Pricing and Costing

Aldon M. Francia

Brennan John Rivera, CPA

 Table of Contents

Module 1: Costs – Concepts and Classifications

Introduction 1
Learning Objectives 1
Lesson 1. Definition 2
Lesson 2. Classification of Costs 2
Lesson 3. Cost Formulas 8
Assessment Task 15
Summary 16
References 16

Module 2: Cost Accounting Cycle

Introduction 17
Learning Objectives 17
Lesson 1. Parts of Cost of Goods Sold Statement 18
Lesson 2. Preparation of Cost of Goods Sold Statement 21
Lesson 3. Preparation of Financial Statements 25
Assessment Task 33
Summary 34
References 35

Module 3: Accounting for Materials

Introduction 36
Learning Objectives 36
Lesson 1. Systems of Accounting for materials 37
Lesson 2. Control Procedures 37
Lesson 3. Materials Control 39
Lesson 4. Methods of Costing Materials 46
Lesson 5. Special problems in materials accounting 50
Lesson 6. Spoiled units, defective units, scrap material, and waste
material 54
Lesson 7. Accounting for Scrap Materials 60
Assessment Task 61
Summary 63
Reference
64
Module 4: Accounting for Labor

Introduction 65
Learning Objectives 65
Lesson 1. Wage plans 66
Lesson 2. Accounting for Labor Costs 66
Assessment Task 73
Summary 75
Reference 75
Course Code: ACCTG 2

Course Description: This course deals in performing price analysis and cost
analysis to determine price reasonableness.

Course Intended Learning Outcomes (CILO):

At the end of the course, students should be able to:

1. analyze the various price analysis applicable to the business;

2. interpret the cost analysis for decision making purposes;
3. differentiate the various pricing techniques; and
4. choose the right pricing method.

Course Requirements:

 Assessment Tasks - 60%

 Major Exams - 40%
Periodic Grade 100%

PRELIM GRADE : 60% (Activity 1-4) + 40% (Prelim exam)

MIDTERM GRADE : 30% (Prelim Grade) + 70 % [60% (Activity 5-7)
+ 40% (Midterm exam)]
FINAL GRADE : 30% (Midterm Grade) + 70 % [60% (Activity 8-10)
+ 40% (Final exam)]
 MODULE 1
COSTS – CONCEPTS AND CLASSIFICATIONS

Introduction

Price and costs are always associated with every business. Cost is the term used in
determining how much is the worth of a particular product. Price is the value of a particular
item or service that a client wishes to buy or avail. Therefore, we can conclude that these two
are important factors in operating a business.
In this workbook, we will first discuss the cost concepts and computations then we will
tackle the price and pricing techniques in the later part.
This is the first module of pricing and costing which includes the costs definition
classification and formula.

Learning Outcomes

After completing the module, the student should be able to:

1. distinguish between cost, expenses, and losses;

2. distinguish between direct and indirect costs;
3. define the three integral components of a product including the prime cost and
conversion cost;
4. explain variable, fixed, and mixed costs;
5. distinguish between common costs and joint costs;
6. differentiate capital expenditures from revenue expenditures; and
7. identify the costs for planning, control and analytical processes

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Lesson 1. Definition (De Leon, G. & De Leon, N., 2012)

Costs are associated with all types of organizations- business, non-business, service,
retail, and manufacturing. Generally, the kinds of costs that are incurred and the way in which
these costs are classified will depend on the type of organization involved.

Our initial focus will be on a manufacturing, but in our discussion we should be aware
that, in a conceptual sense, manufacturing encompasses much more than just firms in the
industrial sector of our economy. Organizations that are typically viewed as being service in
nature, such as movie studios and fast-food outlets. Organizations such as these are involved
in manufacturing in the sense that they create a distinct product for customers or patrons. As
we proceed with our discussion, therefore, we should keep in mind that manufacturing is a
broad term, and that the costs included under the manufacturing heading have application to
a wide range of organizations -many of which may be involved in service-type activities. An
understanding of the cost structure of a manufacturing company therefore provides a broad,
general understanding of costing that can be very helpful in understanding the cost structures
of other types of It also encompasses many organizations.

Before cost terminology can be discussed the term cost itself must be defined. Cost is
the cash or cash equivalent value sacrificed for goods and services that are expected to bring
a current or future benefit to the organization. We say cash equivalent because non-cash
assets can be exchanged for the desired goods or services. For example, it may be possible
to exchange land for some needed equipment.

Costs are incurred to produce future benefits in a profit making firm, future benefits
usually mean revenue. As costs are used up in the production of revenues, they are said to
expire. Expired costs are called expenses. In each period, expenses are deducted from
revenues in the income statement to determine the period’s profit. A loss is a cost that expires
without producing any revenue benefit. The focus of cost accounting is on costs, not
expenses.

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Lesson 2. Classification of Costs (De Leon, G. & De Leon, N., 2012)

CLASSIFICATION OF COSTS
I. Costs classified as to relation to a product
A. Manufacturing costs/product costs
1. Direct materials
2. Direct labor
3. Factory overhead
B. Non-manufacturing costs/period costs
1. Marketing or selling expense
2. General or administrative expense
II. Costs classified as to variability
A. Variable costs
B. Fixed costs
C. Mixed costs
III. Costs classified as to relation to manufacturing departments
A. Direct departmental charges
B. Indirect departmental charges
IV. Costs classified to their nature as common or joint
A. Common costs
B. Joint cost
V. Costs classified as to relation to an accounting period
A. Capital expenditures
B. Revenue expenditures
VI. Costs for planning, control, and analytical processes
A. Standard costs
B. Opportunity costs
C. Differential cost
D. Relevant cost
E. Out-of-pocket cost
F. Sunk cost
G. Controllable cost

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MANUFACTURING COSTS/PRODUCT COSTS/INVENTORIABLE COSTS

Direct materials
All manufactured products are made from basic direct materials. The basic material
may be iron ore for steel, sheet steel for automobiles, or flour for bread. These examples show
the link between a basic raw material and a final product.

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.

Proper storage of materials will avoid waste and spoilage. Large enough storage
space and orderly storage procedures are essential. Materials must be handled and stored
properly to guarantee their satisfactory use in production. Proper records, the materials
stockcards, make it possible to find goods easily. Such records reduce problems caused by
lost or misplaced items.

Direct materials are materials that become part of a finished product and can be
conveniently and economically traced to specific product units. The costs of these materials
are direct costs. In some cases, however, even though a material becomes part of a finished
product, the expense of actually tracing the cost of a specific material is too great. Some
examples of this include nails in furniture, bolts in automobiles, and rivets in airplanes. These
minor materials and other productionsupplies that cannot be conveniently or economically
traced to specific products are accounted for as indirect materials. Indirect materials costs are
part of factory overhead costs.

Direct labor
Labor services are, in essence, purchased from employees working in the factory
organizations outside the company. manufacturing include machine operators, maintenance
workers, managers and supervisors; support personnel, and people who handle, inspect, and
store materials Because these people are all connected in some way with the production

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process, their wages and salaries must be accounted for as production costs and, finally, as
costs of products. However, tracing many of these costs directly to individual products is
difficult.

To help overcome this problem, the wages of machine operators and other workers
involved in actually shaping the product are classified as direct labor costs. Direct labor costs
include all labor costs for specific work performed on products that can be conveniently and
economically traced to end products. Labor costs for production related activities that cannot
be conveniently and economically traced to end products are called indirect labor costs. These
costs include the wages and salaries of such workers as machine helpers, supervisors, and
other support personnel. Like indirect materials costs, indirect labor costs are accounted for
as factory overhead costs. Payroll related costs, such as payroll taxes, group insurance, sick
pay, vacation and holiday pay, and other fringe benefits can be considered as part of direct
labor costs, but are usually included as factory overhead.

Direct labor plus direct materials prime costs, while direct labor plus factory Overhead
= conversion costs.

Prime Cost = Direct Materials + Direct Labor

Conversion Cost = Direct Labor + Factory Overhead

Factory Overhead
The third manufacturing cost element is a catchall for manufacturing costs that cannot
be classified as direct materials or direct labor costs. Factory overhead costs are a varicd
collection of production-related costs that cannot be practically or conveniently traced directly
to end products. This collection of costs is also called manufacturing overhead, factory burden,
and indirect manufacturing costs.

Examples of the major classifications of factory overhead costs are:

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 Indirect materials and supplies: nails, rivets, lubricants, and small tools. Indirect labor
costs: lift-truck driver's wages, maintenance and inspection labor, engineering labor, machine
helpers, and supervisors.

Other indirect factory costs: building maintenance, machinery and tool maintenance,
property taxes, property insurance, pension costs, depreciation on plant and equipment, rent
expense, and utility expense.

NON-MANUFACTURING COSTS/PERIOD COSTS

Marketing or selling expenses

Marketing or selling expenses include all costs necessary to secure customer orders
and get the finished product or service into the hands of the customer. Since marketing
expenses relate to contacting customers and providing for their needs, these expenses are
often referred to as order-getting and order-tilling costs. Examples of marketing expenses
include advertising, shipping, sales travel; sales commissions, sales salaries, and expenses
associated with finished goods warehouses. All organizations have marketing costs,
regardless of whether the organizations are manufacturing, merchandising, or service in
nature.

Administrative or general expenses

Administrative expenses include all executive, organizational, and clerical expenses
that cannot logically be included under either production or marketing Examples of such
expenses include executive compensation, general accounting, secretarial, public relations,
and similar expenses having to do with the overall, general administration of the organization
as a whole. As with marketing expenses, all organizations have administrative expenses.

COSTS CLASSIFIED AS TO VARIABILITY

Fixed, Variable, and mixed One of the most important cost classifications involves the
way a cost changes in relation to changes in the activity of the organization. Activity refers to
a measure of the organization s output of products or services. In specifying cost behaviour,

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the managerial accountant often limits the description to a specific range of activity. This is
called the relevant range.

Fixed cost
Items of cost which remain constant in total, irrespective of the volume of production
Fixed costs are not related to activity within the relevant range. lf activity increases or
decreases by 20 percent, total fixed cost remains the same Cost per unit decreases as volume
increases, and increases as volume decreases. Fixed costs are assignable to departments
based on difference allocation methods Examples are salaries of production executives,
depreciation of equipment computed on a straight-line basis, periodic rent payments, and
insurance

Fixed costs may be classified into two categories, depending on the ability of
management to influence the levels of these costs in the short-term.

1) Committed fixed costs commitments on the part of management as a result of a

past decision. Example is depreciation on equipment.
2) Managed fixed costs (also known as discretionary, programmed, or planned fixed
costs) - costs that are incurred on a short-term basis and can be more easily
modified in response to changes in management objectives. Examples advertising,
research and development and costs of employee training programs.

Shown on the next page is a graph of fixed cost. It is clearly shown that total fixed cost
remains unchanged as activity changes. When activity triples, from 10 to 30 units, total fixed
cost remains constant at P 1,500. If activity level is only I unit, then the fixed cost per unit isP
1,500. If the activity level is 10 units, then the fixed cost per unit declines to P 150 per unit. So
we can conclude that fixed cost per unit will decrease as we increase the volume or units of
production and fixed cost per unit will increase as we decrease the volume of production.

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 Figure 1.1. Graph of Total Fixed Cost (De Leon, G., & De Leon, N., 2012)

Activity Fixed Cost per Unit Total Fixed Cost

1 P 1,500 1,500
2 750 1,500
5 300 1,500
10 150 1,500
20 75 1,500
30 50 1,500

Variable costs
Items of cost which vary directly, in total, in relation to volume of production. If activity
increases by 20 percent, total variable cost increases by 20 percent also. Cost per unit
remains constant as volume changes within a relevant range. Examples are: direct materials,
direct labor, royalties, and commission of salesmen. Shown below is a graph of total variable
cost. As this graph shows total variable cost increases proportionately with activity. When
activity doubles from 10 to 20 units, total variable cost doubles, from P 1,000 to P 2,000.
However, the variable cost per unit remains the same as activity changes. The variable cost
associated with each unit of activity is P100, whether it is the first unit, the fourth, or the tenth.

To summarize, as activity changes, total variable cost increases or decreases

proportionately with the activity change, but unit variable cost remains the same.

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 Figure 1.2. Graph of Total Variable Cost (De Leon, G., & De Leon, N., 2012)
TABULATION OF VARIABLE COST

Activity Fixed Cost per Unit Total Fixed Cost

1 P 100 P 100
10 100 1,000
20 100 2,000
30 100 3,000

Mixed cost
Items of cost with fixed and variable components. Mixed costs vary with the level of
production, though not in direct relation to it, probably because part of the cost is fixed while
the rest is variable. Two types of mixed costs exist -- semi- variable costs and step costs

Semi-variable cost.
The fixed portion of a semi-variable cost usually represent a minimum tee for making
a particular item or service available. The variable portion is the cost charged for actually using
the service. The cost of electricity where there is a basic minimum charge plus a specified
cost per kilowatt hour above the minimum is an example of such a semi-variable cost. The
cost charged for using a cell phone under a plan is also an example of a semi-variable cost.
The cost of the plan is fixed and it is for a specified time used, however it the user exceeds
the time allowed, then charges will be made on a per minute basis.

