MODULE IN COST ACCOUNTING AND CONTROL

Module No. and Title Module 1: Introduction to Accounting and Basic Cost Concepts
Lesson No. and Title Lesson 1: Introduction to Cost Accounting
Learning Outcomes At the end of this lesson you should be able to
1. explain cost accounting systems, purpose of cost
accounting and the relationship between cost accounting
and financial accounting.

Time Frame 1.5 hours

Introduction Welcome to your first lesson in this module. This lesson will help
you acquire knowledge on the basics of cost accounting,
particularly the definition, scope and objectives of cost
accounting as well as the uses of accounting data. Before you
proceed to the lesson in detail, read and analyze the situation
below;
Imagine you are an accountant of a manufacturing company
responsible for financial planning, payroll and preparation of
Activity
financial reports both for internal and external use. Your monthly
financial statements show that your company is profitable.
However, cash flow is becoming a problem that you need to
borrow from the bank. Additionally, you are also receiving
complaints from your sales department manager on time delays of
finished products delivery and price increases.
Based on the scenario above, reflect on the following questions,
Analysis 1. What accounting information do you think is significant
to discuss possible loan arrangement with the bank?
2. What accounting and non-accounting information is
necessary to address the issues related to the sales
department?
3. Can the cost accountant provide relevant data required in
number 1 and 2?
Recall that accounting is the language of business, as such it
provides information relevant not just to investors and creditors
of the organization but also to the management and those charged
with governance, primarily to aid in the execution of their
management functions. Hence, accounting has various branches
 that include financial accounting, cost accounting and
management accounting.
So what is exactly cost accounting and its role as a branch of
accounting?
Abstraction
Cost accounting is a systematic process of recording, measuring
and reporting the cost of goods and the cost of providing services
of a business organization especially manufacturing company
either in detail or in aggregation.

Often, this branch of accounting is a subset of management

accounting that helps managers on how to optimize business
processes in order to achieve cost-effective and cost-efficient
operations. Managers, in the conduct of their management
functions will have to carefully plan, control and decide on the
strategies to implement in order to achieve the objectives of the
organization. Hence, reliable cost information is necessary as a
basis for planning, controlling and decision making.

Additionally, cost accounting information is also commonly used

in financial accounting. Recall that this branch of accounting is
concerned in preparing as well as presenting accounting reports
for external financial reporting. As such, cost information like
product cost is needed to prepare general-purpose financial
statements.

Managers may also rely on the reports of financial accounting.

However, as the business grows and expands in multiple
locations, financial accounting will become less appropriate to
satisfy the information-need of the management as there is a
greater demand for a forward looking information and specialized
financial reports in order to effectively prepare plans, control and
make complex decisions.

Hence, cost accounting overlaps financial accounting and

management accounting.

Data from cost accounting are processed and produced by a

 COST ACCOUNTING SYSTEMS (e.g job order costing, process
costing,etc) which shall be covered in other modules. As
mentioned, cost data is used for many reasons including setting
up prices for products and services, measuring profitability and
even valuing assets.

How does cost data accumulation differ between

merchandising and manufacturing?

Merchandising business buys and sells finished goods as it is with

little to no conversion process involved. On the other hand,
manufacturing business involves converting raw materials into
products prior to its sale to customers. It is important to note that
this conversion process creates the need for cost accounting.

In a merchandising business, costs associated from the purchase

of products for resale are carried in the “ Merchandise
Inventory” account of the Balance Sheet, and when the products
are sold and delivered to customers the costs are then transferred
to “Cost of Goods Sold” account in the Income Statement.

On the other hand, manufacturing business often maintain at least

three inventory accounts;
1. Raw Materials inventory
2. Work in Process inventory
3. Finished Goods inventory
And these accounts are used to accumulate cost as the goods flow
through the manufacturing process.

Think of an existing manufacturing company, list down at least 3

specific cost information needed for management decision
Application
making. In a concise manner, describe why these information are
needed. Write your answer in a paper.
Closure Congratulations! You’re done with your first lesson in this
module. You may now proceed to the next lesson which shall
cover topics on cost classifications and behaviour.

Module No. and Title Module 1: Introduction to Accounting and Basic Cost Concepts
Lesson No. and Title Lesson 2: Cost Concepts, Behavior and Classifications
Learning Outcomes At the end of this lesson you should be able to
1. explain the basic concepts of cost, behavior and
classifications.
Time Frame 1.5 hours
Introduction Welcome to your lesson #2 in this module. In this lesson, you are
expected to learn the reasons costs are associated with cost
objects, the assumptions accountants normally make about cost
behaviour. Finally, you will be guided how costs are classified in
the financial statements and why such classification is useful.

Imagine a manufacturing business that you would like to put up

Activity in the future or interested in. Then, list down all the possible costs
and expenses that would be necessary to operate the business.
After you completed your list, answer the questions in the
following section.

Analysis 1. Which of these costs would be considered as the cost of

producing the finished product?
2. Which cost would be considered costs not related to
manufacturing the finished product?

As cost accountant, you’re expected to clearly communicate cost

information to your intended users. Hence, you must understand
the differences, among various types of costs, how these costs are
computed and used to be effective in your role.
 Cost has various definitions, but essentially it is a sacrifice of
resources made to attain the business objectives. Cost can be
Abstraction
viewed as the OUTLAY COSTS which refers to past, present
and/or future cash flows or as OPPORTUNITY COST- a forgone
benefit from the best alternative course of action. Cost can also be
viewed as EXPENSE- a cost charged against revenue in an
accounting period.

Some of the most important classification of cost are as follows:

Figure 1: Costs Classifications

Association Reaction to Presentation in

with Cost Cost Activity the financial
Objects Statements

Types of *Direct *Variable *Product

Cost (traceable (fluctuates in (Inventoriable)
costs) total) - Prime
- Conversion

*Indirect *Fixed
*Period
(untraceable; (remains
(Expensed)
must be constant in
allocated) total)

*Mixed
(with
variable and
fixed
components)

*Step
(increases at
certain level
of activity)

COST OBJECT ASSOCIATION

A cost can be classified as to its relationship to the cost object.

Cost object is anything for which costs are accumulated and
measured. Most often it is a product, group of products or a
department. Imagine manufacturing a T-shirt and you decided to
collect cost information based on the finished product. The cost
object therefore would be the T-shirt.

DIRECT COST is the cost that can be traceable to the cost

object in a convenient manner. On the other hand, INDIRECT
COST is the cost that is not reasonably traceable to the cost
object, hence to be allocated. Imagine a firm that produces two
products, Product A and Product B. Product A requires wood as
its raw material and Product B needs a steel. The production
process of both products is managed by a factory manager. The
cost of the wood and the steel are considered direct costs because
it can be directly traced to the products (cost objects) but the
salary to the factory manager is an indirect cost because it cannot
be reasonably traced to any of the products.

COST BEHAVIOUR

Costs can also be classified based on their behaviour. In

accounting we call it cost behaviour and it refers to the changes in
cost (in total and per unit) relative to the changes in activity. This
activity may be a number of units produced in a period or number
of hours worked or a variety of things that’s driving the change of
the cost. Hence, some authors would refer to it as cost driver
activity.

In order to comprehend cost behaviour, one should understand

the concept of relevant range, it is the range within which the
company expects to operate. Within the relevant range the two
extreme cost behaviors are variable and fixed cost.

Fixed Cost - the cost that is NOT immediately affected by cost

driver activity. Common example is the total amount of rent of a
production facility which will not change regardless of the
number/volume of cost driver activities within the relevant range.
As such it can be depicted in the graph as follows:
Consider the graph above, the amount of total fixed cost will not
change regardless of the volume of production units (activity
driver). However, when a fixed cost is presented on a per unit
basis it will result in a downward curve because the total amount
of fixed cost will be spread over the volume of the activity driver.

Variable Cost- a cost that changes in direct proportion to

changes in the cost driver activity. It can be depicted in the graph
as follow:

The variable cost varies in total as the activity driver changes but
the variable cost per unit will remain constant within the relevant
range.

To visualize the behaviour of variable and fixed cost whenever

there’s a change in the activity driver within the relevant range,
refer to the following illustration:

Variable Cost Fixed Cost

 Total Change Constant

Per Unit Constant Change

Mixed Costs (Semi Variable Costs)- costs that have both

variable and fixed components. Common example of a mixed
cost is a maintenance cost and utilities. Mixed costs can be
described in the graph as follows:

Accountants use various techniques to determine the variable and

fixed components in the mixed cost such as high-low method and
regression analysis.

Step Costs- Costs that increase in total with steps when the
volume changes to a particular level. This is also known as semi-
fixed cost and can be depicted in the graph as follow:

PRODUCT COST vs PERIOD COST

Let’ us now move to another classification of cost. In a

manufacturing company costs can be classified according to its
presentation in the financial statements;
Product Costs - costs related to making a product that directly
generate the revenue of the entity. These costs are also called the
inventoriable costs because these are accumulated in the
inventories of a manufacturing company. These costs include
● Direct Materials; cost of material that can be easily traced
to the product
● Direct Labor; cost for the time spent by
workers/employees who work specifically in producing
the product
● Manufacturing Overhead; cost of indirect material,
indirect labor and other indirect cost that relate to the
production of the finished product.

Direct Prim
Prod Materi e
uct als Cost
Direct
P100 Con
Cost Labor P30
s versi
0
P200 on
P60 Overhead
0 P300 Cost
P50
0
The sum of direct materials and direct labor cost is referred to as
the prime cost, it is the primary cost of the finished products
while the sum of direct labor and overhead cost represent the
conversion cost, it is the cost necessary to “convert” the materials
to finished product.

Period Costs- costs incurred related to business functions other

than the production of finished products such as marketing and
administrative. Hence, these costs are recognized as expenses in
the period incurred. Examples are advertising, commission and
salaries to administrative staff.

At this point, we already covered the essential concept for this

 lesson, it is now time to apply what you have learned.
Application
Self Test I:Let us check your knowledge about the lesson by
trying these”

In a separate paper, indicate whether each of the following items

is a variable (V), fixed (F), or mixed (M) cost and whether it is a
product/ service (PT) or period (PD) cost. If some items have
alternative answers, indicate the alternatives and the reasons for
them.

1. Wages of factory maintenance workers

2. Wages of forklift operators who move finished goods
from a central warehouse to the outbound loading dock
3. Insurance premiums paid on the headquarters of a
manufacturing company
4. Cost of labels attached to shirts made by a company
5. Property taxes on a manufacturing plant
6. Paper towels used in factory restrooms
7. Salaries of office assistants in a law firm
8. Freight costs of acquiring raw material from suppliers
9. Computer paper used in an accounting firm
10. Cost of wax to make candles
11. Freight-in on a truckload of furniture purchased for resale

(Adapted)

Test II: In a separate paper, classify each of the following costs

incurred in manufacturing bicycles as variable (V), fixed (F), or
mixed (M) cost (using number of units produced as the activity
measure). Also indicate whether the cost is direct material (DM),
direct labor (DL), or overhead (OH).

1. Factory supervision
2. Aluminum tubing
3. Rims
 4. Emblem
5. Gearbox
6. Straight-line depreciation on painting machine
7. Fenders
8. Raw material inventory clerk’s wages
9. Quality control inspector’s salary
10. Handlebars
11. Metal worker’s wages
12. Roller chain
13. Spokes (assuming cost is considered significant)
14. Paint (assuming cost is considered significant)

(Adapted)

Closure Congratulations! At this point you are now ready to study the cost
accounting cycle.

TEMPLATE 4: Module1_Lesson3
(Will be used individually during the self-paced write shop)
Module No. and Module 1: Introduction to Accounting and Basic Cost Concepts
Title
Lesson No. and Title Lesson 3: Cost Accounting Cycle
Learning Outcomes At the end of this lesson you should be able to
1. prepare the manufacturing cost of goods sold statements.
2. illustrate the cost accounting cycle.
3. prepare journal entries to record transactions related to
manufacturing cost elements (materials, labor, overhead)
 in the cost accounting cycle
Time Frame 3 hours
Introduction Welcome to your lesson #3 in this module. In this lesson, you
will learn the recording process and the preparation of the cost of
goods manufactured statement and cost of goods sold statement
for a manufacturing company. Additionally, a discussion of the
conversion process as well as the flow of cost in a manufacturing
company is included to help you gain working knowledge about
the cost accounting cycle.
Activity Study this pro-forma cost of goods sold statement for a
manufacturing company and answer the question in the
following section;

1. Compare the presentation in the previous section with that

of the computation of cost of goods sold for a
Analysis
merchandising company. What do you think are the key
differences between these two?

As discussed in lesson 1, a manufacturing company maintains at

least three (3) types of inventories due to manufacturers’
extensive activities to convert raw materials into finished goods;
● Raw Materials Inventory- materials purchased to make a
product.
● Work-in Process Inventory- materials already in the
production process but not yet completed.
● Finished Goods Inventory- products already completed
but not yet sold.
Further, the manufacturing costs such as direct materials, direct
labor and overhead are accumulated through these inventory
accounts and as the physical materials and products flow through
 the manufacturing process, so do the associated costs.
Abstraction The manufacturing process begins with the purchase of raw
materials needed to produce the desired finished product. The
cost to acquire these materials will be stored in the raw materials
inventory account. The materials will then be placed in the
production process and the cost of such represent direct materials
used in the production and when added to direct labor costs and
overhead costs will result in a total manufacturing cost for the
period. The manufacturing costs will be carried in the work-in-
process inventory until such time that the production process is
complete when the cost will then be transferred to the finished
goods inventory account until it is sold. Once the finished
product is sold, the related cost will be transferred to the cost of
goods sold account which will be presented in the income
statement.

To better visualize the conversion process, refer to the following

illustrations:
Illustrations:

Indirect
RM, Material
s Labor
Inventory
(Factory) Indir
ect
1 Labo Overhead
r
WIP,
Inventory

2
Finished Goods,
Inventory

Cost of Goods
Sold
Illustration 2

(Adapted)

To illustrate the flow of cost in the accounting records, let’s look

at the following demonstration problem;

Suppose you are the accountant of Lenny Manufacturing

Company, and based on the accounting records Lenny had the
following account balances as of August 1, 2020

Raw Materials Inventory P20,300

Work in Process Inventory P7, 000
Finished Goods Inventory P18,000

During August the company incurred the following costs:

1. Purchased P164,000 of raw materials on accounts
2. Issued P180,000 of raw materials to production of which
 P134,000 was for direct materials.
3. Accrued P88,000 in factory payroll costs; P62,000 was for
direct labor and the rest was for supervisors’ salaries.
4. Accrued P7,000 of utility costs; of this amount P1,600
was fixed.
5. Accrued P2,000 of property taxes on the factory
6. Recorded the expiration of P1,600 of prepaid insurance on
factory equipment
7. Recorded P40,000 depreciation of factory equipment
8. Applied actual overhead to work in process inventory
9. Transferred goods costing P320,000 to Finished Goods
inventory
10. Recorded total sales of P700,000; P550,000 were on
account
11. Recorded cost of goods sold of P330,000
12. Recorded selling and administrative costs of P280,000
(Credit to various accounts).
Requirements:
1. Prepare the journal entries
2. Post transactions to T-account of inventories and cost of
goods sold
3. Prepare cost of goods manufactured based on actual
costing
4. Prepare the income statement with a detailed schedule of
cost of goods sold.

Suggested Solution:
Journal Entries
The T-Account will look like this..
After posting the transactions to the accounts, a schedule of cost
of goods manufactured should be prepared,

From the above schedule it will now be easy to prepare the cost
of goods sold schedule;
 Notice that the cost of goods manufactured was transferred to
finished goods inventory to arrive at the cost of goods available
for sale. From the preceding schedule it will now be easy to
prepare the Income Statement of the company;
.

