CHAPTER 3 Cost Accounting Cycle Learning Objectives At the end of the chapter, the learner should be able to: Y Analyze the conversion process in manufacturing companies. Y Classify the elements of manufacturing costs. Y Classify the inventory accounts for manufacturing companies. Y Calculate the cost of goods manufactured and sold and prepare an income statement for manufacturing companies. Y Prepare the pro-forma entries of the common transactions for manufacturing companies. Cost Accounting Cost accounting is an expanded phase of financial accounting which informs management promptly with the cost of rendering a particular service, buying and selling a i product, and producing a product. It is the field of accounting that measures, records and reports information about costs, 49 RETTypes of Manufacturing Costs: 1) Direct Materials These refer to materials used in the manufacturing process that becomea significant part of the finished goods, Examples are wood to manufacture a table, flour to produce cakes, glass to produce windows, Not all materials used to produce a product are direct because it depends on the significance of the materials for the production of a produgt, Materials which are not considered direct materials ate classified as indirect material, which are part of another manufacturing cost, factory overhead. 2) Direct Labor ‘These are salaries paid to employees who work directly with the raw materials in converting them to finished goods. Examples are those who are paid to manufacture the table, to bake the cakes and to make the windows. Therefore, salaries of those employees who are not working directly to the products are not direct labor. 3) Factory Overhead All costs incurred in the factory that cannot be considered as direct materials or direct labor are factory overhead. Sometimes called manufacturing overhead, manufacturing expenses, or factory burden. Manufacturing overhead is usually subdivided into three categories: a. Indirect Materials - Materials that are used in small amounts in the manufacturing process or that cannot easily be traced to specific products. Examples are nails and sandpapers used to produce furniture. b. Indirect Labor - Wages of factory personnel who do not work directly on nw materials. An example is the salary of factory supervisor. ¢. Other Manufacturing Overhead - Includes payroll taxes on factory wages, renton factory building, depreciation of factory building, insurance on factory building and machinery, heat, light and power; repairs and maintenance of machinery an ‘equipment, etc. Many of these relate to physical plant (building, machinery, and equipment) Prime Cost Prime cost reflects the primary sources of costs for units in production.lt is the sum! disect materials and direct labor, Conversion Cost Conversion cost indicates the costs required to convert the raw materials into finish! products, It is the sum of direct labor and factory overhead, 50Inventories for a Manufacturing Company 1, Raw Materials Inventory ‘This inventory represents the materials still unused at the end of a period, 2. Work in Process Inventory This inventory represents the cost of goods placed in the production but not yet finished at the end of the period, Cost of goods means the costs of raw materials, labor and overhead incurred in the production of goods. ‘This is also called as Goods in Process Inventory 3. Finished Goods Inventory This inventory represents the cost of goods already manufactured and ready for sale during a period but not yet sold at the end of the period. Systems of Cost Accumulation This system uses the “actual” costs of materials, labor and factory overhead in determining the total cost of a product. Standard Cost System ‘This system uses the “standard” or predetermined costs of materials, labor and. factory overhead in determining the total cost of a product. 