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 Figure 1.3.Graph of Semi-Variable Cost (De Leon, G., & De Leon, N., 2012)

Assume that a company rents a delivery truck at a flat rate of P 20,000 per month plus
P 1.50/kmdriven. The fixed portion is the P20,000 monthly rental fee, the variable portion is
the P1.50/km driven.If 10,000 km. are driven during the month, the total monthly cost of the
delivery truck is P 35,000, computed as follows:

Flat fee (fixed portion) P 20,000

Variable portion- 10,000 km. x P 1.50 15,000
Total cost P 35,000

Step costs
The fixed part of step costs changes abruptly at various activity levels because these
costs are acquired in indivisible portions. A step cost is similar to a fixed cost within a very
small relevant range.

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 Figure 1.4. Graph of Step Costs (De Leon, G., & De Leon, N., 2012)

The supervisor's salary is an example of step cost. Assume that one supervisor with
a salary of P 30,000 is needed for every 10 workers, then if 15 workers arc used, 2 supervisors
(with salaries of P 60,000) will be needed. If 18 workers are used, still 2 supervisors would be
needed. If the number of workers increases to 22, three supervisors would be needed.

Lesson 3. Cost Formula (De Leon, G., & De Leon, N., 2012)

Ideally, for both planning purposes and for making certain types of decisions, all costs
would be classified as either fixed variable, with semi-variable costs being separated into their
fixed and variable components. One of the most important steps in estimating the variable
and fixed components of a mixed cost is to examine the cause and effect relationship between
activities that affect costs. There are different methods of separating mixed costs to fixed and
variable components: (1) scatter graph, (2) high-low point, (3) and method of least square.
We will illustrate the use of high-low point method and method of least square.

1. High-Low Point Method

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 Month Direct Labor Cost of Electricity
January 28 625
February 24 565
March 30 630
April 33 640
May 38 685
June 34 640
July 35 655
August 40 700
September 42 715
October 47 726
November 43 700
December 32 630

Direct Labor Cost

Highest Month (Oct) 47 726
Lowest Month (Feb) 24 565
Difference 23 161

Variable rate per direct labor hour = P161

Fixed cost be computed from either the high or low data.

High Low
Total Cost of Electricity 726 565
Less: Variable proportion
(P 7 x 47) 329
(P7 x 24) 168
Monthly Fixed Cost 397 397

The formula for projecting the total monthly cost of electricity based on these data
would be P 397 plus P7 multiplied by the direct-labor hours expected to be worked during
the period (Y = FC + VC or Y = FC + VX) where

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 Y = Total Cost VC = Total Variable Cost
V = Variable Cost per Unit FC = Fixed Cost
X = Activity Level

2. Method of Least Square

The three formulas to be used in least-square method are:

Equation 1 Y = a + bx
Equation 2 ΣY = na + bΣx
Equation 3 ΣXY = Σxa + bΣx2

Using the same data as in the high-low method the following have been computed.

DL Hrs. Electricity Cost

X Y XY X2
28 625 17,500 784
24 565 13,560 576
30 630 18,900 900
33 640 21,120 1,089
38 685 26,030 1,444
34 640 21,760 1,156
35 655 22,925 1,225
40 700 28,000 1,600
42 715 30,030 1,764
47 726 34,122 2,209
43 700 30,100 1,849
32 630 20,160 1,024
Σ 426 7,911 284,207 15,620

By substitution:

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 Equation 2 ΣY = na + bΣx
(7,911 = 12a + 426b) 35.5 (426/12)

Equation 3 ΣXY = Σxa + bΣx2

284,207 = 426a + 15,620b
Equation 1x 35.5 280,840.5 = 426a + 15,123b
3,366.5 = 497b
b = 3,366.5/497
b = 6.77

Substituting the value for Equation 2, we can compute for as follows:

7,911 = 12a + (6.77)(426)
7,911 = 12a + 2,884
12a = 7,911 - 2,884
a = 5,087/12
a = 418.92

Formula using high-low method

Y = a + bx
= 397 + 7x

Formula using least square method

Y = a + bx
= 419 + 6.77x

Common cost vs. Joint cost

Common Cost
Costs of facilities or services employed in two or more accounting periods, operations,
commodities, or services. Just like indirect costs, these costs are subject to allocation.

Joint cost

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 Costs of materials, labor, and overhead incurred in the manufacture of two or more
products at the same time. A major difficulty inherent to joint costs is that they are indivisible
and they are not specifically identifiable with any of the products being simultaneously
produced. These costs are also subject to allocation.

Capital expenditure vs. Revenue expenditure

Capital expenditure
Expenditure intended to benefit more than one accounting periods and is recorded as
an asset. The allocation of the cost to the different periods 1s depreciation for fixed tangible
assets, amortization for intangible assets and depletion for wasting assets.

Revenue expenditure
Expenditure that will benefit current period only and is recorded as an expense.

Direct vs. Indirect departmental charges

Direct departmental charges

Costs that are immediately charged to the particular manufacturing department(s) that
incurred the costs since the costs can be conveniently identified or associated with the
department(s) that benefited from said costs.

Indirect departmental charges

Costs that are originally charged to some other manufacturing department(s) or
account(s) but are later allocated or transferred to another department(s) that indirectly
benefited from said costs.

Costs for Planning control and analytical processes

Standard costs
Predetermined costs for direct materials, direct labor, and factory overhead. They are
established by using information accumulated from past experience and data secured from
research studies. In essence, a standard cost is a budget for the production of one unit of

15
product or service. It is the cost chosen by the managerial accountant to serve as the
benchmark in the budgetary control system.

Opportunity cost
The benefit given up when one alternative is chosen over another. Opportunity costs
are not usually recorded in the accounting system. However, opportunity costs should be
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.

Example 1
Michelle has a part-time job that pays her P1, 000 per week. She would like to spend
a week in Bracey during summer vacation from school, but she has no vacation time available.
If she takes the trip anyway, the P1, 000 in lost wages will be an opportunity cost of doing so.

Example 2
Marco is employed with a company that pays him a salary of P20, 000 a month. He is
thinking about leaving the company and returning to school. Since returning to school would
require that he give up his P240, 000 salaries, the forgone salary would be an opportunity cost
of seeking further education.

Differential cost
Cost that is present under one alternative but is absent in whole or in part under
another alternative. An increase in cost from one alternative to another is known as
incremental cost, while a decrease in cost is known as decremental cost. Differential cost is a
broader term, encompassing both cost increases (incremental Cost) and cost decreases
(decremental costs) between alternatives.

The accountant's differential cost concept 1s basically the same as the economist s
marginal cost concept. ln speaking or changes in cost and revenue, the economist employs
the terms marginal cost and marginal revenue. The revenue that can be obtained from selling
one more unit of product is called marginal revenue, and the cost involved in producing one
more unit of product is called marginal cost.

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 Differential costs can be either fixed or variable. To illustrate, assume that Avon Corp.
is thinking about changing its marketing method from distribution through retailers to
distribution by direct sale. Present costs and revenues are compared to projected costs and
revenues in the table below.

Retailer Direct Sale Differential

Distribution Distribution Cost and
Present Proposed Revenues

Revenues (V) 900,000.00 1,200,000.00 300,000.00

Cost of Goods Sold (V) 450,000.00 600,000.00 150,000.00

Advertising (F) 80,000.00 45,000.00 (35,000.00)

Commission (V) - 40,000.00 40,000.00

Warehouse Depreciation (F) 50,000.00 80,000.00 30,000.00

Other Expenses (F) 60,000.00 60,000.00 -

Total 640,000.00 825,000.00 185,000.00

Net Income 260,000.00 375,000.00 115,000.00

The differential revenue is P 300,000, and the differential costs total P 185,000, leaving
a positive differential net income of P 115,000 under the proposed marketing plan. As noted
earlier, those differential costs representing cost increases could have been referred to more
specifically as incremental costs, and those representing cost decreases could have been
referred to more specifically as decremental costs.

Relevant cost

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 A future cost that change across the alternatives. In the example above, the sold,
relevant costs are cost of goods advertising, commissions, and warehouse depreciation.

Out-of-pocket cost
Cost that requires the payment of money (or other assets) as a result of their
incurrence.

Sunk cost
A cost for which an outlay has already been made and it cannot be changed by present
or future decision. Since sunk costs cannot be changed by any present orfuture decision, they
are not differential costs, and therefore they should be used in analysing future courses of
action.

To illustrate the notion of a sunk cost, assume that a firm has just paid P 250,000 for
a special purpose machine. Since the cost outlay has been made, theP 250,000 investment
in the machine is a sunk cost. Even though the purchase may have been unwise, no amount
of regret can relieve the company of its decision, nor can any future decision cause the cost
to be avoided.

Controllable and Non-controllable Costs

A cost is considered to be a controllable cost at a particular level of management if
that level has power to authorize the cost. For example, 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. On the other hand, deprecation of warehouse facilities would
not be controllable by the sales manager, since he or she would have no power to authorize
warehouse construction.

In some situations, there is a time dimension to controllability. Costs that are

controllable over the long run may not be controllable over the short run. A good example is
advertising. Once an advertising program has beenset and a contract signed, management
has no power to change the amount of spending. But the contract expires, advertising costs
can be renegotiated, and thus management can exercise control over the long run.

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 Figure 1.5.Cost Flow – Manufacturing Firms (De Leon & De Leon, 2012)

Figure 1.6.Cost Flow – Merchandising Firms (De Leon & De Leon, 2012)

Figure 1.7.Cost Flow – Service Firms (De Leon & De Leon, 2012)

Work in process consists of goods that are started but not completed. Finished goods
are goods that are complete and ready for sale.

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 The essential purpose of any organization is to transform inputs into outputs. The
activity for merchandising, manufacturing, and service organizations are shown in the
previous and current page. These organizations have many similarities, all require labor and
capital as inputs, and all transform them into a product or service for the market. These
organizations also differ from one another in many respects. The differences between these
organizations are reflected in their accounting systems.

A merchandising organization starts with a finished product and markets it. Because
inventory is acquired in finished form, its cost is easily ascertained.

The accounting system for a manufacturing organization is more complex because

direct materials are first acquired and then converted to finished products. A manufacturer's
accounting system focuses on work in process, which is the account that reflects the costs
involved in transforming input materials into finished goods.

Service organizations are different from manufacturing and merchandising because

they have no inventory of goods for sale. Costs arc charged to responsibility centers for
performance evaluation. In a public accounting firm, for example, costs are charged to the
audit department, the tax department, and so forth. Costs are also charged to jobs. The
assignment of costs facilitates performance evaluation. The manager of each department is
held responsible for the costs of the department, the manager of each job is held responsible
for the cost of that job.

Of the three kinds of operations, manufacturers require the most complex and
comprehensive cost accounting system. All three uses cost information for decision making
and performance evaluation. But in addition, manufacturers need product costing for inventory
valuation and to measure cost of goods sold reported on external financial statements. Many
manufacturers also have service and merchandising activities, costs of which must be
recorded.

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 Assessment Task1

Instruction: Answer the following questions:

Problem 1. Classify the following items as direct or indirect materials.

1. Gold to make jewelry

2. Sandpaper used in furniture making
3. Paper used in printing books
4. Milk to make ice cream
5. Leather to make gloves

Problem 2. Classify the following as manufacturing (M), selling (S), or administrative (A).

1. Factory Supplies
2. Advertising
3. Rent on factory building
4. President’s salary
5. Cost of machine breakdown

Problem 3. The financial statements of Mother Goose Company included these items:

Marketing Costs ₱ 160,000.00

Direct labor cost 245,000.00
Administrative costs 145,000.00
Direct materials used 285,000.00
Fixed factory overhead costs 175,000.00
Variable factory overhea cost 155,000.00

Compute:
1. Prime cost
2. Conversion Cost

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 3. Total Inventoriable/product cost
4. Total period cost

Problem 4. Blanche Corporation estimated its unit costs of producing and selling 12,000 units
per month as follows:

Direct materials used ₱ 32.00

Direct labor 20.00
Variable manufacturing overhead 15.00
Fixed manufacturing overhead 6.00
Variable marketing costs 3.00
Fixed marketing costs 4.00
₱
Estimated unit cost 80.00

Compute:
1. Total variable costs per month
2. Total fixed costs per month

Summary

It is indeed necessary for us to know the different types of cost we are dealing with.
As future business owners and managers, you should have a glimpse and knowledge on the
above-mentioned cost for you to make a fine judgment that will be beneficial to your business.

There are six (6) cost classifications. Some of them are cost relationship: relations to
a product – manufacturing non-manufacturing cost; relation to manufacturing departments –
direct department charges and indirect departmental charges; and relation to accounting
period – capital expenditures and revenue expenditures. The remaining classifications are:
cost classified as to variability – variable cost, fixed cost and mixed cost; classified to their
nature – as common cost of joint cost; and cost for planning, control and analytical processes

22
– standard cost, opportunity cost, differential cost, relevant cost, out-of pocket cost, sunk cost
and controllable cost.

Reference

De Leon Jr. G & De Leon N. (2012). Cost Accounting 2012 Edition. Manila Philippines: GIC
Enterprise & Co., Inc.

