TOPIC OUTLINE:

Introduction to Cost Accounting and Management

Flow of Costs in a Merchandising and

Manufacturing Company
Job-Order Costing System

Process Costing System

Operations Costing
COST ACCOUNTANCY the application of costing and cost accounting
principles, methods and techniques to the science, art and practice
of cost control and the ascertainment of profitability. It includes the
presentation of information derived there from for the purposes of
managerial decision making” - C.I.M.A. London.

Costing (process Cost Accounting

of cost finding) (system)

Cost Control Cost Audit

(keep cost within (verification and
limits) adherence)
 Cost Accounting
Coverage
It deals with ascertainment, allocation,
distribution and accounting aspect of cost.

Approach Narrow, focus is primarily on data

Emphasis Lays emphasis on cost ascertainment and control

Less ending finished goods inventory

Scope
Main purpose is to report current and prospective
Purpose
cost of product, service, department, job or
process
 Conversion Process
Outputs
Inputs (Factors of Production)
 Factory
Direct Material
Overhead

Direct Labor Cost of Goods

 Merchandising Manufacturing
Beginning Merchandise inventory Beginning finished goods inventory
Plus purchases (merchandise)__ Plus cost of goods manufactured__
Materials available for sale Finished goods available for sale
Less ending merchandise inventory Less ending finished goods inventory
Cost of goods sold Cost of goods sold
 Costs Incurred Balance Sheet Income Statement

Goods Inventory Product Cost

Purchased Account Revenues
• Cost of Goods Sold

• Selling and
Administrative Cost
Accounting,
Period Cost
Advertising, Staff,
office Rent, etc.
 Costs Incurred Balance Sheet Income Statement

Material Purchases Raw Materials

Direct Labor Work in Process

Manufacturing
Finished Goods Cost of Goods Sold
Overhead

Selling & Selling &

administrative administrative
 Merchandising Manufacturing
Cost System Service Business
Business Business

Accounting firm, Lumber company,

Custom home builder,
Job Order management personal computer
printer
consultant retailer

Hospital X-ray Newspaper

department, publishing, Soft drink bottler, paper
Process agricultural producer
hotel
housekeeping wholesaler
Job costing or job order costing also called specific order costing
is a method of costing which is used when work is undertaken as
per the customer’s special requirement (tailor-made).

Main feature: In this method of cost ascertainment, costs of

materials, labor and overhead are accumulated for each job
and profit or loss on it is determined.

Production
Job Number Job Cost Sheet
Order
Completion Profit or Loss
Report
Process Costing is a method of costing used to ascertain the cost of
a product at each process or stage of manufacture. In this method,
the costs of materials, wages and overheads are accumulated for
each process separately, for a given period, and then carried
forward cumulatively from one process to the next process till the
last process is completed.
 Normal or Uncontrollable Loss

without scrap value with scrap value

 Normal or Uncontrollable Loss

without scrap value

Abnormal gain Effectiveness

Defectives
 Job Order Cost Flow
Work in process
Direct Materials
Inventory
Direct Labor Finished Goods Cost of Goods
Job No. 101
Manufacturing Inventory Sold
Job No. 102
Overhead
Job No. 103

Process Cost Flow

Direct Materials
Work in Work in Finished
Direct Labor Cost of
process – process – Goods
Manufacturing Goods Sold
Department A Department B Inventory
Overhead
Operation costing is a further refinement of process costing. This
system is used where there is a mass production and processes are
repetitive in nature, and there is a detailed application of process
costing. The procedure of costing is broadly the same as per process
costing, except that cost unit is an operation instead of a process.
Effective target marketing requires:

Market Segmentation

Market Targeting

Market Positioning
Topic Outline:
Activity Based Costing

Activity Based Management

Opportunity Costing Concepts

Variable Costing & Absorption Costing

Advantages & disadvantages of

variable costing
Comparison and reconciliation of net
income for Variable & Absorption Costing

Variable Costing Arguments

Topic Outline:
Activity Based Costing

Activity Based Management

Opportunity Costing Concepts

Variable Costing & Absorption Costing

Advantages & disadvantages of

variable costing
Comparison and reconciliation of net
income for Variable & Absorption Costing

Direct Costing Vs. Absorption Costing

 Think-Tac-Toe

Direct cost Period Cost Prime cost

Activity
Direct labor Indirect cost
drivers

Overhead
Pool rates Period cost
cost
Activity-based costing (ABC) is an accounting
method that identifies and assigns costs to
overhead activities and then assigns those costs to
products.

An activity-based costing (ABC) system recognizes

the relationship between costs, overhead activities,
and manufactured products, and through this
relationship, it assigns indirect costs to products
less arbitrarily than traditional methods.
First Stage: Identify the activities
These activities are work performed or undertaken to
produce products such as number of set ups,
scheduling, orders, parts, inspections, labor hours,
and designs among others.

