Introduction to Cost Accounting

An Overview and Fundamental Concepts

Alfeche, 2021
Discussion Outline

• Definition

• Stages

• Classifications

• Direct and Indirect Cost

• Manufacturing / Product Cost

• Non-Manufacturing / Period Cost

Definition
Cost Accounting
Briefly Defined

Cost accounting is the process of

tracking, recording and analyzing
costs associated with the products
or activities of an organization.

It is a staff function that provides

advice to those in the line position.

Stages
Stage 1 | Cost accumulation is the Cost object refers to any unit, activity, or
collection of cost data in an organized segment for which management wants
way by means of an accounting to accumulate and measure a cost.

system.

Cost tracing refers to the assignment of

Stage 2 | Cost assignment is a general direct costs to a particular cost object.

term that embraces both cost tracing

and cost allocation.
Cost allocation refers to the assignment
of indirect costs to several cost objects

Classifications
 Direct Material

Direct Prime Cost Fixed

Direct Labor
Directly traceable to
Product Cost
cost object

Conversion Cost Associated with Variable

production activities;
inventoriable

Factory Overhead
Fixed
Indirect
Non-
Period Cost
Manufacturing
Difficult to trace to a
cost object or
common to several Associated with
cost objects selling and/or Variable
administrative;
expensed outright
Direct & Indirect Costs
Direct Indirect

Wooden Chair Tree Carpenter Hammer Paint

Colored Hoodie Wool Tailor Needle Dye

Direct costs are traced. Indirect costs are allocated.

Manufacturing / Product Costs

Prime Conversion

Wooden Chair Tree Carpenter Carpenter Hammer Paint

Colored Hoodie Wool Tailor Tailor Needle Dye

DM DL DL FOH FOH
Product Costs
are assets upon recognition even when they get transformed to Finished Goods.
They become part of COGS on the period they are sold. This includes depreciation.
 Period Costs
are non-manufacturing costs that has a remote relationship to
the manufacturing process; expensed at the period of incurrence.
Thank you!
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Module 2: Cost Terminologies and Cost

• Failure costs may be internal (scrap and rework) or external
Behavior Analysis (product returns, warranty costs, complaints to customer service).

Introduction • Finished goods are units of inventory that are fully completed.

The product and period cost classification in the income statement • Fixed cost a cost that remains constant in total within a specified
under the functional format proves to be very useful to external users. range of activity.
However, internal users, more particularly managers and decision
makers, would find that the behavioral cost classification: variable and • Indirect costs are costs that cannot be economically traced to a
fixed, more useful and relevant. Cost behavior is the response of costs particular cost object; but instead, must be allocated to the cost
in relation to changes in the level of activity and preparing reports that object.
utilize this type of cost classification will benefit managers. Managers
would be concerned about which costs would not move together with
• Inventoriable costs include the direct costs of materials and labor
activity levels (units produced or units sold), and thus must be covered
plus the indirect costs of overhead; they become part of the cost
so as not to incur losses.
of the inventory.

Fixed costs will be incurred by a company whether revenue is

• Manufacturer a company engaged in a high degree of conversion
generated or not, and therefore, sufficient revenue must be generated
that results in a tangible output.
to make sure that fixed costs are amply covered.