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 MODULE 2
COST ACCOUNTING CYCLE

Introduction

In the previous module, we have tackled the basic costs concepts and classification
including the cost formulas. On this module, we will be discussing the cost accounting cycle
which will give us a hint on how to prepare the cost of goods sold statement and the financial
statements.

These statements will give us a better insight of our business. This will serve as a
guide whether our business is gaining profit or incurring losses. It is a must for a Bachelor of

Science in Entrepreneurship students like you to be familiar and be adept in preparing and
analyzing the financial statements thus, this module will be very beneficial for you.

Learning Outcomes

After completing the module, the student should be able to:

1. understand the cost accounting cycle;

2. distinguish between a merchandising and a manufacturing entity;
3. distinguish between and account for direct and indirect materials and labor as they are
used in the production process; and
4. prepare the different financial statements for a manufacturing entity.

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25
Lesson 1. Parts of Cost of Goods Sold Statement
(De Leon, G., & De Leon, N., 2012)

The objective of accounting, in general, is the accumulation of financial information

that is useful in makıng 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. The statements include
a balance sheet, income statement, and statement of cash flows. Although these financial
statements are useful to management as well as external users, additional reports, schedules,
and analyses are required for internal use in planning and control. Cost accounting provides
the additional information required by management, and also provides data necessary for the
preparation of external financial statement. For example, 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.

Manufacturing Inventory Accounts

Most manufacturing companies use the perpetual inventory approach. In the
remaining sections of this book, you are to assume that a company uses the perpetual
inventory system unless otherwise indicated. Accounting for inventories is the more difficult
part of manufacturing accounting when compared with merchandising accounting. Instead of
dealing with one account Merchandise Inventory accounts must be used: Materials Inventory,
Work in Process Inventory, and Finished Goods Inventory.

Materials Inventory
The Materials Inventory account, also Materials Inventory Control account, is made up
of the balances of materials and supplies on hand. This account is maintained in much the
same way as the Merchandise Inventory account. The main difference is the way that the
costs of items in inventory are assigned. For the merchandising company, goods taken out of
inventory are items that have been sold. When a sale is made, an entry is needed to debit
Cost of Goods Sold and to credit Merchandise Inventory for the cost of the item. Materials, on
the other hand, are usually not purchased for resale but for use in manufacturing a product.
Therefore, 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).

26
 Figure 2.1.Merchandise Inventory versus Materials Inventory (De Leon, G., & De Leon, N., 2012)

Work in Process Inventory

All manufacturing costs incurred and assigned to products being produced are
classified as Work in Process Inventory costs. This inventory account has no counterpart in
merchandise accountingA thorough understanding of the concept of Work in Process
Inventory is vital in manufacturing accounting Figure 2.2 shows the various costs that become
part of Work in Process Inventory and the way costs aretransferred out of the account.

The issuance of material production, shown in Figure 2.1, begins the production
process. These materials must be cut, moulded, assembled, or in some other way changed
into a finished product. To make this change, people, machines, and other factory resources
(buildings, electricity, supplies. and so on) must be used. All of these costs are manufacturing
cost elements (product costs), and all of them enter into accounting for Work in Process
Inventory.

Direct labor earned by factory employees are also product costs. Since these people
work on specific products, their labor costs are assigned to those products by including the
labor peso earned as part of the Work in Process Inventory account.

Overhead costs are product costs and must be assigned to specific products. Thus,
they, too, are included in the Work in Process Inventory account discussed earlier, there are
many overhead costs to account for on an individual basis. To reduce the amount of work

27
needed to assign these costs to products, they are accumulated and accounted for less than
one account title: Factory Overhead Control. These costs are then assigned to products by
using an overhead rate. Using this rate, called a predetermined overhead rate, costs are
charged to Work in Process Inventory account. In the example in Figure 2.2, factory overhead
costs of P 65,000 were charged to the Work in Process Inventory account.

As products are completed, they are put into the finished goods storage area. These
products now have materials, direct labor, and factory overhead costs assigned to them.
When products are completed, their costs no longer belong to Work in process. Therefore,
when the completed products are sent to the storage area, their costs are transferred from
the Work in Process Inventory account to the Finished Goods Inventory. The balance
remaining in the Work in Process Inventory account (P 13,500 in Figure 2.2) represents the
costs that were assigned to products partly completed and still in process at the end of the
period.

Figure 2.2.The Work in Process Inventory Account (De Leon, G., & De Leon, N., 2012)

Finished Goods Inventory

The Finished Goods Inventory account, like Materials Inventory, has same
characteristics of the Merchandise Inventory account. We have already seen how costs are

28
moved from the Work in Process Inventory account to the Finished Goods Inventory account.
At this point Finished Goods Inventory takes on the characteristics of Merchandise Inventory.
If we compare the Merchandise Inventory account in Figure 2.1 with the accounting for
Finished Goods Inventory in Figure 2.3 we will see that the credit side of both accounts is
handled in the same way. Both examples show that when goods or products are sold, the
costs of those goods are moved from the Finished Goods Inventory account to the Cost of
Goods Sold account. However, the accounting procedures affecting the debit side of the
Finished Goods Inventory account differ from those for the Merchandise Inventory account.
In a manufacturing firm, salable products are produced rather than purchased. All costs
debited to the Finished Goods Inventory account represent transfers from the Work in Process
Inventory account. At the end of an accounting period, the balance in the Finished Goods
Inventory account is made up of the cost of products completed but unsold as of that date.

Figure 2.3. Accounting for Finished Goods Inventory (De Leon, G., & De Leon, N., 2012)

Lesson 2. Preparation of Cost of Goods Sold Statement

(De Leon, G., & De Leon, N., 2012)

For the merchandising concern, the cost of goods sold is computed as follows:

Beginning merchandise inventory

PIus: Purchases (merchandise)
Merchandise available for sale
Less: Merchandise inventory end
Cost of goods sold

29
 The amount of purchases represents the cost of the goods which were acquired during
the period for resale. Since the manufacturing concern makes rather than buys the product it
has available for sale. The term finished goods inventory replaces "merchandise inventory
and the term "cost of goods manufactured" replaces "purchases" in determining the cost of
goods sold.

Beginning finished goods inventory

PIus: Cost of goods manufactured
Total goods available for sale
Less: Finished goods inventory end
Cost of Goods Sold

Regardless of which costing system is used, a cost of goods manufactured (COGM)

statement is prepared to summarize the manufacturing activity of the period. Cost of Goods
Manufactured for a manufacturing firm is equivalent to purchases for a merchandising firm.
Although it may take different forms, essentially the COGM statement is a summary of the
direct materials, direct labor, factory overhead, and work-in-place (WP) account.

ELEMENTS OF MANUFACTURING COST

Manufacturing or production costs are classified into three basic elements: (1) direct
materials. (2) direct labor, and (3) factory overhead.

Direct materials
The cost of material which become part of the product being manufactured and which
can be readily identified with a certain product. Examples are: lumber used in making furniture,
fabric used in the production of clothing, crude oil used to make gasoline and leather used to
make shoes and bags.

Materials that cannot be readily identified with any particular item manufactured are
called indirect materials. Examples are: sandpaper used in sanding furniture, and lubricants
used on machinery. Classified also as indirect materials are materials that actually become
part of the finished product but whose costs are relatively insignificant, such as thread, screws,
rivets, bolts, nails, and glue.

30
Direct labor
The costs of labor for those employees who work directly on the product manufactured
are classified as direct labor. Examples are: salaries of machine operators or assembly line
workers.

The wages and salaries of employees who are required for the manufacturing process
but who do not work directly on the units being manufactured are considered indirect labor.
Examples are: wages and salaries of department heads, inspectors, supervisors, and
maintenance personnel.

Factory Overhead
Includes all costs related to the manufacturing of a product except direct materials and
direct labor. Examples are: indirect materials, indirect labor, and other manufacturing
expenses, such as depreciation on the factory building machinery and equipment, supplies,
heat, light, power, maintenance, insurance, rent and taxes.

Manufacturing Cost Flow

Product costing, inventory valuation, and financial reporting depend on a defined,
structured flow of manufacturing costs. This manufacturing cost flow was outlined in the
discussion of the three manufacturing inventory accounts. Figure 2.4 summarizes the entire
cost-flow process as it relates to accounts in the general ledger. The journal entries to make
this cost flow operational will be illustrated in the latter part of this module.

31
 Figure 2.4. Manufacturing Cost Flow (De Leon, G., & De Leon, N., 2012)

Here we concentrate on the general pattern of manufacturing cost flow, as shown in

Figure 2.5. The cost flow begins with costs being incurred. Manufacturing costs start in many
ways. They may be cash payments, incurred liabilities, fixed asset depreciation, or expired
prepaid expenses. Once these costs have been incurred they are recorded as direct materials,
direct labor, or factory overhead costs. As the resources are used up, the company transfers
its costs to the Work in Process Inventory account. When production is completed, costs
assigned to finished units are transferred to the Finished Goods Inventory account. In much
the same way, costs attached to units sold are transferred to the Cost of Goods Sold account.
Before going on, compare the cost flow as it moves through the general ledger accounts in
Figure 2.4 With the general pattern shown in Figure 2.5. Both figures show the same type of
cost flow.

Figure 2.5. Manufacturing Cost Flow Basic Concepts (De Leon, G., & De Leon, N., 2012)

32
The Manufacturing Statement
Financial statements of manufacturing companies differittle from those of
merchandising companies. Depending on the industry, the account titles found on the balance
sheet are the same in most corporations. (Examples include Cash, Accounts Receivable,
Buildings, Machinery, Accounts Payable and Capital Stock.) Even the income statements for
a merchandiser and a manufacturer are similar. However, a closer look shows that the head
Cost of Goods Manufactured is used in place of the Purchases account. Also, the
Merchandise Inventory account is replaced by Finished Goods Inventory.

The key to preparing an income statement for a manufacturing company is to

determine the cost of goods sold. The amount is the end result of a special manufacturing
statement, the statement of cost of goods manufactured, which is prepared to support the
figure on the income statement.

Statement of Cost of Goods Manufactured and Sold

The flow of manufacturing costs, shown in Figures 2.1 through 2.4, provides the basis
for accounting for manufacturing costs. In this process all manufacturing costs incurred are
considered product costs. They are used to compute ending inventory balances and cost of
goods sold. The costs flowingfrom one account to another during the year have been
combined into one number in the illustrations to help show the basic idea. In fact, hundreds
of transactions occur during a year, and each transaction affects part of the cost flow process.
At the end of the year, the flow of all manufacturing costs incurred during the year is
summarized in the statement of cost of goods manufactured and sold. The statement gives
the peso amount of costs for products completed and moved to Finished Goods Inventory
during the year.

The amount for cost of goods manufactured should be the same as the amount
transferred from the Work in Process Inventory account to the Finished Goods Inventory
account during the year. In the same way, the amount of cost of goods sold should be the
same as the amount transferred from the Finished Goods Inventory account to the Cost of
Goods Sold account during the year The statement of cost of goods sold for Figure 2.1 through
2.4 is shown on the next page. Even though this statement is rather complex, it can be picced
together in four steps. The first step is to compute the cost of materials used. Add the materials

33
for the period to the beginning balance in the Materials Inventory account. This subtotal
represents the cost of materials available for use during the year. Then subtract the balance
of the ending Materials Inventory from the materials available for use. The difference is the
cost of materials used during the accounting period.

Name of Company
Cost of Goods Sold Statement
For the year ended December 31, 2020

Direct Material Used

Materials Inventory, January 1 ₱ 24,600.00
Add: Purchases 53,200.00
Total Available for Use 77,800.00
Less: Materials Inventory, December 31 32,500.00 ₱ 45,300.00
Direct Labor 79,700.00
Factory Overhead 65,000.00
Total Manufacturing Costs 190,000.00
Add: Work in Process, January 1 25,100.00
Cost of Goods put into Process 215,100.00
Less: Work in Process, December 31 13,500.00
Cost of Goods Manufactured 201,600.00
Add: Finished Goods, January 1 70,000.00
Total Goods Available for Sale 271,600.00
Less: Finished Goods, December 31 31,100.00
Cost of Goods Sold - Normal ₱ 240,500.00

The second step is the computation of the total manufacturing costs for the year. The
costs of materials used and direct labor are added to total factory overhead costs applied
during the year. The third step charges total manufacturing costs into total cost of goods
manufactured for the year. Add the beginning Work in Process inventory balance to total
manufacturing costs for the period to arrive at the total cost of work in process during the year.
From this amount, subtract the ending Work in Process Inventory balance for the year to get

34
the cost of goods manufactured, The term total manufacturing costs must not be confused
With the cost of goods manufactured. Total manufacturing costs are the total costs for
materials used, direct labor, and factory overhead incurred and charged to production during
an accounting period. Total manufacturing costs of P 190,000 neurred during the current year
are added to the beginning balance of the Work in Process lnventory costs of P 25,100. The
P25,100 beginning balance, by definition, are costs from an earlier period. The costs of two
accounting periods are now being mixed to arrive at the total cost of goods put into process
during the year. The cost of ending products still in process (P31.100) are then subtracted
from the total cost or Sdsputnto process during the year. The remainder, P201,600,is the cost
of goods manufactured (completed) during the year. It is assumed that the items in beginning
inventory were completed first. Cost attached to the ending. Work in Process inventory are
part of the current period s total manufacturing costs. But they will not become part of the cost
of goods manufactured until the next accounting period when the products are completed.
The fourth step is the computation of the cost of goods sold during the year. The cost of goods
manufactured is added to the beginning balance of the Finished Goods Inventory to get the
total cost of goods available for sale during the period. The cost of goods sold- normal is then
computed by subtracting the ending balance in Finished Goods Inventory (cost of goods
completed but unsold) from the total cost of goods available for sale. Cost of goods sold is
considered an expense for the period in which the related products were sold.
Lesson 3. Preparation of Financial Statements
(De Leon, G., & De Leon, N., 2012)

ILLUSTRATION OF COST ACCOUNTING CYCLE

The Noeled Products Company is a small, newly organized company that
manufactures dining tables and chairs. 1he 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 table tops. 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.