Second Stage: Pool rates

The overhead cost pool is traced to products using the
pool rates.
 Illustration:
Dragon Furniture Company has identified activity centers to
which overhead costs are assigned. The following data are
available:

Activity Centers Costs Activity Drivers

Utilities P300,000 60,000 machine hours
Scheduling and set up 273,000 780 set ups
Material handling 640,000 1,600,000 pounds of materials
The company’s products and other operating statistics are
the following:

Products Product A Product B Product C

Prime costs P80,000 P80,000 P90,000

Machine hours 30,000 10,000 20,000
Number of setups 130 380 270
Pounds of materials 500,000 300,000 800,000
Number of units
40,000 20,000 60,000
produced
Direct labor hours 32,000 18,000 50,000
Procedure:
Step 1. Determine the pool rates by dividing the given costs to
the activity drivers as follows:
Activity Centers Costs Activity Drivers

Utilities P300,000 60,000 machine hours

Scheduling and set up 273,000 780 set ups

Material handling 640,000 1,600,000 pounds of materials

Utilities P300,000/60,000 P5/mhr

Scheduling & setup P273,000/780 P350/set up
Materials handling P640,000/1,600,000 P.40 lbs
 Step 2. Allocate the overhead to the cost drivers using the computed
pool rates as follows:

Activity Centers Costs Activity Drivers

Utilities P300,000 60,000 machine hours

Products Product A Product B Product C

Machine hours 30,000 10,000 20,000

Products Product A Product B Product C Total

Utilities:
A. 30,000 X 5 P150,000
B. 10,000 X 5 50,000
C. 20,000 X 5 100,000
P300,000
 Activity Centers Costs Activity Drivers
Scheduling & Setups 273,000 780 set ups

Products Product A Product B Product C

Number of setups 130 380 270

Products Product A Product B Product C Total

Scheduling & Setups:

A. 130 X 350 P45,500
B. 380 X 350 133,000
C. 270 X 350 94,500
P273,000
 Activity Centers Costs Activity Drivers
Material Handling 640,000 1,600,000 pounds of materials

Products Product A Product B Product C

Pounds of materials 500,000 300,000 800,000

Products Product A Product B Product C Total

Material handling:
A. 500,000 X .40 P200,000
B. 300,000 X .40 120,000
C. 800,000 X .40 320,000
P640,000
TOTAL P395,500 P303,000 P514,500 P1,213,000
It seeks out areas where a business is losing money
so that those activities can be eliminated or
improved to increase profitability.

Activity Based Management (ABM) analyzes the

costs of employees, equipment, facilities,
distribution, overhead and other factors in business
to determine and allocate activity costs.
Identify the activities that the
organization performs

Calculate the cost of each activity

Identify the activity cost driver

for each activity.
Operational activity based management
It relates in making the organization more efficient
by reducing the cost of the activities and
eliminating those activities that do not add value.

Strategic activity based management

It essentially involves deciding which products to
make, and which customers to sell to, based on the
more accurate analysis of product and customer
profitability that activity based costing allows.
Illustration:
A case described by Kaplan and Cooper related to a producer of technical
manuals for the computer industry. The company had run out of storage
space in their main factory in South Street, due to a large amount of slow
moving inventory for their biggest customer, IBM. So additional storage
space was rented in Elmore Street, several kilometers away from South
Street. After production, the manuals for all other customers were
transported to Elmore Street for storage. They would then be returned
to South Street for dispatch to the customer when required.
Illustration:
The management knew that this movement of finished goods to and
from Elmore Street was inefficient. However, since the company used a
traditional cost accounting system, the only visible cost relating to this
was the cost of transport – this was P200,000 per year. A solution to
redesign the storage process in the South Street factory for the fast
moving goods, and to move the slow moving inventory to Elmore Street
(or destroy it entirely) was estimated to cost P600,000. It did not seem
worth investing in this, given that the annual saving would be only
P200,000.
After application of activity based management, the data
shows that the actual costs of operating the inefficient system
were much higher than expected. The annual savings of the
proposed solution analyzed by activity were as follows:

Reduced rental expense P128,000

Reduced transport costs 271,000
Reduced costs of moving WIP within factory 38,000
Reduced costs of moving finished goods within factory 91,000
Reduced costs of finding materials 88,000
Equipment savings 27,000
Reduced cost of managing WIP 44,000
Reduced cost of managing finished goods 68,000
Eliminated use of outside warehouses 53,000
Total annual savings 808,000
Opportunity cost is the cost of a missed opportunity. It is the
opposite of the benefit that would have been gained had an
action, not taken, been taken—the missed opportunity.

