Topic 1

Introduction to Cost Accounting

& Management

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Learning objectives
Upon completion of this chapter, you should be able to:

1. Distinguish between financial, managerial and cost accounting.

2. Distinguish between merchandising and manufacturing operations.
3. Identify the uses of cost accounting data.
4. Distinguish between job order costing and process costing.

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The main and primary objective of
accounting
● To provide financial information about an economic entity to different
types of users.

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Types of users of financial information
1. Internal users - managers (for planning, controlling, and decision
making).
2. External users - government, those who provide funds to the entity,
those who have various interests in the operations of the entity.

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Cost accounting
● It is a field of accounting that measures, records and reports information
about costs.
● It is an expanded phase of general or financial accounting which informs
management promptly with the cost of rendering a particular service,
buying and selling a product, and producing a product.

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● All types of business entities - manufacturing, merchandising, and service
businesses - require information systems which provide the necessary
financial data.
● These financial data are usually documented in information systems
(accounting systems).
● These systems should show what costs were incurred and where and
how these costs were utilized.
● Cost accounting developed originally in manufacturing business to satisfy
management’s need for product cost information.

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Comparison of financial, managerial and
cost acctg.
Two (2) major areas of accounting:

1. Financial accounting
2. Managerial accounting

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Financial accounting
● Is the use of accounting information for reporting to external parties,
including investors and creditors.
● The reports prepared under financial accounting focus on the enterprise
as a whole.
● Based on historical data.
● The information may be historical, quantitative, monetary and verifiable.
● The information provided by financial accounting is usually presented in
the form of financial statements, tax returns, and other formal reports
distributed to various external users. The same information may also be
used internally to provide a basis for financial analysis by management.
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Financial accounting
● Required for many firms organized as corporations because of the
requirements of SEC.
● The BIR also requires financial accounting information for compliance
with country’s tax law.
● Financial accounting attempts to present some degree of precision in
reporting historical information while at the same time emphasizing
verifiability and freedom from bias in the information, relevance to the
general user and some degree of timeliness in reporting which is not as
critical in managerial accounting.

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Managerial accounting
● Focuses on the needs of parties within the organization, rather than
interested parties outside the organization.
● Managerial accounting information commonly addresses individual or
divisional concerns rather than those of the enterprise as a whole.
● The information may be current or forecasted, quantitative or qualitative,
monetary or non-monetary, and most of all, timely.
● The data are futuristic and some of the costs are not recognized on the
accounting books of the organization.

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Managerial accounting
● Managerial accounting is not separate and distinct from financial
accounting. Financial accounting data are used in managerial accounting
system.
● Management decisions made today will affect the financial statement of
future periods.
● There is no requirement or legislation that mandates the format or use of
managerial accounting.
● The timing of information and its relevance to the decision on hand has
greater significance to the internal decision making.

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Managerial accounting
● The measuring bases in managerial accounting does not necessarily have
to be restricted to pesos. It can be in terms of:

1. Economic measure – pesos

2. Physical measure – pounds, gallons, tons, or units
3. Relationship measure – ratios

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Cost accounting
● Is the intersection between financial and managerial accounting.
● Cost accounting information is needed and used by both financial and
managerial accounting.
● It provides product cost information to external parties, such as
stockholders, creditors and various regulatory boards for credit and
investment decisions, and to internal parties such as managers for
planning and controlling.

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Merchandising vs manufacturing
operations
● Many types of business gather information on costs, but doing so is
especially important in manufacturing.
● A merchandising company normally buys a product that is ready for
resale when it is received. Nothing needs to be done to the product to
make it salable except possibly to prepare a special package or display.

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Cost of goods sold for a merchandising
company

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Cost of Goods Sold for a Merchandising Company

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Cost of goods sold for a manufacturing
company

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Cost of Goods Sold for a Manufacturing Company

Finished Goods Finished Goods

Inventory Storage

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Uses of cost accounting data
● The information produced by a cost accounting system provides a basis
for determining product cost and aids management in planning and
controlling operations.

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Uses of cost accounting data
1. Determining product costs
● Cost accounting procedures help management in gathering the data
needed to determine product costs and thus generate meaningful
financial statements and other reports.
● Cost accounting procedures must be designed to permit the computation
of unit costs as well as total product costs.
● For example, if a manufacturer spent P10,000 for labor in a certain
month, the information is insignificant; but if this labor produced 5,000
finished units, the fact that the cost of labor was P2 per unit is significant,
because this figure can be compared to the unit labor cost of other
periods and the trends analyzed.
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Uses of cost accounting data
Unit cost information is also useful in making a variety of important marketing
decisions:

● Determining the selling price of a product. The selling price should be

high enough to cover the cost of producing the product and the
marketing and administrative expenses and provide a profit.
● Meeting competition. You should be able to have a detailed knowledge
regarding the unit cost to be compared to competitors and take
appropriate action for cost reduction.

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Uses of cost accounting data
Unit cost information is also useful in making a variety of important marketing
decisions:

● Bidding on contracts. Unit cost should be competitive when entering

into government biddings so as to be awarded with contracts.
● Analyzing profitability. To determine the amount of profit that each
product earns and possibly eliminate those that are least profitable.

