Cost Accounting

An Overview
 Managerial Cost Concepts
1. Direct materials:
materials raw materials
physically associated with the final
product
2. Direct labor:
labor employees physically and
directly associated with the final product
3. Overhead:
Overhead costs indirectly associated
with the final product
 More Concepts
1. Period costs:
costs costs matched with revenue for
a specific time period. (i.e., net income for a
specific period (i.e., quarterly, annual).
2. Product costs:
costs costs associated with
producing the final product. Not considered an
expense until the product is sold.
3. Total costs:
costs equals direct materials, direct
labor and manufacturing overhead plus indirect
costs (selling and administrative expenses).
Design of the Master Budget
Sales
SalesBudget
Budget
Design of the Master Budget
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget
Design of the Master Budget
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Overhead
Overhead
Budget
Budget Budget
Budget Budget
Budget
Design of the Master Budget
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Overhead
Overhead
Budget
Budget Budget
Budget Budget
Budget

Selling
Sellingand
andAdministrative
Administrative
Expense
ExpenseBudget
Budget
Design of the Master Budget
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Overhead
Overhead
Budget
Budget Budget
Budget Budget
Budget

Selling
Sellingand
andAdministrative
Administrative
Expense
ExpenseBudget
Budget

Cash
CashBudget
Budget
Pro Forma Financial Statements
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Overhead
Overhead
Budget
Budget Budget
Budget Budget
Budget

Selling
Sellingand
andAdministrative
Administrative
Expense
ExpenseBudget
Budget

Capital
Capital
Cash
CashBudget
Budget expenditures
expenditures

Budgeted
BudgetedCash
Cash
Flow Statement
Flow Statement
Pro Forma Financial Statements
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Overhead
Overhead
Budget
Budget Budget
Budget Budget
Budget

Selling
Sellingand
andAdministrative
Administrative
Expense
ExpenseBudget
Budget

Capital
Capital
Cash
CashBudget
Budget expenditures
expenditures

Budgeted
BudgetedCash
Cash Budgeted
BudgetedIncome
Income
Flow Statement
Flow Statement Statement
Statement
Pro Forma Financial Statements
Sales
SalesBudget
Budget

Production
ProductionBudget
Budget

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Overhead
Overhead
Budget
Budget Budget
Budget Budget
Budget

Selling
Sellingand
andAdministrative
Administrative
Expense
ExpenseBudget
Budget

Capital
Capital
Cash
CashBudget
Budget expenditures
expenditures

Budgeted
BudgetedCash
Cash Budgeted
BudgetedIncome
Income Budgeted
Budgeted
Flow Statement
Flow Statement Statement
Statement Balance
BalanceSheet
Sheet
The Master Budget and Pro Forma Financial Statements

Enterprise #1
•Unit sales and expected price
•Unit production and inventory Sales
SalesBudget
Budget
•Direct materials used
•Direct labor used Production
ProductionBudget
Budget
•Manufacturing overhead

Direct
DirectMaterials
Materials
Budget
Budget

Direct
DirectLabor
Labor
Enterprise #n Budget
Budget
•Unit sales and expected price
•Unit production and inventory Overhead
•Direct materials used Overhead
Budget
Budget
•Direct labor used
•Manufacturing overhead
The Master Budget and Pro Forma Financial Statements

Enterprise #1
•Unit sales and expected price
•Unit production and inventory Sales
SalesBudget
Budget
•Direct materials used
•Direct labor used Production
ProductionBudget
Budget
•Manufacturing overhead

Direct
DirectMaterials
Materials
Budget
Budget

Direct
DirectLabor
Labor
Enterprise #n Budget
Budget
•Unit sales and expected price
•Unit production and inventory Overhead
•Direct materials used Overhead
Budget
Budget
•Direct labor used
•Manufacturing overhead
The Master Budget and Pro Forma Financial Statements

Enterprise #1
•Unit sales and expected price
•Unit production and inventory Sales
SalesBudget
Budget
•Direct materials used
•Direct labor used Production
ProductionBudget
Budget
•Manufacturing overhead

Direct
DirectMaterials
Materials
Budget
Budget

Direct
DirectLabor
Labor
Enterprise #n Budget
Budget
•Unit sales and expected price
•Unit production and inventory Overhead
•Direct materials used Overhead
Budget
Budget
•Direct labor used
•Manufacturing overhead
The Master Budget and Pro Forma Financial Statements

