Cost Accounting I Module AUC MT Final 1 - Finall (1) Handout

DREAMLAND COLLEGE
Handout For
Cost and Management Accounting I
Cost and Management Accounting I Handout Page 1

DREAMLAND COLLEGE
UNIT ONE
INTRODUCTION TO COST ACCOUNTING
PART ONE: FUNDAMENTALS OF COST ACCOUNTING

1.1 Purposes of Accounting System
The accounting system is the principal, and the most credible, quantitative information system in
almost every organization. This system should provide information for four broad purposes:
 Purpose 1: Internal routine reporting to managers for cost planning and control of
operations and performance evaluation of people and activities.
 Purpose 2: Internal routine reporting to managers on the profitability of products, brand
categories, customer, and distribution channels, and so on. This information is used in
marking decision on resource allocation and in some cases decisions on pricing.
 Purpose 3: Internal non-routine reporting to managers for strategic and tactical decisions
on matters such as formulating overall policies and long-range plans, new product
development, investing in equipment, and special orders or special situations.
 Purpose 4: External reporting through financial statements to investors, creditors,
government authorities, and other outside parties. To satisfy external purposes,
businesses must report income and inventory costs in accordance with the generally
accepted accounting principles that guide financial accounting.
Both management and external parties share an interest in accounting information but the
emphasis differ. Internal reporting focuses on management planning and controlling. This area
is known as management accounting, Management accounting, focusing on internal customers,
measures and reports financial and other information that assists managers in fulfilling goals of
the organization.
For example, a consumer products company may present a particular estimated “value”
of a brand name (such as the Coca-Cola brand name) in its internal financial reports for
marketing, although doing so is not in accordance with generally accepted accounting principles.
1.2 How Accounting Facilitates Planning and Control?
Planning is defined as (the top box) choosing goals, predicting results under various alternative
ways of achieving those goals, and then deciding how to attain the desired goals. For example,
one goal of GSN may be to increase operating income. Three main alternatives are considered to
achieve this goal:
1. Increase the price per newspaper
2. Increase the rates per charged to advertisers, or
3. Reduce labor costs by having fewer workers at GSN’s printing facility
Planning and control are strongly intertwined that managers do not spend time drawing
artificially rigid distinctions between them. Control can be used in its broadest sense to denote
the entire management process of both planning and control. For example, management control
system can be to refer as management planning and control system.

DREAMLAND COLLEGE
Concept of Cost Accounting

2.1 Meaning of Cost Accounting
Cost accounting is a specialized field of accounting, which measures, analyzes, and reports
financial and non-financial information relating to the cost of acquiring or using resources in an
organization. Cost accounting primarily provides the present financial transaction.
Cost accounting is the process of classifying, recording, and appropriate allocation of
expenditure for determining the cost of product or service, and for the presentation of suitably
arranged data for the purpose of controlling and guidance of the management.
ACCOUNTING Purposes of Cost Accounting
Cost accounting has developed as a specialty within the field of accounting at the same time that
business enterprises become more complex. In simpler times, when individual artisans provided
goods and services, elaborate accounting records were unnecessary.
Planning:
The cost accounting system provides vital information needed to plan future operations. Cost
data help to resolve questions relating to proposed projects or policies, such as the following:
 Should we build a new plant or modernize the old one?
 How far can we go in lowering prices to increase our volume of sales?
 What will be the effect on costs of automating part of our factory operations?
Budgeting:
Cost accounting is also used in preparing a company's budget. A budget is the overall financial
plan for the future activities. All levels of the management should be involved in the
development of budget.
Controlling Costs:
Cost accounting is one of the most valuable management tools to control operations. Comparing
actual costs with budgeted costs are helpful in evaluating the results of operations.
Determining Profits:
One of the objectives of cost accounting is the consistent allocation of manufacturing costs to
units in the ending inventory and to units sold during the period. At the end of the fiscal year, the
matching of costs with revenues determines profits for the period.
Product Pricing:
Management's pricing policy should assure not only the recovery of all costs but also the
securing of a profit even under adverse conditions.
Choosing among Alternatives:
Managers continuously face not one or two alternatives, but numerous alternative actions that
might be taken in any given situation facing a firm.
Estimating and Bidding:
In certain trades, knowledge of the costs of doing business is needed to estimate a job or to bid
for other jobs or contracts.
Comparison of Cost Accounting and Management Accounting

DREAMLAND COLLEGE
Cost accounting is a specialized form of accounting, which measures, analyzes, and reports
financial and non-financial information relating to the cost of acquiring or using resources in an
organization.
Items of Cost Accounting Management Accounting (MA)

Difference (CA)
Purpose The purpose of cost accounting is The purpose of management

to record, classify, accumulate accounting is to provide reports
and the costs of companies’ for management planning and
products and services. control.
Scope/Applic- Cost accounting methods and Management accounting
ability techniques are generally methods and techniques are
applicable to manufacturing applicable to all concerns
concerns
Accounting It is used in accordance with the It is not constrained by GAAP.
Principles GAAP. Double entry principles Double entry principle is not
can be applied in CA applied in the case of MA
Future CA does not attach importance to Future activities are primarily
Activities future activities considered in MA
Development the development of cost Management accounting has
accounting is related to industrial developed only in the last fifty
revolution years.
Table 2.1: Cost Accounting vs. Management Accounting

2.2 Roles of Cost Accountants
Any person responsible for the supply of cost accounting information to management is known
as cost accountant. A cost accountant is a specialist who analyzes the cost recording and
reporting needs of a business and devises a system of records and procedures that will meet these
needs.

DREAMLAND COLLEGE
UNIT TWO
BASIC COST CONCEPTS AND COST CLASSIFICATIONS

1.1 Meaning of Cost
Cost is distinguished from expense, which is the value of assets given up to generate revenue.
Clearly, most costs eventually become expenses. In fact, some become expenses virtually at the
same time as the costs are incurred. When this is true, the terms cost and expenses are
interchangeably used.
1.2 Meaning of Cost Object (Cost Objective)
The cost object is a key feature of management accounting. It may be an activity or operation in
which resources are consumed or received (repairing automobiles, responding in inquires for
information, reconciling bank statement). The cost object may be a product or service e.g.
(Renting room, flying passenger from Addis Ababa to Gondar). The cost object may be project
e.g. constructing a house.
Cost Object
Activity or Product or Project Departments Program

operation services
Exhibit 1.1 Cost Object

By itself, the term cost is meaningless. Cost measurement must be tied to at least one cost object.
The same cost may pertain to many cost objects simultaneously.
1.3 Cost Accumulation and Cost Assignment
A costing system typically accounts for costs in two basic stages: Stage 1: It accumulates costs
by some "natural" (often self-descriptive) classification such as materials, labor, fuel, advertising,
or shipping. Stage 2: It assigns these costs to cost objects. In other words, the cost accounting
system typically includes two processes: cost accumulation and cost assignment.
i) Cost Accumulation
It involves collection of cost data in an organized way by some “natural” classification such as
materials or labor. Costs may be accumulated as materials costs, labor costs, and overhead costs.
ii) Cost Assignment
It is a general term that encompasses both cost tracing and cost allocation. Cost tracing is the
assigning of direct costs to the chosen cost object. Cost allocation is the assigning of indirect
costs to the chosen cost object. Cost assignment is a general term that encompasses both (1)
tracing accumulated costs to a cost object, and (2) allocating accumulated costs to a cost object.
Costs that are traced to a cost object are direct costs, and costs that are allocated to a cost object
are indirect costs.

DREAMLAND COLLEGE
Direct Cost tracing

Costs Cost
Cost assignment Object
Indirect Cost allocation
Costs
Exhibit 1.2 Cost Tracing and Allocation

Direct costs are costs that are related to the particular cost object and that can be traced to it in an
economically feasible (cost – effective) way. In contrast, indirect costs are costs that are related
to the particular cost object but cannot be traced to it in an economically feasible way.
1.4 Cost Driver
A cost driver is any factor whose change causes a change in the total cost of a related cost object.
Drivers are casual factors whose effects are increases in total costs. There are many possible cost
drivers.
Activity Cost Drive
 Product design Number of products, number of parts
 Distribution Type of transportation, miles driven weight number of
stops, speed
 Manufacturing Production volume, in unit of products, number of setups,
number of parts
2.1 Manufacturing Costs Vs. Non-manufacturing Costs

(General Cost Classification)
Costs are generally classified into manufacturing and non-manufacturing costs. Classification of
costs as manufacturing and non-manufacturing costs depends on whether the costs are
considered direct or indirect in relation to the firm’s manufacturing activities taken as a whole.
a) Manufacturing Costs
Manufacturing costs, often called production cost or factory cost, are divided into three broad
categories: direct materials, direct labor, and manufacturing overhead. A discussion of each of
these categories follows.
(A) Direct Materials Costs
Direct materials (direct raw materials) are all materials that physically become an integral part of
the finished product and that can be traced to the manufactured goods in an economically
feasible (cost effective) way. Examples of direct materials may include:
 Lumber used to manufacture furniture
 The crude oil needed to make gasoline
 A handle of a hammer

DREAMLAND COLLEGE
Direct materials costs are the acquisition costs of all materials that eventually become part of the
cost object (say, units finished or in process), and that can be traced to the cost object in an
economically feasible way. Acquisition costs of direct materials include freight-in (inward
delivery) charges, sales taxes, and custom duties.
(B) Direct Labor Costs
Direct labor is a labor that is directly and specifically identified with the production of a
particular product and contributes directly in the completion of the product.
Manufacturing Overhead Costs
Manufacturing overhead includes all costs associated with the manufacturing process that are not
classified as direct material or direct labor costs
i. Indirect Materials Costs
Materials needed for the completion of a production but are insignificant in cost and cannot be
conveniently traced to the units produced, are termed indirect materials (indirect raw materials).
ii. Indirect Labor Costs
Labor that do not work directly on the product but whose services are necessary for the
manufacturing process are classified as indirect labor. Such personnel may include
 janitors in the factory
 production department supervisors
 employees engaged in repairs and maintenance on production equipment
iii. Other Manufacturing Overhead Costs
All manufacturing overhead costs that are neither material nor labor costs are classified as other
manufacturing overhead costs (commonly, other manufacturing costs).
Manufacturing Costs
Direct material Direct labor Factory overhead

+ +
Prime costs Conversion costs

Exhibit 1.2 Manufacturing Costs
b) Non-manufacturing Costs
In addition to manufacturing costs, an understanding of non-manufacturing costs can be very
helpful. Generally, non-manufacturing costs or commercial expenses fall into two large

DREAMLAND COLLEGE
categories: - marketing (distribution or selling) expenses and administrative (general and

administrative) expenses.
i. Selling (distribution or Marketing) Expenses
Selling expenses includes all costs necessary to secure customer orders and get the finished
product or service into the hands of the customer. These costs are often called order getting and
order-filling costs. Examples of selling costs include
 advertising,
 shipping charges,
 travel costs to sales person,
ii. Administrative (General and administrative) Expenses
Administrative costs includes all executive, organizational and clerical costs associated with the
general management of an organization rather than associated with manufacturing, marketing, or
selling.
2.2 Product Costs Vs. Period Costs
In addition to being placed in manufacturing and non-manufacturing categories, costs can also be
classified as either product costs or period costs. To understand the difference between product
costs and period costs, you must first refresh your understanding of the matching principle.
(A) Product Costs
A product cost is a cost assigned to goods that were either purchased or manufactured for resale.
The product cost is used to value the inventory of manufactured goods or merchandise until the
goods are sold.
B Period Costs
Period costs are costs that are matched against revenues on a time period basis. It is to mean that
these costs are treated as expenses and deducted from revenues in the time period in which they
are incurred.
2.3 Direct Costs Vs. Indirect Costs
Another common classification of costs is based on the ease with which costs may be traced to
a cost object. Accordingly, costs are classified as either direct costs or indirect costs.
(A) Direct Costs
A direct cost is a cost that can be easily and conveniently traced to the particular cost object
under consideration in an economical feasible way.
(B) Indirect Costs
An indirect cost is a cost that cannot be easily and conveniently traced to a particular cost
objective in an economically feasible way. Few examples of indirect costs are also listed below
for some cost objects.
Cost Object Examples of Indirect Costs
Product Indirect material costs, indirect labor costs, and other indirect
manufacturing costs
Department A Salary of the corporate general manager, rental costs on building
used by many departments of the company

DREAMLAND COLLEGE
Customer Costs incurred in reception department of a hotel

Branch Salary of the general manager and employee at the head office level
serving the company as a whole
Exhibit 1.3 Indirect Costs
Frequently managers want to know both the costs of running departments and the costs of
products and services; costs are inevitably allocated to more than one cost objective.
Cost Object
Individual Unit
Assembly Product Line of Product
Department A B A B
Direct laborers: Assembly Direct Direct Direct Direct Direct
Department
Line foreman: Product B Direct - Direct - Indirect
Assembly department Direct Indirect Indirect Indirect Indirect

manager
Major subassemblies Direct Direct Direct Direct Direct
Plant wide heating and Indirect Indirect Indirect Indirect Indirect

cooling
Exhibit 1.4 Direct and Indirect Costs
2.4 Variable Costs, Fixed Costs and Mixed Costs
(A) Variable Costs
A variable cost is a cost that changes in total in direct proportion to a change in the level of
activity (or cost driver). A 10% increase in the units of production, for instance, would produce
a 10% increase in variable costs.
A. Graph of total variable cost B. Graph of unit variable cost
C. Tabulation of Variable Cost
Activity (or cost driver) Variable Cost Per unit Total Variable Cost
1 Br.100 Br.100
10 100 1,000
20 100 2,000
30 100 3,000
Total Variable Cost = Unit variable cost x Activity

DREAMLAND COLLEGE
Unit Variable Cost = Total Variable cost

Activity
Panel A of Exhibit 2-5 displays a graph of a variable cost. As this graph show, total variable cost
increases proportionately with activity. When activity doubles, form 10 to 20 units, total
variable cost doubles, from Br. 1,000 to Br. 2,000. In contrast, a variable cost is a cost that
remains constant on a per-unit basis no matter what our level of output. The variable cost
associated with each of activity is Br. 100, whether it is the first unit or the tenth. The table in
Panel C of Exhibit 2-5 illustrates this point.
(B) Fixed Costs
A fixed cost remains unchanged in total as the level of activity (or cost driver) varies. It means
that they are not immediately affected by changes in the cost driver. Some costs that are usually
fixed include:
 Some manufacturing overhead costs, like
 Rent or depreciation expenses for factory building.
 Depreciation on factory machinery and equipment.
 Insurance and property taxes on manufacturing facilities and
 Some non-manufacturing costs, such as
 Office property taxes.
 Office fire insurances.
 Advertising and promotion and
C. Tabulation of Fixed Cost
Activity( or cost driver) Fixed Cost per Unit Total Fixed Cost
1 Br.1,500 Br.1,500
2 750 1,500
5 300 1,500
10 150 1,500
20 75 1,500
30 50 1,500
Fixed costs can be fixed only over a restricted range of possible levels of activity (which is
known as relevant range). For example, rent costs will rise if increased production requires a
larger or additional building. Conversely, rent costs may go down if decreased production
caused the company to move to a smaller plant.
Committed Fixed Costs: They usually arise from an organizations ownership or use and its
basic organization structure. Committed fixed costs are large, individual chunks of cost that the
organization is obligated to incur or usually would not consider avoiding.
Discretionary Fixed Costs: These are costs determined by management as part of the periodic
planning process in order to meet the organization’s goals.

