Module 1 Intro To Cost Acctg

MODULE IN
COST ACCOUNTING AND CONTROL
AE 212
Department of Accountancy
SCHOOL OF ACCOUNTANCY, MANAGEMENT, COMPUTING,

AND INFORMATION STUDIES
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AE 212: COST ACCOUNTING AND CONTROL
Week Topic Learning Outcomes Activities
MODULE 1 – Introduction to Cost Accounting

Week 1 1. Describe the •
environment of cost
accounting from
internal and external
perspectives.
2. Identify the tasks in
which management is
aided by information
provided by the cost
accountant
particularly about
costs and their
benefits.
3. Enumerate the
classification of costs,
define, illustrate and
analyze behavior of
each kind of costs
4. Segregate fixed costs
from variable costs
Do graded activity
MODULE 1:
INTRODUCTION TO COST ACCOUNTING
ACCOUNTING INFORMATION
Understanding and using accounting information is an important ingredient of any business

undertaking. Terms such as sales revenue, net income, cost, expense, operating margin, and cash
flow have clearly defined meanings and are commonly used in business-related communications. To
become an active participant in the business world, one must gain a basic understanding of these
and other accounting concepts.
The primary objective of accounting is to provide information that is useful for decision-making
purposes. From the very start, accounting is not an end, but rather it is a means to an end. The final
product of accounting information is the decision that is enhanced by the use of that information,
whether the decision is made by owners, management, creditors, governmental regulatory bodies,
labor unions, or the many other groups that have an interest in the financial performance of an
enterprise. Sound decisions, based on reliable information, are essential for the efficient distribution
and use of a firm’s scarce resources.
In order to understand and use accounting information in making economic decisions, you need
to understand the following:
• The nature of economic activities that accounting information describes,
• The assumptions and measurement techniques involved in developing accounting
information,
• The information that is most relevant for making various types of decision.
Figure 1-2 illustrates how economic activities flow into the accounting process.
Figure 1-1
The Accounting
Process
Economic Accounting
Activities Information
Decision
makers
Just as there are many types of economic decisions, there are also many types of accounting
information. The terms financial accounting and management accounting often are used in
describing the types of accounting information that are widely used in the business community.
ACCOUNTING SYSTEMS
The accounting information system within an organization has two major subsystems: a financial
accounting system and a management accounting system.
Financial accounting refers to information describing the financial resources, obligations, and
activities of an economic entity (either an organization or an individual). Accountants use the term
financial position to describe an entity’s financial resources and obligations at a point in time and the
term results of operations describe its financial activities during the year. Financial accounting
information is designed primarily to assist external users. External users of accounting information are
individuals and other enterprises that have a financial interest in the reporting enterprise, but that are
not involved in the day-to-day operations of that enterprise. It includes investors, creditors, owners,
employees or labor unions, government agencies, suppliers, customers, trade associations, and the
general public. Each of these groups of external decision makers requires unique information to be
able to make decisions about the reporting enterprise. For example investors and creditors need
information in deciding where to place their scarce investment resources. Such decisions are
important to society because they determine which companies and industries will receive the
financial resources necessary for growth. Customers who purchase from the enterprise need
information to allow them to assess the quality of the products they buy and the faithfulness of the
enterprise in fulfilling warranty obligations. Government agencies may have an interest in whether
the enterprise meets certain governmental regulations that apply.
Management accounting involves the development and interpretation of accounting

information intended specifically to assist the internal users or management in operating the business.
Managers use this information in setting the company’s overall goals, evaluating the performance of
departments and individuals, deciding whether to introduce a new line of products, and making
virtually all types of managerial decisions. Much management accounting information is financial in
nature but is organized in a manner relating directly to the decision at hand.
Management accounting measures and reports financial information as well as other types of
information that assist managers in fulfilling the goals of the organization. It is concerned with purposes
1 to 4. Financial accounting focuses on external reporting that is guided by generally accepted
accounting principles. It is thus concerned with purpose 5. The primary differences between these
two accounting disciplines are given in figure 1-4.
Figure 1-2
FINANCIAL ACCOUNTING vs. MANAGEMENT ACCOUNTING
FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING
1. As to objective Financial statements are used to To provide information needed

determine the company’s by management in making
operating results for a given period decision
and financial condition at a given
period.
2. As to structure It is a single structure built It varies depending on the use
around one fundamental of information. There are three
equation: Assets = Liabilities + types of accounting: full cost
Capital accounting, differential
accounting and responsibility
accounting. Each with its own set
of principles and application.
3. As to It is always prepared in It is not necessarily in conformity

compliance with accordance with GAAP with GAAP to be able to present
GAAP more useful data.
4. As to basis of Data are historical in nature and Data may be both historical
the reports based on objective facts. and estimates. However, more
emphasis is given to future
estimates.
6. As to timeliness Reports are not easily prepared; Reports are promptly prepared
of reports and submission requires time. and submitted to preserve its
usefulness.
7. As to option of Financial reports are prepared It is optional for its existence and
existence and required not only by function since it depends upon
stockholders, prospective management and its needs.
investors, and creditors but also by
the different regulatory bodies.
COST ACCOUNTING
Cost accounting may be defined as the system that records, summarizes, analyzes and
interprets the details of the costs of a manufactured product or a service. In the planning phase, cost
accounting deals with the future. It helps management to budget the future or predetermined
materials costs, wages and salaries and other costs of manufacturing and marketing products and
services. These costs might be used to assist in setting prices and disclosing the profit that will result,
considering competition and other economic conditions. Cost information is also provided to aid
management with problems such as capital expenditure decisions, expansion of facilities for
increased sales production, make-or-buy decisions or purchase-or-lease decisions. In the control
phase, cost accounting deals with the present, comparing current results with predetermined
standards and budgets. Cost control to be effective, depends upon proper cost planning for each
activity, function and condition. Thru the cost accounting media, management is informed frequently
of those operating functions that fail to contribute their share to the total profit or that perform
inefficiently, thereby leading to profit erosion.
Periodically, generally at the end of the fiscal period, cost accounting deals with past costs for
the purpose of profit determination and thereby with the allocation of historical costs to periods of
time. At this point, cost accounting procedure is particularly concerned with the application of
manufacturing costs to units of products to be capitalized in the ending inventory and transferred to
cost of goods sold as shipments are made.
Cost accounting is an area of accounting concerned with cost determination, cost control and
cost analysis.
• Cost determination refers to the accumulation of cost data by products, processes or services to
be able to arrive at a unit cost or cost per work unit.
• Cost control refers to the comparison of standards set for costs per unit and per work unit with the
figures per actual operations so that remedial measures may be adopted.
• Cost analysis refers to the use of cost data in managerial analysis for decision-making.
It’s objectives include:
1. Creating and executing plans and budgets for operating under expected competitive and
economic conditions
2. Establishing costing methods that permit control of activities, reductions of costs and
improvements of quality
3. Controlling physical quantities of inventory, and determining the cost of each product or service
produced for the purpose of pricing and for evaluating the performance of a product,
department or division
4. Determining company costs and profit for an annual accounting period or a shorter period. This
includes determining the cost of inventory and cost of goods sold according to external reporting
rules.
5. Choosing among two or more short-run or long-run alternatives that might alter revenues or cost.
Cost accounting is a hybrid of financial and management accounting. It provides information

on a company’s costs and may be used for both external and internal purposes. When cost
accounting is used for financial accounting, it measures the costs of production and sales in
accordance with GAAP. When used for internal purposes, cost accounting information provides the
basis for planning, controlling and decision making.
Cost accounting creates an overlap between financial accounting and management

accounting. The figure on the next page depicts the relationship of cost accounting to the larger
systems of financial and management accounting. None of the three areas should be viewed as a
separate and exclusive type of accounting.
Figure 1-3
RELATIONSHIP OF FINANCIAL, MANAGEMENT AND COS T ACCOUNTIN
FINANCIAL COST MANAGEMENT
ACCOUNTING ACCOUNTING ACCOUNTING
COST CONCEPTS, USES AND CLASSIFICATION

