INTRODUCTION TO COST ACCOUNTING

This chapter introduces the basic concepts of cost accounting as part of the company’s
information system. Communication among the various users of cost accounting
information is easily facilitated by having a common understanding of the terms and cost
concepts used in cost accounting. Cost accounting information is applicable not only in
manufacturing firms but also in service firms such as repair shops, consulting firms,
financial institutions, schools, hospitals, as well as in government and non-government
organizations (NGOs).

Cost Accounting

Cost accounting is the process of tracking, recording and analyzing costs associated with
the products or activities of an organization. It is considered as a specialized branch of
accounting which involves the classification, accumulation, assignment and control of costs.
Cost accounting helps managers understand the costs of running a business. It is concerned
with cost accumulation for inventory valuation to meet the requirements of external
reporting and internal profit measurement. Modern cost accounting 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. Cost accounting can also be defined as the systematic recording
and analysis of the costs of materials, labor and overhead incident to production.
(http://www.merriamwebster.com/dictionary /cost accounting)

The Origin of Cost Accounting

Jane Gleeson-White is a writer, editor and speaker who has a PhD in creative writing and is
well known for her work on literature, economics and the natural world. She is the author of
the bestselling, internationally acclaimed Double Entry: How the merchants of Venice
shaped the modern world (2011). In her article, she cited that in 1772, Josiah Wedgwood
became the world’s first cost accountant. Wedgwood built the world’s first industrialised
pottery factory. During an economic downturn in 1772, demand for Wedgwood vases
slackened. With serious cash flow problems and an accumulation of stock, Wedgwood
turned to his books to solve his dilemma: should he cut production – or reduce prices?

Through his investigation, he discovered the distinction between fixed and variable costs. He
used the findings of his cost analysis to make management decisions. He revised his policy
of soliciting special commissions and made-to-order sales; lengthened his production runs
for certain products; varied his usual high-price policy; reduced his stock in market
downturns; and kept a careful eye on sales and marketing costs.

Financial crisis and severe depression forced Wedgwood to develop a new business method:
the use of accounts to guide business management and thus the world’s first recorded cost
accountant was born. (http://costmgmt.org/dec2012-book-feature)

Objectives of Cost Accounting

There are five (5) main objectives of Cost Accounting: (1) to ascertain costs of each
product, process, job, operation or service;(2) to facilitate planning of activities or
processes;(3) to control the costs of operation; (4) to serve as the basis in setting the
selling price; (5) to assist management in decision making.

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Cost accounting measures and reports financial and nonfinancial information
relating to the costs of acquiring or utilizing resources in an organization. It
provides information for both management accounting and financial accounting. That is the
role of cost accounting: to help management plan, make decisions, and control the
organization.

Effective control depends on communicating information to management. By issuing

performance reports, the controller (who is regarded as the company’s chief accountant)
advises other managers of activities requiring corrective action. These reports emphasize
deviations from a predetermined plan, following the principle of management by
exception which is a concept that dictates that managers should be provided with
information that directs or focuses their attention to activities that require corrective action.

Cost Accounting Information System

Cost Accounting Information System (CAIS) is

an accounting information system which
determines the costs of products
manufactured or services provided and record
these costs in the accounting records. It is the
key to management’s assessment of the
company’s efforts to achieve profit. Since it is
so important, CAIS must be carefully designed
and properly maintained.The functions of cost
accounting information system include
providing information for external financial statements, planning and controlling activities or
processes, short term as well as long-term strategic decisions.
CAIS provides a structural frame for understanding the cost accounting practices used in
tracing the costs of inventories in various stages of the production process or the costs
involved in producing such goods or services. SuchCAIS accounts for costs in two (2) basic
stages. The first stage is called cost accumulation which is thecollection of cost data in an
organized way by means of an accounting system. The second stage is called cost
assignmentwhichisthe assignment of direct and indirect costs to a particular costing
object.A costing object refers to anything which is being costed like a product or
department. In other words, it answers the question what is to be costed? Assigning direct
costs to a costing object is termed as cost tracingwhile assigning indirect costs or common
costs to several costing objects is termed as cost allocation. Cost accumulation and cost
allocation will be carried out using either the traditional way or it may use the activity-based
costing (ABC) way.The commonly used cost accumulation methods are job order costing
and process costing. Either method may be used by a manufacturing firm depending on the
type of products they produce or the type of service they provide and also the choice made
by management. With the recent developments in the field of cost accounting, a
combination of job order and process costing is employed in some manufacturing firms that
use various types of materials using series of similar processes. This is called the hybrid
costing or operation costing system.

In designing a cost accounting information system, an understanding of both the

organizational structure and the type of information needed is required. Legal, regulatory
and contractual requirements must be met in order to have a cost-effective accounting
system. Such CAIS must have the proper division of authority so that the department heads
or individual managers can be held accountable.

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Essential Requisites of a Good Cost Accounting Information System

To have a good CAIS, it must have the following essential features:

1. It must suit the nature and size of the business. In other words, it is capable of
meeting the requirements of the business;
2. It must be simple to understand, practical, and easy to operate.
3. Uses accurate data;
4. It must have the necessary support and recognition from top management, otherwise
the purpose of CAIS is vitiated.
5. The benefits obtained from the system should be greater than its cost of installation
and operation.
6. The system of costing should not sacrifice the utility by introducing meticulous and
unnecessary details.
7. It must be tailored-fit to the needs of the various stakeholders;
8. It should be more flexible enough to take care of changing business situations and
information needs of the business.
9. It must be economical to use or adopt;
10. It should be devised with the coordinated efforts of all the concerned departments and
their staff.
11. It should ensure proper accounting for materials, labor and overhead.
12. It should clearly mention the details of records to be maintained and the degree of
data accuracy required.
13. Wherever possible, concepts like management by exception, responsibility accounting,
etc. should be adopted into the costing system.
14. It must take care of the importance of comparability of data with base period’s data,
or with competitors’ data, or with industry averages.

Difficulties in Installing Cost Accounting Information System

The difficulties in installing CAIS include lack of support from top management, resistance
from the current workforce for fear of losing their job after its implementation, lack of
cooperation from employees of other departments due to possible increase in workload or
may bring about inefficiency, increased job responsibilities and paper work and may cause a
change in wage structure, shortage of trained staff, or may cause an uneconomical cost
system.

Cost Management

Cost management is the process by which companies plan and control the costs of doing
business. So before you start on a project or any planned activity, the anticipated costs
should be identified and measured. These related costs and expenses must be approved
before purchasing is allowed to happen. In the process of completing the project, costs
incurred must be recorded to help ensure that the costs are controlled and kept in line with
the approved budget.

Relationship of Cost Accounting

to Financial Accounting and Management Accounting

Due to the limitations of Financial Accounting in terms of management control and internal
reporting, Cost Accounting emerged as a separate branch of accounting. The product
costing and service costing information provided by Cost Accounting will be incorporated in
the financial statements which is the final output of the financial reporting process in
Financial Accounting. The cost accounting information integrated in the financial statements
will serve as the basis to support management information needs in Management
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Accounting. Hence, Cost Accounting is like an anchor which Financial Accounting and
Management Accounting can do without. If in Financial Accounting, GAAP determines what
must be reported and how it is reported, usefulness is the guiding light for Cost Accounting.

The cost data are accumulated through a cost accounting information system and
distributed to various cost objects. However, those non-manufacturing entities may not
require elaborate CAIS. Even service firms need to understand how much their services
would cost so that they can determine whether it is cost-effective to engage in those
particular business activities.

Cost accounting plays as the foundation of financial and management accounting. One
cannot prepare financial statements nor generate internal management reports i.e. budgets,
pricing reports, etc. without first determining accurately as possible the cost of the product
or service it provides.