• Mixed cost a cost that has both a variable and a fixed component;
Additionally, managers would also be helped by information about
it changes with changes in activity, but not proportionately.
costs that vary directly with activity levels so they will know the cost
implications of their decisions regarding units produced or sold.
• Normal cost system a valuation method that uses actual costs of
direct material and direct labor in conjunction with a
Glossary predetermined overhead rate or rates in determining the cost of
Work in Process Inventory.
• Actual cost system a valuation method that uses actual direct
materials, direct labor, and overhead charges in determining the • Overhead any factory or production cost that is indirect to the
cost of Work in Process Inventory. product or service; it does not include direct material or direct
labor; any production cost that cannot be directly traced to the
• Appraisal costs are incurred to find mistakes not eliminated product.
through prevention.
• Period costs are related to business functions other than
• Conversion cost the total of direct labor and overhead cost; the production, such as selling and administrative costs; period costs
cost necessary to convert direct material into a finished good or are expensed in the current accounting period.
service.
• Predetermined overhead rate an estimated charge per unit of
• Cost the cash or cash equivalent value necessary to attain an activity used to allocate overhead cost to Work in Process
objective such as acquiring goods and services, complying with a Inventory for the period’s production or services; it is calculated
contract, performing a function, or producing and distributing a by dividing total budgeted annual overhead at a selected level of
product. volume or activity by that selected measure of volume or activity;
it is also the standard overhead application rate.
• Cost allocation the assignment, using some reasonable basis, of
any indirect cost to one or more cost objects. • Predictor an activity measure that, when changed, is
accompanied by consistent, observable changes in another item.
• Cost driver a factor that has a direct cause-effect relationship to a
cost; an activity creating a cost. • Prevention costs are incurred to improve quality by precluding
product defects and improper processing from occurring.
• Cost management system (CMS) a set of formal methods
developed for planning and controlling an organization’s cost- • Product cost a cost associated with making or acquiring the
generating activities relative to its goals and objectives. products or providing the services that directly generate the
revenues of an entity.
• Cost object is anything for which management wants to collect or
accumulate costs. • Raw material is the materials used in the production process.

• Cost of goods manufactured (CGM) the total cost of the goods • Relevant range the specified range of activity over which a variable
completed and transferred to Finished Goods Inventory during the cost per unit remains constant or a fixed cost remains fixed in
period. total; it is generally assumed to be the normal operating range of
the organization.
• Direct costs are costs that is conveniently and economically
traceable to a particular cost object. • Service company an individual or firm engaged in a high or
moderate degree of conversion, using a significant amount of
• Direct labor the time spent by individuals who work specifically on labor, which results in service output.
manufacturing a product or performing a service, the cost of such
time. • Step cost a cost that increases in distinct amounts because of
increased activity. Step variable costs have small steps and step
• Direct material any material that can be easily and economically fixed costs have large steps.
traced to a product.
• Unexpired cost is an asset.
• Distribution cost a cost incurred to warehouse, transport, or
deliver a product or service. • Variable cost a cost that varies in total in direct proportion to
changes in activity; it is constant on a per unit basis.
• Expired cost is an expense or a loss that is shown on the income
statement. • Work in process is work started but not yet completed.
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Lecture Notes

Income Statement Formats

Traditional Contribution

Functional Cost Classification (External) Behavioral Cost Classification (Internal)

Sales xx Sales xx
COGS (xx) Variable Costs (xx)

Gross Margin xx Contribution Margin xx

Operating Expenses (xx) Fixed Costs (xx)

Operating Income xx Operating Income xx

A Comparison of Traditional and Contribution Format Income Statements

In the contribution format income statement, the variable costs are composed of both variable product costs (i.e., DM, DL, VOH) and variable selling
and administrative costs (e.g., commissions). Furthermore, the fixed costs are composed of fixed product costs (i.e., FxOH) and fixed selling and
administrative costs (e.g., salaries, depreciation, rent).

But since most of the accounting systems employed by companies are more geared towards the traditional format because of the requirement by PAS
2 (Inventories) for external reporting, there will be a need to break down costs into variable and fixed classifications. Certain costs will be clearly and
obviously variable based on a trend of data. Similarly, the same trend of data may also clearly depict fixed costs at the outset. However, there will be
some costs that are mixed, which are composed of variable and fixed components. There are three (3) mathematical methods used to separate the
variable from the fixed portion in mixed costs.

