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Cost Accounting
Cost Accounting
YOUR GOALS
This module allows you to explore the fundamental in cost accounting At the end
of this learning module, you are expected to demonstrate the following competencies:
1. Differentiate the costs that are considered as part of product or period costs;
master the process on how to arrive at certain costs; and explain the reasons why
there are variances in the cost of products.
2. Allocate accurately overhead costs to jobs or functions; and determine the cost
of materials, labor, and factory overhead used to produce a specific order or job
and the method of allocation of manufacturing costs incurred during a given
period.
3. Analyze cost variances and attribute them properly to a specific reason and the
efficient management of costs thru Cost/Volume Profit Analysis.
4. Correctly allocate joint costs accounting for by-products/scrap.
YOUR PROJECT
When you have finished going through the experiences and reading resources
contained in this module, you will prepare an analysis based on the cases that are
provided. Please take note of the writing conditions and expectations that follow.
Level 1 – Solve Task 1 with 3 problems. Total points The following will be the rubrics for assessing your calculations:
is 75.
75/55/85 points: The calculations arrived at the correct answers for all
Level 2 – Solve Task 2 with 3 problems. Total points the requirements on the problems for Task 1, 2 and 3 respectively.
is 55.
38/28/43 points: The calculations arrived at the correct answer for the
Level 3 – Solve Task 3 with 3 problems. Total points majority of the requirements of the problems for Task 1, 2 and 3
is 85. respectively.
In addition to the tasks, to assess learning, weekly 20/17/27 points: The calculations arrived at the correct answer for few
assessments shall be conducted. Results shall be of the requirements in the 3 problem each for Task 1, 2 & 3.
included in the grade computation.
YOUR EXPERIENCE
Be guided by the following schedule that you can follow in order to manage your
learning experience well:
There are four required reading resources for this module. You are allowed to look
for other related resources if you have the means to do so. Note that our school library
has online resources that you can access.
Read the summary of cost terminologies and cost behavior derived from the book Cost
Accounting: Foundations and Evolutions; Kinney and Raiborn Seventh Edition.
1. Familiarize yourself with the cost terminologies as these terms will be used
randomly in the discussions.
2. These readings will allow you to differentiate the different costs that comprises a
product as well as costs that are not attributable to the product.
3. This will also give you a way to visualize how cost move in the production of
product or services.
A. Introduction
a. Unexpired cost: The portion of an asset’s value that has not yet been
consumed or sacrificed and which is reported on the balance sheet.
b. Expired cost: The portion of an asset’s value that has been consumed or
sacrificed during the period and which is reported as an expense or loss on the
income statement.
B. Cost Terminology
1. A cost management system is a set of formal methods developed for planning,
controlling, and reporting on an organization’s cost-generating activities relative to its
1. To be useful, the term cost must be defined more specifically before “the cost” of
a product or service can be determined and communicated to others.
2. A cost object is anything (e.g., a product, a product line, a customer) for which
management wants to collect or accumulate costs.
Course Code – Cost Accounting 3
School of Business, Summer, SY 2020-2021
Adaptive Community for the Continuity of Education and Student Services
National Teachers College
a. Direct costs are costs that can be easily traced to the cost object. As the name
implies it is something that has a direct association to the product.
b. Indirect costs are costs that you cannot conveniently trace to the cost object
but instead must be allocated to the cost object .
1. General
a. A cost’s behavior pattern is described according to the way its total cost
(rather than its unit cost) reacts to changes in a related activity measure over
the relevant range.
c. The relevant range is the assumed range of activity that reflects the company’s
normal operating range.
d. Accountants assume that there are three cost behavior patterns: variable,
fixed, and mixed.
ii. A fixed cost is a cost that remains constant in total within the relevant range
of activity but varies inversely with changes in the level of activity on a per
unit basis. For example the depreciation expense of the oven used in baking
pizza remains the same on a monthly basis no matter how many pizza crusts
were baked.
iii. A mixed cost has both a variable and a fixed component. Mixed costs must
be separated into their variable and fixed components in order to make
valid estimates of total costs at various activity levels.
e. A step cost is a cost that shifts upward or downward when activity changes by
a certain interval or “step.” Step costs can be variable or fixed; step variable
costs have small steps while step fixed costs have large steps. A most common
example for step cost are utility bills such as electricity. Within a certain range
the electricity cost is fixed however if you already have gone beyond that
certain range then a new rate is used.
f. Assuming a variable cost is constant per unit and a fixed cost is constant in
total within the relevant range can be justified for two reasons:
i. If the company operates only within the relevant range of activity, the
assumed conditions approximate reality and, thus, the cost behaviors are
appropriate.
ii. Second, selection of a constant per-unit variable cost and a constant total
fixed cost provides a convenient, stable measurement for use in planning,
controlling, and decision making activities.
iii. Traditionally, a single predictor has often been used to predict costs but
accountants and managers are realizing that single predictors do not
necessarily provide the most reliable forecasts, thus causing a movement
toward activity-based costing, which uses multiple cost drivers to predict
different costs.
a. The balance sheet is a statement of unexpired costs (assets) and liabilities and
owners’ capital whereas the income statement is a statement of revenues and
expired costs (expenses and losses).
b. The matching concept provides a basis for deciding when an unexpired cost
becomes an expired cost and is moved from an asset category to an expense
or loss category.
c. When the product is specified as the cost object, all costs can be classified as
either product or period costs.
i. Direct material is any material that can be easily and economically traced
to a product.
ii. Direct labor refers to the time spent by individuals who work specifically on
manufacturing a product or performing a service.
iii.Overhead is any factory or production cost that is indirect (i.e., not direct
material or direct labor) to the product or service.
e. The sum of direct labor and overhead costs is referred to as conversion cost as
those are the costs incurred to convert materials into products. To illustrate,
assume that to make a product you 2 hours of labor at P100/hr. The work area
is assigned electricity rate of P20/kwh. Using labor hours as basis our conversion
cost would be P240.
f. The sum of direct material and direct labor cost is referred to as prime cost as
those are the primary costs in making most products. To illustrate, assume that
a product requires a kilogram of flour @ P200/kg, 2 eggs at P10/each, and 2
hours of labor to make them @ P100 hr. Hence, the conversion cost would be
P420.
g. Period costs are related to business functions other than production, such as
selling and administration.
i. Period costs are generally more closely associated with a particular time
period than with making or acquiring a product or performing a service.
ii. Period costs that have future benefit are classified as assets, whereas those
having no future benefit are expenses. For example, prepaid insurance
(asset) becomes insurance expense.