The following formula illustrates an opportunity cost calculation, for

an investor comparing the returns on different investments:

𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝑐𝑜𝑠𝑡
= 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑡ℎ𝑒 𝑏𝑒𝑠𝑡 𝑜𝑝𝑡𝑖𝑜𝑛 𝑛𝑜𝑡 𝑐ℎ𝑜𝑠𝑒𝑛 − 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑡ℎ𝑒 𝑜𝑝𝑡𝑖𝑜𝑛 𝑐ℎ𝑜𝑠𝑒𝑛
Illustration:
A private investor purchases P10,000 in a certain security, such as shares in a
corporation, and after one year the investment has appreciated in value to
P10,500. The return on investment is 5 percent. The investor considers other
ways the P10,000 could have been invested, and discovers a bank certificate
with an annual yield of 6 percent and a government bond that carries an
annual yield of 7.5 percent. After a year, the bank certificate would have
appreciated in value to P10,600, and the government bond would have
appreciated to P10,750.
Variable costing, also called direct costing, is an accounting method
used to allocate production costs to product being produced. This
method allocates all variable-manufacturing costs to the product
during a particular period.

Advantages:
It provides a clearer picture of the actual
incremental costs associated with a specific product.

It provides an accurate representation of what actually

goes into the costs of producing a product for those
concerned with financial records.

It is unaffected by inventory changes.

It is efficient to use in estimating profitability.

Disadvantages:

It understate the product’s overall cost since it ignores

the manufacturing overhead costs.

Financial statements prepared under variable costing

method do not conform to generally accepted accounting
principles (GAAP).

Variable costing does not assign fixed cost to units of

products. So the production costs cannot be truly
matched with revenues.
Absorption costing is a managerial accounting cost method of which
considers all costs associated with manufacturing a particular
product and is required for Generally Accepted Accounting
Principles (GAAP) external reporting.

Advantages:
It does not account for all fixed expenses.

It reflects more fixed costs attributable to those items

within ending inventory.

It results in a more accurate accounting regarding ending

inventory.

It results in a higher net income calculation when

compared to variable costing calculations.
Disadvantages:

It is unfavorable when compared to variable costing

when making internal incremental pricing decisions
since it includes overhead costs.

It is not helpful in managerial decisions.

It is not helpful in preparation of flexible budget.

Variable Absorption
Costing Costing
Direct Materials
Product
Direct Labor Product
Costs
Variable Manufacturing Overhead Costs
Fixed Manufacturing Overhead
Period
Variable Selling and Administrative Expenses Period
Costs
Fixed Selling and Administrative Expenses Costs
Illustration:
Scarlet produces a product with a selling price of P100/unit. The
following information is available for the first year:

Number of units produced this year 40,000

Number of units sold this year 35,000
Variable Cost per unit:
Direct materials, direct labor &
P40.00
variable manufacturing overhead
Selling & administrative expenses 6.00
Fixed costs per year:
Manufacturing overhead P1,000,000.00
Selling & administrative expenses 290,000.00
 Unit cost calculations:

Absorption Costing Variable Costing

Direct materials, direct labor, &
variable manufacturing overhead P40.00 P40.00

Fixed manufacturing overhead

(P1,000,000.00/40,000 units) 25.00 -

Unit product cost P65.00 P40.00

In general, the difference in income between absorption and
variable costing is the change in inventory value under
absorption minus the change in inventory value under
variable costing.

However, if unit cost does not change (or if there is no

beginning inventory), then:

𝐼𝑛𝑐𝑜𝑚𝑒 𝐴𝑏𝑠𝑜𝑟𝑝𝑡𝑖𝑜𝑛 − 𝐼𝑛𝑐𝑜𝑚𝑒 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒

= 𝐹𝑖𝑥𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 × 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙

where, change in inventory level =

Production - Sales, or Ending Inventory – Beginning
Inventory, in units.
 Difference of change in Inventory
Absorption Variable (Absorption – Variable)
Year 1:
Ending Inventory P325,000.00 P200,000.00
Beginning Inventory - -
Change in Inventory P325,000.00 P200,000.00 P125,000.00
Year 2:
Ending Inventory 195,000 120,000
Beginning Inventory 325,000 200,000
Change in Inventory (130,000) (80,000) (P50,000)
Alternatively, we can reconcile the differences between absorption
and variable income as follows:

Variable costing net income P600,000

Add: Fixed manufacturing
overhead costs deferred in
125,000.00
inventory
(5,000 units X P25 per unit)
Absorption costing net income P725,000.00
Variable costing net income P978,000
Deduct: Fixed manufacturing
overhead costs released from
50,000
inventory
(2,000 units X P25 per unit)
Absorption costing net income P928,000.00
Increase in Profits

Product offerings

Cost Control

Accuracy