There you have it! Proceed to the next section to practice the
concept you just learned.
Application
Lenore Company produces collectible pieces of art. The
company’s Raw Material Inventory account includes the costs of
both direct and indirect materials. Account balances for the
company at the beginning and end of July 2020 follow

July 1 July 31

RM, Inventory P 9,320 P 6,960

WIP, Inventory 14, 640 12,000

FG, Inventory 7,200 10,480

During the month, the company purchased P6,560 of raw

material; direct material used during the period amounted to
 P5,040. Factory payroll costs for July were 7,880 of which 75
percent was related to direct labor. Overhead charges for
depreciation, insurance, utilities, and maintenance totaled P6,000
for July.

In a separate sheet of paper,

a. Prepare a schedule of cost of goods manufactured.

b. Prepare a schedule of cost of goods sold.
Closure Congratulations for completing your first module in this course!
Remember what you have learned in this module because these
are the foundation knowledge of more challenging topics in the
subsequent modules. Feel free to come back and research for
additional materials that you may find necessary to complement
your learning.

MODULE ASSESSMENT (After the students have read and studied all the lessons in
the module, it is at the institutional level to decide whether to administer assessment in
any forms. This part allows flexibility within the institution.)

MODULE SUMMARY: This module covered the basic concepts in cost accounting. We
explored the importance of cost accounting and differentiated the branches of accounting
such as managerial, cost and financial. Accordingly, cost accounting supplies cost
information necessary in preparing the reports in the other branches of accounting.
Further, this module introduced the cost concepts and its classifications. Costs can be
classified into direct and indirect, variable, fixed, mixed and step, product cost and period
costs among others. Finally, the highlight of this module is the preparation of schedule of
cost of goods manufactured and cost of goods sold by looking at the basic recording
process that involves the primary costs of manufacturing companies such as direct
materials, direct labor and manufacturing overhead as well as the flow of these costs in
the manufacturing process through the various inventory accounts.
REFERENCES:
De Leon, Norma et al (2019) Cost Accounting and Control. GIC Enterprises and
Co. Inc. Manila Philippines
Guerrero, Pedro P. (2018) Cost Accounting Principles and Procedural
Applications. GIC Enterprises and Co. Inc. Manila Philippines
 Kinney, Michael; Raiborn, Cecily; Dragoo, Amy. (2011) Cost Accounting,
Foundation and Evolution. Cengage Learning, South Western

Vicente, Ma. Violeta (2009).Cost Accounting and Cost Management.Mutual

Books Inc. Caloocan /city, Philippines

www.accountingcom.com

TEMPLATE 4: Lesson1 ( Module 2)

Module No. and Title Module 2: Cost Accumulation
Lesson No. and Title Lesson 1: Job Order Costing
Learning Outcomes At the end of this lesson you should be able to
1. calculate manufacturing costs in accordance with the job
order costing system.
Time Frame 3 hours
Introduction Welcome to your first lesson in this module. This module in
general will introduce you to product costing systems that are
used to assign and accumulate cost for reporting purposes. You
have learned in the previous module that prior to cost
computation, the cost objects must be defined and the manner of
assigning such costs into the production process. Hence, the need
for cost accumulation systems. Job order costing and process
costing are the primary cost accumulation systems in cost
accounting. This lesson will focus on job order costing and we
will look into the distinguishing characteristics as well as the
primary supporting documents of this system. Take note that
these accumulation systems may use various cost valuation
methods; actual costing, normal costing and standard costing.
This lesson however will focus on the application of actual and
normal costing valuation methods in the job order system as there
will be a separate discussion on standard costing.
Scenario: Mitchell Manufacturing is a small company that
produces specialty bicycles. Each bicycle is made to order per
Activity
customer specifications. Orders are taken by the customer service
department, and handed off to an engineering support person to
configure the job. A parts list is made and then the job is moved
to production. Every Monday morning, the engineering group,
 manufacturing supervisor and accounting manager meet to go
over the orders for the week.
A job number is assigned to each order. Then a bill of materials,
or list of the direct materials needed for each bicycle is created.
From this list, the purchasing department can get all of the items
in order, using a materials requisition form.
The accounting department needs to ensure that the job cost
sheet is generated, that it includes all of the materials for the job,
and that the labor involved and manufacturing overhead is added
As the job goes through the manufacturing process, each step in
the process is added to the job cost sheet which accumulates all of
the costs involved in the building of this one job. When the job is
completed, the accounting department has all of the information
necessary to total the costs involved in making this bike, thus
knowing whether the initial price quoted was accurate.
(adapted)

Illustrate the scenario above through a process flowchart.

Analysis Is your flowchart similar to what is presented below?

The scenario indicates that the company is producing bicycles to

 order and based on customer specifications. Therefore, the best
accumulation cost system is the job order system.

So what exactly is the job order cost system?

Abstraction
Job Order Costing is a system for assigning and accumulating
manufacturing costs of an individual unit of output. The job order
costing system is used when the various items produced are
sufficiently different from each other and each has a significant
cost (Averkamp. 2020). As such it requires the use of a job order
cost sheet that tracks the flow of direct materials, direct labor and
applied and actual factory overhead costs in each job order.
Further, the job order cost generally uses normal costing where
factory overhead costs are estimated using a predetermined
overhead rate and subsequently compared to the actual overhead
cost at the end of the period to determine any over or under
application. From the aforementioned, we can conclude that the
distinguishing characteristics of job order costing are as follows:
● Costs are accumulated by job
● A unique cost will be determined for each job considering
that each job are different
● Requires a job order cost sheet for each job

The following are the essential documents needed for each job
order;
● Job order cost sheets: it contains financial information
about the job. This document supports inventory accounts
such as WIP, inventory for jobs not yet completed and
FG, inventory for jobs already completed and yet to be
delivered. Further, this document may serve as a ledger
for the cost of goods sold for orders completed and
delivered. Example of this document is presented below:
● Material Requisition Forms: this document supports the
issuance of raw materials to WIP inventory to ensure that
DM costs are included in the job order cost sheet of a
specific job. Example:

● Employee Time Sheets: The record of time spent and

worked by the employee on a specific job. This document
is maintained to ensure that direct labor will be included
 in the job order cost sheet. Example

How to accumulate cost in job order costing?

Step 1: DM and DL are included in the job cost sheet

Step 2: Indirect Materials and Labor as well as other overhead are
recorded using an overhead control accounts
Step 3: Overhead is applied using a predetermined overhead rate
at the completion of the job.
Step 4: Jobs and their costs are transferred to another departments
and to finished goods inventory if completed
Step 5: Deliver the finished goods and remove the cost from the
finished goods inventory and transfer to cost of goods sold.

Illustration: Let’s do a practice

On January 2, Jennifer Newsprint Manufacturing purchased 5

rolls of paper on account at P6,000 per roll for use in the
production process. On January 5, 4 rolls of this paper were
issued to Job 01 in the printing department. The printing
department records P35,000 in direct labor and P50,000 factory
overhead to Job 01. On January 8, the printing department
transfers Job 01 to the folding department. The folding
department applies P25,000 in direct labor and factory overhead
at 120% of direct labor to Job 01. The Job 01 was transferred to
finished goods inventory on January 9.
To record the purchase of paper to raw materials inventory the
journal entry would be;

Raw Materials Inventory (5 x P6,000) P30,000

Accounts Payable P30,000

To record the transfer of raw materials to work in process, the

application of direct labor and manufacturing overhead to Job 01
while in the printing department the journal entry would be;

Work in Process- Job 01- Printing (4 x P6,000) P24,000

Raw Materials Inventory P24,000
#
Work in process-Job 01- Printing P35,000
Wages Payable/Cash P35,000
#
Factory Overhead Control P50,000
Various Accounts P50,000
This JE is to record the actual FOH in the printing dept.
#
Work in process-Job 01- Printing P50,000
Factory Overhead Control P50,000
Notice that the printing department uses the actual costs of
factory overhead rather than a predetermined rate. This is because
the department uses actual costing valuation.

To record the transfer of Job 01 to the folding department at

actual cost, the journal entry would be:

Work in Process- Job 01- Folding P109,000

 Work in Process- Job 01- Printing P109,000
Notice that the total amount transferred represents the
accumulated cost of DM, DL and FOH in the printing department
for the job.

To record the application of direct labor and overhead in the

folding department, the entry would be:

Work in process-Job 01- Folding P25,000

Wages Payable/Cash P25,000
#
Work in Process-Job 01-Folding P30,000
Applied FOH (P25,000 x 120%) P30,000

Notice that the folding department uses a predetermined rate to

estimate the factory overhead for the job. Hence, the use of
normal costing valuation. This is normally the case whenever it is
impractical to identify the actual FOH. Therefore, at the end of
the period the applied FOH will be compared to the actual FOH
to assess any over/under application of FOH. Any resulting
over/under application will be charged to and against the cost of
goods sold account for underapplied and overapplied,
respectively.

To record the transfer of Job 01 to finished goods inventory upon

completion, the journal entry would be:

Finished Goods Inventory P164,000

Work in Process-Job 01-Folding P164,000

When you prepare a T- account for WIP-Job 01-Folding, you will

get an ending balance of P164,000. Such cost will be transferred
to Finished goods Inventory when the job is done.
 When delivery of the completed job is done, a journal entry to
record the transfer of cost from finished goods inventory account
to cost of goods sold is necessary:

Cost of Goods Sold P164,000

Finished Goods Inventory P164,000

At this point, you need to gain mastery of the concepts just

presented. Proceed to the next section for further application.
Application Refer to the problem set below:
The following costs were incurred in the February 2020 by
Tigasin Corp., which produces customized steel storage bins:

Direct Material purchased on account P80,000

Direct Material used for Jobs:
Job # 143 48,000
Job # 144 11,200
Other jobs 57,600
Direct Labor Costs for the month
Job # 143 14,400
Job # 144 18,000
Other jobs 23,600
Actual Overhead Cost for February 224,000

The balance in WIP inventory on February was P20,800 which

consisted of P13,200 for Job #143 and P7,600 for Job #144. The
February beginning balance of Direct Materials inventory was
P48,600. Overhead is applied to jobs at a rate of P8.95 per peso
of direct labor cost. Job #143 was completed and transferred to
finished goods inventory during February. Job #143 was
delivered to the customer at the agreed price also in February.
 In a separate paper,
1. Prepare journal entries to record the preceding
information.
2. Determine the February ending balance in WIP inventory.
How much of this balance relates to Job # 144?
3. Determine any over or underapplied in factory overhead.

Congratulations! You’re done with your first lesson in this

module. You may now proceed to the next lesson which shall
Closure
cover topics on process costing.

TEMPLATE 4: LESSON STRUCTURE

Module No. and
Title Module 2: Cost Accumulation
Lesson No. and Lesson 2: Process Costing
Title

Learning After this lesson, you are expected to:

Outcomes
 1. compute equivalent units of production, unit costs and inventory
values using various process costing methods (WA, FIFO).

Time Frame 4.5 hours.

Introduction Managers need to know how much each unit of product costs so that they
can control costs, set selling prices, and make profitable business decisions.
Firms that produce heterogeneous and tailored-made products must trace
product costs to the product using a job order costing system. However, a
different approach must be used by firms that mass produce homogeneous
products. This lesson will illustrate the weighted average (WA) and fist-
in, first-out (FIFO) methods of calculating units cost in a process costing
system.

Activity Video Clip Viewing

What's your favorite Hersheys Kisses Chocolate flavor? Plain milk
chocolate or with almond? Cookies and cream? Caramel? Have you ever
wondered how they are made?
1. Go to YouTube.com and watch the clip of the Hershey’s
Chocolate production process
(https://www.youtube.com/watch?v=PvZaDuYsAk0).
2. List at least two separate processes that are performed in
creating this product.
Based on the video clip, does The Hershey Company produce
Analysis heterogeneous or homogeneous kinds of products? Are the amounts of
materials, labor, and overhead readily identifiable to individual units or
batches? Would the accountant of Hersheys Company mostly likely use
job order costing in accumulating the production cost? Why?

As seen in the video, Hersheys Company produces large quantities of

generic products in a continuous process, thus, keeping track of the costs of
separate batches of product is not necessary, and may not be practical.
Instead of job order costing, a process costing can be used.

Abstraction Process Costing Defined

Process costing is a product costing system that is used when there is a
mass production of similar products using the continuous type of
manufacturing processes. Examples of companies that may use process
costing include Nestle (breakfast cereal), Unilever Company (shampoo),
Boysen Company (paint), etc.

Job Order Costing vs. Process Costing

Job Order Costing Process Costing

Nature of product Heterogeneous; tailor- Homogeneous goods
 made products
Cost Accumulation Tracks cost by job Tracks cost by a batch
order of goods by department
Reporting By job orders By department
When is the unit Upon completion At the end of the costing
cost computed? period (e.g., moth)
Subsidiary record Job order cost sheets Cost of production
for work in process report

Cost Flows: Process Costing

In process costing, the production costs (direct materials, direct labor, and
factory overhead) are accumulated per department. The units completed in
Department 1, along with their costs, are transferred to Department 2.
Upon completion of the process in Department 2, the completed units with
their accumulated costs (the sum of costs incurred in Department 1 and
Department 2) are transferred to finished goods inventory. Thus, the costs
of a unit grow larger as it progresses from one department to the next.

Cost of Production Report

A separate cost of production (CPR) report is prepared for each department
at the end of the month. A CPR is a document that summarizes the
information about the flow of units and costs through the work in process
account of a processing department. It consists of three parts, namely:
1. Quantity schedule
 ✔ The quantity schedule is the first section of a cost of
production report. It summarizes the physical flow units and
it shows the equivalent units for materials, labor and factory
overhead costs.

2. Cost schedule
✔ In this section, the total cost to be accounted for is
determined, which is the sum of the cost of beginning work
in process inventory, costs (materials, labor, and overhead)
incurred by the department during the current period, and cost
transferred in from preceding department during the period.

3. Allocation of Costs
✔ This is the last section of a cost of production report. It is
where the cost charged to the department is reconciled and
allocated to units transferred out of the department, units
remaining in the department, and in some case, to any units
lost.

The preparation of the Cost of Production Report involves the following

steps:
Quantity Schedule:
1. Units to account for
2. Units accounted for
3. Determine equivalent units
Cost Schedule:
4. Costs to account for
5. Compute the cost per equivalent unit
Allocation of Costs:
6. Assign costs to inventories (Transferred Out and Ending Work
in Process Inventory, and any lost units)

Equivalent Units of Production

The direct materials, direct labor, and factory overhead typically enter the
production process at different stages; thus, equivalent units must be
calculated separately for each of these production costs. The equivalent
units of production (EUP) represents the number of units that could have
been completed from the direct materials, direct labor, and factory
overhead used during the period. It is computed as actual units multiplied
by the percentage of work done. For example, two 50% of completed
products are equivalent to one complete product.
 Actual Units = EUP (2 units x 50%)

Process Costing Methods: Weighted Average and First-In, First-Out

There are two methods in accounting for cost flows in process costing:
Weighted Average (WA) and First-In, First-Out (FIFO). These methods
reflect the way in which cost flows are assumed to occur in the production
process.

Weighted Average Method:

✔ It computes a single average cost per unit of the combined WIP
Inventory beginning and current period production.

First-In, First-Out (FIFO) Method:

✔ Under this method, it is presumed that the units placed in process
first are completed first, thus following a chronological order. For
example, the WIP beginning units are presumed to be completed
first followed by those units started in process or received from
preceding department.

Weighted Average vs. FIFO

Illustration 1: Quantity Schedule

Assume the following production:

Work in process, beg. (work done, 2/5) 5,000 units
Started in Process 30,000
Transferred out 31,000
Work in process, end (work done, 4/5) 4,000
The stage of completion indicated above refer to conversion costs which
are evenly applied throughout the process.

Required:
Prepare the quantity schedule under each of the following assumptions
using FIFO method and Weighted Average method.
a. 100% materials are issued at the start of processing
b. 100% materials are issued at the end of processing.
c. 50% materials are issued at the start of processing and the balance
when ½ completed.

See Answers below/next page:

FIFO method

a. 100% materials are issued at the start of processing

`
Note:
✔ No materials had been applied on the 5,000 units (WIP beg.)
since they have already absorbed 100% materials in the previous
month when they were started.
✔ The 4,000 unit in process (WIP end) received 100% materials
having been started during the current month.
b. 100% materials are issued at the end of processing.