DREAMLAND COLLEGE
Mixed Costs
Mixed costs include both fixed and variable components. Many costs, such as repair and
maintenance costs, are incurred in such a way that part of the cost varies with the level of activity
and part of it does not.
Mixed cost is represented by a straight line; the following equation for a straight line can be used
to express the relationship between mixed cost and the level of activity.
y=a+bx
In this equation,
y = the total mixed cost
a = the total fixed cost (the y-intercept of the line)
b = the variable cost per unit of activity (the slope of the line)
x = the level of activity.
The behavior of mixed cost is shown graphically in Exhibit 2.9
Total Cost
Total cost= Fixed cost + variable cost
Y
A
Fixed cost
x Activity level
Exhibit 2-9 Mixed Cost Behaviors
(C) Semi variable costs

Some costs vary with the volume of activity but not proportionately or at a constant. They are
called semi variable costs. They can be divided into two: Semi variable costs that change at a
decreasing rate and those semi variable costs that change at an increasing rate.
(D) Step Function Costs
Step costs, sometimes called semi fixed costs, remain fixed over a range of activity, but beyond
some activity level they change usually by intermittent jumps rather than continuously.
2.3 Controllable Costs Vs. Uncontrollable Costs
Cost Item Manager Classification
Cost of raw materials used Production Controllable – The production
to produce a product department supervisor can exercise some control
supervisors over the quantity of material used by
ensuring that waste and defective units
are minimized.

DREAMLAND COLLEGE
Cost of national Manager for the Uncontrollable

advertising and promotion Dessie Branch
for Moha Soft Drink
Products by the company
Exhibit 2-12 Controllable and Uncontrollable Costs

2.6 Cost Classification for Decision Making
Costs are an important feature of many business decisions. In making decisions, it is essential to
have a firm grasp of the concepts differential cost, opportunity cost and sunk cost.
(A) Differential Costs
Decisions involve choosing between alternatives. In business decisions; each alternative will
have certain costs and benefits that must be compared to the costs and benefits of the other
available alternatives. A difference in costs in any two alternatives is known as a differential
costs. A difference in revenues between any two alternatives is known as differential revenue.
(B) Opportunity Cost
An opportunity cost is defined as the benefit that is sacrificed or forgone when an alternative
course of action is selected over another.
Example 1: Dawit has a part-time job that pays him Br. 100 per week while attending college.
He would like to spend a week at the beach during spring break, and his employer has agreed to
give him the time off, but without pay. The Br.100 in lost wages would be an opportunity cost of
taking the week off to be at the beach.
(C) Sunk Cost
A sunk cost is a cost that has already been incurred and that cannot be changed by any decision
made now or in the future. Since sunk cost cannot be changed by any present or future decision,
they must be ignored when analyzing future courses of action.

DREAMLAND COLLEGE
UNIT THREE
INVENTORIES AND COST FLOW OF MANUFACTURING COMPANIES

1.1 Work Flow of Manufacturing Company
A firm’s cost accounting system should be parallel to the flow of operations. The
sequential steps in a typical cycle of operations of a manufacturing firm that makes and
sells products are outlined as follows:-
1. Procurement
Procurement is the process of acquiring the necessary inputs for production. These
inputs are raw materials, labor, and factory facilities. Factory facilities include
manufacturing machinery, utilities and similar facilities.
2. Production
Production refers to the actual conversion of raw materials into final products by
means of labor and factory facilities. At this stage, raw materials are transferred from
the store room to the factory floor.
3. Warehousing
Warehousing is the movement of the completed products from factory floor to
warehouse to await for sale.
4. Selling
Selling includes finding customers and making shipments of merchandises. Customers
are found, agreement is reached on with the customers, products (goods) will be
shipped from the warehouse, and sales to customers are recorded.
1.2 Matching Cost Flow with Work Flow
The principles and procedures existing in accounting would also exist in cost
accounting. Cost accounting consists of a system that is concerned with precise
recording and measurement of cost elements as they originate and flow through the
productive process.
B. Procurement
Accounts must be provided to record the purchase of materials, labor, and overhead.
These costs will later be charged to production. Three typical general ledger accounts
are used at procurement stage. These are Raw Materials for materials, Factory Payroll
Clearing for labor, and Manufacturing Overhead Control for overhead.
When materials are purchased, Raw Materials account is debited. When salaries and
wages (direct labor cost) are incurred or paid, Factory Payroll Clearing account is
debited. Actual manufacturing overhead costs are debited to Manufacturing Overhead
Control account.
Raw Materials xxxxx
Cash or Accounts Payables xxxxx
C. Production

DREAMLAND COLLEGE
Notice that whenever materials are purchased, it will be debited to Raw Materials
account. This Raw Materials account is credited when materials are issued from store
room to production.
Work in Process xxx
Manufacturing Overhead Control xx
Raw Materials xxxx
Similarly, the cost of direct labor is debited to Work in Process account and the
indirect labor is debited to Manufacturing Overhead Control account. The
corresponding credit is Factory Payroll Clearing account, i.e,
Work in Process xxx
Factory Payroll clearing xxxx
Other overhead costs are also debited to Manufacturing Overhead Control account. For
instance, depreciation on factory building is recorded as follows:
Accumulated Depreciation-Factory Building xx
Likewise, utilities costs incurred in production may be recorded as follows:
Accounts Payable or Cash xx
D. Warehousing
When the goods are completed, they will be moved to the warehouse. An account must
be set up to record the cost of goods that have been completely manufactured and
transferred to the warehouse. This account is referred as Finished Goods account.
The costs of finished goods shipped from the warehouse to customers is credited to the
Finished Goods and charged (debited) to Cost of Goods Sold account.
Finished Goods xxx
Work in Process xxx
E. Selling
At the time finished goods are sold and shipped from the warehouse to customers, their
cost is debited to the Cost of Goods Sold account and credited to the Finished Goods
account. At the end of the accounting period, this Cost of Goods Sold account is closed
by crediting Cost of Goods Sold account and debiting Income Summary account.
Cost of Goods Sold xx
Finished Goods xx
Similarly, the selling price of the goods sold is debited to Cash or Receivable account
and is credited to Sales account.
Cash or Accounts Receivable xxx
Sales xxx
Inventories for a Manufacturing Firm

DREAMLAND COLLEGE
The manufacturing sector differs from the merchandising sector in that products sold to
customers are converted to a different from that of the products purchased from
suppliers. This distinction results in the manufacturer having the following types of
inventories:
2. Raw materials inventory
Raw materials inventory refers to materials on hand and awaiting use in the production
process. Raw materials inventory includes not only raw materials but also factory
supplies.
3. Work-in-process inventory
Work in process inventory represents goods undergoing the production process but not
yet fully completed. Work-in-process inventory contains all the three major
manufacturing costs (direct materials, direct labor, and overhead costs).
4. Finished goods inventory
Finished goods inventory represents goods fully completed but not yet sold. It
increases by transfer of completed goods from work in process inventory and decreases
by the amount of cost of goods sold at the time of sale.
Inventories of manufacturing firms are shown in the balance sheet as follows:
Current Assets
 Cash xxx
 Receivables xxxx
 Inventories:
o Raw Materials xx
o Work-in-Process xxx
o Finished Goods xx xxxxx
 Other current assets xxx
 Total current assets xxxxx
2.1 Statement of Cost of Goods Manufactured
Most manufacturing companies prepare a statement of cost of goods manufactured
(also called schedule of the cost of finished goods manufactured) to provide managers
with an overview of the costs relating to manufacturing activities during the period.
1) Work-in-Process inventory at the beginning of the period
2) Manufacturing costs incurred during the period
3) Work-in-Process inventory at the end of the period
Manufacturing costs are composed of direct materials used, direct labor costs incurred
and overhead costs. Direct materials used can be computed as follows:
 Raw materials inventory, beginning xxx
 Add: Raw materials purchased during the period (Net)
xxx
 Raw materials available for use
xxx

DREAMLAND COLLEGE
 Less: Raw materials inventory, ending

xxx
 Raw Materials used xxx
 Less: Indirect materials used xxx
 Direct materials used xxx
Net raw materials purchased may be computed as follows:
Raw materials purchased during the period xxx
Less: purchase returns and allowance xx
Purchase discounts xx xxx
Net raw materials purchased xxx
In the statement of cost of goods manufactured, the cost of goods manufactured is
computed as follows:
Work-in-Process, beginning xxxx
Add: Manufacturing costs during the period xxxx
Costs of goods that have been in process xxxx
Less: Work-in-Process, ending xxxx
Cost of goods manufactured xxxx
Example 1
The following data relates to the operations of Rommel Company for a given year,
20x2.
Jan 1, 20x2 Dec
31,20x2
Inventories:
 Finished goods Br.43,000 Br.52,000
 Raw materials 12,000 10,000
 Work in process 16,000 14,000
Additional data follows:
 Direct labor 85,000
 Freight in 4,000
 Administrative expense 30,000
 Indirect labor 18,000
 Indirect materials and supplies 3,000
 Insurance expense factory 1,500
 Depreciation- factory plans 7,500
 Raw materials purchases 170,000
 Payroll taxes expense- factory 4,000
 Utilities factory 7,500
 Property taxes factory 3,000
 Property taxes factory 2,500
 Raw materials purchase returns and allowance 4,000

DREAMLAND COLLEGE
 Repair and maintenance- factory 4,000

 Sales 500,000
 Selling expense 85,000
 Sales return and allowance 2,500
Instruction: Prepare statement of cost of goods manufactured and cost goods sold for
Rommel Company for the year ended December 31, 20x2.
Rommel Company
Statement of Cost of Goods Manufactured
For the Year Ended December 31,20x2
Raw materials:
Raw materials, beginning 12,000
Purchase 170,000
Freight in 4,000
Less: - Purchase return and allowance 2,500
Net purchase 171,500
Total materials available 183,500
Less: - raw material, ending 10,000
Raw materials used 173,500
Direct labor 85,000
Manufacturing overhead:
Indirect labor 18,000
Indirect material and supplies 3,000
Depreciation-factory plant and equipment 7,500
Insurance expense-factory 1,500
Payroll taxes expense-factory 4,000
Utilities factory 7,500
Property taxes-factory 3,000
Repair and maintenance factory 4,000
Total manufacturing overhead 48,500
Total current manufacturing cost 307,000
Add: - work in process, beginning 16,000
Less: - work in process, ending 14,000
Cost of goods manufactured 309,000
2.2 Statement of Cost of Goods Sold
A statement of cost of goods sold is a statement that summarizes the costs of finished
goods sold during the period. The cost of goods sold in a manufacturing company is
 Finished goods inventory, beginning xxxx
 Add: Cost of goods manufactured xxxx

DREAMLAND COLLEGE
 Cost of goods available for sale

xxxx
 Less: Finished goods inventory, ending
xxxx
 Cost of goods sold xxxx
Example
The following data have been taken from the accounting records of Arsema
Corporation for the just completed year:
Administrative expenses $ 600,000
Direct labor 800,000
Finished goods inventory, beginning 480,000
Finished goods inventory, ending 640,000
Manufacturing overhead 920,000
Purchases of raw materials 480,000
Raw materials inventory, beginning 160,000
Raw materials inventory, ending 280,000
Sales 3,960,000
Selling expenses 560,000
Work in process inventory, beginning 280,000
Work in process inventory, ending 200,000
The cost of goods sold for Arsema Corporation for the year is computed as follows:
Finished goods inventory, beginning $ 480,000
Cost of goods manufactured (calculated above) 2,160,000
Less finished goods inventory, ending (640,000)
Cost of goods sold $2,000,000

DREAMLAND COLLEGE
UNIT FOUR
ACCOUNTING FOR MATERIAL COSTS
ACCOUNTNG FOR MANUFACTURING COSTS

Proper care should be taken for controlling materials, because cost of materials is the
significant part of manufacturing costs. Therefore, the needs for controlling materials
are:-
a) Quality and cost of materials must meet the specifications on which sales prices are
based
b) Correct quantitative and types of materials must be on hand at the right time for
production
c) Materials must be protected from loss or theft
d) Funds must not be tied up in inventory when they could be used more profitably
elsewhere
e) Risks of spoilage must be minimized
f) Costs of materials handling and storage must be kept to the minimum
Objectives of Materials Control
Materials cost constitute the major part of the total cost of production in manufacturing
firms. Therefore, proper accounting for and control over materials purchases,
consumption and inventories are important for effective management of a business.
a) Materials of the desired quality will be available when needed for efficient and
uninterrupted production
b) Material will be purchased only when need exists and in economic quantities
c) The investments in materials will be maintained at the lowest level consistent with
operation
d) Purchase of materials will be made at the most favorable prices under the best
possible terms
e) Materials are protected against loss by fire, theft, handling with the help of proper
physical controls
f) Materials should be stored in such a way that they can provide minimum of
handing time and cost
Materials Control Personnel
Although actual job titles and duties may vary from one company to another, the
personnel involved in materials control usually include the following: purchasing
agent, receiving clerk, storeroom keeper, and production department supervisor.
(A) Purchasing Agent
The responsibility for buying the materials needed for the manufacturing enterprise
should rest on the shoulders of one person. In a small plant the employee who does the