Enterprise #1
•Unit sales and expected price
•Unit production and inventory Sales
SalesBudget
Budget
•Direct materials used
•Direct labor used Production
ProductionBudget
Budget
•Manufacturing overhead

Direct
DirectMaterials
Materials
Budget
Budget

Direct
DirectLabor
Labor
Enterprise #n Budget
Budget
•Unit sales and expected price
•Unit production and inventory Overhead
•Direct materials used Overhead
Budget
Budget
•Direct labor used
•Manufacturing overhead
The Master Budget and Pro Forma Financial Statements

Enterprise #1
•Unit sales and expected price
•Unit production and inventory Sales
SalesBudget
Budget
•Direct materials used
•Direct labor used Production
ProductionBudget
Budget
•Manufacturing overhead

Direct
DirectMaterials
Materials
Budget
Budget

Direct
DirectLabor
Labor
Enterprise #n Budget
Budget
•Unit sales and expected price
•Unit production and inventory Overhead
•Direct materials used Overhead
Budget
Budget
•Direct labor used
•Manufacturing overhead
The Master Budget and Pro Forma Financial Statements

Enterprise #1
•Unit sales and expected price
•Unit production and inventory Sales
SalesBudget
Budget
•Direct materials used
•Direct labor used Production
ProductionBudget
Budget
•Manufacturing overhead

Direct
DirectMaterials
Materials
Budget
Budget

Direct
DirectLabor
Labor
Enterprise #n Budget
Budget
•Unit sales and expected price
•Unit production and inventory Overhead
•Direct materials used Overhead
Budget
Budget
•Direct labor used
•Manufacturing overhead
The Master Budget and Pro Forma Financial Statements

Examples of direct materials:

•Purchase of corn.
•Purchase of natural gas.
•Purchase of other inputs used in
Enterprise #1 the production process.
•Unit sales and expected price
•Unit production and inventory
•Direct materials used
•Direct labor used
•Manufacturing overhead
Examples of manufacturing overhead:
•Other expenses directly related to
production of a specific product.
•Examples include property taxes, rent
and depreciation
The Master Budget and Pro Forma Financial Statements

Indirect expenses are those expenses not

associated with manufacturing a product or
providing a service. Some examples include:

 Marketing and selling expenses

 Transportation expenses outside the
factory
 Management salaries and other
administrative expenses
 Total
Total Costs
Costs

Production Costs Period Costs

Manufacturing Costs Non-manufacturing Costs

Direct
Direct
Materials
Materials
 Total
Total Costs
Costs

Production Costs Period Costs

Manufacturing Costs Non-manufacturing Costs

Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor
 Total
Total Costs
Costs

Production Costs Period Costs

Manufacturing Costs Non-manufacturing Costs

Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

Manufacturing
Manufacturing
Overhead
Overhead
 Total
Total Costs
Costs

Production Costs Period Costs

Manufacturing Costs Non-manufacturing Costs

Direct
Direct Selling
Selling
Materials
Materials Expenses
Expenses

Direct
Direct
Labor
Labor

Manufacturing
Manufacturing
Overhead
Overhead
 Total
Total Costs
Costs

Production Costs Period Costs

Manufacturing Costs Non-manufacturing Costs

Direct
Direct Selling
Selling
Materials
Materials Expenses
Expenses

Direct
Direct Administrative
Administrative
Labor
Labor Expenses
Expenses

Manufacturing
Manufacturing
Overhead
Overhead
 Total
Total Costs
Costs

Production Costs Period Costs

Manufacturing Costs Non-manufacturing Costs

Direct
Direct Selling
Selling
Materials
Materials Expenses
Expenses

Direct
Direct Administrative
Administrative
Labor
Labor Expenses
Expenses

Manufacturing
Manufacturing Other
OtherIndirect
Indirect
Overhead
Overhead Expenses
Expenses
Three Cost Accounting Concepts

1. Process cost accounting

2. Job order cost accounting
3. Activity based cost
accounting
 1. Process Cost Accounting
Tracking costs associated with a specific
process
Direct materials and labor associated with
the specific process
Manufacturing overhead costs associated
with the specific process
Assigning costs to finished goods
Example: Process Costs in Making Bread
Direct
DirectMaterials
Materials
Direct
DirectLabor
Labor
Variable
VariableOverhead
Overhead

