COST ACCOUNTING AND CONTROL 1 1ST Semester AY 2021-2022

LECTURE NOTES

W1 Introduction to Cost Accounting and Cost Accounting Cycle

Learning Objectives

• Define cost accounting

• Relate cost accounting to other fields of accounting
• Prepare journal entries of a manufacturing company

The term “cost” has many interpretations.

− In layman’s term, cost may mean price.

− In Merriam-Webster dictionary cost means the price paid for something; the amount of
money that is needed to pay for or buy something.
− In cost accounting, a cost means a measurement in monetary terms of the amount of
resources used for the purpose of production of goods or rendering services. It is the cash
or cash equivalent sacrificed for goods and services that are expected to bring current or
future benefit to the organization. It simply means the amount of money involved in
production, marketing and distribution.
Figure 1.1

Differences between Financial Accounting and Management Accounting

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What is Cost Accounting?

Cost Accounting is a branch of accounting, which involves the process of analyzing, recording,
classifying, summarizing and interpreting the details of costs of materials, labor and factory
overhead necessary to produce and sell the product. It includes the determination of the cost of
every order, job, contract, process or unit as may be appropriate. It is considered as a subset of
management accounting and financial accounting.
Objectives of Cost Accounting

• The main objective of cost accounting is the determination of the production cost (materials,
labor and factory overhead) for inventory valuation and income determination.
• It provides the detailed cost information that management need to control current operations
and plan for the future.
• It adds to the effectiveness of financial accounting by providing relevant information which
ultimately results in better decision making process of the company.
• It is also used to guide the management in determining the selling prices of the products.
• It helps in measuring the efficiency of production.
• It is also used in the preparation of budgets and cost control and cost reduction by setting
standards and compared with actual costs, the difference or deviation between the standard
and actual cost is identified and necessary steps are taken to control the cost.
All business organizations require cost accounting to account their activities. The modern cost
accounting was originated during the industrial revolution, when the complexities of running a
large scale business led to the development of systems for recording and tracking costs to help
business owners and managers make decisions.
The following are the uses of cost accounting data:
1. Cost estimation and price setting
2. Decision making
3. Cost control
Cost Accounting Systems
The proper cost accounting system assists management in the planning and control of the
company’s operations as well as in analyzing the product profitability. The cost accounting system
provides management needed information to estimate the cost of their products for profitability
analysis, inventory valuation and cost control.
A well-defined cost accounting system will:
1. Provide means for proper valuation of inventories.
2. Help to control and management the cost properly.
3. Help measure the efficiency of men, machine and usage of materials.
4. Provide data for pricing decision.
5. Help to identify wastes to reduce cost reduction.
6. Provide information as a basis for the preparation of financial statements.

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The Five Parts of a Cost Accounting System

1. An input measurement basis (Systems of Accumulating Costs)
2. An inventory valuation method
3. Methods (Procedures) of Accumulating Costs
4. A cost flow assumption
5. A capability of recording costs flows at certain intervals (Accounting System for
Inventories)
Input Measurement Basis (Systems of Accumulating Costs)
A. Historical Costing or Actual Costing
Under this system, the product costs (materials, labor, and factory overhead) are
determined as they occur simultaneously with the manufacturing operation, but the total products
costs is only known as the operation has been completed. It collects the actual amount of product
costs that is why it is also known as Actual Costing.
Illustration:
Direct labor
Actual Cost
Factory overhead
Direct Materials
Actual Cost
Actual Cost

Inventory

B. Standard Costing (Predetermined)

Under this system, the product costs are determined in advance from analysis and
forecasts made before the actual production begins. All product costs are applied to the inventory
using predetermined costs and quantities. The difference between the actual costs and
predetermined costs (standard costs) are charged to variance account.
Illustration:

Direct labor
Standard Cost
Factory overhead
Direct Materials
Standard Cost
Standard Cost