Mixed Costs

To compute for mixed cost and by extension algebraically solving for its components, we use this formula:

𝑦 = 𝑎 + 𝑏𝑥
Where:
• y is the total mixed costs
• a is the total fixed costs
• b is the variable costs per level of activity or units
• x is the level of activity or number of units

Methods of Separating Variable from Fixed Costs

1. Scatter-Graph Method
a. A visual estimation.
b. Involves plotting cost data into a graph, and approximating a cost line that would be closest to all graphed point.
c. Includes all points, but only provides a rough estimate.

2. High-Low Method
a. A simple, formula-based estimate.
b. Involves a simple mathematical computation of the variable and fixed costs.
c. Includes only two (2) points (highest and lowest), but provides an estimate based only on these two points.

• Variable Cost = Slope of the Line = Rise/Run = (Highest Cost – Lowest Cost) / (Highest Activity – Lowest Activity)

(ℎ𝑐 − 𝑙𝑐)
𝑣𝑐 =
(ℎ𝑎 − 𝑙𝑎)

• Total Cost = Fixed Cost + Variable Cost

• Transpose: Fixed Cost = Total Cost – Variable Cost

3. Least Squares Regression Method

a. Provides the most accurate estimate among all the methods.
b. Involves a more complicated solution.
c. Includes all points in the data set.

𝑛∑𝑥𝑦 − (∑𝑥)(∑𝑦)
𝑏 =
𝑛∑𝑥 ! − (∑𝑥)!

𝑎 = 𝑦0 − 𝑏𝑥̅

or

∑𝑦 − 𝑏∑𝑥
𝑎 =
𝑁

• Once the costs have already been separated into variable and fixed components, it will become easier to prepare a contribution
format income statement, which will help managers in revenue, cost, and activity level decisions.
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Discussion Problems

Problem 1

Marwick’s Pianos, Inc., purchases pianos from a large manufacturer and sells them at the retail level. The pianos cost, on the average, P2,450 each
from the manufacturer. Marwick’s Pianos, Inc. sells the pianos to its customers at an average price of P3,125 each. The selling and administrative
costs that the company incurs in a typical month are presented below:

Costs Cost Formula

Selling:

Advertising P700 per month fixed

Sales salaries and commissions (mixed) P950 per month, plus 8% of sales

Delivery of pianos to customers P30 per piano sold variable

Utilities P350 per month fixed

Depreciation of sales facilities P800 per month fixed

Administrative:

Executive salaries P2,500 per month fixed

Insurance P400 per month fixed

Clerical (mixed) P1,000 per month, plus P20 per piano sold

Depreciation of office P300 per month fixed

During August, Marwick’s Pianos, Inc. sold and delivered 40 pianos.

A. Prepare an income statement for Marwick’s Pianos, Inc. for August. Use the traditional format with costs organized by function.
B. Prepare an income statement for Marwick’s Pianos, Inc. for August. Use the contribution format. Show costs and revenues on both a total
and a per unit basis down through contribution margin.

A. Traditional Income Statement (Functional Income Statement)

Marwick’s Pianos, Inc.

Statement of Financial Performance
For the period ended, August 31, 2020

Sales (3,125 x 40) Php 125,000

Less: Cost of Sales (2,450 x 40) 98,000
Gross Profit 27,000
Less: Operating Expenses
Selling Expenses
Advertising 700
Sales Sal. And Com. [950 + 8%(125K)] 10,950
Delivery (30 x 40) 1,200
Utilities 350
Depreciation – Sales 800 14,000
Administrative Expenses
Executive Salaries 2,500
Insurance Expenses 400
Clerical Expenses [1,000 + (20 x 40)] 1,800
Depreciation – Admin 300 5,000 19,000
Operating Income (Net Income) Php 8,000

B. Contribution Margin Income Statement (Behavioral Income Statement)

Marwick’s Pianos, Inc.