Note:
✔ 100% materials had been applied on the 5,000 units (WIP beg.)
since they were completed only during the current month.
✔ No materials are applied on the 4,000 unit in process (WIP end)
since they will be completed next month.

c. 50% materials are issued at the start of processing and the balance
when ½ completed.

Note:
✔ The first 50% materials was absorbed by the 5,000 units (WIP
beg.) last month when they were started. The other 50% was
applied in the current month when reached their half completion
stage.
✔ 100% materials was applied on the 4,000 unit in process (WIP
 end) since they were started and have gone beyond the half
completion stage during the current period.

Weighted Average Method

a. 100% materials are issued at the start of processing

b. 100% materials are issued at the end of processing.

c. 50% materials are issued at the start of processing and the balance
when ½ completed.
 Note:
✔ Under WA method, there is no assumed flow of manufacturing
operation; thus, the work done last month on the 5,000 units (WIP
beg.) is ignored and they are presumed to have absorbed 100%
materials and conversion costs during the current period.
✔ The difference between the WA and FIFO method is in the treatment
of the WIP beginning.

Illustration 2: Cost of Production Report

The Davao Mfg. Co., operates in two consecutive departments: A and B.
the following information pertains to the production of the two departments
for August:

Department A:
All materials are introduced into production at the beginning of the process.
Conversion costs are evenly applied throughout the process.

Department B:
All materials are added at the end of the processing. Conversion costs are
evenly applied throughout the process.
Required:
Prepare the cost of production report for Department A and Department B
for the month of August using (a) Weighted Average method and (b) FIFO
method.

Answers:
a.) Cost of Production Report - Weighted Average Method

Department A
Note:
● WIP beginning is merged with those started in the process during
the period to arrive at a representative average unit cost.
● The work done percentage of the transferred out units is always at
100%.

Department B
Note:
• The units finished in Department A, along with their costs, are
transferred to Department B.
Journal Entries:
Journal Entries:
a. WIP – Dept. A 204,700
Materials 115,000
Factory payroll 48,700
Factory Overhead, applied 40,500
(current production cost- Dept. A)

b. WIP – Dept. B 221,000

WIP – Dept. A 221,000
(transfer to Dept. B)

c. WIP – Dept. B 277,800

Materials 120,000
Factory Payroll 96,432
Factory overhead, applied 61,368
(current production cost-Dept B)

d. FG Inventory 546,000
WIP – Dept. B 546,000
(transfer to FG inventory)
b.) Cost of Production Report – FIFO
Department A
Note:
• 100% of the materials of the WIP beginning units are added in
the July, thus, there is no need to add materials in August.
• The WIP beg. units are 40% complete as conversion costs as of
the end of July; thus additional 60% conversion costs are added
in August.
• Only the current period costs are considered in the computation
of the cost per EUP.
• The WIP beginning cost is allocated only to WIP beg., finished
and transferred.

Department B
Journal Entries:
Journal Entries:
a. WIP – Dept. A 204,700
Materials 115,000
Factory payroll 48,700
Factory Overhead, applied 40,500
(current production cost- Dept. A)

b. WIP – Dept. B 221,996

WIP – Dept. A 221,996
(transfer to Dept. B)

c. WIP – Dept. B 277,800

Materials 120,000
Factory Payroll 96,432
Factory overhead, applied 61,368
(current production cost-Dept B)

d. FG Inventory 547,651
 WIP – Dept. B 547,651
(transfer to FG inventory)

Check your knowledge:

Application Problem 1 – Identification
For each of the following companies, indicate whether job-order or process
costing is more appropriate.

1. Accounting firm
2. Construction company.
3. Manufacturer of bath soaps.
4. Manufacturer of cement.
5. Manufacturer of balloons.
6. Maker of wedding dress.
7. Manufacturer of canned tuna.
8. Film production company.
9. Maker of custom jewelry.
10. Landscaping company.

Problem 2 – Quantity Schedule

Compute the equivalent units of production in each of the following cases
using (1) Weighted Average Method, and (2) FIFO method
Case A
Dept. 1 Dept 2
In Process, Mar. 1 8,000 units 5,000 units
stage of completion 1/4 1/10
Placed in process 50,000
In Process, Mar. 31 6,000 units 12,000 units
stage of completion 1/5 1/6

Materials are added at the start of processing in Dept. 1 and at the end of
process in Dept. 2

Case B
Placed in Process 60,000 units
In Process, July 1 (work done, 1/3) 12,000
In Process, July 31 (work done, 1/5) 20,000

Sixty percent of the materials are added at the start of the process and the
remainder, when the goods are 80% done.

Problem 2 – Cost of Production Report

Octagon Corp.’s products are manufactured in three separate departments:
Molding, Curing, and Finishing. Materials are introduced in Molding;
 additional material is added in Curing. The following information is
available for the Curing Department for September:
Beginning WIP Inventory (degree of completion:
Transferred in, 100%; direct materials, 80%;
Direct labor, 40%; overhead, 30%) 8,000 units
Transferred in from Molding 40,000 units
Ending WIP Inventory (degree of completion:
Transferred in, 100%; direct material, 70%;
Direct labor, 50%; overhead, 40%) 4,000 units
Cost component WIP beg. Cost Current period cost
Transferred in P400,320 P 3,240,000
Direct materials 85,008 666,600
Direct labor 62,720 1,035,760
Overhead 9,696 535,680

Required:
1. Prepare a weighted average cost of production report for the Curing
Department for September.
2. Prepare a FIFO cost of production report for the Curing Department
for September.

Closure Good job! You have just learned how to prepare the cost of production
report and compute the cost of goods manufactured and cost of the ending
Work in Process Inventory.

TEMPLATE 4: The Lesson Structure

Module No.
and Title Module 2: Cost Accumulation
Lesson No. Lesson 3: Accounting for Production Losses.
and Title
Learning After this lesson, you are expected to:
Outcomes / 1. compute the cost of spoilage and rework in a job order cost system
Objectives 2. compute the cost of spoilage in a process cost system under FIFO and
Weighted Average Methods
Time Frame 4.5 hours.
Introduction Due to increased competition, most companies today are highly concerned about
the quality of their products. To ensure the quality of products, rigid inspection
is conducted during the process to detect any spoiled or defective units.

This lesson discusses the measurement of production losses and illustrates the
treatment of these losses in job order costing and process costing.

Activity Assume that you own a business that manufactures custom made furniture
 products. For the current period, 5,000 custom made chairs for various
customers are in process. Outline the production process. What kinds of
production losses do you expect to incur from these production processes? How
will you ensure the quality of your products?

Analysis While the products are in the painting process, 100 chairs need to be repainted
due to faulty machine. How would you account for the repainting cost (ei. labor,
materials, and overhead)? Would you charge it to the specific customer or would
you spread it over to other customers?

In most industries, production losses are inherent in the manufacturing process.

Their costs should be measured to control cost, evaluate improvements, and for
proper product costing.
Abstraction Production processes may result in losses of direct materials or partially
completed products. These production losses include scrap, spoiled goods, and
defective goods.

Scrap refers to fragments or residual material resulting from manufacturing a

product. Examples are cloth remnants in in the manufacture of t-shirts, sawdust
in a sawmill operations, etc. Although, these sorts of scrap are cannot be
eliminated, they should be minimized and should be reported and controlled.

Spoilage or spoiled goods are those that have been damaged through
imperfect processing. They cannot be corrected either because technically it is
not possible or because it is not economical to correct them.

Defective goods are those that do not meet production standards and are
reprocess so that they can be sold as regular finished goods. The additional costs
of materials, labor and overhead required to bring these goods up to standard are
called rework costs.
The accounting treatment for production loss, such as those that relate to spoilage
and defective goods, depends on whether it is normal or abnormal. Normal loss
refers to cost of units lost in production for causes that are usual and expected
even under efficient operating conditions; examples are: evaporation (alcohol);
breakages (glass), spoilage (dairy products), etc. Abnormal loss is a loss in
excess of the set expectation or that results from nonrecurring or unusual events
such as accidents, strikes, flood, typhoon, etc. Normal loss is treated as a
production cost, while abnormal loss is recorded as a period cost.

Accounting for Production Losses in a Job Order Cost System

Production losses in a job order cost system consists the cost of materials scrap,
spoiled (spoilage), and reworking defective goods.

Accounting for Scrap

Scrap refers to fragments or residue of manufacturing process. Examples are
cloth remnants in in the manufacture of t-shirts, sawdust in a sawmill operations,
etc. Although, these sorts of scrap are cannot be eliminated, they should be
minimized and should be reported and controlled.
The accounting treatment for scrap are as follows:
A. Recognizing Scrap upon Sale (if the value of the scrap is immaterial)
1. Scrap sales treated as other revenue
2. Scrap sales is treated as an adjustment to factory overhead (if scrap
is common to all jobs)
3. Scrap sales treated as adjustment of production cost of a job (if scrap
is attributable to a specific job)

B. Recognizing Scrap upon Production (if the value of scrap is material and
readily determinable)
4. scrap is common to all jobs
5. scrap is attributable to a specific job

Illustration 1
Assume that Kahoy Furniture Co. wood trimmings from the shop floor. It has
a net sales value of P2,500.
The journal entries under each alternative treatment are the following:

A. Recognizing Scrap upon Sale

1. Scrap sales treated as other revenue
Cash or Accounts Receivable 2,500
Scrap Revenue 2,500

2. Scrap sales is treated as an adjustment to factory overhead (if scrap is

common to all jobs)
Cash or Accounts Receivable 2,500
Factory Overhead, Control 2,500

3. Scrap sales treated as adjustment of production cost of a job (if scrap is

attributable to a specific job)
Cash or Accounts Receivable 2,500
Work in Process Inventory 2,500

B. Recognizing Scrap upon Production (if the value of scrap is material and
readily determinable)
4. Scrap is common to all jobs
Scrap Inventory 2,500
Factory Overhead, Control 2,500
(upon production)

Cash or Accounts Receivable 2,500

Scrap Inventory 2,500
(upon sale)
 5. Scrap is attributable to a specific job
Scrap Inventory 2,500
Work in Process Inventory 2,500
(upon production)

Cash or Accounts Receivable 2,500

Scrap Inventory 2,500

Accounting for Spoiled Goods

Spoiled goods are those that have been damaged through imperfect processing.
They cannot be corrected either because technically it is not possible or because
it is not economical to correct them.
The accounting treatment for spoilage depends on the following assumptions:

1. Normal spoilage attributable to a specific job. If the spoilage is due to the

special nature of the job or some actions made by the customer, the cost
of spoilage is treated as part of the cost of the particular job or is left with
Work in Process.

2. Normal spoilage common to all jobs. If the spoilage is considered normal

in the production process, such as an employee error or machine
breakdown, the unrecovered cost of the spoiled goods should be charged
to Factory Overhead Control.

3. Abnormal spoilage. If the spoilage is due to extraordinary factors beyond

the control of production mean (ex. Flood and earthquake) and the
amount is significant, the cost of spoilage is treated as period cost.

Illustration 2
The following cost information pertains to Job 143, which calls for the
production of 400 cabinets:

Materials P912,000
Direct labor 480,000
Applied Overhead (150% of DL cost) 720,000

Suppose that 100 cabinets are spoiled and they can be sold as seconds at its net
disposal value of P6,000 each. The goods units are sold at 130% of cost.

The journal entries under the two assumptions are the following:
1.) Due to Customer 2.) Due to Internal Failure
Specification
(charged to all jobs)
(charged to specific jobs)

a Work in Process 528,000 Work in Process 528,000

 Materials 228,000 Materials 228,000
FOH, applied 180,000 Factory payroll 120,000
Factory Payroll 120,000 FOH, applied 180,000
(production cost)
(production cost)

B Spoiled Goods Inventory 7,500 Spoiled Goods Inventory 7,500

Work in Process 7,500 Factory overhead, control 18,900
(spoiled goods) Work in Process 24,600
(spoiled goods)

C Finished Goods 520,500 Finished goods 501,600

Work in Process 520,500 Work in Process 501,600
(completion of good units) (completion of good units)

D Cash or Receivable 676,650 Cash or Receivable 652,080

Sales 676, 650 Sales 652,080
(sale of the good units) (sale of the good units)

Cost of Goods Sold 520,500 Cost of Goods Sold 501,600

Finished Goods 520,500 Finished Goods 501,600
(cost of good units sold) (cost of good units sold)

E Cash or Receivable 7,500 Cash or Receivable 7,500

Spoiled goods Inventory 7,500 Spoiled goods inventory 7,500
(sale of the spoiled goods)
(sale of the spoiled goods)

Spoilage Cost Charged to

Specific Job All jobs
 (Job 143) (Factory
Overhead)
Total cost of 100 cabinets P 528,000 P 528,000
Less: Scrap value of spoiled goods 7,500
Production cost of spoiled
Goods (P5,280 x 5) 26,400
Total cost of good units 520,500 501,600
Divided by no. good units 95 95
Cost per unit 5,479 P5,280
========= ============
If the spoilage is considered abnormal, the journal entry to take up the spoiled
goods is as follows:
Spoiled Goods Inventory 7,500
Loss from abnormal spoilage 18,900
Work in Process Inventory 24,600

Accounting for Defective Goods

Defective goods are those that do not meet production standards and are
reprocess so that they can be sold as regular finished goods. The additional costs
of materials, labor and overhead required to bring these goods up to standard are
called rework costs.
There are three approaches in accounting for rework costs.
1. Normal rework attributable to a specific job. If the rework is considered
normal and occurs due to the special nature of the job, the rework costs
are to be charged to the Work in Process Inventory account.

2. Normal rework common to all jobs. If the job is a regular one and
imperfections are considered normal, and not attributable to a specific
job, the rework costs are charged to Factory Overhead, and are spread to
all jobs. .

3. Rework costs treated as a period cost. If the imperfections are considered

abnormal or due to extraordinary factors, the rework costs are recorded to
a loss account.
Illustration 3
A Job order for 30 chairs entails the following original costs
Direct materials P36,000
Direct labor 24,000
Applied factory overhead 19,200
Five of the chairs are found to have imperfections and are reprocessed. The
rework costs incurred in reprocessing them amount to P5,920 (direct materials,
P1,600; direct labor, P2,400, and applied overhead, P1,920)

The journal entries under the two assumptions are the following:

Rework costs charged to a Rework costs charged to all

specific job jobs

A WIP inventory 79,200 WIP inventory 79,200

Materials 36,000 Materials 36,000
Factory payroll 24,000 Factory payroll 24,000
FO, applied 19,200 FO, control 19,200
(original cost) (original cost)

b. WIP inventory 5,920 FO, Control 5,920

Materials 1,600 Materials 1,600
Factory payroll 2,400 Factory payroll 2,400
FO, applied 1,920 FO, applied 1,920
(rework costs) (rework costs)

C FG Inventory 85,120 FG Inventory 79,200

WIP inventory 85,120 WIP inventory 79,200

Rework Cost Charged to

All jobs
Specific Job (Factory
Overhead)
Original cost ( 30 chairs) P 79,200 P 79,200
Add: rework costs 5,920
Total cost of good chairs 85,120 79,200
 Divided by no. good chairs 30 30
Cost per unit P2,837 P2,640
======== ============
If the defective work is considered abnormal, the journal entry to take up rework
is as follows:
Loss from abnormal rework 5,920
Materials 1,600
Factory payroll 2,400
FO, applied 1,920

Accounting for Production Losses in a Process Cost System

While the nature of spoiled goods is conceptually the same in both job order
costing system and process costing system, the accounting differs. In process
costing, the normal spoilage and abnormal spoilage are identified and segregated
in the preparation of the cost of production report. The normal spoilage is to be
absorbed by the remaining good units that have survived inspection, while the
abnormal spoilage is separated from the cost of production and is treated as
period cost.

