Principles of Cost

Accounting
Edward J. VanDerbeck

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Chapter 1

Introduction to Cost Accounting

2
Learning Objectives

LO1 Explain the uses of cost accounting

data.
LO2 Describe the ethical responsibilities
and certification requirements for
management accountants.
LO3 Describe the relationship of cost
accounting to financial and
managerial accounting.
3
Learning Objectives

LO4 Identify the three basic elements of

manufacturing costs.
LO5 Illustrate basic cost accounting
procedures.
LO6 Distinguish between the two basic
types of cost accounting systems.
LO7 Illustrate a job order cost system.

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1. The Need for Cost
Accounting
 Cost accounting provides the detailed cost
data that management needs to control current
operations and plan for the future.
 Companies must control costs in order to keep
prices competitive.
 In today’s global environment, cost information
is more crucial than ever in remaining
competitive.

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 Figure 1-1 illustrates the production
process for goods and services for which
cost accounting provides information.
Management uses this information to
decide how to allocate resources to the
most efficient and profitable areas of
the business.

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7
All types of business entities require cost
accounting information systems to track
their activities.

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The Manufacturing
Process
 This process involves the conversion of
direct (raw) materials, direct labor, and
factory overhead into finished goods.
 Product quality is an important competitive
weapon in manufacturing.
 Many companies require their suppliers to
be ISO 9000 certified.

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ISO 9000 Certification
 The International Organization for
Standardization created a set of five
international standards for quality
management, ISO 9000-9004.
 These standards require that
manufacturers have a well-defined quality
control system and they consistently
maintain a high level of quality.

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2. Uses of Cost
Accounting Information
Determining Product Costs and Pricing
 Cost accounting is used to determine
products costs and help with marketing
decisions.
1. Determining the selling price of a product.
2. Meeting competition.
3. Bidding on contracts.
4. Analyzing profitability.
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2. Uses of Cost
Accounting Information
 Planning is the process of establishing
objectives or goals for the firm and
determining the means by which the firm will
attain them. Effective planning is facilitated by
the following:
1. Clearly defined objectives of the manufacturing
operation.
2. A production plan that will assist and guide the
company in reaching its objectives.

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2. Uses of Cost
Accounting Information
 Control is the process of monitoring the
company’s operations and determining
whether the objectives identified in the
planning process are being accomplished.
Effective control is achieved through the
following:
1. Assigning responsibility.
2. Periodically measuring and comparing results.
3. Taking necessary corrective action.

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2.1. Assigning
Responsibility
 Responsibility accounting is the assignment
of accountability for costs or production results
to those individuals who have the most
authority to influence them.
 A cost center is a unit of activity within the
factory to which costs may be practically and
equitably assigned. The manager of a cost
center is responsible for those costs that the
manager controls.
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2.1. Assigning
Responsibility
 Cost and production reports for a cost
center reflect all cost and production data
identified with that center.
 The performance report will include only
those costs and production data that the
center’s manager can control.
 A variance is the favorable or unfavorable
difference between actual costs and
budgeted costs.
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Performance Report Example
Renaldi’s Restaurant
Performance Report
September 30, 2006
Budgeted Actual Variance
Expense Septemb Year-to- Septemb Year-to- Septemb Year-to-Date
er Date er Date er
Kitchen $5,500 $47,000 $5,200 $46,100 $300 F $900 F
Wages
Food 17,700 155,300 18,300 157,600 600 U 2,300 U
Supplies 3,300 27,900 3,700 29,100 400 U 1,200 U
Utilities 1,850 15,350 1,730 16,200 120 F 850 U
Total $28,350 $245,550 $28,930 $249,00 $580 U $3,450 U
0
F = Favorable

U=
Unfavorable
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2.2. Periodically measuring
and comparing results
 Actual operating results should be reviewed
periodically and compared to the objectives
established in the planning process
 The actual dollars, units produced, hours
worked, or materials used are compared
with the budget, which is management’s
operating plan expressed in quantitative
terms (units and dollars).

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2.3. Taking Necessary
Corrective Action
 Appropriate
corrective action
should be
implemented where
necessary. A
significant variance
from the plan is a
signal for attention.

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3. Relationship of Cost to Financial
and Management Accounting

 Financial accounting focuses on gathering

historical financial information to be used in
preparing financial statements that meet the
needs of investors, creditors, and other external
users of financial information.
 Management accounting focuses on both
historical and estimated data that management
needs to conduct ongoing operations and do long
range planning.

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3. Relationship of Cost to Financial
and Management Accounting

 Cost accounting includes those parts of both

financial and management accounting that
collect and analyze cost information. It
provides the product cost data required for
special reports to management (management
accounting) and for inventory costing in the
financial statements (financial accounting).

