Costing and Pricing Handout

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OVERVIEW OF COSTING
Definition of Costing
Costing refers to the method and process of ascertaining the costs. It involves classifying, recording, and
allocating an organization's expenditure to determine the costs of products or services. Also, it requires
the presentation of suitably arranged data for management control and guidance.
The major objectives of costing are the following:
• To determine the cost incurred during each operation to control wages.
• To provide data that establish a product's selling price and a company's pricing policies.
• To provide information about the economic consideration in purchasing materials.
• To help the management make decisions, detect wastages, and reduce total manufacturing costs.
Concepts of Costs
The following are the different definitions of cost:
• It is the number of resources used in exchange for goods or services.
• It is the amount of expenditure incurred on or attributable to a specified object or activity.
• It is an initial value, measured in monetary terms, incurred or potentially to be incurred to achieve
a specific objective.
Costs must be assessed in different aspects as follows:
1. Nature of business. A cost has to be studied concerning the nature of business. For example, a
manufacturing organization is interested in knowing the cost per unit of its product. In contrast, the
organizations rendering services such as electricity and transport are interested in determining the
costs of services they undertake. The cost per unit can be easily determined by dividing the total
expenditure by the number of units produced or total services rendered.
2. Purpose. A cost must be studied with its purpose. For example, the goal is a fixation on selling price
cost. All expenditure items relating to production, administration, and selling will have to be
included. But if the purpose is the valuation of inventories, only the cost of production will have to
be considered. Hence, the concept of cost varies according to the goal.
3. Conditions. A cost must be determined under different conditions. For instance, while dealing with
inventory, work-in-progress is valued at factory cost, whereas the stock of finished goods is valued
at production cost.
4. Context. Cost is a generic term that must be recognized or qualified. It is generally used to include
all the various types of expenditures. However, when the term cost is used specifically, it is always
modified concerning the context of the different types of cost like fixed cost, variable cost, and sunk
cost, among others. Each type of cost implies a certain attribute important in computing and
measuring the cost.
Classification of Costs
Costs can be classified into different categories for different purposes as follows:
a) According to Management Function
• Manufacturing costs. It refers to the costs incurred in the factory for converting raw materials into
finished goods. It includes the cost of raw materials, direct labor, and the costs incurred during the
manufacturing process or factory overhead.
• Non-manufacturing costs. It refers to the costs not incurred for transforming materials into finished
goods. These include selling expenses such as advertising costs, delivery expenses, salaries, and
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commission. It also includes administrative expenses such as salaries of executives and legal
expenses.
b) According to Ease of Traceability
• Direct costs. It refers to the costs that can be traced directly to a particular object of costing such as
a particular product, department, or branch. Examples include materials and direct labor. Some
operating expenses can also be classified as direct costs, such as advertising costs for a particular
product.
• Indirect costs. It refers to the costs that cannot be traced to a particular object of costing. They are
also called common costs or joint costs. Examples include factory overhead and operating costs
associated with more than one (1) product, department, or branch.
c) According to Timing of Charge Against Revenue
• Product costs. It refers to the costs that form part of the inventory and are charged against revenue.
They are also called inventoriable costs. It includes manufacturing costs such as direct materials,
direct labor, and factory overhead.
• Period costs. It refers to the costs that are not inventoriable and are immediately charged against
revenue. It includes non-manufacturing costs such as selling expenses and administrative expenses.
d) According to Accounting Period-Wise Classification of Costs
• Capital expenditure: It refers to the expenditure resulting in an asset's acquisition. It also pertains
to extending or enhancing earning capacity at a smaller cost. It is classified as a fixed asset. Examples
of this include costs of acquiring land, building, and machinery.
• Revenue expenditure: It refers to the expenditure which occurs for maintaining assets in working
conditions and is not intended to increase the revenue-earning capacity. A revenue expenditure
benefits the current accounting period. It is treated as an expense.
e) According to Relevance to Decision-making
• Overhead cost. It refers to the ongoing business expenses not including or related to direct labor or
direct materials used in creating a product or service like rent, utilities, and insurance.
• Standard cost. It refers to the predetermined cost based on some reasonable basis, such as past
experiences, budgeted amounts, and industry standards.
• Opportunity cost. It refers to the benefit forgone or given up when an alternative is chosen over
the other/s. For instance, if a business decides to use its building for production rather than renting
it out to its tenants, the opportunity cost would be the rent income that would be earned had the
business decided to rent out the building.
• Sunk costs. It refers to the historical costs that will not make any difference in decision-making.
Examples include the acquisition cost of office equipment and the manufacturing costs of finished
goods on hand.
• Committed costs. It refers to the costs resulting from an organization’s structure or the use of its
facilities. Examples include property taxes, salaries of management personnel, and the cost of
renting facilities.
• Discretionary costs. It refers to the costs resulting from a management decision to spend a
particular amount of money for a specific purpose. Examples include spending money on research
and development, contributions to charitable institutions, and advertising.
• Controllable costs. It refers to the costs that can be influenced or controlled by a supervisor or
manager for a given period. An example of this is the control of a supervisor on company
expenditures such as the purchase of office supplies and the maximum overtime a rank-and-file
employee may render.

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f) According to Behavior under Activity

• Fixed costs. These are constant costs that do not change with an increase or decrease in the number
of goods or services produced and sold.
The changes in the number of goods and
services produced or sold are classified as
Total cost (Pesos)
15 Fixed Cost Line the activity with a designated relevant range

10 or boundary of minimum and maximum
activity levels. The cost of production or unit
5 cost of goods and services may vary as the
0 activity level increases or decreases, while
1 2 3 4 5 6 the total fixed cost remains constant.
Examples include supervision fees, factory
Volume of Production (Units)
rent, insurance, and taxes.
Figure 1. Fixed cost
ILLUSTRATION: ABC Manufacturing has the following monthly expenses, which present the
breakdown of their factory rent and the cost of production for its three (3) major products: liquid
detergent, baking soda, and paper towels. The management sets the ideal production or relevant
range within 8,000 – 10,000 units for a given month.
Factory Rent (Total Fixed Cost) P100,000 Use the following formula to solve for the
Production in Units: Fixed Cost (FC) per unit:
Liquid detergent 8,000 𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
Baking soda 9,000 𝐹𝐶 =
Paper towels 9,500 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛
Relevant Range 8,000 - 10,000
Liquid detergent Baking soda Paper towels

Total Fixed Cost (Rent) P100,000 P100,000 P100,000
Production 8,000 9,000 9,500
Fixed Cost (FC) per Unit P12.50 P11.11 P10.53
ANALYSIS: The factory rent, which is the total fixed cost, is the same for the three (3) products.
However, the fixed cost per unit decreases as production increases within the relevant range.
• Variable costs. These costs vary in total, in direct proportion to changes in production volume.
Variable cost is a constant amount on a per
unit basis as activity changes within a
150 relevant range. As activity changes, the total
Total cost (Pesos)
Total Variable Cost Line variable cost increases or decreases

100
proportionately with the change, but the
50 unit variable cost remains the same.
Examples include direct materials, direct
0 labor, overtime premium, materials
1 2 3 4 5 6
handling costs, and maintenance costs.
Figure 2. Variable cost

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ILLUSTRATION: The primary component of the bestselling perfume of Kisses Inc. is the plant
substance of citrus fruits which costs the company P5.00 for each bottle of production. The
company’s floor workers handle the perfume production with an associated piece rate of P6.00 for
each bottle they produce. Also, the company's estimated advertising expense or overhead cost is
P3.00 per bottle. The following is the summary of the company’s incurred costs of unit production
for each perfume line:
Production in Units: Variable Cost per Unit:

Magical Citrus 8,000 Direct Materials (citrus fruits) P5.00
Wild Citrus 9,000 Direct Labor (salary of floor workers) 6.00
Victoria’s Citrus 9,500 Overhead (advertising expense) 3.00
Total Variable Cost P14.00
Use the following formula to solve for the Total Variable Cost (TVC):
𝑇𝑉𝐶 = 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 × 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Magical Citrus Wild Citrus Victoria’s Citrus
Production in Units 8,000 9,000 9,500
Variable Cost per Unit P14.00 P14.00 P14.00
Total Variable Cost P112,000 P126,000 P133,000
ANALYSIS: The variable cost per unit is constant at P14.00 per unit, but as the production of each
perfume line increases, the total variable cost increases.
• Mixed Costs. These costs vary in total but not in proportion to activity changes. It includes both
fixed and variable components.
120 Fixed Cost

100
Total Cost (Pesos)
80
Variable Cost
60
40
20
0
1 2 3 4 5 6
Figure 3. Mixed cost
ILLUSTRATION: A water company charges a fixed amount of P200.00 for using less than or
equivalent to 500 gallons of water on a given month. Also, the company imposes an additional P1.00
charged for each gallon consumed more than the 500-gallon base. The fixed component in the given
scenario is the P200.00 charged for consuming less than or equivalent to 500 gallons of water, while
the variable component is the additional P1.00 charge for consuming more than 500 gallons of
water on a given month.

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• Step Costs. These costs remain unchanged or constant for a given output level and then increase
by a fixed amount at a higher output level, i.e., from one level of output to another higher level. An
example of this is the salary of supervisors in a factory. Depending upon the period up to which an
expense can be kept up to a certain level despite the increase in activity, the height and width of
steps vary. If the steps are small and narrow, the behavior of cost is like that of “pure variable cost.”
This is called “step variable cost.” On the other hand, if the steps are wider, the cost is like that of a
“fixed cost.” This is called “step fixed cost.”
ILLUSTRATION: In a goods importing
company, where the freight charge of Php
1,000 will have an additional Php 1,000 for
every 1 cubic meter of finished goods in
excess each time they deliver. Thus a
volume of 1.8 cubic meters of goods will
cost Php 2,000, and the 2.5 cubic meters will
be charged at Php 3,000. Then the very
narrow cost level increases from one range
to the next and can be categorized as Step
Variable Cost.
Figure 4. Step variable cost

Source: Costing Accounting, 2010
ILLUSTRATION: Assume that a supervisor

can effectively supervise 20 workers. A
second supervisor would be needed if
workers exceed 20, and a third supervisor if
workers exceed 40, and so on. There would
be a sudden increase in the salary of the
supervisors. If the activity level increases
from one range to the next in a wider scope,
it can be categorized as Step Fixed Cost.
Figure 5. Step fixed cost

Source: Costing Accounting, 2010

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Separating Mixed Cost

The procedure for separating mixed costs involves using the high-low method on a given set of data within
the relevant range.
ILLUSTRATION: Machine hours and utility costs for DKNY Industries in year 201A were as follows:
Month Machine Hours Utility Costs
January 2,500 P36,800
February 2,900 42,000
March 1,900 27,000
April 3,100 46,000
May 3,800 56,500
June 3,300 44,000
July 4,100 49,500
August 3,500 45,500
September 2,000 31,000
October 3,700 52,000
November 4,700 62,000
December 4,200 55,500
Table 1. DKNY Industries
Source: Cost Accounting, 2016, p.13
PROCEDURE:
1. Select the highest and lowest levels of activity and costs within the data set.
Machine Hours Utility Costs

Highest 4,700 P62,000
Lowest 1,900 27,000
Difference 2,800 P35,000
2. Compute the variable cost element using the following formula:
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐶𝑜𝑠𝑡
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 (𝑉𝐶) 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑐𝑜𝑠𝑡𝑠 𝑃35,000
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 (𝑉𝐶) 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = = = 𝑷𝟏𝟐. 𝟓𝟎 𝒑𝒆𝒓 𝒎𝒂𝒄𝒉𝒊𝒏𝒆 𝒉𝒐𝒖𝒓
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟𝑠 2,800
3. Compute the variable cost at the highest and lowest level of activity using the following formula:
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 = 𝐻𝑖𝑔ℎ𝑒𝑠𝑡 𝑜𝑟 𝑙𝑜𝑤𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 × 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝐻𝑖𝑔ℎ𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙 = 4,700 × 12.50 = 𝑷𝟓𝟖, 𝟕𝟓𝟎 𝐿𝑜𝑤𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙 = 1,900 × 12.50 = 𝑷𝟐𝟑, 𝟕𝟓𝟎
4. Determine the fixed cost at each level of activity using the following formula:
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 = 𝐻𝑖𝑔ℎ𝑒𝑠𝑡 𝑜𝑟 𝑙𝑜𝑤𝑒𝑠𝑡 𝑐𝑜𝑠𝑡𝑠 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑎𝑡 𝑒𝑎𝑐ℎ 𝑙𝑒𝑣𝑒𝑙 𝑜𝑓 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦
𝐻𝑖𝑔ℎ𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙 = 𝑃62,000 − 𝑃58,750 = 𝑷𝟑, 𝟐𝟓𝟎 𝐿𝑜𝑤𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙 = 𝑃27,000 − 𝑃23,750 = 𝑷𝟑, 𝟐𝟓𝟎

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Inventory Accounts
Most companies particularly in the manufacturing industry, maintain the following inventory accounts:
• Raw Materials Inventory. This shows the available raw materials to use in the manufacturing
process. It is a controlling account if the company maintains only one account for direct and indirect
materials.
• Work-in-Process Inventory. This represents the costs of partially completed goods on which
production activities have been started but not yet completed as of a certain period.
• Finished Goods Inventory. This summarizes the costs of the completed job stored in the warehouse
for delivery to the customers.
Raw Materials Inventory System
Manufacturing companies commonly use the following inventory systems:
• Perpetual Inventory System. This system requires the need to maintain stock cards or records of
the status of the goods held in the inventory for each type of raw materials, which reflects the
summary of the inflow, outflow, and balance of raw materials in quantity and peso amount.
Although the quantity of raw materials is available at any time by referring to the stock card, this
system also requires physical counting of raw materials at least once a year to confirm the balance
reflected in the material stock cards.
• Periodic Inventory System. This system does not require a stock card for the raw materials;
however, a physical count of raw materials must be facilitated periodically to determine the units
on hand.
The Flow of Manufacturing Costs
The flow of manufacturing costs is based on the following illustration:
Chart 1. Flow of costs

Source: Cost Accounting, 2016, p.19
The flow of costs of a manufacturing company is outlined as follows:

1. Purchase of Raw Materials. It involves the acquisition of raw materials needed for production. Most
manufacturing companies use a perpetual inventory system where purchases and issuance of raw
materials are recorded directly in the raw materials inventory account as they occur.
2. Issuance of Raw Materials. It involves delivering raw materials to production through a requisition
slip properly accomplished and approved by the production manager. The cost of issued raw
materials can be classified under work-in-process inventory.