Several approaches can be used to account for spoilage or lost units depending on
when they occur in the production process. Losses may occur continuously
during the production process (continuous loss) or at specific point upon
conducting a quality check (discrete loss).
Accounting for Normal Lost Units
Stage of Work Done Cost of Normal Lost Units
Inspection
First Department Second Department
Start of the
production/
normal shrinkage/
Zero No cost of lost Unit cost (preceding)
During the (theory of units x actual normal lost
production neglect) units
(continuous loss)
End of production (unit cost of preceding
(discrete loss) dept x actual normal
lost units) + (unit cost
100% Unit cost (this of this dept x EUP of
dept) x EUP of normal lost units)
normal lost units
Theory of Neglect
The lost units are considered as never having been put into production regardless
of the amount of work performed on them. Thus, the cost of lost units is
automatically absorbed by the remaining good units.

Accounting for Normal Lost Units

Absorbing Units
Start/During
the process
End
FIFO METHOD:
WIP beg, finished and transferred √
Started/Received, finished and transferred √ √
WIP, ending √
WEIGHTED AVERAGE METHOD:
WIP beg, finished and transferred √ √
Started/Received, finished and transferred √ √
WIP, ending √

ABNORMAL LOST UNITS

Stage of Inspection Work Done
Start of the production Zero. Since the lost units were discovered at
the start of the production, then they will be
removed from the actual production and will
never be process
During the production It depends on the point of inspection or what
(continuous/discrete loss) particular percentage abnormal loss happens
End of production 100%. Because they are already completed
(continuous/discrete loss) when they were discovered

Illustration 4-
Cost of Production Report
Assembly Department
Conversion
Quantity Schedule: Material cost cost
Actual
Units wd EUP WdEUeEUP
Work in process,
beginning 20,000
 Started during period 40,000
units to account for 60,000

50,00 5
Transferred out: 0 100% 0,000 100% 50,000
8,0
Work in process, ending 00 100% 8,000 40% 3,200
2,0
Normal spoilage 00 100% 2,000 100% 2,000
60,0
units accounted for 00
Equivalent units 60
production ,000 555,200

Cost Schedule: Totals materials Labor Overhead

2,6
Work in process, beginning 16,000 12,000 67 1,333
16,0
Costs added during period 68,000 44,000 00 8,000
Total costs to account for 84,000 56,000 18,667 9,333
Divided by equivalent units 60,000 55,200 55,200
Cost per EUP 1.44 0.93333 0.33817 0.16908

Note:
✔ Normal spoilage = 60,000 – 50,000 – 8,000 = 2,000 units

✔ The normal lost units are already complete with the production costs
when they are inspected at the end of the process.
✔ Overhead cost applied in the current period is equal to 50% of DL cost.

✔ Only the 50,000 units transferred to the next department have passed
through the inspection; thus, they absorb the cost of normal lost units.
 Cost of Production Report
Finishing Department

Illustration 5 – Cost of Production Report (FIFO method)

Perry Co. has its product processed in two consecutive departments, A and B.
Conversion costs are evenly applied throughout the process while materials are in
at the middle of the process in Dept. B.

The production data for Dept. B for October are as follows:

Department B
Quantity data:
WIP, Oct. 1 2,400 units (1/6
done)
Placed in Process
Received from Dept A
26,000
Normal loss (at the end)
Normal loss (at the start)
3,000
Abnormal loss (at the middle)
1,000
WIP, Oct. 31
? (3/4 done)

Cost data;
Cost incurred last month P6,309
Cost incurred in October:
Transferred in 57,798
Materials 17,780
Labor 14,400
Overhead 6,240
Note
✔ Treatment by Neglect approach is used for the normal lost units since
occur at the start of the process. Thus, the work done for materials and
conversion cost is zero.
✔ The cost of normal lost units is allocated as follows:
Actual units Ratio NL
allocated
Received finished and Transferred 20,000 20/23 5,799
WIP, end 2,000 2/23 580
Abnormal loss 1,000 1/23 _ 290
Total 23,000 6,669

The journal entries are as follows:

a. Work in Process inventory – Dept. B 57,798
Wok in Process inventory – Dept. A 57,798
(transfer from Dept. A)

b. Work in Process Inventory – Dept. B 38,420

 Materials 17,780
Factory payroll 14,400
Factory overhead, applied 6,240
(current cost incurred)

c. Finished Goods inventory 91,168

Work in process inventory – Dept. B 91,168
(cost of goods completed)

e. Loss from abnormal spoilage 3,643

Work in process inventory – Dept. B 3,643
(abnormal loss)
Try these:
Application Problem 1 – Accounting for Scrap
Munoz Metal Products accumulates metal shavings from the shop floor and sells
them periodically to a nearby scrap dealer. Scrap sales, on account, for the
period just ended total P25,500.

Required: Indicate the journal entries when:

1. The scrap sales are viewed as additional revenue.
2. The scrap sales are viewed as a reduction of the cost of goods sold during
the period.
3. The scrap sales are viewed as a reduction of factory overhead.
4. The scrap sales are traceable to individual jobs and are viewed as a reduction
in the cost of materials used on the jobs.

Problem 2 – Accounting for Spoilage

Good Mfg Co. manufactures Product TW. During the current period, an order
for 2,000 units was begun on Job 345. After the job was completed, the products
were inspected and 100 units were determined to be defective. The customer has
agreed to accept the order with only 1,900 units instead of the quantity originally
ordered. The spoiled units can be sold as seconds for P250 each. Spoiled goods
are kept in a separate inventory account from finished goods. Total costs
charged to Job 345 are as follows:

Materials P 10,200
Labor (200 hours x P30 per hour) 6,000
Factory overhead (P19 per labor hour) 3,800__
Total cost charged to Job 345 P 20,000

Custom jobs are marked up 150 percent on cost.

Required:
1. Assuming that the defective units were the result of an internal, prepare
the appropriate general journal entries to record the transfer of the
defective units to a separate inventory account and the completion and
shipment of Job 345 to the customer.
2. Assuming that the defective units were the result of a change in design
specified by the customer after the units were completed, prepare the
appropriate general journal entries to record the transfer of the defective
units to the separate inventory account and the completion and shipment
of Job 345 to the customer.

Problem 3 – Accounting for Defective Work

Sunny Co. manufactured 100 wooden chests in a recent production run and
discovered that 10 chests were defective and required reworking as follows:
Rework cost per unit:
Materials P 100
Labor 250
Factory overhead 250
Total P 600

Normal production cost per unit:

Materials P500
Labor 750
Factory overhead 750
Total P 2,000

Required:
1. Prepare the journal entries to record (a) the normal production costs, (b) the
rework costs, and (c) the transfer of the job costs to Finished Goods
assuming that rework costs were caused by an internal failure.
2. Prepare the same journal entries as in (1), assuming that rework costs were
caused by a change in customer specifications.

Problem 4 – Quantity Schedule

Compute the equivalent units of production in each of the following cases using
the (a) weighted average method, and (b) FIFO method
Case 1
In process, beg 15,000 units, (1/5 done as to conversion
cost)
In process, end 10,000 units, (1/4 done as to
conversion cost)
Started in process 50,000 units
 Abnormal loss 4,000 units

Materials are added at the start of the process. Abnormal loss occurs at the end
of the process.

Case 2
In process, beg 12,000 units, (40% done as to
conversion cost)
In process, end 9,000 units, (70% done as to
conversion cost)
Transferred out 46,000 units
Normal loss 5 ,000 units
Materials are added at the end of the process. Normal loss occurs during the
process.

Case 3
Dept. B Dept. C
In process, beg 3,000 units (20% done) 6,000 units (30%)
Received from preceding ? 40,000 units
dept.
1,000 units -
Abnormal loss at the end
- 3,000 units
Normal loss during the
5,000 units (40% done) ? (25% done)
process
? 35,000 units
In process, end
Finished and transferred

In Dept. B, materials are added at the start of the process. In Dept. C factory
costs are applied evenly throughout the process.

Problem 5 – Cost of Production Report: Normal and Abnormal Losses

Below is information concerning production for the month of March:
Department A Department B
w/d Units w/d Units
Quantity Schedule:
WIP, Aug. 1 40% 16,000 30% 12,000
Units transferred out 38,000 40,000
WIP, Aug. 31 60% 14,500 70% 9,000
 Normal lost units 1,000 500
Abnormal lost units 500 500
Cost Schedule:
WIP,Aug. 1
Transferred in cost -
Material costs P21,480
Labor Costs 12,558
Applied overhead costs 7,862
Cost added in August
Transferred in cost -
Material costs 43,320
Labor costs 25,520
Applied overhead costs 16.720

Additional information:
Department A
● 100% materials are added at the beginning of the process.

● Inspections for lost units takes place at the end of the process.

● Conversion costs are evenly applied throughout.

Department B
● 100% materials are added at the beginning of the process.

● Lost units occurred at the end of the process.

● Conversions costs are evenly applied throughout.

Required:
Prepare the cost of production report for each department using a) weighted
average method, b) FIFO method.

Excellent! You have just learned how to account for production losses under job
Closure order costing method and process costing method.

TEMPLATE 4: The Lesson Structure

Module No.
and Title Module 2: Cost Accumulation
Lesson No. Lesson 4: Accounting for Joint Products and By-Products.
and Title
Learning After this lesson, you are expected to:
Outcomes 1. Allocate joint production costs to joint products through different
methods.
2. Account for By-products using different methods

Time Frame 3 hours.

Introduction Most companies produce and sell multiple products. Companies like flour mills,
lumber mills, dairies, meat packers, and many others produce different products
from a common production process. Thus, the allocation of common production
costs to these various products is required for inventory costing, for income
determination, and for financial statement purposes. This section illustrates the
various methods that can be used to allocate this cost to different products.

Activity Divide yourself into three groups. Choose one of the following material inputs:
milk, sugar cane, and cacao; then, identify the various products can be produced
out of the material input.
Given the products that you have enumerated, which of them are the main
Analysis products? Which of them are the by-products? How would you determine the
production cost of each product?

One of the objectives of cost accounting is to determine the total costs of a

product. Managers need to determine the unit cost so that they can set selling
prices and make profitable business decisions. But when different products are
produced from a common production process, the determination of the unit cost
may be challenging. The common production cost, which is also known as joint
cost, must be allocated first to the main products and by-products. The allocated
joint cost is then added with further processing costs in order to determine the total
production cost.

The joint process is a manufacturing process that simultaneously produces more

Abstraction than one product: main products or joint products and by-products. Joint
products are the primary outputs with high sales value, while by-products are
incidental outputs that have low sales value. The cost of direct materials, direct
labor, and factory overhead incurred during a joint process is referred to as the
joint cost. The point at which joint process outputs are first identifiable as an
individual product is called the split-off point. For example, a chicken processing
plant generates several main products like thigh, wings, leg quarter, breast, liver,
gizzard, etc.; and by-products like head, feet, blood, intestine, etc. These products
may be processed further into another product. For example, with additional
processing costs (or separate costs), chicken wings can be processed further into
buffalo wings.
Allocating Joint Costs to Joint Products

Joint production costs may be allocated to joint products using any of the
following methods:
1. Sales value at split-off method. Allocation is based on the relative sale
values of the products.
2. Net realizable value (NRV) method. Allocates joint cost based on the net
realizable value (NRV) of the joint products at split-off point. Net
realizable value is equal to sales revenue at split-off less further processing
cost and disposal cost.
3. Physical measures method. This method uses the ratio of a common
physical characteristic of the joint products (i.e., weight, quantity, volume,
or linear measure, such as weight (ex, kilograms), quantity (ex. Physical
units) or volume (ex. Board fee).

Illustration 1: Allocation of Joint Cost to Joint Products Using Physical

Method and Sales Value at Split-off Point Method

Products X, Y, and C are produced from a joint production process and are
ready for sale at the point of split-off. The production data are as follows:

Joint Cost P 500,000

Product Units of Sales Value at

Production Split-off per unit
X 1,000 P 350
Y 600 400
Z 400 500
Solution:
1. Allocation of Joint Costs Using Physical Measure Method
Using the number of units produced as the physical measure, joint costs are
allocated as follows:

Allocated
Product No. of Units % Joint Cost
X 1,000 50% 250,000
Y 600 30% 150,000
Z 400 20% 100,000
2000 100% 500,000
Note:
✔ This method ignores the revenue-generating ability of individual joint
products.
✔ Use for products with unstable selling prices.

2 Allocation of Joint Costs Using Sales Value at Split-Off Method

Total Sales
Value Allocated
Product at split-off % Joint Cost
350
X 1,000u x P350 ,000 44.30% 221,500
Y 600 u x P400 240,000 30.38% 151,900
Z 400 u x P400 200,000 25.32% 126,600
790,000 100% 500,000
Note:
✔ To use this method, all joint products must be salable at split-off.

Illustration 2 – Allocation of Joint Cost to Joint Products Using Net

Realizable Value Method
Wallace Co. manufactures joints products: A, B, and C, from a joint process. The
joint cost of P 240,000 shall be allocated using the Net Realizable Value Method.
A B C

Units produced 6,000 4,000 2,000

Final sales value per unit P25 P30 P28
Additional processing costs P12,000 P8,000 P6,000
Solution:
The joint cost is allocated as follows:

Total Final Add’l NRV at

Sales Processing split-off
Allocated
Value cost point
Joint Cost
Product %
A P 150,000 -P12,000 =P138,000 46% P 110,400
B 120,000 -8,000 = 112,000 37.33% 89,592
C 56,000 -6,000 = 50,000 16.67% 40,008
300,000 100% P 240,000
======= ===== =======
Note:
✔ This method is used when the products are not salable at spit-off.

✔ To arrive at the basis for the allocation, the additional processing cost is
subtracted from the final sales value to find the net realizable value.

Accounting for By-Products

Like the joint products, by-products are also produced from a joint cost incurred in
a joint production process. Since by-products are generally incidental outputs, cost
allocation methods differ from those used for joint products.
The methods for accounting by-products fall into two categories:

Category 1 – By-products are recognized when sold.

Under this approach, no value is recognized for the by-products until it is
sold. A By-Product Inventory account is not set up; however, the net
revenue from the sale may be treated as:
1. Additional sales revenue
2. Other income
3. A deduction from the cost of the main product.
 Category 2 – By-products are recognized when produced.
This approach recognizes by-products are recognized when they are
produced. The expected value of the by-product is treated as a deduction
from the total production cost of the main product produced.
4. Net Realizable value method.
Illustration 3 – By-products are recognized when sold,
Bayan Co. produces a main product and by-product:

Product Units Produced Units Sold

M (main product) 50,000 20,000
B (by-product) 12,500 12,500

Additional data:
● Costs incurred up to the split-off point:
Direct materials P150,000
Direct labor 100,000
Factory overhead 50,000
● Operating expense, P75,000.

● Product M – sold for P10 per unit

● Product B – sold for P2 per unit (net of selling costs)

Required:
1. Prepare the journal entries the sale of by-products and the Income
Statement under each method:
a. Net revenue is recorded as additional sales revenue
b. Net revenue is recorded as other income
c. Net revenue is recorded as a deduction from the cost of product M.
Solution:
If by-product is recognized only upon sale, the joint costs must be assigned to the
main product:

Inventory, end. (P300,000/ 50,000 units) x 5,000 units = P30,000

a. Net revenue is recorded as additional sales revenue

Journal entry to record the sale of by-product

Cash or Accounts Receivable 25,000
Sales – Product B 25,000

Income Statement
Sales
Main Product P 500,000
By-Product 25,000 525,000

Less: Cost of Sales

Direct materials P 150,000
Direct labor 100,000
Factory overhead 50,000
Total Manufacturing cost 300,000
Less: Inventory, end 30,000 270,000
Gross Profit 255,000
Less: Operating Expense 75,000
Net Income P 180,000

b. Net revenue is recorded as other income

Journal entry to record the sale of by-product
Cash or Accounts Receivable 25,000
Other Income 25,000

The Income Statement is shown below:

Sales
Main Product 500,000
Less: Cost of Sales
Direct materials 150,000
Direct labor 100,000
Factory overhead 50,000
Total Manufacturing cost 300,000
Less: Inventory, end 30,000 270,000
Gross Profit 230,000
Less: Operating Expense 75,000
Net operating income 155,000
Add: Revenue from by-product 25,000
Net Income 180,000

c. Net revenue is recorded as a deduction form the cost of sales of product M.