DREAMLAND COLLEGE
buying may also perform other duties, while in a large plant the purchasing agent may
head a department established to perform buying activities.
1. Working with the production manager to prevent delays caused by the lack of
materials
2. Compiling arid maintaining information that identifies where the desired materials
can be obtained at the most economical price
3. Placing purchase orders
4. Supervising the order process until the materials are received
5. Verifying purchase invoices and approving them for payments
(B) Receiving Clerk
The receiving clerk is responsible for supervising the receipt of incoming shipments.
All incoming materials must be checked as to quantity and quality and sometimes as to
price.
(C) Storeroom Keeper
The storeroom keeper, who has charge of the materials after they have been received,
must see that the materials are properly stored and maintained.
(D) Production Department Supervisor
Each production department has a person who is responsible for supervising the
operational functions within the department.
1.1 Materials Control Procedures and Accounting for Materials
Specific internal control procedures should be tailored to a company's needs. However,
materials control generally involves the following functions: (1) purchase and receipt
of materials, and (2) storage, requisition and issuance of materials.
i. Purchase and Receipt of Materials
Materials are ordered to maintain the adequate levels of inventory necessary to meet
scheduled production needs.
Supporting documents are essential to maintaining control during the procurement
process. In general, the documents should be pre numbered and protected from
unauthorized use. The documents commonly used in procuring (purchasing and
receiving) materials include:- (1) purchase requisitions, (2) purchase orders, (3)
supplier's invoices, (4) receiving reports, (5) preparing and recording the voucher, (6)
paying the voucher, and (5) debit-credit memoranda.
1. Purchase Requisition
Purchase requisition is a form properly approved, or authorized, written request for
materials. It is the form used to notify the purchasing agent that additional materials
are needed.
The purchase requisition serves three general purposes:
a) It automatically starts the purchasing process and informs the purchasing
department of the need for the purchase of materials
b) It fixes the responsibility of the department making the purchase requisition

DREAMLAND COLLEGE
c) It can be used for future reference

A typical purchase requisition contains details, such as number, date, department,
quantity description, and signature of the concerned individuals as shown below.
Purchase Requisition
Purchase Requisition No._________________
Purchase Order No._____________________
Date_________________________________
Department_________________________
Delivery Required____________________
Item Quantity Description Remarks
No.
Requested by Checked by Approved by

____________ ________________ ______________
Form 1.1 Purchase Requisition
2. Purchase Order
After receiving requisition, the purchasing department places an order with a supplier.
For routine purchases, the order is placed with established suppliers. In other cases, the
purchasing department may ask for bids or send out request for price quotation before
placing the order.
This purchase order should be pre numbered serially and prepared in quadruplicate.
The first copy goes to the supplier, second copy goes to the accounting department,
third copy goes to the receiving clerk, and the purchasing agent retains one copy.
Purchase Order
Date ____________________________ Purchase order No._____________

Supplier _________________________ Requisition No.________________
Department No.________________
Date Required_________________
Item Quantity Description Unit Total Cost Remarks

No. Cost

DREAMLAND COLLEGE
Terms and Conditions: Purchase Manager

_________________________ ___________________
_________________________
Form 1.2 Purchase Order
The purchasing agent's copy of the order should be placed in an unfilled orders file.
Before the order is filed, the purchase requisition on which it is based should be
attached to it. This last important step begins the assembly of a complete set of all the
forms pertaining to the purchase transaction.
3. Supplier’ (Vendor’s) Invoice
The company should receive a vendor's invoice before the materials arrive at the
factory. As soon as it's received, the vendor's invoice goes to the purchasing agent,
who compares it with the purchase order, noting particularly that the description of the
materials is the same, that the price and the terms agree, and that the method of
shipment and the date of delivery conform to the instructions on the purchase order.
4. Receiving Report
As noted previously, a copy of the purchase order goes to the receiving clerk to give
advance notice of the arrival of the materials ordered. This is done to facilitate
planning and to provide space for the incoming materials.
The purchasing agent compares the receiving report with the vendor's invoice and the
purchase order to determine that the materials received are those ordered and billed. If
the documents agree, the purchasing agent initials or stamps the two copies of the
receiving report.
Materials Receiving Report

Purchase Order No.__________________
Date______________________________
Received from:_____________________
Item No Quantity Description Weight (if any) Remarks

Received
Counted (Measured) by __________________ Approved by ________________

Inspected by _________________

DREAMLAND COLLEGE
Form 1.3 Materials Receiving Report

5. Preparing and Recording Voucher
The invoice received from the supplier is sent to the purchasing unit. The purchasing
unit holds the invoice and the purchase order in the open purchase order file until the
receiving report is received from store (receiving department).
Goods ordered have been received in good condition and those listed on the invoice
 Terms, unit prices, shipping charges, and other details agree with order
specifications
 Computations are correct
After comparison, an employee of the purchasing unit staples together one copy of the
invoice, receiving report, and purchasing order, and places them in a completed
purchases file alphabetically by supplier. Next, a disbursement voucher is completed,
and a second set of supporting documents is attached to it. Then, the voucher is
formally approved and sent to the accounting unit for recording. A sample of
disbursement voucher is shown below.
DISBURSEMENT VOUCHER
Payee ____________________________ Voucher No. ______________________

_________________________________ Issued Date _______________________
_________________________________ Discount Date _____________________
Due date _________________________
.
Invoice Date Terms Invoice No. Amount
Price____________________________
Materials Received_________________
Extension OK_____________________
Gross Amount____________________
Discount________________________
Net paid________________________
Approved for pay_________________
Paid by Check No.________________
Date___________________________
Form 1.4 Disbursement Voucher

DREAMLAND COLLEGE
When the voucher, invoice and attached papers reach the accounting unit, the voucher
clerk compares quantities, verifies intentions and footings, computes discounts, and
checks all other computations.
Raw Materials xxxx
Vouchers Payable xxxx
The above entry is recorded in a voucher register and the voucher is sent to the
treasurer’s office, the voucher is filed in the unpaid vouchers file according to the last
date on which the discount may be taken.
6. Paying the Voucher
Before the due date, the voucher is removed from the unpaid vouchers file. A check is
prepared for the net amount.
7 Debit and Credit Memoranda
If a larger quantity has been received than has been ordered and the excess is to be kept
for future use, a credit memorandum is prepared notifying the vendor of the amount of
the increase in the invoice.
Vouchers Payable xxx
Purchase Returns and Allowance xxx
iv. Storage and Issuance of Materials
The preceding discussion outlined ways to maintain the control of materials during the
procurement process.
Storage of Materials
Two types of control are made in store. One is physical control of materials and the
second is accounting control.
Materials Ledger
Material_____________________
Number_____________________
Recorder point_______________
Recorder Quantity____________
Date Reference Received Issued Balance
Units Price Units Price Unit Price
Form 1.5 Materials Ledger
Bin Tag
Materials No.________________________ Location ____________________
Recorder point ______________________

DREAMLAND COLLEGE
Description_________________________
Date Quantity Received Quantity Issued Balance
Form 1.6 Bin Tag

1. Issuance of Materials
Materials should be protected from unauthorized use. No materials should be issued
from the store room except on written authorization to lessen the chance of theft,
carelessness, or misuse.
Material requisition shows the quantity, material number, description, and job number
or department to which the materials are charged. Materials requisition may look like
the following:
Materials Requisition
Requisition No.__________________
Date __________________________
Deliver to ______________________
Acct.__________________________
Charge: Job ____________________
Department______________
Quantity Material No. Description Unit Price Amount
Approved by __________ Delivered by __________ Received by __________

Form 1.7 Materials Requisition
Identification is an important factor in the control of materials. For this reason, the
materials requisition should indicate the job number (job order costing) or department
(process costing) for which the materials are issued. When indirect materials are
issued, such as cleaning materials, lubricants, and paint, the requisition will indicate
the name or number of the factory overhead account to be charged.
After the requisition has been recorded on the related materials ledger card, the
requisition is forwarded to the cost accountant. The cost accountant journalizes the
transaction (issuance of materials) in the journal. The journal entry for the issuance of
materials is as follows:
Work-in-Process xxx

DREAMLAND COLLEGE
Raw Materials xxxx

2. Returned Materials
After materials are requisitioned and issued from the storeroom, some or all of the
materials may be returned back to the storeroom.This report is very similar to the
materials requisition. The bin tag is adjusted. Then the cost accountant will make the
following entry:
Raw Materials xxx
Work-in-Process xx
Manufacturing Overhead Control x
1.2 Determining Costs of Materials Issued
An important area of materials accounting is the cost of materials requisitioned from
the storeroom for factory use. The unit cost of incoming materials is known at the time
of purchase.
There are three inventory flow assumptions. These are: First-In, First-Out (FIFO)
Method, Last-In, First-Out (LIFO) Method, and Average Cost or Moving Average
Method.
First-In, First-Out (FIFO) Method
FIFO method is based on the assumption that stocks (inventories) are issued in a
strictly chronological order. The FIFO method assumes that materials issued are taken
from the oldest materials in stock.
Last-In, First-Out (LIFO) Method
The last-in, first-out (LIFO) method of costing materials, as the name implies, assumes
that materials issued for manufacturing are the most recently purchased materials.
Thus, materials issued are costed at the most recent purchase prices, and inventories on
hand at the end of the period are coasted at prices paid for the earliest purchases. The
LIFO method of costing closely approximates the physical flow of materials in some
industries.
Average Cost or Moving Average Method
A basic requirement of the moving average method is that an average unit price must
be computed every time a new lot of materials is received and this average unit price
must be used to cost all issues of materials until another lot is purchased. Average unit
cost is computed as follows:
Average Unit Cost = Cost of Materials Available for Use
Quantities of Materials Available for Use
The moving average method assumes that the materials issued at any time are simply
withdrawn from a mixed group of like materials in the storeroom and that no attempt is
made to identify the materials as being from the earliest or the latest purchases.
Illustration
The data given below relate to material X for the month of September 2009.
September 1 Opening balance…………………….. 1000 units @ 10.00 each

DREAMLAND COLLEGE
2 Purchase order 220 …………………. 5,000 units @ 12.00 each

3 Requisition 310 …………………….. 3,000 units
30 Requisition 337 …………………….. 500 units
The Company uses perpetual inventory system for its materials.
Required:- Determine the cost of materials issued to production and cost of inventory
on September 30 under: FIFO method, LIFO method, and Moving Average method.
Solution
a) FIFO method
Purchases Issues Balance
Dat Quanti Unit Total Quanti Unit Total Quantit Unit Total
e ty Cost Cost ty Cost Cost y Cost Cost
Sep 1,000 10.00 10,000.00
t. 1
2 5,000 12.00 60,000.0 1,000 10.00 10,000.00
0 5,000 12.00 60,000.00
8 1,000 10.00 10,000.0
2,000 12.00 0 3,000 12.00 36,000.00
24,000.0
0
15 2,000 15.00 30,000.0 3,000 12.00 36,000.00
0 2,000 15.00 30,000.00
18 3,000 12.00 36,000.0
1,000 15.00 0 1,000 15.00 15,000.00
15,000.0
0
24 6,000 18.00 108,000. 1,000 15.00 15,000.00
00 6,000 18.00 108,000.0
0
28 1,000 15.00 15,000.0
4,000 18.00 0 2,000 18.00 36,000.00
72,000.0
0
30 500 18 9,000 1,500 18.00 27,000.00

DREAMLAND COLLEGE
Inventory value is taken from the balance column on the last row, i.e., $27,000. Cost of
materials issued is obtained by adding the total cost column of the cost of issued
materials (i.e., $181,000).
b) LIFO method
Date Quanti Unit Total Quanti Unit Total Quantit Unit Total
ty Cost Cost ty Cost Cost y Cost Cost
Sept. 1,000 10.00 10,000.00
1
2 5,000 12.00 60,000.0 1,000 10.00 10,000.00
0 5,000 12.00 60,000.00
8 3,000 12.00 36,000.0 1,000 10.00 10,000.00
0 2,000 12.00 24,000.00
15 2,000 15.00 30,000.0 1,000 10.00 10,000.00
0 2,000 12.00 24,000.00
2,000 15.00 30,000.00
18 2,000 15.00 30,000.0
2,000 12.00 0 1,000 10.00 10,000.00
24,000.0
0
24 6,000 18.00 108,000. 1,000 10.00 10,000.00
00 6,000 18.00 108,000.0
0
28 5,000 18.00 90,000.0 1,000 10.00 10,000.00
0 1,000 18.00 18,000.00
30 500 18 9,000.00 1,000 10.00 10,000.00

500 18.00 9,000.00
Cost of materials on hand = 10,000 + 9,000 = $19,000
Cost of materials issued = 36,000 + 30,000 + 24,000 + 9,000 = $189,000
c) Average Cost method
Date Quanti Unit Total Quanti Unit Total Quantit Unit Total
ty Cost Cost ty Cost Cost y Cost Cost
Sept. 1,000 10.00 10,000.00
1
2 5,000 12.00 60,000.0 6,000 11.67 70,000.00
0
8 3,000 11.67 35,010.0 3,000 11.67 35,010.00

DREAMLAND COLLEGE
0
15 2,000 15.00 30,000.0 5,000 13.00 65,010.00
0
18 4,000 13.00 52,000.0 1,000 13.00 13,000.00
0
24 6,000 18.00 108,000. 7,000 17.29 121,000.0
00 0
28 5,000 17.29 86,450.0 2,000 17.29 34,550.00
0
30 500 17.29 8,645.00 1,500 17.29 25,905.00
Cost of materials on hand = $25,905.00
Cost of materials issued = 35,010 + 52,000 + 86,450 + 8,645 = $182,105
Materials Inventory Control
Every business requires a system of internal control that includes procedures for the
safeguarding of assets. Because highly liquid assets, such as cash and marketable
securities, are particularly susceptible to misappropriation, the protection provided for
such assets is usually more than adequate.
(1) Limited Access
Only authorized personnel should have access to materials storage areas. Materials
should be issued for use in production only if requisitions for materials are properly
documented and approved. Finished goods should also be safeguarded in limited
access storage areas and not released for shipment in the absence of appropriate
documentation and authorization.
(2) Segregation of Duties
A basic principle of internal control is the segregation of duties to minimize
opportunities for misappropriation of assets. With respect to materials control the
following functions should be segregated: purchasing, receiving: storage, use, and
recording. The independence of personnel assigned to these functions does not
eliminate the danger of misappropriation or misuse because the possibility of collusion
still exists.
(3) Accuracy in Recording
An effective materials control system requires accurate recording of purchases and
issuances of materials. Inventory records shou1d document the inventory quantities on
hand and cost records should provide the data needed to assign it value to inventories
for the preparation of financial statements.
2.1 Controlling Investment in Materials
Maintaining the proper balance of materials on hand is one of the most important
objectives of materials control. An inventory of sufficient size and diversity for
efficient operations must be maintained, but the size should not be excessive in relation
to scheduled production needs.

