Chapter Two

Cost determination:

The costing of resource inputs

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Costs can be classified into various
categories:
1. Manufacturing costs: those costs associated
with the manufacturing activities of the company.
 Manufacturing costs are subdivided into three
categories: direct materials, direct labor, &
factory overhead.
Direct Materials Direct Labors Factory Overhead

Prime Costs Conversion Costs

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A. Direct materials are all materials that become
an integral part of the finished product.
 Manufactured products begin with raw materials
that are converted into finished products.
 Examples are the steel used to make an automobile
and the wood to make furniture.
B. Direct labor: is the labor that is involved directly
in making the product.
 The cost of employee wages that is an integral part
of the finished product is classified as direct labor
cost.
 Direct labor is sometimes called touch labor,
since direct labor workers typically touch the
product while it is being made.
 Like a direct materials cost, a direct labor cost
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must be both of the following:
C. Factory overhead includes all costs of
manufacturing except direct materials and direct
labor.
 Manufacturing overhead includes items such as
indirect materials; indirect labor.
 Some examples include depreciation, rent, taxes,
insurance, fringe benefits, payroll taxes, and cost
of idle time.
 Factory overhead is also called manufacturing
overhead, indirect manufacturing expenses,
and factory burden.

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2. Non-manufacturing Costs
 Generally, non-manufacturing costs are sub
classified into two categories:
1. Marketing or selling costs.
2. Administrative costs.

Marketing/ Selling Costs Administrative Costs

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1. Marketing or Selling Costs: include all costs
necessary to secure customer orders and get the
finished product or service into the hands of the
customer.
 These costs are often called order-getting and
order-filling costs.
 Examples include advertising, shipping, sales
travel, sales commissions, sales salaries, and costs
of finished goods warehouses.
2. Administrative Costs: include all executive,
organizational, and clerical costs associated with
the general management of an organization rather
than with manufacturing, marketing, or selling.
 Examples include executive compensation,
general accounting, secretarial, public relations, and 6
similar costs involved in the overall, general
Work Flow of Manufacturing Firm
1. Procurement:
 It is the processes of obtaining something.
 Purchases of materials, labors, and overhead.
 Recorded as debit to raw materials, factory
payroll, and manufacturing overhead control.
 When used, or applied, in factory operations,
they are credited to these accounts and
transferred to production
2. Production:
 Costs of materials, labor, and overhead
transferred into production are debited to
work-in process.
 When finished their total cost is removed from
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the WIP account by credit entry and debited
3. Warehousing: The cost of FGs transferred from
WIP is recoded as a debit to finished goods.
 The cost of goods shipped from the warehouse
to customers is credited to finished goods,
and debited to Cost of goods sold.
4. Selling: as finished goods are sold and shipped
from the warehouse, their cost is debited to the
CGS.
 At the end of the accounting period, this
account is closed by crediting CGS and
debiting income summary account.

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Product Cost Flows
Diagram

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10
Types of Inventory
 Types of inventories in each organization are
discussed as follows.
1. Inventories of manufacturing Business:
a) Raw materials inventory: This refers to all
materials purchased to be used in the production
process.
 The cost of the raw material is composed of:
 The invoice price of the material
 The transportation cost of the material
 The insurance in transit cost of the material
 Loading and unloading costs
 All other costs incurred on the raw material to
make ready for consumption.
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b) Work in Process Inventory: all items that are still
in process on the date of reporting
 Items not completed to be reported on finished
goods inventory.
 The cost of work in process inventory is composed
of:
 The cost of raw material changed to
production,
 The cost of labor incurred on items in
process, and
 The manufacturing overhead cost
c) Finished Goods Inventory:
 When the manufacturing process is completed,
finished products will be sent to warehouse so that
they will be available for selling.
 The cost is composed of:
 Applicable cost of raw materials
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 Applicable cost of labor and
2. Merchandising sector companies:
 They purchase and then sell tangible products
without changing their basic form.
 They hold only one type of inventory, which is
the product in its original purchased form.
3. Service Sector Companies:
 Service sector companies provide only services
or intangible products to their customers and
hence do not hold inventories of tangible
products for sale.

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Summary of manufacturing costs flows and
their classification

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Summary of merchandising cost flows and their
cost classification