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3. Return of Excess Materials. It involves the returning of excess raw materials to the storage room.
4. Factory Labor Incurred. It involves temporarily accumulating the compensation of factory workers
and other personnel in a factory payroll account when it is incurred, whether it is paid immediately
or not.
5. Distribution of Factory Labor. It involves sorting the time tickets or written records of an employee's
total hours in each pay period and segregating the direct and indirect labor costs. The salaries of
direct laborers or factory workers are classified under the work-in-process account. In contrast, the
salaries of indirect laborers like the manager, supervisor, clerk, and maintenance personnel are
classified under manufacturing overhead.
6. Manufacturing Overhead Incurred. It involves charging the actual overhead cost in production to a
manufacturing overhead account when it is incurred. Other manufacturing costs such as expired
insurance and depreciation of factory plant and equipment are charged to the manufacturing
overhead account only at the end of the year.
7. Actual Factory Overhead Charged to the Job. It involves transferring the actual overhead to the
work-in-process account.
8. Completion of the Job. It involves transferring the accumulated cost of production summarized in
the work-in-process account to the finished goods account.
9. Sale of the Completed Job. It involves setting the price for the completed job. The most common
method in setting prices is the Cost-Plus Pricing method. In this method, the costs include both
production costs and administrative and selling costs. The firm's desired profit and competitors'
prices are the other factors that must be considered in setting the price.
Methods of Accumulating Product Costs
The following are the methods of accumulating product costs:
Actual Costing System
This method requires that all production overhead is available before any cost allocation to the jobs in the
process. Under this system, the actual costs of direct materials used, direct labor, and manufacturing
overhead incurred in production are charged to the job to determine the cost of specific products.
Use the following formula to compute the costs associated with the product using the actual costing
system:
𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝐴𝑐𝑡𝑢𝑎𝑙 𝐷𝑖𝑟𝑒𝑐𝑡 𝐶𝑜𝑠𝑡 + 𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐶𝑜𝑠𝑡
EXAMPLE: High Street Manufacturing has the following account balances at the end of their production
cycle for January:
Direct Labor P120,000
Direct Materials 162,000
Manufacturing Overhead 74,000
Total Actual Cost P 356,000
SOLUTION:
𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = (𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠) + 𝐴𝑐𝑡𝑢𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐶𝑜𝑠𝑡
= (𝑃120,000 + 162,000) + 74,000 = 𝑃282,000 + 74,000 = 𝑷𝟑𝟓𝟔, 𝟎𝟎𝟎
KEY POINTS: Based on the illustration, direct labor and direct materials are added because they are
classified as actual direct costs. Then, the total cost or actual cost will be derived by adding the actual
direct costs and actual overhead cost, which is the given manufacturing overhead.

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Normal Costing System

This method requires the costs of direct materials and direct labor to be charged to the job. Under this
system, the manufacturing overhead applied to production differs because a predetermined overhead
rate is used in computing the amount of overhead charged to the job. The predetermined overhead rate
is the ratio of the estimated total overhead to the estimated total cost driver selected. A company may
employ plant-wide rates or departmental rates. Suppose several rates or departmental rates are used. In
that case, the budgeted manufacturing overhead is divided into several cost pools and uses each driver
as the denominator in computing for the predetermined overhead rate.
Use the following formula to compute the costs associated with the product using a normal costing
system:
𝑁𝑜𝑟𝑚𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 × 𝐴𝑐𝑡𝑢𝑎𝑙 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐻𝑜𝑢𝑟𝑠 𝑢𝑡𝑖𝑙𝑖𝑧𝑒𝑑
EXAMPLE: High Street Manufacturing Company has the following account balances at the end of their
production cycle for February:
Fixed Cost P1,000,000
Variable Cost per Direct Labor Hours (DLH) 40
Budgeted annual Direct Labor Hours (DLH) 125,000
Actual Direct Labor Hours utilized 150,000
SOLUTION:
1. The first step is to get the predetermined overhead rate using the formula:
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑

𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 =
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦
𝑃1,000,000 + (125,000 × 40) 𝑃1,000,000 + 5,000,000 𝑃6,000,000
= = = = 𝑷𝟒𝟖 𝒑𝒆𝒓 𝑫𝑳𝑯
125,000 𝐷𝐿𝐻 125,000 𝐷𝐿𝐻 125,000 𝐷𝐿𝐻
KEY POINTS: Take note that the budgeted manufacturing overhead is the sum of the fixed cost and
variable cost multiplied by the budgeted annual direct labor hours. The budgeted production
activity is the budgeted annual direct labor.
2. To get the normal cost, substitute the values to the formula:
𝑁𝑜𝑟𝑚𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 × 𝐴𝑐𝑡𝑢𝑎𝑙 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐻𝑜𝑢𝑟𝑠 𝑢𝑡𝑖𝑙𝑖𝑧𝑒𝑑
= 𝑃48 × 150,000 = P7,200,000
KEY POINTS: To arrive at the amount of overhead applied to the job through normal costing, the
predetermined overhead rate is multiplied by the number of direct labor hours utilized in the
production.
References:
Accountingverse. (n.d.). Types of costs (cost classifications).
https://www.accountingverse.com/managerial-accounting/cost-concepts/types-of-costs.html
Lalitha, R., & Rajasekaran, V. (2010). Costing accounting. Pearson.
Nikhila, C. (n.d.). Costing: Meaning, aims and methods. https://www.businessmanagementideas.com/cost-
accounting/costing-meaning-aims-and-methods-cost-accounting/7265
Rante, G. A. (2016). Cost accounting. Millenium Books, Inc.
Swiftutors. (n.d.). Aims of costing. http://www.swiftutors.com/estimating/what-is-costing.php

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KEY ELEMENTS OF COSTING PART 1

Direct and Indirect Materials
Raw materials pertain to goods that are purchased for conversion into finished products.
Materials may be classified as follows:
1. Direct Materials. These materials are easily identifiable with the product and form part of the
finished good. The cost of direct materials is directly charged to the products. Generally, the
following items are included in direct materials:
• All purchased materials.
• All issued materials from stores to departments for a specified order, job, or process.
• All specially purchased materials for a specified order, job, or process.
• All transferred materials from one process to another.
• All materials used for primary packing.
2. Indirect Materials. These materials are used in production but do not form part of the finished
product. The cost of indirect materials is treated as overhead. Examples of indirect materials are
indirect labor, depreciation, utilities, rent, repairs, maintenance, and insurance.
Basic Terms Associated with Raw Materials
The following are the basic terms associated with raw materials:
1. Freight-in or transportation costs. It refers to the shipping costs which must be paid by the
merchandise buyer depending on the agreed payment terms. It is a type of product cost which is
part of the merchandise cost and should be included in inventory if the merchandise has not been
sold. Under the perpetual inventory system charges, the freight to the raw materials inventory
account. In this case, the total costs of raw materials purchased include the invoice price plus the
freight.
On the other hand, the freight costs are charged under periodic inventory to a separate account,
recording only the invoice cost in the purchases account. When raw materials are issued, a separate
calculation is made to apportion the freight-in costs to issued and unissued raw materials. The
amount allocated to the raw materials is recorded in the work-in-process account and the invoice
price.
ILLUSTRATION: Dolby Manufacturing Company purchased the following units of flour and wheat for
their pasta production:
Raw Materials Units Weight Transportation Cost per unit Units X Cost per unit
Flour 1,000 1.5 P5.00 P5,000
Wheat 1,000 2.0 20.00 20,000
TOTAL P25,000
KEY POINTS: The total freight-in or transportation costs incurred by Dolby Manufacturing Company
to purchase flour and wheat is P25,000, which is the total cost of each raw material. It is derived from
the number of units purchased and transportation cost per unit.
2. Inventory stock card. It is used to record the movement of inventory. The entries in the stock card
are made in chronological order according to the date of occurrence or purchase of raw materials.
After proper posting on purchases and issuances, the card shows the inventory balance in units and
peso values at a given period.