To study cost accounting and operational control systems, it is necessary to understand the
meaning of cost and to become familiar with the cost terminology associated with the two systems.
One must also understand the process used to assign costs. Cost assignment is one of the key
processes of the cost accounting system. Improving the cost assignment processes has been one of
the major developments in the cost management field in recent years. Before discussing the cost
assignment process, we first need to define what we mean by cost.
COST
The Committee on Cost Concepts and Standards of the American Accounting Association wrote:
“Cost is a foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a
specific objective.” Cost is the cash or cash equivalent value sacrificed for goods and services that
are expected to bring a current or future benefit to the organization. We say cash equivalent
because non-cash assets can be exchanged for the desired goods or services.
Note that the main difference between a cost being classified as an expense or an asset is
timing. Cost is used for both assets and expenses while expense means expired cost.
USES OF COST DATA
The collection, presentation and analysis of cost data should serve the following essential uses or
aims:
1. Planning profit by means of budgets
2. Controlling costs via responsibility accounting
3. Measuring annual or periodic profit, including inventory costing
4. Assisting in establishing selling prices and a pricing policy
5. Furnishing relevant cost data for analytical processes for decision making.
CLASSIFICATIONS OF COST
Cost classification is needed for the development of cost data that are useful to management.
Costs may be classified as follows:
1. Costs to make and sell (Natural classification)

2. Costs in relation to behavior
3. Costs in relation to manufacturing departments
4. Costs in relation to analysis for decision making
5. Costs in relation to timing of charges against revenues
COSTS TO MAKE AND SELL
In a manufacturing concern, the total cost is divided into two groups: [1] Product Cost and [2]
Period Costs.
Product costs or inventoriable costs, are costs that are attached to the product and matched
with revenue in the period in which the product is sold. In the case of manufactured goods, these
costs consist of direct materials, direct labor, and manufacturing overhead. During the accounting
period, that part of factory cost which represents work completed is transferred to Finished Goods
inventory, while incomplete work remains in Work in Process inventory. Direct materials and direct
labor are combined into another classification called Prime Costs. Direct labor and Factory overhead
can be combined into a classification called Conversion Costs, representing the costs of converting
direct materials into finished products.
Direct materials refer to all materials that form an integral part of the finished product and the cost
of which can be included directly in calculating the cost of the finished product. The cost of these
materials can be directly charged to products because physical observation can be used to measure
the quantity consumed by each product. For example, steel in automobile, wood in furniture,
alcohol in cologne, denim in jeans, braces for correcting teeth, surgical gauze and anesthesia for
operation, a casket for a funeral service and food on an airline are all direct materials. The ease and
feasibility with which the materials can be traced to the final products are major considerations in
their designations as direct materials. Glue and tacks to build furniture form part of the finished
product, but for costing purposes such items can be classified as indirect materials since their cost
does not significantly affect the cost of the finished product.
Direct Labor is labor expended directly upon the materials comprising this finished product. This
cost is traceable to the goods or services being produced. As with direct materials, physical
observation can be used to measure the quantity of labor used to produce a product or service.
Those salaries of employees who convert raw materials into a product or who provide service to
customers are classified as direct labor. Workers at the assembly line at a manufacturing firm, a chef
in a restaurant, a surgical nurse attending an open-heart operation, and a pilot for Philippine Air Lines
are examples of direct laborers.
Factory Overhead or Manufacturing Overhead or Factory Burden may be defined as all
production costs other than direct materials and direct labor. It includes the cost of indirect materials,
indirect labor and all other indirect manufacturing costs. These costs form a substantial part of the
total cost to manufacture that cannot be expediently identified with any particular unit or batch. The
Factory Overhead Control account is used to accumulate the actual factory overhead incurred
during the manufacturing process. The following is a list of costs chargeable to this account:
1. Indirect materials and Factory Supplies
Indirect materials are materials needed for the completion of the product but whose
consumption with regard to the product is either so small or so complex that it would be useless
to treat them as direct materials. This is justified on the basis of cost and convenience. The
cost of the tracing is greater than the benefit of increased accuracy. Glue, thread, nails,
tacks, rivets and other such items usually belong to this category.
Factory Supplies, a form of indirect materials, are generally those materials necessary for
production but that do not become part of the finished product or are not used in providing
a service. Examples are oil used for production equipment, cleaning rags and brushes needed
to maintain the working area and machinery in workable and safe condition, and dishwasher
detergent in a fast-food restaurant.
2. Indirect Labor
Indirect Labor may be defined as that labor expended which does not affect the
construction or the composition of the finished product. The term includes the salaries paid to
foremen, shop clerks, general helpers, cleaners, and those employees engaged in
maintenance work or other service work not directly related to physical production.
3. Factory building maintenance costs, such as rent, taxes, depreciation, light and maintenance
4. Factory machine and equipment depreciation
5. Cost of small tools used in the factory
6. Power used in machine operation
7. Payroll taxes and fringe benefits paid to factory employees
8. Cost of spoilage and rework not chargeable to a particular job
9. Overtime premiums
Period costs refer to the costs that are totally charged against current revenues. These are non-
inventoriable costs which are deducted as expenses during the current period without having been
previously classified as costs of inventory. These are assigned to periods of time rather than to units of
product. Since future benefits are not subject to objective measurement, no part of a period cost is
deferred. Rather, the entire amount of a period cost is charged to revenue as an expense in the
period in which the cost was incurred.
Selling Expenses cover the expenses of making sales and delivering products. It begins at the
point where the factory costs end; that is, when manufacturing has been completed and the product
is in salable condition. They are often referred to as order-getting and order-filling costs. Examples of
selling costs include the following: salaries and commissions of sales personnel, advertising,
warehousing, shipping and customer service. The first two items are examples of order-getting costs;
the last three are order-filling costs.
General/ Administrative Expenses include all costs associated with the general administration of
the organization that cannot be reasonably assigned to either marketing or production. General
administration has the responsibility of ensuring that the various activities of the organization are
properly integrated so that overall mission of the firm is realized. The president of the firm, for example,
is concerned with the efficiency of both marketing and production as they carry out their respective
roles. Proper integration of these two functions is essential to maximize the overall profits of the firm.
Examples of administrative costs are top-executive salaries, legal fees, printing the annual report,
general accounting, and research and development.
COSTS IN RELATION TO BEHAVIOR
Some costs vary directly in relation to changes in the volume of output (production or sales), while
others remain relatively fixed in amount. The tendency of costs to change with output must be taken
into consideration by the management for cost control purposes. There are three (3) patterns of
behavior that emerge when costs are classified in relation to volume or activity, namely:
Fixed Costs. These are costs incurred in providing the capacity to do business – the costs of being
in business. The characteristics of fixed costs are:
• Costs tend to remain constant in total amount within the relevant range even the volume
of activity changes
• Cost per unit tend to vary or change in an indirect proportion to volume of activity, that is
fixed cost per unit decreases with increased output or fixed cost per unit increases with
decreased output
A common example of a fixed cost is depreciation of factory machinery. Take note that a
machine has a capacity which defines its relevant range. If a machine can process 12,000 units and
is depreciated at P240,000 annually, then the relevant range is 0-12,000 units. Beyond the relevant
range, the cost of depreciation may be different since the company would need to acquire and
consequently depreciated another machine. This example may be illustrated by the succeeding
graph.
Figure 1-4
FIXED COST BEHAVIOR
Cost
F = P480,000
P480,000
P240,000
4,000 8,000 12,000 16,000 20,000