 Journal entry to record the sale of by-product

Cash or Accounts Receivable 25,000

Work in Process – Product M 25,000

Sales
Main Product P 500,000
Less: Cost of Sales
Direct materials 150,000
Direct labor 100,000
Factory overhead 50,000
Total Manufacturing cost 300,000
Less: Revenue from by product 25,000
Net manufacturing cost 275,000
Less: Inventory, end 30,000 245,000
Gross Profit 255,000
Less: Operating Expense 75,000
Net Income P 180,000

2. Net Realizable Value Method

Journal entries:

By- product Inventory – Product B 25,000

Work in Process-Main Product 25,000
(NRV of the completed by-product)
Cash or Accounts receivable 25,000
By-product inventory – product B 25,000

Sales
Main Product 500,000
Less: Cost of Sales
Direct materials 150,000
Direct labor 100,000
Factory overhead 50,000
 Total Manufacturing cost 300,000
Less: NRV of by-product 25,000
Net manufacturing cost 275,000
Less: Main Product Inventory, end 27,500 247,500
Gross Profit 252,500
Less: Operating Expense 75,000
Net Income 177,500

Joint cost P 300,000

NRV of by - product 25,000
Joint cost allocated to main product 275,000
divided by: units produced 50,000
Unit cost 5.50
x unsold units 5,000
Inventory, end (main product) P 27,500

Summary:
● Most companies produce and sell multiple products, which include main or
joint products and by-products. The by-product has lower sales value
compared to that of the main products.
● Allocation procedure:
Step. 1 Determine the method to account for the by-product:
a. Joint cost is not allocated to the by-product and its net revenue is
recorded as additional revenue or other income or reduction in the
cost of the main product.
b. Allocate joint cost to by-product using Net Realizable Value
Method.
Step 2: Allocate the joint cost to joint products using one of the following
methods:
a. Sales value at split off method
b. Net realizable value method
c. Physical measures method

Apply your knowledge as you solve the following problems:

Application Problem 1
Cruz Company produces only two products and incurs joint processing costs that
total P375,000. Products AA and BB are produced in the following quantities
during each month: 9,000 and 12,000 gallons, respectively. The selling price per
gallon at the split-off point for the two products are P200 and P175, respectively.

Required:

1. What amount of joint processing costs is allocated to each product based on

 gallons produced?
2. What amount of joint processing costs is allocated to each product using the
sales value at split-off point method?

Problem 2
Products A, B, and C are produced from a common process and are ready for sale
at the point of split-off. The production data are as follows;
Product Units of Weight per Sales value per
production unit unit at split off
A 1,000 8 kgs P700
B 600 6 kgs 800
C 400 6 kgs 1,000
Joint cost amounted to P500,000.
Required:
1. Allocate the joint cost based on the physical units.
2. Allocate the joint cost based on the weight of the products.
3. Allocate the joint cost using the sales value at split-off method.

Problem 3
Canada Inc. manufactures two beverages Cherry Concentrate and Cherry Juice.
The production process is such that both beverages are jointly processed in the
Basic Blending Department. At the end of the basic blending process, Cherry
Concentrate is sold at P500 per gallon, but Cherry Juice must be processed at a
further cost of P350 per gallon before it can be sold at P750 per gallon. In June,
the total joint cost amounted to P4,800,000, while 5,000 gallons of Cherry
Concentrate and 12,500 gallons of Cherry Juice were produced. There were no
beginning inventories. At the end of June, there were 1,500 gallons of Cherry
Concentrate and 2,000 gallons of Cherry Juice on hand. The company allocates
joint costs using the NRV method.
Required:
1. Allocate the joint cost.
2. Calculate the ending inventory cost of each product.
3. Calculate the gross profit of each product.

Problem 4
Happy Co. process raw materials in Department 1, from which come two main
products, A and B, and a by-product C. A is further processed in Department 2, B
in Department 3, and C in Department 4. The net realizable value of the by-
product reduces the cost of the main products, and the net realizable value method
used to allocate joint costs.
Product Production Final Selling
 Price per lb.
A 10,000 lbs P100
B 20,000 lbs 50
C 10,000 lbs 20

Costs incurred in each department are as follows:

Department 1 P900,000
Department 2 P 100,000
Department 3 80,000
Department 4 100,000
Required:
1. Compute the joint cost allocated to each A and B.
2. If ending inventory consists of 5,000 lbs of B and 1,000 lbs of C, what is
the value of the inventory?
Problem 5
Maroon Co. manufactures two products XY and AB. The AB are a by-product
from its regular process. During the year, 10,000 XY were sold at P8 each. The
total production cost was P5 per unit of XY, and marketing and administrative
expenses totaled P20,000. There were no beginning inventories, but ending
inventories amounted to 1,000 units. From the sale of AB, the company received
P12,000, which was recorded as additional revenue from sales.
Required:
1. Prepare an income statement assuming that the sales of the by-product is
treated as other income.
2. Prepare an income statement assuming that the sales of the by-product is
treated as other revenue.
Problem 6
Lipton Company produces tea bags. As part of the manufacturing process, the tea
leaves are separated from the stalks and stems. The tea leaves are sold as the main
product, while the stalks and stems are sold as the by-product for use in nursery
mulch. During May, the company processed 25,000 boxes of teabags at a unit cost
of P75. Beginning inventory consisted of 2,000 boxes at a unit cost of P70 per
box. During May, 20,000 boxes were sold for P175 each. The company also sold
500 pounds of stalks and stems at a total price of P8,500. Marketing and
administrative expenses amounted to P12,000.
Required:
Prepare an income statement showing the operating income for May, assuming
that the revenue from the company's by-product sales is deducted from the
production costs.
Excellent!, You have just completed the topic of Module of 2. You are now ready
Closure to proceed to Module 3, which covers the detailed discussion of the elements of
 the production costs: materials, labor, and overhead.

MODULE SUMMARY

● Production can be accumulated using either job order costing method or process
costing method. Job order costing is used by companies that produce small
quantities of product which are heterogeneous in nature. The production cost is
traced directly to each job using the job order cost sheet. On the hand, process
costing is used by companies that produce homogenous products in a continuous
production process. A cost of production report is prepared for each producing
department to accumulate the production costs using either FIFO method or the
Weighted Average (WA) method.

● In most companies, production losses are difficult to avoid. Production losses

include the cost of materials scrap, spoiled goods (spoilage), and reworking
defective goods.

● Joint product costs arise from the simultaneous processing of joint products and
by-products from the same process. For inventory costing and financial reporting,
several methods are used for costing by-products and joint products.

REFERENCES:
De Leon, Norma et al (2019) Cost Accounting and Control. GIC Enterprises and
Co. Inc. Manila Philippines
Guerrero, Pedro P. (2018) Cost Accounting Principles and Procedural
Applications. GIC Enterprises and Co. Inc. Manila Philippines
Vicente, Ma. Violeta (2009).Cost Accounting and Cost Management. Mutual
Books Inc. Caloocan /city, Philippines
TEMPLATE 4: Module 3 The Lesson Structure
Module No. Module 3:Costing and Control of Elements of Cost
and Title

Lesson No. Lesson 1-COSTING AND CONTROL OF MATERIALS

and Title
Learning After this lesson, you are expected to:
Outcomes
1. Discuss the importance of materials control.
2. Compute for the cost of materials using different inventory costing methods.
3. Explain the concepts of Just In Time Costing and Backflush Accounting.
Time Frame 4 hours
Introduction Material is an important element of the production process. It is considered as a
prime cost to be incurred in order to produce a finished product. Greater percentage
of product costs is incurred for the cost of materials used in in the process of
production. No conversion cost will be incurred without purchasing materials first.
It is necessary that an effective inventory management must be implemented by
manufacturing companies to be able to plan and control its inventory. From the
point of materials’ procurement to the delivery of goods.

What comes into your mind when you plan to produce the following?
Activity 1. Table 2, Sardines 3. Burger 4. Leche Flan
Try to imagine a table, sardines, a burger or a Leche Flan. What you need most to
be able to make a table, to produce sardines, prepare a burger or a leche flan?
How much would it cost you to start producing your desired product or recipe?

Can you imagine a burger, without a bun or a fatty?, a leche flan without egg or
Analysis milk? A sardines without a fish or a sauce?
How important is an egg to a leche flan? How much egg would you need in order
 to make a 10 cm. wide leche flan?
Would it be wiser for you to buy 2 dozen eggs if your desired leche flan needs only
1 dozen eggs.?
Every time you think of producing a product, you will imagine what the product
will be made of. Then you think of where, when and how to get it. Production
process requires planning and controlling in the same way that materials as an
essential element of manufacturing costs must be planned, controlled and managed
so as not to over stock or run out of stock which would cause interruption of
production. These are the things you will tackle in this lesson.

Accounting for Materials

Abstraction There are two classification of materials used in the production process:

Materials can be classified as Direct which are those directly identifiable to the
finished product such as lumber or rattan for a table or Indirect which refers to
materials which cannot be directly attributable to the product such as nails or wood
glue used in producing a table. Direct Materials are recognized as Direct Cost
charge to (Work In Process) manufacturing cost while Indirect Materials are
charges to factory overhead.

INVENTORY SYSTEMS

There are two inventory system to account for materials used and ending
inventories.
1. PERIODIC INVENTORY SYSTEM- this system requires estimates and
periodic physical counting of materials that are available for use at the end of the
accounting period. The cost of inventory is determined only at the end.
2. PERPETUAL INVENTORY – this system requires the maintenance of a stock
cards to monitor the flow of materials of which materials inventory can be easily
determined by looking at the stock cards.

MATERIALS CONTROL
Advantages Of Material Control:
1. Minimize Wastages in the use of material.
2. Minimum risk of loss from fraud and theft (if not eliminated)
3. There is accuracy of reporting through the maintenance of records
4. Storage cost is reduced.
5. Investment in inventories is controlled at a minimum level of cash outlay.

Commonly Used Control Procedures

● ORDER CYCLING – methods where materials on hand are reviewed on a

regular or periodic cycle. Essential or important material will have a shorter
review cycle than less important items.

● MIN-MAX METHOD – based on the assumption that materials inventory

has minimum and maximum level.

● TWO-BIN METHOD – used for materials that are considered inexpensive

and/or nonessential. Materials are divided and placed into two separate bins.

● AUTOMATIC ORDER SYSTEM – method used by most companies that

are computerized . An order is automatically placed when the level of
inventory reaches a predetermined order point quantity.

● ABC PLAN –method used by companies with large number of materials,

each one having a different value. The ABC plan is a systematic way of
grouping materials into separate classification and determining the degree
of control that each group requires.
Material Control
 A. PHYSICAL CONTROL OR SAFEGUARDING MATERIALS
involves LIMITED ACCESS, SEGREGATION OF DUTIES
ACCURACY IN RECORDING
B.CONTROL OF THE INVESTMENT IN MATERIAL
ORDER POINT – a subsidiary ledger must be kept for each individual item of raw
material used in the manufacturing process.
Calculations of the order point is based on the Usage, Lead Time & Safety Stock
ECONOMIC ORDER QUANTITY – the purchase order which results in the
minimum total inventory cost.
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 amount and ordering costs are calculated for each
alternative. Assume: Ordering Cost is 10/ order
Storage Cost is .40
ORDE NO. OF TOTAL AVERAGE TOTAL
R SIZE ORDER ORDER COST INVENTOR CARRYING
S Y COST
100 100 1000 50 40
300 33 330 150 120
500 20 200 250 200
700 14 140 350 280
900 11 110 450 360
2. FORMULA METHOD – easy to use and it produces an exact figure. The
formula that can be used is

EOQ=
√ 2 CN
K
Where:
EOQ = economic order quantity
C = cost of placing an order
N = number of units required annually
 K = carrying cost per unit of inventory

Documents Used to Support Material Transactions

1. PURCHASE REQUISITION – a written request sent to inform the
purchasing department of a need for materials or supplies.
2. PURCHASE ORDER – a written request to a supplier for specified goods
at an agreed upon price, it also stipulates the terms of delivery and terms of
payment.
3. RECEIVING REPORT – a form that indicates the order was received.
4. MATERIALS REQUISITION SLIP – a written order to the storekeeper
to deliver materials or supplies to the place designated or to issue the
materials to the person representing a properly executed requisition.

Methods of Costing Materials

1. FIRST-IN, FIRST-OUT (FIFO) METHOD OF COSTING
Illustrative Problem:
July 1 Inventory 300 units at P10 P3 000
12 Purchase 600 units at P12 7 200
16 Issue 400 units
18 Purchase 400 units at P15 6 000
20 Issue 200 units
25 Purchase 400 units at P16 6 400
28 Issue 400 units
The inventory on July 31 shows 700 units on hand. Under periodic inventory
system, the most recent costs would be assigned to the units as follows:
From July 25 purchase 400 units a P16 P 6 400
From July 18 purchase 300 units at P15 4 500
Total 700 P10,900
If the ending inventory is valued at P10,900, cost of materials issued is
P11,700 computed as follows:
 Materials, July 1 P 3 000
Purchases (7 200 + 6.000 + 6,400) 19 600
Total available for use 22 600
Less: Materials, July 31 10 900
Direct materials used P11 700
When perpetual inventory system is used, a stock card is used to record the costs
assigned and to cost relating to the units on hand.
DATE RECEIVED ISSUED BALANCE
JULY 1 300 at P10.00 P4 000
JULY 12 600 at P12.00 300 at P10.00 P4 000
600 at P12.00 P7 200
JULY 16 300@ P10.00
500 at P12.00 P6 000
100 @ P12.00
JULY 18 400 at P15.00 500 at P12.00 P6 000
400 at P15.00 P6 000
JULY 20 200 at 12.00 300 at P12.00 P3 600
400 at P15.00 P6,000
JULY 25 400 at P16.00 300 at P12.00 P3 600
400 at P15.00 P6 000
400 at P16.00 P6 400
JULY 28 300 at P12.00 300 at P15.00 P4 500
100 at P15.00 400 at P16.00 P6 400
As shown on the issued section of the stock card above, the cost of materials issued
is:
300 at P10.00 P 3 000
100 at P12.00 1 200
200 at P12.00 2 400
300 at P12.00 3 600
 100 at P15.00 1 500
1 100 P 11,700
The value of the units on hand, JULY 31 using perpetual inventory system
is the same as that computed under period inventory system. The amount is
computed as follows:
300 at P15.00 P 4 500
400 at 16.00 6, 400
700 P 10 900

AVERAGE COST
A. WEIGHTED AVERAGE METHOD – Use 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 end is computed by multiplying the weighted average
cost per unit by the units on hand.
The weighted average unit cost is computed as follows:
300 units at P10.00 P 3 000
600 units at P12.00 7 200
400 units at P15.00 6 000
400 units at P16.00 6 400
1700 P 22,600
Weighted average unit cost = 22, 600
1,700 = P 13.294/ unit

Inventory, JULY 31 (700 units x P 13.294) = P9,305.88

B. MOVING AVERAGE METHOD – when a perpetual inventory 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
July 1 300 @ P 10 = P 3,000
12 600 @ 12 900 @ P 11.333= P 10,200
16 400 @ 11.333 500 @ P 11.333=P 5,666
18 400 @ 15 900@ P 12.962= P 11,666
20 200 @ 12.962 700 @ P12.962= P 9,073
25 400 @ 16 1,100 @ P 14.067=P 15,473
28 400 @ 14.067 700@ P 14.067= 9,846.90

the computation of the unit cost is as follows:

JULY 12 Balance 300 at P10.00 P 3 000
Purchase 600 at P12.00 7 200
900 10 200
the new weighted average unit cost = P 10,200
900 units = P 11.333
Note: Every time you receive goods, you need to compute the new unit cost.
The cost of materials issued may be computed from the data presented under the
issued section.
400 units at P 11.333 P 4, 533.33
200 units at P 12.962 2,592.40
400 units at P 14.067 5 626.80
1000 units P12,752.53

Just in Time (JIT):

Just In Time (JIT) is a production system which allows minimum inventory storage
in the sense that raw materials needed are delivered and received just in time for
issuance to production and goods are finished just in time for delivery or shipment
to customers. Applying the JIT concept will reduce or eliminate avoidable costs of
investments in raw materials inventory, work in process and finished goods. This
will help management save from losses due to pilferage, spoilage and obsolescence.
This requires a good supplier relationship management to demand for frequent and
on time deliveries of small quantities.
To illustrate the difference between the traditional costing and the Just In Time
costing, we will use the transactions of Light Bearers Corp. which produced led
lamps. Transactions for the month of July follows:
A. Purchased P 180,000 of raw materials
B. All materials purchased were requisitioned for production
C. Light Bearers incurred direct labor costs of P 100,000
D. Actual factory overhead costs amounted to P 140,000
E. The company applied conversion costs total P 240,000 (including direct
labor cost of P 100,000)
F. All led lamps produced were completed and sold.
Under JIT costing, no entries are made for transaction B,and E. No Entry for
transaction B is needed because the it is assumed that materials purchased are
issued right away into production as soon as it is received in transaction A. No
separate entry is required for (c) because direct labor is combined with factory
overhead and maybe debited first to conversion cost or maybe debited directly to
cost of goods sold. Below is the comparison of how entries are prepared using
traditional and JIT costing.