3. Normal Cost System This system uses actual cost of materials, actual cost of labor and applied factory overhead in determining the total cost of a product. Question: ‘What is the difference between actual and applied overhead? Answer: Actual factory overhead is the factory overhead “actually” incurred during a period while applied factory overhead is measured using a pre-determined rate or application rate multiplied by the actual activity level or cost driver for a period. Predetermined/ =, Budgeted annual factory overhead application rate Budgeted annual activity level ‘The commonly used activity levels in computing predetermined overhead rate are: Units produced Direct labor hours Direct labor costs Machine hours Material costs SLRecording Transactions of a Manutacturing Guimpany ‘Transactions Pro-forma Entry Acquisition/purchase of raw mat Raw materials XX Cash/Accounts payable 2 | Return of materials to supplier _ | Cash/Accounts payable XX Raw materials 3 [Issuance of raw materials to Work in process XX | production FOH-control XX | 4. Direct materials, Raw materials | b Indirect materials | 4 [Return of excess materials from_ | Raw materials XK | | | production department Work in process | FOH-control S| Payroll fora specified period | Payroll XX Withholding tax payable SSS contributions payable PHILHEALTH cont. payable PAG-IBIG cont. payable Accrued payroll & | Employer’ share for contribu- | FOH-control XX tions Selling expense XX Administrative expense xX, SSS contributions payable PHILHEALTH cont. payable PAG-IBIG cont. payable Distribution of payroll Payment of payroll | Payrol Work in process Factory overhead-control Selling expense Administrative expense ‘Accrued payroll Cash Withholding tax payable $88 contributions payable PHILHEALTH cont, payable PAG-IBIG cont. payable Cash aeI i he t 10] Incurrence of various overhead, | Eactory overhead-control XX her than indirect lak Accumulated depreciation Xxx indirect materials 1 insurance Xx Depreciation of factory plant | Various accounts xXx & equipment Maintenance of factory plant & equipment Insurance of factory plant & equipment Power, light and water Ti [Overhead is applied to Work in process XX production Factory overhead-control XX 12 | Completion of goods put into | Finished goods XX, process _ Work in process XX 13, | Sale of goods on account ‘Accounts receivable XX Sales XX ost of goods sold XX Finished goods XX Discussions: 1). Manufacturing companies usually use the perpetual inventory system. Under perpetual inventory system, every physical flow of inventories, inflow or outflow must be recorded using the appropriate inventory account, Therefore, at the time the materials are purchased, the Raw Materials account is debited instead of Purchases account which is used in the other system, periodic inventory system. 2) Incase of returns of materials purchases, the entry is simply to reverse the entry made in the materials purchases. 3) If the raw materials are issued to production, this means that these are no longer raw materials and the Raw Materials account should be credited and debited to Work in Process account if the materials issued are direct materials and Factory Overhead- Control account if the materials are indirect. 4) Issuing of materials to production does not necessarily mean that these will be immediately used. Therefore, there are some instances that after the issuance, some materials are returned to materials stockroom and the entry to record this transaction is to simply preverse the entry made in the issuance, 5) A payroll serves as a list of employees of a company that will be given salaries for a period. This includes the gross salary, payroll deductions such as withholding taxes, contributions to 88S, PHILHEALTH and PAG-IBIG and the net salary. Italso includes 53the employer's share for , PHILHEALTH and PAG-IBIG. Payroll account is debited for an amount representing the total gross pay of all employees, whether they are related to manufacturing, sales or administrative functions. Withholding tax, SSS, PHILHEALTH and PAG-IBIG Contributions payable accounts are credited at amounts equal to the “employee” share, Note that the Accrued Payroll account credited represents the net pay. 6) Employer's share for the salaries’ deductions is expense oni the part of the company. Therefore, expense accounts are debited to record such transactions depending on the nature of the expense, If the employers share relates to the salaries of factory employees, Factory Overhead-Control account is debited. If this relates tothe salaries of employees related to sales functions, Selling Expense is used and if this relates to the salaries of related to administrative functions, Administrative Expense is debited. employ 7). Distribution of payroll means proper classifying the Payroll account. At the time the salaries/wages are incurred, the Payroll account is debited with that which represents the total salaries of all employees of the company at gross amounts. But it must be subsequently classified if these are related to the salaries of manufacturing, sales or administrative personnel, Salaries of manufacturing personnel, if directly working on the product (direct labor) must be debited to Work in Process account. Salaries of manufacturing personnel, if not directly working on the product (indirect labor) must ‘be debited to Factory Overhead-Control account. Salaries of sales personnel are debited to Selling Expense and the salaries of personnel related to administrative functions are debited to Administrative Expense. 