CHAPTER 1 (INTRODUCTION TO COST ACCOUNTING) - Managerial accounting is not separate and distinct from financial

▲ Cost Accounting – an expanded phase of general or financial accounting accounting. Financial accounting data are used in the managerial accounting
which informs management promptly with the cost of rendering a particular systems. Management decisions made today will affect the financial statement
service, buying and selling a product and producing a product of future periods
- It is the field of accounting that measures, records, and reports information - There is no requirement or legislation that mandates the format or use of
about costs managerial accounting. Managerial accounting methods are tools that are
available for use to management.
- Financial accounting attempts to present some degree of precision in
- All types of business entities require information systems which provides the reporting historical information while at the same time emphasizing
necessary financial data verifiability and freedom from bias in the information, relevance to the
- Due to the nature of manufacturing process, the information system of general user and some degree of timeliness in reporting which is not as critical
manufacturing entities must be designed to accumulate detailed cost data in managerial accounting.
relating to the production process. - The timing of information and its relevance to the decision on hand has
- Thus, it is common for manufacturing companies to have structured costs greater significance to the internal decision-maker. Management is more
accounting systems. These systems should show what costs were incurred and concerned on the timeliness of the information so management cannot wait
where and how these costs were utilized until tomorrow for information that is required for today's decision.
- The measuring based in managerial accounting does not necessarily have to
- In order to appreciate the importance of an efficient cost system, it is be restricted to pesos.
necessary to understand the nature of the manufacturing process
- The manufacturing process involves the conversion of raw materials into ■ Various Bases Appropriate to Report Managerial Information
finished goods through the application of labor and the incurrence of various ◊ Economic measure (pesos, dollars, or euro)
factory expenses
◊ Physical measure (pounds, gallons, tons, or units)
- The manufacturer must make a major investment in physical facilities
(factory buildings, warehouses) and acquire many specialized types of ◊ Relationship measure (ratios)
machinery and equipment.
- In order to carry out the manufacturing process, the manufacturer must • Cost Accounting – the intersection between financial and managerial
purchase appropriate quantities of raw materials, supplies and parts, and build accounting
up a work force to convert these resources into finished goods. - Cost accounting information is needed and used by both financial and
- Once the goods are completed and are ready for sale, the manufacturer managerial accounting.
performs basically the same functions as the merchandiser in storing and - Cost accounting provides product cost information to external parties for
marketing the goods. credit and investment decisions and to internal parties for planning and
controlling
- Although it is developed originally in manufacturing business to satisfy
management’s need for product cost information, it is useful for all types of ▲ Relationship of Financial, Management, and Cost Accounting
organization
- Essential not only for profit-seeking entities but also for non-profit
organizations such as governmental agencies, churches, and charities

▲ Comparison of Financial, Managerial, and Cost Accounting

• Financial Accounting - the use of accounting information for reporting to ▲ Merchandising vs Manufacturing Operations
external parties, including investors and creditors.
- 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 the 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. The data are historical
and are supported by documents
- 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.
- The same information may also be used internally to provide a basis for
financial analysis by management.
- Financial accounting is required for many firms organized as corporations
because of the requirements of the Securities and Exchange Commission.
- The Bureau of Internal Revenue also requires financial accounting • Material Inventory
information for compliance with the country's tax laws. Information based on
accounting data is required for all firms without regard to their size. - Purchased materials unused during the production process make up the
ending Materiais Inventory balance

• Managerial Accounting – focuses on the needs of parties within the

organization, rather than interested parties outside the organization. • Work in Process Inventory