1. General
a. In general, product costs are incurred in the production (or conversion) area
and period costs are incurred in all nonproduction (or nonconversion) areas.
E. Stages of Production
1. The production or conversion process occurs in three stages: (1) work not started
(raw material), (2) work started but not completed (work in process), and (3) work
completed (finished goods).
a. Cost accounting uses Raw Material, Work in Process, and Finished Goods
Inventory accounts to accumulate processing costs and assign them to the
goods produced.
2. In the first stage of processing, the costs incurred reflect the prices paid for raw
materials and/or supplies.
4. The total costs incurred in stages 1 and 2 equal the total production cost of
finished goods in stage 3.
5. In a service firm, the work not started stage of processing normally consists of the
cost of supplies needed to perform the services (Supplies Inventory). When
supplies are placed into work in process, labor and overhead are added to
achieve finished results.
1. Direct Material
a. Direct material cost includes the cost of all materials used to manufacture a
product or perform a service.
b. Material costs that are not conveniently or directly traceable are classified as
indirect costs and included in overhead. Examples are spare parts of cars such
bolts.
2. Direct labor
b. Direct labor cost consists of the wages or salaries paid to direct labor personnel
conveniently traceable to the product or service. For example, the wage
given to the car mechanic who assembled the parts of a car.
d. Costs for overtime or shift premiums are usually considered overhead rather
than direct labor cost and are allocated among all units unless the overtime
costs resulted from expediting a customer’s request.
3. Overhead
c. Variable overhead includes the costs of indirect material, indirect labor paid
on an hourly basis lubricants used for machine maintenance, and the variable
portion of factory utility charges.
ii. Appraisal costs are costs incurred for monitoring or inspecting products in
order to find mistakes not eliminated through prevention.
iii. Internal Failure costs are costs such as scrap and rework that results when
quality problems are detected before the product reaches the final
customer.
iv. External Failure costs are incurred when quality problems are not
discovered until after the product has been delivered to the final customer
and includes costs such as product returns and warranty claims.
f. Some quality costs are variable in relation to the quantity of defective output,
some are step fixed with increases at specific levels of defective output, and
some are fixed for a specific time.
Course Code – Cost Accounting 8
School of Business, Summer, SY 2020-2021
Adaptive Community for the Continuity of Education and Student Services
National Teachers College
1. General
a. To satisfy the historical cost and matching principles, which require that all
production or acquisition costs attach to the units produced or purchased,
overhead must be accumulated over a period and allocated to the
products manufactured or services rendered during that period.
c. Overhead costs are allocated to cost objects for three reasons: (1) to
determine the full cost of the cost object, (2) to motivate the manager in
charge of the cost object to manage it efficiently, and (3) to compare
alternative courses of action for management planning, controlling, and
decision making.
ii. The following entries are used in accounting for the flow of product
costs:
a. In a normal cost system, actual direct material and direct labor costs and an
estimated amount of overhead (assigned using a predetermined overhead
rate or rates) are accumulated in WIP.
b. The Cost of goods manufactured (CGM) is the total production cost of the
goods that were completed and transferred to Finished Goods Inventory
during the period.
Beginning WIP
+ Cost of Direct Materials Added (See Note 1)
+ Cost of Direct Labor Added
+ Cost of Overhead
= Total Cost to Account For
- Ending WIP
= Cost of Goods Manufactured (CGM)
i. The Cost of goods sold is computed as beginning Finished Goods plus the
cost of goods manufactured less the ending Finished Goods.
Illustration
Assume that Mark Company has beginning inventory worth P100,000. During the year,
the company purchased inventory of P100,000 monthly. On the average, Mark
Company uses 90% of the previous months inventory and 80% of the current purchases.
There was no work in process inventory in the beginning, but on the average 95% of
those in production are made into finished goods. There was a P40,000 worth of
inventory left in the warehouse from the previous year. On the average, 85% of the
finished goods produced are sold. Direct Labor is 50% of Materials and Overhead is 75%
of Direct Labor. Depreciation expense related to the manufacturing plant is P50,000.
Prepare the Schedule of Cost of Goods Manufactured as well as the Cost of Goods Sold
portion of the Income Statement.
Solution:
A. Introduction
1. Overhead consists of all non-direct material and non-direct labor costs incurred
in the production area and in selling and administrative departments.
2. Historically, direct material and direct labor were the manufacturer’s primary
costs while inventory and sales salaries were the retailer’s primary costs.
1. General
b. Normal costing assigns actual direct material and direct labor to products but
allocates production overhead to products using a predetermined overhead
rate.
c. There are four primary reasons for using predetermined overhead rates in
product costing:
Let say for example that budgeted overhead for the year is
P1,000,000, and that the average volume of work annually is 10,000 direct
labor hours. Using the formula above we will have a predetermined rate of
P100 per hour (1,000,000/10,000).
b. Overhead is typically budgeted for one year although a longer period may
be used by some companies (e.g., ship builder).
d. The activity base should be a cost driver that directly causes the incurrence of
overhead costs. Common activity bases include:
3. Machine hours.
a. The journal entries required under normal costing are identical to those made
in an actual cost system with one exception: the amount of overhead applied
to production.
Let us assume that during the period that factory workers worked a total of
12,500 direct labor hours. Using the predetermined rate in the previous
illustration, the amount to be applied for overhead is P1,250,000 (12,500 x P100).
e. Actual overhead incurred during a period will rarely equal applied overhead.
b. If actual results are close to budgeted results (in both dollars and volume),
expected capacity should result in product costs that most closely reflect
actual costs and thus result in immaterial amounts of underapplied and
overapplied overhead.
