MODULE 1 - Introduction To Cost System
MODULE 1 - Introduction To Cost System
Introduction
Management needs prompt cost information in the decision-making process. In any type of organization, be it business,
political, religious or civic, it is imperative for management to be aware not only of its total costs and expenses, but
also of the specific product, department or activity for which they are incurred, costs per unit and per work unit of its
products and services, respectively, and of whether the amounts incurred are in accordance with the financial plans and
standards.
COST DEFINED
- The cash or cash equivalent value sacrificed for goods and services that are expected to bring a current or
future benefit to the organization.
- Expired costs are called expenses. In each period, expenses are deducted from revenues in the income
statement to determine the period’’s profit.
- Loss – a cost that expires without producing any revenue benefit.
● Cost determination. This refers to accumulation of cost data by products, processes or services to be able to
arrive at unit cost or cost per work unit*.
● Cost control. Standards are set for costs per unit and per work unit and are subsequently compared with the
figures per actual operations so that remedial measures may be adopted.
Cost accounting facilitates the performance by management of its planning and control functions. Cost standards are
established for materials, labor and factory overhead based on product design, time and motion studies, and analysis
of factory overhead. These standards subsequently serve as bases in measuring performance and as deterrents to
pilferages and unnecessary wastages of materials and inefficiency of manpower.
Page | 1
Cost Accounting, Financial Accounting and Management Accounting
The recording of the costs of a product or a service is part of financial accounting. The use of cost
for valuation of inventory and cost of goods sold for external reporting is also financial accounting. The
use of cost data in choosing between two or more alternatives is part of managerial accounting. Differential
cost analysis is considered by others as a form of applied microeconomics. Cost accounting provides data
for use in decision models for finance, operations management, and marketing. Cost accounting is also
related to motivation and behaviour because it is used in planning and performance evaluation. Finally,
tools from statistics, mathematics, and computer sciences are used to perform cost analysis.
Page | 2
USES OF COST DATA
Cost data provides management with a basis in making decisions and these may involve the following:
● Price setting. Selling prices are set based on desired profit and incremental costs.
● Choice of product line. A product may be dropped or added based on estimated contribution to
company’s income.
● Make or buy. The company may decide to buy its product instead of continuing to manufacture it
depending on the relevant costs involved.
● Contraction or expansion. A department, agency, branch or an affiliate may be closed or added
based on the estimated decrease or increase in revenue, costs and expenses.
● Temporary shutdown. Management may opt for temporary cessation of operations during slump
seasons based on estimated decrease in both revenue and costs.
CLASSIFICATION OF COSTS
1. Costs classified as to relation to a product
a. Manufacturing costs/ product costs
i. Direct materials
- materials that become part of a finished product and can be conveniently and
economically traced to specific product units.
- Examples:
Iron ore for steel
Sheet steel for automobiles
Flour for bread
- The way a company buys, stores, and uses materials is important.
Timely purchasing is important because if the company runs out of materials, the
manufacturing process will be forced to shut down. Shutting down production results
in no products, unhappy customers, and loss of sales and profits.
- Buying too many direct materials, on the other hand, can lead to high storage costs.
ii. Direct labor costs
- Wages of machine operators and other workers involved in actually shaping the
product.
- Include all labor costs for specific work performed on products that can be
conveniently and economically traced to end products.
- Indirect labor costs
- Labor costs for production related activities that cannot be conveniently and
economically traced to end products
- accounted for as part of factory overhead costs
- include the wages and salaries of
Machine helpers
Supervisors
Other support personnel
iii. Factory overhead
- A catchall for all the manufacturing costs that cannot be classified as direct materials
or direct labor costs.
- A varied collection of production – related costs that cannot be practically or
conveniently traced directly to end products.
- Also called
Manufacturing overhead
Factory burden
Indirect manufacturing costs
Page | 3
b. Non-manufacturing costs/ period costs
i. Marketing or selling expense –
- Include all costs necessary to secure customer orders and get the finished product or
service into the hands of the customer
- Often referred to as order-getting and order-filling costs.
- Examples:
a. Advertising d. Sales commissions
b. Shipping e. Sales salaries
c. Sales travel
Page | 4
4. Costs classified to their nature as common or joint
a. Common costs
- Costs of facilities or services employed in two or more accounting periods,
operations, commodities or services.