The beginning balance sheet for the company on January of the current year is
presented below.
Noel Products Company

35
 Balance Sheet
January 1, 2020

Assets Liabilities and Stockholder's Equity

Cash ₱ 80,000.00 Liabilities ₱ -
Building 750,000.00
Machinery and Equipment 150,000.00 Capital Stock 980,000.00
Total Assets ₱ 980,000.00 Total Liabilities and
Stockholders' Equity ₱ 980,000.00

To make things casy, 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 50,000
Accounts Payable 50,000

This procedure differs in two ways from the recording of purchases for a
merchandising firm. First, the debit is to a Material Inventory account instead of a purchases
account because the inventory system is perpetual. Second, the inventory account used is a
control account. Some companies have hundreds of items in inventory. To keep a separate
account for each item in the general ledger would crowd the ledger and make it hard to work
with. At the time that entry I is posted to the general ledger, the individual stock cards are also
updated.

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 40,000

36
 Factory Overhead Control 1,900
Materials 41,900

This entry shows that P 40,000 of direct materials and P 1,900 of indirect materials
were issued. The debit to the Work in Process account records the cost of direct materials
issued to production. Such costs can be directly traced to specific job orders. As the direct
materials costs are charged to work in process, the amounts for individual jobs are entered
on the job order cost sheets. Indirect materials are debited to the Factory Overhead Control
account.

3. Total payroll for the month amounted to P 36,000, consisting of P 20,000 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 36,000
Accrued Payroll 36,000

Accrued Payroll 36,000

Cash 36,000

Recording labor costs for a manufacturing company requires three journal entries. The
first labor cost entry records the total payroll liability of the company. The second entry records
the payment of the payroll liability established in the first entry. The third entry (No. 4) Is now
needed to account properly for labor costs. The P 36,000 debited to the Payroll account must
be moved to the production accounts. Gross direct labor costs are debited to Work in Process
account, and total indirect labor costs (factory supervision) are debited to Factory Overhead
Control. Payroll is credited to show that the total account has been distributed to the
production accounts.

4. The entry to record the distribution or classification of the payroll would be

37
 Work in Process 20,000
Factory Overhead Control 7,000
Selling and Administrative Expense Control 9,000
Payroll 36,000

The wages earned by laborers working directly on the product are charged to Work in
Process, while the salaries and wages of the factory supervisor, who do no work directly on
the product, are charged to Factory Overhead Control. Sales salaries and administrative
salaries are charged to Selling and Administrative Expense Control.

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 3,375

Selling and Administrative Expense Control 375
Accumulated Depreciation - Bruilding 3,750

Depreciation for the portion of the building used for factory.operations 750,000 x 6% x
1/12 x 9/10; for the portion used by the office= 750,000x 6% x 1/12 x 1/10

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 2,500

Accumulated Depreciation- Mach. & Equipt. 2,500

7. The cost of heat, light, and power for the month was P3,000.

Factory Overhead Control 2,700

38
 Selling and Administrative Expense Control 300
Accounts Payable 3,000

The cost of heat, light, and power charged to Factory Overhead Control= 3,000 x 9/10
and charged to Selling and Administrative Expense = 3,000 x 1/10

8. Miscellaneous expenses for telephone, office supplies, travel, and rental of office furniture
and equipment totaled PI,500.
Selling and Administrative Expense Control 1,500
Accounts Payable 1,500

Many other expenses may be incurred by a manufacturingorganization, but for

purposes of simplicity, it is assumed there are no other expenses during the month. After
posting the journal entries to the appropriate ledger accounts, the factory Overhead account
will reflect the following debits.

Transaction Description Amount

2 Indirect Materials ₱ 1,900.00
4 Indirect Labor 7,000.00
5 Depreciation of building 3,375.00
Depreciation of machiner and
6 equipment 2,500.00
7 Heat, light and power 2,700.00
Total ₱ 17,475.00

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

Work in Process 17,000
Factory Overhead Applied 17,000

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:

39
 Transaction Description Amount
2 Direct materials ₱ 40,000.00
4 Direct labor 20,000.00
9 Factory overhead 17,000.00
Total ₱ 77,000.00

10. Assuming that all goods started in process have been finished, the following entry is
recorded:
Finished Goods 77,000
Work in Process 77,000

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

Amount Units Produced Unit Cost

Direct materials ₱ 40,000.00 1,000.00 ₱ 40.00
Direct labor 20,000.00 1,000.00 20.00
Factory overhead 17,000.00 1,000.00 17.00
Total ₱ 77,000.00 ₱ 77.00

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 analysed
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 400 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:

Manufacturing cost P 77.00

Gross profit (40%) 30.80

40
 Selling Price P107.80

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 34,000
Cash 34,000
12. 800 tables are sold to jobbers at a net price of P86,240
Accounts Receivable 86,240
Sales 86,240

Cost of Goods Sold 61,600

Finished Goods 61,600

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

Cash 55,000
Accounts Receivable 55,000

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

Cash Accounts Receivable

Beg 80,000.00 3 36,000.00 12 86,240.00 3 55,000.00
13 55,000.00 11 34,000.00 31,240.00
65,000.00

Materials Work in Process

1 50,000.00 2 41,900.00 2 40,000.00 10 77,000.00
8,100.00 4 20,000.00
9 17,000.00

41
 Finished Goods Building
10 77,000.00 12 61,600.00 Beg 75,000.00
15,400.00

Accum. Depreciation - Building Machinery and Equipment

5 3,750.00 Beg 150,000.00

Accum. Depreciation - Mach. &

Equipment Accounts Payable
6 2,500.00 1 34,000.00 1 50,000.00
7 3,000.00
8 1,500.00
20,500.00

Accrued Payroll Capital Stock

3 36,000.00 3 36,000.00 Beg 980,000.00

Factory Overhead Control Selling and Admin Exp. Control

2 1,900.00 4 9,000.00
4 7,000.00 5 375.00
5 3,375.00 7 300.00
6 2,500.00 8 1,500.00
7 2,700.00 11,175.00
17,475.00

Payroll Cost of Goods Sold

3 36,000.00 4 36,000.00 12 61,600.00

Sales Factory Overhead Applied

12 86,240.00 9 17,000.00

42
 Now let us compare the factory overhead of the two statements, the cost of goods sold
statement on page 52 for Figure 3-1 through 3-4 and the statement of cost of goods sold for
the illustrative problem which is shown on page 63. 1he factory overhead of the statement on
page 52 is total actual factory overhead incurred tor the period, while the factory overhead of
the statement on page 63 Is applied at 85% of direct labor cost. The predetermined overhead
rate (85%% ot direct labor cost) was used to apply overhead to production. Two overhead
accounts are used in the illustrative problem: Factory Overhead Control and Factory
Overhead Applied. Factory Overhead Control was used to accumulate all actual factory
overhead costs. The estimated amount charged to production was credited to Factory
Overhead Applied. After determining the balance of each general ledger account, a trial
balance is prepared to prove the equality of the debits and credits.

Noel Products Company

Balance Sheet
January 31, 2020

Cash P 65,000.00
Accounts Receivable 31,240.00
Finished Goods 15,400.00
Materials 8,100.00
Building 750,000.00
Accumulated Depreciation - Building P 3,750.00
Machinery and Equipment 150,000.00
Accumulated Depreciation - Mach &
Equipt. 2,500.00
Accounts Payable 20,500.00
Accrued Payroll -
Capital Stock 980,000.00
Slaes 86,240.00
Cost of Goods Sold 61,600.00
Factory Overhead Control 17,475.00

43
 Factory Overhead Applied 17,000.00
Selling and Admin Expense Control 11,175.00
Total P 1,109,990.00 P1,109,990.00

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

Noel Products Company

Income Statement
For the month ended January 31, 2020

Sales ₱ 86,240.00
Less: Cost of Goods Sold (Schedule 1) 62,075.00
Gross Profit ₱ 24,165.00
Less: Selling and Administrative Expenses
Selling and Administrative Salaries ₱ 9,000.00
Depreciation - Building 375.00
Heat, Light and Power 300.00
Miscellaneous 1,500.00 11,175.00
Net Income ₱ 12,990.00

Schedule 1

Noel Products Company

Cost of Goods Sold Statement
For the month ended January 31, 2020

Direct Materials Used

Purchases ₱ 50,000.00
Less: Materials, January 31 ₱ 8,100.00
Indirect Materials 1,900.00 10,000.00 ₱ 40,000.00
Direct Labor 20,000.00

44
Factory Overhead 17,000.00
Total Manufacturing Costs/COGM ₱ 77,000.00
Less: Finished Goods, January 31 15,400.00
Cost of Goods Manufactured and Sold - Normal ₱ 61,600.00
Add: Under-applied factory overhead 475.00
Cost of Goods Sold - actual ₱ 62,075.00

Noel Products Company

Balance Sheet
January 31, 2020

ASSETS
Current Assets
Cash ₱ 65,000.00
Accounts Receivable 31,240.00
Finished Goods 15,400.00
Materials 8,100.00
Total Current Assets ₱ 119,740.00
Plant and Equipment
Building ₱ 750,000.00
Less: Accumulated Depreciation 3,750.00 ₱ 746,250.00
Machinery and Equipment 150,000.00

Less: Accumulated Depreciation 2,500.00 147,500.00 893,750.00

Total Assets ₱ 1,013,490.00

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
Accounts Payable ₱ 20,500.00
Stockholders' Equity
₱
Capital Stock 980,000.00

Retained Earnings 12,990.00 992,990.00

45
 Total Liabilities and Stockholder's
Equity ₱ 1,013,490.00

The cost of goods manufactured/completed divided by the number of units

produced/completed will give the cost to manufacture per unit of the product, which is
equivalent to purchase price tor a merchandising concern.

The format of the income statement for a manufacturer is not significantly different
from that for a merchandiser. In the income statement of a manufacturing concern the cost of
goods sold is usually shown as one figure, supported by the cost of goods sold statement,
which is also the general procedure in a published report.

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 under applied factory overhead which is considered unfavourable 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 factoryoverhead control account is less than the
factory overhead applied, then what we have Is overapplied factory overhead which is
considered favourable 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 17,000

Underapplied factory overhead 475
Factory Overhead control 17,475

At the end of the year, the total underapplied (or net under/overapplied overhead
account is closed to Cost of Goods Sold account. If the amount of the under/over-applied
overhead is significant, then the amount is prorated to the Cost of Goods Sold account,

46
Finished Goods account, and Work in Process account, according to the balances at the end
of the period.

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

Materials Beg. + Total Materials available Materials used +

1 Purchases = for Use = Materials, end

WP, beg + Total Mfg. Total Cost of Goods put Cost of Goods
2 Cost = into Process = Manufactured

FG, beg + Cost of Total Goods Available Cost of Goods Sold + FG,
3 Goods Manufactured = for Sale = end

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

1. Prime cost = direct materials used + direct labor cost

2. Conversion cost = direct labor cost + factory overhead
3. Total manufacturing cost = direct material used + direct labor cost + factory OH

Assessment Task2

Instruction: Answer the following questions.

Problem 1. Queen Manufacturing Corporation had the following information relating to the
year 2020.

47
 Work in Process Inventory, January 1 250,000.00
Work in Process Inventory, December 31 100,000.00
Direct Material Used 950,000.00
Direct Labor 1,100,000.00
Factory Overhead Applied at 70% of direct labor cost
Finished Goods Inventory, January 1 150,000.00
Finished Goods Inventory, December 31 450,000.00
Sales 3,000,000.00
Selling and General Expenses 750,000.00

Required: From the preceding information, compute the following:

1. Cost of Goods Manufactured
2. Cost of Goods Sold
3. Net income or loss

Problem 2. Donna Company submits the following data for May, 2020.

Direct Labor Cost P 60,000

Cost of Goods Sold 250,000
Factory Overhead – Applied at 150% of direct labor costs.
Inventories May 1, 2020 May 31, 2020
Finished Goods P 50,000 P 22,000
Work in Process 29,200 24,000
Materials 24,000 15,000

Required: Cost of Goods Sold Statement.

Problem 3. The Accounting department of the Blanche Corporation provided the following
data for March, 2020.