Number of units processed
Other examples are Property taxes, Depreciation, Rent, Salaries of production executives, Patent
amortization, Wages of security guards/janitors, Repairs and maintenance of buildings and grounds,
Insurance on property
Variable Costs. These are costs incurred in utilizing the available capacity and which represents
the cost of doing business as against the costs of being in business. The characteristics of a variable
cost are as follows:
• Costs tend to vary or change in total amount in direct proportion to volume of activity
• Comparatively constant cost per unit in the face of changing volume
• Easy and reasonably accurate assignments to operating departments
• Control of their incurrence and consumption by the responsible department head
To illustrate, a company uses 2 yards of cloth to manufacture 1 unit of T-shirt. The results of the
factory is shown in figure 1-5. As the number of units produced increases, the cost of cloth used in
making T-shirts also increases. Notice also that the unit cost of direct materials is constant.
Figure 1-5
VARIABLE COST PER UNIT COMPUTATION
Cost of Cloth Number of T-shirts Unit Cost
P 240,000 4,000 P 60.00
480,000 8,000 60.00
720,000 12,000 60.00
960,000 16,000 60.00
1,200,000 20,000 60.00
Figure 1-13 graphically illustrates a variable cost.
Figure 1-6
VARIABLE COST BEHAVIOR
Cost
1,200,000 YV = P60 X
960,000
720,000
480,000
240,000
4,000 8,000 12,000 16,000 20,000
Variable cost behavior is represented by a straight line coming out of the origin. Notice that at
zero units processed, total variable cost is zero. However, as units produced increase, the total
variable cost also increases. Here it can be seen that total cost increases in direct proportion to
increases in the number of computers processed (the activity driver); the rate of increase is measured
by the slope of the line. At 12,000 units, the total cost of direct materials is P720,000 (or P60 x 12,000
computers processed), at 16,000 units, the total cost is P960,000.
Mixed Costs. These costs contain both fixed and variable elements. They vary with output but
not in direct proportion to the volume. These costs include an amount that is fixed within a relevant
range of output below which it will not fall and an amount that varies proportionately when output
changes.
For example, sales representatives are often paid a salary plus a commission on sales. Suppose
that a company has ten sales representatives, each earning a salary of P300,000 per year plus a
commission of P500 per unit sold. The activity is selling, and the activity driver is units sold. If 10,000
computers are sold, then the total selling cost (associated with the sales representatives) is P8,000,000
– the sum of the fixed salary cost of P3,000,000 (10 x P300,000) and the variable cost of P5,000,000
(P500 x 10,000 computers). The linear equation for a mixed cost is given by:
For DC Computers, the selling cost is represented by the following equation:
Y = P3,000,000 + P500X
The following figure shows the selling cost for different levels of sales activity:
Figure 1-7
COST PER UNIT COMPUTATION
Fixed Cost Variable Total Cost Number of Selling

of Selling Cost of Units sold Cost per
Selling Unit
P3,000,000 P2,000,000 P5,000,000 4,000 P 1,250.00
3,000,000 4,000,000 7,000,000 8,000 875.00
3,000,000 6,000,000 9,000,000 12,000 750.00
3,000,000 8,000,000 11,000,000 16,000 687.50
3,000,000 10,000,000 13,000,000 20,000 650.00
The graph for the mixed cost example is given in figure 1-8. The graph assumes that the relevant
range is 0 to 20,000 units. Mixed costs are represented by a line that intercepts the vertical axis (at
P3,000,000 for this example). The intercept corresponds to the fixed cost component, and the slope
of the line gives the variable cost per unit of activity driver (slope is P500 for the example portrayed).
Figure 1-8
MIXED COST BEHAVIOR
13,000,000
11,000,000
C
o 9,000,000 Variable
s Costs
7,000,000
t
5,000,000
3,000,000
Fixed
Costs
4,000 8,000 12,000 16,000 20,000

COSTS IN RELATION TO MANUFACTURING DEPARTMENTS
A factory is generally organized along departmental lines for production purposes. This factory
departmentalization is the basis for the important classification and subsequent accumulation of costs
by departments to achieve the following [a] cost budgeting with responsibility accounting and
control and [b] a greater degree of reliable costing.
The departments of a factory fall into two categories: [1] Producing departments and [2] Service
departments.
Producing department is one whose costs may be charged to the product because they have
contributed directly to its production, such as the machining, forming, upholstering, or assembling
departments. In many cases, producing departments are further subdivided into cost centers or cost
pools. Where two or more different types of machines perform operations on a product within the
same department, a breakdown into cost centers increases the accuracy of product costs. For
example, in the manufacture of cotton yarn and cloth, the producing department “Carding” can be
broken up into the cost centers: opening cotton bales, picking, carding, drawing and slubbing.
Service department is one that is not directly engaged in production but renders a particular type
of service for the benefit of other departments. In some instances these services benefit other service
departments as well as the producing departments. The costs incurred in the operation of service
departments represent a part of the total factory overhead that must be absorbed in the cost of the
product by means of the factory overhead rate. Some service departments common to many
manufacturing concerns are receiving, inspection, storeroom maintenance, timekeeping, payroll,
cost accounting, factory office, cafeteria and plant protection.
Within a department, whether producing or service, expenses may be direct or indirect, common
or joint. When the cost is directly traceable to the product that pass the department, then such cost
is a direct departmental cost whereas those expenses, the benefits from which may be shared with
the other departments are indirect or common costs. For indirect and common costs, allocation has
to be made proportionately to the departments receiving the benefits. Joint cost occurs when two
or more products are manufactured at the same time such as those coming from the same raw
materials. Meat-packing, lumber and liquor industries are examples where production costs have to
be allocated to the different products manufactured. In such industries, joint costs can be allocated
to joint products only by arbitrary calculations. Data resulting from joint cost allocation must therefore
be very carefully treated in some decisions, as explained in a later chapter.
COSTS IN RELATION TO ANALYSES FOR DECISION MAKING
Costs as a basis for analysis are estimated costs which may be incurred if any one of several
alternative courses of action is adopted. For analytical purposes, these costs are generally classified
as [1] relevant costs and [2] irrelevant costs. The cost is said to be relevant when the same can be
changed or influenced by a decision. Irrelevant costs are those that will not be changed by a
decision. Relevant costs have two basic characteristics, namely: [1] they are future costs, and [2] they
are different between decision alternatives. This implies that a cost may be a future cost, yet it is
considered irrelevant if it will not differ under each alternative course of action. Likewise, a cost is
irrelevant if, though it is different under each alternative yet it is not a future cost. So, to be relevant,
a cost item must possess both of the two characteristics discussed above. Different types of costs
involve varying kinds of considerations in managerial analysis for decision making.
Differential Cost refers to the difference between any two alternative courses of action. If the
difference in cost of the alternatives is an increase, the differential cost is appropriately termed as
Incremental cost while a decrease is properly called as Decremental cost. Generally speaking, a
differential cost is a relevant cost for decision making purposes. It is interesting to note that a cost to
be relevant it must be both relating to the future and differential.
Avoidable cost are costs that can be eliminated by virtue of an alternative. In form, avoidable
costs are cost savings arising from a decision to discontinue an undertaking. Thus, a particular cost
that cannot be eliminated by a decision is said to be an unavoidable cost. One form of an
unavoidable cost is committed cost. This cost is a result of a long-run decision such as the acquisition
of equipments subject to periodic depreciation or a long-term lease contract that will bring about
periodic rental charges for a definite period of time.
Postponable costs are costs that may be deferred or shifted to a future date or period of time
without adversely affecting current operations. For instance, the cost involved in repainting a building
is considered postponable cost if the management can decide to defer the repainting job to a future
date. Note that postponable costs are not avoidable costs, since the incurrence of cost is merely
deferred and not actually avoided.
Out-of-pocket cost are future outlay of financial resources as a consequence of a decision. A

