COST

ACCOUNTING
CYCLE
6.53

Chapter 3
LEARNING
OBJECTIVES
 Upon completion of this chapter, you should be
able to:

 Understand the cost accounting cycle.

 Distinguish between a merchandising and a

manufacturing activity.

 Distinguish between and account for direct

and indirect materials and labor as they are
used in the production process.

 Prepare the different financial statements

for a manufacturing entity.

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COST ACCOUNTING CYCLE
 The objective of accounting, in general, is the accumulation of financial information that is useful in
making economic decisions.
 Financial accounting focuses on the gathering of information to be used in the preparation of
financial statements that meet the needs of investors, creditors, and other external users of financial
information.
 Cost accounting provides the additional information required by the management, and also provides
data necessary for the preparation of external financial statement.
 Cost accounting procedures are necessary for the determination of cost of goods sold on the income
statement and the valuation of inventories on the balance sheet.

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 MANUFACTURING
INVENTORY ACCOUNTS
MATERIALS INVENTORY (CONTROL) ACCOUNT
 The Materials Inventory account is made up of the balances of materials
and supplies on hand.

WORK IN PROCESS INVENTORY

 All manufacturing costs incurred and assigned to products being
produced are classified as Work in Process Inventory costs.

FINISHED GOODS INVENTORY

 The Finished Goods Inventory account has same characteristics of the
Merchandise Inventory account.

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 MATERIALS INVENTORY ACCOUNT
 This account is maintained in much the same way as the
Merchandise Inventory account.
 Materials are usually not purchased for resale but for use in
manufacturing a product.
 An item taken out of Materials Inventory and requisitioned
into production is transferred to the Work in Process
Inventory account (not Cost of Goods Sold).
Figure 3-1. Merchandise Inventory vs Materials Inventory.

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 WORK IN PROCESS INVENTORY

Figure 3-2. The Work in Process Inventory Account.

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 FINISHED GOODS INVENTORY

Figure 3-3. Accounting for Finished Goods Inventory.

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 COST OF GOODS SOLD

MERCHANDISING MANUFACTURING

Beginning Merchandise Inventory Beginning Finished Goods Inventory

Plus: Purchases (Merchandises) Plus: Cost of Goods Manufactured

Merchandise Available for Sale Total Goods Available for Sale

Less: Merchandise Inventory, End Less: Finished Goods inventory, End

Cost of Goods Sold Cost of Goods Sold

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 ELEMENTS OF MANUFACTURING COST

DIRECT MATERIALS DIRECT LABOR FACTORY OVERHEAD

 The cost of material  The cost of labor for  Includes all costs related
which become part of those employees who to the manufacturing of a
the product work directly on the product except direct
manufactured and which product manufactured. materials and direct
can be readily identified labor.
with a certain product.

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 MANUFACTURING COST FLOW

Figure 3-4. Manufacturing Cost Flow.

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 MANUFACTURING COST FLOW

Figure 3-5. Manufacturing Cost Flow Basic Concepts

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 THE MANUFACTURING STATEMENT

 Financial statements of  However, a closer look shows  The key to preparing an income
manufacturing companies that the head Cost of Goods statement for a manufacturing
differ little from those of Manufactured is used in place company is to determine the cost
merchandising companies. of goods sold. The amount is the
of the Purchases account.
end result of a special
Also, the Merchandise manufacturing statement, the
Inventory account is replaced statement of cost of goods
by Finished Inventory manufactured, which is prepared
account. to support the figure on the
income statement.

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 STATEMENT OF GOODS MANUFACTURED AND SOLD

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 The Noeled Products Company is a small, newly organized company that manufactures dining tables and chairs. The company's products
are sold to jobbers or wholesale distributors, who in turn sell them to retailers. The basic steps in the company's manufacturing process are
as follows:
1. Lumber is cut to size for tabletops, legs, seats, arms, and backs.
2. The individual pieces of cut lumber are painted in various bright colors.
3. The pieces are assembled into tables and chairs.

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 The beginning Statement of Financial Position for the company on January 1 of the current year is presented below:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 To make things easy, let us assume that the company for the month of January makes only one style of table and no chairs. The following
transactions are completed for January and recorded, in summary form as follows:
1. Materials (lumber, paint, screws, lubricants, and solvents) are purchased on account at a cost of P 50,000.

Materials P50,000.00
Accounts Payable P50,000.00

2. During the month. direct materials (lumber and paint) costing P 40,000 and indirect materials (screws. lubricants for machine. and
solvents for cleaning) costing P 1,900 are issued to the factory.