Using high-low method and least squares regression analysis in analyzing mixed costs
1. General
1. Therefore, the general formula for a straight line can be used to describe
any cost within a relevant range of activity:
y = a + bx
Where:
c. A fixed cost remains fixed in total within the relevant range of activity under
consideration.
d. A variable cost varies in total as production changes, but the cost per unit
remains the same.
a. The high-low method is a technique for determining the fixed and variable
portions of a mixed cost by using only the highest and lowest levels of activity
and related costs within the relevant range.
c. The fixed portion of a mixed cost a is found by subtracting total variable cost
from total cost at either the high or low activity level:
a = y – bx
where: y = total cost for either one of the observations used to determine b
b = variable cost per unit (determined in the previous step)
x = activity volume of the observation used to determine y
Substituting the values using the values above. For this matter the Low scenario
e. Two potential weaknesses of the high-low method are that outliers can
inadvertently be used and the method uses only two data points
(observations) to determine the cost equation.
b. OLS determines the line of “best fit” for a set of observations by minimizing the
sum of the squares of the vertical deviations between actual points and the
regression line.
c. When multiple independent variables exist, the least squares method can be
used to select the best predictor of the dependent variable based on which
independent variable has the highest correlation with the dependent
variable.
e. A regression line is any line that goes through the means (or averages) of the
set of observations for an independent variable and its dependent variables.
Mathematically, there is a line of “best fit” which is the least squares regression
line
f. OLS can be used to determine the fixed and variable portions of a mixed cost.
1. The equations needed to compute the variable cost per unit (b) and total
fixed cost (a) are provided and illustrated in the text.
g. The following considerations are important when using the OLS model:
3. The OLS model is useful only as long as the circumstances existing at the
time of its development remain constant.
4. Flexible Budgets
b. A flexible budget presents variable and fixed costs separately at various levels
of activity within a relevant range of activity.
c. Flexible budgets are prepared for both product and period costs.
5. General
1. Authoritative accounting bodies such as the FASB and the SEC believe
absorption costing furnishes external parties with a more informative picture
of earnings, as compared to variable costing.
1. A functional classification is a group of costs that were all incurred for the
same principle purpose. Examples include cost of goods sold, selling
expenses, and administrative expenses.
Sales xxx
3. As seen in the format, absorption costing is the one that is used in the
presentation of financial statements in accordance with GAAP.
1. Since total variable product costs increase with each additional product
made or each additional service rendered, these costs should be
considered product costs and inventoried until the product or service is
sold.
a. Variable costing is not acceptable for external reporting and tax returns.
Sales xxx
1. Cost of goods sold is more appropriately called variable cost of goods sold
since it is composed of only the variable production costs (DM, DL, VOH)
related to the units sold.
e. Total contribution margin is the difference between revenue and all variable
costs regardless of the area of incurrence (production or nonproduction).
1. General
b. Case assumptions:
i. All costs are assumed to remain constant over the three years in question;
ii. All units started were completed and thus there are no WIP inventories at
the end of the period;
iii. All actual costs are assumed to be equal to standard and budgeted costs
for the years presented; and
iv. Changes in inventory levels are provided at the bottom of text Exhibit 3-13.
2.
d. The differences in income between the two methods are only timing
differences based on when fixed overhead costs flow through to the income
statement as part of cost of goods sold under absorption costing.
3. Phantom profits are the difference between absorption costing and variable
costing profits caused by fixed manufacturing overhead added to absorption
costing inventory and therefore not expensed during a period.
b. The total amount of fixed overhead cost is expensed as a period cost under
variable costing.
2. Absorption costing income will be less than variable costing income if production
is less than sales.
a. Absorption costing expenses all of the current period fixed overhead cost as
well as releasing some fixed overhead cost from beginning inventory where it
had been deferred from a prior period.
b. Variable costing shows on the income statement only current period fixed
overhead, so that the additional fixed overhead released from beginning
inventory makes absorption costing income lower.
c. The process of deferring and releasing fixed overhead costs into and from
inventory makes it possible to manipulate income under absorption costing by
adjusting levels of production relative to sales. This leads some to believe that
variable costing might be more useful for external reporting purposes than
absorption costing.
Reference
Kinney and Raiborn. 2009. Cost Accounting Foundations and Evolutions 7 th edition.
Southwestern. USA
PRELIM TASK
Case 1
The Jessica Co. has the following information available regarding costs and revenues
for two recent months. Selling price is P 1,000.
March April
Sales revenue P 3,000,000 P 5,000,000
Cost of goods sold -1,800,000 - 3,000,000
Gross profit P 1,200,000 P 2,000,000
Less other expenses:
Advertising P 30,000 P 30,000
Utilities 210,000 280,000
Salaries and commissions 160,000 200,000
Supplies (bags, cleaning supplies etc.) 16,000 20,000
Depreciation 115,000 115,000
Administrative costs 95,000 95,000
Total -626,000 -740,000
Net income P 574,000 P1,260,000
Required:
a. Identify each of the company's expenses (including cost of goods sold) as being
either variable, fixed, or mixed.
b. By the use of the high-low method, separate each mixed expense into variable
and fixed elements. State the cost formula for each mixed expense.
c. What is the total cost equation?
Case 2
Sports Innovators has developed a new design to produce hurdles that are used in track
and field competition. The company's hurdle design is innovative in that the hurdle yields
when hit by a runner and its height is extraordinarily easy to adjust. Management
estimates expected annual capacity to be 90,000 units; overhead is applied using
expected annual capacity. The company's cost accountant predicts the following
current year activities and related costs:
Other than any possible under or overapplied fixed overhead, management expects
no variances from the previous manufacturing costs. Under or overapplied fixed
overhead is to be written off to Cost of Goods Sold.
Required:
1. Determine the amount of under- or overapplied fixed overhead using (a) variable
costing and (b) absorption costing.
2. Prepare projected income statements using (a) variable costing and (b)
absorption costing.
Case 3
On December 30, a fire destroyed most of the accounting records of the Adams
Division, a small one-product manufacturing division that uses standard costs and
flexible budgets. All variances are written off as additions to (or deductions from)
income; none are pro-rated to inventories. You have the task of reconstructing the
records for the year. The general manager informs you that the accountant has been
experimenting with both absorption costing and variable costing.
Required:
Read the concise explanation about activity based costing from www.cliffnotes.com.
Traditionally, in a job order cost system and process cost system, overhead is allocated
to a job or function based on direct labor hours, machine hours, or direct labor dollars.
