CHAPTER I: Introduction to Cost Accounting and Cost Accounting Cycle

COST means the measurement in monetary terms, of the amount of resources used for the
purpose of production of goods and services.
 Cash or cash equivalent sacrificed for goods and services that are expected to bring
current or future benefit to the organization
 Amount of money involved in production, marketing, and distribution.

ACCOUNTING is the art of recording, classifying, and summarizing in a significant manner

and in terms of money, transaction and events which are part at least, of financial character
and interpreting the results thereof.
 Financial Accounting
 Managerial Accounting
 Cost Accounting
 Auditing
 Taxation
 FINANCIAL COST ACCOUNTING MANAGERIAL
ACCOUNTING ACCOUNTING
 Recording of a  Process of  Providing
company’s analyzing, information to
transactions and recording, managers for use in
preparation of classifying, planning and
financial summarizing and controlling
statements. interpreting the operations for
details of costs of decision making.
materials, labor, and
factory overhead
necessary to
produce and sell the
product.
 Provides historical,  Determination of the  Financial analysis,
monetary, and cost of every order, budgeting and
verifiable job, contract, forecasting, cost
information to the process or unit as analysis, evaluation
company. may be appropriate. of business
decisions, etc…
 Used by external  Used by  Prepares financial
users such as management to reports for internal
investors, control current users
stockholders, operations and plan (management).
creditors for for the future.
decision making
purposes.

Cost Accounting as an Intersection between Financial Accounting and

Managerial Accounting
 Provides information regarding cost of products and services
 Provides cost data accumulated by the company, classified, summarized
interpreted and presented in ways that are useful for decision making.
 Adds to the effectiveness of financial accounting by providing relevant
information which ultimately results in better decision-making process of the
company.
 Guide the management in determining the selling prices of the products
 Helps in measuring production efficiency
 Used in preparation of budgets and cost control and cost reduction by setting
standards.
Cost Accounting System
 Used to track and allocate costs and expenditures. It provides management
needed information to estimate the cost of their products for profitability analysis,
inventory valuation and cost control. A well-defined cost accounting system will:

1. Provide means for proper valuation of inventories.

2. Help to control and management the cost properly.
3. Help measure the efficiency of men, machine, and usage of materials.
4. Provide data for pricing decision.
5. Help to identify wastes to reduce cost reduction.
6. Provide information as a basis for the preparation of financial statements.
FIVE PARTS OF A COST ACCOUNTING SYSTEM
1. INPUT MEASUREMENT BASIS (System of Accumulating Costs)
 Nature or type of costs, which flows into and through the inventory accounts.
Historical Costing Standard Costing Normal Costing
total product costs all product costs are Combination of
are known as the determined in actual and standard
operation has been advance. The costing.
completed. difference between
actual and standard
cost are charged to
variance account
Direct Actual Cost Standard Cost Actual Cost
Material
Direct Labor Actual Cost Standard Cost Actual Cost
F. Overhead Actual Cost Standard Cost Standard Cost

2. INVENTORY VALUATION METHODS

Throughput Direct Full Activity
Costing (Variable Absorption Based
Costing) Costing Costing
Direct Material Inventory Inventory Inventory Activity Cost
Pools
Direct Labor Expense (sold) Inventory Inventory Activity Cost
Pools
F. Overhead Expense (sold) Variable: Inventory Activity Cost
Inventory Pools
Fixed:
Expense
(sold)
3. COST ACCUMULATION METHODS
a. Job Order Costing
 Heterogenous products.
 Keeps the cost of different jobs, orders, contracts separate during
manufacture.
b. Process Costing
 Homogenous products
 Units are not separately distinguishable from one another during
manufacturing process.
c. Backflush Costing
 Just in Time (JIT) inventory system
 Delays the costing process until the production of goods is actually produced
or completed.
d. Hybrid Costing
 Combination of job order and process
 Direct Materials: Job Order; Conversion Cost (DL & OH): Process

4. CASH FLOW ASSUMPTION

a. Specific Identification
 Actual cost is charged as COGS
 Cost of Inventory = Inventory Units x Unit cost
b. FIFO
 Goods first purchased, first sold
 Inventory cost = Recent and new prices
 Inventory sold = Older prices
c. LIFO
 Goods last purchase, first sold
 Inventory = older prices; COGS = recent prices
d. Weighted Average
 Beginning inventory are combined together with newly purchase inventories
 Average cost per unit = COGAS / no. of units purchased
 Then multiplied to units sold to determine COGS and unit on hand
for ending inventory.