Traditional Costing Just in Time Costing

A. Materials 180,000 A. Raw and In Process 180,000
Accounts Payable 180,000 Accounts Payable 180,000

B. Work In Process 180,000 B. no entry required

Materials 180,000

C. Work In Process 100,000 C. Conversion Cost 100,000

 Accrued Payroll 100,000 Accrued Payroll 100,000

D. Factory Overhead 140,000 D. Conversion Cost 140,000

Miscellaneous 140,000 Miscellaneous 140,000
Accounts Accounts

E. Work In Process 140,000 E: No entry required

Factory Overhead 140,00
0

F. Finished Goods 420,000 F. Cost of Goods Sold 4 420,000

Work In Process 420,00 Raw and In Process 180,000
0
Conversion Cost 240,000

Backflush Accounting
This is also known as Backflushing or Backflush costing. This is used in operations
where the JIT system is applied. In comparison with the traditional costing where
subsidiary accounts are maintained and kept updated by several accounting entries
to be able to compute the product costs during various stages of the manufacturing
cycle. Implementing a JIT system and applying Backflush accounting enables you
to disregard monitoring of the cost and eliminates recording of Work In Process.
This is due to the fact that the time gap from issuance of materials to completion of
the product is shorter.
Theoretically, it is called backflush because the costs are computed after the
products are completely manufactured, delivered and sold. Companies save time
and minimize expenses or cost by not recognizing costs during the manufacturing
process when backflush costing is used.
Backflushing occurs when there are inventories at the end like undelivered goods or
unfinished goods. Inventories are adjusted at the end of the accounting period.
Some or all of the elements of costs of finished goods are determined only after the
production is completed.

Special Considerations
 Companies using backflush costing generally meet the following three conditions:

Short production cycles: Backflush costing shouldn’t be used for goods that take a
long time to manufacture. As more time goes by, it becomes increasingly difficult
to assign standard costs accurately.

Commoditized products: The process is not suitable for the fabrication of

customized products since this requires the creation of a unique bill of materials for
each item manufactured.

Material inventory levels are either low or constant. When inventories, the array
of finished goods held by a company, are low, the bulk of manufacturing costs will
flow into the costs of goods sold, and it is not deferred as inventory cost.

Please take note that Backflush costing does not totally conform to the generally
accepted accounting principles.
Try these: For you to check your knowledge about this lesson, answer the following
accordingly: (Submit your answer through email or you may take pictures to your
Application
answer and submit it through my personal messenger account.)
1. Why should a company control its material costs?
2. Assuming you are employed as Purchasing manager, what measures will you
implement to control material costs? Elaborate your answer.

Problem 1. Generosity Mfg, Corporation furnish you the following data related to
their inventories:
Oct. 1- beginning inventory 450 units costing 4,500
5- Purchased 250 units @ 10 per unit
6- Issued 400 units to production
10- Purchased 500 units @ 9.50 per unit
15- Issued 700 units to production
20- issued 300 units to production
25- Purchased 400 units @ 11
 28- Issued 250 units to production
Required: Compute for the cost of materials used and the cost of inventory at the
end of the month using:
1. FIFO Costing 2. Moving Average Method

Problem 2- Jolo Company estimates that 75,000 units of materials will be used
during the year. The materials are forecasted to cost P 15.00 per unit. It is
anticipated that
It will cost P50 to place an order. The annual carrying cost is P3.00.
1. Determine the most economic order quantity
2. Compute the total ordering and carrying cost at the EOQ point.

Problem 3 Good Shepherd Company has a short production cycle and implements
Just In Time system of operations. At the end of each month all inventories are
counted, conversion costs components are estimated and adjustments to inventory
account balances are made. Raw materials cost is backflushed from RIP to Finished
Goods. Information for their June operation follows:
Materials purchased for cash P 219,000
RIP beginning including P 6,600 conversion costs 22,500
Finished Goods beginning including P 16,300 conversion cost 54,000
RIP end, including P 11,700 of conversion cost 36,000
Finished Goods end including P 9,750 conversion cost 27,000
Conversion cost- P 120,000 direct labor and P150,000 overhead
Required:
1. Compute for the amount of materials backflushed from RIP to Finished Goods
2. Compute for the amount of materials backflushed from Finished Goods to Cost
of Goods Sold
3. Prepare all necessary journal entries.
Congratulations, you have completed this lesson, You are now ready to proceed to
the next element of manufacturing cost.
Closure
TEMPLATE 4: The Lesson Structure
Module Module 3:Costing and Control of Elements of Cost
No. and
Title
Lesson No. Lesson 2-COSTING AND CONTROL OF LABOR
and Title
Learning After this lesson, you are expected to:
Outcomes
1. Describe wage plans and payroll procedures.
2. Prepare payroll summary sheet.
3. Compute and distribute labor costs to production.

Time Frame 3 hours

Introductio In this lesson, you will discover the importance of applying labor to be able to
n produce a product, you will tackle the importance of controlling labor cost to be
able to prevent wastage and maintain labor efficiency. You are expected to
develop skills in computing earnings of employees and preparing payroll
summary sheets. This lesson is good for three (3 hours). Accomplish the self-test
provided at the end of this lesson. For the meantime, relax and may you learn
with fun…

How does the following relate to one another?

Activity
1. Captain – ship 2. Building = Engineer 3. Textile – Tailor
4. Machine – Operator 5. Lumber – Carpenter
One of the favorite foods of every Filipino is “Adobo”, /Assuming you crave for
an adobo and you buy 1 kilogram of pork including all the ingredients. However,
Analysis
after buying all the ingredients, you place it on the refrigerator and you go back
to bed. Do you think by mealtime you can now eat your Adobo? Of course not?
You need to prepare all the ingredients and cook so that you will eat and satisfy
your cravings for Adobo. You need to exert effort by cooking so you can eat. In
the same manner the raw materials will not be converted into a finished product
without the application of labor. You will incur labor cost in order to produce a
product. Today you will study another element of cost which is labor. So relax
and enjoy learning.
ACCOUNTING FOR LABOR
Abstraction
Labor cost is an important element of manufacturing cost particularly in a
company utilizing more manual operations. It is the cost of human effort
employed in the production of a product particularly those which requires
organized forces forits control. Labor does not only refer to the salaries or wages
paid to workers but it also includes cost incurred in training and development of
manpower and other employer taxes and contributions for fringe benefits
incurred in relation to their working force.

Labor refers to the physical or mental effort exerted in producing goods or

services. Labor cost is the price paid for exerting effort or for using human
resources.

Difference Between Wages and Salaries

● WAGES – payment made on an hourly, daily, or piecework basis.

● SALARIES – refers to fixed monthly or semi-monthly payments made

regularly for top level, supervisory level employees or clerical services.
There are two (2) Classification of Labor cost:

● DIRECT LABOR – labor that is directly identifiable with the product.

Those labor costs or payroll costs that are directly charged to the work in
process account.

● INDIRECT LABOR – labor costs incurred related to the production but

are not directly identifiable with the finished product; it is considered
either too remote or too insignificant to be charged directly to production.
This is charged to the factory overhead control account.

The Accounting System of a Manufacturer must include the following

procedures:

● Recording the numbers of hours used in total. and the quantity produced
by the workers.

● Analyzing the hours used by employees to determine how time is to be

 charged.

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

● Preparation of the payroll, including computation and recording of the

employees’ gross earnings, deductions, and net earnings.

Controlling Labor Costs

Some companies install control mechanism for their labor cost by establishing
the following departments;

● TIME-KEEPING DEPARTMENT

- Take charge in accounting for the time spent by the employees in the
factory and submit it to the payroll department.
- Issue and consolidate Clock cards, Time tickets, Production reports

● PAYROLL DEPARTMENT

● Prepares payroll summary by computing each employee’s gross

earnings, deductions for contributions and other payroll taxes and
withholdings and determine net earnings to be paid to each
employee.

● Forms: Payroll records, Employee’s earning records, Payroll

summaries
After the clock cards, time tickets and production reports are gathered, checked
and validated by the timekeeping department, total work done per employee is
determined and submitted to the payroll department for the preparation of the
payroll summary and net earnings per worker. The payroll summary will then be
forwarded to the accounting department for recording of payroll, distribution of
labor costs, setting up the accrued payroll account and preparation of voucher.

Definition of Terms

● TIME TICKET shows the employee’s starting and stopping time on

each job, the rate of the pay, and the amount of payments.
 ● INDIVIDUAL PRODUCTION REPORTS are used instead of time
tickets when labor costs are calculated using piece rates.

● LABOR COST SUMMARY is used as the source for making a general

journal entry to distribute payroll to the appropriate accounts.

● OVERTIME PAY is extra pay when a worker works beyond the

regularly scheduled time.

● OVERTIME PREMIUM is an additional rate allowed for the extra

hours worked.

● GROSS EARNINGS is the compensation of an employee and includes

regular pay and overtime pay.

Labor Cost Summary Preparation

● In preparing payroll summary any overtime must be separated from

regular time.

● To record regular time simply charged to job/ product by debiting work

in process account while cost for overtime pay may be charged to jobs, to
factory OH, or allocated partly to jobs and partly to OH.

Illustration: Overtime Premium

An employee regularly earns P40 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:
Direct labor - 8 hrs. at P 40 P 320
Direct labor - 4 hrs. at P 40 P160
FOH (overtime premium - 4×20) 80 P 240
Total earnings P 560
Employer’s Payroll Taxes

● SSS CONTRIBUTION - pay social security taxes on wages and salaries

equivalent to 55% of the total contribution credited to the employee.

● PHILHEALTH CONTRIBUTIONS - the amount contributed by the

employer is equal to the amount deducted from the employee’s salary and
wage.

● PAG-IBIG FUNDS CONTRIBUTION - the amount deducted from the

employee’s salary is equivalent to 3% of basic or 100 whichever is lower.

Illustration Problem:
Joshua Mfg. Corp. pays employees every 2 weeks. Monday, June 1, is the start
of a new payroll period. The following payroll summary is prepared by its
payroll dept. and was forwarded to the accounting dept. for recording:
Payroll Summary
For the period June 1 – 14
Factory Worker Sales and Adm. Employee Total
Gross Earnings P 10,000.00 P20,000.00 P 30,000.00
Withholding & Deductions:
Income Tax P 1,979.25 P 2,833.33 P 4,812.58
SSS Premiums 333.30 500.00 833.30
PhilHealth Contributions 125.00 250.00 375.00
Pag-ibig Contributions 100.00 100.00 200.00
Total Deductions P 2,537.55 P 3,683.33 P 6,220.88
Net Earnings P 7,462.45 P 16,316.67 P 23,779.12

after verification of data, a payroll is prepared and recorded as follows:

June 14 Payroll 30,000
 Withholding Tax Payable 4,812.58
SSS Premium Payable 833.30
PHIC Contributions Payable 375.00
Pag-ibig Funds Premium Payable 200.00
Accrued Payroll 23,779.12

to record the payment of the net earnings to employees.

June 14 Accrued Payable 23,779.12
Cash 23,779.12

assuming that of the total factory payroll of P10,000 – P4,000 is indirect

labor, the entry to record distribution of the payroll is:
Work in process 6,000
Factory Overhead Control 4,000
Selling & Adm. Expense Control 20,000
Payroll 30,000

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 706.70 125.00 100.00 931.70
Selling & Adm. 1,060 125.00 100.00 1,285.00
Total 1,766.70 250.00 200.00 2,216.70
The entry to record the employer’s payroll taxes as follows:
Factory Overhead Control 931.70
Selling & Adm. Expense Control 1,285.00
SSS Premium Payable 1,766.70
PhilHealth Contributions Payable 250
 Pag-ibig Funds Contributions Payable 200

LABOR OVERHEAD
1. Waiting time or idle time - cost of non-productive hours of direct labor
caused by lack of work, waiting for materials delays etc. It should be charged to
factory overhead control.

Illustration: Lily spent 35 hours on Job 101 and was idle for 5 hours during
the week. Lily’s rate is P50 per hour for a 40-hour week, as per union contract.
Entry to record Lily’s total wages
Work in process Job 101 (35 hrs. × P50) 1,750
Factory Overhead Control - Idle Time (5 hrs×P50) 250
Accrued payroll 2,000

2. Make-up pay - when payments to an employee are based solely on the no. of
units produced (piecework rate).
Assume: Lily is paid P20 per piece produced and during the week she produced
65 pieces. If guaranteed weekly pay is P1,500, then the difference between
P1,500 (guaranteed pay) and P1,300 (actual pay) is charged to factory overhead
control. The entry will be:

Work in process - Job 101 1,300

Factory overhead Control - Make-up pay 200
Accrued Payroll 1,500

If Lily is guaranteed a weekly pay of P1,200

Work in Process - Job 101 (65×P20) 1,300
Accrued Payroll 1,300

3. Overtime Premium - amount paid in excess of regular rate or working during

holidays or their rest day.
Example: Lily works for 45 hours during the week and she is paid time and a
half
Work in Process (45 hrs. × P50) 2,250
Factory Overhead Control ( 5 hrs. × P25) 125
Accrued payroll 2,375

If the overtime work is caused by rush order and the customer has agreed to pay
for special services, then the premium will be debited to work in process instead
of factory overhead control.

4. Shift Premium - extra pay to work during less desirable evening shift (2 pm to
10 pm) or night shift (10 pm to 6 am). It should be charge to factory overhead
control.
Assuming Lily is assigned to a night shift and is paid a shift premium of P20 per
hour
Work in process (40 hrs. × P50) 2,000
Factory Overhead Control (40 hrs.× P20) 800
Accrued Payroll 2,800

5. Employer’s Payroll Taxes - amounts remitted to different government

agencies for SSS Premiums, PhilHealth Contributions, and Pag-ibig
contributions

Payroll Summary
Using the data given below prepare the payroll summary for Generosity
Corporation for the Period June 1-15, 2020: Employees regularly work 40 hours/
week and is paid time and a half for every hour worked in excess of 40 hours.
Employee Classification Rate / No. of Hours
Hour Worked
Althea Direct 40 45
Brad Direct 35 48
Nica Direct 32 40
 Vince Indirect 25 46
Josh Indirect 30 42
Payroll deductions follows:
SSS – 100 per employee, Pag-Ibig is 2% of gross earnings.
Required: Compute the employees net earnings:
Prepare all necessary journal entries.
Prepare the payroll summary
Journal Entry:
Payroll 7,515
Pag Ibig Contributions Payable 150.30
SSS Contribution Payable 500.00
Accrued Payroll 6,864.70
Solution:
Generosity Corporation
Payroll Summary
For the period June 1-15, 2020
Employee Regular Overtime Gross Deductions Net
Pay Earnings Earnings
Premium
Althea 1800 100 1900 138.00 1,762.00
Brad 1680 140 1820 136.40 1,683.60
Nica 1280 1280 125.60 1,154.40
Vince 1150 75 1,225 124.50 1,100.50
Josh 1260 30 1290 125.80 1,164.20
Total 7,170 345 7,515 650.30 6,864.70
Self Test: To test your knowledge on this lesson, Answer the following
accordingly:
Application
1. Differentiate Direct Labor and Indirect Labor and give examples.
2. Dave is paid P 40 per hour for 40 hours work per week and a time and one
fourth for every hour worked overtime. He is guaranteed a weekly pay of P1,800
 During the week, Dave worked for 46 hours, How much is gross earnings?
Record his payroll.