- Subject to allocation.
b. Joint cost
- Costs of materials, labor and overhead incurred in the manufacture of two or more
products at the same time.
- Major difficulty inherent to joint cost – they are invisible and they are not specifically
identifiable with any of the products being simultaneously produced.
- Subject to allocation.
5. Costs classified as to relation to an accounting period
a. Capital expenditures
- Expenditure intended to benefit more than one accounting period and is recorded as
an asset.
- The allocation of the cost to the different periods is
a. Depreciation for fixed tangible assets
b. Amortization for intangible assets
c. Depletion for wasting assets
b. Revenue expenditures
- Expenditure that will benefit current period only and is recorded as expense
6. Costs for planning, control and analytical processes
a. Standard costs
- Predetermined costs for direct materials, direct labor, and factory overhead.
- Established by using information accumulated from past experience and data secured
from research studies.
b. Opportunity costs
- The benefit given up when one alternative is chosen over another.
- Not usually recorded in the accounting system.
- However, it is considered when evaluating alternatives for decision-making.
- If an asset can be used to perform only one function and cannot be sold or used in
other ways, the opportunity cost of that asset is zero.
c. Differential costs
- Cost that is present under one alternative but is absent in whole or in part under
another alternative.
- Encompasses both cost increases and cost decreases between alternatives.
d. Relevant costs
- A future cost that change across the alternatives.
- Examples:
a. Cost of goods sold c. Commissions
b. Advertising d. Warehouse depreciation
e. Out-of-pocket cost
- Cost that requires the payment of money (or other assets) as a result of their
incurrence.
f. Sunk cost
- A cost for which an outlay has already been made and it cannot be changed by present
or future decision.
Page | 5
g. Controllable cost
- A cost is considered to be a controllable cost at a particular level of management if
that level has power to authorize the cost.
- Example:
a. Entertainment expense would be controllable by a sales manager if he or
she had power to authorize the amount and type of entertainment for
customers.
b. On the other hand, depreciation of warehouse facilities would not be
controllable by the sales manager since he or she would have no power
to authorize warehouse construction.
Materials
Materials purchases Purchase returns
Freight in Purchase discounts
Returns of materials previously issued Materials issued
Work in Process
Materials, labor and factory overhead Cost of goods manufactured
charged to production
Finished Goods
Cost of goods manufactured Cost of goods sold
Cost of returned goods which were Goods returned to factory
previously sold for reprocessing
Page | 6
Flow of cost as reflected by postings to both controlling accounts and subsidiary records – Next page
- They may be used under both periodic and perpetual inventory methods because they do not affect
the inventories. They are:
o Factory overhead control
o Selling expenses control
o General and Administrative Expenses Control
o These are supported by subsidiary records or analysis sheets.
Example: The company pays for the following: Factory supplies – P 600; factory repairs – P 500; store
supplies – P 300; and office supplies – P 200.
The journal entry and the corresponding postings to be made on subsidiary records would be as
follows:
The footings per subsidiary records must tally with the balances per controlling accounts in the general
ledger.
- Similar to that under the non-cost system with the exception of the account titles affecting cost of
goods manufactured and cost of goods sold.
- The chart of accounts as given under the non-cost system is revised and is shown below.
Page | 7
22 Materials inventory 72 Patents
26 Prepaid Insurance 79 Other Intangible Assets
39 Miscellaneous Prepaid Items
Plant, Property and Equipment (40-69) Other Assets (80-89)
41 Land
42 Buildings Other Assets (90-99)
42.1 Accumulated Depreciation – Buildings
44 Machinery and Equipment – Factory
Page | 8
336 Repairs and Maintenance – Buildings 551 Depreciation Expense – Buildings
337 Repairs and Maintenance – Machinery 552 Depreciation Expense – office Furniture
and Equipment and Fixtures
351 Depreciation Expense- Buildings 599 Miscellaneous General and
Administrative Expenses
352 Depreciation Expense- Machinery and Other Income (600-619)
Equipment
399 Miscellaneous Factory Overhead 601 Income from Investments
602 Interest Income
Selling Expenses (400-499) 603 Rental Income
401 Selling Expenses Control 604 Commission Income
402 Salaries – Sales Supervision 605 Miscellaneous Income
403 Salaries – Salesgirls
404 Salaries – Clerical Help Other Expense (620-629)
405 Sales Commissions 621 Interest Expense
411 Delivery Expense
416 SSS Contributions Income Deductions (630-639)
417 Medicare Contributions 631 Provisions for Income Tax
418 Pagibig Contributions
419 Employees’ Compensation Premiums Temporary Account
425 Telephone and Telegraph 700 Payroll
426 Light, Power and Water
- When transactions are voluminous and/or the factory is far from the main office,
manufacturing transactions are preferably recorded in a factory journal and posted to the
factory ledger.
