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List of contents
Chapter 5 1. Expenses, cost, classification of cost

Accounting for 2. Accounting for manufacturing cost

3. Accounting for cost of finished goods
production expenses,
cost of finished goods
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Cost and Cost Terminology

Expenses
Expenses are decreases in economic benefits during
the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that
result in decreases in equity, other than those
relating to distributions to equity participants (VAS
01 – Framework)
• Cost is a resource sacrificed or foregone to
achieve a specific objective.
• It is usually measured as the monetary
amount that must be paid to acquire goods
and services.
• An actual cost is the cost incurred (a historical
cost) as distinguished from budgeted costs

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Cost and Cost Terminology Cost and Cost Terminology

• A cost object is anything for which a separate
measurement of costs is desired. • There are two basic stages of accounting
for costs:
• A cost pool is a group of individual costs that a
company allocates to cost objects using a 1.Cost accumulation
single cost-allocation base. 2.Cost assignment to various cost objects:
• A cost driver is a factor, such as the level of
activity or volume, that causally affects costs
(over a given time span).

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Cost and Cost Terminology Cost and Cost Terminology

• Cost accumulation is the collection of cost data
Cost Object in some organised way by means of an
accounting system.
Cost • Cost assignment is a general term that
Accumulation Cost Object
encompasses ...
– tracing accumulated costs to a cost object and
Cost Object – allocating accumulated costs to a cost object.
Cost Assignment

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Classification of costs/expenses
• Business function
R&D, production, marketing, distribution,…
customer service
• Assignment to a cost object
Direct vs. Indirect costs
• Behaviour pattern in relation to changes in the
level of a cost driver
Variable vs. Fixed costs
• Assets or expenses
Capitalised (product) vs. Revenue (period) costs
9 costs to the particular cost object.
Variable vs. Fixed costs
• Variable costs change in total in proportion
to changes in the related level of total
activity or volume.
• Fixed costs do not change in total for a
given time period despite wide changes in
the related level of total activity or volume.
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Direct vs. Indirect costs
• Direct costs of a cost object are those that are
related to a given cost object (product,
department, etc.) and that can be traced to it in
an economically feasible way.
– Cost-Tracing describes the assignment of direct
costs to the particular cost object.
• Indirect costs are related to the particular
cost object but cannot be traced to it in an
economically feasible way.
– Cost allocation describes the assigning of indirect
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Capitalised vs. Revenue Costs
• Capitalised costs are all costs of a product that
are regarded as an asset when they are incurred
and then become cost of goods sold when the
product is sold.
• Revenue costs are all costs in the Profit and loss
account other than cost of goods sold.
– Revenue costs are recorded as expenses of the
accounting period in which they are incurred.
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Manufacturing entities
• Manufacturing operations transform raw
materials - the basic materials from which a
product is made - into other goods through
the use of labor and factory facilities.
• In manufacturing companies, products are
frequently the cost object.
• Manufacturing companies classify
production costs as either (1) direct material,
(2) direct-labor, or (3) indirect production
costs.
Direct labour costs
• Direct manufacturing labour costs include the
compensation of all manufacturing labour that
can be traced to the cost object in an
economically feasible way.
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Direct material costs
• Direct-material costs include the acquisition
costs of all materials that a company identifies
as a part of the manufactured products and that
it can trace to the products in an economically
feasible way.
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Indirect Production Costs
(Manufacturing Overhead)
• Manufacturing overhead includes all costs
associated with the production process that the
company cannot trace to the manufactured goods
(the cost object) in an economically feasible way.
• Examples:
– power, supplies, supervisory salaries, property taxes,
rent, insurance, and depreciation, indirect materials
and indirect labour
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Flows of costs in manufacturing entities Categories of Inventory

Costs & Expenses
Product Costs Balance Sheet

Materials Materials • The three categories of Inventory found in

Purchases Inventory
Period costs flow many manufacturing companies depict stages
Direct directly to the in the conversion process:
Work in
Labor income statement
Process
Factory
Inventory – materials
Overhead Income Statement
Finished
– work-in-progress
Goods Cost of
Period Expenses Inventory Goods Sold – finished goods
Selling and Selling and
Administrative Administrative

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Categories of Inventory (Cont’d) Categories of Inventory (Cont’d)

• Direct materials capitalised costs are used to
calculate the cost of materials used.
• Opening direct materials stock
+ Purchases of direct materials
– Closing direct materials stock
= Direct materials used
• Work-in-progress capitalised costs are used to
calculate the cost of goods manufactured.
• Opening work-in-progress stock
+ Manufacturing costs incurred during the period
– Closing work-in-progress stock
= Cost of goods manufactured

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Categories of Inventory (Cont’d) Example

• Finished goods capitalised costs are used to
calculate the cost of goods sold.
• Opening finished goods stock
+ Cost of goods manufactured
– Closing finished goods stock
= Cost of goods sold
• Kruger Bicycles had $50,000 of direct
materials stock at the beginning of the period.
• Purchases during the period amounted to
$180,000 and ending stock was $30,000.
• How much direct materials were used?

