TABLE OF CONTENTS

Chapter 1 – Introduction to Cost Accounting

Chapter 2 – Costs – Concepts and Classification
Chapter 3 – Cost Accounting Cycle
Chapter 4 – Job Order Costing
Chapter 5 – Just in Time and Blackflush Accounting
Chapter 6 – Accounting for Materials
Chapter 7 – Accounting for Factory Overhead
Chapter 8 – Accounting for Labor
Chapter 9 – Process Costing
Chapter 10 – Average and FIFO Costing
Chapter 11 – Joint Product sand By-Products
Chapter 12 – Standard Costing

CHAPTER 1
INTRODUCTION TO COST ACCOUNTING

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.

The primary objective of accounting is to provide financial information about an

economic entity to different types of users.
First, we have internal users – managers for planning, controlling, and decision-
making.
Then we have external users – the government, those who provide funds, and those
who have various interests in the operations of the entity.

In order to appreciate the importance of an efficient cost system, it is necessary to

understand the nature of the manufacturing process. In many ways, the activities of a
manufacturing organization are similar to those of a merchandising business. Both are
concerned with purchasing, storing, and selling goods; both must have efficient
management and adequate sources of capital; both may employ hundreds or thousands
of workers.
In the manufacturing process itself, we see the distinction:
Merchandisers, such as SM buy items in marketable form to be resold to their
customers,
Manufacturers such as Philippine Appliance Corp. must make the goods they sell. Once
the merchandising organization has acquired and stored goods, it is ready to carry out
the marketing function. The purchase of materials by a manufacturer, however, is only

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the beginning of a long, and sometimes complex, chain of events that will eventually
produce a finished article ready for sale.

Manufacturing Process
The manufacturing process involves the conversion of raw materials into finished goods
through the application of labor and the incurrence of various factory expenses. The
manufacturer must make a major investment in physical facilities, such as factory
buildings and warehouses, and acquire many specialized types of machinery and
equipment.
To carry out the manufacturing process, the manufacturer must purchase appropriate
quantities of raw materials, supplies, and parts, and build up a workforce to convert
these resources into finished goods.
Once the goods are completed and ready for sale, the manufacturer performs the same
functions as the merchandiser in storing and marketing the goods. The methods of
accounting for sales, cost of goods sold, selling and administrative expenses are also
similar to those of the merchandising organization.
Although cost accounting was developed originally in manufacturing business to satisfy
management’s need for product cost information, cost accounting information is useful
for all types of activities in all types of organizations.
Cost accounting is essential not only for profit-seeking entities but also for not-for-profit
organizations such as governmental agencies, churches, and charities.

Comparison of Financial, Managerial, and Cost Accounting:

A. Financial Accounting
1. Financial accounting is the use of accounting information for reporting to external
parties including investors and creditors.
2. Financial accounting is primarily concerned with financial statements for external use
by those who supply funds to the entity and other persons who may have a vested
interest in the financial operations of the firm.
3. The suppliers of funds include stockholders (the owners of the corporation) partners (the
owners of the partnership) and sole proprietors.
4. Creditors who provide debts are also interested in the financial statements of the entity.
5. The financial statements are the output of an accounting system.
6. Financial accounting is based on historical transaction data. The information may be
historical, quantitative, monetary, and verifiable. The data are historical and are supported by
documents (evidence).
7. 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.
8. The same information may also be used internally to provide a basis for financial analysis by
management.
9. Financial accounting is required for many firms organized as corporations because of the
requirements of the Securities and Exchange Commission.

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10. The Bureau of Internal Revenue also requires financial accounting information for
compliance with the country’s tax laws. Information based on accounting data is required for all
firms without regard to their size.

B. Managerial Accounting
1. Managerial accounting focuses on the needs of parties within the organization rather
than interested parties outside the organization.
2. Managerial accounting information commonly addresses individual or divisional
concerns rather than those of the enterprise as a whole.
3. 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 recorded on the accounting books of the organization.
4. Managerial accounting is not separate and distinct from financial accounting.
Financial accounting data are used in the managerial accounting system. Management
decisions made today will affect the financial statements of future periods. No
requirement or legislation mandates the format or use of managerial accounting.
Managerial accounting methods are tools that are available for use in management.
5. 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. The timing of
information and its relevance to the decision on hand has greater significance to the
internal decision maker. Management is more concerned about the timeliness of
the information so management cannot wait until tomorrow for information that is
required for today’s decision.
6. The measuring based on managerial accounting does not necessarily have to be
restricted to pesos. Various bases may be appropriate to report managerial information.
Examples include:
a. an economic measure such as pesos;
b. a physical measure such as pounds, gallons, tons, or units; and
c. a relationship measure such as ratios.
C. Cost Accounting
1. Cost accounting is the intersection between financial and managerial accounting.
Cost accounting information is needed and used by both financial and managerial
accounting.
2. Cost accounting provides product cost information to external parties, such as
stockholders, creditors, and various regulatory boards for credit and investment
decisions.
3. Cost accounting provides product cost information also to internal parties such as
managers for planning and controlling.