o This requires the use of reciprocal accounts General Ledger (for the factory) and
Factory Ledger (for the main office) when a transaction affects accounts found in both
books.
- Factory Ledger – refers to the book of final entry for manufacturing operations, or
o the account title used by main office in recording transactions affecting accounts
found in both the books of the factory and the main office.
- The accounts carried on factory books are those used in recording manufacturing operations.
- Factory fixed asset accounts – may either be in the books of the factory or the main office.
o If the problem is silent, they are assumed to be on factory books.
o The accounts that must be on books of the factory are:
▪ Materials ▪ Plant, Property and Equipment ▪ Factory Overhead Control
▪ Work in Process ▪ Accumulated Depreciation ▪ Factory Overhead Variance
▪ Finished Goods ▪ Applied Factory Overhead ▪ General ledger
o The factory may have its own petty cash fund so that this account may also be found
on its books
- All functions other than manufacturing are taken care of by main office so that
o Disbursements
o collections
o sales and the corresponding expenses
involved are recorded on the main office books.
Page | 9
Transfer Voucher
- an intra-company form used to inform the factory when transactions are entered into by the
main office but the same affect manufacturing accounts
- Example
o The main office buys machinery for the factory for P 30,000. Factory fixed assets are
carried on factory books.
▪ a transfer voucher is prepared by the main office informing the latter of the
transaction and to the effect that the factory ledger is debited by the main office for P
30,000.
▪ Based on this, the entries on both books are:
Page | 13
JOB ORDER COSTING AND PROCESS COSTING
Nature of products:
Heterogeneous Homogeneous
Cost accumulation:
By job orders By departments or processes
Reporting
By job orders By departments or processes
When is unit cost computed:
Upon completion End of costing period (usually a
month)
Unit cost computation:
Production costs per job Departmental costs
Number of units Equivalent units of production
Subsidiary record for work in process:
Job order cost sheets Cost of production reports (or
departmental cost sheets)
Page | 14
JOB ORDER COSTING
Job order costing
- costing by products, job or work orders, or by contracts.
- The cost unit is the job and each job order is assigned a number for clear and brief
identification.
- All costs directly traceable to each job (direct materials and direct labor) are charged to it
directly.
- Factory overhead – charged to each job at a predetermined rate periodically or upon
completion.
- Cost per unit of the products in each job = accumulated cost / number of units.
- Cost accumulation – done with the use of cost sheets (or job order cost sheets).
- Each job order is provided with a cost sheet so that if there are ten jobs in process, there must
be ten cost sheets.
o Each of them provides columns for materials cost and direct labor cost and space or
column for factory overhead.
▪ Materials issued (per materials requisition form) and labor hours expended (per labor
time tickets) for a job – posted to the corresponding work sheet.
● Thus, materials requisition and labor time tickets (totalled daily or weekly
and tallied with the payroll) should contain the job order numbers to
which they pertain.
Elements of product cost – materials cost, labor cost and factory overhead.
For job order costing, materials and labor costs refer to direct materials cost and direct labor cost,
respectively.
Direct materials cost – refers to those items that form part of the finished product and which
can be measured and directly charged to the product
● Examples: leather for shoes, lumber for furniture and metal parts for
automobiles
Direct labor cost – refers to cost of labor expended in the manufacture of a product and which
can be directly charged to the product
Factory overhead – also known as manufacturing expenses or burden.
- Refers to the indirect element of cost
- Includes all manufacturing cost not classified as direct materials or as direct
labor
- Examples:
o Indirect materials – those needed for the completion of the product
but the consumption of which with regard to the product is either so
small or allocation would be too complex so that for convenience, it
is treated as an indirect product cost.