- Managerial accounting information commonly addresses individual or - The cost of materials (direct materials) used plus the costs of labor services
divisional concerns rather than those of the enterprise as a whole. (direct labor) and factory overhead are transferred to the Work in Process
Inventory account when the materials, labor services and overhead items are
- The information may be current or forecasted, quantitative or qualitative, used in the production process
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 - Factory overhead includes such items as indirect materials, indirect labor,
organization utility costs, depreciation of factory machinery, depreciation of factory
building, and supplies)
• Finished Goods Inventory • Planning and Control
- Direct materials, direct labor, and factory overhead are accumulated in the ■ Planning – the process of establishing objectives or goals for the firm and
Work in Process Inventory account during the accounting period determining the means by which the firm will attain them.
- When a batch or order is completed, all manufacturing costs assigned to the - Planning is essential to good management because it provides a means of
completed units are moved to the Finished Goods Inventory account. coordinating all of the operations of firm.
- 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 - Cost accounting helps in the development of plans by providing historical
process Inventory account. costs that serve as basis for projecting data, for planning.
- The Finished Goods Inventory account is set up in the same way as the - Management can analyze trends and relationships among such data as an aid
Merchandise Inventory account under Merchandising. in estimating future costs and operating results and in making decisions
- Costs of completed goods are entered into the Finished Goods Inventory regarding the acquisition of additional facilities, changes in marketing
account. Then costs attached to unsold items at year end make up the ending strategies, and obtaining additional capital
balance in the Finished Goods Inventory account.
- All costs related to units sold are transferred to the Cost of Goods Sold ◊ Three Components of Planning
account and reported on the income statement.
 Strategic planning – concerned with setting long range goals and
objectives to determine the overall direction of the company.
▲ Uses of Cost Accounting Data  Tactical planning – concerned with plans for a shorter range (or tine
• Determining Product Costs period) and emphasizes plans to achieve the strategic goals
- Cost accounting procedures help management in gathering the data needed  Operations planning – relates to the day to day implementation of tactical
to determine product costs and thus generate meaningful financial statements plans.
and other reports. - It emphasizes the coordination of the major factors of production (materials,
- Cost procedures must be designed to permit the computation of unit costs as labor and facilities)
well as total product costs.
- For example, if a manufacturer spent P10,000 for labor in a certain month, ■ Control – the process of monitoring the company's operations and
the information is insignificant, but if this labor produced 5,000 finished units, determining whether the objectives identified in the planning process are
the fact that the cost of labor was P2 per unit is significant, because this figure being accomplished
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 ▲ Recent Development in Cost Accounting
marketing decisions. - Cost accounting is experiencing dramatic changes. Manual bookkeeping has
■ Determining the selling price of a product been reduced because of the use of computers. Changes in production
methods have made traditional applications of cost accounting obsolete in
- A knowledge of the cost of manufacturing a unit of product helps in setting some cases.
the selling price, which should be high enough to cover the cost of production,
pay a portion of marketing and administrative expenses and provide a profit. - Increasing emphasis on cost control is seen now in hospitals, in industries
facing stiff foreign competition and in many organizations that have
- It will be difficult to set the selling price without knowing the costs incurred traditionally not focused on cost control.
in the manufacture of a product and cost incurred in rendering a service.
- The traditional role of cost accounting is to record full product cost data for
external reporting.
■ Meeting competition - However, the use of accounting data for decision making and performance
- If a competitor is selling the product at a low price, detailed information evaluation has gained importance in recent years
regarding unit costs can be used to determine the action to be taken by the
company.
▲ Cost Accounting and Other Fields of Study
- The company would know if selling price must be reduced, or
manufacturing costs must be reduced, or the product must be eliminated. - The recording of the costs of a product or a service is part of financial
accounting. The use of cost for valuation of inventory and cost of goods sold
for external reporting is also financial accounting.
■ Bidding on contracts - The use of cost data in choosing between two or more alternatives is part of
- Many manufacturing firms must submit competitive bids in order to be managerial accounting.
awarded manufacturing contracts by the government or private firms. - Differential cost analysis is considered by others as a form of applied
- An analysis of the unit costs relating to the manufacture of a particular microeconomics.
product is of great importance in determining the bid price to be submitted. - Cost accounting provides data for use in decision models for finance,
- The bid price must be able to cover costs to be incurred and at the same operations management, and marketing
provide profit for the company. - Cost accounting is also related to motivation and behavior because it is used
- It must not be set so high so as to be able to compete with other bidders. in planning and performance evaluation.
- Finally, tools from statistics, mathematics, and computer sciences are used to
■ Analyzing profitability perform cost analysis.
- Unit cost information enables management to determine the amount of profit
that each product earns and possibly eliminate those that are least profitable, ▲ Two Basic Product-Costing Systems
thereby concentrating efforts on those items that are most profitable • Job order costing – a system for allocating costs to groups or unique
product.
- Costs are said to be used for managerial accounting purposes when costs are - It is applicable to the production of customer specified products such as the
used inside the organization by managers to evaluate the performance of manufacture of special machines.
operations or personnel, or as a basis for decision making. - Each job becomes a cost center for which costs are accumulated.
- When costs are used by outsiders to evaluate the performance of top - A subsidiary record (job cost sheet) is needed to keep track of all unfinished
management and make decisions about the organization, we say costs are used jobs (work in process) and finished jobs (finished goods).
for financial accounting purposes.

