Chapter 4

Cost Accounting Systems

 Cost Accounting Systems

Cost accounting is that part of the cost

management system that measures
costs for the purposes of management
decision making and financial reporting
 Cost Accounting System

Collecting costs by some

Cost
“natural” classification
accumulation:
such as materials or labor

Cost Tracing costs to one or

assignment: more cost objectives
 Cost Accounting System
Cost Material costs
accumulation (metals)
Cost assignment
to cost objects
Machining Department Finishing Department
1. Departments
Activity Activity Activity Activity
2. Activities Activity Activity Activity Activity

Cabinets Cabinets

3. Products Desks Desks

Tables Tables
 Cost
A cost is a sacrifice or giving up of
resources for a particular purpose.
Costs are frequently measured by
the monetary units that must be
paid for goods and services.
 Cost Object
A cost object (objective) is anything for which
A separate measurement of costs is desired.

Customers Departments
Service

Product
Processing orders
Direct, Indirect, and Unallocated Costs

Direct costs can be identified specifically and

Exclusively with a given cost objective in an
economically feasible way.

Indirect costs cannot be identified specifically and

Exclusively With a given cost objective in an
economically feasible way.

Unallocated costs are recorded but

not assigned to any cost object.
 Cost Allocation
Cost allocation is used to assign indirect costs to cost objects, in
Proportion to the cost object’s use of a particular
cost-allocation base.
A cost-allocation base is some measure of input or output that
determines the amount of cost to be allocated to
a particular cost object.

An ideal cost-allocation base would measure how much

of the particular cost is caused by the cost objective.

Note the similarity of this definition to that of a cost driver—

an output measure that causes costs. Therefore, most
allocation bases are cost drivers.
 Cost Allocation
Cost allocations support a company’s CMS—the system
providing cost measurements for strategic decision making,
operational control, and external reporting.

Four purposes of cost allocation:

 Predict the economic effects of strategic and operational
control decisions.
 Provide desired motivation and to give feedback for
performance evaluation.
 Compute income and asset valuations for financial
reporting.
 Justify costs or obtain reimbursement.
 Cost Pool
A cost pool is a group of individual costs that a company
allocates to cost objects using a single cost-allocation base.

1. Accumulate indirect costs for a period of time.

2. Select an allocation base for each cost pool, preferably a
cost driver, that is, a measure that causes the costs in the
cost pool.
3. Measure the units of the cost-allocation base used for each co
object and compute the total units used for all cost objects.
4. Determine the percentage of total cost-allocation base units
used for each cost object.
5. Multiply the percentage by the total costs in the cost pool to
determine the cost allocated to each cost object.
 Cost Allocation
Direct costs are physically traced to a cost object.
Indirect costs are allocated using a cost-allocation base.
 Direct Material Costs
Direct materials include the acquisition costs
of all materials that a company identifies
as a part of the manufactured goods.

These costs are identified in an economically

feasible way.
 Direct Labor Costs

Direct Labor costs include the

wages of all labor that can be
traced specifically and exclusively
to the manufactured goods in an
economically feasible way.
 Indirect Production Costs
(Manufacturing Overhead)
Manufacturing overhead includes all costs
associated with the production process
that the company cannot be traced to
the manufactured goods in an
economically feasible way.
 Product Costs
Product costs are costs identified with goods
produced or purchased for resale.

These costs first become part of the

inventory on hand, sometimes called
inventoriable costs.

Inventoriable costs become expenses in the form of

cost of goods sold only when the inventory is sold.
 Period Costs

Period costs are deducted as expenses

during the current period without
going through an inventory stage.

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 27 28 29 30 31
 Financial Statement Presentation
– Merchandising Companies
Merchandising Company
(Retailer or Wholesaler) Sales
Minus
Product Cost of
Merchandise Merchandise Expiration Goods Sold
Purchases Inventory
(Inventoriable) (Expenses)

Costs Equals Gross Margin

Minus

Selling Expenses
Period
and Administrative
Costs
Expenses

Equals Operating
Income
 Financial Statement Presentation
– Manufacturing Companies
Manufacturing Company Direct
Direct Material
Product Material Inventory
Purchases
(Inventoriable) Finished
Direct Labor Sales
Goods
Costs Indirect Minus
Inventory
Manufacturin Cost of
g Expiration Goods Sold
Work-in-
Process (Expenses)
Inventory Equals Gross Margin
Minus
Selling Expenses
Period
and Administrative
Costs
Expenses
Equals Operating
Income
 Current Asset Sections
of Balance Sheets

Manufacturer Retailer or Wholesaler

Cash $ 4,000
Cash $ 4,000
Receivables 25,000
Receivables 25,000
Subtotal $29,000
Finished goods 32,000
Work in process 22,000
Direct material 23,000
Merchandise inventories 77,000
Total inventories $77,000
Other current assets 1,000
Other current assets 1,000
Total current assets $107,000
Total current assets $107,000
 Income Statement Presentation
of Costs for a Manufacturer

The manufacturer’s cost of goods produced

and then sold is usually composed of
the three major categories of cost:

Direct materials
Direct labor
Indirect manufacturing
 Income Statement Presentation
of Costs for a Retailer
The merchandiser’s cost of goods sold
is usually composed of the purchase
cost of items, including freight-in,
that are acquired and then resold.