Mixing WIP Baking WIP Packaging WIP Finished

Mixing Baking Packaging Finished
Department
Department Department
Department Department
Department Goods
Goods

Production
ProductionCost
Cost
Report
Report
Example: Process Costs in Making Bread
Direct
DirectMaterials
Materials
Direct
DirectLabor
Labor
Variable
VariableOverhead
Overhead

Mixing WIP Baking WIP Packaging WIP Finished

Mixing Baking Packaging Finished
Department
Department Department
Department Department
Department Goods
Goods

Production
ProductionCost
Cost Production
ProductionCost
Cost
Report
Report Report
Report
Example: Process Costs in Making Bread
Direct
DirectMaterials
Materials
Direct
DirectLabor
Labor
Variable
VariableOverhead
Overhead

Mixing WIP Baking WIP Packaging WIP Finished

Mixing Baking Packaging Finished
Department
Department Department
Department Department
Department Goods
Goods

Production
ProductionCost
Cost Production
ProductionCost
Cost Production
ProductionCost
Cost
Report
Report Report
Report Report
Report
Comparison of Cost Systems
Process Cost
Features System
Work in process Multiple work in
accounts process accounts
Documents used Production cost
reports
Determination of Each period
total manf. costs
Unit-cost Total manf. costs/
computations units produced
during the period
2. Job Order Cost Accounting
Tracking costs associated with a specific
order or job
Direct materials and labor associated with
a specific order or job
Manufacturing overhead costs associated
with a specific order or job
Assigning costs to finished goods
Comparison of Cost Systems
Process Cost Job Order
Features System Cost System
Work in process Multiple work in One work in
accounts process accounts process account
Documents used Production cost Job cost sheets
reports
Determination of Each period Each job
total manf. costs
Unit-cost Total manf. costs/ Cost of each job/
computations units produced units produced for
during the period the job
3. Activity Based Cost Accounting
An approach for allocating overhead.
An activity is any event, action, transaction or
work sequence that incurs when producing a
product or providing a service.
An activity cost pool is a distinct type of activity
(e.g., ordering materials).
A cost driver is any factor or activity that has a
direct cause-effect relationship with resources
consumed (e.g., machine hours).
 Steps in ABC Accounting
1. Identify and classify activities and
allocate overhead to cost pools.
2. Identify cost drivers – correlation
between driver and use.
3. Compute overhead rates – ABC rate.
4. Assign overhead costs to products – use
of cost drivers.
5. Comparison of unit costs across
products.
 Activity Based Cost Allocation
Overhead
OverheadCosts
Costs
Activity cost pools:
Activity cost pools:

Ordering
Ordering Setting
Setting Machining
Machining Assembly
Assembly Inspecting
Inspecting Painting
Painting
and
and Up
Up Cost
Cost Cost
Cost and
and Cost
Cost
Receiving
Receiving Machines
Machines Pool
Pool Pool
Pool Testing
Testing Pool
Pool
Materials
Materials Cost
Cost Cost
Cost
Cost
CostPool
Pool Pool
Pool Pool
Pool
Cost drivers:
Cost drivers:

##of
of ##of
of ##of
of ##of
of ##of
of ##of
of
Purchase
Purchase Setups
Setups Machine
Machine Parts
Parts Tests
Tests Direct
Direct
orders
orders hours
hours hours
hours

Products
Products
Example of ABC Accounting
ABC Overhead rate = Overhead per activity ÷ Cost driver per activity
Initial status:
Activity Cost Pool Process Driver AB overhead
overhead activity rate
Setting up machines $300,000 1,500 setups $200/setup
Machining $500,000 50,000 hours $10/hour
Inspecting $100,000 2,000 inspection $50/inspection
Total $900,000

Step 1: Assigning overhead driver activity to products:

Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500
Example of ABC Accounting
Step 1: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500

Step 2: Partitioning of process overhead:

Overhead Product 1 Product 2___
Setting up machines $300,000 (33%) $100,000 (67%) $200,000
Machining $500,000 (60%) $300,000 (40%) $200,000
Inspecting $100,000 (25%) $25,000 (75%) $75,000

500/1,500
500/1,500xx$300,000
$300,000or
or500
500units
unitsxx$200/setup
$200/setup
Example of ABC Accounting
Step 1: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500