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 Cost vs. Financial and Managerial
Accounting
Cost Accounting System

Characteristics Financial Accounting Managerial Accounting

Users: •External Parties

•Managers Managers
Focus: Entire business Segments of the business
Uses of Cost Product costs for •Budgeting
Information: calculating cost of •Special decisions such as make or
goods sold and finished buy a component, keep or replace a
goods, work in process, facility, and sell a product at a
and raw materials special price.
inventory using •Nonfinancial information such as
historical costs and defect rates, % of returned products,
GAAP. and on-time deliveries
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 Cost vs. Financial and
Managerial Accounting
 Cost accounting includes those parts of both
financial and management accounting that collect
and analyze cost information.

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 Cost of Goods Sold

Merchandiser Manufacturer
Beginning merchandise inventory Beginning finished goods inventory

Plus purchases Plus cost of goods manufactured

Merchandise available for sale Finished goods available for sale

Less ending merchandise inventory Less ending finished goods
inventory
Cost of good sold Cost of good sold
•Note that the income statements for service businesses do not have a cost of goods sold section, because they provide a service rather than a product.

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 Inventories

Merchandiser Manufacturer
Current assets:
Current assets:
Cash
Cash Accounts receivable
Accounts receivable Inventories:
Finished goods
Merchandise Work in process
inventory
Materials
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•Service entities do not have inventories on their balance sheets because they provide a service rather than a product
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Valuation of Inventories

 Most manufacturers maintain a perpetual

inventory system that uses FIFO, LIFO, or
moving average methods of costing.
 An inventory ledger is maintained to
provide support for the control accounts.
 Some manufacturers may use a factory
ledger, which contain all of the accounts
relating to manufacturing.
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4. Elements of
Manufacturing Costs
 Direct materials
 Materials that become part of the finished good and can
be readily identified.
 Direct labor
 Labor of employees who work directly on the product
manufactured.
 Factory overhead
 Includes all costs related to production other than direct
materials and direct labor.

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 4. Elements of
Manufacturing Costs
Prime Cost and Conversion Cost

Direct Materials
Elements Prime Cost
of Cost
Direct Labor
Conversion
Factory Overhead Cost

Marketing expenses, general administrative costs, and other non-factory expenditures are not included in the costs of manufacturing.

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 Flow of Manufacturing
Costs

Direct Materials Work in Process Finished Goods

Direct Labor (Assets) (Assets)
Factory Overhead

Cost of Goods Sold

(Expenses)

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Illustration of Accounting
for Manufacturing Costs
 Materials xx  Factory Overhead (Utilities) xx
 Accounts Payable xx  Selling & Admin Exp (Utilities) xx
 Work in Process (Direct Materials) xx  Accounts Payable xx
 Factory Overhead (Indirect Materials) xx  Selling & Admin Exp xx
 Materials xx  Accounts Payable xx
 Payroll xx  Work in Process xx
 Wages Payable xx  Factory Overhead xx
 Wages Payable xx  Finished Goods xx
 Cash xx  Work in Process xx
 Work in Process (Direct Labor) xx  Accounts Payable xx
 Factory Overhead (Indirect Labor) xx  Cash xx
 Selling & Admin Exp (Salaries) xx  Accounts Receivable xx
 Payroll xx  Sales xx
 Factory Overhead (Depr. Bldg) xx  Cost of Goods Sold xx
 Selling & Admin Exp (Depr. Bldg) xx  Finished Goods xx
 Accum. Depr. – Bldg xx  Cash xx
 Factory Overhead (Depr. Mach & Eq) xx  Accounts Receivable xx
 Accum. Depr. – Mach & Eq xx

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Cost Accounting Systems
 Job Order Cost System
 Output consists of special or custom-made
products.
 Provides a separate record for the cost of each
quantity of these special or custom-made
products.
 Process Cost System
 Accumulates costs for each department or
process in the factory.
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Job Order Cost System

Direct Materials Work in Process Finished Goods

Direct Labor Account Account
Factory Overhead

Job Cost Sheets

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Process Cost System

Work in Process
Work in Process
Dept. 2 Finished Goods
Dept. 1

Direct Direct Direct Direct

Materials Labor Materials Labor

Factory Factory
Overhead Overhead

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Standard Cost System
 May be used with either a job order or a
process cost system.
 Uses predetermined standard costs to furnish a
measurement that helps management make
decisions regarding the efficiency of operation.
 Standard costs are costs that would be incurred
under efficient operating conditions and are
forecast before the manufacturing process
begins.

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Appendix
Standards of Ethical Conduct for
Management Accountants
 Members of the IMA have an obligation to
the public, their profession, the
organizations they serve, and themselves
to maintain the highest standards of
ethical conduct.
1. Competence
2. Confidentiality
3. Integrity
4. Credibility

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Appendix (cont.)
 Resolution of Ethical Conflict
 When applying the standards of ethical conduct, IMA
members may encounter problems in identifying
unethical behavior or in resolving an ethical conflict.
1. Discuss problems with the immediate superior except
when it appear that the superior is involved.
2. Clarify relevant ethical issues by confidential discussion
with an objective advisor.
3. Consult your own attorney as to legal obligations and
rights concerning the ethical conflict.

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