Cost Accounting Reviewer

Introduction
COST ACCOUNTING
Provides detailed cost information management needs:
Control operations
Plan for the future

Allocation of resources to most efficient and profitable areas of the business

Types of Business Entities (Relevance of Cost Accounting)
Manufacturers Convert purchased raw materials into finished goods through labor, technologies, and facilities.

Accounting system designed to accumulate detailed cost relating to the production process
Common to have cost accounting system that track costs incurred to produce and sell their diverse product lines
Major investment in physical assets; property, plant, and equipment
Other costs unique to manufacturers; Machine maintenance and repair, materials handling, production setup,
production scheduling, inspection

Other expenses in the production process similar to incurred by a merchandising concern:

Ex. Depreciation, Taxes, Insurance, and utilities
Other costs similar to those incurred by merchandisers and service businesses:
Selling and Administrative Expenses
Merchandisers Purchases finished goods for resale
Retailers individual consumption
Wholesalers purchases finished goods from manufacturers and sell to retailers
For-profit Service Businesses Sell services rather than products; Health Clubs, Accounting Firms, NBA Basketball Teams
Non-profit Service Agencies Provide services at little or no cost to the user; Charities, Governmental Agencies, Public Health
Care Facilities
Quality Standards
Product quality is as important a competitive weapon as cost control
ISO 9000 Family International standards for quality management
Origin
Originally issued for companies marketing products in Europe
Designed by the International Organization for Standardization, based in Switzerland
Standards
a well-defined quality control system
Consistently maintain a high level of product quality to enhance customer satisfaction
Achieve continual improvement of their performance in pursuit of these objectives
Accepted in 158 countries, 106 are member bodies with full voting rights on technical and policy issues
GE and Procter & Gamble require their suppliers to obtain ISO 9000 certification

Uses of Cost Accounting Information

Determining Product Costs and Pricing Cost accounting information must be designed to permit determination of unit costs
as well as total product costs, for example;
$100,000 for labor in a certain month is not, in itself, meaningful; but if this labor produced 5,000 finished units, the fact that the
cost of labor was $20 per unit is significant
Uses of Unit Cost Information

Cost Accounting Reviewer

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Determining the selling price of a product Set a price high enough to cover the cost of production, marketing, and
administrative expenses as well as to provide a satisfactory profit to the owners
Meeting competition Resolve pricing issues on products being undersold by competitors;
Bidding on contracts submit competitive bids to be awarded contracts
Analyzing profitability allocate scarce resources to those that are most profitable

Planning and Control

Planning The process of establishing objectives or goals and determining the means by which they will be met.
Effective planning is facilitated by the following:
1. Clearly defined objectives of the manufacturing operation;
a. Number of units to be produced
b. Desired quality
c. Estimated unit cost
d. Delivery schedules
e. Desired inventory levels
2. A production plan that will assist and guide the company in reaching its objectives.
a. Description of the manufacturing operations to be performed
b. Projection of human resource needs for the period
c. Coordination of the timely acquisition of materials and facilities
Cost accounting information enhances the planning process by providing historical costs that serve as a basis for future
projection
Control process of monitoring the companys operations to determine if objectives identified in the planning process are
being accomplished
Effective control is achieved as follows:
1. Assigning Responsibility Responsibility should be assigned for each detail of the production plan. Managers should
precisely know their responsibilities in terms of efficiency, operations, production and costs
Responsibility Accounting Assignment of accountability for costs of production results to those individuals with
most authority/ influence
Cost Centers Unit of activity within the company where costs may be practically and equitably assigned
Criteria for a cost center;
(1) a reasonable basis on which manufacturing costs can be traced or allocated
(2) a person who has control over and is accountable for many of the costs charged to that center
Cost and Production Report Reflects costs of a cost center in currency, and its production in units
Performance Report Includes those costs and production data that the manager can control
Variance Represents the amount by which the actual result differs from the budgeted/ planned amount
These reports must be furnished at regular intervals (monthly, weekly, or daily) on a timely basis.
2.

Periodically Measuring and Comparing Results

Actual operating results which may be made monthly, weekly, daily or even hourly is a major part or cost
control to compare current performance with the overall plan.

Actual amount spent, units produced, hours worked or materials used are compared with the budget

This comparison is a primary feature of cost analysis

3.