Sales 1,200,000.00
Marketing Expenses 5% of sales
Administrative Expenses 1% of sales
Purchases 400,000.00

48
 Factory Overhead 2/3 of Direct Labor costs
Direct Labor 210,000.00
Inventories March 1 March 31
Finished Goods ₱ 100,000.00 ₱ 82,500.00
Work in Process 102,350.00 117,135.00
Materials 50,000.00 47,485.00

Required:
1. Income Statement
2. Cost of Goods Sold

Summary

The manufacturing business provides us with different kind of computation on financial

statements and types of inventories. There are three inventories available in manufacturing
namely: materials inventory, work in process inventory and finished goods inventory. Since
this kind of business involves the buying of raw materials; processing this raw materials into
finished goods. That is why it is necessary to have and monitor the mentioned inventories.

There are three elements of manufacturing cost – direct materials, direct labor and
factory overhead. We must be able to identify if a transaction belongs to any of these
elements. Failure to do so will have an impact in the preparation of financial statements.

The pro-forma entries for the cost of goods manufactured statement, cost of goods
sold statement, balance sheet or statement of financial position, and the income statement
serves us a guide on how to prepare these statements in our future busines. These statements
will surely aid you in deciding what is the best for your business.

49
 Reference

De Leon Jr. G & De Leon N. (2012). Cost Accounting 2012 Edition. Manila Philippines: GIC
Enterprise & Co., Inc.

50
 MODULE 3
ACCOUNTING FOR MATERIALS

Introduction

The purpose of materials accounting is to provide a summary fromthe general ledger

of the total cost of materials purchased and used in manufacturing. All materials issued during

the month and materials returned to stock are recorded on a summary of materials issued and

returned form.

Learning Outcomes

After completing the module, the student should be able to:

1. Distinguish between and account for direct and indirect materials as they are used in
the production process.

2. Differentiate among the forms used in the purchase and issuance of materials such as

purchase requisition, a purchase order, a receiving report and a materials requisition

3. Distinguish between the periodic and perpetual cost accumulation systems used to

account for materials issued to production and for ending materials inventory
4. Distinguish among the five common control procedures used to assist management is
keeping inventory costs to a minimum

Lesson 1. Systemsof Accounting for Materials

51
(De Leon, G., & De Leon, N., 2012)
Either the periodic inventory system or the perpetual inventory system may be used to

account for materials issued to production and ending materials inventory

ACCOUNTING BY THE PERIODIC INVENTORY SYSTEM

Under a periodic inventory system, the purchase of direct and indirect materials is

recorded in an account entitled "Purchases". If a beginning materials inventory exists, it is

recorded in a separate account entitled "Materials Inventory – Beginning Purchases added to

the materials inventory - beginning will be equal to materials available for use. Ending

materials inventory is determined by a physical count of the materials on hand at the end of
the period. Cost of materials issued is determined by deducting from the materials available
for use the materials inventory - end. Note that under this method the cost of materials issued

is not directly determined. it is indirectly computed by deducting the remaining inventory on

hand from the total available for use

ACCOUNTING BY THE PERPETURAL INVENTORY SYSTEM

Under a perpetual inventory system, the purchase of direct and indirect materials is

recorded in an account entitled "Materials Inventory" rather than in a purchase account. The

beginning materials inventory is the balance of the materials inventory at the end of the
previous period. When materials are issued, the Materials Inventory account is credited for
the cost of direct materials with a corresponding debit to the work in process inventory

Issuance of indirect materials in debited to the factory overhead control account. Under the
perpetual inventory system, both the cost of materials issued and the ending materials

inventory can be directly ascertained after each transaction.

Lesson 2. Control Procedures (De Leon, G., & De Leon, N., 2012)

52
 It is of utmost importance that company has good system of materials inventory

control. Achievement of good control keeps costs at a minimum level and plant production on
a month interrupted schedule. The following concepts should be employed in inventory control
system

1. Inventory is the result of purchasing raw materials and parts. It is the result of applying tabor
and factory and to the raw materials to produce finished

2. Reduction of inventory is the result of normal use and also finding alternative users for

scrapping unneeded items

3. Optimum inventory investment is based on quantitative techniques, which are designed to

minimize the cost of eating inventory and the cost of ordering inventory.

4. Efficient purchasing management, and investment in materials depend on the accurate

forecast of sales and resulting production schedules.

5. Forecast help determine when to order materials. Controlling inventory can be

accomplished by scheduling production.

6. Inventory control is more than maintaining inventory records. Control is exercise by people
who are making personal judgements partially on the basis of past experience but within the
general framework of organizational objectives and policies to achieve them.

7. Methods of inventory will vary depending on the cost of the materials and their importance
to the manufacturing procedure. Expensive materials and materials a to production will send

to line their program for control reviewed more frequently despite the cost and effort of doing

so by experienced personnel.

The finished product is composed of the amount spent for materials direct labor and share in

the factory overhead. It becomes necessary therefore to adopt a good control system for each

53
element. The major function in general of any control system is to keep expenditures within
the limits provided is designed to control the people responsible for the expenditures because

people control costs, costs do not control themselves.

COMMONLY USED CONTROL PROCEDURES

1. Order cycling

2 Min-max method

3. Two-bin method

4. Automatic order system

5. ABC plan

Order cycling - method where materials on hand are reviewed on a regular or periodic cycle,

like let's say every 30 days. The cycle length will differ according to the type of material being

reviewed. Essential or important materials will have a shorter review cycle than less important
items. At the time of the review, an order will be placed to bring the inventory to a desired
level. A technique often used for small items is the 90-60-30-day method. When the inventory

level drops to a 60-day supplies an order will be placed for a 30-day suppls

Min-max method - this method is based on the assumption that materials inventory have

minimum and maximum levels Once the specific minimum and maximum quantities are
determined, the minimum quantity will represent the order point When the inventory reaches

the minimum level, an order is placed to increase the inventory to the maximum level.
Minimum quantities are usually determined to protect the company against stock out

54
Two-bin method - this method is used for materials that are considered inexpensive and/or
nonessential. The advantage of this method is that it is simple and requires only a minimum

of clerical time Under this materials are divided and placed into two separate bins The quantity
of materials that will be used between the time an order is received and the next order is

placed will be on the first bin. The second bin will contain the quantity of materials that will be
used between the ordering and delivery, plus additional units of safety stock When the first

bin is emptied. an order is placed. The contents of the second bin will be used until the receipt

of the shipment

Automatic order system - this method used by most companies that are computerized An
order is automatically placed when the level of inventory reaches a predetermined order point
quantity Perpetual inventory record cards are maintained which record purchases and

issuance of the specific materials. When the inventory balance is equal to the predetermined

order point quantity an order is placed with the use of a computer, it is possible to periodically
recompute the optimum investment in inventory and thus revise the quantity to be purchased

ABC Plan - method used by companies with a large number of materials, each one having a

different value. The materials control for a high-value item will naturally be different from the
material control for a low-value item, The ABC plan is a Systematic way of grouping materials
into separate classification and determining the degree of control that each group requires.
For an example, inexpensive or not critical materials may be accounted for by using the min-

max method. For expensive and critical materials, a more sophisticated method, such asthe

automatic order system, may be used

Lesson 3. Materials Control (De Leon, G., & De Leon, N., 2012)

There are two basic aspects of materials control

55
1. Physical control or safeguarding materials

2. Control of the investment in materials

Physical Control of Materials

Every business requires a system of internal control that includes procedures for the

safeguarding of assets. Inventories, just like cash and marketable securities, must be

protected from unauthorized use or theft Inventories usually represent a significant portion of
a manufacturer's current assets and because of this, materials must be controlled from the

time the order is placed with the vendor until they are shipped to customers in the finished

form. In general, effective control of materials involves

1. Limited access

2. Segregation of duties

3. Accuracy in recording

Limited Access - Only authorized personnel should have access to materials storage area. All
issuance of materials for use in production and release of finished goods for shipment should
be properly documented and approved

Segregation of Duties. The following functions should be segregated to minimize opportunities

for misappropriation of inventories - purchasing, receiving, storage, use, and recording

Accuracy in Recording - Inventory records should permit the determination of inventory

quantities on hand upon request, and cost records should provide the data for the valuation

of inventories for the preparation of financial statements

Controlling the Investment in Materials

One of the most important objectives of materials control is maintaining the proper balance of
materials on land. An inventory of sufficient size and diversity for efficient operations must be

56
maintained, but the size should not be excessive in relation to scheduled production needs.
The planning and control of the materials inventory investment requires careful study of the

following factors: usage of funds, costs of materials banding, storage, and insurance against
fire, theft, or other casualty loss from damage, deterioration, and obsolescence. These factors

should be considered in determining (1) when orders should be placed, and (2) how many
units should be ordered

Order Point

A subsidiary ledger must be kept for each individual item of raw material used in the

manufacturing process. This lodger will indicate the inventory on hand for each item. The point

at which an item should be ordered, called the order point occurs when the predetermined
minimum level of inventory on hand is reached Calculation of the order point is based on the
following data.

1. Usage - the anticipated rate at which the materials will be used

2. Lead time - the estimated time interval between the placement of an order and receipt of

the material

3. Safety stock - the estimated minimum level of inventory needed to protect against running

out of stock

Assume that the expected daily usage of an item of material is 100 units, the
anticipated lead time is 4 days, and it is estimated that a safety stock of 800 units is needed.
The following calculation shows that the order point is 1,200 units

100 units (daily usage) x 4 days (lead time) 400 units

Safety stock 800 units

Order point 1,200 units

57
Economic Order Quantity

The purchase order which results in the minimum total inventory cost. In determining the
quantity to be ordered, the cost of placing an order and the cost of carrying inventory must
be considered

Factors to be considered in determining ordering costs

1. Salaries and wages of employees engaged in purchasing, receiving and inspecting

materials

2. Communication costs associated with ordering, such as telephone, postage, and forms of

stationery

3. Materials accounting and record keeping

Factors to be considered in determining carrying costs

1 Materials storage and handling costs

2. Interest, instance, and property taxes

3. Loss due to theft, deterioration, or obsolescence

4. Records and supplies associated with the carrying of inventories

METHODS OF COMPUTING ECONOMIC ORDER QUANTITY

1. TABULAR METHOD - Under this method, several purchase order quantity alternatives are
listed in separate columns Total inventory costs, showing both carrying and ordering costs

58
are calculated for each alternative. The column with the lowest total amount of inventory cost
will be the economic order quantity.

The economic order quantity can also be determined by constructing a table as shown

below

Order Size No. of Total Order Average Total Total order

Orders Cost Inventory carrying & carrying
cost cost
100 100 1,000 50 40 1,040
300 33 330 150 120 450
500 20 200 250 200 400
700 14 140 350 280 420
900 11 110 450 360 470

EOQ-500 units (order size where total costs - 400)

Order size = number of units per order

No of order = 10,000/order size

Total order cost = No. of orders x 10 per order

Average Inventory = Order size / 2

Total carrying cost = average inventory x 0.80

Total order & carrying cost = total order cost + total carrying cost

Total ordering costs and total carrying costs vary inversely. The greater the inventory on hand,
the greater the total carrying costs but the lower the ordering costs. If a small inventory is on

hand total carrying costs will be lower but more orders will be placed, the creating the total

59
ordering costs It is the responsibility of management to find the proper inventory policy that
keeps the total inventory costs (total carrying cost + total ordering costs) to a minimum

2. FORMULA METHOD - The formula method is easy to use and it produces an exact
figure. The formula that can be used is

EOQ = 2CN

Where:

EOQ=economic order quantity

C =cost of placing an order

N = number of units required annually

K =carrying cost per unit of inventory

ILLUSTRATIVE PROBLEM 1

To illustrate the application of the formula, let us assume the following

Number of units of materials required annually 10,000

Cost of placing an order P 10.00

Annual carrying cost per unit of inventory P 0.80

Using the EOQ formula

EOQ = 2 (cost of order) (number of limits required annually)

(carrying cost per unit)

60
 = 2 (10) (10,000)

0.80

= P200,000

0.80

= 500 units

Order Point

Once the Economic Order Quantity has been determined, management must decide when to
place the order, the order point must be established If the lead time and the inventory usage
rate are known, determination of the order point is easy. Lead time is the period between the

placement of the order and the receipt of the materials ordered Inventory usage rate is the

quantity of materials used in production over a period of time. The order point should be where
the inventory level reaches the number of units that would be consumed during the Iead time

ILLUSTRATIVE PROBLEM 2

Assume that the expected daily usage of an item of material is 100 units and the anticipated

lead time is 4 days. The following calculation shows that the order point is 400 units

Order point =100 units (daily usage) x 4 days (lead time)

=400 units

When the inventory level of materials is reduced to 400 units, an order should be placed for

500 units (the EOQ)

61
Safety Stock

Since it is almost impossible to estimate lead time and average usage rate with accuracy,

many companies prefer to carry a safety stock (or additional inventory) as a cushion against

possible stock outs. In such a case, the order point is computed by adding the safety stock to
the estimate usage during the lead time. A safety stock calculation should arrive at a figure

which properly balances the risk of a stockout against the additional carrying costs incurred

by the extra inventory

ILLUSTRATIVE PROBLEM 3

Assume the use of same data as in the computation of the order point above (without the

safety stock), the revised order point may be computed as follows assuming safety stock of

800 units

100 units (daily usage) x 4 days (load time) 400 units

Safety stock 800 units

Revised order point 1,200 units

ILLUSTRATIVE PROBLEM 4

A television manufacturer buys wooden cabinet from outside suppliers at P 400 per set.