decision to acquire equipment involves cost. Such cost is a typical example of out-of-pocket cost.
Similarly, to process further a particular product will incur an out-of-pocket cost. Oftenly referred to
as variable or direct costs because of their relevance to any decision, the concept is specially
significant in deciding whether a particular undertaking will at least return the cash expenditures
relative to such undertaking.
Opportunity cost refers to the income or benefit sacrificed or foregone when an alternative is
selected over another. Though cost generally looked upon as outlays of resources either in the
present or in the future, it also includes sacrifices made by refusing an alternative. To illustrate, assume
the existence of an opportunity to produce only one product out of two different product lines.
Product A is estimated to contribute P35,000 a year to profit while product B will generate P30,000 a
year. Naturally, product A should be selected and the opportunity cost for selecting product A is the
sacrifice of P30,000 that could be earned by producing product B. Another example is the use of a
presently owned facility for operations where there is an offer to lease such facility for P10,000. The
offer of P10,000 constitute an opportunity cost once rejected. Sacrifices associated with alternatives
are the basis for measuring opportunity costs. When a decision does not require a sacrifice, there is
no opportunity cost. Opportunity cost is not entered in the accounting records. However, for decision
making purposes, these costs are usually considered relevant.
Imputed costs are assumed or hypothetical costs representing the cost or value of a resource that
is utilized for a specific purpose. This cost does not involve actual outlay of cash but is considered as
a relevant factor in decision making. Although it may not be recorded in the books of accounts, the
importance and relevance of the rental value of company-owned facilities and the salaries of owner-
operator of a single proprietorship cannot be overlooked. Also, the equivalent interest for a borrowed
capital that could have been invested somewhere else constitute an imputed cost.
Sunk cost is a cost that has already been incurred and that cannot be changed by any decision
made now or in the future. Therefore, sunk cost is irrelevant in decision making processes.
Expenditures made in the past are the result of foregone decision where the chances of recovery are
almost nil. For example, when a project should be abandoned or capital costs are never fully
recovered through revenues. The undepreciated book value of an asset is irrelevant in the decision-
making process as the same is a sunk cost.
Quality cost is cost associated with conforming to standards. It refers to the costs incurred to
prevent, or the costs arising as a result of, producing a low-quality product. Quality is a managerial
concern on two general levels. First, the quality of the product or service as it is perceived by the
consumer is an important consideration. On another level, managers are concerned about the
quality of the production process. Both levels of quality generate costs that often total 20 to 25
percent of sales.
There are two basic categories of quality costs: [1] the cost of control or compliance with
standards and [2] the cost of failure to control or non-compliance with standards.
The cost of control includes prevention cost and appraisal cost. The second category of quality
costs is failure costs, which may be internal or external.
Prevention cost has for its purpose the improvement of quality by preventing product defects
resulting from dysfunctional processing. Prevention costs support activities whose purpose is to reduce
the number of defects. Companies employ many techniques to prevent defects including statistical
process control, quality engineering, training, and a variety of tools from Total Quality Management
(TQM). A company can increase its product and service quality by investing in prevention costs.
Amounts spent on improved production equipment, training, and engineering and modeling are
considered as prevention costs.
Appraisal cost represents quality control costs incurred for monitoring since some mistakes are not
eliminated through prevention activities. These are sometimes called inspection costs that are
incurred to identify defective products before the products are shipped to customers. Appraisal cost
complements prevention cost. Both of these costs can be expected to cause a reduction in another
group of costs known as failure costs.
Failure cost may be internal loss such as scrap or rework, or it may also be an external loss, such
as warranty cost, or cost of recalling defective product. Internal failure costs result from identification
of defects before they are shipped to customers. These costs include scrap, rejected products,
reworking of defective products, and downtime caused by quality problems. External failure costs
result when a defective product is delivered to customers. These costs include warranty repairs and
replacements, product recalls, liability arising from legal action against a company, and lost sales
arising from a reputation for poor quality. Such cost can reduce profits.
Compliance costs are incurred to eliminate the present costs of failure and maintain that zero
level in the future; thus, they are proactive on management’s part. Furthermore, effective use of
prevention costs can even minimize the cost of appraisal. Alternatively, the cost of noncompliance
results from production imperfections and is equal to internal and external failure costs.
Figure 1-9 presents specific examples of each type of quality costs. The items in the figure come
from all business functions of the value chain, and they are broader than the internal failure costs of
spoilage, rework and scrap in manufacturing.
In manufacturing, quality costs may be variable in relation to the quantity of the defective output;
may be step fixed with increases at specific levels of defective output; or maybe fixed. For example,
scrap and rework costs approach zero if the quantity of defective output is also nearly zero. However,
these costs would be extremely high if the defective parts produced were high. In contrast, training
expenditures are set by management choice and, therefore, would not vary regardless of the
quantity of defective output produced in a given period of time. Understanding quality costs will help
managers in their control and decision-making functions.
Figure 1-9
TYPES OF QUALITY COSTS
COSTS OF CONTROL or COMPLIANCE COSTS OF FAILURE OR NON-COMPLIANCE
Prevention Costs Appraisal Costs Internal Failure External Failure
Employees: Before Production: Product: Organization:
• Hiring of quality • Reworking • Staffing complaint
• Receiving
• Providing training • Having waste departments
inspection
and awareness • Storing and • Staffing warranty
• Establishing Production Process: disposing claims department
participation • Monitoring and • Re-inspecting
Customer:
programs inspecting rework
• Losing future sales
• Keeping the process
Customers: Production Process: • Losing reputation
consistent, stable
• Surveying needs • Reprocessing • Losing goodwill
and reliable
• Researching needs • Having
• Using procedure
• Conducting field unscheduled
verification
trips interruptions Product:
• Automating
• Experiencing • Repairing
Machinery:
During and After unplanned • Replacing
• Designing to detect
Production: downtime • Reimbursing
defects
• Recalling
• Arranging for • Conducting quality
• Handling litigation
efficient flow audits
• Arranging for Service:
Information Process
monitoring • Providing
• Recording and
• Incurring preventive unplanned service
reporting defects
maintenance • Expediting
• Measuring
• Testing and • Service after
performance
adjusting purchase
equipment Organization:
• Fitting machinery for
• Administering
mistake-proof
quality control
operations
management
Suppliers:
• Arranging for quality
• Educating suppliers
• Involving suppliers
Product Design:
• Developing
specifications
• Engineering and
modeling
• Testing and
adjusting for
conformity,
effective and
efficient
performance,
durability, ease of
use, safety, comfort,
appeal and cost
COSTS IN RELATION TO TIMING OF CHARGES AGAINST REVENUES
Costs under this category may also be classified into [a] capital expenditures and [2] revenue
expenditures.
Capital expenditures relate to use of resources for future benefits – the benefits extending over two
or more accounting periods. These are recorded as assets. These are the costs paid in relation to the
acquisition of plant, property and equipment which are capitalized or added in the related asset
account. Any costs incurred during the purchase, installation and dry-run are capitalized. Since these
will benefit several accounting periods, they are treated as assets. Examples of capital expenditures
are building, equipment, machinery, and patent, purchased for the operation of the business.
Revenue expenditures are costs that will benefit only the current period. They are not material in
amount, thus, they are recorded under the expense accounts. Examples of revenue expenditures are
depreciation on most of the capital expenditures, repairs and maintenance, amortization of
intangibles, insurance. All non-manufacturing costs are revenue expenditures.
ESTIMATING AND CONTROLLING COSTS
In a business enterprise there are many different costs such as materials, wages, insurance,
and taxes, and each has its own peculiar characteristics. Even within a company, a particular type
of cost will behave differently depending upon the way a particular service or material is used by a
division or a department. A knowledge of how costs are affected by operations is essential in the
budgeting process and the control of costs.
Techniques of Cost Estimation
Cost studies are made continuously inasmuch as cost behavior may change over time as
conditions change. Management is constantly examining cost behavior in an effort to prepare better
budgets through more accurate cost prediction. The costs of projects or departments may be
estimated or predicted by a combination of two approaches:
1. Engineering estimates of materials and work requirements
2. An examination of past cost behavior
Engineers who are familiar with the technical requirements will estimate the quantities of
materials that are needed for production and the labor or machine hours required for various
operations. Prices and rates are applied to the physical measurements to obtain cost estimates. In
the preparation of budgets, the effect of changes in critical factors such as materials prices, labor
rates, or machine hours of operation must be considered in the prediction process and controlled to
the extent possible in actual operations.
Past cost behavior is also studied as a guide in predicting costs. The future is seldom a
duplication of the past, yet a study of past cost behavior can be effectively utilized in the overall
problem of cost allocation.
It may appear that costs that have already been incurred can be determined precisely. This
is not always true. For example, the cost of repairs may have been P600 at a time when a department
operated at 300 hours and may have been P700 in another period of similar length. The rate of cost
variability per hour may not be determinable at a precise amount. As a general rule, the problem is
estimating cost behavior, which is, determining the average rate of cost variability.
COST SEGREGATION
Costs are segregated for the purpose of determining the rate of past cost variability. After the
variable cost is determined, the estimated fixed cost can be established. Three methods are often
employed in cost segregation the: [a] high-low point method; [b] least squares method; [c] visual fit
method.
HIGH-LOW POINT METHOD
In the high-low point method, the observed costs for various hours of activity are listed in order
from the highest number of hours in the range to the lowest. The difference in hours between the
highest level of activity and the lowest is divided into the difference in cost for the corresponding hours
to arrive at a rate of variable cost per hour. For example, repair costs for various hours of operation
have been incurred in the past as follows:
Hours of Activity Repair Cost
High 80,000 P 246,000.00
70,000 216,000.00
60,000 186,000.00
50,000 156,000.00
40,000 126,000.00
Low 30,000 96,000.00
The difference in hours is 50,000 (80,000 – 30,000), and the difference in cost is P150,000
(P246,000 – P96,000). The variable repair cost is computed below:
Difference in cost P150,000
-------------------------- = ------------- = P3.00 vc/hr
Difference in hours 50,000
The fixed cost can be estimated at any level (assuming a uniform rate of variability) by
subtracting the variable cost portion from the total cost. At 80,000 hours, for example, the total cost is
P246,000; and the total variable cost is P240,000 (80,000 hours x P3.00 variable cost per hour). Hence,
the fixed cost is P6,000 (P246,000 – P240,000). In this example, it was assumed that a constant rate of
variability existed over the entire range. For every increase of 10,000 hours, there was a P30,000
increase in cost. In some cases, however, the rate of variability may change, and this possibility must
be considered in cost analysis.
LEAST SQUARES METHOD
When cost characteristics are such that they do not always vary at a constant rate for each
hour of activity, the most frequently used alternative to the high-low point method is the line of
regression method wherein an average rate of variability is computed. The costs for the various
numbers of hours may be plotted on a graph, and by visual inspection a line of average that
represents the costs for the various hours can be fitted to the data. The line of average for costs that
are influenced by a factor such as hours of activity is called the line of regression. The variable cost
per hour is indicated by the slope of the line, and the fixed cost is measured where the line begins at
zero hours of activity.
For purposes of illustration, it is assumed that a record of maintenance cost has been kept for
various hours of operation as follows:
Hours Maintenance Cost