Inventory

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C. Normal Costing
It is a combination of actual costing and standard costing wherein direct materials and
direct labor are accumulated using actual costing and factory overhead is accumulated using
standard costing. The overhead is determined using the predetermined factory overhead rate per
activity measure, and then it is multiplied to the actual quantity of activity measure. The difference
between the applied factory overhead cost and the actual overhead costs is called variance.
Illustration:

Direct labor
Actual Cost
Factory overhead
Direct Materials
Standard Cost
Actual Cost

Inventory

Inventory Valuation Methods

A. Throughput Costing
Under this method, only direct materials are recorded as part of the inventory while direct labor
and factory overhead costs are charged as an expense during the period. The total sales less the
costs of direct materials are known as throughput. The throughput costing does not provide proper
matching of cost and revenue because direct labor and factory overhead costs are expensed as
they are incurred rather than capitalizing it in the inventory. This method is not acceptable for
external reporting, but can be used internally.
Illustration:

Direct INVENTORY
Materials

Direct Labor Sold

EXPENSE
Factory
Overhead

B. Direct (Variable) Costing

Under this method, the costs are divided into two parts: variable and fixed costs. This method
treats all variable costs as part of the inventory and all fixed costs as period costs. This method
does not provide proper matching of cost and revenue because the fixed factory overhead costs
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are charged to expense regardless of whether or not the inventory is sold during the period. This
method is not acceptable for external reporting but can be used internally.
Illustration:

Direct
INVENTORY
Materials

Direct Labor Sold

Variable
Factory
Overhead EXPENSE

Fixed Factory
Overhead

C. Full Absorption Costing

Under this method, all product costs are capitalized in the inventory once incurred and will be
charged as an expense when the inventory is sold to the customer. This method provides proper
matching of cost and revenue. It is also used by the companies for external reporting purposes.
Illustration:

Direct
Material INVENTORY

Direct Labor Sold

EXPENSE
Variable
Factory
Overhead

Fixed Factory
Overhead

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D. Activity Based Costing

This method assigns factory overhead costs to products in a more logical manner than the
traditional way of simply allocating costs on the basis of direct labor hours or machine hours. This
approach provides more accurate product costs. The ABC method identifies a company’s
activities and assigns costs to products produced based on the number of activities used by each
product. It first determines the cost and purpose of each activity performed by the company and
then assign costs to each individual product based on its use of those activities.
Illustration:

Direct
Materials

Direct Labor

ACTIVITY INVENTORY
COST POOLS
Variable
Factory Sold
Overhead
EXPENSE

Fixed Factory
Overhead

Cost Accumulation Methods (Procedures)