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Uses of cost accounting data
2. Planning and control
● Planning is the process of establishing objectives or goals for the firm
and determining the means by which the firm will attain them.
● Planning is essential to good management because it provides a means of
coordinating all of the operations of the firm.
● Cost accounting helps in development of plans by providing historical
costs serve as basis for projecting data for planning.
● Management can analyze trends and relationships among such data as
an aid in estimating future costs and operating results and in making
decisions regarding the acquisition of additional facilities, changes in
marketing strategies, and obtaining additional capital.
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Uses of cost accounting data
Three (3) components of planning:

1. Strategic planning – long range goals and objectives.

2. Tactical planning – short range goals and objectives to achieve strategic
goals.
3. Operational planning – day-to-day implementation of tactical plans.

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Uses of cost accounting data
● Control is the process of monitoring the company’s operations and
determining whether the objectives identified in the planning process are
being accomplished.

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Recent developments in cost accounting
● Manual bookkeeping has been reduced because of the use of computers.
● Changes in production methods have made traditional applications of
cost accounting obsolete in some cases.

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Two basic product costing systems
1. Job order costing
● A system for allocating costs to groups of unique product.
● It is applicable to the production of customer-specified products such as
the manufacture of special machines.
● Each job becomes a cost center for which costs are accumulated.
● A subsidiary record (job order sheet) is needed to keep track of all
unfinished jobs (work-in-process) and finished jobs (finished goods).

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Two basic product costing systems
2. Process costing
● A system applicable to a continuous process of production of the same or
similar goods (e.g. oil refining and chemical production).
● Since there is no need to determine the costs of different groups of
products because the production is uniform, each processing department
becomes a cost center.

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Two basic product costing systems
● The objective of the two systems is the same. They both provide product
unit cost information for pricing, cost control, inventory valuation, and
income statement preparation.
● End-of-period values for cost of goods sold, work-in-process inventory,
and finished goods inventory accounts are computed using product unit
cost data.

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Characteristics of job order costing
● A product costing system used by companies making one-of-a-kind or
special products.
● Direct materials, direct labor, and factory overhead costs are assigned to
specific job orders or batches of production.
● In computing unit costs, the total manufacturing costs for each job order
are divided by the number of good units produced for that order.
● Procedures similar to those used in job order costing are used in many
service industry firms, even if these firms have no work-in-process or
finished good inventories. In a public accounting firms, for example, costs
are assigned to audit engagements.
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Primary characteristics of a job order cost
system
a. It collects all manufacturing costs and assigns them to specific job or
batches of product.
b. It measures costs for each completed job rather than for set time periods.
c. It uses work-in-process inventory control account in the general ledger.
This account is supported by a subsidiary ledger of job order cost cards or
sheets for each job-in-process at any point of time.

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Characteristics of process costing
● A product costing system used by companies that make a large number
of similar products or maintain a continuous production flow. In these
cases, it is more economical to account for product-related costs for a
period of time (a week or a month) than to try to assign them to specific
products or job orders.
● Unit costs are computed by dividing total manufacturing costs assigned to
a particular department or work center during a period by the equivalent
unit of production.
● If a product is routed through four departments, then four unit cost
amounts are added to find the product’s total unit cost.
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Main characteristics of a process cost
system
a. Manufacturing costs are grouped by department or work center, with
little concern for specific job orders.
b. It emphasizes a weekly or monthly time period rather than the time taken
to complete a specific job.
c. It uses several work-in-process accounts – one for each department or
work center in the manufacturing process.

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Hybrid costing
● The blending of job order costing and process costing.

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● The costing system an organization selects will mainly depend on its
underlying production system.

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Operation costing
● Is a hybrid costing system often used in repetitive manufacturing where
finished products have common, as well as distinguishing characteristics.
● For example, in the manufacture of clothing, basic suits can be assembled
in one operation (process costing). These suits can then move on to the
next operation and have a deluxe lining added (job order costing). Based
on the variations, the products and the related costs are identified by
batches or by production runs.

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Batch production
● Some companies process large orders or identical units as a group
through the same production sequence. Each of these orders is called
batch.
● In batch production, costs are allocated to each batch.
● Whenever a change in the production line is required to continue
production, a new batch is created.
● Generally, job order costing concepts are used to account for batch
production and each batch is treated as a job for costing purposes.

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Major differences between process & job order
costing Process costing Job order costing
1. Homogenous units pass through a 1. Unique jobs are worked on during a
series of similar process. time period.

2. Costs are accumulated by processing 2. Costs are accumulated by individual

dept. job.

3. Unit costs are computed by dividing
the individual dept.’s costs by the EUP.
4. The cost of production report
provides the detail for the WIP account
for each dept.
3. Unit costs are determined by dividing
the total costs on the job cost sheet by
the no. of units on the job.
4. The job cost sheet provides the detail
for the WIP account.
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● Process costing has less detailed recordkeeping.
● The choice of process versus job order costing systems involve a
comparison of the costs and benefits of each system.
● If recordkeeping costs were equal under job and process systems, for the
units in a product line, then the job order costing systems are better
because they provide all the data that process systems do.

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END

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