DREAMLAND COLLEGE
In addition, inventory levels more than required could increase the possibility of loss
from damage, deterioration, and obsolescence. The planning and control of the
materials inventory investment requires that all of these factors be carefully studied to
determine (1) when orders should be placed and (2) how many units should be ordered.
(1) Reorder Quantity and Reorder Point
A minimum level of inventory should be determined for each item of raw material, and
inventory records should indicate how much of each item is on hand.
Calculating the reorder point is based on the following data: usage, lead time, and
safety stock.
a) Usage- Usage is the anticipated rate at which the material will be used. It
represents the consumption patterns.
b) Lead time- Lead time is the estimated time interval between the placement of an
order and receipt of the material. It is the amount of time it takes for the materials
to be delivered from the supplier.
c) Safety stock- Safety stock is the estimated minimum level of inventory needed to
protect against stock outs (running out of stock).
Example
Assume that a company's expected daily usage of an item of material is 100 units, the
anticipated lead time is 5 days, and the estimated safety stock is 1,000 units. The
following calculation shows that the reorder point is reached when the inventory on
hand reaches 1,500 units:
 100 units (daily usage) x 5 days (lead time) 500 units
 Safety stock required 1,000 units
 Reorder point 1,500 units
According to the above example, a new purchase order is placed when the quantities of
raw materials on hand reaches 1,500 units. If estimates of usage and lead time are
accurate, when the new order is received, the level of inventory would be equal to the
safety stock of 1,000 units. If, however, the new order is delivered three days late, the
company would need to issue 3,000 units of material from its safety stock to maintain
the production level during the temporary delay.
(2) Economic Order Quantity (EOQ)
The reorder point establishes the time when an order should be placed, but it does not
indicate the cost economical number of units to be ordered.
Salaries and wages of employees engaged in purchasing, receiving, and inspecting
materials;
 communications costs associated with ordering, such as telephone charges,
postage, and forms or stationery; and
 clerical costs of processing an order
A variety of factors must be considered in determining carrying costs:
 costs of handling and storing materials

DREAMLAND COLLEGE
 Interest, insurance, and property taxes

 Loss due to theft, spoilage, deterioration, and obsolescence
 Clerical costs of maintaining inventory records
Order costs and carrying costs move in opposite directions. Annual order costs
decrease when order size increases, while annual carrying costs increase when order
size increases.
Quantitative models or formulas have been developed for calculating the economic
order quantity. One formula that can be used is the following:
EOQ =
Where
EOQ = economic order quantity
C = cost of placing an order
N = number of units required annually
K = carrying cost per unit of inventory
The average number of units in inventory would be calculated as follows:
Average number of units in inventory = (½ x EOQ) + Safety stock
The total carrying costs then would be calculated as follows:
Carrying costs = Average inventory x carrying costs per unit
Example
Bethaneya Printing has determined that the cost to place an order for papers is Br.5
and the cost to carry this item in inventory is Br.8 per dozen. If 8,000 dozen of papers
are required for production each year, the economic order quantity would be 100 units
EOQ =
= 100 units
Limitations of Order Point and EOQ Calculations

The techniques illustrated for determining when to order (order point) and how much
to order (EOQ) may give a false impression of exactness. However, because these
calculations are based on estimates of factors such as production' volume, lead time,
and order and carrying costs, they are really approximations that serve as a guide to
planning and controlling the investment in materials.

DREAMLAND COLLEGE
UNIT FIVE
ACCOUNTING FOR LABOUR COSTS
Labor can be defined as the mental and physical effort of human beings which
participates in the manufacturing of products. And labor cost represents the price paid
in using human resource
Direct labor is the personnel who work directly with the raw materials in converting
them to finished goods. In other words, direct labor is the time spent by a work,
identifiable with the particular job or process. Direct labor cost represents payroll costs
traced directly to the product. Accounting for Labor Costs
Time Keeping Procedure
Time keeping is the process or procedure for keeping records of time worked by each
employee. It serves as a basis to calculate employee earnings. From these amounts
appropriate deductions are computed to determine employee net pay.
a) Time Card (Clock Card)
Time cards provide evidence of the presence of a worker inside the plant and the time
of his entry or departure. Time cards are prepared every month for each employee by
the payroll unit. Each employee has his/her own time card which shows the dates
worked and the time the employee entered and left each day. They are placed in a rack
next to an electronic time clock near the plant entrance.
Time Card
Name _________________________________________________________________
No. ___________________________________________________________________
Month_________________________________________________________________
Regular Extra
Hrs. In Out In Out In Out Hrs.

DREAMLAND COLLEGE
Form 1.1 Time Card
b) Time Tickets (Job Ticket)

Time card shows only the number of hours worked by an employee during a day, but it
does not show which particular work the employee was performing. Some record
showing the use of time must be prepared, since labor costs are charged to specific jobs
or department.
It provides instructions for operations to be performed
a) It records time spent in performing the operations
The worker normally collects the ticket from the foreman’s office. On completion of
the operations, the worker records time of completion on the ticket, submits the same
to the foreman and collects a new ticket for the next job to be worked on. The time
ticket (card) shows the employee’s name and number, department worked on,
operation, starting and stopping time on the job and time spent on each job. The format
of time ticket is shown below.
Time Ticket
Date_________ Employee No. (or Name) ______________
Job No.__________ Department_________
Time Started____________ Time Stopped____________
Hours Worked_______________ Hours Rate _____________
Amount _____________________
Operation______________________ Pieces Completed________________
Form 1.2 Time Ticket

Approved by _____________________
At the end of the day, all time tickets are collected by a time clerk. The time clerk will
complete the following procedures.
1. Compare the hours shown on each employee’s time tickets with the total time
shown on the employee’s time card
2. Investigate the differences between time tickets and time cards
3. Enter the earnings (amount) on the time tickets
4. Enter the number of hours worked during the day by each worker, in the payroll
register
5. Separate individual parts of the time tickets to make it easier to sort by job or
department
The five steps of time keeping activities described above provide the data needed by
the payroll unit for computing earnings and completing labor cost records.
Overtime Premium and Idle Time Cost

DREAMLAND COLLEGE
i) Overtime Premium
An overtime premium is the extra compensation paid to an employee who works
beyond the time normally scheduled. Suppose an electronics technician who
assembles radios earns Br. 16.00 per hour. The technician works 48 hours during a
week instead of the scheduled time or 40 hours.
For instance, assuming the overtime pay scale is 150 percent of the regular wage. The
technician’s compensation for the week is classified as follows:
Direct labor cost (Br. 16 x 48)-------------------------------------Br. 768
Overhead overtime premium: ½ (Br. 16 x 8)------------------------64
Total compensation paid--------------------------------------------Br. 832
Only the extra compensation of Br.8 per hour is classified as overtime premium. The
regular wage of Br.16 per hour is treated as direct labor, even for the eight overtime
hours.
ii) Idle Time Cost
Idle time is time that is not spent productively by an employee due to such events as
equipment breakdowns or new setup of production runs. Idle time is said to occur if
time cards show more hours as compared to the time tickets. Idle time may occur
because of the following reasons:
 Hour lost waiting for materials
 Hour lost waiting for assignment to a new job
 Hour lost waiting for a machine to be repaired
 Strikes, fire, floods, etc.
For instance, suppose that during one 40-hour shift, a machine breakdown resulted in
idle time of 1 hour and power failure idle workers for an additional 1 hour. If an
employee earns Br. 14 per hour, the employee’s wages for the week will be classified
as follows:
Direct labor cost (Br. 14 x 38)---------------------------------Br. 532
Overhead (idle time: Br. 14 x 2)------------------------------------28
Total compensation paid ---------------------------------------Br. 560
Note that the short time spent during the morning and afternoon rest periods is not
considered idle time. It is absorbed into whatever job the employee is working on at
the time of the break.
At the end of each week, an analysis of idle time is made and an idle time sheet is
prepared. Then the idle time sheet is attached to time ticket.
1.1 Payroll Procedure
1. Payroll Department
The payroll unit or department is responsible for the following:
a) Maintain details of job classification, cost center and wage rate of each employee
b) Maintain a list of mandatory deductions, such as employee income taxes
c) Maintain a list of voluntary deductions such as credit association contribution

DREAMLAND COLLEGE
d) Determine for each employee the amount of income tax to be deducted from each
employee’s gross pay
e) Determine the net amount payable to each employee
f) Prepare wage sheets which form the basis for disbursement of wages
g) Summarize the cost by cost center including the gross amount earned, deductions,
net pay hours worked, overtime premium incurred, incentive earned by each
employee, etc.
2. Factory Payroll Register
The time keeping procedure provides the data needed by the payroll department for
computing earnings and completing labor cost records. Factory payroll register is used
to compute earnings and complete labor costs. Factory payroll register may be
prepared weekly, semi-monthly or monthly.
a) Preparation of Weekly Factory Payroll Register
Information about hours worked and wage rate is transferred to a weekly factory
payroll register from time tickets daily. In other words, time tickets are the source of
information for preparing weekly factory payroll register.
i. Normal hours worked and normal rate
ii. Overtime hours worked
iii. Overtime premium
Note that as you have studied in your principles of accounting course, overtime
premium varies from country to country.
b) Posting from the Payroll Register
At the end of the payroll period, the total gross earnings and the totals for each of the
various liabilities are posted directly from the payroll register to the general ledger
accounts. The total gross earnings are debited to the Factory Payroll Clearing account.
Deductions are credited. Salaries and wages payable account is credited for the net
pay. The general journal entry is shown below.
Factory Payroll Clearing xxxx
Employee Income Tax Payable xx
Pension Contribution x
Salaries & Wages Payable xxx
Note that the above general journal entry is made on any payroll date or at the end of
each pay day.
c) Paying Payroll
After the payroll register is completed and posted to general ledger accounts, the
payroll clerk prepares a voucher for the net amount of the payroll. The voucher is
forwarded to the voucher clerk. The voucher clerk completes the voucher and records
in the payroll register. The accounting entry is a debit to salaries and wages payable
and a credit to vouchers payable.
Salaries and wages Payable xxxx

DREAMLAND COLLEGE
Vouchers Payable xxxx

Then, the voucher goes to the treasurer, who prepares a check and records it in the
check register. If employees are paid by check, a payroll check is prepared for each
employee. If employees are paid in cash, the check will be cashed. When the check is
prepared, the required entry is:
Cash in Bank xxx
3. Individual Earnings Record
An employer should keep an individual record of the earnings of each employee and
deductions. The source of information for individual earnings record is the payroll
register prepared at the end each of pay period.
1.2 Charging Labor Costs into Production

Labor costs are transferred to production by means of journal entries. After the analysis
of factory labor costs for a month, the Work-in-Process account is debited for the total
direct labor costs and MOH Control account is debited for the total indirect labor costs.
The corresponding credit account is Factory Payroll Clearing account. This account is
credited for the total labor costs (i.e., direct labor + indirect labor). The general journal
entry is summarized below.
Work-in-Process xx
Factory Payroll Clearing xxx
The balance of Factory Payroll Clearing account may be shown in the name of either:
a) Factory Payroll Clearing
b) Salaries and Wages Payable or Accrued Wages Payable
If this alternative is chosen, the adjusting entry is made at the end of the period as
follows:
Factory Payroll Clearing xxx
Salaries and Wages Payable xxx
Example
Assume that the total labor costs paid during the month is Br.200,000. The analysis of
time tickets indicates that labor costs of Br.40,000 were not paid at the end of the
month.
Required:-
a) What is the amount by which Factory Payroll Clearing account has been debited
during the month?
b) What is the amount by which Factory Payroll Clearing account has been credited
during the month?
c) Determine the balance Factory Payroll Clearing account at the end of the month.

DREAMLAND COLLEGE
d) How much should be shown as a current liability in the balance sheet at the end of
the month?
Solution
a) Factory Payroll Clearing account has been debited for the amount of salaries and
wages paid during the month, which is Br.200,000.
b) Factory Payroll Clearing account has been debited for the sum of the amount that
has been debited to the same account and unpaid wages at the end of the month,
which is Br.240,000 (200,000+40,000).
c) Factory Payroll Clearing account has a credit balance of Br.40,000 at the end of the
month.
d) The amount of unpaid wages and salaries (Br.40,000) will be shown in the balance
sheet as a current liability.
Fringe benefits are costs related to salaries and wages. These include vacation and
holiday pay, compensation insurance of workers, hospitalization insurance, life
insurance, etc.
UNIT SIX
ACCOUNTING FOR OVERHEAD COSTS
Meaning of Overhead Costs

Overhead costs refer to any cost which is not directly attributable to a particular unit of
product or service. In other words, overheads are real costs and represent spending on
resources or services which benefit all units of products and services. These operating
costs of cannot be traced specifically to a unit of production.
1.1 Classification of Overhead Costs
As described above, overheads comprise of indirect materials, indirect employee costs
and indirect expenses which are not directly identifiable or allocable to a cost object in
an economically feasible way.
1) On the basis of functions
On the basis of functions to which the overheads are related, overheads are classified
into factory or production overhead, administrative overhead, selling overhead, and
distribution overhead.