However, in some companies, new technologies have changed the manufacturing
environment such that the number of hours worked or dollars earned by employees are
no longer good indicators of how much overhead will be needed to complete a job or
process products through a particular function. In such companies, activity‐based
costing (ABC) is used to allocate overhead costs to jobs or functions.
Activity‐based costing assumes that the steps or activities that must be followed to
manufacture a product are what determine the overhead costs incurred. Each
overhead cost, whether variable or fixed, is assigned to a category of costs. These cost
categories are called activity cost pools. Cost drivers are the actual activities that cause
the total cost in an activity cost pool to increase. The number of times materials are
ordered, the number of production lines in a factory, and the number of shipments
made to customers are all examples of activities that impact the costs a company
incurs. When using ABC, the total cost of each activity pool is divided by the total
number of units of the activity to determine the cost per unit.
The number of activities a company has may be small, say five or six, or number in the
hundreds. Computers make using ABC easier. Assume Lady Trekkers, Inc., has identified
its activity cost pools and cost drivers (see the following table).
A per unit cost is calculated by dividing the total dollars in each activity cost pool by
the number of units of the activity cost drivers. As an example to calculate the per unit
cost for the purchasing department, the total costs of the purchasing department are
divided by the number of purchase orders. Lady Trekkers, Inc., has determined that both
the purchasing and receiving departments' costs are based on the number of purchase
orders; therefore, the two departments' costs may be added together so that one per
unit cost is calculated for these departments. Once the per unit costs are all calculated,
they are added together, and the total cost per unit is multiplied by the number of units
to assign the overhead costs to the units.
Activity categories
While using cost drivers to assign overhead costs to individual units works well for some
activities, for some activities such as setup costs, the costs are not incurred to produce
an individual unit but rather to produce a batch of the same units. For other costs, the
costs incurred might be based on the number of product lines or simply because there
is a manufacturing facility. To assign overhead costs more accurately, activity‐based
costing assigns activities to one of four categories:
The costs of unit‐level, batch‐level, and product‐line activities are easily allocated to a
specific product, either directly as a unit‐level activity or through allocation of a pooled
cost for batch‐level and product‐line activities. In contrast, the facility‐level costs are
kept separate from product costs and are not allocated to individual units because the
allocation would have to be made on an arbitrary basis such as square feet, number of
divisions or products, and so on.
https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-ii/activity-based-
costing/activity-based-costing-activities
Read a concise explanation of how job order costing is being used from
www.cliffnotes.com.
1. Job order costing is commonly used for custom made products.
2. Take into consideration the forms that are being used in this article. However,
this should not limit your imagination to use other forms in the future.
3. As technological evolution has brought forth a lot of change, the explanations
below are very useful to understand the logic behind how a product cost was
computed.
The job order cost system is used when products are made based on specific customer
orders. Each product produced is considered a job. Costs are tracked by job. Services
rendered can also be considered a job. For example, service companies consider the
creation of a financial plan by a certified financial planner, or of an estate plan by an
attorney, unique jobs. The job order cost system must capture and track by job the costs
of producing each job, which includes materials, labor, and overhead in a
manufacturing environment. To track data, the following documents are used:
Job cost sheet. This is used to track the job number; customer information; job
information (date started, completed, and shipped); individual cost information for
materials used, labor, and overhead; and a total job cost summary. See Figure 1.
Materials requisition form. To assure that materials costs are properly allocated to jobs in
process, a materials requisition form (see Figure 2) is usually completed as materials are
taken from the raw materials inventory and added to work‐in‐process.
Time ticket. Labor costs are allocated to work‐in‐process inventory based on the
completion of time tickets (see Figure 3) identifying what job a worker spent time on.
If direct labor costs are $20,000 for the month, overhead of $24,000 ($20,000 × 120%)
would be allocated to work‐in‐process inventory. Factory overhead would be allocated
to individual jobs based on the portion of the $20,000 direct labor cost that is assigned
to each job. If job number 45 had $9,000 in direct labor cost for the month, factory
overhead of $10,800 ($9,000 × 120%) would also be allocated to the job.
Once a job is completed, the total costs assigned to the job are transferred from work‐
in‐process inventory to finished goods inventory. Once the job is sold and delivered, the
job costs are transferred from finished goods inventory to cost of goods sold. Figure 4
summarizes the flow of costs in a job order cost system and Figure 5 summarizes the
journal entries required given the flow of costs in Figure 4. The ending balances in the
three inventory accounts would be reported as inventories on the balance sheet and
cost of goods sold would be reported on the income statement.
The factory overhead account (see Figure 5) has a balance which indicates the
amount of overhead applied to work‐in‐process inventory is different from the actual
overhead incurred. When there is a debit balance in the factory overhead account, it
is called under‐applied overhead meaning not enough overhead was allocated to
jobs. If the balance in the factory overhead account was a credit, the overhead would
be over‐applied, meaning too much overhead was allocated to jobs. Factory
overhead must be zero at the end of the year. Most companies transfer the balance in
factory overhead to cost of goods sold. An alternative method, although more
complex, is to allocate the under‐ or over‐applied balance among the work‐in‐process
inventory, finished goods inventory, and cost of goods sold accounts. The $2,600
account balance in factory overhead in Figure 5 is relatively small. To zero out the
account balance and transfer it to cost of goods sold, the entry would be:
Key:
https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-ii/traditional-cost-
systems/job-order-cost-system
Some companies have homogeneous or very similar products that are not made to
order and are produced in large volumes. They continually process their product,
moving it from one function to the next until it is completed. In these companies, the
manufacturing costs incurred are allocated to the proper functions or departments
within the factory process rather than to specific products. Examples of products that
companies produce continuously are cereal, bread, candy, steel, automotive parts,
chips, and computers. Companies that refine oil or bottle drinks and companies that
provide services such as mail sorting and catalog order are also examples of continuous,
homogeneous processing.
To illustrate, assume the Best Chips company manufactures potato chips. The company
has three work areas they call preparation, baking, and packaging. The preparation
area includes cutting potatoes and adding flavorings. Conveyor belts are used to move
the product from one function to the next. In this company, raw materials are added in
two of the functions: the preparation function and the packaging function. Labor and
overhead are incurred in each function. Figure shows the process flow and costs
associated with Best Chip's process cost system.