8) Once the salaries of employees are paid, the Accrued Payroll account must be debited with the amount equivalent to the payment. 9) The payroll process includes withholding of payroll deductions and incurrence of employer's contributions. These deductions are withheld from the salaries of employees but these should subsequently be remitted to corresponding government agencies such 4s BIR, SSS, PHILHEALTH and PAG-IBIG. At the time these were withheld/incurred, the entry was a credit to each of the appropriate liability accounts, Therefore, at the time of their remittance, the entry must be a debit in order to close those liabilities and credit cash to represent the payment. 10) All factory overhead items actually incurred during a period shall be debited to factory overhead-control account. The accounts credited depend on the specific account incurred, For instance, the pro-forma entry includes a credit to Accumulated Depreciation account because the factory overhead item is related to depreciation and the entry to record depreciation ts debit Depreciation Expense and credit Accumulated Depreciation. In short, the account debited is the only account that should be substituted by factory overhead-control account and the credit should be the same.11) The pro-forma entry shows that the company uses actual costing because the account credited is factory overhead-control account. The amount that is credited to this account is equivalent to the sum of all factory overhead actually incurred during a period. Alternatively, if a company uses normal costing, factory overhead-applied is credited. 12) Once the goods placed in production are already completed, the entry is to credit WIP and to debit FG to reclassify the inventory from “in process” to “finished”: 13) Accounts Receivable is debited and Sales account is credited by an amount equivalent to the sales price of the goods sold, Finished Goods account is credited by an amount equal to the cost of goods sold because the goods are already sold and are no longer in the possession of the company. Mustration: Given the following information for McCurley Corporation, prepare the necessary journal entries, assuming that the Raw Material Inventory account contains both direct and indirect material. a. Purchased raw materials on account, P28,500. b. Issued materials to production: P15,000 of direct materials and P3,000 of indirect materials. «Accrued payroll of P90,000, of which 70 percent was direct and the remainder was indirect. 4. Incurred and paid other overhead items, P36,000. Completed goods costing P86,500. £. Sold goods costing P71,300 on account for P124,700. Solution: a Raw Materials 28,500 Accounts Payable 28,500 b. Work in Process 15,000 Factory Overhead-Control 3,000 Raw Materials 18,000 © Work in Process 63,000 Factory Overhead-Control 27,000 Salaries/Wages Payable ‘ 90,000 d Factory Overhead-Control 36,000 Cash 36,000 55€. Finished Goods 86,500 Work in Process, 86,500 £ Accounts Receivable 124,700 Sales 124,700 Cost of Goods Sold 71,300 Finished Goods 71,300 Pro-forma Cost of Goods Sold Statement for Manufacturing Companies: Raw materials, beginning xxx Raw materials purchases xxx Raw materials available for use co Raw materials, end (20x Raw materials used xa Direct labor xxx, Factory overhead x Total manufacturing cost 2X Work in process, beginning “Total work placed in process Work in process, end Cost of goods manufactured Finished goods, beginning Total goods available for sale Finished goods, end Cost of goods sold Mlustration: Prepare a Schedule of Cost of Goods Statement (in good form) for the Luffy Comps" from the following information for June 2016: Inventories Beginning Ending Raw Material P 6,700 P8,900 Work in Process 17,700 22,650 Finished Goods 29,730 19,990 Additional information: purchases of raw materials were P-46,700; 19,700 direct ls” hours were worked at P11.30 per hour; overhead costs were P33,300,Solution: Raw