50 P120
30 110
10 60
50 150
40 100
30 80
20 70
60 150
40 110
20 50
If the maintenance costs are to be plotted on a graph, and a line of regression will be fitted
to the data, the line is drawn so that the sum of the distances from the line to all points above the line
is equal to the sum of the distances form the line to all points below it, as shown below. The average
(defined as an arithmetic mean) is the point at which the sum of the deviations above that point is
equal to the sum of the deviations below that point. The line of regression represents a continuous
series of average points and thus is the line of averages.
Figure 1-10
160
140
120
100
80
60
40
20
0
0 10 20 30 40 50 60 70
The line of regression begins at P30 and rises P20 for each increase of 10 hours. Therefore the
estimated fixed cost is P30, and the variable cost is an average rate of P2 per hour (P20 ÷ 10 hours).
A line of regression can be fitted to a large quantity of data more precisely by the least squares
method. The line of regression is derived by simultaneous equations, with the equation for a straight
line serving as a foundation for the computations. The equation for the determination of a point on a
line is given below:
Y = a + bX
This equation states that the value of Y is equal to a point (a) plus a percentage (b) of the
change in X. in the last example, a is the P30 value of fixed cost. The percentage (b) was the change
in Y in relation to the change in X. In the example, Y increased by P20 for each increase of 10 hours.
Hence, the percentage of change was 200 percent (20/10)
Then,
Y = P30 + 200% X
If X is assigned a value of 10, Y is equal to 50,
Y = P30 + 2(10)
Y = P50
By substituting various values for X, a line is formed on a graph.
The equation for a point on a line is Y = a + bX, and the equation for a line is the equation for
a set of connected points, ∑Y = Na + b∑X. N represents the number of items of data.
Assume that maintenance costs for various hours of operation have been recorded and that
computations have been made as shown below:
Hours Maintenance
X Cost Y X2 XY
20 200 400 4,000
50 500 2,500 25,000
30 450 900 13,500
20 250 400 5,000
10 150 100 1,500
60 650 3,600 39,000
30 250 900 7,500
40 500 1,600 20,000
60 550 3,600 33,000
50 600 2,500 30,000
40 200 1,600 8,000
10 200 100 2,000
∑X=420 ∑Y=4,500 ∑X2=18,200 ∑XY=188,500
The first step in obtaining a line of regression is to set up an equation for a line that will represent all of
the data.
Equation (1) ∑Y = Na + b∑X
Another equation [Equation (2)] is formed by multiplying each point that constitutes Equation (1) by
∑X. Note that Equation (1) is not merely multiplied by ∑X. Instead, each point (Y = a + bX) is multiplied
by ∑X.
Equation (2) ∑XY = ∑Xa + b∑X2
Referring to the data listed above, substitute values and by simultaneous equations, solve for either a
or b.
Equation (1) 4,500 = 12a + 420b
Equation (2) 188,500 = 420a + 18,200b
To solve for b multiply Equation (1) BY 35 (420 ÷ 12) to provide:
Equation (3) 157,500 = 420a +14,700b.
Subtract Equation (3) from Equation (2); the a values will cancel out to yield:
31,000 = 3,500b b = P8,857 the rate of variable maintenance cost/hour.
Substitute the value of b in Equation (1) and solve for a.
4,500 = 12a + 3,719.94