The cost report for Best Chips summarizes how manufacturing costs (direct materials,
direct labor, and manufacturing overhead) are assigned to the three departments.
The report for June is as follows:
The raw materials are assigned based on material requisition forms, the labor based on
time tickets, and the overhead based on predetermined overhead rates based on
direct labor dollars. The journal entries to record these transactions are made prior to
the period end entries that transfer the amounts from one work‐in‐process inventory
account to another, from work‐in‐process inventory to finished goods inventory, and
from finished goods inventory to cost of goods sold. The letters of the journal entries used
to illustrate the accounting for process cost systems correspond to the letters in Figure.
Best Chips started the month of June with $5,200 in raw materials inventory. Best Chips
uses the perpetual inventory method, so raw materials purchased are added to the raw
material inventory account when they are received. Raw materials requisitioned that
become part of the final product or are used by a specific function are considered
direct materials used. The costs of direct materials are added to the proper
department's work‐in‐process inventory account. Raw materials requisitioned that are
used for general production purposes are added to factory overhead. The journal
entries related to raw material activity for June are:
At the end of the month, $2,000 of materials remained in raw materials inventory.
Factory labor
As the factory labor payroll is prepared and recorded, the payroll costs are split
between those employees who work in specific functions (departments) and those
involved in the general functions of the factory. The specific function costs are called
direct labor and are assigned to work‐in‐process inventory. The general factory labor
costs are indirect labor costs that are added to factory overhead. Unlike the accounting
for payroll under the job order cost system, the employee does not have to be physically
involved in making a product to be assigned to a specific function. If a specific
maintenance worker or supervisor is assigned to the preparation function, their wages
are allocated to that function even though these workers are not directly involved in
preparing the chips to be baked. The accounting for the labor costs for June includes
the following journal entries, shown in the following table.
The balance in the factory labor account should be zero at the end of each period.
Factory overhead
In a process company, factory overhead represents those costs not directly assigned to
one function. For example, the depreciation expense of a machine used solely by the
preparation function would be assigned to work‐in‐process inventory for the
preparation department while depreciation expense for the plant (the factory building)
would be assigned to factory overhead as all functions occupy the plant. The journal
entries that follow illustrate the accounting for general overhead costs.
At the end of the period, the factory overhead account has a credit balance of ($125).
This is called overapplied overhead and an entry would be made at the end of the
period to move it to cost of goods sold, or alternatively, to allocate the difference to
work‐in‐process inventories, finished goods inventory, and cost of goods sold. After
recording this entry, the balance in the factory overhead account is zero.
At the end of the period, entries are needed to record the cost of the products moved
from one function (department) to another. In this example, costs are moved from work‐
in‐process inventory‐preparation to work‐in‐process inventory‐baking and from work‐in‐
process inventory‐baking to work‐in‐process inventory‐packaging. This is how the entries
would look:
When the packaging function (department) completes its work, the product is ready to
be sold. The costs of the completed products are then transferred from work‐in‐process
inventory‐packaging to finished goods inventory. This transfer also requires a journal
entry.
https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-ii/traditional-cost-systems/process-cost-system
MIDTERM TASK
Case 1
Allocation # of Total
Activity Measure People Cost
Issuing purchase orders # of purchase 1 $150,000
orders
Reviewing receiving # of receiving 2 $175,000
reports reports
Making phone calls # of phone calls 3 $225,000
During the year, 50,000 phone calls were made in the department; 15,000 purchase
orders were issued; and 10,000 shipments were received. Product A required 200 phone
calls, 150 receiving reports, and 50 purchase orders. Product B required 350 phone calls,
400 receiving reports, and 100 purchase orders.
Case 2
Grace Company manufactures picture frames of all sizes and shapes and uses a job-
order costing system. There is always some spoilage in each production run. The
following costs relate to the current run:
The actual cost of a spoiled picture frame is $7.00. During the year 170 frames are
considered spoiled. Each spoiled frame can be sold for $4. The spoilage is considered a
part of all jobs.
Case 3
Keener Company manufactures a specialized product. Department 2 adds new
material to the units received from Department 1 at the end of process. A normal loss
occurs early in processing. Production and cost data for Department 2 for the month of
September are as follows:
Cost Record:
Work in process inventory, September 1:
Preceding department cost $ 620
Processing cost 2,000 $2,620
Cost from preceding department in September 1,800
Material cost for September 4,800
Processing cost for September 10,200
Required: Determine the following for Department 2 under (a) weighted average the
method of costing and (b) the FIFO method of costing: (1) unit costs for each cost
component, (2) cost of production transferred to finished goods, (3) cost of work in
process inventory of September 30.
Read the summarized outline of Chapter 7 on Standard Costing and Variance Analysis.
1. General
iii. After management has determined the input resources needed to achieve
desired output quality at reasonable cost, it can develop quantity and
price standards.
2. Material standards
a. The first step in developing material standards is to identify and list the specific
direct material components used to manufacture the product. Four things
must be known about the materials inputs:
i. types of inputs;
c. The standard direct material cost per unit is found by multiplying the standard
quantity of material required per unit of output by the standard price per
material input.
3. Labor Standards
e. Labor rate standards should reflect the wages paid to employees who perform
the various production tasks as well as the related employer costs such as
fringe benefits, FICA, and unemployment taxes.
i. A weighted average rate, computed as the total wage cost per hour
divided by the number of workers, should be used if employees are paid
different wage rates.
f. The standard direct labor cost per unit is found by multiplying the standard
quantity of labor required per unit of output by the standard price per labor
input.
4. Overhead standards
c. Both actual and standard costs are recorded in a standard cost system. But
standard costs, rather than actual costs, are charged to the Raw (Direct)
Material, Work in Process, and Finished Goods Inventory accounts with any
differences between actual and standard costs reported as variances
1. General
i. Such a difference is favorable if actual cost is less than standard cost and
unfavorable if actual cost is greater than standard cost.
b. A total variance is the difference between total actual cost for the production
inputs and the total standard cost applied to the production output:
i. A price/rate variance reflects the difference between the actual price (AP)
paid for inputs and the standard input price (SP) for the actual quantity
(AQ) of inputs used during the period:
e. The standard quantity (SQ) is the quantity of input (in hours or some other cost
driver measurement) required at standard for the output actually achieved for
the period.