The Cost Department

The cost department keeps detailed records of materials, labor, factory overhead, and
marketing and administrative expenses; analyzes these costs; issues control reports;
prepares cost studies for planning and decision making; and coordinates cost and budget
data with other departments.

For product research and design, the manufacturing departments need estimates of
materials, labor, and machine process costs; for measuring and efficiency of scheduling,
producing, and inspecting products, the departments need to know the costs incurred. The
personnel department supplies employees’ wage rates. The treasury department needs
accounting, budgeting, and related reports in scheduling cash requirements. The marketing
department needs cost information in setting prices. The public relations department needs
information on prices, wages, profits, and dividends in order to inform the public. The legal
department needs cost information for keeping many affairs of the company in conformity
with the law. (Cost Accounting by Carter, 14thedition)

The Cost Department is a department responsible for gathering, compiling and

communicating information about the company’s activities. It analyzes costs and issues
reports tailored fit to the needs of company’s management for use in controlling and
improving operations. It coordinates with the other departments such as the Production
Department, Personnel or Human Resources Department, Treasury Department, Marketing
Department, Public Relations Department and Legal Department. It is headed by the
company’s cost accountant with the latter under the supervision of the general accountant
or the company’s comptroller.

Organizational Hierarchy

All positions or functional units can be categorized in most organization charts into two (2)
groups: the line position which makes decisions and the staff position which gives advice
and performs technical functions.

Within the organization, one needs to know what is his responsibility and to whom he is
accountable to in order to delineate superior-subordinate relationship. Accountability is
identical with responsibility accounting. Accountability deals with the discharge of an
individual’s responsibility to achieve assigned objectives within the costs and expenses
allowed for the performance and agreed to by the individual.

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 CFO/VP Finance

COMPTROLLER/
TREASURER
CONTROLLER

COST
CASHIER
ACCOUNTANT

ACCOUNTING PAYROLL
STAFF CLERK

Exhibit 1.1
Hierarchy of responsibility & accountability in the Cost Department

Exhibit 1.1 shows the usual hierarchy within the organization. Generally, the
Finance/Accounting Department in an organization is headed by the Chief Financial Officer
(CFO) or the Vice President for Finance as in some other institutions. The controller
(otherwise known as comptroller) is the one who supervises the cost accountant in the
accounting department, whose function is classified primarily as a staff function.
Organization charts are used by companies to present the line and staff functions. It is
useful to ascertain the superior who supervises and oversees the staff function and to whom
a staff is accountable.

The controller and the treasurer within an organization has different functions as the former
is primarily responsible for the cost accumulation and preparation of cost reports while the
latter oversees the coffers of the company. The treasurer is responsible in handling the
inflow and outflow of cash in an institution.

The Role of Cost Accountant

Accounting is a staff function as it provides advice to

those in the line position. To be an important player
on the management team, a controller needs the
skills required of all high-level executives – excellent
written and oral communication skills, competent
accounting skills, solid interpersonal skills and a
deep knowledge of the industry in which the firm
competes. Such qualifications may also apply to the
Cost Accountant who keeps records of the costs of
production and distribution of the company’s
products or services.

The company’s cost accountant is tasked to provide various types of information for
external financial reports such as inventory valuation, which in turn impacts cost of
goods sold. He may also be involved in the compilation or updating of the notes to financial
statements. He also produces reports for internal use which are not governed by the
application of GAAP as the cost accountant is free to use any costing paradigm that will
result in the most informative reports for the management team. The format and content of
internal reports may vary substantially from the format used for external reporting.

An enormous range of topics can be covered by internal reports. Because they lack the
amount of structure imposed on external reports, they are much more interesting to

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prepare, giving the cost accountant free rein to design the perfect format that that will
result in easy readability and effective management decision making.

Cost accountants are in the best position to supply the budget information since they
have access to all the needed information—bills of material, routings, throughput capacity
constraints, and sales estimates by unit. Similarly, the direct labor budget requires input
about expected labor costs, which requires information from the cost accountant regarding
expected labor utilization rates and overtime estimates.

If there is no Human Resource Department to provide information about labor and

benefit costs, the cost accountant is expected to supply this information too. It may also
be necessary to assist in compiling estimated costs for various departments that do not
have an internal staff skilled in such work and help them determine cost estimates for the
coming budget period.

Finally, the cost accountant is frequently called on to estimate facility-wide budgeted

costs, including repairs and maintenance, insurance, and utilities. Given the wide-ranging
nature of these costs, it is evident that the cost accountant can expect to allocate a great
deal of time to the budgeting activity at the times of the year that it is done.

Product costing information is essential in determining appropriate prices. The cost

accountant is in charge of compiling these costs and presenting them to the sales or
marketing staff. This is true for special orders when valued customers offer a large volume
of product only if the sales price is substantially lowered. In this case, the cost accountant
must determine the direct cost of the special order as well as the incremental costs
associated with the production run that creates the customer’s product. It may also be
useful to determine the overall impact on the company’s profits via a throughput accounting
analysis. A separate analysis must be made for each customer pricing request since larger
companies may face these issues on a regular basis, they may employ teams of cost
accountants who deal with only this type of work.

Another important pricing-related task is determining the profitability of individual

customers, products, product lines, or facilities. Each of these calculations must
incorporate only the costs relevant to the particular analysis. For example, a review of
profits by customer may include only direct costs if the analysis is meant to cover a short
period of time, but should use activity-based costing (ABC) if the company’s long-term
impact on profits is the objective of the analysis. For short-term analysis profit impact
using throughput accounting should be included. Given the wide range of costing methods
available, these analyses can take a great deal of time and require extensive explanations
for the management team so that they fully understand the consequences of any actions
taken based on this information.

The cost accountant has a great deal of influence over the types of data collection and
summarization systems used by a company as well as those that one would not normally
associate with the cost accounting function. His main concern is collecting a large enough
quantity of data to create a sufficiently large pool of information that can be used for
various types of costing analysis. However, there is a cost associated with data collection.
The more data you collect, the higher is the costs incurred in obtaining it. Consequently, the
cost accountant must spend time exploring new types of data collection automation to keep
these costs low, while still providing sufficient quantities of data. For example, replacing
manual time cards for direct labor personnel with automated bar code scanning equipment
eliminates a significant amount of labor costs associated with it.

It is also common to be involved in the assignment of costs to various entities, such as

departments or product lines and to constantly re-review this information and reassign the
costs as needed. This is a common activity in organizations where managerial compensation
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is based on localized profits, since managers are constantly attempting to shift cost
allocations away from their areas of responsibility, thereby producing instant improvements
in the profits attributed to them. Rather than allocating costs, as just noted, the cost
accountant may be asked to take the reverse approach, that is, to determine why costs
have been incurred and allocated in a certain manner by tracing them back
through the accounting system, perhaps all the way back to their original source
documents. This information can be used for a simple report to management regarding the
causes of costs, or it can be used as the foundation for a project to alter the system to
allocate costs in a different manner.

It is also common to be assigned to any number of cost-related projects as an internal

consultant. For example, a department manager may want to know what will happen to
costs if certain functions are outsourced to a supplier. Alternatively, the warehouse staff
may want assistance in determining the amount by which working capital requirements will
be reduced if a new project to shrink inventory levels is implemented.

In addition, it may be necessary to conduct a benchmarking study to find better ways to

complete a task, either by searching within other divisions of the company or looking
outside the company for “best practices”. These activities may stop with a presentation of
the suggested improvements to management but can continue through monitoring of the
implementation of these best practices—a common activity for the cost accountant. Thus,
the cost accountant may be asked to review a wide variety of function-specific activities on
a project basis.

The cost accountant may also be required to assist in preparing legal justification for
the company’s case and may even be called on to testify. He can contribute several
types of costing information to the planning process that are of assistance in making
strategy alterations that will result in enhanced profitability levels or at least in the
avoidance of low-profit strategy alternatives. A large part of this information comes from a
database of costs that encompass a much wider range of potential production volumes than
those currently used by the company. With this information, strategy planners can
determine what will happen to internal costs if the company pursues various strategies that
either increase or decrease production or sales volume for various product lines.

