Introduction To Cost Accounting PDF

BM2404 INTRODUCTION TO COST ACCOUNTING Cost accounting is the process of providing financial information about a business or economic entity to various types of users. I...

BM2404 INTRODUCTION TO COST ACCOUNTING Cost accounting is the process of providing financial information about a business or economic entity to various types of users. Internal users include managers who plan, control, and make decisions. External users include the government, those providing funds, and those with various interests in the business or economic entity. Cost accounting is an extension of general or financial accounting that informs management quickly about the cost of providing a service, buying, selling, or producing a product. Cost accounting is the practice of accounting to measure, record, and report information about costs. In today's economy, cost accounting is seen as essential for effective collaboration between business and industry. Because of the nature of manufacturing, information systems must be designed to collect detailed cost data related to the manufacturing process. As a result, cost accounting systems are commonly used in small, medium, or large manufacturing companies. Comparison of Financial, Managerial, and Cost Accounting Financial accounting is the process of using accounting information to report to outside parties, such as investors and creditors. The primary focus of financial accounting is financial statements for use by those who provide funds to the entity and other people who may have a financial interest in the firm. Stockholders, partners, sole proprietors, and creditors who provide debts all have an interest in the entity's financial statements. The financial statement is the output of the accounting system. Reports prepared under financial accounting are focused on the enterprise. The information used in financial accounting is based on historical transaction data, which may be historical, quantifiable, monetary, or verifiable. The information is historical and supported by evidence. The information is typically presented in financial statements, tax statements, and other forms of reporting to outside parties. The same information can be used internally to support financial analysis by management, and is necessary for many organized corporations due to the requirements of the SEC. Management accounting addresses the needs of stakeholders within the organization rather than outside stakeholders. Managing accounting information typically addresses individual or departmental needs rather than the needs of the entire enterprise. The information may be up-to-date or forecasted quantitatively, qualitatively, quantitatively, or quantifiably. Most of the data is futuristic. Some costs may not be recorded on the organization’s accounting books. There is no difference between managerial accounting and financial accounting. Financial accounting data is used in the management accounting system. Today’s management decisions will impact future financial statements. No legal requirements or regulations dictate the format or usage of managerial accounting methods. These are tools that can be used in management. 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. 01 Handout 1 *Property of STI Page 1 of 8  BM2404 Financial Cost Management Accounting Accounting Accounting Figure 1: Relationship of Financial, Management, and Cost Accounting Merchandising versus Manufacturing Operations Much of our accounting education has centered on the merchandising organization. Thus, explaining the difference in accounting for manufacturing and merchandising firms is important. Many businesses gather information on costs, which is especially important in manufacturing. A merchandising company normally buys a product ready for resale upon receiving it. Nothing needs to be done to the product to make it salable except possibly to prepare a special package or display. As shown in Figure 1-1, total beginning merchandise inventory plus purchases is the basis for computing both the cost of goods sold and ending merchandise inventory (MI) balances. 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. The following example shows the computation. Beginning merchandise inventory ₱1,000 Add: Total purchases 10,000 Cost of goods available for sale 11,000 Less: Ending merchandise inventory 3,000 Cost of goods sold 8,000 The example above and Figure 1 show how easy it is to compute the cost of goods sold for a merchandising company. The only expenditure occurs when salable goods are purchased. Any item unsold at year-end makes up the ending inventory balance. The cost of goods sold is computed by subtracting the ending inventory (MI end) balance from the total of the beginning inventory balance and purchases during the period. 01 Handout 1 *Property of STI Page 2 of 8  BM2404 Balance Sheet Transaction Income Statement Preparation Preparation Cash Purchases Add: Merchandise Inventory beginning MI Cost of Cost of Goods Cost of Cost of Unsold items Available for sale Goods End Sold items Sold Figure 2. Cost of Goods Sold for a Merchandising Company On the other hand, manufacturing operations transform raw materials into something else the end consumer desires. A wide range of companies and industries engage in this type of activity. In its Industry Classification System, the US government defines manufacturing as the mechanical, physical, or chemical transformation of materials, substances, or components into new products. Figure 2 shows a flow chart of the manufacturing process involving three inventory accounts: Direct Materials, Direct Labor, and Factory Overhead. All of these compose the products being manufactured. 