1. Material Variances
a. Text Exhibit 7-4 presents the standard cost card for a mountain bike made by
Harris Corporation as well as actual costs and quantities used. This information
is used in the text narrative to illustrate variance analysis.
b. The total material variance can be subdivided into the material price variance
and the material quantity variance:
AP × AQ SP × AQ SP × SQ
Material Material
Price Variance Quantity Variance
d. The material price variance (MPV) indicates whether the amount paid for
material was less than or more than standard price.
e. The material quantity variance (MQV) indicates whether the actual quantity
used was less than or more than the standard quantity for the actual output
achieved.
a. When the quantity of material purchased is not the same as the quantity of
material placed into production, the general variance model can be easily
modified to isolate material price variances as early as possible to provide
more rapid information for management control purposes.
i. Because the material price variance relates to the purchasing (rather than
the production) function, the point of purchase model calculates the
material price variance using the quantity of materials purchased (Qp)
rather than the quantity of materials used (Qu).
b. The total material variance can be subdivided into the material purchase
price variance and the material price usage variance:
AP × AQP SP × AQP
SP × AQU SP × SQ
c. The material purchase price variance is the materials price variance when
computed based on the quantity of materials purchased during the period
rather than the quantity of materials used.
d. The material quantity variance is the material usage variance when computed
based on the quantity of materials used during the period.
3. Labor Variances
a. The total labor variance can be subdivided into the labor rate variance and
the labor efficiency variance.
AP × AQ SP × AQ SP × SQ
Labor Labor
Rate Variance Efficiency Variance
b. The labor rate variance (LRV) is the difference between the actual wages paid
to labor for the period and the standard cost of actual hours worked.
c. The labor efficiency variance (LEV) indicates whether the amount of time
worked was less than or more than the standard quantity for the actual output.
D. Overhead Variances
1. Overhead Variances
b. If the company uses separate variable and fixed overhead application rates,
separate price and usage components are calculated for each type of
overhead. This four-variance approach provides managers the greatest detail
and, thus, the greatest flexibility for control and performance evaluation.
2. Variable Overhead
VOH VOH
Spending Variance Efficiency Variance
i. This variance quantifies the effect of using more or less of the activity or
resource which is the base for variable overhead application. When actual
input exceeds standard input allowed, production operations are
considered to be inefficient. Excess input also indicates that an increased
VOH budget is needed to support the additional activity base being used.
3. Fixed Overhead
a. The total fixed overhead variance is the difference between actual fixed
overhead costs incurred and standard fixed overhead cost applied to the
period’s actual production.
FOH
Spending Variance Volume Variance
b. The left column is simply the total actual fixed overhead incurred. The middle
column, budgeted FOH, is a constant amount throughout the relevant range
of activity and was the amount used to developed the predetermined FOH
rate; thus, this amount is a constant figure regardless of the actual quantity of
input or the standard quantity of input allowed. The right column is the amount
of fixed overhead applied to production based on the standard fixed
overhead rate and standard quantity allowed.
c. The fixed overhead spending variance is the difference between the total
actual fixed overhead and budgeted fixed overhead.
d. The fixed overhead volume variance is the difference between budgeted and
applied fixed overhead.
b. The total overhead variance is the difference between total actual overhead
and total applied overhead, and is the only variance computed under the
one-variance approach:
Total Applied Overhead
(Combined OH Rate × Standard
Input Allowed for Actual
Total Actual Overhead Production)
(Variable OH + Fixed OH) (SP × SQ)
i. The budget variance is the difference between total actual overhead and
budgeted overhead based on standard hours allowed for the production
achieved; it is computed as part of the two-variance analysis; it is also
referred to as the controllable variance.
ii. The volume variance can be computed under the four-variance, three-
variance, or two-variance analysis.
d. A column representing budgeted overhead based on actual hours is inserted
immediately to the right of total actual overhead under the three-variance
approach:
Budgeted Budgeted
Total Actual Overhead Overhead Total Applied
Overhead (for actual (for actual Overhead
(VOH + FOH) input used) output) (SP × SQ)
1. Note that unfavorable variances have debit balances while favorable variances
have credit balances.
2. Although standard costs are useful for internal reporting, they can be used in
financial statements only if the amounts are substantially equivalent to those that
would have resulted from using an actual cost system.
3. At year-end, adjusting entries are made to eliminate standard cost variances. The
entries depend on whether the variances are, in total, insignificant or significant.
1. Clerical efficiency—a company that uses standard costs to trace the flow of costs
through its accounting system usually discovers that less clerical time and effort
are required than in an actual cost system.
b. The setting of upper and lower tolerance limits for deviations allows managers
to implement the management by exception concept.
1. Appropriateness
b. Standards are developed from past and current information, and they should
reflect technical and environmental factors expected during the period in
which the standards are to be applied.
d. Standards must evolve over the organization’s life to reflect its changing
methods and processes.
2. Attainability
b. Expected standards are standards set at a level that reflects what is actually
expected to occur in the future period; these standards anticipate future
waste and inefficiencies and allow for them; they are not of significant value
for control and performance evaluation purposes.
d. they allow for normal, unavoidable time problems or delays and for worker
breaks; they are believed to be most effective in inducing the best
performance from workers, since such standards represent an attainable
challenge.
e. Ideal standards are standards that provide for no inefficiencies of any type,
are impossible to attain, and are sometimes called theoretical standards.
c. Ideal standards become expected standards under such a system, and there
is no (or only minimal) level of acceptable deviation from standard.
ii. Current problems must be identified and their causes must be pinpointed.
iii. Management must empower workers with the authority to react effectively
to problems since management has delegated the responsibility for quality
to the workers.
iv. Management must provide rewards for achievement since people are
required to work at their maximum potential.
e. Standards will move away from the practical and closer to the ideal in order
for American companies to compete in global markets.