Step 2: Partitioning of process overhead:

Overhead Product 1 Product 2___
Setting up machines $300,000 (33%) $100,000 (67%) $200,000
Machining $500,000 (60%) $300,000 (40%) $200,000
Inspecting $100,000 (25%) $25,000 (75%) $75,000

1,000/1,500
1,000/1,500xx$300,000
$300,000or
or1,000
1,000xx$200/setup
$200/setup
Example of ABC Accounting
Step 1: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500

Step 2: Partitioning of process overhead:

Overhead Product 1 Product 2___
Setting up machines $300,000 (33%) $100,000 (67%) $200,000
Machining $500,000 (60%) $300,000 (40%) $200,000
Inspecting $100,000 (25%) $25,000 (75%) $75,000

30,000/50,000
30,000/50,000xx$500,000
$500,000or
or30,000
30,000xx$10/hour
$10/hour
Example of ABC Accounting
Step 1: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500

Step 2: Partitioning of process overhead:

Overhead Product 1 Product 2___
Setting up machines $300,000 (33%) $100,000 (67%) $200,000
Machining $500,000 (60%) $300,000 (40%) $200,000
Inspecting $100,000 (25%) $25,000 (75%) $75,000

20,000/50,000
20,000/50,000xx$500,000
$500,000or
or20,000
20,000xx$10/hour
$10/hour
Example of ABC Accounting
Step 1: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500

Step 2: Partitioning of process overhead:

Overhead Product 1 Product 2___
Setting up machines $300,000 (33%) $100,000 (67%) $200,000
Machining $500,000 (60%) $300,000 (40%) $200,000
Inspecting $100,000 (25%) $25,000 (75%) $75,000

500/2,000
500/2,000xx$100,000
$100,000or
or500
500xx$50/inspection
$50/inspection
Example of ABC Accounting
Step 1: Assigning overhead driver activity to products:
Activity Cost Pool Cost driver Driver Product 1 Product 2
activity
Setting up machines # setups 1,500 500 1,000
Machining Hours 50,000 30,000 20,000
Inspecting # inspections 2,000 500 1,500

Step 2: Partitioning of process overhead:

Overhead Product 1 Product 2___
Setting up machines $300,000 (33%) $100,000 (67%) $200,000
Machining $500,000 (60%) $300,000 (40%) $200,000
Inspecting $100,000 (25%) $25,000 (75%) $75,000

1,500/2,000
1,500/2,000xx$100,000
$100,000or
or1,500
1,500xx$50/inspection
$50/inspection
Example of ABC Accounting
Step 2: Partitioning of process overhead:
Overhead Product 1 Product 2
Setting up machines $300,000 $100,000 $200,000
Machining $500,000 $300,000 $200,000
Inspecting $100,000 $25,000 $75,000
Total $900,000 $425,000 $475,000
Step 3: Process overhead costs per unit:
Units produced 25,000 5,000
Process overhead cost per unit $17 $95

Traditional process overhead cost per unit* $30 $30

* $900,000 divided by 30,000 units

Avoids
Avoidsoverstating
overstatingprofitability
profitability
ofofsome
someenterprises
enterprisesand
and
understating
understatingprofitability
profitabilityofof
others
others
Example of ABC Accounting
Product 1 Product 2
COP unit costs with ABC costing:
Direct materials $40 $30
Direct labor $12 $12
ABC overhead $17 $95
Total unit costs $69 $137

COP unit costs with traditional costing:

Direct materials $40 $30
Direct labor $12 $12
Traditional overhead * $30 $30
Total unit costs $82 $72

* $900,000 divided by 30,000 units

Traditional
Traditionaloverhead
overheadcosting
costing
suggests
suggests that Product22isis
that Product
cheaper
cheaperto toproduce
producethan
than
Product
Product1,1,which
whichisisnot
nottrue!
true!
 LOC and the Master Budget
 Identifying monthly cash flow
surpluses and deficits.
 Determining the required LOC – peak
value of monthly draws less monthly
repayments.
 Role of the Master Budget; LOC a
component of the cash budget.
 Cash Management
 Acceleration of cash receipts
 Pre-addressed stamped envelopes
 Obtain deposits on large orders
 Charge interest on overdue receivables
 Delay cash payments
 Pay with check (float)
 Delay frequency of paying employees
 Just in time inventories