The cost accountant can reliably expect to be assigned various tasks and that what makes
his job an interesting one, far more than that of a general accountant, whose job is much
more closely defined by external accounting reporting rules. The cost accountant’s
recommendations ultimately have a direct impact on the company’s operations and overall
profitability.

Career Options

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The list of career options is endless for an accounting or accountancy graduate. Even if you
have completed your bachelor’s degree, you still have the option for career advancement
such as pursuing your education in graduate studies, earning additional certifications or
both.

For career advancement, cost accountants should obtain a professional license such as a
Certified Public Accountant, and/or an international certification or professional accreditation
such as that of a Certified Cost Accountant accreditation.Modern accounting is highly
collaborative and team-based while accountants do their fair share of individual work, being
able to work well with others will be critical, especially in a corporate world.

Qualifications of the Cost Accountant

Companies hiring for cost accountants may look into his educational attainment, previous
job experience, certifications and technical skills. Oftentimes, soft skills and personality
traits are also taken into account. Such qualifications may vary from one company to
another. Shown below is an example of what a cost accountant must possess to qualify him
for that job:
 Bachelor’s Degree in Accounting or related field required
 6+ years’ experience in general accounting or cost accounting
 General familiarity with the apparel industry preferred
 Experience in a manufacturing warehouse or facility a plus

The Cost Accountant’s Job Description

A great job description can help you attract the most qualified candidate for the position of
the company’s Cost Accountant. It consists of job title that describes the nature of the work
performed, the purpose of a job and the key functions to be performed or the so-called
duties and responsibilities. Action verbs describe the duties in which the description will be
listed in the order of importance.
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A job title is the first element you will find in the job description as it concisely defines the
job and briefly explains what level or position the applicant will hold. Effective job titles
reveal how much authority and responsibility the employee will have within the
organization.

The second element of a job description is usually the longest because it details specific job
duties. Some HR managers use bullets to quickly and efficiently list job responsibilities.
According to career coach Gary Cohen, job descriptions should be written with both present
and future goals in mind, and must be updated frequently to accommodate new job
demands such as technology upgrades and advanced software programs.

The third element of a job description lists specific qualifications that must be met in order
to apply for the job. For instance, "High school diploma required," "Bachelor's degree in
finance or a related field," or "Minimum 3 years experience in sales." The most effective job
descriptions focus on qualifications that are necessary to the position, not qualities that are
theoretical. In other words, it may include formal training, education, certification, licenses
or work experience that qualifies an applicant for that particular position. The description
states the knowledge or skills needed to perform the essential responsibilities of the role. It
also identifies the working conditions and physical demands of the job like for example
“Willingness to travel to various branches here and abroad is required.” Avoid confusing job
seekers by using vague descriptions.

Most job descriptions, specifically those used to solicit potential applicants, include logistical
details. Information such as when the position will be available, application deadlines,
resume submission guidelines and company contact information is provided. Some may list
a general salary range, relocation requirements and benefits or perks if the company feels
the added information helps draw eligible candidates. Part-time job descriptions list the
days and hours required, and teaching or university positions specify the required years of
service.

Shown below are the examples of Cost Accountant’s duties and responsibilities:

 Prepare monthly journal entries manually or by initiating electronic creation through our
software program;

 Review journal entries carefully for anomalies and other inconsistencies;

 Prepare monthly and quarterly accounting reports for submission to management

 Conduct inventory reserve analysis on a quarterly basis and generate reports for senior
management

 Assist the Staff Accountant with suggesting changes to policies or procedures to increase
cash flow

 Review rates of depreciation, labor and overhead and suggest policy changes to improve
numbers

 Classify costs accurately

 Establish standard costs and update them as appropriate

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 Maintain and review the general ledger and reconcile balance sheets

 Analyze costs of raw materials and other supplies and create cost-benefit analyses for
changing vendors

Costs vs. Expenses

Many people use these terms interchangeably. Accountants define cost as a resource
sacrificed (used) or forgone to achieve a specific objective. Hence, a cost is the amount of
resources given up in order to receive some goods or services and represents future
economic benefit to a company.

An asset is a cost. As costs are used up in the production of revenues, they are said to
expire and these expired costs are called expenses. Expenses are matched with revenues
on the income statement. A good example for understanding a cost and expense is a fixed
asset. When a fixed asset is purchased, it is a cost to the company and is shown on the
statement of financial position. When the fixed asset is used, it is depreciated and a portion
of the cost becomes a depreciation expense, which is included in the income statement and
matched with the revenues.

The unexpired cost shall be recognized as an asset though ultimately it will become an
expense by the passage of time or as the cost has expired as it is used up by the business
to earn revenues.

Expenses and losses are both considered as expired costs. However the distinction is that
expenses are intentionally incurred in the process of generating revenues while losses are
not intentionally incurred.

Cost Classification

Classification of cost means the grouping of costs according to their common characteristics.
Sometimes cost classification requires an accountant to exercise his good judgment. By
understanding the different cost terminologies, you will be able to classify costs according
to:

I. Time period for which the cost is computed:

 Historical Costs are costs incurred in the past. This is the type of cost used primarily
in the preparation of financial statements for external reporting purposes.

 Budgeted Costs are costs expected to be incurred in the future.

II. Management Function

 MANUFACTURING COSTS (also known as production costs or factory costs) are

those costs associated with the production activities of the company. The three
(3) cost elements of production are Materials, Labor and Factory Overhead.

Materials Costs

 Direct Materials are those materials that form an integral part of the
finished product whose costs can be conveniently traced into it. The
following are included as part of direct material costs:
o invoice price less discounts (whether taken or not)

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 o sales taxes
o customs duties
o delivery costs paid to vendors
o cost of delivery containers, net of deposit refunds

 Indirect Materials are those materials needed to complete a product but

the use of which is so minimal or so complex that treating them as direct
materials is futile. Such items of material may become an integral part of
the finished product but may be traceable into the product only at great
cost and inconvenience. Glues, nails, welding materials, grease,
lubricating oil, cleaning rags, brushes and other minor items are called
indirect materials (or supplies) and are classified as part of factory
overhead.

Labor Costs

 DirectLabor is the labor directly involved in making the product or those

labor costs that can be so traced without undue cost or
inconvenience.The following are included as elements of direct labor cost:
o basic compensation
o production efficiency bonuses
o employer's portion of social security taxes
o cost of living allowance (COLA)

 Indirect Labor is defined as expended labor which does not directly affect
the construction or the composition of the finished product or those
factory labor costs which are supportive or supervisory in nature whose
services are essential to factory operations but do not work directly on
the product. This includes the wages of supervisory personnel and
janitors which are classified as part of factory overhead. These are
incurred to support production.

Note that premium pay for overtime, special shifts, or for work on
holidays is usually treated as indirect labor and included as
manufacturing overhead unless such work relates to the requirements of
a specific product.

Factory Overhead (also known as manufacturing overhead; production overhead;

factory expense or factory burden) are those production costs incurred in the
plant or factory that cannot be classified as direct materials nor direct labor. This
includes factory supplies or indirect materials used, indirect labor, depreciation of
plant assets, fringe benefits, payroll taxes and cost of idle time.

Prime Cost is the sum of direct materials and direct labor costs.

Conversion Cost is the cost of converting direct materials into finished product
and is the sum of direct labor costs and factory overhead.

DIRECT MATERIALS
COST
PRIME COST

DIRECT LABOR COST

11 CONVERSION
COST
FACTORY OVERHEAD
COST
  NON-MANUFACTURING OR NON-PRODUCTION COSTS are the costs associated
with the functions of selling and administration.