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16
Recording of Costs and Schedule of Costs
of Products.
Cost of Goods Sold Schedule
Example 1
Direct materials:
Beginning raw materials inventory . . . . . . . . $
60,000
Add: Purchases of raw materials . . . . . . . . . . .
400,000
Raw materials available for use . . . . . . . . . . . .
460,000
Deduct: Ending raw materials inventory . . . . …
50,000
Raw materials used in production . . . . . . . . . . . . . . .
. $ 410,000
Direct
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labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
 Depreciation, factory . . . . . . . . . . . . . . . . . . . . . .
90,000
Property taxes, factory . . . . . . . . . . . . . . . . . . . . .
8,000
Total overhead
costs . . . . . . . . . . . . . . . . . . . . . . . . ….. . . . .
350,000
Total manufacturing costs:.
……….. . . . . . . . . . . . . . . . ….. . . 820,000
Add: Beg work in process inventory . . . . . 90,000
……..…...90,000
Deduct: End WIP inventory . . . . . . . . .
…………………..….. 60,000
Cost of goods manufactured . . . . . . . . . .
…... . . . . . . . . . . $ 850,000 18
Illustration:
 Prepare Cost of Goods Sold statement and
Income statement
 The following information has been taken from the
accounting records of AAA Corporation for last year:
Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . $
140,000
Raw materials inventory, January 1 . . . . . . . . ….. . .
$ 90,000
Raw materials inventory, December 31 . . . . . . …..
$ 60,000
Purchases of raw materials . . . . . . . . . . . . . . . … .
$ 750,000
Utilities, factory . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 36,000
Direct labor cost . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19
Administrative expenses . . . . . . . . . . . . . . . . . .
…. $ 270,000
Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 300,000
Maintenance,
factory . . . . . . . . . . . . . . . . . . . . .. . ... $ 87,000
Work in process inventory, January 1 . . . . . . ….. . .
$ 180,000
Work in process inventory, December 31 . . . …. . . .
$ 100,000
Finished goods inventory, January 1 . . . . . . . .
……. . $ 260,000
Finished goods inventory, December 31. . . . …... . .
$ 210,000 20
Required:
1. Cost of Goods Manufactured
AAA Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials inventory, January 1 . . . . . . . . .. . . . . . .$
90,000
Add: Purchases of raw materials . . . . . . . . .. . . . . . . . .
750,000
Raw materials available for use. . . . . . . . . .. .. . . . . . . .
840,000
Deduct: Raw materials inventory, December 31 . . . . .
60,000
Raw materials used in production . . . . . . . . . . . . .
………... . . $ 780,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . .
…. . . . . …… ... 150,000 21
Indirect labor . . . . . . . . . . . . . .. . . . . . . . . . . . . . . .
300,000
Maintenance,
factory . . . . . . . . . . . . . . .. . . . . . . . . . .87,000
Total manufacturing overhead costs. . . .. . . . . . .
……………….. . 640,000
Total manufacturing cost . . . . ……………. . . . . . . . .
. . . . . . . . 1,570,000
Add: Work in process inventory, January 1 . . . . . . .
180,000
2. Cost of Goods Sold
Deduct:
Cost of goods Work inmanufactured
process inventory,. . . December
... 31 . .
100,000
…………. . . . . . . . . . . . . $ 1,650,000
Cost
Add: of goodsgoods
Finished manufactured ......
inventory, January
………….
1 . . . . . . .. .. .. . .. .. .. ..….$
. . . 260,000
. . $ 1,650,000
Goods available for
sale . . . . . . . . . . . . . . . . . . . . . . ……….. . .
1,910,000 22
Deduct: Finished goods inventory, December 31 . .
3. Income Statement
AAA Corporation
Income Statement
For the Year Ended December 31
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,500,000
Cost of goods
sold . . . .. . . . . . . . . . . . . . . . . . . . . . . . 1,700,000
Gross
margin . . . . . . . .. . . . . . . . . . . . . . . . . . . . . .. . .
800,000
Selling and administrative expenses:
Selling expenses . . . . . . . . . .. . . .. . . . .. . . $
140,000
Administrative expenses . . . . . . .. . . . . . . . .
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270,000 … 410,000
Exercise:
Use the following data and compute CGS for Grey
company
Direct labor cost . . . . . . . . . . . . . . . . . . . . . . . . . .
$70,000
Purchases of raw materials . . . . . . . . . . . . . . . . .
$118,000
Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$30,000
Maintenance, factory equipment . . . . . . . . . . . .
$6,000
Advertising expense . . . . . . . . . . . . . . . . . . . . . . .
$90,000
Insurance, factory equipment . . . . . . . . . . . . . . .
$800 Beginning of the Year End of the Year
Raw materials
Sales salaries . . . . . $. .7,000
. . . . . . . . . . . . . .$15,000
........
Work in$50,000
process $10,000 $5,000
FinishedRent,
goods
factory facilities $20,000
. . . . . . . . . . . . . . .$35,000
....... 24
Solution
Grey Company
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning..................$ 7,000
Add: Purchases of raw materials .....................118,000
Raw materials available for use........................125,000
Deduct: Raw materials inventory, ending..........15,000
Raw materials used in
production.....................................$110,000
Direct
labor..........................................................................
..70,000
Manufacturing overhead:
Indirect labor ...................................................30,000
Maintenance, factory equipment ......................6,000
Insurance, factory equipment ..............................800
Rent, factory facilities.......................................20,000
Supplies factory .................................................4,200
Depreciation, factory equipment ....................19,000
Total overhead
costs .............................................................80,000
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Total manufacturing
Cost of Goods Sold
Cost of goods manufactured ..............................
$265,000
Add: Finished goods inventory, beginning .............
$ 20,000
Goods available for sale........................................
285,000
Deduct: Finished goods inventory, ending ........
35,000
Cost of goods
sold..................................................
$250,000
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End of Chapter- 2

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