory Labor

● Factory Labor - It represents the wages of workers in the factory, both direct and
indirect laborers.
○ It includes the regular basic pay; cost of living allowances, 13th month,
overtime pay and other remuneration.
● Labor Remuneration
○ Basic Pay
○ Overtime Pay
○ Holiday Pay
○ Hazard Pay
○ Night Shift Differential Pay
○ 13th Month Pay and Other Bonuses
● Deduction From Payroll
○ Absences
○ Tardiness/Late
○ Withholding Tax
○ SSS Premium
○ HDMF Premium
○ PHIC Premium
● Direct Labor VS Indirect Labor
○ Direct Labor - is the total amount paid to the factory workers who are directly
engaged in the conversion of raw materials to finished product.
○ Indirect Labor - is the cost of any labor that supports the production process,
but which is not directly involved in the active conversion of raw materials to
finished product.
● Rule on Overtime Pay and Overtime Premium
○ The overtime pay is included in the direct labor.
○ If the overtime is scheduled to meet the production requirement, the overtime
premium is included in the manufacturing overhead.
○ If the overtime is due to customer specifications, the overtime premium is
included in the direct labor.
● Rule on SSS, PHIC and HDMF Contribution
○ The employee’s share in SSS, PHIC, and HDMF is already included in the
gross payroll, hence it is already included in the direct labor.
○ The employer’s share in SSS, PHIC, and HDMF is to be included in the
manufacturing overhead.
● Time Record - It is the document used to monitor and organize time information.
○ It captures the time the employee is at work.

● Time/Job Ticket - It is a document used by an employee to record hours worked

in a specific job.
○ It captures the time that individual workers spend on each production job.

● Basic Transactions
Exercise 1-4

d-g ay manufacturing overheads

- charged to WIP
Add info:

a.

b. 339k is the 75%

Wip inventory beg + total manufacturing costs = costs placed into process

c.

Cost of goods manufactured and sold

Cost of goods manufactured (multiply to 25%)

Fg ending (25% ng 339k)

Exercise 1-5

B. 79k -91k (cost og gm - cost into process)

Cost placed into process + cost of gm = wip end

Ex 1-6

Direct m, direct l, factory overhead

1. Direct materials
2. Dm
3. F overhead
4. Period cost
5. Direct labor
6. Period cost - selling exp
7. Period cost - adm exp
8. Dm
9. Fo
10. Period cost - selling exp
11. 3.6 k is fo & 8.4k is period cost
12. 9k is fo & 5k period cost
13. 360, fo (30%) & 840 period cost
14. 75% FO (1,800) & 25% period cost (600)
15. Period cost - selling exp
16. Other categories - sales disc
17. 60% (1,440) FO & 40% (960) Period cost
18. Dm
19. FO
20. Fo
Problem 1-1

Deduct the deposit

25% cogs

Total manufacturing cost = total factory cost

Problem 1-2

Workback

Increase in FG is deducted, instead of adding FGI beg, to cost of GM

Decrease in fg is added
Problem 1-3

Prime cost = direct materials + direct labor

Conversion cost = direct labor + manufacturing/factory overhead

1. Dm - 600k
2. Dl - 50k
3. Dl - 40k
4. Period cost so ignored
5. FOH - 2k
6. Period cost
7. FOH - 3.5k
8. Period cost
9. FOH - 6.5k

Prime cost = 690k

Conversion cost = 102k

Problem 1-4

Mark up - multiply
Gross rate - divide
Problem 1-5

Workback
normal costing

Actual costing ito:

Normal costing ito:

Problem 1-6

B
Problem 1-7

Normal costing

Problem 1-8

Multiple choic

1. B
2. B
3. C
4. A
5. B
6. B
7. B
8. C
9. D
10. D
11. C
12. D
13. A
14. c/d
15. C
16. D
17. D
18. D
19. D
20. A

1. T
2. F
3. F
4. F
5. T
6. T
7. T
8. F
9. T
10. F
11. T
12. F
13. F
14. F
15. T

1. 2,487,000
2. 1487500
3. 336000
4. 686000
5. 3020000 materials 2575000 labor 1545000 fo
6. 3500000
7. 21490000
8. 27920000
9. 20k decrease in wip, 600k increase in fg
10. 150000
11. 1010000
12. 150000 overapplied
13. 905000
14. 2625000
15. D

1. B
2. C
3. B
4. D
5. B
6. B
7. A
8. B
9. B
10. B
11. C
12. A
13. C

1. D
2. B
3. D
4. C
5. B
6. D
7. A
8. C
9. A
10. A
11. D
12. A
13. C
14. D
15. C
16. B
17. D
18. D
19. D
20. C
21. A
22. D