▪ Examples: glue, tacks and polish in the manufacture of shoes
o Indirect labor – refers to cost of manpower which cannot be
identified as pertaining to a particular product.
▪ Examples: salaries and wages of forement, timekeepers and utility men.
o Factory supplies
Page | 15
o Depreciation of factory building
o Factory insurance
Note: Distinctions between direct and indirect materials and between direct and indirect labor are
not observed in process costing inasmuch as under the latter, costs accumulation is by departments
or processes and not by products or jobs.
16-18 3,700
- Forms of Cost sheets – cost sheets may vary in form depending on desired additional
information such as the items, quantity and unit cost of material, number of labor hours,
bases used in charging overhead and the departments in which the different cost items are
charged.
LIGAYA MANUFACTURERS, INC..
Cost Sheet
Order No. 555
For: Singalong Furniture
Product: Rocking Chais
Specification: Narra withs long arm rest
Quantity: 10 units
Date Ordered: May 11, 2013 Date Wanted: June 16, 1997
Date Started: May 16,2013 Date Completed: June 12, 1997
Page | 16
DIRECT MATERIALS COST DIRECT LABOR
COSTS
234
May 16 Carpentry P 5,000 5/16- Carpentry 96 P
22 2,880
54
311
1,600
26 Carpentry 2,000 22-28 Carpentry
336 360
6/5- Finishing 80
11
SUMMARY
- When overhead is charged to jobs upon completion, there exists a difference between work
in process per general and the total of the accumulated costs per cost sheets. This difference
is equal to the amount of overhead not so applied on the cost sheets yet.
Direct Labor
Date Time Card No. Hours Rate Cost
Factory Overhead
Date Activity Base Quantity Application Rate Cost
Cost Summary
Direct Materials
Direct Labor
Factory Overhead
Total Cost
Page | 17
2. Materials stock card
a. These records are the perpetual book inventory of costs and quantities of
materials on hand
b. The file of materials stock cards for unused materials is the subsidiary ledger for
Materials Control.
Location in
Description Storeroom
Minimu
Maximum m Stores Ledger Acct. No.
MATERIALS REQUISITION
Date No.
To
Approved by Issued by
Received by
Page | 18
JOB TIME TICKET
Employee
Name Date
Employee Departmen
Number t
MATERIALS
Inventory beginning Cost of direct materials issued
Purchase of materials Cost of indirect materials issued
Freight-in Cost of materials returned to supplier
Cost of excess materials returned from factory
- The balance of the Materials account represents the Materials inventory at the end of the
period under consideration.
- The amount should be equal to the total of the balances of all the material stock cards.
Time tickets
- Prepared for each worker to determine the time spent for each job as basis in determining
the amount to be charged to direct labor cost and indirect labor cost.
- For various jobs, they are sorted, priced and summarized , and the time ticket hours should
be reconciled with the clock card hours.
● At regular intervals, usually daily or weekly, the labor time and labor cost
for each job are entered on the job order cost sheets. For each payroll
period – weekly, every two weeks, or monthly – the summary of
employees’ earnings and the liability for payment is journalized and
posted to the general ledger.
Page | 20
- Factory overhead control is charged for the indirect labor cost incurred.
- Tax withheld is computed based on the table provided by the Bureau of Internal Revenue.
- For the SSS Premiums and Medicare Contributions, the table is provided by the Social
Security System.
- The clearing account for the total wages due to the factory personnel is the payroll account
summarized as follows:
PAYROLL
Total wages and salaries earned by factory personnel Total payroll during the payroll period at the same
during the payroll period time debiting work in process for direct labor and
overhead for indirect labor
- The account used to accumulate the liability for payroll or factory overhead is the Accrued
Factory Payroll summarized as follows:
ACCRUED FACTORY PAYROLL
Total amount of wages paid to factory personnel at Balancing beginning
the time crediting accounts payable or cash
Total amount of wages and salaries due to factory
personnel at the same time debiting payroll
Page | 21
FACTORY OVERHEAD CONTROL
Cost of indirect materials and supplies issued from the Total debit footing at the end of the accounting
warehouse at the same time crediting materials period when closing the books
Cost of indirect labor at the same time crediting payroll
Cost of indirect expense purchased from outsiders
Cost of other indirect expense incurred by the company
Factory overhead applied – account used for accumulating the total overhead charged to
production during period.