Taking Necessary Corrective Action

Appropriate corrective action should be implemented in problem areas and business plan deviations
identified through the performance reports

An investigation reveals a weakness to be corrected or a strength to be better utilized

Apart from the results of the operation, it is important to know how the resultsfavorable or
unfavorablecompare with the plan.

Cost Accounting Reviewer

Effective Planning and Control Model:

PLANNING
Clearly Defined Objective
Plan to Reach the Objective
CONTROL
Measure and Compare Results
Take Corrective Action;
Outcome will be the basis of Planning Objective for the next period

Relationship of Cost Accounting to Financial and Management Accounting

Financial Accounting
Focuses on gathering of historical financial information to be used in preparing financial statements such as;

Income Statement

Retained Earnings Statement; Changes in Equity

Balance Sheet

Statement of Cash Flows

External FunctionCreditors, Investors, Regulators etc.
Management Accounting
Focuses on both historical and estimated data that management needs to conduct ongoing operations and do longrange planning.
Cost Accounting
Includes both parts of financial and management accounting
Provides product cost data required for special reports to management (management accounting) and for inventory
costing in the financial statements (financial accounting)

Helps determine whether to make or buy a product component

Determines if a special order can be accepted at a discounted price

Determines the amount at which cost of goods sold should be reported on the income statement; and the
valuation of inventories on the balance sheet
Description Prepared by the Institute of Management Accountants
Users and Uses of Cost Accounting Information
Cost Accounting System
(Accumulates Cost Information)

Characteristics
Users:

Financial Accounting
External Parties (Shareholders, Creditors,
Regulators)

Management Accounting
Internal Parties

Managers
Focus:

Entire Business

Segments of the Business

Uses of Cost Information:

Product Costs for Calculating Cost of Goods Sold

(Income Statement) and Finished Goods, Work in
Process, and Raw Materials Inventories (Balance
Sheet) Using Historical Costs and Generally
Accepted Accounting Principles

Special Decisions Such as Make or Buy a

Component, Keep or Replace a Facility, and Sell a
Product at a Special Price
Nonfinancial Information Such as Defect Rates,
Percentage of Products Returned, and Percentage
of On-Time Deliveries (All of the Above Using a
Combination of Historical Data, Estimates, and
Future Projections

Cost Accounting Reviewer

Financial Accounting
(For inventory costing
purposes in the
financial statements)

Cost Accounting
(Product Cost
Information)

Management
Accounting
(For special reports to
management for
decision-making
purposes)

Cost of Goods Sold

Merchandising: Computation of Goods Sold

Manufacturing: Computation of Goods Sold

Beginning merchandise inventory

Beginning finished goods inventory

Plus Purchases (goods acquired for resale)

Plus cost of goods manufactured

Merchandise available for sale

Finished goods available for sale

Less Ending Inventory

Less Ending finished goods inventory

Cost of goods sold

Cost of goods sold

The format of the income statement for a manufacturer is not significantly different from that of a
merchandiser;
The cost accounting procedures needed to determine the cost of goods manufactured are considerably
more complex than the procedures needed to determine the cost of merchandise purchased in its
finished form
Income statements for service businesses do not have a cost of goods sold section, because they sell
service rather than a product

Inventories
Merchandising:
Cost of unsold items on hand at the end of an accounting period is reflected in the current assets section of the
balance sheet:
Current assets:
Cash
Accounts receivable
Merchandise Inventory

Cost Accounting Reviewer

Manufacturing:
Balance Sheet of a manufacturing business:
Current assets:
Cash
Accounts receivable
Inventories:
Finished goods total cost incurred in manufacturing goods completed but still on hand
Work in process manufacturing costs incurred to date for goods in various stages of production but not yet completed
Materials cost of all materials purchased and on hand to be used in the manufacturing process (ram materials,
prefabricated parts, and other factory materials and supplies