 Selling (marketing or distribution) expenses are the expenses associated

with obtaining sales and the delivery of the product or service. Fixed
marketing expenses are also identified as CAPACITY COSTS while variable
marketing costs are referred to as VOLUME COSTS. Since marketing costs
relate to contacting customers and providing for their needs, these costs
are often referred to as order-getting and order-filling costs.

 General and Administrative Expenses include those expenses incurred in

connection with performing general and administrative activities. It
includes all executive, organizational and clerical costs that cannot
logically be included under production nor marketing.

 Cost of Goods Manufactured represents the total cost of goods completed during
the current period.

III. Generally Accepted Accounting Treatment

 Product Cost or inventoriable cost is any cost incurred in the factory. Product costs
are inventoried if not sold & are expensed only when revenue is recognized.

 Period Costs are costs that are expensed in the period in which they are incurred. A
period cost is identified with a time period & not with the production of products &
services. The time period in which the benefit is received is the period in which the
cost should be deducted as an expense.

IV. Their Ease of Traceability

Costs may be viewed as either direct or indirect in terms of the extent that they are
traceable to a particular costing object such as products, jobs, departments, and sales
territories. A direct cost in one situation may be an indirect cost in another.

For example, the salary of a production department supervisor is a DC of the plant &
that department, but it is an indirect cost with respect to an array of products produced
in that department.

 DirectCosts are those costs that can be directly traceable to a costing object.
Examples are direct materials, direct labor, and advertising outlays made directly to
a particular sales territory.

 IndirectCosts are costs that are difficult to directly trace to a specific costing object,
i.e. factory overhead and those costs shared by different departments or segments
called commoncostsorjointcosts.

 Avoidable Costs are costs that will not be incurred if an activity is suspended or
stopped. They are the cost savings arising from a decision to discontinue an
undertaking or it is a cost that can be eliminated (in whole or in part) as a result of
choosing one alternative over another.

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V. Behavior or in relation to Volume or Activity Level (The way a cost responds to a change
in activity is known as its cost behavior)

 Fixed Costs are costs that remain constant in total but will vary on a per unit basis
within the defined relevant range regardless of changes in activity level.

As a general rule, expressing fixed costs on an average per unit in internal reports
must be avoided as this will create a false impression that fixed costs are like
variable costs and that total fixed costs actually change as the volume changes.

For planning purposes, fixed costs can either be committed or discretionary.

Committed fixed costs are organizational investments which cannot be reduced
significantly even for short span of time without making any changes. Examples are
insurance expense, investments in facilities and equipment, real estate tax and
salaries of top management. Even if you cut back the operations or operations are
interrupted, commited fixed costs remain unchanged in the short term because the
costs of restoring them later are greater than its realized short-run savings.

Discretionary fixed costs (also called managed fixed costs) are those that arise
usually from annual management decisions to spend on certain fixed cost items.
Examples are advertising costs, costs of doing research, public relations and
management development programs. You can cut them for short term with minimal
damage to the long-run goals of the company.

 VariableCosts are costs that vary in total as the volume of production or sales
changes.

TOTAL COST PER UNIT COST

Changes in direct proportion Remains constant

VARIABLE COSTS to the change in activity regardless of change in
level activity level

Remains constant regardless Changes in inverse

FIXED COSTS of change in activity level proportion to the change in
activity level

Exhibit 1.2Distinction between variable cost & fixed costs within the relevant range

 Mixed Cost or Semi-Variable Costs are costs that vary with changes in volume but
unlike variable costs, do not vary in direct proportion. Semi-variable costs tend to be
predominately variable but with a change in per unit cost as activity changes.

Examples are the rental of a delivery truck where a fixed rental fee plus a variable
charge based on mileage is made; and power costs where it consists of a fixed
amount plus a variable charge based on consumption which is also true to most of
the utility costs.

This type of costs’ behavior is difficult to classify as to whether it is variable or fixed

for internal reporting purposes. It is likewise necessary to estimate its fixed or
variable portion through the use of various methods such as high & low points
method, scattergraph method or the least squares method.

 A step cost is a variable or fixed cost that shifts upward or downward when activity
changes by a certain interval or step. It is a cost that increases by a fixed amount as
13
 certain levels of activity are reached. Step costs may have a few large steps & be
fixed over broad ranges of activity or have many small steps & appear to act like
variable costs.

 Semi-fixed cost is a cost that increases in lumps of cost with changes in output or
activity. Semi-fixed costs are predominately fixed but change in peso lumps at some
point within the relevant range.

For cost behavior information to be properly identified, analyzed, and used, a time frame
must be specified to indicate how far into the future a cost should be examined, and a
particular range of activities must be assumed. The assumed activity range usually reflects
the company's normal operating range and is referred to as the relevant range.

When fixed costs are involved, the average cost of a unit of product will depend on the # of
units being manufactured. As production increases, the average cost per unit will fall as the
FC is spread over more units. Conversely, as production declines, the average cost per unit
will rise as the FC is spread over fewer units.

Step-variable costs are costs that stay fixed over a range of activity and then change
after this range is overcome. In other words, these costs change in increments.

Step-variable costs include characteristic of both variable and fixed costs in a way that (a)
such costs change as production level changes, and (b) such costs change only when a
production level (range of activity) is overcome. Within that range of activity, step-variable
costs remain fixed.

The major differences between step-variable costs and fixed costs are that step-variable
costs are changed by activity (rather than by a management decision) and they are more
easily changed compared to fixed costs.

Examples of step-variable costs and their cost drivers are provided below:

Type of Business Cost Cost Driver

Manufacturing Number of workers Number of units
produced
Restaurant Number of waiters Number of clients
Hotel Number of Number of rooms
housekeepers occupied
Hospital Number of nurses Number of patients

To illustrate step-variable costs, assume that an employee can operate one equipment to
produce 100 valves per day. If 320 valves need to be produced, the company would hire
four employees (three employees won't be enough because three employees can only
produce 300 valves). If the valve production requirement is increased to 400 units, four
workers will still be able to cope with the work load. However, for 410 valves, an additional,
fifth employee would be needed.

Thus, the company's payroll costs change in steps, from costs for four (4) employees at 320
or 400 units, to payroll costs for five (5) employees at 410 units.

14
Step-variable cost graph

Exhibit 1.3
Step-Variable Cost

This graph describes step-variable payroll costs, where the width of each step represents
the volume of activity (i.e., valve production) needed before the step-variable costs increase
to the next level (i.e., an additional employee is hired). Once the next level is achieved, the
payroll costs increase and remain constant until the next level is achieved again.Note that a
narrow width means that a step-variable cost is sensitive to fairly small fluctuations in
related activity.
VI. Significance in Decision Making

 Relevant Costs (also known as differential costs) are expected future costs that will
differ between 2 or more alternatives. Such costs may either be incremental or
decremental. Incremental costs are the cost increases or the additional costs while
decremental costs are the decreases in cost.

 Irrelevant Costs are costs that do not relate to any of the decision alternatives and
are either historical in nature, or are the same under all decision alternatives.

VII. Managerial Control or Managerial Influence

 A cost is said to be controllable when the amount of the cost is assigned to the
department head and the level of the cost is significantly under the manager's
influence.

 Non-controllable costs are those not subject to influence at any given level of
managerial supervision or influence.

VIII. Commitment to Cost Expenditures

 Out-of-Pocket Costs are costs that must be met with a current expenditure or cash
outlay. It is opposite to imputed costs.

 Committed Costs are costs that are the inevitable consequence of a previous
commitment. It is a cost item that cannot be changed in the short-run as it results
from a commitment made in the past like depreciation of equipment.

 Discretionary Costs or Programmed Costs (subject to managerial control) are costs

for which the size or the time of incurrence is a matter of choice. It is an item of cost
which can be changed by management decisions like advertising expense.