Merchandising versus Manufacturing Operations.

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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.

Merchandise inventory, beginning P 5,000

Plus purchases 24,000
Cost of goods available for sale P 29,000
Less Merchandise inventory, ending 6,500
Cost of goods sold P 22,500

Cost of Goods Sold for a Manufacturing Company.

Computing the cost of goods sold for a manufacturing company is more complex.
Instead of one inventory account, a manufacturer maintains three inventory accounts:
Materials Inventory, Work in Process Inventory, and Finished Goods inventory.
Purchased materials unused during the production process make up the ending
materials inventory balance.
The cost of materials used plus the costs of labor services and factory overhead are
transferred to the Work in Process Inventory account when the materials, labor
services, and overhead items are used in the production process.
(Factory overhead includes such items as indirect materials, indirect labor, utility costs,
depreciation of factory machinery, depreciation of factory building, and supplies).
The three types of costs mentioned are often called direct materials, direct labor, and
factory overhead (abbreviated DM, DL, and FO).
These costs are accumulated in the Work in Process Inventory (WP Invty.) account
during the accounting period.
When a batch or order is completed, all manufacturing costs assigned to the completed
units are moved to the Finished Goods Inventory Account.
Costs remaining in the Work in Process Inventory account belong to partly completed
units. These costs make up the ending balance in the Work in Process Inventory
account. The Finished Goods Inventory (FG Invty.) account is set up in the same way as
the Merchandise Inventory account under Merchandising. Costs of completed goods
are entered into the Finished Goods Inventory account.
Then costs attached to unsold items at year-end make up the ending balance in the
Finished Goods Inventory account. All costs related to units sold are transferred to the
Cost of Goods Sold account and reported on the income statement.

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.

Determining Product Costs

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Cost accounting procedures help management gather the data needed to determine
product costs and thus generate meaningful financial statements and other reports.
Cost 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 was P2 per unit is significant, because this figure can be compared to the unit
labor cost of other periods and the trends analyzed.
Unit cost information is also useful in making a variety of important marketing decisions:
1. Determining the selling price of a product.
2. Meeting competition.
3. Bidding on contracts
4. Analyzing profitability

1. Costs are said to be used for managerial accounting purposes when costs are used
inside the organization by managers to evaluate the performance of operations or
personnel, or as a basis for decision-making.
When costs are used by outsiders, such as stockholders or creditors, to evaluate the
performance of top management and make decisions about the organization, we say
costs are used for financial accounting purposes. (Take Note!)
2. One of the most important functions of cost accounting is the development of
information that can be used by management in planning and controlling operations.
Cost accounting helps in the development of plans by providing historical costs that
serve as a basis for projecting data for planning.
3. 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.

TWO BASIC PRODUCT-COSTING SYSTEMS

1. Job order cost – a system for allocating costs to a group of unique products. It
applies to the production of customer-specified products such as the manufacture of
special machines. Each job becomes a cost center for costs are accumulated. A
subsidiary record (job cost sheet) is needed to keep track of all unfinished jobs (work in
process) and finished jobs (finished goods).
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 product is uniform,
each processing department becomes a cost center.

The primary characteristics of a job order cost system are as follows:

1. It collects all manufacturing costs and assigns them to specific jobs or batches of
products.

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2. It measures costs for each completed job, rather than for set periods.
3. It uses just one 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 in time.

Characteristics of Process Costing

A process cost accounting system is 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 the four-unit cost amounts are added
to find the product’s total unit cost.
Companies producing paint, oil and gas, automobiles, bricks, or soft drinks use some
form of a process costing system.

The main characteristics of a process cost accounting system are as follows:

1. Manufacturing costs are grouped by department or work center, with little concern for
specific job orders.
2. It emphasizes a weekly or monthly time period rather than the time taken to complete
a specific order.
3. It uses several Works in Process Inventory accounts – one for each department or
work center in the manufacturing process.

Major differences between Process & Job Order Costing

PROCESS COSTING JOB ORDER COSTING
1. Homogeneous units pass through a series 1. Unique jobs are worked on during a time
of similar processes. period.
2. Costs are accumulated by the processing 2. Costs are accumulated by individual jobs.
department.
3. Unit costs are computed by dividing the 3. Unit costs are determined by dividing the
individual departments’ costs by the total costs on the job cost sheet by the
equivalent production. number of units on the job.
4. The cost of production report provides the 4. The job cost sheet provides the detail for
detail for the Work in Process account for the Work in Process account.
each department.

As a general rule, job systems are usually more costly than process systems.

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