2. Adjusting Standards
a. Standards were traditionally set and retained for at least one year.
b. The current business environment changes so swiftly that a standard might not
be useful for management control purposes during the entire year.
a. The material price variance calculation has usually been based on purchases
rather than on usage.
c. Such variance calculation at the point of purchase does allow the manager
to measure the impact of buying decisions more rapidly, but may not be
relevant in a JIT environment.
a. The necessity for direct labor variance calculations will be minimized as the
percentage of total product cost represented by direct labor cost declines.
b. Direct labor cost may become a small part of a conversion cost category.
1. Direct labor cost usually represents an extremely small part of total product cost
in highly automated factories.
a. One worker may oversee a large number of machines and deal mainly with
trouble-shooting machinery malfunctions.
b. The worker’s wages may be more closely related to indirect labor rather than
to direct labor.
2. Many companies have responded to overhead costs being so much larger than
direct labor costs by adapting their standard cost systems to provide for only two
elements of product cost: direct material and conversion.
a. Conversion costs are likely to be separated into their variable and fixed
components.
b. Conversion costs are also likely to be separated into direct and indirect
categories based on their ability to be traced to a machine rather than to a
product.
3. Variance analysis for conversion cost in automated plants usually focuses on:
b. Efficiency variances for machinery and production costs rather than labor
costs; and
a. A material price variance shows the dollar effect of paying prices that differ
from the raw material standard.
c. The material yield variance is the difference between the actual total quantity
of input and the standard total quantity allowed based on output and uses
standard mix and standard prices to determine variance; (standard mix ×
actual quantity × standard price) minus (standard mix × standard quantity ×
standard price).
a. The labor mix variance presents the financial effect associated with changing
the proportionate amount of higher or lower paid workers in production;
(actual mix × actual hours × standard rate) minus (standard mix × actual hours
× standard rate).
b. The labor yield variance shows the monetary impact of using more or fewer
total hours than the standard allowed; (standard mix × actual hours × standard
rate) minus (standard mix × standard hours × standard rate).
Reference:
Kinney and Raiborn. 2009. Cost Accounting Foundations and Evolutions 7th edition.
Southwestern. USA
Cost-Volume-Profit Analysis
CVP analysis requires that all the company's costs, including manufacturing,
selling, and administrative costs, be identified as variable or fixed.
Key calculations when using CVP analysis are the contribution margin and
the contribution margin ratio. The contribution margin represents the amount of
income or profit the company made before deducting its fixed costs. Said
another way, it is the amount of sales dollars available to cover (or contribute to)
fixed costs. When calculated as a ratio, it is the percent of sales dollars available
to cover fixed costs. Once fixed costs are covered, the next dollar of sales results
in the company having income.
The contribution margin is sales revenue minus all variable costs. It may be
calculated using dollars or on a per unit basis. If The Three M's, Inc., has sales of
$750,000 and total variable costs of $450,000, its contribution margin is $300,000.
Assuming the company sold 250,000 units during the year, the per unit sales price
is $3 and the total variable cost per unit is $1.80. The contribution margin per unit
is $1.20. The contribution margin ratio is 40%. It can be calculated using either the
contribution margin in dollars or the contribution margin per unit. To calculate the
contribution margin ratio, the contribution margin is divided by the sales or
revenues amount.
Break-even point
The break‐even point represents the level of sales where net income equals zero.
In other words, the point where sales revenue equals total variable costs plus total
fixed costs, and contribution margin equals fixed costs. Using the previous
information and given that the company has fixed costs of $300,000, the break‐
even income statement shows zero net income.
The $1.80 per unit or $450,000 of variable costs represent all variable costs
including costs classified as manufacturing costs, selling expenses, and
administrative expenses. Similarly, the fixed costs represent total manufacturing,
selling, and administrative fixed costs.
In this equation, the variable costs are stated as a percent of sales. If a unit has a
$3.00 selling price and variable costs of $1.80, variable costs as a percent of sales
is 60% ($1.80 ÷ $3.00). Using fixed costs of $300,000, the break‐even equation is
shown below.
The last calculation using the mathematical equation is the same as the break‐
even sales formula using the fixed costs and the contribution margin ratio
previously discussed in this chapter.
The break‐even point in units may also be calculated using the mathematical
equation where “X” equals break‐even units.
Again it should be noted that the last portion of the calculation using the
mathematical equation is the same as the first calculation of break‐even units
that used the contribution margin per unit. Once the break‐even point in units has
been calculated, the break‐even point in sales dollars may be calculated by
multiplying the number of break‐even units by the selling price per unit. This also
works in reverse. If the break‐even point in sales dollars is known, it can be divided
by the selling price per unit to determine the break‐even point in units.
Targeted income
CVP analysis is also used when a company is trying to determine what level of
sales is necessary to reach a specific level of income, also called targeted
income. To calculate the required sales level, the targeted income is added to
fixed costs, and the total is divided by the contribution margin ratio to determine
required sales dollars, or the total is divided by contribution margin per unit to
determine the required sales level in units.
Using the data from the previous example, what level of sales would be required
if the company wanted $60,000 of income? The $60,000 of income required is
called the targeted income. The required sales level is $900,000 and the required
number of units is 300,000. Why is the answer $900,000 instead of $810,000
($750,000 [break‐even sales] plus $60,000)? Remember that there are additional
variable costs incurred every time an additional unit is sold, and these costs
reduce the extra revenues when calculating income.
calculated, then income taxes would also be added to fixed costs along with
targeted net income.
Assuming the company has a 40% income tax rate, its break‐even point in sales is
$1,000,000 and break‐even point in units is 333,333. The amount of income taxes
used in the calculation is $40,000 ([$60,000 net income ÷ (1 – .40 tax rate)] –
$60,000).
Margin of Safety
The margin of safety is a tool to help management understand how far sales
could change before the company would have a net loss. It is computed by
subtracting break‐even sales from budgeted or forecasted sales. To state the
margin of safety as a percent, the difference is divided by budgeted sales. If the
Three M's, Inc., has budgeted sales of $800,000, its margin of safety is $50,000
($800,000 budgeted sales – $750,000 break‐even sales) or 6.7% ($50,000 ÷
$750,000), a rather low margin of safety. If, however, its budgeted sales are
Reference
https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-
ii/cost-volume-profit-relationships/cost-volume-profit-analysis
3. Joint cost refers to the costs incurred for material, labor, and overhead during a
joint process up to the split-off point.