15
  Marginal Costs are costs associated with the next unit or an incremental cost
associated with additional unit produced or sold.

 Sunk Costs are the cost of resources already incurred in the past whose total will not
be affected by any decision made now or in the future. These are the past costs
about which nothing can be done hence they are considered as irrelevant costs.

 Imputed Costs are hypothetical costs representing the cost or value of a resource
measured by its use value. They do not involve actual cash outlay, not recorded in
the books and not considered in the company's regular cost and profit calculations.
Examples are the interest on invested capital and the rental value of company-
owned properties.

IX. Other Cost Classification

 Standard Cost is production or operating cost that is carefully predetermined. It is a

target cost that should be achieved.

 Opportunity Cost is the net revenue foregone by rejecting an alternative, or the

measurable value of an opportunity bypassed by rejecting an alternative use of
resources. It is a type of future costs.

 Information Costs are the costs of obtaining information.

 Ordering Costs are costs that increase with the number of orders placed for
inventory like preparing the requisition and the purchase order, handling the
incoming shipment, preparing a receiving report and communicating in case of errors
or delays in receipt of materials.

 Capitalized Costs are treated as assets and become expenses in future periods as the
asset is depreciated or amortized.

 Engineered Cost is an item of cost for which the optimum amount that should be
spent can be estimated. It has a clear relationship to output. Examples: Direct
materials and direct labor costs.

 Postponable Costs are costs that cannot be avoided but the incurrence of which is
deferred at a future date.

 Staff Service Costs are incurred by the different departments that provide assistance
to the line or operating units. They are indirect costs of the line departments with
the exception of those costs which are traceable directly to the latter.

 General Corporate Costs are those incurred in the general management of a

company and in meeting the company’s public responsibilities. They are seldom
identified with a specific function so that they are treated as indirect costs in general.
Examples are the compensation given to the members of the BOD, top executives,
and their personal staffs, donations to charitable organizations, membership fees in
trade associations, costs of court litigations, and the costs of the legal staff.

 Costs of Capital are the costs of using the capital invested in the assets of the
company. It consists of both the costs of borrowed capital and costs of equity
capital.

16
  Distribution Costs refers to the costs directly related to the marketing of a company’s
products such as storage costs, advertising, commissions, salesmen’s salaries and
shipping costs. It refers to all expenditures made from the time the finished product
leaves the factory until it is delivered to the customer and the customer’s payment
has been recorded.

 Order-getting costs are the costs incurred to increase the volume of sales or to
obtain the desired sales mix. They are incurred to improve the sales level and are
not generally traceable to sales orders.

 Order-filling (or logistics) costs are those costs incurred to enable the company to fill
an order or deliver the product to the customer. They are incurred based on actual
sales orders and/or expected sales volume so that most of them can be traced to
sales orders. They will include warehousing or storage costs, packing & shipping
costs, order-assembly costs, transportation costs, credit & collection costs and also
financial costs of carrying inventory.

Methods of Separating Mixed Costs

Management usually needs to know what fixed and variable costs are included in mixed
costs. There are three (3) alternative methods of separating a mixed cost into its fixed and
variable components, namely: high-low method, scatter-graph method, and method of least
squares.

High-low Method. As the name indicates, this method uses two extreme data points: the
highest point and the lowest point. The advantage of this method is its simplicity. However,
this method ignores all data points other than the highest and the lowest activity levels. The
highest and the lowest activity points often do not represent the rest of the points, which
leads to a possible inaccuracy of the final results. This is the main disadvantage of this
method. So before using the high-low method, it is important to plot or graph all of the
data available to be certain that the two sets of numbers being used are indeed
representative. In order to get more precise results, it is better to use the scatter-graph
method or the method of least squares.

Suppose you put up a business that produces valves for the automotive industry. How
much should you charge for one valve in order to stay in business? How many valves should
be sold in a given month at a given price to cover your costs? These questions can be
answered with the aid of cost information. Cost information can support managers' decision-
making.

To illustrate the use of this method, let us assume that you have incurred the following
costs during the past six months:

Month Total Cost Valves

Production
July P44,000 10,000
August P60,000 15,000
September P85,000 23,000
October P75,000 21,000
November P70,000 19,000
December P98,000 28,000
17
The lowest level of production was in July and the highest level of production was in
December. The difference between the number of valves produced and the difference
between the total cost at the highest and lowest levels of production are shown on the next
page:

Total Cost Production

 
Highest Level P98,000 28,000 units
Lowest Level P44,000 10,000 units
Difference P54,000 18,000 units

As the total fixed cost does not change with changes in the production volume, the
difference in the total costs represents the change in the total variable costs. So, if we
divide the difference in the total costs by the difference in the production levels, we will
have an estimate of the variable cost per valve: Variable Cost per Unit = P54,000 ÷
18,000 units = P3.00 per unit or per valve.

The fixed cost will be the same at both the highest and lowest levels of production because
fixed costs don't change in terms of total amount. To estimate the fixed costs, subtract the
estimated total variable cost from the total cost:

@ the Highest Point: @ the Lowest Point:

Total Cost ………………………………. P 98,000 Total Cost …………………………. P 44,000
Less Total Variable Cost P3 x 28,000 = 84,000 Less Total Variable Cost P3 x 10,000 = 30,000
Total Fixed Cost P 14,000 Total Fixed Cost P 14,000
======== =======
Regardless of what activity level you operate, notice that the total fixed cost is the same.
To estimate the total costs for the planned production level, use this formula:

TC = FC + (UVC x N or planned production level)

where TC is the total cost, FC is the fixed cost, UVC is the unit variable cost, and N is the
number of units to be produced.

In other words, the algebraic formula for a mixed cost is y = a + bx

Where: y = the total cost
a= the fixed cost per period
b = the variable rate per unit of activity
x = the number of units of activity.

Based on this algebraic equation, it can therefore be stated that:

To get b =Highest Cost – Lowest Cost

Highest Activity Level – Lowest Activity Level

To get a = y - bx

What happens when the high-low method ends up with a negative amount? The high low
method of determining the fixed and variable portions of a mixed cost relies on only two
sets of data: 1) the costs at the highest level of activity, and 2) the costs at the lowest level
of activity. If either set of data is flawed, the calculation can result in an unreasonable,
negative amount of fixed cost. The negative amount of fixed costs is not realistic. Either
18
the total costs at either the high point or at the low point are not representative. This brings
to light the importance of plotting or graphing all of the points of activity and their related
costs before using the high low method. (The number of units uses the scale on the x-axis
and the related total cost at each level of activity uses the scale on the y-axis.) It is
possible that at the highest point of activity the costs were out of line from the normal
relationship—referred to as an outlier.  In this case, use the second highest
level of activity, if the related costs are more representative.

The high-low method is not preferred because it can yield an incorrect understanding of the
data if there are changes in variable or fixed cost rates over time, or if a tiered pricing
system is used. Thus, the high-low method should be used when it is not possible to obtain
actual billing data or when the data available is limited.

Scatter-graph Method. This method (also called scatter plot or scatter chart method)
involves estimating the fixed and variable elements of a mixed cost visually on a graph. It
requires that all recent, normal data observations be plotted on a cost (Y-axis) versus
activity (X-axis) graph. The vertical axis of the graph represents the total costs and the
horizontal axis shows the volume of related activity.

The first step is to plot the points on a graph. Then draw a line that most closely represents
a straight line composed of all the data points. The point where this line intersects the
vertical axis is the fixed costs. The angle (slope) of the line can be calculated to give a
fairly accurate estimate of the variable cost per unit. This method is simple to use and
provides clear representation of correlation between costs & the volume of activity.
However, the disadvantage of this method is the difficulty in determining the location of the
best-fit line.

Method of Least Squares. The most robust method of separating mixed costs is the least-
squares regression method. This tool is ideally suited to cost behavior analysis though it
might appear to be complicated. It requires the use of 30 or more past data observations
for both the activity level (in units) and the total costs.