DREAMLAND COLLEGE
i) Factory Overhead Costs

Factory overhead costs refer to all costs incurred in the factory not chargeable directly
to the finished product. Factory overhead is the aggregate of indirect costs associated
with manufacturing activities.
A variety of other terms have been used to describe this type of cost, such as
manufacturing overhead, manufacturing expenses, indirect manufacturing costs, or
factory burden. These costs are also referred to simply as "overhead" or “burden."
ii) Administration Overhead Costs
Administration overhead is the aggregate of the costs of formulating the policy,
directing the organization and controlling the operations of an undertaking which is not
directly related to production, selling and distribution.
iii) Selling Overhead Costs
Selling overhead costs refer to those indirect costs which are associated with marketing
and selling (excluding distribution) activities. Examples are:
iv) Distribution Overhead Costs
Distribution overhead costs are the aggregate of indirect costs associated with the
distribution of finished goods. Distribution includes such activities as moving goods to
central or local storage, moving goods to and from prospective customers. Some
examples of distribution overhead are:
 Packing charges
 Warehousing expenses
 Insurance of finished goods
 Wastage of finished goods
 Depreciation, repairs and maintenance, insurance, and costs of operating the
distribution vehicles
2) On the basis of Behavior
Overheads may also be classified on the basis of behavior into variable overheads,
semi-variable overheads, and fixed overheads.
i) Variable overheads
Variable overheads comprise of expenses which vary in proportion to the change of
volume of production. For example, cost of utilities etc.
ii) Fixed overheads
Fixed overheads comprise of expenses whose values do not change with the change in
volume of production such as salaries, rent etc.
Semi-variable overheads
Semi-variable overheads are partly affected by change in the production volume. They
are further segregated into variable overheads and fixed overheads.
1.2 Control of Factory Overhead Costs

DREAMLAND COLLEGE
The methods used to account for manufacturing overhead costs vary. The key factors
that affect the selection of method are the size of the company, the way the company is
organized, and the types of products manufactured.
Ref. Total Indirect Indirect Payroll Depreciation Utilities Others
Materials Labor Taxes
Usually, large businesses divide factory operations into departments so that costs can
be effectively controlled. There are two methods of achieving cost departmentalization.
1) Maintain Separate Control Accounts
Under this method, a control account is maintained for each different manufacturing
overhead cost. An analysis sheet is used to show the amount chargeable to each
department in a subsidiary ledger. For example, a control account for indirect materials
through the factory may be set up in the following manner.
Indirect Materials __________________________________________ No._______
Post Departmental Analysis
Date Explanation Ref. Dep. 1 Dep. 2 Dep. 3 Dep. 4 Total
2) Maintain Single Control Accounts

Under this method, a single control account is maintained for all manufacturing
overhead costs. The subsidiary ledger may organize costs in two ways:
a) Subsidiary ledger by type of cost
For each manufacturing overhead cost, a subsidiary ledger account is maintained (or
kept). For example, a separate account is established for indirect labor. Another
account is maintained for utilities. This method enables to accumulate costs by type.
b) Subsidiary ledger by department
Under this method, the departmental overhead analysis sheet is used as a subsidiary
ledger account.

DREAMLAND COLLEGE
Accounting for Overhead Costs

Identifying Cost Behavior Patterns of Overhead Costs
Factory overhead expenses include costs that may be classified as variable, fixed, or
semi-variable. Therefore, factory overhead creates a difficulty problem for most
companies because they must predict costs that will be incurred at various levels of
production. The factory overhead costs that behave in the same pattern as direct
materials cost and direct labor costs are considered variable costs and are readily
forecasted because they move up or down proportionately with production volume
changes.
Budgeting Factory Overhead Costs
Budgets are management's operating plans expressed in quantitative terms, such as
units of production and related costs. After factory overhead costs have been classified
as either fixed or variable, budgets can be prepared for expected levels of production.
Budgeting is a valuable management tool for planning and controlling costs. A flexible
budget aids management in establishing realistic production goals and in comparing
actual costs with budgeted costs.
Recording Actual Factory Overhead Costs
Cost accounting systems are designed to accumulate, classify, and summarize the
factory overhead costs actually incurred. The specific procedures used to account for
actual factory overhead costs depend on the nature and organization of the
manufacturing firm.
Once we obtain the necessary source documents, the necessary entries are made in the
voucher register. In order to record in a voucher register, a voucher must be prepared
first using the following steps:
1. Compare the invoice with purchase order and receiving report and all computations
are checked
2. Prepare a voucher, including a notation of the department to be charged
3. Record the voucher in the voucher register. The entry is
Manufacturing Overhead Control xxx
4. The cost clerk will post the cost to the appropriate departmental overhead analysis
sheet.
The format of the voucher register is shown below.
Voucher Register
Date Voucher No. Payable Paid Vouchers MOH
to Date Check No Payable Control
Credit Credit

DREAMLAND COLLEGE
Form 1.3 Voucher Register

Note that the above four steps do not apply to the manner of recording indirect
materials and indirect labor. Indirect materials are directly entered into departmental
overhead analysis sheet from materials requisition. Indirect labor is directly transferred
from time ticket analysis to departmental overhead analysis sheet.
2.1 Applying Factory Overhead Costs to Production
Companies avoided estimating and applying factory overhead to production by
charging the actual or incurred factory overhead costs to the Work-in-Process account.
Companies used these procedures to emphasize the flow of costs and the basic
techniques used in cost accounting without unduly complicating the fundamentals.
The advantages of estimating and charging factory overhead include billing customers
on a timelier basis and preparing bids for new contracts more accurately.
Developing Predetermined Factory Overhead Rate
(A) Actual Costing Vs. Normal Costing
In actual cost system, actual direct materials and direct labor costs are accumulated in
work in process inventory account as they are incurred. Actual overhead costs are
assigned to work in process inventory at the end of a period. In this system, all cost
elements are actual costs and no predetermined overhead rate is used.
1) Generally accepted accounting principles require it to determine valuations for
financial statements. The allocation of overhead is related to the cost principle,
which requires that all costs of acquisition or production attach to the units
purchased or produced (or the services rendered)
2) Overhead allocation is necessary for managers to efficiently and effectively
perform their function of planning control and decision making.
(B) Meaning of a Predetermined Factory Overhead Rate

A predetermined overhead rate (or predetermined overhead application rate) is an
estimated and constant charge per unit of activity that is used to assign overhead to the
period’s production or services quantity. It is calculated by dividing total budgeted or
estimated overhead costs by the related budgeted or estimated level of volume or
activity.
Predetermined Overhead rate = Total budgeted Factory Overhead Costs
Total budgeted level of volume or activity
(Bases)
Companies should use an activity base that provides a logical relationship between the
base and overhead cost incurrence.

DREAMLAND COLLEGE
The concept of homogeneity underlies all cost allocation. A measure of activity must
be determined that is common to all output to allocate overhead to heterogeneous
products. Direct labor hours and direct labor dollars have been the most commonly
used measures of activity; however, their application has decreased as companies
increasingly automated and managers are made aware of the potential cost distortions.
(C) Reasons for Using Predetermined Overhead Rates
There are three primary reasons for using predetermined overhead rates rather than
actual overhead costs for product costing. These are:-
1. A predetermined overhead rate allows overhead to be assigned to the goods
produced or services rendered during the period. If actual overhead is to be
assigned to products, all manufacturing overhead costs must be available before
any allocations can be made.
2. Use of predetermined overhead rates can compensate for fluctuations in actual
overhead costs that are unrelated to activity levels. Overhead may vary on a
monthly basis because of seasonal or calendar factors.
3. Using of predetermined overhead rate can overcome the problem of fluctuations in
activity levels that have no impact on actual fixed overhead costs.
In an actual cost system, product costs are only recorded when they are incurred. This
technique is usually acceptable for the recording of direct material and direct labor
because they can be easily traced to specific jobs.
The actual cost of direct material used to produce a specific product is readily available
in the materials requisition form. The actual cost of direct labor used is obtained from
time tickets. However, it is impossible to determine the actual cost of FOH to a
specific job or product because of the following two reasons:
i) FOH is incurred for general factory use but not for a specific job or
product.
ii) Manufacturing companies produce goods continuously (daily, weekly,
or monthly) but the actual amount of FOH is conveniently determined at
the end of the fiscal period, e.g. depreciation.
(D) Types of Bases
To compute predetermined factory overhead rates, companies must first select a base
to apply overhead to the products manufactured or services rendered. The base should
be a cost driver that directly causes the incurrence of overhead costs. In other words,
the base selected for applying FOH to jobs or departments should be closely related to
functions represented by the FOH costs being applied.
(1) Direct Labor Hours Method
This method is appropriate when there is a direct relationship between factory
overhead costs (FOH) and direct labor hours (DLH) and when there is a significant
disparity in hourly wage rates. The predetermined rate is computed by dividing the

DREAMLAND COLLEGE
budgeted factory overhead cost by the estimated direct labor hours to be worked. The
formula is as follows:
FOH rate per DL Hour = Estimated_ FOH Costs
Estimated DL hours
This method would be inappropriate if factory overhead costs were composed of costs
unrelated to labor activity. In other words, it is more appropriate if labor operations are
the major part of the production process.
Example
A summary of the budget data for Binda Manufacturer for the year ended December
31, 2015 is given below.
 Budgeted manufacturing overhead costs Br.600,000
 Budgeted direct labor hours 240,000 units
The predetermined direct labor hour rate is Br.2.50 per direct labor hour, computed as
follows:
FOH rate per DL Hour = Estimated_ FOH Costs
Estimated DL hours
= Br. 600,000
240,000 Hours
= Birr 2.50 per Direct Labor Hour
The rate implies that if one direct labor hour is incurred for a job or product, the
amount of overhead applied to the job or product is birr 2.50.
(2) Machine Hours Method
The machine hours method uses the time required for machine to perform similar
operations as a base in computing the FOH application rate. This method is appropriate
when a direct relationship exists between factory overhead costs and machine hours.
The predetermined rate is computed by dividing the budgeted factory overhead cost by
the estimated machine hours to be used by production. The formula is as follows:
FOH rate per Machine Hours = Estimated FOH Costs
Estimated Machine Hours
It is a complex method that requires substantial preliminary study before installation
and an additional quantity of records to be maintained. However, the advantages to be
gained by a more dependable factory overhead application rate may more than
outweigh the additional effort and costs involved.
Example
 Budgeted machine hours 350,000 hours

DREAMLAND COLLEGE
The predetermined machine hour rate is Br.1.71 per machine hour, computed as
follows:
= Birr 600,000
350,000 Hours
= Birr 1.71 per Machine Hour
The rate implies that if one direct machine hour is used for a job or product, the
amount of overhead applied to the job or product is birr 1.71.
(3) Direct Labor Cost Method
This is the most widely used base because direct labor costs are generally closely
related to FOH costs and payroll data are readily available.
The predetermined rate is computed by dividing the estimated (budgeted) factory
overhead cost by the estimated (budgeted) direct labor cost. The formula is as follow:
FOH rate per DLC = Estimated FOH Costs x 100%
Estimated DL Costs
The direct labor cost method is appropriate in departments that require mostly human
labor and in which the direct labor cost charges are relatively stable from one product
to another.
Overhead expense incurred by the department. Any fluctuation in the departmental
direct labor cost not accompanied by a proportional increase in actual factory overhead
expenses will cause a distortion in the product's total cost.
Example
 Budgeted direct labor cost Br.400,000
The predetermined direct labor cost rate is 150% of direct labor costs, computed as
follows:
FOH rate per DLC = Estimated FOH Costs x 100%
Estimated DL Costs
= Birr 600,000
Birr 400,000
= 150% of DLC
The rate implies that the amount of overhead applied to a job or product is 150% of
actual direct labor cost incurred on that job or product.
(4) Units of Production (Physical Output) Method
This method is very simple because the units produced are readily available for
applying FOH. It applies the factory overhead costs equally to each units produced and

DREAMLAND COLLEGE
is appropriate when a company or department manufactures only one type product or a

few similar types of products.
The predetermined rate is computed by dividing the estimated (budgeted) factory

overhead cost by the estimated (budgeted) number of units to be produced. The
formula is as follow:
FOH rate per Unit = Estimated FOH Costs
Estimated Units of Production
Example
 Budgeted units of production 30,000 units
The predetermined unit of production rate is birr 20 per unit, computed as follows:
FOH rate per Unit = Estimated FOH Costs
Estimated Units of Production
= Birr 600,000
30,000 Units
= Birr 20 per Unit
The rate implies that if one unit is produced, the overhead applied to this unit would be
Birr 20.
(5) Direct Material Cost Method
This method is suitable when there exists a logical relationship between direct material
costs and factory overhead cost. However, the method has only limited use because no
such relationship persists between direct material cost and factory overhead costs.
Under this method, the overhead application rate is expressed as a percentage of direct
material costs. The formula is as follow:
FOH rate per DMC = Estimated FOH Costs x 100%
Estimated Direct Material Costs
Example
 Budgeted direct material costs Br.360,000
The predetermined direct material cost rate is 167% of direct material costs, computed
as follows:
FOH rate per DMC = Estimated FOH Costs x 100%
Estimated Direct Material Costs
= Birr 600,000
Birr 360,000

