SAINT COLUMBAN COLLEGE

College of Business Education

ACCTG 104 – COST ACCOUNTING & CONTROL I

INTRODUCTION TO COST ACCOUNTING

The main and 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 interest in the
operations of the entity.

Cost Accounting 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, producing a product. It is the
field of accounting that measures, records, and reports information about costs.

All types of business entities require information systems which provide the necessary financial data. Because
of the nature of the manufacturing process, the information system of manufacturing entities must be designed to
accumulate detailed cost data relating to the production process. The manufacturing process involves the conversion
of raw materials into finished goods through application of labor and the incurrence of various factory expenses.

 COMPARISON OF FINANCIAL, MANAGERIAL AND COST ACCOUNTING

There are two major areas of accounting – (1) Financial Accounting and (2) Managerial Accounting.

Financial Accounting is the use of accounting information for reporting to external parties, including investors
and creditors. 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 vested interest in the financial operations of the firm. The
financial statements are the output from an accounting system. The reports prepared under financial accounting focus
on the enterprise as a whole. Financial accounting is based on historical transaction data. The information may be
historical, quantitative, monetary and verifiable.

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. Management accounting is not separate and distinct from financial
accounting. Financial accounting date are used in the 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.

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

 RELATIONSHIP OF FINANCIAL, MANAGEMENT AND COST ACCOUNTING

Cost
Accounting
Financial Management
Accounting Accounting

 MERCHANDISING VERSUS MANUFACTURING OPERATIONS

A merchandising company normally buys a product that is ready for resale when it is received. Total beginning
merchandise inventory plus purchases is the basis for computing both the cost of goods sold and ending merchandise
inventory. Costs assigned to unsold items make up the ending inventory balance. The difference between the cost of
goods available for sale and the ending inventory amount is the cost of goods sold during the period.
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.

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 Purchased Materials unused during the production process make up the ending Materials Inventory balance. The
cost of materials used plus the cost of labor services and factor 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 cost, 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 as DM, DL, and FOH). These are accumulated in the Work in Process (WIP) Inventory Account during an
accounting period. When batch or order is completed, all manufacturing costs assigned to the completed units are
moved to the Finished Goods (FG) Inventory account. Costs remaining in the Work in Process Inventory account
belongs to partly completed units. These costs make up the ending balance in the Work in Process Inventory account.
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.

Figure 1-1. Cost of Goods Sold for a Merchandising Company

Balance Sheet Transactions Income Statement

Preparation Preparation
Cash

Purchases

Plus: Merchandise
Inventory Beginning

Merchandise Cost of Cost of Goods Cost of Cost of Goods

Inventory End Unsold Items Available for Sale Sold Items Sold

Figure 1-2. Cost of Goods Sold for a Manufacturing Company

Balance Sheet Transactions Income Statement

Preparation Preparation
Cash

Purchase of

Materials Labor Factory

Overhead

Materials Inventory Unused Materials

End Storage

When Used

Work In Process Unfinished Production Process

Inventory End

Finished Goods Unsold Finished Goods Products Cost of Goods Sold

Inventory End Products Storage Sold

The illustration assumes that there are no beginning inventory balances in the three inventory accounts.

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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.
 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. Unit cost
information is also useful in making a variety of important marketing decisions.
1. Determining the selling price of the product
2. Meeting competition
3. Bidding on contracts
4. Analyzing profitability

 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. Cost accounting helps in the development of plans by providing historical costs
that serve as basis doe 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. Planning
can be divided into three (3) components:
1. Strategic Planning – concerned with setting long range goals and objectives to determine the overall
direction of the company.
2. Tactical Planning – concerned with plans for a shorter range and emphasizes plans to achieve the
strategic goals.
3. Operations Planning – relates to day-to-day implementation of tactical plans.
Control is the process of monitoring the company’s operations and determining whether the
objectives identified in the planning process are being accomplished.

 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. Increasing emphasis on cost
control is seen now in hospitals, in industries facing stiff foreign competition and in many organizations that
have traditionally not focused on cost control.
The traditional role of cost accounting is to record full product cost data for external reporting. However,
the use of accounting data for decision making and performance evaluation has gained importance in recent
years.

 TWO BASIC PRODUCT-COSTING SYSTEMS

1. Job Order Costing -a system for allocating costs to groups of unique products. 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.
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 not need to determine the costs of
different groups of products because the product is uniform, each processing department becomes a cost
center.

 Characteristics of Job Order Costing

1. It collects all manufacturing costs and assigns them to specific job or batches of product.
2. It measures costs for each completed job, rather than for set time 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 of
time.

 Characteristics of Process Costing

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 Work in Process Inventory accounts – one for each department or work center in the
manufacturing process.

 MAJOR DIFFERENCES BETWEEN PROCESS AND JOB ORDER COSTING

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

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READING ASSIGNMENT:
 COSTS – CONCEPTS AND CLASSIFICATIONS
 ANALYSIS OF MIXED COSTS – (1) High-Low Method, (2) Least-Squares Regression Method,
(3) Scattergraph Method

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