12a = 780.06
a = P65 the estimated fixed maintenance cost (approximately).
Control Limits
From the data given in the example, it has been estimated that the fixed maintenance cost
should amount to P65 and that the variable maintenance cost should vary at the rate of P8,857 per
hour. For 20 hours of operation the total cost is estimated to be approximately P242. This is an average
cost, however, and it is unlikely that the actual cost will be precisely P242.
Because some variation in cost can be expected, management should establish an

acceptable range of tolerance. Costs that lie within the limits of variation can be accepted. Costs
beyond the limits, however, are identified and may be investigated. Before investigating a cost
variance, management should recognize that there is a cost attached to investigation. A certain
amount of time and money must be spent to find out why the variance occurred. Management must
balance the benefits to be derived from the investigation against the costs of the investigation. Time
itself has a cost and thus, time has been taken for the analysis of insignificant variations or the analysis
of variations that are not likely to occur again could have been used to better advantage. There is
an opportunity cost of investigating one variation in preference to another.
In dealing the cost variances, or variances in any type of data, it is necessary to consider the
way that the data are distributed. Statistical data may form a pattern of distribution designated as a
normal distribution. In a normal distribution, data can be plotted on a smooth, continuous,
symmetrical, bell shaped curve with a single peak in the center of distribution. Surveys have revealed,
for example, that the height of persons or the length of steel bars manufactured in a production
process can be described by a normal distribution.
Management may find that cost data are normally distributed and, in deciding upon an
acceptable range of cost variability, may employ the standard deviation concept that is commonly
used in statistics. The standard deviation measures the extent of variation that may be expected in a
distribution of data, and in this chapter, it will be assumed that the cost data are normally distributed.
Published tables show what proportion of the data may be expected to lie within plus or minus a given
number of standard deviations from the mean (average).
Assume that an average cost has been estimated to be P180 and that the standard deviation
has been computed to be P10. A table of probabilities for a normal distribution shows that 2/3 of the
data (more precisely, 68.27%) lie within plus and minus one standard deviation from the mean. Hence,
there is a 68.27% probability that the cost will be between P170 and P190, that is, P180 minus P10 and
P180 plus P10.
If more confidence in the prediction is desired, the limit of variation must be extended. For
example, there is a 95% probability that a cost in a normal distribution will lie within plus and minus 1.96
standard deviations. From the data given above, there is a 95% probability that the cost will be
between P160.40 and P199.60 [P180 plus and minus P19.60 (1.96 x P10)]. Management will have to
make a decision by balancing two alternatives:
1. A relatively narrow range of cost variation with a low probability of being correct.
2. A relatively wide range of cost variation with a high probability of being correct.
A standard deviation is computed from the 12 items of data given in the maintenance cost
illustration:
Actual *Ave Cost Deviations

Deviations Squared
Cost _ _
_
Hours X X (X – X)
(X – X)2
20 P200 242.14 42.14
1,775.78
50 500 507.85 7.85
61.62
30 450 330.71 119.29
14,230.10
20 250 242.14 7.86
61.78
10 150 153.57 3.57
12.74
60 650 596.42 53.58
2,870.82
30 250 330.71 80.71
6,514.10
40 500 419.28 80.72
6,515.72
60 550 596.42 46.42
2,154.82
50 600 507.85 92.15
8,491.62
40 200 419.28 219.28
48,083.72
10 200 153.57 46.43
2,155.74
∑ =92,928.56
* Line of regression values (hours multiplied by P8,857 plus P65)
With a standard deviation of P92, there is a probability of 68.27 percent that the cost will lie
within a range extending from P92 above the line of regression to P92 below the line of regression. At
40 hours of operation, for example, the cost can be expected to lie between P327.28 and P511.28
about 2/3 of the time.
Standard Deviation
Plus One Minus One
Average cost P419.28 P419.28
Standard Deviation + 92.00 - 92.00
Limit P511.28 P327.28
VISUAL-FIT METHOD
When a cost has been classified as semi-variable, or when the analysts has no clear idea about
the behavior of a cost item, it is helpful to use the visual fit method (also known as scattergraph
method) to plot recent observations of the cost at various activity levels. The resulting scatter diagram
helps the analyst to visualize the relationship between cost and the level of activity (or cost driver).
To illustrate, the controller of a business establishment compiled the following historical data for the
company’s utility costs.
Month Units Delivered Cost of Delivery
for the Month
January 1,500 P 24,000
February 1,800 33,000
March 2,500 39,000
April 1,200 23,400
May 3,000 43,000
June 2,100 33,000
July 4,000 54,000
August 800 22,000
September 3,600 47,000
October 2,600 35,000
November 3,300 49,000
December 4,600 57,000
The scatter diagram of these data is shown in the graph below. The vertical axis is the cost while the
horizontal axis represents the units. The cost analyst can visually fit a line to these data by laying a ruler
on the plotted points. The line is positioned so that a roughly equal number of plotted points lie above
and below the line. It is not a general rule but a good in drawing the line would be to let it pass through
at least two points. Using this method, the controller visually fit the line shown in the graph.
Figure 1-11
60000
50000
40000
30000
20000
10000
0
0 1000 2000 3000 4000 5000
Just a glance at the visually fit cost line reveals that the company’s utilities cost is a semi-
variable cost within the relevant range. The scatter diagram provides little or no information about the
cost relationship outside the relevant range.
The visually fit cost line in the graph intercepts the vertical axis at P10,000. Thus P10,000 is the
estimate of the fixed-cost component in the semi-variable cost approximation. To determine the
variable cost per unit, subtract the fixed cost from the total cost at any activity level that passes along
the line. The remainder is the total variable cost for that activity level. For example, the total variable
cost for an activity level of 4,000 deliveries is P44,000 (total cost of P54,000 minus fixed cost of P10,000).
This yields a variable cost of P11 per unit (P44,000 ÷ 4,000 = 11).
The scatter diagram and visually fit cost line provide a valuable first step in the analysis of any
cost item suspected to be semi-variable or curvilinear. The method is easy to use and to explain to
others, and it provides a useful view of the overall cost behavior pattern.
The visual-fit method also enables the cost analyst to quickly spot outliers in the data. An outlier
is a data point that falls far away from the other points in the scatter diagram and is not representative
of the data. Suppose, for example, that the data point for February had been P34,000 for 1,500
deliveries. The graph would reveal (see below) that such a data point would be way out of line with
the rest of the data. The cost analyst would follow up on such a cost observation to discover the
reasons behind it. It could be that the data point is in error. Perhaps a utility bill was misread when the
data were compiled, or possibly the billing itself was in error. Another possibility is that the cost
observation is correct but due to unusual circumstances such as a record cold wave during January
that required the company’s shops to use unusually high amounts of electricity. An outlier can result
from many causes. If the outlier is due to an error or very unusual circumstances, the data point should
be ignored in the cost analysis.
The primary drawback of the visual fit method is its lack of objectivity. Two cost analysts may
draw two different visually fit cost lines. This is not usually a serious problem, however, particularly if the
visual fit method is combined with other more objective methods.
Figure 1-12
60000
50000
40000
30000
20000
10000
0
0 1000 2000 3000 4000 5000
DISCUSSION QUESTIONS:
1. Differentiate financial accounting from management accounting.