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3. Materials requisition form. It serves as the basis for recording the issuance of raw materials.
4. Scrap materials. These are the defective or leftover materials in production. Scraps include fillings
or excessive trimmings of materials after manufacturing operations, defective materials unsuitable
for manufacturing operations, and broken parts of materials resulting from employee error or
machine breakdown, which causes poor quality in the product.
Material Costing and Accounting
The following are the different expenditures associated with the total cost of a product:
1. Purchase of item. The actual cost of the goods purchased.
2. Local taxes and duties. The expenses incurred to import the goods from other countries.
3. Inward freight (Freight-in or Transportation Cost). The cost for moving the goods from the source
to the buyer’s place. It involves any transport medium like trucking, shipping, air freight, or train.
4. Cash discount. An additional reduction in the value of an invoice or billing that the seller allows the
buyer to pay in advance than the due date or regular payment scheme.
5. Volume discount. Sellers offer lower product costs to encourage bulk orders.
6. Trade discount. The amount by which a manufacturer reduces the retail price or published rate of a
product and/or other additional cost-saving propositions to increase sales or market share.
7. Rebates and subsidies. The credit back programs of sellers or the government to induce additional
sales or patronization of products with corresponding terms and conditions.
8. Packing expenses. The total cost to pack and secure the goods during the delivery. It entails more
than the goods’ main packaging like boxes or bags individually, as well as the crates, containers, etc.,
to secure all the units ordered.
9. Joint purchase cost. The appropriate reallocation of the total costs to the various materials if they
shared a standard costing like Inward Freight, Discounts, Packaging, etc.
10. Extra/spare parts. The additional costs to consider in purchasing goods is the requirement of extra
parts, accessories, spare parts, supplies, and others to run or use the item accordingly.
11. Cost of containers. A high-cost equipment/packaging to handle the products for bulk and high-
volume goods delivery. It can be returnable/refundable or not, thus should be accounted for if to be
considered or not in cost.
12. Storage cost. The cost for keeping the materials for buffer use or holding.
Inventory Valuation Methods
The following are the most common methods of valuing raw materials inventory under a perpetual
inventory system:
FIFO (First in, first out)
It is a cost flow process wherein the first goods purchased are also the first goods sold. This is based on
the assumption that goods are sold or used in the same chronological order in which they are bought.
Hence, the cost of goods purchased first (first in) is the cost of goods sold first (first out).
ILLUSTRATION:
Below are the purchases and issuance of timber used in the house construction of Moonlight Company:
Date Transaction
July 1 Balance, 800 units at P98
2 Purchased 1,000 units at P100 per unit
3 Issued 1,000 units to Dept. 1
5 Purchased 1,500 units at P105 per unit

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Date Transaction
7 Purchased 500 units at P110
10 Purchased 500 units at P108
15 Purchased 800 units at 105
PROCEDURE:
1. Separate purchases from the issuance of raw materials and tabulate the given data as follows:
Units (Timber) Unit Cost
Inventory, July 800 98
Purchases:
July 2 1,000 100
5 1,500 105
7 500 110
10 500 108
15 800 105
Raw Materials Available
Less: Issuance
July 3 (1,000)
8 (1,200)
20 (2,000)
Raw Materials Issued
Raw Materials Inventory
2. Compute the number of inventory purchases by multiplying the number of given units by its
corresponding unit cost. Then, get the sum of the total units and the total amount of units, and input
the result on raw materials available as follows:
Units (Timber) Unit Cost Amount (Units x Unit Cost)
Inventory, July 800 98 P78,400
Purchases:
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials Available 5,100 P528,900
Less: Issuance
July 3 (1,000)
8 (1,200)
20 (2,000)
Raw Materials Issued
Raw Materials Inventory

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3. Compute the amount of raw materials issuance by assessing the required units of issuance for a
particular date of the transaction versus the available number of units in inventory as follows:
Units Unit Cost Inventory Amount (Units x Unit Cost)
Purchases:
July 2 200 100 20,000
Issuance, July 3 1,000 98,400
*The amount of inventory issuance for July 3 is derived by getting the sum of the total inventory amount
based on the number of required units which is 1,000, and its corresponding unit cost.

Inventory, July 0 0 0
Purchases:
July 2 800 100 80,000
5 400 105 42,000
*Inventory issuance for July 8 is derived by getting the sum of the total inventory amount based on the
number of required units which is 1,200, and its corresponding unit cost on the remaining inventory.

Purchases:
July 2 0 0 0
5 1,100 105 115,500
7 500 110 55,000
10 400 108 43,200
Issuance, July 20 2,100 213,700
*Inventory issuance for July 20 is derived by getting the sum of the total inventory amount based on the
number of required units which is 2,100, and its corresponding unit cost on the remaining inventory.
4. Input the amount of inventory issuance for each date of transaction. Get the sum of total issued units
and the total amount of issued units and input the result on raw materials issued. Then, get the
difference between raw materials available and raw materials issued, and input the result into the
raw materials inventory.
Purchases:
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Less: Issuance
July 3 (1,000) (P98,400)
8 (1,200) (122,000)
20 (2,000) (213,700)

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Raw Materials Issued (4,200) (P434,100)
Raw Materials Inventory 900 P94,800
5. Present the composition of the remaining raw materials inventory as follows:
100 units at 108 P10,800
800 units at 105 84,000
TOTAL: 900 units P94,800
* After deduction of all unit issuance, the composition of remaining raw materials is
based on the available units in the inventory and their corresponding unit cost.
Average Cost (Moving Average)

This is a cost flow process of recalculating each inventory item after every inventory purchase. The
calculation involves the total cost of each item purchased divided by the number of items in stock. The
cost of ending inventory and the cost of goods sold is then set at the average.
ILLUSTRATION: From the above transaction of Moonlight Company, provide the raw materials available
for use, raw materials used, and raw materials inventory using the moving average method.
PROCEDURE:
1. Apply steps 1-2 of the FIFO costing method and compute the unit cost of each transaction for raw
materials issuance as follows:
Purchases:
July 2 1,000 100 100,000
*The unit cost of raw materials issuance for July 3 is derived by getting the sum of the total amount of
inventory purchases before the issuance date, divided by the total number of units in the inventory.
𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 178,400

𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 = = = 𝟗𝟗. 𝟏𝟏
𝑇𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 1,800

Purchases:
July 2 800 99.11 79,288
5 1,500 105 157,500
7 500 110 55,000
*The unit cost of raw materials issuance is derived by assessing the remaining inventory in stocks versus the required
number of units for issuance, which is 2,800. The remaining inventory for the previous issuance shall be multiplied by the
new unit cost based on the previous issuance, which is 99.11. By adding the total amount of inventory divided by the
number of units available in the inventory before the issuance date, we can derive the new unit cost for July 8 transaction.

𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 = = = 𝟏𝟎𝟒. 𝟐𝟏

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Purchases:
July 2 0 0 0
5 1,100 104.21 114,631
7 500 104.21 52,105
10 500 108 54,000
15 800 105 84,000
Issuance, July 20 2,900 304,736
*Issuance was derived by assessing the remaining inventory in stocks versus the required number of units for issuance,
which is 2,900. The remaining inventory for the previous issuance shall be multiplied by the new unit cost based on the
previous issuance, which is 104.21. By adding the total cost of inventory divided by the number of units available in the
inventory before the issuance date, we can derive the new unit cost for July 20 transaction.

𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 = = = 𝟏𝟎𝟓. 𝟎𝟖
2. Input the unit costs for each issuance transaction. Multiply the number of required units for issuance
to its corresponding unit cost. Then, get the sum of total issued units and the total amount of issued
units, and input the result on raw materials issued. Now, get the difference between raw materials
available and raw materials issued, and input the result into the raw materials inventory.
Units Unit Cost Amount (Units x Unit Cost)
Purchases:
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Less: Issuance
July 3 (1,000) 99.11 (P99,110)
8 (1,200) 104.21 (125,052)
20 (2,000) 105.08 (210,160)
Raw Materials Issued (4,200) (P434,322)
Raw Materials Inventory 900 P94,578
* Under the Moving Average method, the total cost of inventory is divided by the total units to arrive at the
average unit cost. This procedure is repeated every time raw materials are acquired.
References:
AccountingTools. (n.d.). Moving average inventory method. https://www.accountingtools.com/
articles/2017/5/13/moving-average-inventory-method
Investopedia. (n.d.). First in, first out - FIFO. https://www.investopedia.com/terms/f/fifo.asp
Lalitha, R. & Rajasekaran, V. (2010). Costing accounting. Pearson.