Total annual needs are 5.000 units at a rate of 20 sets per working day. The following cost
data are available

Desired annual return on inventory investment (10% x 400) 40

Rent, insurance, taxes per unit per year 10

Carrying costs per unit per year 50

62
 Costs per purchase order - clerical costs, supplies, telephones, etc P50

Requirements

4 What is the economic order quantity?

5 Compute for

a. Annual ordering costs

b. Annual carrying costs

SOLUTION TO ILLUSTRATIVE PROBLEM 4

1 EOQ = 2 (cost of order) (number of limits required annually)

(carrying cost per unit)

= 2 (50) (5,000)

50

= 500,000

50

= 10,000

= 100 units

2. a) Annual ordering cost = 5,000 x 50 = P2,500

100

63
b) Annual carrying cost = 100 x 50 = P 2,500

Lesson 4. Methods of Costing Materials

(De Leon, G., & De Leon, N., 2012)

The main objective of cost accounting is to produce accurate and meaningful figures for the
goods manufactured and sold which are to be used by management for control, analysis and
for the determination of the of the operating income.

The more common methods of costing materials issued and finished goods sold are:
1. First-in, first-out (FIFO)
2. Average cost

These methods are related to the flow of costs and not necessarily to the actual flow of
materials or finished goods If only the materials were acquired at the same cost all year round,
then valuation of materials inventory, cod, will not be a problem because the value can be
computed by simply multiplying the units on hand and the unit cost. The same can be said for
the finished goods because if the units were produced at the same cost all year round, the
value at the end of the period can be computed by multiplying the finished goods on hand by
the cost to produce each unit. The different methods are used because the materials are
acquired at different costs during the year Average cost for perpetual inventory system refers
to moving average and for periodic inventory system - weighted average.

FIRST-IN, FIRST OUT (FIFO) METHOD OF COSTING

The first in, first-out (FIFO) method is based on the assumption that cost should be charged
to manufacturing cost or cost of goods sold in the order in which incurred inventories are
stated in terms of the most recent costs and expense is charged with the earliest costs
incurred

Illustrative problem:

64
August 1 Inventory 400 units at PI0 4,000
12 Purchase 600 units at P12 7,200
16 Issue 300 units
18 Purchase 300 units at P15 4,500
20 Issue 200 units
25 Purchase 400 units at P14 5,600
28 Issue 400 units

The inventory on August 31 shows 600 units on hand. Under periodic inventory system, the
most recent costs would be assigned to the units as follows
From Aug 25 purchase 400 units at 14 P5,600
From Aug 18 purchase 200 units at 15 3,000
Total 8,600
If the ending inventory is valued at P 8,610, cost of materials issued is P 12,700 computed as
follows:
Materials, Aug 1 4,000
Purchases (7,200 + 4,500 + 5,600) 17,500
Total available for use 21,200
Less: Materials. Aug 31 8,600
Direct materials used 12,700
When perpetual inventory system is used, a stock card is used to record the costs assigned
to units issued and to cost relating to the units on hand
Date Received Issued Balance
400 @ 10.00 4,000
12 600 @ 12.00 400 @ 10.00 4,000
600 @ 12.00 7,200
16 400 @ 10.00
100 @ 12.00 500 @ 12.00 6,000
18 300 @ 15.00 500 @ 12.00 6,000
300 @ 15.00 4,500
20 200 @ 12.00 300 @ 12.00 3,600
300 @ 15.00 4,500
25 400 @ 14.00 300 @ 12.00 3,600

65
 300 @ 15.00 4,500
400 @ 14.00 5,600
28 300 @ 12.00 200 @ 15.00 3,000
100 @ 15.00 400 @ 14.00 5,600

As shown on the issued section of the stock card on page 171, the cost of materials issued

is:

400 at 10.00 4,000

100 at 12.00 1,200

200 at 12.00 2,400

300 at 12.00 3,600

100 at 15.00 1,500

1,100 12,700

The value of the units on hand, August 31 using perpetual inventory system is the same as
that computed under period inventory system. The amount is computed as follows

200 at 15.00 3,000

400 at 14.00 5,600

600 3,000

AVERAGE METHOD

a. Weighted average method - used for periodic inventory system. This method is based on

the assumption that units issued should be charged at an average cost, such average being

influenced or weighted by the number of units acquired at each price. The inventory at the

66
end is computed by multiplying the weighted average cost per unit by the units on hand. Using
the illustrative problem on page 56, the weighted average unit cost is computed as follows:

400 units at 10.00 4,000

600 units at 12.00 7,200

300 units at 15.00 4,500

400 units at 14.00 5,600

1,700 21,300

Weighted average unit cost = 21,300

1.700

= 12 529

Inventory, August 31 (600 units x 12.529) =7,517.65

b. Moving Average Method. When a perpetual inventory system is used, a new weighted
average unit cost is calculated after each new purchase and this amount is used to cost each
subsequent issuance until another purchase is made.

Date Received Issued Balance

8/1 400 @ 10.00 4,000
12 600 @ 12 1000 @ 11.20 11,200
16 500 @ 11.20 500 @ 11.20 5,600
18 300 @ 15 800 @ 12.625 10,100
20 200 @ 12.625 600 @ 12.625 7,575
25 400 @ 14.00 1,000 @ 13,175
13.175

67
 28 400 @ 13.175 600 @ 13.175 7,905

The computation of the unit cost is as follows:

August 12

Balance 400 @ 10.00 4,000

Purchase 600 @ 12.00 7,200

1,000 11,200

The new weighted average unit cost = 11,200

1,000 units

= 11.20

August 18

Balance 500 @ 11.20 5,600

Purchase 300 @ 15.00 4,500

800 10,100

The new weighted average unit cost = 10,100

800 units

= 12.625

68
The cost of materials issued may be computed from the data presented under each section

500 units @ 11.20 5,600

200 units @ 12.625 2,725

400 units @ 13.175 5,270

13,595

COMPARISON FIFO AND AVERAGE METHODS

FIFO AVERAGE

Inventory 4,000 4,000

Purchases 17,300 17,300

Total available for use 21,300 21,300

Less: Inventory. Aug 31 8,600 7,905

Direct materials used 12,700 13,395

Lesson 5. Special problems in materials accounting

(De Leon, G., & De Leon, N., 2012)

1. DISCOUNTS- constitute a reduction in the list price

1. Trade discounts - generally given in terms of percentage (15%, 10%,5%) and are
used to convert single price list into a son of price lists for different types of middleman. Trade

discounts are not recorded on the books because purchases are recorded on the books net

of the discount

69
Illustrative problem

Windy Corporation buys all of materials and supplies from the Oregon Company and allowed

a trade discount of 10% Purchases during the month were P 400.000 before the discount

The entry to record the purchase is

Materials 360,000

Accounts Payable 360,000

(400,000 90%)

2. Quantity discounts represent cost savings for volume purchases Like trade
discounts, quantity discounts are not given explicit accounting recognition in the books

3. Cash discounts - granted to customers to motivate them to pay promptly

a) When taken method - purchases and liabilities are recorded at gross amounts at
the time of purchase. The discount is only recognized when the account is paid within

the discount period

b) When not taken method - purchases and liabilities are recorded at net at the time
of purchase, when payment is made after the lapse of the discount period, the discount
not availed of is charged to a Purchase Discount Lost" account It is called when not

taken method because even if the account is paid within the discount period, no Purchase

Discount" is recorded and therefore readers of the financial statements would not
know that the company has availed of the discount

c) When offered method - purchases are recorded at net and the liability is recorded

at gross, the difference is changed to an "Allowance for Purchase Discount" account.

When payment is made after the lapse of the discount period, the discount not availed of is

charged to the Purchase Discount Lost" account

70
Illustrative Problem:

The Jenelle Company purchased materials listed at P 40.000; terms. 2/15, n/30 on

August 1

Assume payments as follows

a) Full payment is made on August 14,

b) Full payment is made on August 30

Requirements. Entries to record the purchase and payments assuming

1) When taken method is used

2) When not taken method is used

3) When offered method is used.

1) When taken method is used:

Aug 1 Materials 40,000

Accounts Payable 40,000

14 Accounts Payable 40,000

Purchase Discount 800

Cash 39,200

71
 30 Accounts Payable 40,000

Cash 40,000

2) When not taken method is used:

Aug 1 Materials 39,200

Accounts Payable 39,200

14 Accounts Payable 39,200

Cash 39,200

30 Accounts Payable 39,200

Purchase Discounts Lost 800

Cash 40,000

3) When offered method is used:

Aug 1 Materials 39,200

Allow. For purchase discount 800

Accounts Payable 39,200

14 Accounts Payable 40,000

Allow. For purchase discount 800

72
 Cash 39,200

30 Accounts Payable 40,000

Purchase Discounts Lost 800

Allow. For purchase discount 800

Cash 40,000

II. FREIGHT-IN

1. Direct charging - the freight incurred on the purchase of raw materials is added to the
invoice price. The account debited for the freight is Materials. The effect is an increase in the
unit cost. If two or more materials are purchased and delivered at the same time, the freight

must be allocated using the following methods.

a. Relative peso value method - freight is allocated on the basis of the peso value of
the items purchased. This is used for materials purchased and expressed in different

terms of measurement

b. Relative weight method - freight is allocated on the basis of the weight of the items
purchased

2. Indirect charging - the freight incurred on the purchase of raw materials is charged to
Factory Overhead Control account.

Illustrative problem

An invoice for raw materials A, B. and C is received from the Bulacan Corporation. The
invoice totals are A-P 25,000, B - P15,000, C-P10,000 The freight charge on this shipment

73
weighing 10.000 pounds is P 1,500. Shipping weights for the respective materials are 5,000,
2,000, and 1,000, respectively.

Required

1. Entry to record the purchase of materials and the freight using

a. Direct charging method

b. Indirect charging method.

2. The cost per pound to be entered in the materials ledger cards for A, B. and C, if freight is

allocated using

a Relative peso value method

b. Relative weight method.

1. Direct charging method

Materials 51,500

Accounts Payable 51,500

b) Indirect charging method

Materials 50,000

Factory Overhead Control 1,500

Accounts Payable 51,500

2. a) Relative peso value method

74
 Materials Invoice Percentage Share in Freight Total Cost Cost per
Pound
A 25,000 3% 750 25,750 5.15
B 15,000 3% 450 15,450 7.725
C 10,000 3% 300 10,300 10.30
50,000 1,500 51,500
b) Relative weight method

Materials Weight (lbs.) Freight /lbs Share in Freight Total Cost Cost per
Pound
A 5,000 0.1875 937.50 25,937.50 5.1875
B 2,000 0.1875 375.00 15,375.00 7.6875
C 1,000 0.1875 187.50 10,187.50 10.1875
8,000 1,500 51,500

Lesson 6. Spoiledunits, defectiveunits,scrap material, and

waste material (De Leon, G., & De Leon, N., 2012)
The terms spoiled units, defective, scrap material and waste material are not synonymous,

and they should not be used interchangeably. For this discussion, the following definitions will
apply. Spoiled units are units that do not meet production standards and are cither sold for

their salvage value or discarded when spoiled units are discovered, they are taken out of
production and no further work is performed on them. Defective units are units that do not

meet production standards and must be processed further in order to be salable as good units
or as irregulars. Scrap material are left over from the production process that cannot be put
back into production for the same purpose, but may be usable for a different purpose or
production process or which may be sold to outsiders for a nominal amount.

Waste materials are left over from the production process that has no further use or resale

value and may require cost for their disposal

75
TWO METHODS OF ACCOUNTING FOR SPOILED MATERIALS

The method to account for spoiled materials depends on the reason for such spoilage

1. Charged to the specific job - this method is used if the reason for the spoilage is the job
itself, because it requires exacting specifications, or a difficult, intricate or complicated
manufacturing process. The effect of this method is that it will increase the unit cost of the
remaining perfect finished articles in the job

Entry: Spoiled goods xxx

Work in process xxx

The amount debited to spoiled goods and credited to work in process is equal to the number

of units spoiled multiplied by the estimated sales value per unit.

2. Charged to all production - this method is used if the reason for the spoilage is considered
normal to the process and the number does not exceed the limit set by the company. With
this method, all units manufactured during the period are charged with an additional cost which

is added to the factory overhead rate. The unit cost originally charged will not increase
anymore even if there are spoiled units discovered later on.

Entry Spoiled goods xxx

Factory overhead control xxx

Work in process xxx

The amount debited to spoiled goods is equal to the number of units spoiled multiplied by the
estimated sales value per unit. The amount credited to work in process is equal to the total

costs incurred charged to the spoiled units. The loss is charged to factory overhead control.

If the number of units spoiled exceed the limit set by the company, or if the reason is not
considered normal to the process, the loss on the spoiled units is charged to a loss account.