3. A weekly payroll summary made from time tickets shows the following data:
Number of Hours
Employee Classification Rate/Hour
Regular Overtime
Austria, B Direct P 36 40 2
Bautista, D. Direct 36 40 3
De Santos, M. Direct 45 40 4
Motus, R. Indirect 30 40
Reyes, A. 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.
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.
4. Why does a company control its labor cost?

Congratulations, you are now halfway to finishing this module. Job well done
and keep it up. Please prepare for your next topic which is about the accounting
Closure
and control for factory overhead.

TEMPLATE 4: The Lesson Structure

(Will be used individually during the self-paced write shop)
Module No. Module 3:Costing and Control of Elements of Cost
and Title
Lesson No. Lesson 2-COSTING AND CONTROL OF FACTORY OVERHEAD AND
and Title DEPARTMENTALIZATION
Learning At the end of this lesson, you are expected to:
Outcomes
1. Compute a factory overhead rate using the different bases.
2.Compute and record factory overhead costs charge to production.
3.Apply the concept of actual factory overhead and applied factory overhead
4.Formulate overhead cost using predetermined rates.
5.Explain the need for departmentalization.
6.Identify and compute allocation of service department costs.
Time Frame 4 hours
Introduction This lesson will help you explore another element of manufacturing cost, the
factory overhead. For three (3) hours, the concept of actual and applied factory
overhead will be tackled; different overhead bases will be illustrated including the
explanation of the importance of controlling overhead costs. . You will also develop
skill in computing factory overhead given the different bases, in this way you will
learn to formulate overhead costs applying predetermined rates. A discussion on the
reason and benefits of factory overhead departmentalization is also included in this
lesson.

Connect the word/ words which you think are related to each other:
Activity
Lumber sugar/ baking powder chef table
Fish nails/ wood glue carpenter cake
flour tomatoes sewer dress
cloth (Textile) thread baker sardines

Let us see if you were able to connect it properly..

Analysis What product can you make from a lumber? Correct but how can you make a table,
of course you need a carpenter to do it and nails or wood glue to put it together.
As you can see, a fish will not be converted to a finished product “sardines” without
a cook (direct Labor) and the tomatoes that would give flavor to the sardines. The
wages you pay to the cook is considered direct labor costs but what about the cost
of tomatoes, oil and other spices for sardines? Can we identify tomatoes, oil and
 etc. to sardines? Are these ingredients important in making sardines? As you see
they are materials added to the product but are indirectly identifiable with the
finished product, thus they are classified as indirect materials or supplies which
form part of your factory overhead.
Factory Overhead refers to the cost of indirect materials, indirect labor and other
necessary costs or expenses incurred in a manufacturing process whose cost is
Abstraction
insignificant or immaterial and is not directly identifiable with a finished product.

Factory Overhead are Classified into Three Categories on the Basis of their
Behavior in Relation to Production

1.VARIABLE FACTORY OVERHEAD COSTS

These are factory overhead costs that vary in direct proportion to the level of
production, within the relevant range. Variable cost per unit remains constant as
production either increases or decreases. Total variable costs vary in direct
proportion to production, that is, the greater the number of units produced, the
higher the total variable cost.

2.FIXED FACTORY OVERHEAD COSTS

These are the factory overhead costs that remain constant within the relevant range
regardless of the varying levels of production. The total remains constant but the
fixed cost per unit varies inversely with the production, that is, the greater the
number of units produced, the lower the fixed cost per unit.

3.MIXED FACTORY OVERHEAD COSTS

These factory overhead costs are neither wholly fixed nor wholly variable in nature
but have characteristics of both. Mixed factory overhead costs must ultimately be
separated into their fixed and variable components for purposes of planning and
control.
Factors to be Considered in the Computation of Overhead Rate
1.BASE TO BE USED
a. Physical output d. Direct labor hours
b. Direct materials costs e. Direct labor cost
 c. Machine hours
2.ACTIVITY LEVEL TO BE USED
a. Normal capacity b. Expected actual capacity
USE OF SINGLE RATE OR SEVERAL RATES
a.Plant-wide or blanket rate-one rate for all producing departments
b.Departmentalized rate- one rate for each producing department.

1. BASE TO BE USED

● Direct labor hours

Factory overhead rate= Estimated factory overhead

Estimated direct labor hours
= Factory overhead rate/ direct labor hour

● Direct labor cost

Factory overhead rate = Estimated factory overhead × 100

Estimated direct labor cost
= Percentage of direct labor cost

● Machine hours

FOH = Estimated factory overhead

Estimated machine hours
= Factory overhead rate/ machine hour

● Direct materials costs

FOH Rate = Estimated factory overhead × 100

Estimated direct material cost
= Percentage of direct materials cost

● Units of production
 FOH rate= Estimated factory overhead × 100
Estimated units of production
= Factory overhead rate/ unit of production
Illustrative Problem 1:
The Honesty Company estimates factory overhead at P400,000 for the next
fiscal year. It estimated that 80,000 will be produced at a material cost of
P500,000. Conversion will require an estimated 100,000 direct labor hours
at a cost of P3.20 per hour, with 40,000 machine hours.
Required: Compute the predetermined factory rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours

Solution to Illustrative Problem 1

a. Factory overhead rate = Est. factory overhead
Est. direct mat. Cost
= P 400,000 X 100
P500,000 = 80% of direct mat. Cost
b. Factory overhead rate = Est. factory overhead
Est. units of production
= ____P 400,000______
100,000 direct labor hrs. = P 4.00/ unit
c. Factory overhead rate = Est. factory overhead
Est. machine hours
= P 400,000/ 40,000 machine hours
= P 10.00/ machine hour
d. Factory overhead = Est. factory overhead
 Est. direct labor cost
= P 400,000 X 100
P 320,000
= P 125% of direct labor cost
e. Factory overhead rate = Est. factory overhead
Est. direct labor hours
= _____P 400,000______
100,000 direct labor hours
= P 4.00/ direct labor hour
COMMON COST TYPICAL ALLOCATION BASE
Labor – related
1. Supervision No. of employees, payroll amount of DLHrs
2. Personnel services Number of employees
Machine – related
1. Insurance on equipment Value of equipment
2. Taxes in equipment Value of equipment
3. Equipment depreciation Machine-hours, equipment value
4. Equipment maintenance Number of machines, machine hours
Space – related
1. Building rental Space occupied
2. Building insurance Space occupied
3. Heat & air – conditioning Space occupied, volume occupied
4. Concession rental Space occupied & desirability of location
5.Interior bldg.. maintenance Space occupied

Service – related
1. Material handling Quantity or value of materials
 2.Building and accounting Number of documents
3. Indirect materials Value of direct materials

NEED FOR DEPARTMENTALIZATION

In some large manufacturing companies, operation is departmentalized or divided
into departments. This is called departmentalization which enables precision in job
costing and product costing.
The use of different overhead rates for applying factory overhead is required in
departmentalization. The amount of factory overhead varies instead of charging
single overhead to jobs or products as they pass through the different departments.
Factory overhead is charged to a particular job or product for work done in a
particular department based on the department’s predetermined overhead rate.
Estimating or budgeting factory overhead is done per department. The use of the
appropriate basis for applying overhead is important. The actual factory overhead is
still recorded in a factory overhead control subsidiary ledger for each department.
This procedure allows comparison of actual departmental manufacturing overhead
with applied departmental manufacturing overhead. The variance is determined and
analyzed per department.

CLASSIFICATION OF DEPARTMENTS
Departments are classified into two categories: producing departments and service
departments. Producing departments are those departments that are directly
engaged in the manufacturing activities (for example, assembly, finishing, and
packaging departments). Service departments are those departments that assist
indirectly by rendering services (for example, purchasing, medical and maintenance
departments) to producing departments.

Calculation of Departmental Overhead Application Rates

The steps involved in the calculation of departmental overhead application rates are
as follows:
1. Have a budget at different expected levels of capacity for the total direct
factory overhead costs of producing departments and total direct expenses
of service departments.
2. Determine the bases to be used in allocating indirect factory overhead costs
in service department costs by conducting a factory survey.
 3. To facilitate cost distribution by department, set up an application rates
worksheets.
4. Budgeted cost that can be traced directly to specific departments is recorded
as direct departmental costs.
5. Budgeted factory overhead costs that cannot be traced to specific
departments shall be allocated according to the basis selected.
6. Budgeted service department’s costs are distributed or reallocated to
producing departments.
7. Calculate departmental predetermined rates by dividing the total budgeted
overhead costs charged to each producing department by the base selected.
Direct Departmental Overhead Costs
Direct departmental overhead costs are those that can be easily traced to specific
departments. Example are as follow:

● Repairs and maintenance – traced to maintenance department.

● Indirect labor – traced to payroll summaries of a department.

● Indirect materials – traced through stores requisition of a department.

● Depreciation of equipment – traced to the department using the equipment.

Allocating Indirect Departmental Costs

It is necessary to obtain certain data to be used as the basis of allocating indirect
departmental costs to benefiting and producing departments. This is usually done
through a survey of factory facilities and resources. Each department should be
charged with its fair share of the costs determined by the benefits it has received.
The principle of allocating indirect departmental costs is somewhat difficult to
apply in practice.

Below is a list of some of the indirect departmental costs that require allocation and
the best possible bases usually used.
Indirect Departmental Costs Distribution Bases
Factory rent Square footage
Depreciation – Factory Building Square footage
Fire insurance on building Square footage
Repairs and maintenance Square footage
Telephone No. of employees or No. of telephone
Light Kilowatt hour
Freight – in Materials used

Methods of Allocating Service Department Cost to Producing Departments

1. DIRECT METHOD – the most widely used method.

Service Department Producing Department

2. STEP METHOD – sometimes called sequential method of allocation.

Service Department Producing Department

3. ALGEBRAIC METHOD – sometimes called reciprocal method.

Service Company Producing Company
Illustrative Problem 2
Diligent Company’s factory is divided into four departments – producing
departments, Assembling & Decorating serviced by the Cutting and Grounds and
the Factory Administration departments. Cutting & Grounds cost will be allocated
using square feet (floor area) and Factory Administration cost will be allocated
using direct labor hours. In computing predetermined overhead rates, machine
hours are used as the base in Assembling and direct labor hours as the base in
Decorating.

Cutting & Factory

Assembling Decorating
Grounds Admin.

Budget FO P 400,000 P 600,000 P 80,000 P120,000

Direct labor
200,000 100,000
hours
Floor area 100,000 60,000 2,000 4,000
Machine hours 200,000 100,000
Requirements: Allocate the cost of services departments using:
1. Direct method
2. Step method – start with Cutting & grounds
3. Algebraic method
Solution to Illustrative Problem 2:
1. Direct method

Assembling Decorating C& G Factory

Budgeted FO P400,000 P600,000 P80,000 P120,000

Allocated FO- C&G 50,000 30,000 (80,000)

Allocated FO- Fcatory 80,000 40,000 (120,000)

Total FO 530,000 670,000 - -

 200,000 100,000
Base
MHrs. DLHrs.
FO Rate P 2.65/MHr. P6.70/DLHr.

Allocation of C & G cost

Assembling = 100 × 80,000 = 50,000
160
Decorating= = _60_ × 80,000 = 30,000
160
Allocation of FA cost
Assembling = 200 × 120,000 = 80,000
300
Decorating = 100 × 120,000 = 40,000
300
2. Step Method
Assembling Decorating C&G FA
Budgeted FO P 400,000 P 600,000 P80,000 P120,000
Allocated FO
B&G 48,781 29,628 (80,000) 1,951
FA 80,000 40,650 (121,951)
Total FO P 530,000 P 669,918
200,000 100,000
Base
MHrs. DLHrs.
FO Rate P 2.65/MHr. P6.70/DLHr.
Allocation of C & G cost
Assembling = 100 × 80,000 = 48,781
164
Decoration = _60_ × 80,000= 29,628
164
 FA = _4_ × 80,000 = 1,951
164

3. Algebraic method
Additional information for the illustrative problem:
Service provided by
C&G FA
Assembling 50% 40%
Decorating 30% 50%
C&G - 10%
FA 20% -
Algebraic equation:
C & G = 80,000 + 10%(FA)
FA = 120,000 + 20%(BG)
Substitution: C & G = 80,000 + 10%(120,000 + .20CG)
= 80,000 + 12,000 + .02CG
.98CG = 92,000 / .98 = 93,878
FA = 120.000 + 20%(CG)
= 120,000 + 20%(93,878)
= 138,776
The allocation will be as follows:
Assembling Decorating C& G FA
Budgeted FO P 400,000 P 600,000 P80,000 P120,000
Allocated FO
C&G 49,939 29,628 (93,878) 18,776
FA 55,510 69,388 13,878 (138,776)
 Total FO P 502,449 P 697,551

200,000 100,000
Base
MHrs. DLHrs.

FO Rate P 2.51/MHr. P6.98/DLHr.

Capacity Production
a. THEORETICAL, MAXIMUM OR IDEAL CAPACITY – a capacity
to produce at full speed without interruptions. It gives no allowance for
human capacity to achieve the maximum nor due allowance for any
circumstance that might result in a stoppage of production within or not
within the control of management.

b. PRACTICAL CAPACITY – a capacity of production that provides

allowance for circumstances that might results to stoppage of production

c. EXPECTED ACTUAL CAPACITY – a capacity concept based on a

short range outlook which is feasible only for firms whose products are
seasonal or where the market and style changes allow price adjustments
according to competitive conditions and customer demands.

d. NORMAL CAPACITY – a capacity of productions taking into

consideration the utilization of the plant facilities to meet commercial
demands served over a period long enough to level out the peaks and
valleys which come with seasonal and cyclical variations. This capacity
is commonly used in the computations of overhead rates.
Method of Accumulation of Factory Overhead Costs

1. NON-CONTROLLING ACCOUNT for each kind of overhead

expense according to their nature is opened in the ledger and charges to
such account are made upon incurrence of the expense.

2. CONTROLLING ACCOUNT SYSTEM – an Overhead Control

account is opened in the general ledger wherein the overhead incurred
 are charged and a subsidiary ledger is maintained to show in detail the
nature and account of the expense.
Actual overhead costs are usually incurred daily and recorded
periodically in the general ledgers. Subsidiary ledgers permit a greater
degree of control overhead factory overhead costs as related accounts
can be grouped together and various expenses incurred by different
departments can be described in detail.
Computations of Overhead Chargeable to Individual Cost Sheets – (Factory
Overhead Applied)
After the factory overhead applications rate has been determined, it is used
to apply (or match) estimated factory overhead cost to productions. The estimated
factory overhead costs are applied to production on an on-going basis as goods are
manufactured, according to the base used (i.e. as percentage of direct material costs
or direct labor cost or on the basis of direct labor hours, machine hours, or units
produced). Applied factory overhead can be computed by multiplying the actual
factor incurred per cost sheet x predetermined overhead rate.

Entry to charge production with applied overhead:

Work in process-overhead xxx
Factory – overhead applied xxx

Factory Overhead Variance – the difference between the actual factory overhead
as shown by factory overhead control account and the overhead charged to
production as shown by the factory overhead applied account.