• 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 • Operation costing – is a hybrid costing system often used in repetitive
because the product is uniform, each processing department becomes a cost manufacturing where finished products have common, as well as
center. distinguishing characteristics.
- For example, in the manufacture of clothing, basic suits can be assembled in
▲ Characteristics of Job Order Costing one operation. These suits can then move on to the next operation and have a
deluxe lining added. Based on the variations, the products and the related
- A job order cost accounting system is a product costing system used by costs are identified by batches or by production runs.
companies making one-of-a-kind or special-order products.
- A television assembly plant, which produces a basic chassis and component
- In such a system, direct materials, direct labor, and factory overhead costs system, but which varies options such as remote control and cabinetry would
are assigned to specific job orders or batch of production. be a logical user of operation costing.
- In computing unit costs, the total manufacturing costs for each job order are - Some companies process large orders of identical units as a group through
divided by the number of good units produced for that order. the same production sequence. Each of these orders is called a batch.
- Industries that use a job order cost accounting system include those that - In batch production, costs are allocated to each batch.
make ships, airplanes, large machines, and special orders.
- Whenever a change in the production line is required to continue production,
- Job order costing may also be used when producing a set quantity of a a new batch is created.
product for inventory replenishment, such as a production run of 500 identical
lawn mowers. - A furniture manufacturer may produce a batch of chairs, then a batch of
tables, then a batch of drawers, and so forth.
- Procedures similar to those used in job-order costing are used in many
service industry firms, even if these firms have no work in process or finished - Generally, job costing concepts are used to account for batch production and
goods inventories. each batch is treated as a job for costing purposes.
- In a public accounting firms, for example, costs are assigned to audit
engagements. For consulting and architectural firms, costs are assigned to ▲ Major Differences Between Process & Job Order Costing
contracts, while for universities it maybe for every research project. ● Homogeneous units pass through & series of similar processes.
○ Unique jobs are worked on during a time period
■ Primary Characteristics of a Job Order Cost System ● Costs are accumulated by processing department
• It collects all manufacturing costs and assigns them to specific job or batches ○ Costs are accumulated by individual job
of product.
● Unit costs are computed by dividing the individual departments' costs by
• It measures costs for each completed job, rather than for set time periods. the equivalent production
• It uses just one Work in Process Inventory Control account in the general ○ Unit costs are determined by dividing the total costs on the job cost sheet by
ledger. This account is supported by a subsidiary ledger of job order cost the number of units on the job
cards or sheets for each job in process at any point of time.
● The cost of production report provides the detail for the Work in Process
account for each department
▲ Characteristics of Process Costing ○ The job cost sheet provides the details for the work in Process account.
- 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 job costing, costs are accumulated for each job or batch produced. In
process costing, costs are accumulated by department for an accounting
- In these cases, it is more economical to account for product-related costs for period
a period of time (a week or a month) than to try to assign them to specific
products or job orders. - Process costing has less detailed record keeping, hence, if a company was
choosing between job and process costing, it would generally find that record
- Unit costs are computed by dividing total manufacturing costs assigned to a keeping costs are lower under process costing.
particular department or work center during a period by the equivalent unit of
production. - Process costing does not provide as much information as job costing because
records of the cost of each unit produced are not kept using process costing.
- If a product is routed through four departments, then four unit cost amounts
are added to find the product's total unit cost. - The choice of process versus job costing systems involves a comparison of
the costs and benefits of each system.
- Companies producing paint, oil and gas, automobiles, bricks, or soft drinks
use some form of a process costing system. - As a general rule job systems are usually more costly than process systems.
So if managers and accountants must decide whether to use job costing or
process costing, record keeping costs must be compared with additional
■ Main Characteristics of a Process Cost Accounting System benefits that will be derived from knowing the actual cost of each unit.
• Manufacturing costs are grouped by department or work center, with little - If record keeping costs were equal under job and process systems, for the
concern for specific job orders units in a product liņe, then the job costing systems are better because they
• It emphasizes a weekly or monthly time period rather than the time taken to provide all of the data that process systems do.
complete a specific order
• It uses several Works in Process Inventory accounts one for each department
or work center in the manufacturing process.

▲ Hybrid Costing System

- Many manufacturing firms have production systems which are not suited for
strictly job-order costing or process costing, but instead require a costing
system which incorporates ideas from both.
- This blending of ideas is known as hybrid costing
- The continuum below demonstrates the relationship between these costing
systems
Job-order costing → Hybrid costing system → Process costing

- The costing system an organization selects will mainly depend on its

underlying production system.