Over / under applied overhead – the difference between the actual overhead incurred and the applied
overhead.
- Accumulation of factory overhead incurred (or actual factory overhead) takes time especially
in cases wherein adjustments are done on an annual basis.
- Instead of charging actual factory overhead to production, the practice of charging overhead
based on predetermined rates is adopted.
o Account used may either be Applied Factory Overhead or Factory Overhead.
o At the end of the period, both applied factory overhead and factory overhead control
are closed and the difference is called the factory overhead variance which may be
overapplied (credit) or underapplied (debit).
▪ Example: Factory Overhead Charged to production is P 25,760 and factory overhead
incurred amounts to P 26,000. The entries would be as follows:
● To charge overhead to production:
Work in Process P 25,760
Applied Factory Overhead P 25,760
● To take up factory overhead incurred:
Factory Overhead Control P 26,000
Sundry credits P 26,000
● To close Applied factory overhead to Factory Overhead Control
Applied Factory Overhead P 25,760
Factory Overhead Control P 25,760
Page | 22
After this entry, Factory overhead control shall have a debit balance of P 240, the
factory overhead variance. This is set up in the following entry:
Factory Overhead Variance P 240
Factory Overhead Control P 240
● In the given example, Actual Factory overhead exceeds applied overhead
so that the variance is a debit ( underapplied, underabsorbed, or
unfavourable).
● When Actual Overhead is more than Applied overhead, the variance must
be a debit (underapplied, underabsorbed or unfavourable).
● When Actual Overhead is less than Applied overhead, the variance must
be a credit (overapplied, overabsorbed or favourable).
● Factory Overhead Variance- preferably used so that both overapplied
and underapplied variances may be posted to the same ledger page.
● Instead of crediting “Applied Factory Overhead” in charging overhead to
production, the credit may be to “Factory Overhead Control”. This practice
eliminates the need to close the former to the latter.
o Disposition of Factory Overhead Variances.
▪ Factory overhead, in general, is treated as a period cost and is closed to cost of goods
sold or to income and expense summary.
● However, when it is significant in amount, it implies an error in costing or
that a wrong overhead rate was used. In this case, the variance is treated
as an adjustment to cost of goods sold and the inventories of finished
goods and work in process.
▪ In the example given in the preceding section, the variance is closed to cost of goods
sold as follows:
Cost of Goods Sold P 240
Factory Overhead Variance P 240
▪ Based on the given entry, an unfavourable variance increases cost of goods sold and a
favourable variance reduces the same.
Manufacturing costs:
Direct materials cost P 75,000
Direct labor cost 55,000
Factory overhead applied 55,000 P 185,000
Work in process, Jan. 1 33,000
Work in process, Dec. 31 (45,000)
Cost of Goods Manufactured P 173,000
Finished Goods, Jan. 1 29,000
Finished Goods, Dec. 31 (22,000)
Cost of goods sold, normal P 180,000
Underapplied factory overhead 240
Cost of goods sold, actual 180,240
Gross profit on sales 69,760
Less: Operating expenses 55,000
Net income 14,760
In the foregoing illustration, cost of goods sold prior to adjustment for factory overhead
variance is described as normal, that is, based on what has been estimated or planned.
Page | 23
Work in process - a controlling account used to record the flow of the elements of cost
through the factory during a given period
- Used to accumulate during the month the total cost of materials placed in process, labor
used and factory overhead applied.
- Amounts entered on the cost sheet should equal the amounts debited to the work in process
account during the month.
- As jobs are completed, the cost sheets for the corresponding jobs are totalled and the
amount is now transferred to the finished goods account.
Entry: Transfer from Work in process to Finished Goods account
Finished Goods xxx
Work in process xxx
,
WORK IN PROCESS
- Cost of beginning inventory - Cost of materials, labor and factory overhead
- Cost of direct materials issued to production at the applied to jobs completed during the period at the
same time crediting materials same time debiting finished good
- Cost of direct labor applied to production during - Cost of direct materials returned to the warehouse
the period at the same time crediting the payroll at the same time debiting materials
account
FINISHED GOODS
- Cost of inventory at the beginning - Cost of finished goods sold during the period at
the same tie debiting cost of goods sold
- Factory cost of job order completed at the same
time crediting work in process
- Cost of goods returned by the customer at the
same time crediting cost of goods sold
Cost of Goods Sold – an account used to accumulate he cost of finished goods disposed through
sale to customers.