The goal of least squares is to define a line so that it fits through a set of points on a graph,
where the cumulative sum of the squared distances between the points and the line is
minimized (hence the name “least squares”). It identifies the line that best fits the data
points (the sum of the squared deviations is minimized).

This method is the most sophisticated and provides the user with a measure of the
goodness of fit, which can be used to assess the usefulness of the cost formula. Usually this
method requires the use of software which will also provide statistical insights .

Classes of Inventories in a Manufacturing Firm

In a manufacturing firm, the production or conversion process can be viewed into three (3)
stages: 1) work not started; 2) work started but not completed yet; and 3) fully completed
work. Cost of inventories associated with each stage include raw materials inventory, work
in process inventory and finished goods inventory.

Perpetual inventory system is used to account for these three (3) classes of inventory of a
manufacturer. The controlling accounts used and the related subsidiary records are as
follows:

19
Controlling Accounts Subsidiary Records

Materials Material ledger card

Used for both direct and indirect materials

Work in process Inventory Job Order Cost Sheet

Represents the accumulated cost of unfinished (for job order costing)
units or jobs still in process
Cost of Production Report
(for process costing)

Finished Goods Inventory Finished goods ledger card

Represents the accumulated cost of the finished
units or the completed jobs

Costing for a Service Provider or Service Companies

In a service firm or service providers, the work not started stage consists of the cost of
supplies needed to perform the services which is reflected in the account called Supplies or
Supplies Inventory. When the cost of supplies are charged to a particular customer or job
order, conversion costs are also added to determine the total cost of services provided
which shall be used as the basis in determining the amount to be billed to that customer
after the markup has been added. Determining the cost of services provided is essential for
both profit-oriented service businesses and not for profit entities. For example, architectural
firms accumulate the costs incurred for designs and models of each project while hospitals
accumulate the costs of an X-ray, MRI or Outpatient Services for each patient.

Like product costs, cost of services includes three (3) components: Direct Materials, Direct
Labor & Overhead. However, the proportions of each may vary since service firms typically
have few material costs and large amounts of labor & overhead. Although they have both
direct & indirect costs, they generally have larger proportions of indirect costs. So the
predetermined overhead rate is typically based on direct labor cost. It is also common to
combine labor cost with the predetermined overhead rate, so the amount charged to a job
for each direct labor hour represents both labor and overhead. The only remaining items to
be charged to each job are the directly traceable costs other than labor. In a repair shop,
cost of parts corresponds to direct material cost in manufacturing. In a professional service
business, directly traceable costs include costs of travel, meals, entertainment, long
distance telephone charges, photocopying & subcontracted services. Work in process
accounts are commonly used on projects that were incomplete at month-end, such as audits
by accounting firms, lengthy legal cases by law firms, and consulting engagements that are
long term.

An employee who incurs reimbursable expenses is typically required to report the date of
the expenditure, the client's name or job #, the nature of the cost, & an original receipt for
large amounts. This information establishes the legitimacy of the reimbursement & also
enables the costs to be traced directly to jobs. To trace long distance telephone charges,
each employee is required to log each call. Weekly or monthly summaries of all costs are
prepared and entered on the job order cost sheet.

Cost of Goods Sold Statement

A company must determine first how much of the available supply of materials (both direct
and indirect) was transferred into production during the period.  The perpetual inventory
system tracks the material as it is placed into production.  Shown below is a pro-forma

20
schedule of direct materials used which summarizes the activity for the period and
concludes with the peso amount attributed to direct materials that have flowed into the
production cycle: 

Schedule of Direct Materials Used

Materials Inventory Beginning ………………………………………………. P xx

Add Net Purchases of Materials ……………………………………………. xx
Materials Available for Use ………………………………………………… P xx
Less Materials Inventory End ……………………………………………… xx
Direct Materials Used or
Raw Materials Transferred to Work in Process P xx
====

The Schedule of Cost of Goods Manufactured is used to calculate the cost of producing
products for a period of time. Such schedule reports the total manufacturing costs for the
period that were added to work-in-process, and adjusts these costs for the change in the
work-in-process inventory account to calculate the cost of goods manufactured.

Schedule of Cost of Goods Manufactured

Direct Materials Used:

Materials Inventory Beginning ………………………………………………… P xx
Add Net Purchases of Materials ………………………………………………. xx
Materials Available for Use ……………………………………………………. P xx
Less Materials Inventory End ………………………………………………… xx
P xx
Direct Labor ………………………………………………………………………………….. xx
Factory Overhead:
Indirect Materials Used ………………………………………………………… P xx
Indirect Labor Cost ……………………………………………………………… xx
Factory Utilities ………………………………………………………………….. xx
Depreciation of factory assets …………………………………………………. xx
Miscellaneous factory overhead …………………………………………… xx
Total Manufacturing Costs or
Total Production Costs This Month P xx
Add Work in process, beginning or
Total Production Costs Last Month xx
Cost of goods placed into process ………………………………………………………… P xx
Less Work in process, end …………………………………………………………………… xx
Cost of Goods Manufactured ………………………………………………………………… P xx
=====

The cost of goods manufactured is transferred to the finished goods inventory account
during the period and is used in calculating cost of goods sold on the income statement.
Manufacturing companies normally prepare the schedule of costs of goods manufactured
before they prepare the income statement.

21
Shown below is the Schedule of Cost of Goods Sold for a manufacturing business:

Schedule of Cost of Goods Sold

Finished Goods Inventory Beginning ………………………………………………… P xx

Add Cost of Goods Manufactured ……………………………………………………. xx
Total Goods Available for Sale or TGAS …………………………………………… Pxx
Less Finished Goods Inventory End ………………………………………………… xx
Cost of Goods Sold …………………………………………………………………… Pxx
====

The Schedule of Cost of Goods Sold for a trading or merchandising business will look
like this:

Merchandise Inventory Beginning ………………………………………………… P xx

Add Net Cost of Purchases …………………………………………………… . xx
Total Goods Available for Sale or TGAS …………………………………………… Pxx
Less Merchandise Inventory End ………………………………………………… xx
Cost of Goods Sold or Cost of Sales………………………………………………… Pxx
====

Cost of Goods Manufactured is the manufacturer’s counterpart to the trader’s Purchases.

When finished goods are sold, their cost is called the Cost of Goods Sold. There are
instances when the beginning and ending inventory balances are not given. Instead, the
peso amount of increase or decrease of an inventory account is provided. Remember, there
is increase in inventory when the Balance End is greater than Balance Beginning or
inventory decreases when the Balance End is less than its Balance Beginning. To illustrate
this, assume that Finished Goods Inventory beginning exceeded its ending balance by
P 600,000 and the cost of the completed goods this month is P 8.6 million. Hence, Cost of
Goods Sold is computed as follows:

Cost of Goods Manufactured P 8,600,000

Add Decrease in Finished Goods Inventory 600,000
Cost of Goods Sold P 9,200,000
========

Name: ____________________________________________ Score: _____________

22
Class Schedule: ____________________________________ Date : _____________

Exercise 1-1(True or False)

Instruction: On the blank space provided for each number shown below, write R if the
statement is true; write W if the statement is false (n x 1)