DREAMLAND COLLEGE
= 167% of DMC
The rate implies that the amount of overhead applied to a job or product is 167% of
actual direct material cost used for that job or product.
2.2 Applying Factory Overhead Costs at Predetermined Rates
After selecting the application method and computing the predetermined rate to be
used, all jobs or processes should be charged with the estimated overhead cost rather
than the actual factory overhead costs being incurred.
In general, the following procedures are used to apply manufacturing overhead to jobs
or products.
Step 1 Select the application base (bases described earlier)
Step 2 Prepare a factory overhead budget for the planning period. The two key items
are (a) budgeted total overhead, and (b) budgeted total volume of the
application base
Step 3 Compute the overhead application rate by dividing the budgeted total overhead
by the budgeted total volume of the application base
Step 4 Obtain the actual application base data (such as machine hours) for the planning
period
Step 5 Apply the overhead to the jobs or products by multiplying the overhead
application rate by the actual application base data
Step 6 Prepare the necessary entry to record the applied factory overhead by the
following entry:
Work in Process ………………………………….. xxxx
Manufacturing Overhead Applied ……………………. xxxx
Step 7 At the end of the period, account for any difference between the amount of
overhead actually incurred and overhead applied to products
Example
Suppose that Binda Company budgeted its factory overhead for the forthcoming year
as Birr 900,000. Assume that manufacturing overhead is applied to products on the
basis of machine hours of 600,000 hours. Assume further that a job cost sheet for
product #22 included the following information:
 Actual direct materials cost Birr 2,500
 Actual direct labor cost Birr 3,000
 Actual machine hours 2,000 hours
Required:-
a) Determine the overhead application rate
b) Compute the overhead applied to product #22
c) Prepare the entry to record overhead cost applied to product #22
a) Determination of predetermined overhead application rate

DREAMLAND COLLEGE
The predetermined machine hour rate is Birr 1.51 per machine hour, computed as
follows:
= Birr 900,000
600,000 Hours
= Birr 1.50 per Machine Hour
The rate implies that if one direct machine hour is used for product #22, the amount of
overhead applied to the job or product is birr 1.50.
b) Computation of the overhead applied to product #22
The amount of overhead cost applied to product #22 is birr 3,000, computed as
follows:
Applied Overhead = Predetermined Overhead Rate x Actual Activity Base
= 1.50 x 2,000 hours
= Birr 3,000
c) Journal Entry
The estimated factory overhead applied to the product is debited to Work in Process
account and is credited to Factory Overhead Applied account.
Work in Process 3,000
Manufacturing Overhead Applied 3,000
2.3 Over-applied or Under-applied Overhead
After selecting the application method and computing the predetermined rate to be
used, all jobs or processes should be charged with the estimated overhead cost rather
than the actual factory overhead costs being incurred. The estimated factory overhead
is applied to production, by a debit to Work in Process and a credit to an account
entitled applied factory overhead.
If a balance {debit or credit) remains in the factory overhead control account, it
indicates that the actual factory overhead incurred did not equal the estimated factory,
overhead applied.
Disposition of Under and Over Applied Overhead
At the end of the period, the amount of actual overhead incurred during a period will
not be equal to the applied overhead. This difference is referred to as under or over
applied overhead.
If the amount of under or over applied overhead is material or significant it should be
allocated among the account containing applied overhead. These accounts are work in
process inventory, finished goods inventory and cost of goods sold. A significant
amount of under or over applied overhead means that the balances in each of these
accounts are quite different from what they would have been if actual overhead costs
had been assigned to production.

DREAMLAND COLLEGE
What disposition should be made of any under or over applied balance remaining in
the Manufacturing Overhead account at the end of a period? Generally, any balance in
the account is treated in one of two ways:
1. Closed out to Cost of goods Sold. If the balance in the Manufacturing Overhead
account is small, most companies will close it out directly to Cost of Goods Sold,
since this approach is simpler than allocation.
2. Allocated between Work in Process, Finished Goods, and Cost of Goods Sold in
proportion to the ending balances in these accounts. The choice between these two
approaches depends in large part on the amount of under or over applied overhead
involved. The greater the amount, the more likely a company is to choose the
second alternative.
Example 1: The following information pertains to Belay Glass Works for the year just
ended:
Factory overhead incurred …………………. Br 900.000
Factory overhead applied…………………… 1,200,000
The difference between actual and the applied factory overhead costs is considered to
the material. And further assume that the ending balances (before prorating the over or
under applied overhead costs) were as follows:
Cost of Goods Sold ………………….. Br. 1,000,000
Work in Process …………………….. 400,000
Finished Goods ……………………… 600,000
Instruction:
a) Compute under applied or over applied overhead at year end.
b) Perorate under applied or over applied overhead among the three balances
c) Prepare the closing entry to record the prorated amount assuming that applied
overhead was recorded in manufacturing overhead control account.
d) Compute the new balances of the account after peroration.
Solution:
a) Determining the over or under applied overhead:
Factory overhead applied ……………………………..Br 1,200,000
Less Factory overhead incurred ………………………. 900.000
Over applied overhead ………………………………… Br 300.000
b) Proration of over applied overhead is shown below:

Cost of goods Sold = 1,000,000 x 300,000 = Br.150,000
2,000,000
Work in Process = 400,000 x 300,000 = Br.60,000
2,000,000
Finished Goods = 600,000 x 300,000 = Br.90,000

DREAMLAND COLLEGE
2,000,000
c) If Belay Glass Work had chosen to prorate over applied overhead, the following
journal entry would have been made:
Factory Overhead control ……… 300,000
Cost of Goods sold ……………………… 150,000
Work in Process ………………………… 60,000
Finished Goods …………………………. 90,000
d) The balance of the three accounts after peroration are:
Cost of Goods sold = 1,000,000 - 150,000 = Br 850,000
Work in Process = 400,000 - 60,000 = 340,000
Finished Goods = 600,000 - 90,000 = 510,000
2.4 Overhead Costs of Service Departments
(A) Service Departments Vs. Production Departments
In a factory, the manufacturing process consists of a series of operations performed in
departments or cost centers. Departments are divided into two classes: service
departments and production departments.
(B) Reasons for service department cost allocations
All service department costs are incurred to support production or service rendering
activities. As long as operating activities occur, there is a need for service department
activity.
Managers of revenue producing areas are made more aware of and sensitive to the
support provided by the service area when full costs are determined.
(C) Allocation Bases
The distribution of the service department costs to production departments involves an
analysis of the service department's relationship to the other departments before an
apportionment process can be developed.
Common bases for distributing service department costs include the following:
Service Departments Basis for Distribution
Building Maintenance Floor space occurred by other departments
Inspection and Packing Production Volume
Machine Shop Value of Machinery and equipment
Personnel Number of purchase orders
Shipping Floor space occurred by other departments
Stores Units of materials requisitioned
Tool Room Total direct labor hours in departments
served
(D) Methods of Allocation
There are three basic ways to allocate the accumulated service department costs to the
revenue producing departments:-

DREAMLAND COLLEGE
1) Direct method
Direct method assigns service department costs directly to revenue producing areas
with only one set of intermediate cost pool or allocations. Cost assignments under the
direct method is made using one specific cost driver to the intermediate pool, for
example, personnel department costs are assigned to production departments (the
intermediate-level pool) based on the number of people in each production department.
2) Step method
The step method of cost allocation assigns service department costs to the cost objects
after considering some interrelationships of the service departments.
3) Algebraic Equation (Reciprocal) method
The algebraic (reciprocal) method of allocating service department costs considers all
departmental interrelationships and reflects these relationships in simultaneous
equations.
These equations provide for reciprocal allocation of service costs among the service
departments as well as to the revenue producing departments.
Example
MT Manufacturing Company is divided into five departments, A, B, C, D, and E. The
first three departments are engaged in production work. Department D and E are
service departments. During the month of June, the following factory overhead was
incurred for the various departments:
Department A………….Br 21,000 Department D………….Br 9,000

Department B…………. 18,000 Department E……….….. 6,400
Department C…………. 25,000
The bases for distributing service department expenses to the other departments
follow:
Department E- On the basis of floor space occupied by the other departments as
follows: Department A, 10,000 sq. ft.; Department B, 4,500 sq. ft.; Department C,
10,500 sq. ft.; Department D, 7,000 sq. ft.
Department D- Divided: Department A-30%; Department B-20%; Department C-
50%;
Required:- Prepare schedules showing the distribution of the service departments’
expenses for the following:
a. The direct distribution method
b. The sequential distribution method in the order of numbers of other departments
served.
Solution:
a. Distribution of service department costs to production departments using direct
method
Department D’s overhead cost distribution to:

DREAMLAND COLLEGE
Department A= 9,000 x 30%= Br 2,700

Department B= 9,000 x 20% = Br 1,800
Department C= 9,000 x 50%= Br 4,500
Department E’s overhead cost distribution to:
Department A= 6,400 x 10,000 = Br.2,560
25,000
Department B= 6,400 x 4,500 = Br.1,152
25,000
Department C= 6,400 x 10,500 = Br.2,688
25,000
b. Sequential distribution of service department costs to production departments
Department E’s overhead cost distribution to:
Department A= 6,400 x 10,000 = Br.2,000
32,000
Department B= 6,400 x 4,500 = Br.900
32,000
Department C= 6,400 x 10,500 = Br.2,100
32,000
Department D= 6,400 x 7,000 = Br.1,400
32,000
Department D’s overhead cost distribution to:

Department A= 10,400 x 30%= Br 3,120
Department B= 10,400 x 20% = Br 2,080
Department C= 10,400 x 50%= Br 5,200

DREAMLAND COLLEGE
UNIT SEVEN
JOB ORDER COSTING SYSTEM

Concept of Job Order Costing System
1.1 Meaning of Job Order Costing System
One of the two basic types of cost accumulation systems is job order costing system.
Job order costing is used in those business concerns where production is carried out as
per the customer’s order and specifications or that produce a high variety of products
for stock.
Job order costing system provides for separate records of the cost of each particular
quantity of product manufactured. A particular quantity of product is termed as job.
Job order costing is costing method applied to determine the costs of specific job
generally manufactured according to customer’s specification.
The main feature of the job order costing system is that no two orders are necessarily
the same. Under this method costs are collected and accumulated for each job/work
order separately.
1.2 Characteristics of Job Order Costing System
The major objective of job order costing is to find out the profit or loss on each job.
When distinct products are produced, there is need that costs be identified with specific
orders. Some of the common features of this method of costing are given below:-
a) The distinction between direct and indirect costs is more important in job order
costing than in case of process costing
b) Orders are issued, and costs are kept for each lot of product manufactured
c) Direct costs are charged to the work in process account and are entered on job
sheets
d) This method is used for estimating the amount of applied indirect costs, also known
as applied manufacturing expenses in respect of each order. Such amount are
entered on cost sheets and charged to the work in process account
e) This method is relatively more labor intensive. That means majority of the
expenses are related to labor or payroll.
1.3 Advantages of Job Order Costing System
Job order costing system has the following advantages
1. The cost of material, labor and overhead for every job is readily available and
management is able to control the efficiency of operations.
2. It is simple as the recording of direct materials, direct labor, and overhead is done
for each job.
3. Spoilage and defective works can be easily identified with specific jobs so that
responsibility can be fixed.
4. It provides basis for comparing one job cost to another or through period.

DREAMLAND COLLEGE
1.4 Disadvantages of Job Order Costing System

Job order costing system has the following limitations
1. Job costing is very expensive as more clerical work is involved in identifying each
element of cost with specific jobs
2. With the increase in clerical processes, chances of errors are enhanced
3. In case of inflation, comparison of cost of a job for one period or with that of
another becomes meaningless
Accounting Procedures in Job Order Costing System
2.1 Accounting for Materials Costs
As discussed previously, the term material refers to such commodities which are
supplied to the manufacturing industry in their crude or original form.
Raw materials:- Materials which are worked on in the course of manufacturing a
product and which make up the physical form of the product, for example rubber, steel,
lumber and others.
Components:-Finished part which are attached to the product during manufacturing a
product, for example instruments, spare parts and so on
Consumable materials: - Materials used in running the factory generally, for example
soap, brushes, etc.
Maintenance materials: - Materials required for the maintenance of plant and
buildings
The procedures used to purchase, store and issue materials to production often differ
among manufactures. When materials are purchased and stored, the journal entry to
record the purchase of materials is:
Materials……………………………………….. xxx
Cash (Accounts Payable)………………………….. xxx
Materials are drawn from the storeroom to the factory by the use of materials
requisition form. Direct materials assignable to specific jobs on the production line are
charged to Work in Process account. Indirect materials used in production are debited
to Manufacturing Overhead (MOH) Control account.
WIP-Job xxx……………………………………xxx
MOH-Control………………………………….. xxx
Materials……………………………………………. xxx
Observe that MOH Control account is separate from the Work in Process account. The
purpose of Manufacturing Overhead Control account is to accumulate all
manufacturing overhead costs as they are incurred during a period.
Accounting for Labor

DREAMLAND COLLEGE
As work is performed in various departments of a manufacturing company, employee

time tickets are filled out by workers, collected, and forwarded to the accounting
department. In the accounting department, the tickets are costed according to the
various rates paid to the employees, and the resulting costs are classified as either
direct or indirect labor. This costing and classification resulted in the following
summary entry:
WIP……………………………………………. xxx
MOH Control…………………………………... xxx
Salaries and Wages Payable…………………… xxx
Only that portion of labor cost that represents direct labor is added to the Work in
Process account. At the same time direct labor costs are added to Work-in-Process,
they are also added to the individual job cost sheet. The labor cost that is charged to
MOH represents the indirect labor costs of the period, such as supervision, janitorial
work, and maintenance.
2.2 Accounting for Factory Overhead Costs
(A) Recording Actual Factory Overhead Costs
As we learned in previous units, all costs of operating the factory other than direct
materials and direct labor are classified as manufacturing overhead (MOH). These
costs are entered directly into the Manufacturing Overhead as they are incurred. The
following entry records these items:
MOH Control…………………………………………. xxx
Accounts Payable………………………………….…… xxx
Accumulated Depreciation……………………………... xxx
Prepaid Insurance ………………………………………. xxx
Property Taxes Payable ………………………………… xxx
Cash…………………………….……………………….. xxx
Other Accounts……….…………………………………. xxx
(B) Applying Factory Overhead Costs to Production
Since actual overhead costs are charged to Manufacturing Overhead Control account
rather than to Work in Process, how are manufacturing overhead costs are assigned to
Work in Process? The answer is easy; it is by means of the predetermined overhead
rate.
2.3 Accounting for Finished Goods and Cost of Goods Sold