Statement of Financial Performance (Contribution Margin)
For the period ended, August 31, 2020

Sales (3,125 x 40) Php 125,000

Less: Variable Costs * 110,000
Total Contribution Margin 15,000
Less: Fixed Costs ** 7,000
Operating Income (Net Income) Php 8,000

*Variable Costs
Product Cost ( 2,450 x 40) 98,000
Delivery Cost ( 30 x 40) 1,200
Clerical Cost ( 20 x 40) 800
Sales Commission (8% x 125,000) 10,000
Total Variable Cost 110,000

**Fixed Costs
Advertising 700
Sales Salaries 950
Utilities 350
Depreciation – Sales 800
Executive Salaries 2,500
Insurance 400
Clerical 1,000
Depreciation – Admin 300
Total Fixed Costs 7,000
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Problem 2

Tom’s Charters operates a fleet of powerboats in Fort Myers, Florida. Tom wants to develop a cost formula for labor costs (a mixed cost). He has
gathered the following data on labor costs and two potential predictive bases: number of charters and gross receipts:

Month Labor Costs Number of Charters Gross Receipts

January P16,000 10 P 12,000
February 18,400 14 18,000
March 24,000 22 26,000
April 28,400 28 36,000
May 37,000 40 60,000
June 56,000 62 82,000
July 68,000 100 120,000
August 60,000 90 100,000
September 48,000 80 96,000

a. Using the scatter graph method, estimate the labor cost formula using each prediction base.
b. Using the high-low method, develop a labor cost formula using each prediction base.
c. Using the least squares method, develop a labor cost formula using each prediction base.
Alfeche, 2021

Cost Behavior Analysis

Concepts and Formulas
Discussion Outline

• Definition

• Income Statement Formats

• Mixed Costs

• Methods of separating variable and fixed costs

• Scatter-graph

• High-Low

• Least Squares Regression

Definition
Cost Behavior
Definition

Cost behavior is the response of

costs in relation to changes in the
level of activity and preparing
reports that utilize this type of cost
classification will benefit managers.

Internal users would find that the

behavioral cost classification:
variable and fixed is significantly
more useful and relevant.
Income Statement
Formats
Traditional vs Contribution
Income Statement Formats
Comparison

In the contribution format income statement, the variable costs are composed of both variable product costs (i.e., DM, DL, VOH) and variable selling and administrative costs (e.g.,
commissions). Furthermore, the fixed costs are composed of fixed product costs (i.e., FxOH) and fixed selling and administrative costs (e.g., salaries, depreciation, rent). Such
segregation is not readily available in reality since accounting systems are pre-disposed to follow the traditional format. Thus the need to identify costs based on their behavior.

Mixed Costs
Methods of Separating
Variable and Fixed Costs
y = a + bx
mixed costs formula
y is total mixed costs
a is total fixed costs
b is total variable costs
x is cost driver
Scatter-Graph Method

• A visual estimation

• Involves plotting cost data into a graph, and approximating a cost line that
would be closest to all graphed point.

• Includes all points, but only provides a rough estimate.

High-Low Method
• A simple, formula-based estimate.

• Involves a simple mathematical computation of the variable and fixed costs.

• Includes only two (2) points (highest and lowest), but provides an estimate
based only on these two points.

• Variable Cost = Slope of the Line = Rise/Run = (Highest Cost – Lowest

Cost) / (Highest Activity – Lowest Activity)
Least Squares Regression Method
• Provides the most accurate estimate among all the methods.

• Involves a more complicated solution.