_____1. The balance of the Finished Goods Inventory account includes all manufacturing
costs incurred to date for goods in various production stages but not yet
completed.
_____2. The main features of service businesses are that they have little or no inventory
and that labor costs account a large portion of its total costs.
_____3. Knowing the cost of providing services is not important in contract bidding as well
as in deciding what types of services will be offered to the general public.
_____4. The basic document used to accumulate costs for a service business using job
order costing is the job order cost sheet.
_____5. The cost accounting system must be designed to determine total production costs
as well as the unit production cost.
_____6. One of the most important aspects of cost accounting is the preparation of reports
that management can use to plan and control operations.
_____7. The payroll-related costs of factory workers such as sick leave with pay, vacation
pay, retirement program contributions, and other fringe benefits are usually
treated as indirect labor costs.
_____8. Job Order Cost Sheet is the subsidiary record for the controlling account Work in
Process Inventory.
_____9. Opportunity cost is the value of benefit sacrified in favor of an alternative course
of action.
____10. The plant manager’s salary is not considered an engineered cost because it does
not have a direct cost relationship to outputs.
____11. Not all selling and administrative expenses are treated as period costs.
____12. Period costs are expensed on the income statement in the period in which they are
incurred using the usual rules of accrual accounting.
____13. The costs of operating finished goods warehouse is classified as a selling cost.
____14. The cost of an advertising campaign dedicated to a specific product is an indirect
cost of that product while the salary of a marketing manager who oversees
numerous products is a direct cost with respect to individual products.
____15. If Skechers is assigning costs to its various regional and national sales offices,
then the salary of the sales manager in its Tokyo office would be a direct cost of
that office.
____16.In 1772, Joshua Wedgwood became the world’s first cost accountant.
_____17. Manufacturers that use a job order cost system are sometimes called job shops.
_____18. Any balance in the factory overhead control account should be carried over to the
next accounting period.
_____19. The Finished Goods account is a controlling account for the subsidiary Finished
Goods ledger or stock ledger.
____20. Period costs are used in generating revenue during the current period but are not
involved in the manufacturing process.

Name: ____________________________________________ Score: _____________

Class Schedule: ____________________________________ Date : _____________

23
Exercise 1-2 (Graded group activity to familiarizevarious cost terms)

Instruction: Using the terms found in Chapter 1, prepare a crossword puzzle.

Exercise 1-3(Computation of Manufacturing Costs)

Analyze the following independent cases:

1. Work in process inventory increased by P11,500. Costs incurred during September were
P12,000 for materials used, P63,000 for direct labor, and P21,000 for overhead.
Compute the cost of goods manufactured for September.

2. Costs incurred in June were P15,000 for materials purchased, P40,000 for direct labor,
and P50,000 for overhead. Materials inventory decreased by P4,000. If cost of goods
manufactured in June was P99,000 and beginning work in process inventory was
P28,000, compute the ending work in process inventory.

3. The cost of goods sold for November was P156,000, finished goods inventory decreased
by P13,000, and work in process inventory increased by P9,000. Determine the total
manufacturing costs for November.

4. Dwan Company has the following data at the end of November of the current year:

Factory burden in November P 75,254.50

Decrease in Materials Inventory 6,075.00
Decrease in Work in process Inventory 1,475.00
Increase in Finished Goods Inventory 3,301.00

The factory burden is 50% of the direct labor costs and the conversion costs is 50% of
the total cost of manufacturing. All materials are purchased FOB shipping point.
Determine the cost of goods manufactured for the month.

Name: ____________________________________________ Score: _____________

Class Schedule: ____________________________________ Date : _____________

24
Exercise 1-4 (Cost Classification)

CT’s Burger Haus produces and sells hamburgers. Each burger sells for P 15.00. During
December, CT’s sold 10,000 burgers (the average number sold each month). This
establishment employs cooks, servers, and one supervisor (the owner, Addy Yee). All cooks
and servers are part-time employees. It maintains a pool of part-time employees so that
the number of employees scheduled can be adjusted to the changes in demand. Demand
varies on a weekly as well as monthly basis. A janitor is hired to clean the building on a
weekly basis. The building is leased from a local real estate company. The building has no
seating capabilities. All orders are filled on a drive-through basis. The supervisor schedules
work, opens the building, counts the cash, advertises, and is responsible for hiring and
firing. The following costs were incurred in December:
1. Hamburger meat …… P 16,000 9. Utilities ………………… P 5,000
2. Lettuce ……………… 3,000 Depreciation:
3. Tomatoes ……………… 2,500 10. Cooking Equipment … 2,000
4. Buns …………………… 3,000 11. Cash register ………… 500
5. Other ingredients ………. 200 12. Advertising …………… 1,000
6. Cooks’ wages …………. 25,500 13. Janitor’s wages ……… . 1,200
7. Servers’ wages………… 20,320 14. Janitorial supplies…… .. 500
8. Supervisor’s salary …… 20,000 15. Rent …………………… 8,000

REQUIRED: Classify the costs for CT’s Burger Haus December operations in one of the
following categories: Direct materials, direct labor, overhead or selling and
administrative expenses.

1. ___________________ 9. __________________

2. ___________________ 10. ___________________

3. ___________________ 11. ___________________

4. ___________________ 12. ___________________

5. ___________________ 13. ___________________

6. ___________________ 14. ___________________

7. ___________________ 15. ___________________

8. ___________________

Name: ____________________________________________ Score: _____________

Class Schedule: ____________________________________ Date : _____________

25
Exercise 1-5 (Cost Classification)

For each cost description, identify whether the cost is mainly fixed or variable with respect
to the possible measure of activity listed on the right side.

Cost Description Possible Measure of Activity

1. Cost of vaccine used at a clinic Vaccines administered

2. Building rent at a taco shop Peso sales

3. Salary of production manager at a

pharmaceutical company Medicinal bottles produced

4. Cost of electricity for production equipment

at a water refilling station Gallons of water produced

5. Ferry captain’s salary on a regularly

scheduled passenger ferry Number of passengers

6. Cost of glue used in furniture production Units produced

7. Janitorial wages at a car assembly

plant Cars produced

8. Depreciation on factory building at a

cement manufacturing firm Cement bags produced

9. Cost of advertisement at an airline company Airline tickets sold

10 Cost of shipping bags of fertilizer to a Bags shipped

. customer at a chemical plant

Name: ____________________________________________ Score: _____________

Class Schedule: ____________________________________ Date : _____________

26
Exercise 1-6 (Fixed and Variable Cost Behavior)

D Best Coffee Shop operates a number of coffee stands in various shopping malls in Cebu
City. A partially completed schedule of the coffee shop’s total cost and cost per cup of
coffee over the relevant range of 30,000 to 50,000 cups served and sold monthly is given
below:

Cups of Coffee Served and Sold

30,000 40,000 50,000

Total Variable Costs P 180,000 ? ?

Total Fixed Costs 300,000 ? ?
Total Costs P 480,000 ? ?

Cost per cup of coffee:

Variable Cost ? ? ?
Fixed Cost ? ? ?
? ? ?

Required: Complete the schedule of the coffee shop’s total costs and cost per cup of
coffee. Assuming that the coffee shop can serve and sell 45,000 cups during
the month at a selling price of P16 per cup, will they be able to operate
profitably? If Yes, how much profit will they earn? How many cups of coffee
must be served and sold per month in order to breakeven?

I LOVE
ACCOUNTING

Name: ____________________________________________ Score: _____________

Class Schedule: ____________________________________ Date : _____________

27
Exercise 1-7(Inventory Balances; Journal Entries)

Lindy Co. commences its operations on April 1 of the current year. Information from job
cost sheets shows the following:
Manufacturing Costs Assigned
Job # April May June
70 P 5,200 P 4,400
71 4,100 3,900 P 3,000
72 1,200
73 4,700 4,500
74 3,900 3,600
Job 72 was completed in April. Job # 70 was completed in May, and Jobs 71 and 73 were
completed in June. Each job was sold for 50% above its cost in the month following
completion.

 What is the balance in Work in Process Inventory at the end of each month?

1. April _____________ 2. May ______________ 3. June __________________

 What is the balance in Finished Goods Inventory at the end of each month?

4. April _____________ 5. May ______________ 6. June __________________

 What is the gross profit for June and July?

1. June ___________________ 8. July __________________

 Prepare the journal entry or entries reflecting the cost of the completed job(s) in June.