materials, beginning P 6,700 Raw materials purchases 46,700 Raw materials available for use P 53,400 Raw materials, end (8900 ) Raw materials used P 44,500 Direct labor (19,700 hrs x P11.30/hr) 222,610 Factory overhead 33,300 Total manufacturing cost P 300,410 Work in process, beginning 17,700 Total work placed in process P 318,110 Work in process, end ( 22,650 ) Cost of goods manufactured P 295,460 Finished goods, beginning 29,730 Total goods available for sale P 325,190 Finished goods, end (19,990 ) Cost of goods sold PB Over and Under-applied Factory Overhead Over or under-applied factory overhead is the difference between the actual and applied factory overhead. If the factory overhead applied during a period is higher than the actual, it is said to be over-applied and under-applied if ovehead applied is lower than the actual. This account is just a temporary account and will eventually be closed at the end of a period. This over or under-applied factory overhead can be material (significant) or immaterial (insignificant) in relation to cost of goods sold and the inventory accounts. If immaterial, the over or under-applied factory overhead is closed to cost of goods sold only. But if the cover or under-applied overhead is material, it is closed to cost of goods sold and appropriate inventory accounts. Question: What are these appropriate inventory accounts? Answer: Work in Process and Finished Goods Inventory only. Materials Inventory account is not included because the application process of factory overhead comes first through Work in Process Inventory account, Work in Process : xx Factory Overhead-Applied =x Note that actual factory overhead is the sum of all factory overhead-control debited during a period and the normal balance of factory overhead-applied is credit. a7pro-forma entries for closing over or under-applied factory overhead: 1) Immaterial under-applied factory overhead Factory overhead-applied xx Cost of goods sold xx Factory overhead-control x 2) Immaterial over-applied factory overhead Factory ovethead-applied xx Cost of goods sold xx Factory overhead-control x Material under-applied factory overhead Factory overhead-applied Cost of goods sold Work in process Finished goods Factory overhead-control x goo s Material over-applied factory overhead Factory overhead-applied x Cost of goods sold Work in process Finished goods Factory overhead-control gee e If the over or under-applied factory overhead is material, this amount is closed not only to Cost of Goods Sold but also to Work in Process and Finished Goods allocated based ox the amounts of factory overhead applied to each of COGS, WIP and EG if still possible determine. But if this is not determinable, the allocation should be based on the balances of COGS, WIP and FG. iMustration: ‘. Hume Corporation has the following data for the current year: Direct Labor P 220,000 Direct Material 137,800 Actual Overhead + 320,000 ‘Applied Overhead 395,000 S Raw Material 51,394 . Work in Process 101,926 Finished Goods 111,192 Cost of Goods Sold 250,182Required: 1, Compute the amount of under- or overapplied overhead 2. Prepare the necessary journal entry to dispose of under- or overapplied overhead Solution: 1) Applied Overhead 395,000 Actual Overhead 320,000 Overapplied Overhead Since, the amounts of factory overhead applied to COGS, WIP and FG are not cterminable; the allocation is based on the balances of those accounts. wip P101,926/P463,300 x = P16,500 FG P111,192/P463,300 x P18,000 COGS — P250,182/P463,300 x 40,500 P463,300 75,000 Factory Overhead-Applied 75,000 Work in Process P16,500 Finished Goods 18,000 Cost of Goods Sold 40,500 59Date: Name: Rating: Year and Course: EXERCISES PROBLEM-SOLVING Problem 1 Instruction: Determine whether each of the following costs should be classified as direct materials (DM), direct labor (DL), or factory overhead (FOH). Depreciation on factory equipment —. Wages paid to assembly line workers Factory rent 4. Depreciation of pencil painting machinery Lead inserted into pencils 6. Wages of assembly line worker ——7. Factory machinery maintenance . Wood used to manufacture furniture ). Eraser compound 10, Steel used in manufacturing product. ———I1. Insurance on factory building. ———12. Rivets and screws used in production. ———13. Tires used in manufacturing vehicles. ———I4. Nails and glue used in production 5. Cabinet maker's wages . Factory supervisors’ salaries . Depreciation on factory machines . Factory