Classification of Manufacturing Overhead Variance

a. UNDERAPPLIED OVERHEAD – the difference between actual overhead
and applied overhead when the actual is more than the applied.
b. OVERAPPLIED OVERHEAD – the difference between actual overhead
and applied overhead when the actual is less than the applied.
Causes of the Manufacturing Overhead Variance:
a. SPENDING VARIANCE – the variance due to expense factors.
b. IDLE CAPACITY OR VOLUME VARIANCE – the variance due to
difference in volume and activity factors.
 Computations of Manufacturing Overhead Variance
a. SPENDING VARIANCE
Actual factory overhead incurred P xxx
Less: budget allowed based on capacity used
Fixed factory overhead P xxx
Variable factory overhead xxx _ xxx
Spending variance P xxx

b. IDLE CAPACITY VARIANCE

Budget allowed based on capacity used P xxx
Less: Factory overhead applied _ xxx
Idle capacity variance P xxx
Accounting for Overhead Variance
a. Before the closing of the books, the overhead variance is not recognized in the
account and the actual factory overhead account as well as the applied factory
overhead accounts are kept open. When an interim financial statement is prepared
and the variance should be deferred rather than disposed of immediately.
b. At the end of the accounting period
1. If the amount of the overhead variance is immaterial or it is established
to be the result of inefficiency, it is closed to the cost of goods sold.
2. If the amount of the overhead variance is material and found to be the
result of an erroneous computation of the predetermined overhead rate,
such variance is distributed to the cost of goods sold, finished goods
inventory, and the work in process inventory.
Illustrative Problem 3 ( Adapted)
The Carlson Corporation made the following data available from its
accounting records and reports.
Budgeted factory overhead P 300,000
Budgeted direct labor hours 100,000 hrs.
Variable factory overhead P 1.00/DLHr.
Actual factory overhead P 350,000
 Actual direct labor hours used 110,000 hrs.
Solution:
Spending variance:
Actual factory overhead P 350,000
Budget allowed on actual hours
Fixed P 200,000
Variable 110,000 __310,000
Spending variance – unfavorable P _40,000
Idle capacity variance:
Budget allowed on actual hours P 310,000
Applied factory OH(110,000×P3.00) _ 330,000
Idle capacity variance – favorable P (20,000)
To understand fully the computation of the variance, the following table may be
prepared:
Total Per Hour
Fixed overhead P 200,000 P 2.00
Variable overhead __100,000 __1.00
Total P 300,000 3.00
Factory overhead rate = _300,000_
100,000 hrs. = P 3.00/DLHr.
Variable overhead cost = 100,000 Hrs. x P1.00 = P 100,000

Try this! To Check your knowledge, answer the following items accordingly:
Application 1. What are the different methods of distributing service department cost to
producing departments?
2. Differentiate normal capacity from practical capacity.
3. Why is departmentalization important?
4.The Jesus is Mine corporation’s normal operating capacity is 120,000 direct hours
per month. The direct labor cost per hour is P 5.00 per hour. It is estimated that its
factory overhead at this level is P250,000 with expected volume of 50,000 units at a
 material cost of P 280,000. the machine will run for 2,000 hours.
Required: 1. Compute the predetermined factory overhead rate based on:
a. Physical Output c. direct labor hours e. Direct labor cost
b. Material Cost d. machine hours
5, Johnson Manufacturing Company's normal operating capacity is 80,000 machine
hours per month for a production of 120,000 units . The fixed factory overhead of
this operating level is estimated to beP 32,000 and variable factory overhead is
estimated to be P24,000. During the month of June, the company operated at
79,000 machine hours producing 120,000 units. Actual factory overhead is
P59,000.
Required: Compute the following:
1. The overhead variance 3. The idle capacity variance
2. The spending variance

6.The following information relates to Happy Mfg. Co. for the previous accounting
period:
Producing Departments Service Department
C D A B___
Direct Costs 150,000 200,000 160,000 120,000
Proportion of service by A to 60% 30% - 10%
Proportion of service by B to 20% 50% 30%

Required: Compute for service dept.’s cost allocated to each producing dept, using
the a. Algebraic method b, Direct Method

Congratulations, job well done. You are almost done with this module as you have
completed Lesson 3. You are now to get ready for the last lesson which is activity
Closure
based costing.
 TEMPLATE 4: The Lesson Structure
(Will be used individually during the self-paced write shop)
Module No. Module 3: Costing and Control of Elements of Cost
and Title
Lesson No. Lesson 4: Activity Based Costing
and Title
Learning At the end of this lesson, you are expected to:
Outcomes 1. explain the concept of Activity Based Costing.
2. apply the concept in computing overhead costs.

Time
Frame 1.5 hours
Introduction With high hopes that you are feeling good today, welcome to Lesson 4, in this lesson
you will explore the basic concepts of another overhead application bases called
Activity Based Costing. This is normally used in manufacturing companies which are
highly automated wherein significance of direct labor cost has diminished while
overhead costs have increased. Thus there is a need to apply another type of basis
for allocating overhead cost is necessary.

Imagine you are a manager at a company that makes two products: the basic model
Activity and customized. Presently, you are using a traditional costing method and assigning
manufacturing overhead based on direct labor hours. So all of the direct labor and
materials are being charged to each of the models, and then the overhead is allocated.

But what if the customized model is consuming three times as much machine time due to
more frequent setups? Or what if there are more parts in the deluxe model requiring
a great deal more time in the purchasing department?

Analysis Do you think your previous knowledge (traditional costing) on the bases of overhead
cost application would still give accurate cost calculations.
Do you think it is justifiable to use it given the considerations above?
These activities could cause traditional costing to be “off” compared to costing
based on each activity.
Abstraction Concept of Activity Based Costing
The Chartered Institute of Management Accountants (CIMA), London, defines it as a
technique of ―cost designation to cost units on the basis of benefits received from indirect
activities like ordering, setting up, quality assurance. Hence, it is a method of assigning
organization‘s costs through activities (called cost drivers) to the products and services. It
is generally used by a company having products that differ in volume and complexity of
production for the purpose of allocation of overhead costs.

Activity Based Costing is also known as transaction costing. This is being used in many
highly-automated manufacturing entities particularly those having production process that
are highly using machines instead of human resources. The overhead cost has tremendously
increased due to the acquisition, installation, maintenance and operation of high
technologies in manufacturing goods. Using Direct labor as a basis for overhead
applications rates may not give correct overhead charges because they no longer represent
cause and effect relationship between output and overheads costs.

“User’s fee” refers to the process of charging for services consumed by users of the
service. It is based on the premise that if a product consumes may resources (activities)
that comprise overhead, it should bear a greater share of overhead costs than other
product that does not consume as any activity units.

Five Basic Steps in Applying ABC

1. FORM ACTIVITY CENTERS BY GROUPING SIMILAR ACTIONS
You may do it by classifying actions with different levels of activities; namely,
Unit-level activities, batch-level activities, product-level activities, and facilities-
level activities

2. ASSIGN AND CLASSIFY COSTS BY ACTIVITY CENTER AND BY TYPE

OF EXPENSE
Costs that can be identified to the activity center should be assigned directly to
activity centers. Other costs shared by two or more activity centers should be
assigned according to some cost driver that controls the utilization of the costs
involved.
3. SELECT COST DRIVERS
The costs drivers are the links between costs, activity, and product. Costs drivers are
not needed for direct costs because these can be traced immediately to a product,
However, indirect costs such as factory overhead need links or drivers to link a pool
 of costs in an activity center to the product.

4. COMPUTE A COST FUNCTION TO ASSOCIATE COSTS AND COST-

DRIVERS WITH RESOURCE USE
A costs function is used to translate the pool of costs and cost driver data into a rate
per cost driver unit or a percentage of other cost amounts, just like the plant-wide or
departmentalized factory overhead rate.
For example: If the costs of the setup activity center is P25,000 and the selected cost
driver is 500 hours, then the cost function will be P50 per setup hour (P25,000/500
hours)
5. ASSIGN COST TO THE COST OBJECTIVE
The last step is to allocate the costs to then different users of the resource. This is
done by multiplying the rate determined in the preceding paragraph by the actual
data of the cost driver.
If actual setup hours used is 40, then the allocated cost will be P2,000 (40 hours ×
P50).
ILLUSTRATION -4.1
Given below is the data for manufacturing costs of He Reigns Company.
Computation of Unit Cost under Traditional Costing follows:

Manufacturing Costs Product XX Product YY

Direct materials P100 P60

Direct labor 34 34
Overhead 60* 60*
Total unit cost P194 P154

*predetermined overhead rate times labor hours (P60 x 1 hr. =P60)

Unit Cost Under Activity Based Costing:

To compute the unit cost under ABC, the following three procedures are to be used:
1. Determine the major activities that relate to the production of specific products
and allocate factory overhead costs to activity centers.
2. Identify the cost drivers that correctly measure each activity’s contribution to
the finished product and compute the activity based overhead rate.
3. Using the activity-based overhead rates (cost per driver) allocate factory
overhead costs for each activity centers to the product.

Identifying Activities and Allocating overhead to Activity Centers

This requires a detailed analysis of the activities performed to manufacture the product.
For example, He Reigns Company identified three activity centers: setting up machines,
machining, and inspecting. Estimated overhead cost are allocated directly to each
activity centers once the activity centers are identified, as shown below:

Illustration 4.2
He Reigns Company
Activity Centers and Estimated Overhead

Activity Centers Estimated Overhead

Setting up machines P1,500,000
Machining 2,200,000
Inspecting 400.000

TOTAL P4,100, 000

Identifying Cost Drivers and Computing Overhead Rates

After overhead costs are allocated to the activity centers, the cost drivers for each
activity center must be identified. The cost driver must accurately measure the actual
consumption of the activity by the various products. Readiness and simplicity of
obtaining data relating to the activity cost driver is an important factor that must be
considered in its selection.

The cost driver identified by He Reigns Company and their total expected use per activity center
are shown below:
Illustration 4.3
He Reigns Company
Computation of Activity-based Overhead Rates
Expected use of cost Drivers
Activity Centers Cost Drivers per Activity
Setting up machines Number of setups 3,000 setups
Machining Machine hours 100,000 machine hours
Inspecting Number of inspection 4,000 inspections
An activity-based overhead rate for each activity can now be computed using the
following formula:

Estimated Overhead per Activity_____ Activity-Based

Expected used of Cost drives per Activity = Overhead Rate

He Reigns Co. computes its activity-based overhead rate by using total estimated
Overhead per activity center, shown in illustration 4.2, and the total expected used
of cost drivers per activity, shown in illustration 4-3. Using the formula,
the computations are shown below:
Illustration 4.4
He Reigns Company
Computation of Activity-based Overhead Rates
Activity Centers Estimated Expected Use of Cost Activity Based
Overhead Drivers per Activity Overhead Rates

Machine Set Up P 1,500,000 3,000 set ups P500 per set up

Machining 2,200,000 100,000 machine hrs. P22 per machine hr
Inspecting 400,000 4,000 inspections 100 per inspection

Total 4,100,000

Allocating Overhead Costs to Products

Before allocating overhead costs, the expected use of cost drivers for each product
should first be determined:

Illustration 4.5
He Reigns Company
Allocation of overhead Costs Drivers per Product
Expected use of cost Expected use of cost
Drivers per Activity Driver per Product
Activity Centers Cost Drivers Product XX Product YY
Setting up machines Number of setups 3,000 setups 1,000 2,000
Machining Machine hours 100,000 hrs. 60,000 40,0000
Inspecting No. of inspections 4,000 inspections 1,000 3,000

To allocate overhead costs to each product, the activity-based overhead rates

(Illustration 4.4) are multiplied by the number of cost drives expected to be used
per product (Illustration 4.5). The allocation of He Reigns Co.’s estimated annual
overhead cost to each product is shown next:

Illustration 4-6
He Reigns Company
Allocation of Overhead Costs to Products (Product XX)
Expected Use Allocated
of Cost Activity Based Overhead
Activity Centers
Drivers per Overhead Rates
Product Costs

Machine Set Up 1,000 P 500 P 500,000

Machining 60,000 22 1,320,000
Inspecting 1,000 100 100,000

Total Allocated Costs(a) 1,920,000

 Units Produced (b) 50,000

Overhead Cost per Unit 38.40

(a ÷ b)

Product YY
Expected Use of Activity Based Allocated
Activity Centers Cost Drivers per Overhead Rates Overhead
Product Costs

Machine Set Up 2,000 P 500 1,000,000

Machining 40,000 22 880,000
Inspecting 3,000 100 300,000

Total Allocated Costs (a) 2,180,000

Units Produced 10,000

Overhead Cost per Unit (a

P218
÷b¿
The above data show that ABC is more suitable to high-volume product
(Product XX , 50,000 units) than the low-volume product (Product YY, 10,000).

Application Self Test : Check your knowledge:

Problem 4.1
All Tribes Company manufactures two products: Product Joy and Product Hope.
During January, 100 units of Product Joy and 300 of Product Hope were produced,
and overhead costs of P121,500 were incurred. An analysis of overhead costs showed
the following activities:
Activity Cost Driver Total Cost
Materials Cutting No. of Requisition P 45,000
Machine Set ups Number of Setups 40,500
Quality Inspection Number of Inspection 36,000

The cost drive volume per product was as follows:

Cost Driver Product Joy Product Hope
No. of Requisition 400 600
Number of Setups 200 400
Number of Inspection 100 200
 Required:
1. Determine the overhead rate per activity
2. Allocate the factory overhead costs to each product using ABC.
Congratulations! By completing this module you have finished the whole course.
Closure You really did a good job. God bless you.

MODULE ASSESSMENT (After the students have read and studied all the lessons in
the module, it is at the institutional level to decide whether to administer assessment in
any forms. This part allows flexibility within the institution.)

MODULE SUMMARY:
In this module, you were able to explore the different elements of costs incurred in the
whole manufacturing process. It is important to note the importance of planning and
controlling for each element of cost as this has an effect on product pricing and profit.
Materials, labor and overhead being the primary costs to be incurred in the production
needs attention as much as management cannot afford to waste time and money.
Materials as the most essential elements of production should be controlled as much as
any wastage and investments in materials may affect cash flow, product pricing and the
profits as well. Management must exercise control so as not to incur greater cost of
ordering and storing of materials while monitoring inventories to maintain safety stock
level.
Labor productivity must be monitored to be able to maintain minimum labor cost without
disregarding product quality. A sound control mechanism for labor cost must be
implemented to have efficiency in the production process which means higher
productivity at lesser cost for a quality product.
Overhead costs may be variable or fixed, a careful consideration on the appropriate basis
to be used in computing factory overhead rates must be done so as not to over apply or
under apply. With the advance technology and the emergence of robotics, direct labor as
an application basis is no longer relevant.
This module introduced you to a new method of computing allocation basis for overhead
called Activity based costing where the allocation of cost is based on certain activities in
the department. Applying your understanding on the different methods of costing and the
different bases of cost application including the new concepts such as just in time costing
and backflush accounting, you are now capable to calculate, allocate and account product
costs.
REFERENCES
 Carter, William K. (2015) Cost Accounting 14th Edition. Cengage Learning Asia
Pte.Ltd. Singapore
De Leon, Norma et al (2019) Cost Accounting and Control. GIC Enterprises and
Co. Inc. Manila Philippines
Guerrero, Pedro P. (2018) Cost Accounting Principles and Procedural
Applications. GIC Enterprises and Co. Inc. Manila Philippines
Hammer, Lawrence.; Usry, Milton F.; Carter, William K. ;(1994) Cost
Accounting.South-Western Publishing Company
Vicente, Ma. Violeta (2009).Cost Accounting and Cost Management. Mutual
Books Inc. Caloocan /city, Philippines
IMPORTANT Reminders:
1. References should be added at the end of each module.
2. Number of modules may vary depending on the number of clustered ILOs that
are significant to the course.
3. Each module could have a maximum of 5 lessons.
4. If there are significant contents/readings necessary for the abstraction part, it
can be put as an annex or appendix of the entire course pack. However, proper
labelling is necessary.
5. Use A4 paper size, Times New Roman font style, size 12, 1.5 inch
left margin and 1inch on the remaining sides. Use single line
spacing in the module contents.
6. The module format should be followed for the project write. The template
and format may be customized should the participating HEIs wish to
implement it in their respective institutions.