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KEY ELEMENTS OF COSTING PART 2

Labor Cost
Labor costs can be classified as follows:
• Direct labor. It pertains to the employee labor directly contributing to producing a certain product.
It can be readily identified in converting raw materials into finished goods. The cost incurred on
direct labor is known as “direct labor cost.”
• Indirect labor. It pertains to the employee labor which does not contribute to the construction,
composition, or condition of a particular product. The cost of wages, which cannot be readily
identifiable with a job, process, or operation, is called “indirect labor costs.”
Costing of Labor Cost
The following describes the different costs incurred by workers:
• Monetary Benefits. These include the basic wages or the basic rate of pay. These include
allowances, overtime pay, bonuses, holiday pay, government-mandated benefits (SSS/GSIS, Pag-
IBIG, and PhilHealth), and special incentives that an organization or company gives to its respective
employees.
• Non-monetary Benefits. These include hospital facilities, subsidized food, subsidized or free
transport, and recreational facilities that an organization provides to its employees.
• Deferred Monetary Benefits. These involve the benefits not paid in a month but in the future.
Examples of these benefits include pension and gratuity, among others.
EXAMPLE: XYZ Corporation desires to determine the cost associated with the labor of their employees.
The following data is available:
Monthly salary Php 26,000
Employer’s monthly contribution to government 6.3%
Leave benefit per month 1 day
Healthcare cost per head Php 800/month
Monthly pension plan allocation 2%
Working hours 8 hours a day, 26 days in a month
PROCEDURE:
1. Find the total labor cost per month.
Given Costs Monthly Cost Equivalent
Monthly salary
P26,000 P26,000
(Fixed)
Employer’s contribution to government
6.30% 1,638
(Monthly salary x Contribution percentage)
Leave benefit
1 of 26 days/ month 1,000
(Monthly salary/No. of working days)
Healthcare cost per head in a month
800 800
(Fixed)
Monthly pension plan allocation
2% 520
(Monthly salary x Pension plan percentage)
TOTAL P29,958

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2. Identify the percentage weight of the monetary benefit, non-monetary benefit, and deferred
monetary benefit from the total labor cost by dividing the monthly cost equivalent to the total
monthly labor cost.
Given Monthly Cost Equivalent Percentage
Monetary Benefit
Monthly salary P26,000 86.8%
Employer’s contribution to government 1,638 5.5%
27,638 92.3%
Non-Monetary Benefit
Leave benefit 1,000 3.3%
Healthcare cost per head in a month 800 2.7%
1,800 6.0%
Deferred Monetary Benefit
Monthly pension plan allocation 520 1.7%
520 1.7%
TOTAL P29,958 100%
3. Determine the percentage of cost relevant to the sales of total labor cost, given that there are 25
employees in the company and the revenue of the company is 1,000,000 monthly.
Total employees 25
Cost per employee in a month 29,958
Total labor cost per month 748,950
(Total employees x Cost per employee in a month)
Total monthly revenue 1,000,000

Labor cost percentage to sales 74.90%
(Total labor cost per month/Total monthly revenue)
Overheads
Overhead refers to the costs required to run a business but are not directly attributed to any specific
business activity, product, or service. Overheads comprise the total cost of indirect materials, indirect
labor, and indirect expenses. Overheads can be classified as follows:
Functional Classification
• Production overhead. It comprises the indirect material cost, indirect wages, and indirect expenses
incurred concerning the manufacturing activity. Examples include rent, taxes, insurance, and idle
wages.
• Administration overhead. It comprises indirect material, indirect wages, and indirect expenses
incurred concerning the management of an organization. Examples include the salary of
administrative-office personnel, rent, utility expenses, and other general office expenses.
• Research and development overhead. It comprises the indirect material cost, indirect wages, and
indirect expenses incurred in the research and development activities of an organization. Examples
of this include patent changes, insurance premiums, depreciation, and repair and maintenance
expenses concerning research and development offices, equipment, furniture and fixtures, and
materials used in research, among others.
• Selling overhead. It comprises the indirect material, wages, and expenses incurred for creating and
stimulating demand for a firm’s products. Examples of this include salary and all incentives offered

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for sales personnel, traveling expenses of sales personnel, rebates and discounts in the cost of price
list, brochures, samples, and collection costs for debts, among others.
• Distribution overhead. It comprises the indirect material, wages, and expenses incurred for making
a firm’s products available to customers. Examples of this include expenses on the delivery vehicles,
delivery and packing expenses, salary and wages of drivers, packers, delivery personnel, rent, rates,
taxes on the finished goods, and repairs and maintenance costs, among others.
Element-wise Classification
• Indirect materials. These materials cannot be measured in any standardized physical units but are
essential for the smooth running of the manufacturing process. Examples include the cotton waste
used for cleaning plants and pieces of machinery, industrial lubricants, coolants, printing, and
stationery.
• Indirect labor. It pertains to the costs that do not alter a product's construction or composition.
Examples include wages and salaries for supervisors, management personnel, store personnel,
production personnel, security personnel, administrative personnel, and secretarial and accounts
personnel.
• Indirect expenses. These are costs that cannot be directly allocated to cost units. Examples include
rent, rates, taxes, postage, telegram, fax, email expenses, insurance premium, lighting, and heating.
Behavior-wise Classification
• Variable overhead. It pertains to the costs which remain constant per unit. Examples include power
consumption, selling commission, etc.
• Fixed overhead. It pertains to the costs which remain unaffected by the change in output volume.
Costs are fixed for a given period over a relevant range of output. Examples include insurance
premiums and depreciation concerning fixed assets, rent, rates, and taxes.
• Semi-variable overhead. It pertains to the costs, which are partly fixed and partly variable. Some
overheads possess characteristics of both fixed and variable costs. These costs do not change in the
same ratio in which the output changes. Examples of this include maintenance expenses, telephone
expenses, and stationery expenses.
Administration, Selling, and Distribution of Overheads
Other types of overheads are as follows:
• Administration overhead. It is the aggregate of the costs of formulating the policy, directing the
organization, and controlling the operations of an undertaking that is not directly related to
production, selling, distribution and research or development, or any other function. Examples
include the salary of office staff, directors’ remuneration, rent, rates and taxes of office buildings,
office lighting, healing, depreciation of office furniture and fixtures, repair and maintenance of office
building, the insurance premium for the office building, postage, courier, fax, email charges, legal
expenses, printing and stationery expenses, audit fees, and bank charges.
• Selling overhead. It is the aggregate of indirect materials, wages, and expenses to create and
stimulate demand for a firm’s products and secure and execute the orders. Also, this is the cost of
making sales and retaining customers to promote different products. The costs associated with the
manufacture and distribution of products are not included in selling overhead. Examples of selling
overhead are advertisement and publicity expenses, salary commission and benefits of the sales
force, technical representatives, bad debts, showroom costs, costs of catalog and price lists,
commission, and brokerage to third parties.