2. What is the relationship among financial accounting, management accounting and cost
accounting?
3. Define cost accounting. What are its objectives?
4. Enumerate the various classifications of costs.
5. State the principal elements that make up the following: [a] prime cost; [b] factory cost; [c]
operating expenses; [d] total cost
6. What is the difference between a variable and a mixed cost, given that each changes in total
with changes in activity levels?
7. Why is there a need for cost segregation?
8. What is the major disadvantage of the high low method?
9. What is meant by the term least squares regression?
10. Give at least two advantages of using the scattergraph
Exercise 1-1. TRUE OR FALSE. Write letter “T” if you believe the statement is true, the letter “F” if the
statement is false.
__1. Cost accounting is applicable only to businesses engaged in manufacturing operations.

__2. The cost accountant is concerned with internal reporting to management and external
reporting to the public and to the government
__3. Progress reports are provided by accounting to management to enable the latter to determine
how much have been achieved to attain its goals for a given period.
__4. Managerial accounting draws heavily on economics, statistics, operations research and other
disciplines as necessary in providing accounting and financial information.
__5. Management accounting is primarily intended for external reporting purposes.
__6. Receiving, inspection, storeroom, maintenance and timekeeping are examples of producing
departments.
__7. Under a job order cost system, the cost of direct materials, direct labor, and factory overhead
applicable to each job or lot is accumulated.
__8. Under a process cost system, the focal point in costing are the various departments or processes.
__9. It is possible that a lower actual cost compared to budgeted cost may prove to be detrimental
to the firm.
__10. Variable costs are fixed per unit and fixed costs are variable per unit.
__11. Costs that tend to remain relatively constant per unit of output at different production levels
are known as variable costs.
__12. Fixed costs are costs that do not change with changing levels of activity. In other words, fixed
costs per unit remain constant regardless of the change in activity level.
__13. Relevant costs are future costs that will differ across alternative courses of action.
__14. Past costs and revenues are irrelevant, but they may be used as a basis to predict or estimate
the costs and revenues associated with alternative courses of future action.
__15. A differential cost may either be incremental or decremental cost.
__16. A sunk cost has relevance to a decision while opportunity cost does not.
__17. A difference in cost between one course of action and another is an opportunity cost.
__18. Factory overhead is incurred when a company is engaged in manufacturing rather than in
trading.
__19. Some materials, although an integral part of the finished product are not classified as direct
materials.
__20. Certain expenses such as insurance, property taxes, and salaries of executives may be classified
partly as factory overhead and partly as general or selling expenses of the company.
__21. In actual cost accounting, the goods in process at the end of the accounting period is
determined by taking a physical inventory.
__22. Under the normal cost system, factory overhead is allocated to products on a predetermined
basis rather on an actual basis.
__23. When cost of goods sold exceeds cost of goods manufactured, finished goods inventory
decreases.
__24. In the least-squares regression method, total cost is considered to be “Y”, the dependent
variable.
__25. The least-squares regression method computes the regression line that minimizes the sum of the
squared deviations from the plotted points to the line.
__26. Account analysis is a special form of least-squares regression in which more than one account is
analyzed at the same time.
__27. The visual fit method is not often used by managers for cost segregation because it is not very
accurate.
__28. The scattergraph do not give any insight on a company’s costs.
__29. The high-low method is the most accurate method of segregating costs.
__30. In the high-low method, the focus is the highest cost rather than the highest activity level.
Exercise 1-2. COST CLASSIFICATIONS.
A. Classify each cost as either variable or fixed with respect to the volume of goods or services
produced and sold by the organization.
B. Classify each cost as period or product cost.
C. If the cost is a product cost, classify further as to whether it is direct material, direct labor, or
factory overhead.
Use the following column headings and put “X” on the appropriate column. Item number 1 is done
for you.
Item Fixed Variable Mixed Period Product Direct Direct Factory