DREAMLAND COLLEGE
When a job has been completed, the finished output is transferred from the production
department to the finished goods warehouse.The following journal entry transfers the
costs of the job from WIP to Finished Goods:
Finished Goods…………………………………. xxx
WIP……………………………………………………. xxx
Cost of jobs not completed by period end will remain in the WIP account and carry
over to the next period. If a balance sheet is to be prepared at the end of the period, the
cost accumulated thus far on uncompleted jobs will appear as “WIP inventory” on the
asset section.
As units in finished goods are shipped to fill customers’ orders, the unit cost appearing
on the job cost sheet is used as a basis for transferring the cost of the items sold from
the Finished Goods account to the Cost of Goods Sold account. If a complete job is
shipped, as in the case where a job has been done to a customer’s specifications, then it
is simple matter to transfer the entire cost appearing on the job cost sheet into the Cost
of Goods Sold account. Two journal entries are initiated under perpetual inventory
system at point of sale:
a) Entry to record sales
Cash (Accounts Receivables)…………………………… xxx
Sales……………………………………………………….xxx
b) Entry to record cost of goods sold
Cost of Goods Sold……………………………………… xxx
Finished Goods……………………………………………xxx
Pay particular attention to the following subtle but important point: Actual overhead
costs are not charged to jobs; actual overhead costs do not appear on the job cost sheet
nor do they appear in the WIP account. Only the applied overhead cost, based on the
predetermined rate, appears on the job cost sheet and in the WIP account.
Example
South Company is manufacturing firm that uses job order costing. On January 1, the
beginning of its fiscal year, the company’s inventory balances were as follows:
Raw materials…………………………… Br 20,000
Work in process…………………………. 15,000
Finished goods……………..…………… 30,000
The company applies overhead cost to jobs on the basis of machine hours worked. For
the current year, the company estimated that it would work 75, 000 machine hours and
incur Br 450, 000 in manufacturing overhead cost.
The following transactions were recorded for the year.
a. Raw material were purchased on account , Br 410,000
b. Raw materials were requisitioned for use in production, Br 380,000 (Br360,00
direct material and Br 20, 000 indirect materials).

DREAMLAND COLLEGE
c. The following cost were incurred for employee service: direct labor, Br 75,000;
indirect labor, Br 110, 000; sales commissions, Br90,000; and administrative
salaries, Br200,000.
d. Sales travel costs were incurred, Br 17, 000.
e. Utility costs were incurred in the factory, Br 43, 000.
f. Advertising costs were incurred, Br180,000.
g. Depreciation was recorded for the year, Br350,000 (80% relates to factory
operations, and 20% relates to selling and administrative activities).
h. Insurance expired during the year, Br10, 000 (70% relates to factory operations,
and the remaining 30% relates to selling and administrative activities).
i. Manufacturing overhead was applied to production. Due to greater than expected
demand for its products, the company worked 80,000 machine hoursduring the
year.
j. Goods costing Br 900,000 to manufacture according to their job cost sheets were
completed during the year.
k. Goods were sold on account to customers during the year at a total selling price of
Br 1,500,000. The goods cost Br 870, 000 to manufacture according to their job
cost sheets.
Required:- Prepare journal entries to record the preceding transactions.
Solution:
1. Journal Entries of South Company for the month of January
a. Raw Materials…………………………………410,000
Accounts Payable…………………………. 410,000
b. Work in Process…………………………360,000
Manufacturing Overhead……………….. 20,000
Raw Materials……………………………………380,000
c. Work in Process………………………....... 75,000
Sales Commissions Expense*…………….. 90,000
Administrative Salaries Expense*……… 200,000
Salaries and Wages Payable…………………475, 000
For example, here above, both sales commissions and administrative salaries may be
debited to Selling and Administrative Expenses. Usually, separate general ledger
control account would be established for selling expenses and administrative expenses.
d. Sales Travel Expense…………………..17, 000
Accounts Payable………………………….17,000
e. Manufacturing Overhead………………..43,000
f. Advertising Expense……………….. 180,000

DREAMLAND COLLEGE
g. Manufacturing Overhead………………..280,000
Depreciation Expense…………………. 70,000
Accumulated Depreciation…………………. 350,000
h. Manufacturing Overhead……………….. 7,000
Insurance Expense………………..……. 3,000
Prepaid Insurance…………………….…………. 10,000
i. Work in Process……………….. 480,000
Predetermined overhead rate can be calculated as:
= Estimated Machine Hours= Br.45,000 = Br.6/MHR
Estimated MOH 75,000MHRS
* Br 480,000= 6 x 80, 000
j. Finished Goods………………900,000
Work in Process……………………….900,000
k. i) Entry to record credit sales
Accounts Receivable……………1,500,000
Sales………………………………………..1,500,000
ii) Entry to record cost of goods sold
Cost of Goods Sold………………………….870,000
Finished Goods……………………………..…..870,000
UNIT EIGHT
PROCESS COSTING SYSTEM

Concept of Process Costing System
1.1 Nature of Process Costing System
Process costing is a system used to assign costs to goods that are mass produced in a
continuous sequence of steps called processes.
Continuous process/operations have one or more of the following features:
a) The product is produced in a single process/operation
b) If the manufacturing of products involves more than one process/operation, output
of one process/operation becomes the input for the next process/operation
c) During the continuity of the process/operation, products or materials are not
distinguishable from one another.
A process costing system is appropriate in industries that produce homogenous
products manufactured through mass production or continuous process.
A product can move through a factory in different ways. These product flow system
associated with process costing are:

DREAMLAND COLLEGE
i. Sequential product flow: In this case each product is processed in the same
sequence one after the other.
ii. Parallel product flow: Here certain portion of the work is done simultaneously
and then brought together in a final process or processes for completion.
iii. Selective product flow: In this case the product moves to different department
with in the factory depending upon the desired final product.
Most continuous process manufacturing companies are organized into two or more
production departments each of them performs a specialized function or a series of
production operations in the sequence of manufacturing the products.
1.2 Characteristics of Process Costing System
Process costing system has the following major features or characteristics:-
1. The manufacturing costs are accumulated for each production department or
process.
2. Each process or department has its own account and records the processing costs
incurred by the department.
3. Under processing industries, the production is continuous and the emphasis is on
uniform or standardized product.
4. Completed units and their associated costs are transferred to the next process, if
something is still to be done on those units. Completed units are transferred to
finished goods, if nothing is to be done.
5. A cost of production report s used to collect, summarize and compute the total and
unit cost.
6. Production in process at the end of a period is restated in terms of equivalent units.
7. As the production process is continuous, there is always work in process at the end
of each accounting period.
8. It is impossible to build up cost records for cost per unit of finished product
because production in progress is an indistinguishable.
1.3 Distinction between Job Order Costing System and Process Costing
System
Process costing and job order costing can differ in the following points:-
Job Order Costing Process Costing
 Each job can be identified from the  The production process is continuous and
beginning to the end of the a particular unit cannot be identified at
manufacturing process any point during the manufacturing
process
 Job costing is applicable in situations  Process costing on the other hand, is used
where the objective is to identify in cases of mass production of similar
costs with specific products or jobs units that continuously pass through
different departments or processes
 Costs are accumulated for each job  Costs are accumulated for each process

DREAMLAND COLLEGE
or department
 The job cost sheet is the key  The department production report is the
document controlling the key document showing the accumulation
accumulation of costs by a job and disposition of costs by department
 Job cost is computed only when job is  Costs are compiled on time basis, i.e., for
completed a given accounting period
 Unit costs are computed by jobs on  Unit costs are computed by department
the job cost sheet on the department production report
 manufacturing costs are accumulated  manufacturing costs are accumulated for
for particular jobs the entire departments
 Production is generally dependent on  Production is done for building stock of
customer orders and specifications goods and for future sale
 There may or may not be any work in  Output of one process is transferred to
process at the end of an accounting the next process as raw materials until the
period products are completely manufactured
 In job costing exercise of control over  In process costing exercise of control is
jobs is relatively difficult as each job easier since the processes are repetitive
in separate and unique and more or less identical from period to
period
1.4 Advantages of Process Costing System

Process costing system has the following advantages
1. In process costing, the product is uniform type, so the computation of average costs
is easier.
2. The cost is calculated periodically and not at the completion of each job as is done
in the case of job costing.
3. The clerical efforts and costs are less as compared to job costing.
4. Effective control over production can easily be exercised.
1.5 Disadvantages of Process Costing System
Process costing system has the following disadvantages
1. Since the process costs are average costs they are not always accurate. The chances
of errors are more. Moreover, once an error is committed in one process it is
carried over to the subsequent processes.
2. Since the process costs are collected at the end of the period, they are in the nature
of historical costs there may be use of excessive materials and labor but they are
not revealed until the end of the period.
3. Computation of average cost becomes more difficult when more than one type of
product is manufactured.
1.6 Key Steps in Process Costing System
The basic steps in process costing system may include the following:-

DREAMLAND COLLEGE
B. To calculate the total physical units for which the department is responsible
or the total units to be accounted for. This amount is equal to the total
number of units worked on in the department during the current period.
That is beginning inventory plus units started.
C. Determine what happened to the units to be accounted for during the
period. This step also requires the use of physical units. These units may fit
into one or two of the following categories.
(1) Completed and transferred
(2) Partially completed and remaining in the ending work in process inventory.
At this point, you should verify that the total units to be accounted for are equal to
the units that are accounted for.
D. Use either the weighted average or FIFO method to determine the
equivalent units of production for each component.
E. Find the total cost to be accounted for, which includes the balance in work
in process inventory at the beginning of the period plus all current costs for
direct materials, direct labor and overhead.
F. Compute the cost per equivalent units for each cost component using either
the weighted average or FIFO equivalent units of production in step 3.
G. Use the cots computed in step 5 to assign costs to units completed and
transferred from the production process and to the units remaining in
ending work in process inventory.
Accounting Procedures in Process Costing System
Accounting for Materials Costs
Company that has only one production department. If there are several
departments/processes, it is preferable to use departmental work in process accounts
(i.e., maintain work in process account or each production department).
 Work in Process – Department 1
 Work in Process – Department 2
When materials (both direct and indirect) are charged against production, the issuance
of materials is recorded as follows:
WIP- Department 1................................................... xxx
WIP- Department 2................................................... xxx
MHO-Control……………………………………… xx
Materials........................................................ xxxx
Work in process accounts are debited for direct materials and MOH Control account is
debited for the indirect materials.
When department 1 completes and transfers goods to department 2, the costs incurred
in department 1 are transferred to department 2. Then the work in process of
department 2 is debited and the work in process of department 1 is credited for the total

DREAMLAND COLLEGE
cost of goods transferred to department 2. For transferring purpose, the unit cost is
calculated for departments.
WIP-Department 2................................................... xxx
WIP-Department 1.....................................................xxx
When department 2 completes and transfers finished goods to warehouse, Finished
Goods account is debited and Work in Process of the last production
department/process is credited.
Finished Goods xxxx
WIP-Department 2 xxxx
2.1 Accounting for Labor Costs
The detailed clerical work of accumulating labor costs by job order costing is
eliminated in process costing because labor costs are identified by and charged to
departments. When direct and indirect labor costs are charged against production, the
costs are distributed to departments using the following entry:
WIP- Department 1..................................................... xxx
MOH Control……...................................................... xxx
Factory Payroll Clearing………............................... xxx
2.2 Accounting for Manufacturing Overhead Costs
In process costing systems, when manufacturing overhead costs are incurred, they are
recorded in MOH Control account and posted to departmental expense analysis sheets,
which constitute the subsidiary ledger. Actual MOH costs are recorded as follows:
MOH Control........................................................... xxx
Account Payables........................................................ xxx
Accumulated Depreciation ........................................ xxx
Materials .................................................................... xxx
Factory Payroll Clearing............................................. xxx
At the end of each period either actual or applied overhead is charged to the producing
departments. When overhead costs are applied (allocated) to departments, the
following entry is made:
MOH Applied ............................................................xxxx
2.3 Accounting for Finished Goods and Cost of Goods Sold
When goods are completed, the finished goods are transferred from the last production
department to the finished goods warehouse. By this time, the accounting department
debits the Finished Goods account and credits the Work in Process account of the last
production department/process is credited.
Finished Goods………………………………………. xxxx

DREAMLAND COLLEGE
Work in Process – Department 2……………………. xxxx

As units in finished goods are sold, the cost of products sold is debited to Cost of
Goods Sold account and credited to Finished Goods account to account for the cost. In
addition, cash or Accounts Receivable account is debited and Sales is credited for the
selling price of the products.
Cash (Accounts Receivable)……………………………… xx
Cost of Goods Sold………………………………………. xxxx
Sales………………………………………………………… xx
Finished Goods……………………….……………………. xxxx
2.4 The Cost of Production Report (CPR)

The cost of production report is analysis of the activity in the department or cost center
for the period. It is the source for summary journal entries for the period. The costs of
production report for each department may be prepared following the key steps that
appear here below:
Step 1: Quantity and Equivalent Unit Schedule,
Step 2: Costs to Account for Schedule, and
Step 3: Cost recapitulations (Costs Accounted for Schedule)

DREAMLAND COLLEGE
Comparison of Weighted Average and FIFO Costing Methods
Weighted Average Method FIFO Method

Quantity Schedule and Equivalent Units
 The quantity schedule includes all  The quantity schedule divides the units
units transferred out in a single figure transferred out into two parts. One part
consists of units in the beginning
inventory, and the other part consists of
units started and completed during the
current period
 In computing equivalent units, the  Only work needed to complete units in
units in the beginning inventory the beginning inventory is included in
treated as if they were started and the computation of equivalent units.
completed during the current period Units started and completed during the
current period are shown in separate
figure
Total and Unit Costs
 The “Cost to be accounted for” part of  The “Cost to be accounted for” part of
the report is the same for both methods the report is the same for both methods
 Costs in the beginning inventory are  Only costs of the current period are
added in with costs of the current included in unit cost computations
period in unit cost computations
 Unit costs will contain some element  Unit cost will contain only elements of
of cost from the prior period cost from the current period
Cost Reconciliation
 All units transferred out are treated the  Units transferred out are divided into
same, regardless of whether they were two groups (a) units in the beginning
part of the beginning inventory or inventory and (b) units started and
started and completed during the completed during the period
period  Units in the ending inventory have cost
 Units in the ending inventory have applied to them in the same way under
cost applied to them in the same way both methods
under both methods