4. Separate costs can be incurred in later stages of production that are assignable
to specific primary products
5. Joint products are the primary outputs of a joint process, each of which has
substantial revenue-generating ability.
a. Joint products are also called primary products, main products, and co-
products.
6. By-products are incidental outputs of a joint process; they are salable, but the
sales value of by-products is not substantial enough for management to justify
undertaking the joint process; they are viewed as having a higher sales value than
scrap.
7. Scrap is an incidental output of a joint process; it is salable, but the sales value
from scrap is not enough for management to justify undertaking the joint process;
it is viewed as having a lower sales value than a by-product; leftover material that
has a minimal but distinguishable disposal value.
a. Text Exhibit 11-1 describes the outputs produced from steer processing.
2. The split-off point is the point at which the outputs of a joint process are first
identifiable or can be separated as individual products.
3. A joint cost includes the costs incurred up to the split-off point for material, labor,
and overhead during a joint process.
a. Joint costs must be allocated to the primary outputs of the production process
for inventory valuation purposes.
4. Costs incurred after split-off are assigned to the separate products for which those
costs are incurred.
5. Allocated joint costs should not be used in making decisions about further
processing of joint products.
a. Management must decide whether the total expected revenues from the sale
of the joint process output are likely to exceed the total expected processing
costs of the output. Other potential costs must be considered in determining if
the revenues are expected to exceed the costs;
b. Managers must compare the net income from this use of resources to the net
income that would be provided by all other alternative uses of company
resources if total anticipated revenues from the “basket” of products exceed
the anticipated joint and separate costs. Management would then decide
that this joint production process is the best use of capacity and would begin
production if joint process net income is greater than the net income that
would be provided by other uses;
d. Management must then decide whether any (or all) of the joint process output
will be sold (if marketable) at split-off or whether it will be processed further.
2. Managers must have a sound estimate of the selling price for each type of joint
process output in order to make decisions at any potential point of sale. Expected
selling prices should be based on both cost and market factors
a. General
i. Monetary measure allocation uses the following steps to prorate joint costs
to joint products:
• Step 2: list the values that compose the base for each joint product;
• Step 3: sum the values in step 2 to obtain a total value for the list;
• Step 5: multiply the joint cost by each proportion to obtain the amount
to be allocated to each product; and
• Step 6: divide the prorated joint cost for each product by the number of
equivalent units of production for each product to obtain a cost per EUP
b. This further processing does not change the allocation of joint cost previously
made to the joint products.
4. In summary:
a. Each method discussed allocates a different amount of joint cost to the joint
products and results in a different per-unit cost for each product and,
accordingly, has its own advantages and disadvantages; and
b. For most companies, approximated NRV at split-off provides the most logical
joint cost assignment.
i. This is because, for each joint product, approximated NRV captures the
intended level of separate processing, costs of separate processing,
expected selling costs of each joint product, and the expected selling price
of each joint product. Thus, approximated NRV is the best measure of the
expected contribution of each product line to the coverage of joint costs.
ii. The method is, however, more complex than the other methods because
estimations must be made about additional processing costs and potential
future sales values.
1. General
a. The net realizable value (or offset) approach is a method of accounting for by-
products or scrap that requires the net realizable value of such products to be
treated as a reduction in the cost of the primary products.
b. The NRV is debited to inventory and one of two accounts may be credited:
a. The realized value (or other income) approach is a method of accounting for
by-products or scrap that does not recognize any value for these products until
they are sold; the value recognized at the time of sale can be treated as other
revenue or as other income.
d. Alternative presentations include depicting the realized value from the sale of
the by-product or scrap as:
1. Job order costing systems can have by-products or scrap even though joint
products are not normally associated with such systems.
1. Joint costs in service businesses and not-for-profit (NFP) organizations often do not
relate to production processes but to marketing and promotion activities such as:
2. Service businesses may allocate joint costs using either a physical or monetary
base.
a. Joint costs for service businesses usually relate to advertisements rather than to
a process.
3. Although service businesses may decide that allocating joint cost is not necessary,
financial accounting requires that not-for-profit organizations allocate joint costs
among the activities of fund-raising, offering an organizational program (program
activities), or conducting an administrative function (management and general
activities).
4. No specific allocation method is prescribed; only that the method used must be
rational and systematic, result in reasonable allocations, and be applied in the
same manner under similar situations.
5. There are three tests that must be met for allocation; if all the tests are not met, all
the costs associated with the joint activity must be charged to fundraising:
a. The purpose test must demonstrate that the activity’s purpose includes
accomplishing some program or management/general function.
b. The audience test must demonstrate that the NFP chose the audience
because it is suitable for accomplishing the activity’s program or
management/general functions.
c. The content test must demonstrate that the activity’s content supports
program or management/general functions.
Reference:
Kinney and Raiborn. 2009. Cost Accounting Foundations and Evolutions 7 th edition.
Southwestern. USA
FINAL TASK
Case 1
Snider Company produces and sells two products: A and B in the ratio of 3A to 5B. Selling
prices for A and B are, respectively, $1,200 and $240; respective variable costs are $480
and $160. The company's fixed costs are $1,800,000 per year.
Required:
a. break even.
c. earn $800,000 of income after income taxes, assuming a 30 percent tax rate.
d. earn 12 percent on sales revenue in before-tax income.
Case 2
Direct material:
2 quarts of A $14
4 quarts of B 16
Total direct material $30
Direct labor:
2 hours 16
Manufacturing overhead 12
Total $58
The flexible budget system provides for $50,000 of fixed overhead at normal capacity of
10,000 direct labor hours. Variable overhead is projected at $1 per direct labor hour.
Required:
1. What is the application rate per direct labor hour, the total overhead cost
equation, the standard quantity for each material, and the standard hours?
Case 3
Leigh Manufacturers produces three products from a common manufacturing process.
The total joint cost of producing 2,000 pounds of Product A; 1,000 pounds of Product B;
and 1,000 pounds of Product C is $7,500. Selling price per pound of the three products
are $15 for Product A; $10 for Product B; and $5 for Product C. Joint cost is allocated
using the sales value method.
Required:
a. Compute the unit cost of Product A if all three products are main products.
b. Compute the unit cost of Product A if Products A and B are main products and
Product C is a by-product for which the cost reduction method is used.