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• Distribution overhead. It is the aggregate of indirect materials, indirect wages, and indirect expenses
incurred for moving finished products to central and local storage; and moving finished products to
customers. It is the cost of servicing and maintaining demand by making a firm’s products available
to customers. Examples of distribution overheads are warehousing expenses, carriage, and freight
outwards, wastage of finished goods, cost of secondary packing, the insurance premium for finished
goods, all expenses incurred in the maintenance of delivery vehicles, etc.
Primary Distribution of Overheads

It is the process of allocating and apportioning the overhead costs to all the departments of a company.
The bases used for apportionment of manufacturing overheads are the following:
1. Direct allocation. It involves directly distributing traceable overheads to a particular job or
department. An example of this is the allocation of electricity.
2. Labor hours. It involves apportioning overheads based on direct labor hours for different
departments.
3. Machine hours. It involves distributing overheads based on machine hours relevant to the
activities entirely dependent on machinery.
4. Direct materials. It involves apportioning overheads like indirect materials and material handling
charges based on the value of direct materials consumed.
5. Direct wages. It involves apportioning overheads like indirect wages and general overheads based
on direct wages.
6. The number of staff. It involves the apportionment of overheads incurred for workers' welfare
based on the number of employees in each department.
7. Floor area. It involves apportioning overhead expenses such as rent, tax, lighting, and building
maintenance expenses based on the space occupied by different departments.
8. Capital value. It involves apportioning overheads like depreciation, insurance premium, repairs,
and maintenance based on the capital value of assets.
9. Light points. It involves apportioning overheads like lighting expenses based on light points in
various departments.
10. Kilowatt-hours. It involves apportioning overheads such as power expenses based on kilowatt
hour (KWH).
EXAMPLE: ABC Company has three (3) production departments, A, B, and C, and two (2) service
departments, D and E. The following figures are extracted from the records of the company:
Cost Item Amount of Cost
Rent and rates P 10,000
Depreciation of machinery 20,000
Electricity 3,000
Administrative expenses 20,000
The following details are also available:
Resources Dept. A Dept. B Dept. C Dept. D Dept. E Total
Floor space (sqm) 1,500 1,500 3,000 2,000 2,000 10,000
Direct wages (in peso) 10,000 15,000 50,000 20,000 5,000 100,000
Horsepower of machines 40 30 100 20 10 200
Value of machines P50,000 10,000 25,000 12,000 3,000 100,000

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PROCEDURE:
1. To apportion the costs to various departments through primary distribution, identify the cost
relationship for each cost item with the resources of each department.
Cost Item Resources
Rent and rates Floor space
Depreciation of machinery Value of machines
Electricity Horsepower of machines
Management expenses Direct wages
2. Determine the cost allocation and cost percentage associated with the different departments for
each cost item and its corresponding resource.
Rent and Rates Dept. A Dept. B Dept. C Dept. D Dept. E Total
Floor space (sqm) 1,500 1,500 3,000 2,000 2,000 10,000
Cost percentage per department 15% 15% 30% 20% 20% 100%
(Departmental cost/Total cost)
Allocation per department 1,500 1,500 3,000 2,000 2,000 10,000
(Given rent and rates x Cost
percentage per department)
Depreciation of Machinery Dept. A Dept. B Dept. C Dept. D Dept. E Total

Value of machines 50,000 10,000 25,000 12,000 3,000 100,000
Cost percentage per department 50% 10% 25% 12% 3% 100%
Allocation per department 10,000 2,000 5,000 2,400 600 20,000
(Given depreciation of machinery X
Cost percentage per department)
Electricity Dept. A Dept. B Dept. C Dept. D Dept. E Total

Horsepower of machines 40 30 100 20 10 200
Cost percentage per department
20% 15% 50% 10% 5% 100%
Allocation per department
(Given electricity cost X Cost 600 450 1,500 300 150 3,000
Administrative Expense Dept. A Dept. B Dept. C Dept. D Dept. E Total

Direct wages 10,000 15,000 50,000 20,000 5,000 100,000
Cost percentage per department
10% 15% 50% 20% 5% 100%
Allocation per department
(Given administrative expense X Cost 2,000 3,000 10,000 4,000 1,000 20,000
References:
Wilkinson, J. (2013). Labor costs. https://strategiccfo.com/ labor-costs

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ACTIVITY-BASED COSTING (ABC) SYSTEM

Key Terms of Activity-Based Costing (ABC)
Activity-based costing (ABC) system is a technique of cost attribution to cost units based on indirect
activities like ordering and setup. It involves the identification of costs with each cost-driving activity. It is
the basis for the absorption of the expenses over different products.
The following key terms are associated with ABC:
• Cost objects. This fundamental cost concept focuses on individual activities such as products,
customers, services, and locations.
• Activities. These are events, tasks, or work units with a particular purpose. These are divided into
two (2) groups: the support activities and production process activities. Support activities include
scheduled production, machine setup, materials purchasing, and custom order. Production process
activities include machine products and assembled products.
• Cost pool. It pertains to the grouping of individual cost items. It expresses the costs of goods or
services allocated to specific activities within a business operation.
• Cost drivers. These are the causes or reasons for the occurrence of overhead costs. These are
variables or a level of activity that casually affects costs over a given period. The cost driver of a
variable cost is the level of activity or volume, which causes proportionate changes in variable costs.
For example, the number of vehicles assembled is the cost driver of the cost of steering wheels.
• Cost hierarchies. These designate activities based on how easily they can be traced to a product. The
cost hierarchy comprises four (4) levels as follows:
1. Output unit-level costs. These are the cost of activities performed on each unit of product or
service. The cost of activities increases in proportion to the production or sales volume. An
example of this is the manufacturing operations cost.
2. Batch-level costs. These are the costs of activities performed on each batch or group of units of
products or services. The cost of activities increases in proportion to the production or sales
volume. An example of this is the procurement cost.
3. Product-sustaining costs. These are the costs of activities undertaken to support products or
services, irrespective of the number of units or batches. An example of this involves marketing
costs to launch new products.
4. Facility-sustaining costs. These are the costs of activities that cannot be traced to individual
products. They are common to all products and support an organization's entire activities. An
example of this includes general administration costs.
Salient Features of Activity-Based Costing (ABC)
The following are the unique features of the Activity-Based Costing (ABC) system:
• Activity-based. The ABC system is based on activities that consist of different functions that are
associated with cost objects.
• Activity cost center. The ABC system involves identifying the overhead cost of an activity and
assigning the cost to each activity's cost center.
• Use of cost drivers. The ABC system involves the causes of overheads, called cost drivers. These are
used to assign costs to products.
• Accumulation of overhead costs. The ABC system involves the accumulation of overheads
completed by various activities. A single unit and the entire organization are not considered.

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• Traceability. The ABC system involves overhead costs which can be traced easily. Hence, cost data
are more reliable and accurate.
• Elimination of non-value-added activities. The ABC system states that the product cost would be
less since the non-value-added activities are eliminated. The non-value-added activities do not
contribute anything to the value of the product.
• Costs in proportion to cost-driving activities. The ABC system involves the overhead costs charged
to different products in proportion to the cost-driving activities.
Implementation of Activity-Based Costing
Stages that are involved in the ABC system are explained as follows:
• First Stage: Identify the activities. These activities are work performed or undertaken to produce
products, such as the number of setups, scheduling, orders, parts, inspections, labor hours, and
designs.
• Second Stage: Pool rates. The overhead cost pool is traced to products using the pool rates. These
activities are used as cost drivers in computing overhead rates. The total factory overhead is then
allocated to activity cost pools. The cost per activity is divided by the drivers’ practical capacity to
arrive at the overhead rate per activity.
EXAMPLE: Dragon Furniture Company has identified activity centers to which overhead costs are assigned.
Activity Centers Costs Activity Drivers
Utilities P300,000 60,000 machine hours
Scheduling and Setup 273,000 780 setups
Material Handling 640,000 1,600,000 pounds of materials
The following are the company’s products and other operating statistics:
Product A Product B Product C

Prime costs P80,000 P80,000 P90,000
Machine hours 30,000 10,000 20,000
Number of setups 130 380 270
Pounds of materials 500,000 300,000 800,000
Number of units produced 40,000 20,000 60,000
Direct labor hours 32,000 18,000 50,000
PROCEDURE:
• Step 1. Determine the pool rates by dividing the given costs by the activity drivers:
Activity Centers Solution Pool rates
Utilities P300,000/60,000 P5/mhr
Scheduling & setup P273,000/780 P350/set up
Materials handling P640,000/1,600,000 P.40 lbs
• Step 2. Determine the product costs by allocating the overhead or activity centers to the cost of
activity drivers using the computed pool rates:

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Product A Product B Product C TOTAL