Work in Process P40,000.00

Factory Overhead Control P 1,900.00
Materials P41,900.00

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ILLUSTRATION OF COST ACCOUNTING CYCLE

3. Total payroll for the month amounted to P36,000, consisting of P20,000 earned by laborers working on the product; P 7,000 for
factory supervision; P 9,000 for sales and administrative employees. The entry to record the payroll and the payment to employees
(ignoring payroll deductions) would be:

Payroll P36,000.00
Accrued Payroll P36,000.00

Accrued Payroll P36,000.00

Cash P36,000.00

4. The entry to record the distribution or classification of the payroll would be Work in Process:

Work in Process P20,000.00

Factory Overhead Control P 7,000.00

Selling and Administrative Expense Control P 9,000.00

Payroll P36,000.00

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ILLUSTRATION OF COST ACCOUNTING CYCLE

5. Depreciation expense, for the building is 6% per year. The office occupies One-tenth of the total building, and the factory operation is in
the other nine-tenths. The depreciation expense for one month is recorded as follows:

Factory Overhead Control P3,375.00

Selling and Administrative Expense Control P 375.00

Accumulated Depreciation – Building P3,750.00

6. Depreciation expense for machinery and equipment is 20% per year. All machinery and equipment is used in the factory for production
purposes, so the depreciation expense is charged to Factory Overhead Control.

Factory Overhead Control P2,500.00

Accumulated Depreciation – Mach. & Equipt. P2,500.00

7. The cost of heat, light, and power for the month was P3,000.
Factory Overhead Control P2,700.00
Selling and Administrative Expense Control P 300.00

Accounts Payable P3,000.00

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ILLUSTRATION OF COST ACCOUNTING CYCLE

8. Miscellaneous expenses for telephone, office supplies, travel, and rental of office furniture and equipment totaled P1,500.

Selling and Administrative Expense Control P1,500.00

Accounts Payable P1,500.00

After posting the journal entries to the appropriate ledger accounts, the factory overhead account will reflect the following debits.

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ILLUSTRATION OF COST ACCOUNTING CYCLE

9. Factory overhead is charged to production at 85% of direct labor cost:

Work in Process P17,000.00

Factory Overhead Control P17,000.00

The three elements of manufacturing cost - direct materials, direct labor, and factory overhead - are now accumulated in Work in Process, and
the debits, in the account are as follows:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

10. Assuming that all goods started in process have been finished, the following entry is recorded:

Finished Goods P77,000.00

Work in Process P77,000.00

Assuming that 1,000 tables were produced during the month, the unit cost is P77.00.The umit cost for each element of manufacturing cost is
calculated as follows:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 If the same type of table is produced in future periods, the unit costs of those periods can be compared with the unit costs determined
above, and any difference can be analyzed so that management might take appropriate action.
 The unit cost also serves as a basis for establishing the selling price of the tables.
 After considering the anticipated selling and administrative expenses, a selling price can be established that should provide a reasonable
profit.
 If management determines that a 40% gross profit percentage is necessary to cover the product's share of selling and administrative
expenses and earn a satisfactory profit, the selling price per unit, rounded to the nearest cent, would be computed as follows:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 To continue with the example, assume that the following transactions take place in January in addition to those already recorded.

11. Costs of materials, utilities, and selling and administrative expenses paid amounted to P 34,000.

Accounts Payable P34,000.00

Cash P34,000.00
12. 800 tables are sold to jobbers at a net price of P86,240.

Accounts Receivable P86,240.00

Sales P86,240.00

Cost of Goods Sold P61,600.00

Finished Goods P61,600.00

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ILLUSTRATION OF COST ACCOUNTING CYCLE

13. Cash totaling P55,000 is collected on accounts receivable.

Cash P55,000.00
Accounts Receivable P55,000.00

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 The accounts in the general ledger will reflect the entries as follows:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

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ILLUSTRATION OF COST ACCOUNTING CYCLE

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ILLUSTRATION OF COST ACCOUNTING CYCLE

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 From the trial balance, financial statements are prepared as follows:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 Schedule 1

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ILLUSTRATION OF COST ACCOUNTING CYCLE

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ILLUSTRATION OF COST ACCOUNTING CYCLE

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 At the end of the period, we compare the total of the Factory Overhead Control account and the Factory Overhead Applied account.
 In our example the factory overhead control (P17,475) is greater than the factory overhead applied (P17,000), that is why we have an
underapplied factory overhead which is considered unfavorable because the tendency is to increase the cost of goods sold.
 An increase in the cost of goods sold will lead to a decrease in the gross profit.
 However, if the factory overhead control account is less than the factory overhead applied, then what we have is overapplied factory
overhead which is considered favorable because the effect is a decrease in the cost of goods sold thereby increasing the gross profit.
 We assume, in our example, that the company is closing its underapplied/overapplied account at the end of the year, so no entry is made at
the end of the month.
 If the company is closing the factory overhead control and factory overhead applied account at the end of each month, the following entry
will be made at the end of the month.

Factory Overhead Applied P17,000.00

Underapplied Factory Overhead P 475.00

Factory Overhead Control P17,475.00

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 From the cost of goods sold statement, the following different equations are derived:

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ILLUSTRATION OF COST ACCOUNTING CYCLE

 The following formulas are also of importance with regards to the costs of goods sold statement.

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PROBLEMS
PROBLEM 1

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PROBLEM 2

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PROBLEM 3

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PROBLEM 4

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PROBLEM 5

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PROBLEM 6

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PROBLEM 7

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 THANK YOU
Joshua F. Abad, CPA
abad.joshua@gordoncollege.edu.ph

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