CHAPTER 3

COST ACCOUNTING CYCLE

Learning Objectives:
Upon completion of this chapter, you should be able to
 Understand the cost accounting cycle
 Differentiate service, merchandising, and a-manufacturing entities
 Distinguish between and account for direct and indirect materials and labor as they are used in
the production process
 Prepare the different financial statements for a service entity, merchandising entity and
manufacturing entity

General Objective of Accounting

 Accumulation of financial information that is useful in making economic decisions.
a) Financial Accounting
-focuses on the gathering of information to be used in the preparation of financial statements
that meet the needs of external users of financial information
b) Cost Accounting
-provides the additional information required by management
-provides data necessary for the determination of cost of goods sold on the income statement
and the valuation of inventories on the balance sheet

Types of Business Entities

1. A manufacturing company uses labor and other inputs to transforms raw materials into finished
product and then sells the product.
2. A merchandising company buys and sells goods known as merchandise.
3. A service company does not produce/sell products, instead it provides service. 

The major difference between the three types of companies can be found in the cost of goods sold (services
provided) calculation.
Service Company Merchandising Company Manufacturing Company

Cost of services provided: Cost of goods sold: Cost of goods manufactured

Primarily labor and overhead Net purchase price Materials

costs
Labor

Overhead
Manufacturing Inventory Accounts
1. Materials Inventory – also Materials Inventory Control account, is made up of the balances of
materials and supplies on hand.
2. Work in Process Inventory – are all manufacturing costs incurred and assigned to products
being produced
3. Finished Goods Inventory – is made up of the cost of products completed but unsold as of that
date.
Elements of Manufacturing/ Production Cost
1. Direct Materials
2. Direct Labor
3. Factory Overhead

Materials Inventory
 The issuance of materials production begins the production process.
 Materials Inventory usually not purchased for resale but for use in manufacturing a product.
 An item taken out of Materials Inventory and requisitioned into production is transferred to the
Work in Process Inventory account.

Work in Process Inventory

 This inventory account has no counterpart in merchandising accounting.
 All manufacturing cost elements (production costs) enter into accounting for Work in Process
Inventory.