76
Illustrative problem

Job 3044 called for the making of 4,000 with these unit costs

Direct materials 15.00

Direct labor 13.00

Factory overhead (includes a P1 00

allowance for spoiled work) 12.00

Total 40.00

When the order was completed. 200 rejected units a normal number, were sold for 18,00

each

Required

1 Entries of the loss is charged to all production

2. Entries if the loss is charged to the specific job

1. Loss is charged to all production

a) Work m Process 160,000

Materials 60,000

Payroll 52,000

Factory Overhead Applied

Materials =4,000 x 15.00

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 Labor =4,000 x 13.00

Overhead =4,000 x 12.00

b) Spoiled Goods 3,600

Factory Overhead Control 4,400

Work in Process 8,000

Spoiled =200 x 18.00

WP =200 x 40.00

c) Finished Goods 132,000

Work in Process 132,000

2. Loss is charged to the specific job.

a) Work in Process 156,000

Materials 60,000

Payroll 44,000

Factory Overhead Applied

Materials =4,000 x 1500

Labor =4,000 X 13.00

Overhead =4,000 x 1100

b) Spoiled Goods 3,600

Work in Process 3,600

c) Finished Goods 152,400

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 Work in Process 152,400

Under the method, loss charged to all production, the unit cost of the completed units remains

at P40.00. In spite of the spoiled units, the unit cost remained the same because the increase

was made at the start (when PL.00 was added to the factory overhead rate as allowance for
spoiled work). All units processed during the period, even those jobs without spoiled units, will

absorb the additional P100 Upon completion of the job, even if there were spoiled units, the

unit cost will be the same as the amount originally charged to the job, On the other hand under
the method, loss charged to the specific job, it will be noted that the factory overhead rate was
recorded at the original amount P11.00 (allowance of PL.00 for spoiled work was not added).

The remaining perfect units in the job will absorb the loss on the spoiled, resulting in an

increase in the unit cost

152,400

3,800 units= 40.105/unit

the increase in the unit cost (40 105 - 39.00 - 1.105) may be computed as follows.

Cost of spoiled (200 x 39.00) 7,800

Less Amount recovered from sale (200 x 18) 3,600

Loss on spoiled goods 4,200

The loss on spoiled goods will be absorbed by the remaining good units (4,200 divided by

3,800 units = 1.10/unit),

TWO METHODS OF ACCOUNTING FOR DEFECTIVE MATERIALS

The accounting problem for defective units is the additional costs to be incurred in
reprocessing the units to convert them into perfect articles. There are two methods available

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1. Charged to the specific job - same for spoiled units, if the reason for the defect is the job
itself, the additional costs incurred (materials, labor, and overhead) will be charged to all units

in the job,

Entry

Work in process xxx

Materials xxx

Payroll xxx

Factory Overhead Applied xxx

2. Charged to all production - if the reason is normal to the process and the number of
defective units does not exceed the normal limit, then the additional costs incurred will be

charged to all units being processed during the period

Entry

Factory overhead control xxx

Materials xxx

Payroll xxx

Factory overhead applied xxx

Illustrative problem:

Job 3044 called for the making of 4,000 units with these unit costs

Direct materials 15.00

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 Direct labor 13.00

Factory overhead (includes a 1.00

allowance for defective units) 12.00

Total 40.00

During processing 300 units were found to be defective and required the following total

additional costs materials - P 2,000, tabor - P4.000 and overhead -P2.000

Required

1 Entries if the additional cost is charged to all production

2 Entries if the additional cost is charged to the specific job.

1 Additional cost is charged to all production,

a) Work in Process 160,000

Materials 60,000

Payroll 52,000

Factory Overhead Applied 48,000

b) Factory Overhead Control 8,000

Materials 2,000

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 Payroll 4,000

Factory Overhead Applied 2,000

c) Finished good 160,000

Work in Process 160,000

The cost of the finished goods will remain at the original amount charged to the job (160,000

divided by 4.000 units P40 000)

2. Additional cost is charged to the specific job.

a) Work in Process 156,000

Materials 60,000

Payroll 52,000

Factory Overhead Applied 44,000

b) Work in Process 8,000

Materials 2,000

Payroll 4,000

Factory Overhead Applied 2,000

c) Finished Goods 164,000

Work in Process 164,000

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The unit cost of the completed units increased from the original P39.00 to P41.00 (164,000
divided by 4.000 units). All units in the job will share in the cost incurred to ro-process the

defective units

Lesson 7. Accounting for Scrap Materials

(De Leon, G., & De Leon, N., 2012)
A cost accounting system should provide a method of costing and control for scrap as it does
for spoilage and defective units. When the amount of scrap produced exceeds the norm, it

could be an indication of inefficiency. A predetermined rate for scrap should be prepared as a

guide for comparison with the actual scrap those results Ir large differences occur,

management should find the reason and correct the problem. Scrap materials have commonly
been accounted for in either of the following ways

1. If the scrap recovered can be traced to a specific job, the entry is

Scrap Material xxx

Work in Process xxx

The amount recovered for the scrap will be entered negative) on the materials section of the

job order cost sheet

2. If the scrap recovered are not traceable to a specific job. the entry is

Scrap Materials xxx

Miscellaneous Income xxx

3. If the scrap recovered are from factory supplies the entry is

Scrap/Scrap Materials xxx

Factory overhead control xxx

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ACCOUNTING FOR WASTE MATERIAL

The cost of disposing of waste materials may be allocated either to all jobs (included in the
factory overhead application rate) or to specific jobs (not included in the factory overhead
application rate)

1. If the cost of disposing the waste materials is allocated to all jobs, the entry is

Factors overhead control xxx

Accounts payable xxx

2. If the cost of disposing the waste materials is allocated to a specific job, the entry

WIP inventory – Job # xxx

Accounts payable xxx

Waste exceeding a specified normal level (based on past experience) indicates inefficiencies

somewhere in the production process and signals management to take corrective action.

Although the cost of disposing of waste materials is minimal as compared to the total

production costs, in some manufacturing and service corporations it may involve significant
expenditure. For example, a chemical manufacturer may have toxic waste which requires

special packaging before disposal and thus results in an expensive disposal cost.

The cost of disposing of most type of waste is expected to increase significantly in the near

future as existing garbage dumps fill up and more elaborate and expensive forms of disposal

must be developed.

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 Assessment Task

PROBLEMS

Problem 1

The Norman Company predicts that 8,000 units of material will be used during the year. The
materials are expected to cost P400 per unit. It is anticipated that it will cost P 40.00 to place

each order. The annual carrying cost is P 25.00 per unit

Determine

a. The most economical order quantity

b. The total cost of ordering and carrying at the EOQ point

Problem 2

Abner Company has been buying material A in lots of 1.200 units which represent a four

month's supply. The cost per unit is P220 The order cost is P200 per order, and the annual
inventory carrying cost per unit is P25 Assume that the units will be required evenly
throughout the year

Required: Compute for the following

a. Economic order quantity

b. Number of orders in a year

c. Average inventory based on economic order quantity

d. Total carrying cost and total ordering costs at economic order quantity

Problem 3

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Olive Corporation buys a material for P20 per unit Sixteen thousand parts a year are needed
Carrying cost is P3.00 per unit and the ordering cost is P15

Required

a. Compute the economic order quantity

b. Prepare a tabular analysis to compute the total costs assuming the following order sizes

100 units. 200 units, 400 units, 1.600 units and 6,400 units. The table should have the
following columns order size, number of orders, cost per order, total ordering costs, average

inventory, carrying cost per unit, total carrying costs, and total costs

Problem 4

An invoice for X. Y. and Z us received from Heavyweight Co. Inc. totals are X 11,250. Y –
13,500, 2 – 15,730. The freight charges on this shipment of 18,000 pounds total 1,620.
Weights for the respective materials are +4,500, 6,000 and 7,500 pounds

Required

1 Cost per pound to be catered on the stock cards for each material based on cost

2. Cost per pound to be entered on the stock cards for each material based on shipping
weight

Problems 5

Maxie Company regularly buys merchandise from Dawson Suppliers and is allowed a trade
discount of 20/10/10 from the list price for the month of September. Marie Company

purchased merchandise with a list price of P 100,000 and terms of 2/10 n/30

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Requirements

1. The amount debited to Materials if the purchase discount is treated as other income

(Purchases recorded at gross)

2 The amount debited to Materials of the purchase discount as treated as a reduction of

purchases. (Recorded as net)

Problem 6

The following information is to be used in costing inventory on August 31

August 1 Beginning balance 1,600 units at 6.00

5 Purchased 400 units at 7.00

9 Purchased 400 units at 8.00

16 Issued 800 units

24 Purchased 600 units at 9.00

27 Issued 1,000 units

Required: The cost of materials used and the cost assigned to the August 31 inventory by
each of these perpetual inventory costing methods

1. First-in, first-out

2. Average

Summary

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 Material costing is the process of determining the costs at which inventory items are
recorded into stock, as well as their subsequent valuation in the accounting records. We deal

with these concepts separately.

A company must decide whether it will record acquired materials at their purchased
prices, or if additional costs will be added, such as freight in, sales taxes, and customs duties.

The addition of these other costs is allowable, but may require a certain amount of additional

work. It is easier to charge these additional costs to expense as incurred, so they appear
immediately in the cost of goods sold.

Overhead is not allocated to raw materials, since these items have not undergone any

production activities (with which overhead is associated). Overhead is only allocated to work-
in-process and finished goods inventory.

Once inventory has been received into stock, it is subject to the lower of cost or market

(LCM) rule. In essence, this rule states that the recorded cost of inventory should be at the
lower of its recorded cost or the market rate. From a practical perspective, this rule is usually
only applied to those inventory items having the largest extended costs. Its application to low-
value items would not result in any material changes, and so is avoided from an efficiency
perspective.

A cost layering concept must also be applied to inventory. Cost layering refers to the
order in which inventory items are charged to the cost of goods sold when units are sold to
customers. Several possible cost layering concepts that can be used are:

Specific identification method. Assign costs to specific units of inventory, and charge

these costs to expense when the specific units are sold. Usually only applies to expensive

and unique inventory items.

First in, first out method. Assign costs based on the assumption that the earliest goods
acquired are the first ones sold. If prices are increasing, this tends to result in higher profits.

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 Last in, first out method. Assign costs based on the assumption that the last goods
acquired are the first ones sold. If prices are increasing, this tends to result in lower profits.

This method is not allowed under international financial reporting standards.

Weighted average method. Uses an average of the costs of all units in stock when
charging costs to the cost of goods sold.

References

De Leon Jr. G & De Leon N. (2012). Cost Accounting 2012 Edition. Manila Philippines: GIC
Enterprise & Co., Inc.

MODULE 4
ACCOUNTING FOR LABOR

Introduction

Labor is the physical or mental effort expended in manufacturing a product

Labor cost is the price paid for using human resources. The compensation paid to

employees who engage in production related activities represents factory labor. The principal
labor cost is wages paid to production workers. Wages are payments made on an hourly,

daily, or piecework basis. Salaries are fixed payments made regularly for managerial or

clerical services. However, in practice, the terms "wages" and "salaries are often incorrectly
used interchangeably.

Factory payroll costs are divided into - a) direct labor, and b) indirect labor. Direct labor
represents payroll costs that are allocated directly to the product and is debited to the work in

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process account. Indirect labor costs of labor costs incurred for a variety of jobs that are
related to the production process but are considered either too remote or too insignificant to

be charged directly to production Indirect labor costs are charged to the factory overhead
control account. Included as indirect labor are salaries and wages of the factory

superintendent, supervisors, janitors, clerks, factory accountants, and timekeepers.

Learning Outcomes

After completing the module, the student should be able to:

1. Distinguish between and account for direct and indirect labor as they are used in the

production process

2. Identify the three activities involved in accounting for labor

3. Understand the consequences of and be able to account for employee and employer taxes
and fringe benefit costs

4. Identify the guaranteed wage and incentive plans that may be used

Lesson 1. Wage plans (De Leon, G., & De Leon, N., 2012)

The accounting system of a manufacturer must include the following procedures for
recording payroll costs.

1. Recording the numbers of hours used in total and by job.

2. Recording the quantity produced by the workers

3. Analyzing the hours used by employees to determine how time is to be charged

4. Allocation of payroll costs to jobs and factory overhead accounts

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5. Preparation of the payroll, including computation and recording of the employee’s gross
earnings, deductions, and net earnings

WAGE PLANS

There are different wage plans that are being used by companies. The plan established by
management is approved by the union and should comply with regulations of government
agencies. Some of these plans are hourly-rate plan, piece rate plan, and modified wage plan

Hourly-Rate Plan

Under this plan, a definite rate per hour is set for each employee. The employees' wages are

calculated by multiplying the rate per hour by the number of hours worked. The hourly-rate
plan is simple to use but does not provide incentive for the employee to achieve a high level

of productivity. The employee is paid for merely "being on the job."