5. RECORDING INTERVAL CAPABILITY

Perpetual Periodic
 Require stock cards that updates  Requires a physical counting of
the inventory accounts after each inventories on hand at the end of
purchase of sale of the company. the accounting period.

 Computer based inventory and bin  Generally used by retailers whose

 location inventory items have small peso
investment.


COST ACCOUNTING CLASSIFICATION AND ESTIMATION

2.1 Know the different elements of costs
ELEMENTS OF COST
1. Material
 Includes cost of procurement, freight in, taxes and duties, insurance, etc.
 Directly attributable to the acquisition of materials
 The rebates (trade discount, refunds, returns, VAT) are DEDUCTED
2. Labor
 Converts raw materials into finished goods/products.
 Includes wages , salaries, allowances, production incentives or bonus, overtime
pay, holiday pay, and fringe benefits paid to employees.
3. Expenses ‘
 Costs incurred other than materials and labor.
 Direct Expenses: directly allocated to a particular product
 Indirect Expenses: cannot be conveniently or directly allocated to a particular
product.

2.2 Distinguish the direct materials, direct labor and factory overhead costs
BASIS DIRECT COST INDIRECT COST
Meaning Easily attributable/traceable to a Cannot be easily assigned or
cost object traced to a particular cost
object
Benefits Single Multiple
Aggregate Total of all direct cost (prime Total of indirect cost (factory
cost) overhead)
Traceable Yes No

OVERHEAD
total amount of indirect materials costs; indirect labor costs and indirect expenses.
Costs which cannot be associated directly with specific products and it is allocated or
apportioned to products/services on some rational basis.
Types of Overhead: Factory Overhead, Administrative Overhead, and Selling and
distribution Overhead
Factory Overhead
  Indirect cost incurred in the factory such as indirect materials and labor, factory
supplies, depreciation expense of the factory PPE, factory insurance, factory
rent, etc.

2.3 Differentiate product cost vs period cost

PRODUCT COST PERIOD COST
Meaning  Cost of DM, DL, and  Cost NOT associated with
FOH used in production
manufacturing of
products
Treatment  ASSETS  EXPENSE
1. Direct Cost 1. Selling and Marketing
DM and DL Costs
2. Indirect Cost 2. Administrative / General
FOH Costs
Note: Product and Period Costs may be fixed, variable, and mixed costs.

2.4 Learn relevant cost, opportunity cost, and sunk cost

RELEVANT COST
 Future costs that differ across the alternatives
 Helps the manager in taking a right decision in furtherance of the company’s
objectives
 Affect the decision making of the management
OPPORTUNITY COSTS
 The benefit given up when one alternative is chosen over another. ‘
 Measured in terms of revenue which would have been earned by choosing the
goods or service in some other alternative uses.
 NOT recorded in the books of accounts of the company.
SUNK COST
 Cost for which an outlay has already been made and it cannot be charged by
present or future decision
 Historical cost and IRRELEVANT in the decision-making process
 Results of the past decisions and cannot be change any future decisions

2.5 Know the different cost estimation analysis

OBJECTIVE OF ESTIMATION
  Estimate the amount of fixed and variable costs and to identify the linear cost
function equation (y = a + bx) means:

Total mixed cost = Total fixed cost + (Variable cost x Number of Units)

1. High – Low Points Method

The quick and easy method that uses historical data from several reporting periods to
estimate the variable cost per unit and total amount of fixed cost that are part of mixed
cost.
 Computed from two sampled data points – the highest and the lowest points
based on activity or cost drivers.
Advantage: Simple, inexpensive and easy to apply
Disadvantage: Use only 2 data points which may not produce accurate result
1. Identify the high and low activity levels from the data self:
Total amount of mixed costs occurring (level of production) at the HIGHEST and
LOWEST of ACTIVITY
Note: this method uses high and low activity and NOT peso amounts
2. Calculate the variable cost per unit
Variable cost per unit (b) = Change in Costs (highest – lowest)
Change in activity (highest – lowest)
3. Calculate the total fixed cost. (