COST OF GOODS SOLD
- Cost of finished goods disposed through sale to - Cost of finished goods returned by customers
customers at the same time crediting finished at the same time debiting the finished goods
goods account
- Adjustment for under applied factory overhead - Adjustment of over applied factory overhead
- Balance of the account at the end of the period
at the same time debiting income summary
ILLUSTRATION:
The following information is provided by Bacolor Corp. For 2014:
Page | 24
2014
a. Direct materials issued:
Job order No. 14 ................................................ P 9,000
15 ................................................. 12,000
16 ................................................. 8,000
P 29,000
b. Direct labor costs:
Job order No. 14 ................................................ P 3,500
15 ............................................... 5,400
16 ............................................... 3,300
P 12,200
c. Factory overhead is charged to production at 60% of direct labor cost.
d. Job orders nos. 14 and 15 are completed.
The entries and corresponding postings to the work in process account and the cost sheets
would be as follows:
a. Work in Process P 29,0000
Materials P 29,000
Direct materials issued.
b. Work in Process 12,200
Payroll 12,200
Direct labor costs
c. Work in Process 7,320
Applied Factory Overhead 7,320
Overhead charged at 60% of direct labor costs
d. Finished Goods 35,240
Work in Process 35,240
Jobs 14 and 15 completed
Per general ledger; the work in process account should have the following postings:
Work In Process
Direct materials 29,000 Cost of completed jobs 14 and 15 35,240
Direct labor 12,200
Factory overhead applied 7,320
- The ending balance of work in process is P 13,280 (or P 48,520 minus P 35,240). This must
be the accumulated cost of Job No. 16. However, per cost sheet for said job, the total is only
P 11,300 (that is, P 8,000 + 3,300) because of the non-application yet of factory overhead of
P 1,980 (or 60% x P 3,300).
- Assuming that job order no. 16 is completed during the next period (or in 2015) after
incurring additional direct materials and direct labor costs of P 4,000 and P 2,000,
respectively, the total factory cost of the job would be as follows:
- It should be emphasized that although the total overhead charged to job order no. 16 in
2015 is the total of P 3,180, the journal entry is only for P 1,200 which is based on the
current labor cost of P 2,000. Applied overhead that corresponds to the 2013 labor cost is
included in the 2014 entries.
100,000.0
Materials (Stores) 0 Purchases 100,000.00
Page | 26
Materials (Stores) 75,000.00
125,000.0
Finished Goods 0 No entry
105,000.0
Cost of goods sold 0 No entry
Instead of " Factory Overhead" the account " Applied Factory Overhead" may be used.
Page | 27
ILLUSTRATION OF ENTRIES UNDER COST AND NON-COST SYSTEM
The following transactions are journalized under both the cost and the non-cost systems:
SSS 1,500.00
Medicare 500.00
Pagibig 1,000.00
Page | 28
Withholding taxes payable 800.00
d. Breakdown of payroll: direct labor - P 25,000; indirect labor - P 5,200; sales - P 10,000; and office - P 9,800.
Work in process 25,000.00 Labor cost (Factory Salaries and wages) 30,200.00
Payroll 50,000.00
Cash 55,000.00
i. Remittance of payroll deductions including counterpart contribuutions and workmen' compensation premiums amounting to P 2,000
(factory - P 1,000; sales - P 600; office - P 400)
Cash 5,800.00
Page | 30
Work in Process 30,000.00 no entry
Page 25
k. Cost of goods manufactured, P 80,000
Sales 130,000.00
m
. Sales returns, P 2,000; cost of returned goods, P 1,100.
n. Provision for depreciation: factory machinery and equipment - P 5,500; factory office furniture - P 3,000; store furniture - P 2,800; and,
office furniture and equipment, P 2,000.
o. Expired insurance is P 1,500 out of the total premiums charged to prepaid insurance. Distribution: Factory, sales and office, 60:30:10.
Factory Overhead Variance 380.00 inventories and closing the beginning inventories and nominal accounts.
Page | 32
The nominal amounts are closed to income and expense summary.
Sales 130,000.00
Page | 33
Page | 34