DREAMLAND COLLEGE

DREAMLAND COLLEGE
UNIT NINE
SPOILAGE, REWORK AND SCRAP

1.1 Meaning of Spoilage
Spoilage is units of production – whether fully or partially completed – that do not
meet the standards required by customers for good units and that are discarded or sold
for reduced prices.
1.2 Types of Spoilage
Spoilage is an important consideration in any production related planning and
controlling decisions. Management must determine the most efficient production
process that will keep spoilage to a minimum. Spoilage is classified as normal spoilage
and abnormal spoilage.
(A) Normal spoilage
Normal spoilage is spoilage inherent in a particular production process that arises even
under efficient operating conditions. Depending on the production process,
management decides the spoilage it considers normal. Costs of normal spoilage are
typically included as a component of the costs of good units manufactured because
good units cannot be made without also making some units that are spoiled.
(B) Abnormal Spoilage
Abnormal Spoilage is spoilage that would not arise under efficient operating
conditions. It is not inherent in a particular production process. Abnormal spoilage is
usually regarded as avoidable and controllable.
1.3 Job Order Costing and Spoilage
The concepts of normal and abnormal spoilage also apply to job-costing systems.
Abnormal spoilage is separately identified with the goal of eliminating it altogether.
(1) Job Order Costing and Normal Spoilage
When assigning cost, job-costing systems generally distinguish normal spoilage
attributable to a specific job from normal spoilage common to all jobs. In other words,
in job order costing systems, normal or planned are considered part of normal
manufacturing costs. Normal spoilage costs have commonly been accounted for by one
of the following two methods:
a) Allocated or applied to a specific job
b) Allocated or applied to all jobs
a) Normal Spoilage attributable to a Specific Job
When normal spoilage occurs because of the specifications of a particular job, that job
bears the cost of the spoilage reduced by the disposal value of the spoilage. The
journal entry to recognize disposal value is
Material (spoiled goods at current net disposal value) ……………… xxx
Work-in-Process (specific job)………………………..………….. xxx

DREAMLAND COLLEGE
b) Normal spoilage Common to All Jobs

In some cases, spoilage may be considered a normal characteristic of a given
production cycle. The spoilage inherent in production will, of course, occur when a
specific job is being worked on. But the spoilage is not attributable to, and hence is not
charged to, the specific job. Instead, the spoilage is costed as manufacturing overhead.
The journal entry is
Materials (Spoiled goods at current disposal value) xxx
Manufacturing Overhead Control (normal spoilage) xx
Work-in-process (specific job) xxxx
(2) Job Order Costing and Abnormal Spoilage

If the spoilage is abnormal, the net loss is charged to an abnormal loss account. Unlike
normal spoilage costs, abnormal spoilage costs are not included as a part of the cost of
good units produced. Considering the above example, the total cost of the 45 good
units is birr 90,000 (45 units X birr 2,000 per unit). The cost per good unit is birr
2,000 (birr 90,000 ÷ 45 good units).
Materials (5 units X birr 600/unit) 3,000
Loss from Abnormal Spoilage (birr 10,000 - birr 3,000) 7,000
Work-in-process (specific job): 5 units X birr 2,000/units 10,000
Even though, for external reporting purposes, abnormal spoilage costs are written off
in the period and are not linked to specific jobs or units, companies often identify the
particular reasons for abnormal spoilage, and, when appropriate, link abnormal
spoilage with specific jobs or units for cost management purposes.
1.4 Process Costing and Spoilage
An inspection point is the stage of the production cycle at which products are
examined to determine whether they are acceptable or unacceptable units. Spoilage is
typically assumed to occur at the stage of completion where inspection takes place.
That’s because spoilage is not detected until inspection. Units of normal spoilages can
either be counted (approach A) or not counted (approach B) when computing output
units—physical or equivalent—in a process costing system. The following example
and discussion illustrate the superiority of approach A over approach B.
Chipmakers, Inc. manufactures computer chips for television sets. All direct materials
are added at the beginning of the production process. To highlight issues that arise
with normal spoilage, we assume no beginning inventory and focus only on direct
materials costs. In May 2003, birr 270,000 in direct materials were introduced into
production. Production data for May indicate that 10,000 units were started, 5,000
good units were completed, and 1,000 units were spoiled (all normal spoilage). Ending
work in process was 4,000 units—each unit 100% complete as to direct material costs.
Spoilage is detected upon completion of the process. Assume all spoilage (normal and
abnormal) has zero net disposal value.

DREAMLAND COLLEGE
Approach A Approach B
Recognizing Not Counting
Spoiled Units When Spoiled Units
When
Computing Output Computing
output
in Equivalent Units in Equivalent
nits
Costs to account for Br 270,000 Br 270,000

Divide by equivalent units ÷ 10,000 ÷9,000
Cost per equivalent unit Br. 27 Br.
30
Assignment of costs
Good units completed: (5,000 x birr 27; 5,000 x birr 30) Br 135,000 Br
150,000
Add normal spoilage: (1,000 x birr 27) 27,000
0
Costs of good units transferred out Br 162,000 Br 150,000
Work in process, ending:
(4,000 x birr 27; 4,000 X birr 30) 108,000 120,000
Costs accounted for Br 270,000 Br 270,000
The 1,000 units were known to be spoiled after they had used a cost required for 1,000
good units fully. Therefore Approach A is superior to Approach B which doesn’t count
the spoiled units while determining the equivalent units. As a result the total cost of
good units under approach B (Br 150,000) is Br 15,000 more than the cost of the good
units themselves (Br. 135,000). It means that Approach B assigns only Br 15,000 of
the total normal spoilage cost (Br. 27,000) to the good units while the remaining Br
12,000 is included in the total cost of the ending work in process. The 4,000 units in
the ending work in process have not yet been inspected. Hence failure to count the
spoiled units resulted in understatement of the cost of the good units by Br. 12,000
whereas the cost of the 4,000 units in the ending work in process is overstated by the
same amount.
Meaning of Scrap
Scrap is material left over when making a product. It has low sales value compared
with the sales value of the main product. Some examples of scrap are:
Operations Name of Scrap
1. Radio Assembly plant………………… Bits and pieces of wire and solder
2. Metal toy factory……………………… Blanks and fragments

DREAMLAND COLLEGE
3. Saw mill (wood working operations)…. Saw dust, bark and discarded end pieces
4. Chemical factory……………………… Chemical sediments
No distinction is made between normal and abnormal scrap because no cost is attached
to scrap. The only distinction made is between scrap attributable to a specific job and
scrap common to all jobs. Scrap has value. It may be sold or reused.it is normally
stored until a marketable quantity is collected. Then it is sold to scrap dealers, other
industries, or individuals.
3.1 Accounting for Scrap
There are two aspects of accounting for scrap:
1. Planning and control, including physical tracking
2. Inventory costing, including when and how it affects operating income
Initial entries to scrap records are commonly in physical terms. In various industries,
items such as stamped-out metal sheets or edges of molded plastic parts are quantified
by weighing, counting, or some other expedient means. Scrap records not only help
measure efficiency, but they also help keep track of scrap and so reduce the chances of
theft. Scrap reports are prepared as source documents for periodic summaries of the
amount of actual scrap compared with the budgeted or standard amounts. Scrap is
either sold or disposed of quickly, or stored for later sale, disposal, or reuse.
3.1.1 Recognizing Scrap at the Time of its Sale
The two main issues which relate to scrap are:
1. When should the value of scrap be recognized in the accounting records-at the
time scrap is produced or at the time scrap is sold?
2. How should revenues from scrap be accounted for?
To illustrate, we extend our Hull example. Assume the manufacture of aircraft parts
generates scrap and that the scrap from a job has a net sales value of birr 900.
(A) If scrap is Immaterial
When the birr amount of scrap is immaterial, the simplest accounting is to make a
notation of the quantity of scrap returned to the storeroom and to regard scrap sales as
a separate line item of other revenues in the income statement. The only journal entry
to record the sale of scrap is
Cash or Accounts Receivable 900
Scrap Revenues 900
(B) If Scrap is Material

When the dollar amount of scrap is material and the scrap is sold quickly after it is
produced, the accounting depends on whether the scrap is attributable to a specific job
or common to all jobs.
(i) Scrap attributable to a specific job

DREAMLAND COLLEGE
Job-costing system sometimes traces the scrap revenues to the jobs that yielded the
scrap. This method is used only when the tracing can be done in an economically
feasible way. The journal entries:
Scrap returned to storeroom: No journal entry
(Notation of quantity received and related job is entered in
the inventory record)
Sale of scrap: Cash or Accounts Receivable 900
Work-in-Process 900
(Posting made to specific job cost record)

DREAMLAND COLLEGE
Unlike spoilage and rework, there is no cost attached to the scrap, and hence no
distinction is made between normal and abnormal scrap. All scrap revenues, whatever
the amount, are credited to the specific job. Scrap revenues reduce the costs of the job.
(ii) Scrap common to all jobs

The journal entry in this case is
Scrap returned to storeroom: No journal entry
(Notation of quantity received and related job is entered in
the inventory record)
Sale of scrap: Cash or Accounts Receivable 900
Manufacturing Overhead Control 900
Posting made to subsidiary ledger-"Sales of Scrap"
Column on department cost record.
This method does not link scrap with any particular job or product. Instead, all
products bear production costs without any credit for scrap revenues except in an
indirect manner: Recognizing Scrap at the Time of its Production
Our preceding illustrations assume that scrap returned to the storeroom is sold quickly
and hence is not assigned an inventory cost figure. Sometimes, as in the case with
edges of molded plastic parts, the value of scrap is not immaterial, and the time
between storing it and selling or reusing it can be long.
(A) Scrap attributable to a specific job
The journal entry in the Hull example to record the scrap returned to storeroom is
Materials 900
Work-in-Process 900
(B) Scrap common to all jobs

The journal entry to record the scrap returned to storeroom is
Materials 900
Observe that Materials account is debited in place of Cash or Accounts Receivable.
When the scrap is sold, the journal entry to record the sale of scrap is
Cash or Accounts Receivable 900
Materials 900
Scrap is sometimes reused as direct materials rather than sold as scrap. In this case,
Materials Control is debited at its estimated net realizable value and then credited
when the scrap is reused. For example, the entries when the scrap generated is
common to all jobs are

DREAMLAND COLLEGE
Scrap returned storeroom: Materials 900

Reuse of scrap: Work in Process 900

Materials 900
The accounting for scrap under process costing is like the accounting under job costing
when scrap is common to all jobs because process costing applies to the manufacture
of masses of identical or similar units.

Cost Accounting I Module AUC MT Final 1 - Finall (1) Handout

Uploaded by

Copyright:

Available Formats

You might also like

Cost Accounting I Module AUC MT Final 1 - Finall (1) Handout

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Cost Accounting I Module AUC MT Final 1 - Finall (1) Handout

Uploaded by

Copyright:

Available Formats

DREAMLAND COLLEGE

Cost and Management Accounting I Handout Page 1

INTRODUCTION TO COST ACCOUNTING

PART ONE: FUNDAMENTALS OF COST ACCOUNTING

Cost and Management Accounting I Handout Page 2

Concept of Cost Accounting

Cost and Management Accounting I Handout Page 3

Items of Cost Accounting Management Accounting (MA)

Purpose The purpose of cost accounting is The purpose of management

Table 2.1: Cost Accounting vs. Management Accounting

Cost and Management Accounting I Handout Page 4

BASIC COST CONCEPTS AND COST CLASSIFICATIONS

Activity or Product or Project Departments Program

Exhibit 1.1 Cost Object

Cost and Management Accounting I Handout Page 5

Direct Cost tracing

Exhibit 1.2 Cost Tracing and Allocation

2.1 Manufacturing Costs Vs. Non-manufacturing Costs

Cost and Management Accounting I Handout Page 6

Direct material Direct labor Factory overhead

Prime costs Conversion costs

Cost and Management Accounting I Handout Page 7

categories: - marketing (distribution or selling) expenses and administrative (general and

Cost and Management Accounting I Handout Page 8

Customer Costs incurred in reception department of a hotel

Line foreman: Product B Direct - Direct - Indirect

Assembly department Direct Indirect Indirect Indirect Indirect

Major subassemblies Direct Direct Direct Direct Direct

Plant wide heating and Indirect Indirect Indirect Indirect Indirect

Cost and Management Accounting I Handout Page 9

Unit Variable Cost = Total Variable cost

Cost and Management Accounting I Handout Page 10

(C) Semi variable costs

Cost and Management Accounting I Handout Page 11

Cost of national Manager for the Uncontrollable

Exhibit 2-12 Controllable and Uncontrollable Costs

Cost and Management Accounting I Handout Page 12

INVENTORIES AND COST FLOW OF MANUFACTURING COMPANIES

Cost and Management Accounting I Handout Page 13

Cost and Management Accounting I Handout Page 14

Cost and Management Accounting I Handout Page 15

 Less: Raw materials inventory, ending

Cost and Management Accounting I Handout Page 16

 Repair and maintenance- factory 4,000

Cost and Management Accounting I Handout Page 17

 Cost of goods available for sale

Cost and Management Accounting I Handout Page 18

ACCOUNTING FOR MATERIAL COSTS

ACCOUNTNG FOR MANUFACTURING COSTS

Cost and Management Accounting I Handout Page 19

Cost and Management Accounting I Handout Page 20

c) It can be used for future reference

Requested by Checked by Approved by

Date ____________________________ Purchase order No._____________

Item Quantity Description Unit Total Cost Remarks

Cost and Management Accounting I Handout Page 21

Terms and Conditions: Purchase Manager

Materials Receiving Report

Date ________________ Purchase order No._

Counted (Measured) by __ Approved by

Payee ______ Voucher No.

Approved by Delivered by Received by __