Fixed Cost = Highest Activity Cost – (Variable Cost per unit x Highest Activity
Units)

or

Fixed Cost = Lowest Activity Cost – (Variable Cost per unit x Lowest activity
units)

4. State the results in equation form y = a + bx

2. Scattergraph Method
A graphical technique of separating fixed and variable components of mixed cost. It
considers all data points. All observed data at various levels are plotted on a graph.
  Regression line is then fitted to the plotted point which used to estimate the total
fixed and variable cost per unit.
 The point where the line intercepts y-axis (total costs) represents the total
estimated fixed cost and the slope of the line is the average variable cost per
unit.
Advantage Disadvantage
 Uses all observations of cost data  The fitting of the line to the graph
is subjective
 Relatively easy to understand and  Difficult to do if there are several
apply independent variables (cost
drivers) to be used
 It provides more accurate results  Unable to give the exact extent of
than high – low method correlation
 Outliers or values of extreme items
are easily seen and do not affect
this method

STEPS
1. Plot the data points for each period on a graph
2. Visually fit a line to the data points
3. Estimate the total fixed costs
4. Calculate the variable cost per unit
5. State the result in equation form y = a + bx

3. Least – Square Regression Method

A statistical technique that investigates the association between dependent (the cost)
and independent variables (the activity). It uses all data points and mathematical
equations to find the best possible fit of the line to the data points.
 Provides more accurate results that scattergraph method
 Determines the line of best fit for a set of observations by minimizing the sum of
the squared deviation between cost line and the data points.
Simple Regression - 1 dependent variable: 1 independent variable
Multiple Regression – 1 dependent variable: Multiple independent variable
Formula:
(1) ∑y = na + b∑x
(2) ∑xy = a∑x +b∑x²
 Advantage Disadvantage
 Uses all observation of cost data  It requires relatively strict
assumptions for the results to be
valid
 Relatively easy to use with  If an outlier is present this can
computer and calculators adversely affect the results

STEPS
I. Compute the mean in of the x values, the mean of the y values, the mean of xy
values and the mean of x²
II. Supply the values in the formula and compute the value of variable cost per unit
III. Compute the value of y-intercept (total fixed cost)
IV. State the result in equation form y = a + bx

4. Account Analysis Method

The identification of each cost as fixed and variable depends on the relationship
between the cost and the activity.
 The mixed costs are broken down into their variable and mixed components
 It estimates the total fixed cost by accumulating all cost identified as fixed
 To determine variable cost per unit, all variable cost are summed up and divided
by the number or activities.
Advantage Disadvantage
 It provides detailed expert  Subjective, judgmental approach
analysis of the cost  The different analyst may derive different
behavior each account estimates of cost behavior
 It is more labor intensive and time
consuming than regression analysis
 The cost of data collection may surpass
benefit

5. Other cost estimation method

a. Engineering method
 Study of physical relation between input (M, L, OH) and each unit of output (FG)
is done. It uses cost and activity projections instead of historical costs. It
estimates indicate what and how much costs should be.
Advantage Disadvantage
 It can be used to estimate cost of  It is quite expensive to use
totally new activities because it because each activity is using
 does not require data from prior expert engineers that are costly.
activities in the organization
 It can detail each step required to  Are often based on optimal
perform an operation condition. (No error, machine
breakdown)

It is not useful when physical relationship

between inputs and outputs is indirect
 It permits a comparison of other
centers in which similar operations
are performed and enables the
company to review its productivity
and identify strengths and
weaknesses. It helps managers to
identify non-value added activities

b. Conference Method
 Cost are classified based on opinions from various company departments such
as purchasing process engineering, manufacturing, employee relations and so
on.
Advantage Disadvantage
Its credibility is gained through the Its accuracy (cost estimate) is dependent
pooling of expert knowledge on objectivity, care of the people providing
the information.