Service Entities do not have inventories on their balance sheet

Valuation of Inventories
Many procedures used to gather costs are unique to manufacturers
Manufacturers inventories are valued for external financial reporting purposes by using inventory costing
methodsuch as first-in, first-out (FIFO); last-in, first-out (LIFO)
Most manufacturers maintain a perpetual inventory system that provides a continuous record of
purchases, issues and balances of all goods in stock. Generally, these data are verified by periodic counts
of selected items throughout the year.
Under a perpetual system, inventory valuation data for financial statement purposes are
available at any time, as distinguished from a periodic inventory system that requires estimating
inventory during the year for interim financial statements and shutting down operations to
count all inventory items at year-end
Information from detailed cost data and perpetual inventory records are used to;
Control inventory levels
Ensure timely availability of materials for production
Detect pilferage, waste, and spoilage
Inventory Ledgers
Merchandisers and Manufacturers
Maintain various subsidiary ledgers
Account receivables
Accounts payables
Unique to Manufacturers
Subsidiary ledgers for the general ledger inventory control accounts
Finished goods
Work in process
Materials
**Subsidiary ledgers track support the balances in the control accounts and aid in managing the business on a daily
basis

Cost Accounting Reviewer

Elements of Manufacturing Costs

3 Basic Elements of Manufacturing or Production Cost
Direct Materials materials that become part of a certain manufactured product and can be readily identified
Rubber in athletic shoes
Wood used in making furniture
Fabric used in production of clothing
Screws, rivets, nails, and glue and other materials that actually become a part of the finished
product
Indirect Materials items used for general factory use; sandpaper for furniture, lubricants for machinery
Direct Labor the labor of employees who work directly on the product manufactured
Machine operators
Assembly line workers
Indirect Labor employees who are required for the manufacturing process but who do not work directly
on the units being manufactured; Department heads, inspectors, materials handlers, and maintenance
personnel
Payroll-related costs, such as payroll taxes, group insurance, sick pay, vacation and
holiday pay, and other fringe benefits are usually treated as indirect costs
Some companies treat the fringe benefits paid for direct laborers as additional direct labor cost
for the purpose of more precisely determining how much each hour of direct labor really costs
Factory Overhead includes all costs related to the manufacture of a product except direct materials and direct
labor
Includes indirect materials and indirect labor, plus other manufacturing expenses;
Depreciation on the factory building and the machinery and equiptment
Heat
Electricity
Maintenance
Insurance
Taxes
Summary of Manufacturing Costs
Prime cost combined costs of direct materials and direct labor
Conversion cost combined direct labor cost and factory overhead; costs which are necessary to convert the direct
materials into finished goods

Direct Materials
Elements
of Cost

Prime Cost
Direct Labor
Conversion Cost
Factory Overhead

Cost Accounting Reviewer

Marketing expenses, general administrative costs, and other non-factory expenditures are not included in
the costs of manufacturing
Some costs incurred by a manufacturer, however, may benefit both factory and non-factory operations. In
this situation, an allocation of cost must be made to each business function
Depreciation
Insurance
Property taxes on building that houses both factory and administrative offices

Flow of Cost
Direct Materials
Direct Labor
Factory Overhead

Work in Process
(Assets)

Indirect labor, indirect

materials and other
factory materials

Finished Goods
(Assets)

Cost of Goods
Sold
(Expenses)

Cost Accounting Reflected on Ledgers

Both the cost of direct and indirect materials appears in the general ledger
Direct materials issued are charged directly to the work in process control account because they can be
readily traced to the individual jobs
Indirect materials are charged to the factory overhead account because they cannot be easily identified
with specific jobs
The factory overhead account will be used to accumulate various factory expenses that will later be
allocated to individual jobs using some equitable formula
Wages earned by employees working directly on the product are charged to Work in Process
The salaries and wages of the factory supervisor and the maintenance and custodial personnel are
charged to Factory Overhead as indirect labor
The salaries of non-factory employees are debited to the selling and administrative expenses account
To focus on cost accounting procedures as distinguished from general accounting procedures, the
general ledger account Selling and Administrative Expenses will be used to accumulate all nonmanufacturing expenses
Usually, separate general ledger control accounts would be established for individual selling and
administrative expenses.
Only costs directly related to production should be charged to Factory Overhead
A manufacturer may incur many

Mark on Percentage a percentage of the manufacturing cost per unit added to manufacturing cost which will
determine the selling price

In later periods, owing to intense competition, it might be found that an item cannot be sold at a price
that will be high enough to cover all of its cost and provide a normal profit margin