A. Job Order Costing
The job order costing keeps the costs of different jobs, orders, contracts separate during their
manufacture. This is applicable to companies producing heterogeneous products. Under job order
costing, each job has different costs. It is applicable for work done based on customer
specifications (made to order products) such as construction projects, repair shops, shipbuilders,
government contracts, job printing, textbooks, etc.
B. Process Costing
This method is used when the units are not separately distinguishable from one another during
the manufacturing process. The cost under this method is accumulated by departments, operation
or processes. This is applicable to companies producing large quantities of homogeneous
products.
C. Backflush Costing
This method is a simplified cost accumulation method that is usually used by companies that
adopts Just in Time (JIT) inventory system. This method delays the costing process until the
production of goods is actually produced or completed. The costs are then flushed back at the
end of the production and assigned to the goods. One of the objectives of this system is to zero
out or minimize inventory on hand.
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D. Hybrid Costing
This method is a combination of job order and process costing method wherein direct materials
are accounted using job order costing while conversion cost (labor and factory overhead) is
accounted using process costing.
Cost Flow Assumption
A. Specific Identification
Under this cost flow assumption, the actual cost of the item sold is determined and charged as
cost of goods sold. The cost of the inventory is determined by simply multiplying the inventory
units by their corresponding unit cost.
B. First in; First Out (FIFO)
Under this cost flow assumption, the goods first purchased are first sold. The goods purchased
at the end of the accounting period remain in ending inventory. Thus, the inventory costs are
recorded at recent or new prices while the inventory sold is recorded at older prices.
C. Last in; First Out (LIFO)
Under this cost flow assumption, the goods last purchased are first sold. In this assumption the
goods at the beginning of the period is assumed to remain in the ending inventory. Thus, the
inventory is recorded in terms of older prices and the cost of goods sold is recorded at recent
prices.
D. Weighted Average
Under this cost flow assumption, the beginning inventory units lose their separate identity because
they are combined together with the newly purchase inventories. The cost of goods available for
sale is divided by the number of units purchased in the period to arrive at an average cost per
unit. The average unit cost is then multiplied to units sold to determine the cost of goods sold and
unit on hand to determine the ending inventories.
Recording Interval Capability (Accounting System for Inventories)
A. Perpetual
The perpetual system requires maintenance of records called stock cards. This stock card
updates the inventory accounts after each purchase or sale of the company. The perpetual
inventory system has the advantage of providing an up to date inventory balance and a reduced
level of physical counts. This system works best when combined with a computer database
inventory and bin locations.
B. Periodic
The periodic system requires the physical counting of inventories on hand at the end of the
accounting period to determine the total inventories. It is generally used by retailers whose
inventory items have small peso investment.

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Functions of Cost Accounting

1. Bookkeeping involves recording of all cost from their incurrence, then to allocation of costs to
departments, jobs, produces or services.
2. Cost Control is exercised through utilization of cost information for exercising control such as
cost collection, cost analysis, cost presentation and cost interpretation.
3. Cost Analysis deals with the process of finding out the causal factors of why actual costs differ
from the budgeted costs.
4. Cost Comparison deals with the comparison between costs from alternative courses of actions
such as use of the technology for production, cost of producing different products and
activities.
5. Cost Planning involves the accounting of all costs in the records in a proper manner.
6. Cost Finding is the measurement or estimation of different products, departments or other
segments of the company’s operations.
COST ACCOUNTING VS FINANCIAL ACCOUNTING
Cost Accounting Financial Accounting
User Internal External and Internal
Purpose Control of Cost Financial Reporting and
compliance
Preparation of Financial Not Required Required
Statements
Guiding Principles Management wants and GAAP
needs
Amount of detail Extensive and detailed Compressed and simplified
Type of information Provides monetary and non- Primarily Financial (monetary)
monetary terms in nature
Emphasis of reports Relevance (timeliness of Reliability (precision of data)
data)
Frequency of reporting As frequently as the need Periodic (annually)
arises
Valuation of inventory At cost Cost or Net realizable value,
whichever is lower
Forecasting Is possible through budgeting Forecasting is not at all
techniques possible
Profit analysis Profit is analyzed for a Profit is analyzed as business
particular product, job or as a whole
process
Recording Based on an estimation of Based on actual transactions
cost and recording of actual only (historical cost)
cost (historical and
predetermined cost)

Cost Accounting Cycle

Cost accounting cycle is a process of recording, classifying and summarization of transaction
costs of a business that is used in the preparation of financial statements. The cost accounting

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cycle of a company varies on the type of business organization. This is because the cost
accounting cycle is very much influenced by the cycle of activities undertaken by the company.
MERCHANDISING COMPANY
Merchandising company is a company that buys merchandise (finished goods) from other
businesses with the intent of reselling it to a customer at a higher price. It is also known as a
trading business. It includes dealerships, clothing stores and supermarkets, grocery stores,
department stores. The primary product of this kind of business is known as “merchandise
inventory”. The operating cycle of a merchandising company consists of the following
transactions:
1. Purchase of merchandise
2. Sale of merchandise
3. Collection of cash
Presented below is the Cost of Goods Sold Statement of a Merchandising Company:

Merchandise Inventory, beg xx

Add: Net purchases
Gross Purchases xx
Add: Freight-in xx
Less: Purchase returns and allowances xx
Purchase discounts xx xx
Total Cost of Goods Available for Sale xx
Less: Merchandise Inventory, end xx
Cost of Goods Sold xx

The ending inventory will be recorded in the Statement of Financial Position while the Cost of
Goods Sold account will be recorded in the Statement of Comprehensive Income.
MANUFACTURING COMPANY
Manufacturing company is a company that buys raw materials, converts them into finished
products, and then sells the products to customers. It includes the following companies: car
manufacturers, brewery, electronic manufacturers, producers of drugs and medical supplies,
shoes and clothes manufacturer, etc.
The manufacturing company has three inventory accounts:
1. Raw materials inventory
It represents items that the company has purchased from other companies to use in
manufacturing a product. It can be classified as direct or indirect materials.

Direct materials are raw materials that become an integral part and can be physically and
traced to finished products. Examples: wood used in the production of tables and chairs or
leather used in the manufacture of bags and shoes, the processing chip in a personal
computer.

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Indirect materials are raw materials that are not conveniently traced to the finished product or
its costs is relatively insignificant and its association with the final product is too small to be
easily traced to the final product. Examples: paint, nails, glue used in the manufacture of tables
and chairs or paper used by architects in preparing project plans.

The Raw Materials Inventory includes the following information:

1. Amount of raw materials at the beginning of the period (debit balance)
2. The cost of materials purchased during the period (debit balance)
3. The cost of materials requisitioned (used) in the production process (credit balance)
4. Unused raw materials at the end of the period. The unused raw materials at the end
of the period become the beginning balance in the following period.
The raw materials used in the production will be computed as follows:

Raw materials Inventory, beginning xx

Add: Net Raw Materials Purchases xx
Less: Raw materials, end xx
Indirect Raw Materials Used xx
Diret Materials used xx

2. Work in Process Inventory

It represents all manufacturing cost (raw materials used, direct labor and factory overhead)
incurred and assigned to products that are partially completed. In other words, it is a company’s
partially finished goods.
The Work in Process Inventory includes the following information:
1. The work in process beginning balance (debit balance). It represents the total manufacturing
cost of the unfinished production in the prior period.
2. The total manufacturing costs (the sum of direct materials used, direct labor and factory
overhead costs charged to production.
3. The Cost of Goods Manufactured. It represents the goods which were finished during the
period. The manufacturing costs, which were transferred to Finished Goods Inventory
account.
4. The ending balance of work in process inventory. It represents the manufacturing costs of the
unfinished production at the end of the period.
The cost of goods manufactured in the production will be computed as follows:

Work In process, beginning xx

Add: Total Manufacturing Costs xx
Direct materials used xx
Direct labor xx
Factory overhead xx
Total costs of goods put into process xx
Less: Work in process, ending xx
Cost of goods manufactured xx

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3. Finished goods inventory

It represents completed products that the company has produced or ready for sale to customers.
The Finished Goods inventory includes the following information:
1. The finished goods inventory beginning balance (debit balance). It represents the finished
goods inventory unsold in the prior period.
2. The cost of goods manufactured. The manufacturing costs, which were transferred to finished
goods inventory account during the period (debit balance)
3. The ending balance of finished goods inventory, It represents the unsold finished products at
the end of the period.
4. Cost of goods sold (credit balance)
The cost of goods sold is computed as follows:

Finished goods, beginning xx

Add: Total cost of goods manufactured xx
Total goods available for sale xx
Less: Finished goods, ending xx
Cost of Goods Sold xx
References:

A Closer Look in Cost Accounting (2019) by Paul Anthony Dela Fuente De Jesus
https://www.graduatetutor.com/accounting-tutors/difference-between-financial-accounting-
managerial-accounting/
https://slidetodoc.com/chapter-1-the-accountants-role-in-the-organization/

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