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Example Example
• Assume that the work-in-progress stock
• Direct labour costs incurred were $105,500. at the beginning of the period was $30,000,
and $35,000 at the end of the period.
• Indirect manufacturing costs were $194,500.
• What is the cost of goods manufactured?
• What are the total manufacturing costs
incurred?
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Example Flow of Costs in Manufacturing Firm

Work-in-Process Inventory Finished Goods Inventory
• Assume that the finished goods stock at the Direct material cost Product cost transferred
beginning of the period was $10,000, Direct labor cost
and $15,000 at the end of the period. Manufacturing overhead when product is finished
• What is the cost of goods sold?
Cost of Goods Sold Income Summary
Expense closed into

Income Summary at end

of accounting period
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2.Accounting for manufacturing costs 2.1 Perpetual and Periodic System

Flow of Costs
2.1 Perpetual and Periodic System
2.2 Accounting for direct material costs
2.3 Accounting for direct labour costs
2.4 Accounting for manufacturing overhead
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Perpetual System
 Maintain detailed records of the cost of
each inventory purchase and sale.
 Records continuously show inventory that
should be on hand.
 Company determines cost of goods sold
each time a sale occurs.
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2.1 Perpetual and Periodic System
Flow of Costs
Periodic System
 Do not keep detailed records of the goods
on hand.
 Determine cost of goods sold only at end of
accounting period.
 Physical inventory count to determine cost
of goods on hand.
 Calculation of Cost of Goods Sold
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2.2 Accounting for raw materials cost
• Related documents used
• Account used for raw materials cost
• Recording transactions of raw materials cost
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2.1 Perpetual and Periodic System
Flow of Costs
Additional Consideration
Perpetual System:
 Traditionally used for merchandise with
high unit values.
 Provides better control over inventories.
 Requires additional clerical work and
additional cost to maintain inventory
records.
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2.2 Accounting for raw materials cost
* Source documents:
- Material allocation sheet
- VAT invoice, Sale invoice
* Account used: Acc 621 – Direct material cost
Acc 621
• Unused material at the end of the period
• Material used directly for • Scrap collected during the period
production incurred during the • Allocate direct material cost to cost center
period
Detailed account of Acc 621: Acc 6211-PX1; Acc6212-PX2;...
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Accounting entries flowchart for direct materials costs Explanations:

Ac. 152 (611) Ac. 621 Ac. 152,111…
(1) Material used for directly manufacturing products and
(1) supplying services
(3)
(2) Purchase of raw material (not through the company’s
warehouse) used for manufacturing product and
Ac. 111,112,331.
Ac. 632 supplying services
(2)
(4)
(3) Returning unused material at the end of accounting
period
Ac. 133 (4) Transferring the value of raw material exceeded the
Ac. 154(631)
normal rates (abnormal cost)
(5)
(5) At the end of accounting period, transfer (or allocate)
cost of raw material to each cost centre
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2.3 Accounting for direct labor cost

2.3 Accounting for direct labor cost * Content
* Source document:
• Related documents used - Payroll and payroll related compensation sheet
- -….
• Account used for direct labor cost
* Account used
• Recording transaction of direct labor cost Acc 622 – Direct labor cost
Acc. 622

Direct labor cost Allocate direct labor

incurred during the cost to cost center
period

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2.3 Accounting for direct labor cost Explanation:

Ac. 334 Ac. 622 Ac. 154 (631)
1. Salaries, wages and allowances for direct employees
(1)
(5) 2. Recognizing payroll compensations for direct
employees
3. Provision for annual leave
Ac. 338
4. Actual benefits payable to employees when leave is
(2) taken
Ac. 632
5. At the end of accounting period, transfer (or allocate)
direct labor cost to cost centre for calculating costs of
Ac. 335 (6)
Ac. 334 product and services.
(4) (3) 6. Transfer of direct labor cost higher than normal rate to
account 632
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2.4 Accounting for factory overhead costs 2.4 Accounting for factory overhead costs

• Related documents used

• Account used for factory overhead costs Manufacturing overhead cost includes:
• Recognizing transaction of factory overhead
Indirect labor cost Services rendered
costs outside