_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
______________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
______________________________________________________________________

28
Name: ____________________________________________ Score: _____________
Class Schedule: ____________________________________ Date : _____________

Exercise 1-8(inventory costs; manufacturing costs)

Familia Corp. began operations on October 1. It employs a job order costing system.
Overhead is charged at a normal rate of P2.50 per direct labor hour. The actual operations
for the month of October are summarized as follows:

a. Purchased raw materials, 25,000 pieces @ P 1.20 per piece.

b. Material and labor costs charged to production:

Job Order # Units Material Direct Labor Cost Direct labor hours
501 10,000 P 4,000 P 6,000 3,000
502 8,800 3,600 5,400 2,700
503 16,000 7,000 9,000 4,500
504 8,000 3,200 4,800 2,400
505 20,000 8,000 3,600 1,800

c. Actual overhead costs incurred:

Variable ……………………..P 18,500

Fixed …………………….. 15,000

d. Completed Jobs: 501, 502, 503 and 504

e. Sales amounted to P 105,000. All units produced on Jobs 501, 502 and 503 were
sold.

REQUIRED: Compute the following balances on October 31:

1. Material Inventory _________________________

2. Work in process inventory ________________________

3. Finished Goods Inventory _________________________

4. Cost of Goods Sold _________________________

5. Under-or overapplied overhead _________________________

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Name: ____________________________________________ Score: _____________
Class Schedule: ____________________________________ Date : _____________

Exercise 1-9Multiple Choice

Instruction: Encircle the letter of your chosen best answer. No erasuresallowed.

For Items 1-5:

A manufacturing firm keeps its accounting and cost records on a personal computer. During
the month of January, data were lost as a result of errors made by a new operator.
Fortunately, some data were retrieved and are set forth as follows:
 The debit balance in the Payroll account was P 130,000. This balance included
P 20,000 in indirect labor that was charged to the Factory Overhead account.

 The debit balance in the Factory Overhead account totaled P 166,000. This balance
included the indirect labor cost mentioned above.

 Factory overhead is applied to the products at 150% of direct labor cost.

 The Work in Process Inventory account showed a January 1 balance of P 91,000.

Materialsrequisitioned and charged to Work in Process during the period amounted
to P 98,000. The balance in Work in Process Inventory on January 31 was P 82,000.

 The Finished Goods Inventory balance at January 1 was P 48,000.

 Cost of Goods Sold had a debit balance of P 389,000. This amount did not include
the under (over)applied factory overhead.

From the information given above, determine the following:

1. Direct labor cost incurred in January:

a. P 150,000 b. P 130,000 c. P110,000 d. P 90,000

2. The factory overhead applied to production in January:

a. P 165,000 b. P 166,000 c. P 208,000 d. P 275,000

3. The cost of work completed and transferred to the Finished Goods Inventory for the
month:
a. P 373,000 b. P 382,000 c. P 389,000 d. P 464,000

4. The Finished Goods Inventory on January 31 should be:

a. P 41,000 b. P 48,000 c. P 82,000 d. P 91,000

5. The under-applied or (over-applied) factory overhead in January is:

a. P 2,000 b. (P 2,000) c. (P 1,000) d. P 1,000
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For Items 6 & 7:
Waymee Inc. reported the following information:
On January 31, 2019:
Job # 501 was the only job in process with accumulated costs of P 3,000.

Name: ____________________________________________ Score: _____________

Class Schedule: ____________________________________ Date : _____________

During February, the following costs were added to production:

Job # 501 P 10,000
Job # 502 8,000
Job # 503 7,000
On February 28, 2019:
Job # 501 was completed and sold for P 18,000;
Job # 502 was completed but not sold;
Job # 503 remains in production.

6. What is the cost of goods manufactured in February?

a. P 8,000 b. P 10,000 c. P 13,000 d. P 21,000

7. What is the gross margin in February?

a. P 5,000 b. P 8,000 c. P 13,000 d. P 18,000

For Items 8-10:

Based on the following production data for two (2) levels of plant operations:

Budgeted production in units 140,000 160,000

Budgeted production costs:
Materials P 84,000 P 96,000
Labor 140,000 160,000
Factory Supplies 28,000 30,000
Heat, Light and Power 34,000 38,000
Other Factory Overhead 25,000 25,000
Total P311,000 P349,000
======== =======
The company uses the high and low point method of segregating the two (2) semi-variable
costs (factory supplies and the costs of heat, light and power).

8. The variable rate per unit of factory supplies is:

a. P 0.05 b. P 0.10 c. P 0.15 d. P 0.20

9. The fixed cost portion of heat, light and power is:

a. P 4,000 b. P 5,000 c. P 6,000 d. P 7,000

10. The estimated manufacturing costs at a production level of 150,000 units is:
a. P 310,000 b. P 320,000 c. P 330,000 d. P 350,000

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Name: ____________________________________________ Score: _____________
Class Schedule: ____________________________________ Date : _____________

PROBLEMS

Instruction: Solve each problem by showing your solution in good form. Double rule your
final answer.

Problem 1-A (Computation of Manufacturing Costs)

Golets Sporting Goods Company manufactured 100,000 units in 2019 and reported the
following costs:

Sandpaper P 32,000 Leasing costs - plant P 384,000

Materials handling 320,000 Depreciation - equipment 224,000
Coolants & lubricants 22,400 Property taxes - equipment 32,000
Indirect manufacturing labor 275,200 Fire insurance - equipment 16,000
Direct manufacturing labor 2,176,000 Direct material purchases 3,136,000
Direct materials, 1/1/19 384,000 Direct materials, 12/31/19 275,200
Finished goods, 1/1/19 672,000 Sales revenue 12,800,000
Finished goods, 12/31/19 1,280,000 Sales commissions 640,000
Work-in-process, 1/1/19 96,000 Sales salaries 576,000
Work-in-process, 12/31/1964,000Advertising costs 480,000
Administration costs 800,000

Required:
1.What is the amount of direct materials used during 2019?
2.What manufacturing costs were added to WIP during 2019?
3.What amount of prime costs was added to production during 2019?
4.What amount of conversion costs was added to production during 2019?
5. How much is cost of goods manufactured in2019?
6. How much is cost of goods sold in2019?

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Name: ____________________________________________ Score: _____________
Class Schedule: ____________________________________ Date : _____________

Problem 1-B(Cost of Goods Manufactured & Sold)

The following transactions took place for Suchi Manufacturing Company (a producer of
digital glucometers) in January, 2019, the first month of its operations:

a. Purchased P105,200 of materials.

b. Used P68,200 of direct materials in production.
c. Incurred P 130,800 of direct labor wages.
d. Incurred P 150,200 of factory overhead.
e. Transferred P303,000 of work in process to finished
goods.
f. Sold goods with a cost of P 360,000 which is 75% of
its sales.
g. Incurred P66,400 of selling expenses and P53,600 of general and administrative
expenses.

REQUIRED: Using the information given above:

1. prepare the January 2019 statement of financial operations for Suchi
Manufacturing Co.
2. determine the inventory balances at the end of the first month of
operations.

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Name: ____________________________________________ Score: _____________
Class Schedule: ____________________________________ Date : _____________

Problem 1-C (Manufacturing Costs Computation)

For each of the following independent cases, determine the amount indicated by a question
mark:

1. Merchandise Inventory Purchases P420,000

Cost of goods sold 446,000
Beginning balance 82,000
Ending balance ?

2. Direct Materials Beginning balance P 14,000

Ending balance 28,000
Purchases 96,000
Direct materials used ?

3. Work-in-process Inventory Ending balance P 44,000

Cost of goods manufactured 42,000
Beginning balance 16,000
Current manufacturing costs ?

4. Finished Goods Inventory Cost of goods manufactured P124,000

Ending balance 40,000
Cost of goods sold 122,000
Beginning balance ?

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