• Includes all points in the data set

Thank you!
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Module 3: The Manufacturing Business product or performing a service. The wages (or salaries) of
these individuals are considered direct labor cost.
a. As with direct materials, direct labor costs that are
Introduction not conveniently and economically traceable to
the product are classified as indirect costs
Cost accounting is used for both the service and production sectors (overhead).
of business. A service industry however does not have a clear b. Overtime costs are also considered part of
distinction of the direct costs of services since it varies greatly as to overhead unless the customer specifically
the type of services they provide. However, the basic component for requests that a job to be scheduled during
service industries include labor costs and service overhead costs. The overtime or shift premiums for situations such as
production sector or manufacturing business often benefit more from a rush order.
the use of cost accounting. A manufacturing business is one that uses c. In highly automated production facilities, direct
raw materials, parts, and components to assemble finished goods. labor costs represent less than 10 to 15 percent
Manufacturing businesses often employ machines, robots, computers, of total manufacturing costs.
and humans to produce the merchandise and typically use an 3. Overhead is any factory or production cost that is indirect to
assembly line, which enables a product to be put together step by manufacturing a product or providing a service; it does not
step, moving from one workstation to the next. Manufacturing include direct material or direct labor.
businesses can choose to sell their products directly to consumers, to a. Overhead may be variable or fixed.
other manufacturers, to distributors or to wholesalers. This module b. Overhead includes indirect material and indirect
revolves around the accounting for the various production costs for a labor as well as other costs incurred in the
manufacturing business, specifically, raw materials, direct labor, and production process.
manufacturing overhead. c. Overhead has become a progressively larger
portion of total manufacturing costs.
The Manufacturing Process d. Quality cost is an important type of overhead
cost.
The production process requires the conversion of raw materials into i. Prevention cost is a quality control cost
finished products for sale through a combination of labor and other that is incurred to improve quality by
factory resources. There is also a need to invest in properties and preventing defects from occurring.
equipment to aid in the conversion process. All these elements of ii. An appraisal cost is a quality control
production entails costs and will have to be reported in the financial cost that is incurred for monitoring or
statements and in internal inventory reports. inspection. Appraisal costs compensate
for mistakes not eliminated through
prevention.
iii. A failure cost is a quality control cost
that is associated with goods or
services that have been found not to
conform or perform to the required
standards as well as all related costs.
Failure cost may be internal (scrap and
This process is equivalent to the purchase of inventories for a rework) or external (product returns,
merchandising business. If we recall, the way to compute the cost of warranty costs, customer complaints).
goods sold is as of follows:
Materials
Merchandise Inventory, Beginning xxxx
Add: Net Purchases The main concern of the accounting for materials relates to
Gross Purchases xxxx safeguarding of the assets and the control of investment in these
Add: Freight - in xxxx materials. Safeguarding of materials means the protection from the
Less: Purchase Discounts xxxx misuse or misappropriation, while controlling of the costs in materials
Purchase Allowance xxxx means maintaining appropriate quantities required in production.
Purchase Returns xxxx xxxx
Total Goods Available for Sale xxxx Labor
Less: Merchandise Inventory, Ending xxxx
Cost of Goods Sold xxxx Labor represents the costs, wages, and/or salaries of the workers
traceable to production of goods/services. The timekeeping (usually
However, for a manufacturing, the cost accumulation process is from the Human Resources Department) and payroll departments are
illustrated below: responsible for maintaining labor records. The payroll function uses
the timekeeping records to compute the gross pay of each employee,
including incremental payments for overtimes, holiday premiums and
bonuses. Mandatory and discretionary deductions are then taken from
the gross pay to compute for the net pay. Deductions include but are
not limited to withholding taxes, social security, home development
mutual funds, health insurance, tardiness, loan payments, cash
advances amortization, etc.

Factory Overhead

As discussed in the previous module, factory overhead may be

broadly classified based on its behavior, variable and fixed. It is
necessary to segregate these costs especially for internal purposes.
Factory overhead accounting however depends on the cost
accumulation system applied by the company.