Indirect
Other expenses in
material cost
cash
Indirect tool cost Depreciation cost

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2.4 Accounting for factory overhead costs

2.4 Accounting for factory overhead costs * Account used: Acc 627 - Manufacturing overhead cost
Acc. 627
* Source documents:
Manufacturing - Manufacturing overhead cost
- Salary and social insurance allocation sheet deduction
overhead cost
- Material allocation sheet
incurred during the - Allocate manufacturing
- Depreciation allocation sheets period overhead cost to cost centre
- VAT invoice, sale invoice
Detaited account
- Debit note issued by bank
- …. Acc 6271: Indirect labor cost Acc 6274: Depreciation cost
* Account used: Acc 627 – Manufacturing overhead cost Acc 6272: Indirect material cost Acc 6277: Service rendered outside

Acc 6273: Indirect tool cost Acc 6278: Other expenses paid in cash

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2.4 Accounting for factory overhead costs 2.4 Accounting for factory overhead costs
Allocation method
Variable manufacturing overhead cost

Detailed account of Acc627

Fixed overhead Total fixed overhead cost incurred Actual goods
X
Fixed manufacturing overhead cost is allocated on = Normal production capacity produced
cost cost center

+ If actual production < normal capacity ->….

•Fixed overhead cost under Total fixed Fixed overhead
+ If actual production > normal capacity ->…. _ cost is allocated
normal capacity is not = overhead cost
allocated in cost center incurred on cost center

Example:

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Ac. 627
Explanation:
Ac. 334,338
Ac. 111,112,138 (1) Indirect labor incurred
(1) (6)
(2) Indirect materials used
Ac. 152 (3) Tools and supplies are used for administrating the factory
(611),111,112… (2)
Ac. 154 (631) (4) Depreciation cost of fixed asset used in the factory
(8)
Acc 153 (611), 242… (5) Services and other expenses used for administrating the
(3) factory
(6) Decrease in factory overhead cost
Ac. 214 Ac. 632
(4) (7) Amount of fixed overhead costs not allocated
(7)
(8) Transfer (or allocate) of factory overhead cost to cost
Ac. 112,113,331… centre
(5)
Ac.133
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3.1 Perpetual inventory method

3 Accounting for cost of finished goods

3.1 Perpetual inventory method Account 154 “Work in progress”

3.2 Periodic inventory method  - Allocation of production
costs in the period
1.  Value of goods and materials,
expenses are rendered from
outside processing
 - Value of non-repairable
products
 Actual cost of finished goods
 Value of finished goods and
materials returned from
outside processing

Costs of work in progress

at the end of period
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Explanation:
3.1 Perpetual inventory method (1) At the end of the period, direct material expenses are
Ac. 621 Ac. 154 Ac.152,138,632... allocated to cost centre
(2) At the end of the period, direct labor expenses are
(1) (4)
allocated to cost centre
Ac. 155
(3) At the end of the period, factory overhead expenses are
allocated to cost centre
Ac. 622 (5)
(4) Value of non-repairable products is not counted into the
(2)
cost of finished goods
Ac. 632
(5) Cost of finished goods put in the store during the period
(6
(6) Finished goods directly transferred to customers, not
Ac. 627 through the warehouse
Ac. 157
(7) Finished goods sent on consignment to customers, not
(3)
(7) through the warehouse
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3.2 Periodic inventory method 3.2 Periodic inventory method

*Enterprises using the periodic inventory method:
Accounts used to reflect the total expenses and calculate Account 631 “Cost of products manufactured”
the cost of finished products:
Account 154 – Work in progress  - Opening balance of work in  - Value of finished goods and
progress completed services
Debit: Allocation of the closing balance of work in
 - Expenses incurred in the  - Closing balance of work in
progress accounting period progress
Credit: Reallocation of the opening balance of work in
progress
Debit balance: Work in progress at the end of period

Acc 631 has no ending balances

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Explanations:
3.2 Periodic inventory method
1. Reallocate opening balance of work in progress to account
Ac. 154
Ac. 631
631
(1)
Ac. 621
Ac.138,632... 2. At the end of the period, direct material expenses are
allocated to cost centre
(6)
3. At the end of the period, direct labor expenses are
(2)
allocated to cost centre
Ac. 622
4. At the end of the period, overhead expenses are allocated
(3)
to cost centre
Ac. 632
5. Allocation of the closing balance of work in progress to
account 154
Ac. 627
(7) 6. Value of non-repairable products is not counted into the
(4)
cost of finished goods
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