Utilities:
A. 30,000 mhr X P5 P150,000
B. 10,000 mhr X P5 P50,000
C. 20,000 mhr X P5 P100,000
P300,000
Scheduling and Setup:
A. 130 set ups X P350 45,500
B. 380 set ups X P350 133,000
C. 270 set ups X P350 94,500
273,000
Material Handling:
A. 500,000 lbs X P0.40 200,000
B. 300,000 lbs X P0.40 120,000
C. 800,000 lbs X P0.40 320,000
640,000
TOTAL P395,500 P303,000 P514,500 P1,213,000
References:
AccountingExplained. (n.d.). Activity-based costing. https://accountingexplained.com/managerial/cost-
systems/activity-based-costing

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UNIT COSTING AND JOB COSTING

Unit Costing
Unit costing is commonly used in industries that produce identical products. Also, this is used in uniform
manufacturing processes and situations when cost units have similar costs. Examples of companies that
employ unit costing include industries that manufacture homogeneous products like sugar, bricks, cement
works, and breweries.
The following are the features of unit costing:
• Average unit cost. Unit costing computes the average unit cost by dividing the total costs by the
number of units produced in a specified period.
• Single product. Unit costing involves a single product or several product grades.
• Applicability. Unit costing is applied to industries where the manufacturing process is not
continuous.
EXAMPLE: The management of Pizza Restaurant desires to determine the unit cost associated with their
10,000 sales of pepperoni pizzas. The following variable expenses per pizza are available:
Flour P0.50
Yeast 0.05
Water 0.01
Cheese 3.00
Pepperoni 2.00
Total Variable Cost (VC) per unit P5.56 per pizza
The fixed expenses of Pizza Restaurant are the following:
Labor P1,500
Rent 3,000
Insurance 200
Advertising 500
Utilities 450
Total Fixed Cost (FC) P5,650
SOLUTION:
𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 𝑃5,650
𝑈𝑛𝑖𝑡 𝐶𝑜𝑠𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝑉𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 + = 𝑃5.56 +
𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 10,000
= 𝑃5.56 + 𝑃0.5 = 𝑷𝟔. 𝟏𝟑
KEY POINTS: The unit cost provides a dynamic overview of revenues, costs, and profits relationships. It
helps business owners determine if their business is earning a profit. Also, it helps them price their
products by considering the costs associated with the product per unit.
Job Costing
It is a cost allocation method used by companies that make custom products. This system performs work
on customers’ requirements based on custom orders. The work is carried out within the factory, which
passes through the processes or operation activities. Job costing is used in industries engaged in printing,
steel structures, switchgear, transformers, motors, pumps, general engineering works, oil wells, and
shipping.

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The following are the features of job costing:

• A job consisting of a single order or contract.
• Each job is unique.
• Products are not manufactured for general consumption.
• Each order is given a job number.
• Costs are accumulated with a reference number.
• Costs are determined for each order.
• The duration of the job order is comparatively short-term.
• Identifying a job at each stage of its manufacturing process is possible.
The main objectives of job costing are the following:
1. To determine the cost of production of every order.
2. To assess the profitability of each job to undertake future orders of similar nature.
3. To control operational efficiency by comparing actual costs with estimated costs.
4. To plan for future courses of activities.
EXAMPLE 1: ABC Premier Cabinets uses job costing to calculate the cost of jobs as they are completed.
The company estimates that it will have P1,250,000 overhead costs in 201A. The company believes the
employees will have to work 200,000 hours to complete the job. Calculate the predetermined overhead
rate assuming the company uses direct labor hours to allocate overhead to jobs.
SOLUTION: The predetermined overhead rate can be derived by dividing the estimated overhead by the
estimated activity.
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑
𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒 =
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦
1,250,000
= = 𝟔. 𝟐𝟓 𝒑𝒆𝒓 𝒅𝒊𝒓𝒆𝒄𝒕 𝒍𝒂𝒃𝒐𝒓 𝒉𝒐𝒖𝒓 (𝒅𝒍𝒉)
200,000
EXAMPLE 2: ABC Premier Cabinets completes job #322 on July 7. The job used 45 direct labor hours and
30 machine hours. The job consumed P1,800 worth of materials. The average direct labor rate is P18.00
per hour, and the company uses the predetermined overhead rate calculated in Example 1. Calculate the
total cost of job #322.
FORMULA: The three (3) components of job cost are direct materials, direct labor, and applied overhead.
𝑇𝑜𝑡𝑎𝑙 𝐽𝑜𝑏 𝐶𝑜𝑠𝑡 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 + 𝐴𝑝𝑝𝑙𝑖𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑
PROCEDURE:
1. Calculate the direct labor. Based on the illustration, the average direct labor rate is P18.00 per direct
labor hour, and the activity or cost driver is 45 labor hours.
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 = 𝑅𝑎𝑡𝑒 × 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 = 18.00 𝑝𝑒𝑟 𝑑𝑙ℎ × 45 𝑑𝑙ℎ = 𝑷𝟖𝟏𝟎. 𝟎𝟎
2. Apply the overhead to the job by multiplying the predetermined overhead rate by the activity.
𝐴𝑝𝑝𝑙𝑖𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = 𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒 × 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦
= 6.25 𝑝𝑒𝑟 𝑑𝑙ℎ × 45 𝑑𝑙ℎ = 𝑷𝟐𝟖𝟏. 𝟐𝟓

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3. Compute the job’s total cost.

Direct Materials P1,800.00
Direct Labor 810.00
Applied Overhead 281.25
𝑇𝑜𝑡𝑎𝑙 𝑗𝑜𝑏 𝑐𝑜𝑠𝑡 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 + 𝐴𝑝𝑝𝑙𝑖𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑
= 1,800 + 810 + 281.25 = 𝑷𝟐, 𝟖𝟗𝟏. 𝟐𝟓
KEY POINTS: The value of direct materials is given in the problem.
References:
Accounting in Focus. (n.d.). Job costing and overhead allocation.
https://accountinginfocus.com/managerial-accounting-2/overhead-allocation/job-costing-and-
overhead-allocation
InvestingAnswers. (n.d.) Cost per unit. https://investinganswers.com/financial-dictionary/financial-
statement-analysis/cost-unit-5333
Surbhi, S. (2017). Difference between job costing and batch costing.
https://keydifferences.com/difference-between-job-and-batch-costing.html

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BATCH COSTING AND PROCESS COSTING

Batch Costing
Batch costing is used by companies that make custom products. This system produces goods in similar
units (referred to as batches).
The following are the unique features of batch costing:
• Batch-wise cost collection. It involves assigning batch numbers and associated costs for each
product group.
• Identical products. It involves indistinguishable items produced in a batch.
• Grouping. It involves classifying items for costing.
In batch costing, it is crucial to determine the number of units to produce. The optimum size of the batch
is termed “economic batch quantity.” The need for economic batch quantity arises when the production
rate exceeds the sales turnover rate.
The two (2) main elements associated with economic batch quantity are as follows:
• Set-up cost. These are costs incurred for setting up tools and machines for each batch. It is a fixed
amount per batch. It is incurred irrespective of the batch size. The total set-up cost increases if there
is an increase in the number of batches.
• Carrying cost. It is also known as storage costs. It consists of the interest on capital, defective work,
storage loss, obsolescence, premium, etc. Carrying cost is considered as a rate per unit. There will
be an increase in carrying or storage costs followed by a decline in set-up costs if there is an increase
in the batch quantity.
The Economic Batch Quantity (EBQ) is the point where storage costs equal the set-up costs. At this point,
the total costs are at a minimum level. EBQ is based on production costs, set-up costs, storage costs, the
interest rate on capital, product demand, labor skills, wastage of materials, etc.
EXAMPLE: Xenon Ltd. is the major supplier of R-103 speakers to ABC Radio. It supplies 12,000 units of
speakers per annum to the radio company. It is estimated that the cost for holding the inventory for each
speaker is P0.10 monthly, while the set-up cost in manufacturing the speakers is P162 per run.
PROCEDURE:
1. Calculate the economic batch quantity:
2 × 𝑆𝑒𝑡 − 𝑢𝑝 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑏𝑎𝑡𝑐ℎ × 𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑

𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝐵𝑎𝑡𝑐ℎ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = √
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑡𝑜𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
2 × 162 × 12,000 324 × 12,000 3,888,000

=√ =√ =√ = √3,240,000 = 𝟏, 𝟖𝟎𝟎 𝒖𝒏𝒊𝒕𝒔
0.10 × 12 1.2 1.2
2. Calculate the number of batches per annum:

𝐴𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 12,000 𝑢𝑛𝑖𝑡𝑠
𝑁𝑜. 𝑜𝑓 𝑏𝑎𝑡𝑐ℎ𝑒𝑠 𝑝𝑒𝑟 𝑎𝑛𝑛𝑢𝑚 = = = 𝟔. 𝟔𝟔 𝒐𝒓 𝟕 𝒃𝒂𝒕𝒄𝒉𝒆𝒔
𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑏𝑎𝑡𝑐ℎ 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 1,800 𝑢𝑛𝑖𝑡𝑠

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3. Calculate the interval between two (2) consecutive optimum runs:

12 𝑚𝑜𝑛𝑡ℎ𝑠
𝐼𝑛𝑡𝑒𝑟𝑣𝑎𝑙 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑡𝑤𝑜 (2) 𝑐𝑜𝑛𝑠𝑒𝑐𝑢𝑡𝑖𝑣𝑒 𝑜𝑝𝑡𝑖𝑚𝑢𝑚 𝑟𝑢𝑛𝑠 =
𝑁𝑜. 𝑜𝑓 𝑏𝑎𝑡𝑐ℎ𝑒𝑠 𝑝𝑒𝑟 𝑎𝑛𝑛𝑢𝑚
12
= = 𝟏. 𝟕𝟏 𝒐𝒓 𝟐 𝒎𝒐𝒏𝒕𝒉𝒔
7
Process Costing
Process costing determines the product cost at each manufacturing operation, process, or stage. It is
generally suitable for firms where goods or services result from continuous or repetitive operations or
processes.
Process costing is used in the industries below:
1. Manufacturing industries that produce iron and steel, textiles, glass, cement, rubber, soap, paper,
food, etc
2. Mining industries that produce coal and oil
3. Public utility services that provide generation of electricity and water supply
4. Chemical industries
The following are the features of process costing:
• Costs flow from one process to another. It involves costs relating to direct material, direct wages,
and factory overheads which are charged to the process accounts.
• Average unit cost consumption. It involves calculating the average cost per unit by dividing the total
costs by the output in a period.
• Not distinguishable. In process costing, the products are not distinct in the processing stage.
• Normal spoilage. In process costing, the cost of normal spoilage or wastage is included in the cost
of the total units produced.
• Equivalent production computation. In process costing, the incomplete units at each stage of
production are converted into equivalent production based on the degree of incompleteness.
EXAMPLE: Stellar Wine Company crushes grapes to be used in winemaking. The company’s production
process involves two (2) stages: crushing and packaging. In February of 201A, the company produced
50,000 gallons of wine. The company's management wants to determine the product cost per gallon for
each stage of manufacture for their produced wine.
Operating expenses Amount
Grapes purchased P100,000
Grape press maintenance 25,000
Packaging supplies 75,000
Packager labor 50,000
Normal spoilage (gallons loss in the process) 10,000
PROCEDURE:
• Step 1. Determine the relationship between the firm’s production stages and operating expenses:

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Stages of production Operating expenses

Crushing Grapes purchased
Grape press maintenance
Packaging Packaging supplies
Packager labor
• Step 2. Determine the net production volume by deducting the cost of normal spoilage from the
production volume.
𝑁𝑒𝑡 𝑣𝑜𝑙𝑢𝑚𝑒 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 𝑉𝑜𝑙𝑢𝑚𝑒 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑛𝑜𝑟𝑚𝑎𝑙 𝑠𝑝𝑜𝑖𝑙𝑎𝑔𝑒
= 50,000 − 10,000 = 𝟒𝟎, 𝟎𝟎𝟎
Key points: Normal spoilage (or losses) must be considered in the computation of production volume
to determine the total correctly and per unit cost of the whole process. In this case, for every 50,000
gallons of grapes processed, 10,000 gallons were wasted and thus giving a 20% normal spoilage rate.
• Step 3. Calculate the cost per unit for direct materials and conversion costs for each stage of the
production process.
Stages of Operating Cost per gallon
Amount
production expenses (Operating expenses/Net volume of production)
Crushing Grapes purchased P100,000 P2.5 direct materials
Grape press
25,000 0.63 conversion
maintenance
TOTAL P3.13 Total Crushing
Packaging Packaging supplies 75,000 P1.88 of direct materials
Packager labor 50,000 1.25 conversion
TOTAL P3.13 Total Packaging
• Step 4. Calculate the total cost associated with each stage of production.
Stages of production Cost per unit
Crushing P3.13
Packaging 3.13
TOTAL P6.26
Key points: The total cost associated with crushing and packaging wine per gallon Stellar Wine
Company produces is P6.26.
References:
Aisha, P. (n.d.). Service costing: Definition and application and formula.
https://study.com/academy/lesson/process-costing-definition-examples.html
Bilant, S. (n.d.). Process costing: Definition & examples. https://study.com/academy/lesson/process-
costing-definition-examples.html


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BM2209

01 Handout 1 *Property of STI

01 Handout 1 *Property of STI

f) According to Behavior under Activity

15 Fixed Cost Line the activity with a designated relevant range

Liquid detergent Baking soda Paper towels

Total Variable Cost Line variable cost increases or decreases

Figure 2. Variable cost

01 Handout 1 *Property of STI

Production in Units: Variable Cost per Unit:

120 Fixed Cost

Volume of Production (Units)

Figure 3. Mixed cost

01 Handout 1 *Property of STI

Figure 4. Step variable cost

ILLUSTRATION: Assume that a supervisor

Figure 5. Step fixed cost

01 Handout 1 *Property of STI

Separating Mixed Cost

Machine Hours Utility Costs

01 Handout 1 *Property of STI

Chart 1. Flow of costs

The flow of costs of a manufacturing company is outlined as follows:

01 Handout 1 *Property of STI

01 Handout 1 *Property of STI

Normal Costing System

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑

01 Handout 1 *Property of STI

KEY ELEMENTS OF COSTING PART 1

02 Handout 1 *Property of STI

02 Handout 1 *Property of STI

02 Handout 1 *Property of STI

Units Unit Cost Inventory Amount (Units x Unit Cost)

Units Unit Cost Inventory Amount (Units x Unit Cost)

02 Handout 1 *Property of STI

Units (Timber) Unit Cost Amount (Units x Unit Cost)

Average Cost (Moving Average)

𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 178,400

Units Unit Cost Inventory Amount (Units x Unit Cost)

𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 291,788

02 Handout 1 *Property of STI

Units Unit Cost Inventory Amount (Units x Unit Cost)

𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 304,736

02 Handout 1 *Property of STI

KEY ELEMENTS OF COSTING PART 2

03 Handout 1 *Property of STI

Total monthly revenue 1,000,000

03 Handout 1 *Property of STI

03 Handout 1 *Property of STI

Primary Distribution of Overheads

03 Handout 1 *Property of STI

Depreciation of Machinery Dept. A Dept. B Dept. C Dept. D Dept. E Total

Electricity Dept. A Dept. B Dept. C Dept. D Dept. E Total

Administrative Expense Dept. A Dept. B Dept. C Dept. D Dept. E Total

03 Handout 1 *Property of STI

ACTIVITY-BASED COSTING (ABC) SYSTEM

04 Handout 1 *Property of STI

Product A Product B Product C

04 Handout 1 *Property of STI

Product A Product B Product C TOTAL

04 Handout 1 *Property of STI

UNIT COSTING AND JOB COSTING

05 Handout 1 *Property of STI