No. material Labor Overhead
1. X X X
1. Cost of microchips in cellphones
2. Factory airconditioning costs
3. Maintenance costs of factory machinery
4. Training costs of sales personnel
5. Travel costs of the company’s CEO
6. Salaries of factory workers
7. SSS premiums for employees in the human resource department
8. Costs of shipping products to customers
9. Depreciation of factory equipment
10. Supplies used in the factory
11. Cost of cloth in making Tshirts
12. Production manager’s salary
13. Metal sheets used in car production.
14. Cost of electricity used in the showroom
15. Advertising costs
16. Philhealth premiums for bakers in a bakeshop
17. Rent for the administrative building.
18. Property tax for the plant.
19. Salaries of the security guards in the factory.
20. Depreciation of computers in the accounting department.
21. Insurance of factory building.
22. Nails used in furniture making.
23. Costs paid to Cleaners Inc. by SM mall.
24. Secretary’s salary in a doctor’s clinic.
25. Repairs cost on the delivery equipment.
26. Interest expense on notes payable.
27. External auditors’ fee
28. Cost of disposing the factory’s hazardous waste
29. Depreciation of an ECG machine in a hospital.
30. Salary of the principal in an elementary school.
Exercise 1-3. COST CLASSIFICATIONS (MERCHANDISING).
Chu Stores reported sales revenue of P1,950,000 for the current year. Inventory at the beginning
of the year was P195,000. Purchases during the year amounted to P1,140,000. At the end of the year
inventory on hand was P142,500. Various operating expenses for the year are listed as follows: Supplies
– P99,000; Salaries – P171,000; Communication – P30,000; Advertising – P69,000; Utilities – P19,500; Taxes
and Insurance – P25,500; Depreciation – P18,000, Insurance – P45,000.
Required: Prepare an income statement for the company.
Exercise 1-4. COST COMPUTATIONS (MANUFACTURING).
Golden Manufacturers provides you with the following data: Cost of goods sold, ₱ 3,600,000;
Raw materials used, P1,500,000; Labor cost, P1,000,000; Factory overhead, P1,000,000. Ending
inventory of work in process and beginning inventory of finished goods inventories are 50% and 83
1/3% of beginning inventory of work in process, respectively. Finished goods inventory, end is 140% of
finished goods inventory, beginning.
Required:
Compute for the following: 1.Prime cost; 2. Conversion cost; 3. Cost of goods manufactured
Exercise 1-5 COST BEHAVIOR.
Orange Inc. manufactures a product line that requires materials costing P35 for each unit of
product. Four units of product are produced each labor hour at a labor rate of P40 per hour. Variable
manufacturing overhead has been budgeted at P8 per hour and fixed manufacturing overhead has
been budgeted at P600,000 for the year. In a good year, the company can produce and sell 60,000
units or product. Normally only 50,000 units are produced and sold each year. If the market is weak,
the company may produce and sell only 40,000 units.
Required: Compute for the following:
1. Product unit cost if 50,000 units are to be manufactured each year.
4. Compute for the gross profit per unit under the three activity levels assuming that the product is
sold at P100 per unit.
Exercise 1-6. COST BEHAVIOR
For each unit of product, Heavy Company has the following costs: Direct materials, P100;
Direct labor, P280; Variable overhead, P70. The company has a monthly normal capacity of 1,500
units where it incurs fixed production costs of P75,000.
Required:
1. Compute for the total production cost and the cost per unit of product if the company is able to
produce 1,200 units.
produce 1,500 units.
produce 100 units.
Exercise 1-7. QUALITY COSTS
Ealsy Company's quality cost report is to be based on the following data:

Maintenance of test equipment P95,000
Cost of field servicing and handling
complaints 17,000
Statistical process control activities 77,000
Net cost of scrap 62,000
Downtime caused by quality problems 23,000
Technical support provided to supplier 93,000
Depreciation of test equipment 81,000
Supplies used in testing and inspection 33,000
Warranty repairs and replacements 24,000
Required:
1. What would be the total prevention cost appearing on the quality cost report?
2. What would be the total appraisal cost appearing on the quality cost report?
3. What would be the total internal failure cost appearing on the quality cost report?
4. What would be the total external failure cost appearing on the quality cost report?
Exercise 1-8. COST SEGREGATION
Donna Company would like to estimate the variable and fixed components of its maintenance
costs and has compiled the following data for the last five months of operations:
Labor Hours Maintenance Cost
January 190 P677
February 120 P593
March 170 P646
April 110 P623
May 100 P582
Required:
[a] Using the high-low method of analysis, how much is the estimated variable cost per labor
hour for maintenance?
[b] Using the high-low method of analysis, how much is the estimated total fixed cost per
month?
[c] Using high-low, compute for the expected maintenance cost for June if expected labor
hours is 150 hours.
[d] Using the least-squares regression method, how much is the estimated variable cost per
labor hour for maintenance?
[e] Using the least-squares regression method, how much is the estimated total fixed cost per
month for maintenance?
[f] Using the least-squares regression method, compute for the expected maintenance cost for
June if expected labor hours is 150 hours.
[g] Using the least-squares regression equation, where is the total maintenance cost for March
located with respect to the regression line?
Exercise 1-8. COST SEGREGATION (Needs Graphing paper)
The owner of the Queensland Restaurant would like to determine the fixed and variable
components of the restaurant's utility expenses. The owner believes that the variable component of
the utilities cost is driven by the number of meals served.
Meals Utilities
served Cost
January 3,600 P1,560
February 2,000 P1,060
March 2,900 P1,350
April 3,500 P1,500
May 3,900 P1,580
June 2,100 P1,250
July 1,900 P1,100
August 1,000 P 850
September 1,250 P 990
October 1,400 P 880
November 2,600 P1,180
Required:
[a] Plot the data on a graphing paper.
[b] Using the scattergraph method, derive a cost formula for utilities cost.
[c] Use your cost formula to predict the utilities cost if 5,200 meals are served.

Module 1 Intro To Cost Acctg

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MODULE IN

COST ACCOUNTING AND CONTROL

SCHOOL OF ACCOUNTANCY, MANAGEMENT, COMPUTING,

MODULE 1 – Introduction to Cost Accounting

Understanding and using accounting information is an important ingredient of any business

Management accounting involves the development and interpretation of accounting

1. As to objective Financial statements are used to To provide information needed

3. As to It is always prepared in It is not necessarily in conformity

It’s objectives include:

Cost accounting is a hybrid of financial and management accounting. It provides information

Cost accounting creates an overlap between financial accounting and management

RELATIONSHIP OF FINANCIAL, MANAGEMENT AND COS T ACCOUNTIN

FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTING ACCOUNTING

COST CONCEPTS, USES AND CLASSIFICATION

USES OF COST DATA

1. Costs to make and sell (Natural classification)

COSTS TO MAKE AND SELL

COSTS IN RELATION TO BEHAVIOR

4,000 8,000 12,000 16,000 20,000

Figure 1-13 graphically illustrates a variable cost.

4,000 8,000 12,000 16,000 20,000

Number of units processed

Fixed Cost Variable Total Cost Number of Selling

4,000 8,000 12,000 16,000 20,000

COSTS IN RELATION TO MANUFACTURING DEPARTMENTS

COSTS IN RELATION TO ANALYSES FOR DECISION MAKING

Out-of-pocket cost are future outlay of financial resources as a consequence of a decision. A

ESTIMATING AND CONTROLLING COSTS

Techniques of Cost Estimation

HIGH-LOW POINT METHOD

LEAST SQUARES METHOD

Hours Maintenance Cost

Equation (1) ∑Y = Na + b∑X

Equation (2) ∑XY = ∑Xa + b∑X2

To solve for b multiply Equation (1) BY 35 (420 ÷ 12) to provide:

31,000 = 3,500b b = P8,857 the rate of variable maintenance cost/hour.

Substitute the value of b in Equation (1) and solve for a.

4,500 = 12a + 3,719.94

Because some variation in cost can be expected, management should establish an

Actual *Ave Cost Deviations

1. Differentiate financial accounting from management accounting.

__1. Cost accounting is applicable only to businesses engaged in manufacturing operations.

Item Fixed Variable Mixed Period Product Direct Direct Factory

Exercise 1-4. COST COMPUTATIONS (MANUFACTURING).

Exercise 1-5 COST BEHAVIOR.

Exercise 1-6. COST BEHAVIOR

Ealsy Company's quality cost report is to be based on the following data:

Exercise 1-8. COST SEGREGATION

February 120 P593

March 170 P646

April 110 P623

May 100 P582

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