utilities ), Property taxes on the factory building ). Insurance on factory equipment 61Problem 2 Manny Manufacturing Company has the following data at June 30, 2016: Raw materials inventory, June 1 P 13,800 Work in process inventory, June 1 18,100 Finished goods inventory, June 1 13,500 Total manufacturing costs 510,000 Sales 590,000 Work in process Finished goods Raw materials inventor nventory, June 30 30,400 tory, June 30 50,200 June 30 18,000 Required: Prepare an income statement through gross profit for the month of June Problem 3 The following information is for the Mojacko Manufacturing Company for November. Inventories Beginning Ending Raw Material P 17,400 P 13,200 Work in Process 31,150 28,975, Finished Goods 19,200 25,500 Direct Labor (21,000 DLH @ P13) Raw Material Purchases P 120,000 Indirect Labor 11,200 Factory Supplies Used 350 Other Expenses: Depreciation ~ Factory Equipment 17,300 Insurance - Office Building 2,570 Office Supplies Expense 900 Insurance - Factory Building 1,770 Depreciation - Office Equipment 3,500 Repair & Maintenance - Factory Equipment 7,400 Required: Prepare the Cost of Goods Sold section of Mojacko Manufacturing Comps" income statement,Problem 4 From the following information for the Doraemon Company, compute prime costs and conversion costs, Inventories Beginning Ending Raw Material P9,900 P 7,600 Work in Process 44,500 37,800 Finished Goods 36,580 61,300 Raw materials purchased during the period cost P40,800; overhead incurred and paid or accrued for the period was P21,750; and 23,600 direct labor hours were incurred at a rate of P13.75 per hour. The following miscellaneous data has been collected for a manufacturing company for the most recent year-end: Inventories Beginning Ending Raw material 50,000 55,000 : Work in process 40,000 45,000 : Finished goods 60,000 50,000 : Costs recorded during the year: : Purchases of raw material 195,000 . : Direct labor 150,000 Cost of goods sold 595,000 "Required: Prepare the Cost of Goods Sold section of Doraemon Company income state- ment 63Problem 5 Selected data concerning the past fiscal year’s operations (000 omitted) of the Clark | ‘Manufacturing Company are presented below: : Inventories Beginning Ending Raw materials p75 Pas Work in process 80 30 Finished goods, 90 110 Other data: Raw materials used P 326 Total manufacturing costs incurred (FOH is applied at a rate of 60% of DL) 686 Cost of goods available for sale 826 Selling and general expenses 25 Required: Compute for the following: 1. Cost of raw materials purchased during the year. 2. Direct labor costs charged to production during the year. 3. Cost of goods manufactured. 4. Cost of goods sold. Problem 6 ‘The following events took place at the Dreams Company for the current year: + Purchased P120,000 in direct materials +, Incurred labor costs as follow: a. Direct labor, P72,000 b. Supervisor labor, P26,000 (part of FOH) + Purchased manufacturing equipment for P94,000 “4 Other manufacturing overhead excluding supervisor labor, was P88,000 «Transferred 80% of the materials to the manufacturing assembly line + Completed work on 70% of the goods in process, Costs are assigned equally across all | work in process » Sold 60% of the completed goods ‘There were no beginning balances in the inventory accounts. All costs incurred wert debited to the appropriate account and credited to accounts payable. Required: Compute for the following: 1.. Ending balance of direct materials inventory. 2. ‘The amount of cost of goods told, 64 iProblem 7 In June 2016, the Lufly Company has Cost of Goods Manufactured of 296,000. beginning Finished Goods Inventory of P29,730; and ending Finished Goods Inventory of 19,990. The following additional information is available Selling Expenses P 40,500 Administrative Expenses 19,700 Sales 475,600 Required: Prepare an income statement for Lufly Company for the month ended July 31 + 2016. MULTIPLE-CHOICE 1. Direct labor is a: Conversion Cost — Manufacturing Cost. Prime Cost a Yes Yes Yes : b No Yes Yes : « No No No a No No Yes (AICPA, Adapted) 2. A factory overhead cost: a, isa direct cost b. isa prime cost c. canbea variable cost or a fixed cost d. can only bea fixed cost (AICPA, Adapted) | —_3. Which of the following costing methods of valuation are acceptable in a job order costing system? Actual Standard Actual Predetermit Material Material Labor Overhead Cost Cost Cost Cost a yes yes no yes. byes no no yes «no yes yet yes 4. yes yes yes 65