Piece-Rate Plan

Under a piece-rate plan, earnings are calculated by multiplying the employee's output by the
rate per piece. The plan provides an incentive for the employee to produce more. However,

the employee might sacrifice quality to maximize earnings

Modified Wage Plan

This plan combines the features of hourly-rate and piece-rate plans. An example of a modified
wage plan would be to set a minimum hourly wage that will be paid by the company even if

an established quota of production is not attained by an employee. If the established quota is

exceeded, an additional payment per piece would be added to the minimum wage level

Lesson 2. Accounting for Labor Costs

(De Leon, G., & De Leon, N., 2012)
For all regular hourly employees, the hours worked should be recorded on a time ticket

or individual production report. The time ticket shows the employee's starting and stopping

time on each job, the rate of pay, and the amount of earnings. Individual production reports

91
are used instead of time tickets when labor costs are calculated using piece rates. The time
tickets and production reports are sent to payroll on a daily basis The pay rates and gross

earnings are entered, and the reports are forwarded to accounting Cost accountants sort the
time tickets and production reports and charge the labor costs to the appropriate jobs or

department and factory overhead. The accounting department records the earnings in factory
overhead ledger and on the labor cost summary.

The labor cost summary is used as the source for making a general journal entry to
distribute payroll to the appropriate accounts. The entry is then posted to the control accounts,
Work in Process and Factory Overhead in the general ledger.

In preparing the labor cost summary from the tickets, it is important to separate any
overtime from an employee's regular time because the accounting treatment may be different
for each type of pay. Regular time worked is charged to job debiting

Work in Process. Overtime may be charged to jobs, to factory overhead, or allocated

partly to jobs and partly to overhead. Overtime distribution depends upon the conditions
creating the need for overtime hours

If an employee works beyond the regularly scheduled time but the employee is paid at
the regular hourly rate, the extra pay is called overtime pay. If an additional rate is allowed for

the extra hours worked, the additional rate earned is referred to as overtime premium. The
premium pay rate is added to the employee's regular rate for the additional hours worked. The
premium rate will depend on the collective bargaining agreement (CBA) between
management and the union

To illustrate how a payroll is calculated where overtime premium is a factor, assume

an employee regularly earns P 30 per hour for an 8-hour day. If called upon to work more than
8 hours in a working day, the company will have to pay overtime premium for hours worked

in excess of 8 hours. Assuming the employee works 12 hours on Monday, is paid 50%

overtime premium (time-and-half) the earnings would be calculated as follows:

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 Direct labor - 8 hours at P 30 240

Direct labor - 4 hours at P 30 120

Factory overhead (overtime

premium - 4 x 15) 60 180

Total earnings 420

If the previously mentioned employee is paid a premium of 100% (double time), the earnings

would be:

Direct labor - 8 hours at P 30 240

Direct labor - 4 hours at P 30 120

Factory overhead (overtime

premium-4 x 30) 120 240

Total earnings 480

With the preceding illustration, the regular rate (240 + 120) will be charged to Work in

Process, while the overtime premium (60 in the first illustration and 120 in the second
illustration) will be charged to Factory Overhead Control. By charging the overtime premium

to the factory overhead account, all jobs worked on during the period share the cost of
overtime premiums paid. If the job contract stipulated that it was a rush contract, it would be
appropriate to charge the premium pay to the job (Work in Process) instead of to a factory

overhead account.

EMPLOYER'S PAYROLL TAXES

Payroll taxes imposed on employers include social security premiums, Pag-ibig fund
contributions and Philhealth premiums. Employers are responsible for periodically reporting

and paying the taxes to the appropriate government agencies.

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Employers who fail to file require reports or pay taxes due are subject to civil, and in some
cases, criminal penalties

SSS Contribution

The Social Security System requires employers to pay social security taxes on wages and
salaries equivalent to approximately 55% of the total contribution credited to the employee.
Let us consider the SSS contribution of an employee with a salary of P10,000/month. Per the

table - Appendix - the total contribution is P925 - P506.70 being contributed by the employer
and P333.30 deducted from the employee's salary

PhilHealth contributions

The amount contributed by the employer is equal to the amount deducted from the employee's

salary or wage. The maximum deduction per table P37.50 for salaries P9,759 and over. The

contribution of the employer, maximum, is also P37.50.

Pag-ibig Funds Contribution

The amount deducted from the employee's salary is equivalent to 3% of basic or P100,

whichever is lower. The contribution of the employer is also equal to the amount deducted
from the employee.

Illustrative Problem

The Ingrid Manufacturing Company pays employees every two weeks. Monday, May 1, is the

beginning of a new payroll period. The following payroll summary is prepared by the payroll
department and forwarded to accounting for recording:

Payroll Summary

for the period May 1-14

Factory Sales and

Employees Adm. Employees Total

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Gross Earnings 100,000 30,000 130,000

Withholdings & deductions:

Income tax 12,000 2,400 14,400

SSS Premiums 3,330 950 4,280

PhilHealth contributions 375 150 525

Pag-ibig contributions 2,000 600 2,600

Total 17,705 4,100 21,805

Net earnings 82,295 25,900 108,195

After the data are verified, a payroll voucher is authorized and recorded as follows:

May 14 Payroll 130,000

Withholding Tax payable 14,400

SSS Premium Payable 4,280

PhilHealth Contributions Payable 525

Pag-ibig Funds Contributions Payable 2,600

Vouchers Payable 108,195

To record the payment of the net earnings to employees, the following entry is

May 14 Vouchers Payable 108,195

Cash 108,195

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Assuming that of the total factory payroll of P100,000 - P30,000 is indirect labor, the entry to
record the distribution of the payroll is

Work in Process 70,000

Factory Overhead Control 30,000

Selling & Admin Expense Control 30,000

Payroll 130,000

The following schedule provides the information necessary to record the employer's payroll

taxes for the period.

SSS Premiums Philhealth Pag-ibig Total

Factory payroll 5,067 375 2,000 7,442

Selling & Adm 3,540 150 600 4,290

Total 8,607 525 2,600 11,732

The entry to record the employer's payroll taxes is as follows:

Factory Overhead Control 7,442

Selling and Expense Control 4,290

SSS Premium Payable 8,607

PhilHealth Contribution payable 525

Pag-ibig Funds Contributions Payable 2,600

CLASSIFICATION FOR LABOR

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1. Direct labor - labor identified with particular products which is considered feasible to be
measured and charged to specific production order cost sheet

2. Indirect labor

a. Labor identified with particular products but which is not considered feasible to measure
and charge to a specific production order

b. Labor expected for the benefit of production in general and not identified with particular
products

3. Labor Overhead

a. Waiting time or idle time - cost of non-productive hours of direct labor caused by lack of

work, waiting for materials delays from scheduling machine breakdown and machine set-up.
For example, when a new job is being "set-up for production, some workers may temporarily
have nothing to do. If their idleness is normal for the production and cannot be avoided the

cost idle time should be charged to factory control. Let us assume Maxine Garcia spent 36

hours on Job 101 and was idle for hours during the week Maxine's rate is P50.00 per hour for

a 40-hour week, as per union contract

The following entry should be made to record Maxine's total wages

Work in process Job 101 (36 hrs. P 30) 1,800

Factory overhead control Idle time hrs. x 150) 200

Accrued payroll 2,000

b. Make-up pay. When payments to an employee are based solely on the number of units

produced the employee is said to be paid at a "piecework rate. Many companies will pay
employees a minimum wage but they can earn more if they produced more. This labor

payment system benefits new employees because it guarantees them a minimum salary while

they are learning their new job (during which time they usually do not produce enough units).

97
If the output multiplied by the piece rate results in an amount less than the guaranteed wage.
the difference is charged to factory overhead control. If the output multiplied by the piece rate

results in an amount greater than the guaranteed wage, the employee is paid the amount
earned. Let us assume Maxine Garcia is paid P15.00 per piece produced and during the week,

she produced 80 pieces. If the guaranteed weekly pay is P1.500, then the difference between
P 1.500 (guaranteed pay) and P1.200 (actual pay) is charged to factory overhead control.

The entry to record the Maxine's pay

Work in process Job 101 1,200

Factory overhead control. -- Make-up pay 300

Accrued payroll 1,500

If Maxine, in the previous illustration) is guaranteed a weekly pay of P1,000, then the entry

will

Work in process - Job 101 (80 x 75) 1,200

Accrued payroll 1,200

c. Overtime premium - represents amount paid, in excess of regular rate, to employees

working in excess of 8 hours in a day. or working during holidays or their rest day. Regular

earnings represent the total hours worked, including overtime hours, by the regular rate.
Overtime premium represents the overtime hours multiplied by the premium rate. The

premium rate for

overtime is usually some fraction of the regular rate. For example, if Maxine worked for 45
hours during the week and she paid time ad a half then the entry will be

Work in process (45 hours x P 50) 2,250

Factory overhead control (5 hours x P 25) 125

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 Accrued payroll 2,375

If overtime results from the requirements of a specific job and not from random scheduling the

overtime premium should be charged to the specific job that caused the overtime For example,

if the overtime worked by Maxine was caused by a rush order and the customer has agreed
to pay for the special service, then the premium will be debited to work in process instead of

factory overhead control

d. Shift premium - extra pay to work during less desirable evening shift (2 pm to 10 pm) or
night shift (10 pm to 6 am). This shift premium, or shift differential, should be charged to factory

overhead control rather than work in process. Assume that Maxine is assigned to night shift

and is paid a shift premium of P20 per hour, the entry for her pay will be

Work in process (10 hours x P 50) 2,000

Factory overhead control (40 hours x P 20) 800

Accrued payroll 2,800

e. Employers' payroll taxes - amounts remitted to difference government agencies for SSS

premiums, PhilHealth contributions, and Pag-ibig contributions

GROSS EARNINGS OF EMPLOYEES

1. Wages - gross earnings of an employee who is paid by the hour for only the actual hours
worked.

2. Salaries - gross earnings of an employee who is paid a flat amount per week or month

regardless of the hours worked in a period.

3. Gross earnings - the compensation of an employee and includes regular pay and overtime
premiums.

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PAYROLL DEDUCTIONS

1. Employee's income tax - the amount of tax to be withheld each period depends on the

following:

a. Amount of the employee's earnings

b. Frequency of the payroll period, and

c. Classification of the taxpayer and number of qualified dependents.

2. Social Security System premiums - levied against both the employer and the employee

(based on table provided).

3. PhilHealth Contributions - levied against both the employer and the employee in equal
amounts (based on table provided)

4. Pag-ibig Contributions - levied against both the employer and the employee in equal

amounts (based on table provided)

Assessment Task

TRUE - FALSE QUESTIONS

Indicate whether the following statements are true or false by inserting in the blank space a
capital "T' for true or "F" for false.

1. In ideal circumstances, each payroll check is delivered personally to the employee who

signs a receipt for it.

100
2. The amount of income taxes withheld from employee gross pay is an expense to the
employer

3. An entry is made debiting Accrued Payroll and crediting Cash when payroll checks drawn

against a payroll checking account are issued

4. To better provide for a good division of labor, one individual should be in charge of time
keeping and payroll record keeping and distribution functions

5. To avoid congestion at the time clock, it is desirable that one employed punch in or out for

several other employees.

6. Remuneration for manual labor, both skilled and unskilled, is commonly referred to as
salaries

7. Total factory labor cost is composed of direct labor and indirect labor

8. Direct labor cost is recorded by a debit to Work in Process account.

9. Payroll deductions are based on the gross earnings of the employee (regular earnings plus
overtime pay).

10. The amount debited to the Work in Process account represents the total amount of direct
labor (at regular rate) charged to the different jobs I process

PROBLEMS

Problem 1

The Evergreen Company produces tools on a job order basis. During May, two jobs were

completed, and the following costs were incurred:

Job 401 Job 402

Direct materials 28,000 37,000

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Direct labor – regular 18,000 23,000

overtime premium 6,000

Other factory costs for the month totaled P 16,800. Factory overhead costs are allocated one-
third to Job 401 and two-thirds to Job 402.

Required

a) Describe two alternative methods of recording the overtime premium and explain how the

appropriate method affect the cost of each job.

b) Compute the cost of Job 401 and Job 402 under each of the two methods.

Problem 2

A weekly payroll summary made from time tickets shows the following data:

Exemption Number of Hours

Employee Status Classification Rate/Hour Regular Overtime

Austria. B. S Direct 36 40 2

Bautista, D. ME Direct 36 40 3

De Santos, M. ME-2 Direct 45 40 4

Motus, R. HF-4 Indirect 30 40

Reyes, A HF Indirect 30 40

Overtime is payable at one-and-a-half times the regular rate of pay for an employee.

Required:

a) Determine the net pay for each employee.

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b) Prepare journal entries for:

1. recording the payroll.

2. payment of the payroll.

3. distribution of the payroll.

4. the employer's payroll taxes.

Summary

The cost of labor is the sum of all wages paid to employees, as well as the cost of
employee benefits and payroll taxes paid by an employer. The cost of labor is broken into

direct and indirect (overhead) costs.

Accounting for labor involves: recording the time worked and/or the quantity of output

by the employee; analyzing employees' time to determine how time is to be charged; allocating
the factory labor costs to the proper accounts; and preparing the payroll.

Labor cost includes direct labor, indirect labor and overhead cost

Reference

De Leon Jr. G & De Leon N. (2012). Cost Accounting 2012 Edition. Manila Philippines: GIC
Enterprise & Co., Inc.

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