Components of Product Cost

Production Actual Normal Standard Activity-based
Costs Costing Costing Costing Costing
1. A direct material is any readily identifiable part of a product.
In theory we should include all direct materials in this Direct
Actual Actual Standard Actual
category. As a practical matter, we include direct materials Materials
that are convenient and economically traceable to the
product. Direct materials that are not conveniently and Direct Labor Actual Actual Standard Actual
economically traceable to the product are classified as
indirect costs (overhead).
Factory Predetermined Activity-
2. Direct labor refers to the cost of the time spent by Actual Rate Standard
Overhead based
individuals who work specifically on manufacturing a
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Statement of Goods Manufactured

Unlike the merchandising concern, the goods available for sale for a manufacturing concern would include inventories produced by the manufacturing
entity. Thus, the cost of goods sold portion of the income statement need to be expanded to follow the cost flow from materials, conversion to finished
goods. The preliminary step therefore to compute for the cost of goods sold will be the preparation of the Statement of Cost of Goods Manufactured.
The CGM Statement is the equivalent of “net purchases” for a merchandising concern. The CGM represents the total production cost of the goods that
were completed and transferred to the finished goods inventory during the period. Also, a manufacturing concern will recognize three different
inventory accounts, namely: Raw Materials Inventory; Work-in-Process Inventory; and the Finished Goods Inventory. The following is the format for the
CGM Statement:

Raw Materials Inventory, Beginning xxxx

Add: Net Purchases xxxx
Gross Purchases xxxx
Add: Freight-in xxxx
Less: Purchase Returns, Discounts, and Allow. xxxx xxxx
Raw materials available for use xxxx
Less: Indirect Materials xxxx
Raw Materials Inventory, Ending xxxx xxxx
Raw Materials Used in Production (Direct Materials Used) xxxx
Direct Labor xxxx
Factory Overhead (Variable and Fixed) xxxx
Total Production Cost xxxx
Add: Work-in-Process Inventory, Beginning xxxx
Total Cost of Goods Placed in Process xxxx
Work-in-Process Inventory,
Less: Ending xxxx
Cosf of Goods Manufactured xxxx

And this is linked with the Cost of Sales Portion in the following way:

Finished Goods Inventory, Beginning xxxx

Add: Cost of Goods Manufactured xxxx
Total Goods Available for Sale xxxx
Less: Finished Goods Inventory, Ending xxxx
Cost of Goods Sold xxxx
University of San Jose – Recoletos
School of Business and Management | Accountancy and Finance Department
Cost Accounting and Control

Discussion Problem

Problem 1

The Maple Company had the following balances as of August 1, 2021:

Raw Materials Inventory 20,300
Work-in-Process Inventory 37,000
Finished Goods Inventory 18,000

During the month of August, the company had the following transactions:
1. Purchased Php 164,000 of raw materials on account.
2. Issued Php 180,000 of raw material to production, of which Php 134,000 was for direct materials.
3. Materials Returned to the warehouse Php 18,000, of which Php 4,000 was for indirect materials.
4. Materials returned to vendors, Php 1,500.
5. Payroll costs after mandatory deductions amounts to Php 68,000 for the month. Deductions included Php 9,500 for withholding taxes; Php
4,200 for SSS Premiums; Php 3,400 for Philhealth Premiums; Php 2,900 for PAG-IBIG Premiums.
6. Of the total payroll, Php 62,000 was for direct factory labor, while the rest if for factory supervisors’ salaries.
7. The share of the employer for the mandatory deductions are as follows: Php 8,400 for SSS Premiums; Php 3,400 for Philhealth Premiums;
Php 2,900 for PAG-IBIG Premiums.
8. Accrued utility costs amounts to Php 7,000.
9. Property Taxes for Factory paid at Php 2,000.
10. Expired Insurance Premium amounts to Php 1,600.
11. Depreciation on factory equipment amounts to Php 30,000
12. Actual factory overhead was charged to production.
13. Transferred finished and completed products to the finished goods inventory, Php 320,000
14. Sales during the period amounts to Php 700,000, of which Php 550,000 were on account.
15. Cost of Goods Sold amounts to Php 330,000.
16. Operating expenses during the period amounts to Php 180,000.
17. Cash collections during the period amounts to Php 305,000.

Required:
1. Journalize each transaction
2. Post to the Ledger
3. Prepare the Cost of Goods Manufactured Statement for the month of August
4. Prepare the Cost of Goods Sold Statement
5. Prepare the Financial Performance Statement.