01 Handout 1 *Property of STI Page 3 of 8  BM2404 Cost of Goods Sold for a Manufacturing Company (assumes there was no beginning balance in the three inventory accounts) Balance Sheet Transaction Income Statement Preparation Preparation Cash Purchase of Materials Labor Factory Overhead Mat. Unused Materials Invty Storage When Used Mat. Unfinished Production Process Invty Unsold Products FG Products Finished Goods Sold Cost of Invty Storage Goods Sold Figure 1-2. Cost of Goods Sold for a Manufacturing Company 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 producers help management in gathering the data needed to determine product costs and thus generate meaningful financial statements and other reports. Cost producers 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. However, suppose labor produced 5,000 finished units. In that case, the labor cost of 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. Knowledge of the cost of manufacturing a unit of a product helps in setting 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. It will be difficult to set the 01 Handout 1 *Property of STI Page 4 of 8  BM2404 selling price without knowing the cost incurred in the manufacture of a product and the cost incurred in rendering a service. 2. Metting competition. If a competitor is selling the product at a low price, detailed information regarding unit cost can be used to determine the action to be taken by the company. The company would know if the selling price must be reduced, manufacturing costs must be reduced, or the production must be eliminated. 3. Bidding on Contracts. Many manufacturing firms must submit competitive bids in order to be awarded manufacturing contracts by the government or private firms. An analysis of the unit costs relating to the manufacture of a particular product is of great importance in determining the bid price to be submitted. The bid price must be able to cover costs to be incurred and, at the same, provide profit for the company. It must not be set so high as to be able to compete with other bidders. 4. Analyzing profitability. Unit cost information enables management to determine the amount of profit each product earns and possibly eliminate those that are least profitable, thereby concentrating efforts on the most profitable items. 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. Planning and Control One of the most important functions of cost accounting is developing information that management can use in planning and controlling operations. Planning is the process of establishing objectives or goals for the firm and determining the means by which the firm will attain them. Planning is essential to good management because it coordinates all of the firm’s operations. Cost accounting helps in the development of plans by providing historical costs that serve as a basis for projecting data for planning. Management can analyze trends and relationships among such data to estimate future costs and operating results and make 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 (or time period) and emphasizes plans to achieve strategic goals. 3. Operations planning – relates to the day-to-day implementation of tactical plans. It emphasizes the coordination of the major factors of production (materials, labor, and facilities). 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 Cost accounting is experiencing dramatic changes. Manual bookkeeping has been reduced because of the use of computers. Changes in production methods have made traditional applications of cost accounting obsolete 01 Handout 1 *Property of STI Page 5 of 8  BM2404 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. Cost Accounting and Other Fields of Study Recording 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. The use of cost data in choosing between two or more alternatives is part of managerial accounting. Others consider differential cost analysis as a form of applied microeconomics. Cost accounting provides data for use in decision models for finance, operations management, and marketing. Cost accounting is also related to motivation and behavior because it is used in planning and performance evaluation. Finally, tools for statistics, mathematics, and computer sciences are used to perform cost analysis. Two Basic Product-Costing Systems 1. Job order costing – a system for allocating costs to groups of unique products. It applies to the production of customers specified products such as manufacturing special machines. Each job becomes a cost center for which 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 products; because the product is uniform, each processing department becomes a cost center. Job Order versus Process Costing Job order and process costing are the two traditional approaches to product cost accounting systems. Actual cost accounting systems may differ widely. However, all are based on one of these two product costing concepts. Once the type of system is selected, it is then adjusted to fit a particular industry, company, or operating department. The objective of the two systems is the same. They both provide product unit cost information for pricing, cost control, inventory valuation, and income statement preparation. End-of-period values for the Cost of Goods Sold, Work in Process Inventory, and Finished Goods Inventory accounts are computed using product unit cost data. Characteristics of Job Order Costing A job order cost accounting system is a product costing system used by companies making one-of-a-kind or special-order products. In such a system, direct materials, direct labor, and factory overhead costs are assigned to specific job orders or batches of production. In computing unit costs, the total manufacturing costs for each job order are divided by the number of good units produced for the order. Industries that use a job order cost accounting system include those that make ships, airplanes, large machines, and special orders. Job order costing may also be used when producing a set quantity of a product for inventory replenishment, such as a production run of 500 identical lawnmowers. 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 goods inventories. In a 01 Handout 1 *Property of STI Page 6 of 8  BM2404 public accounting firm, for example, costs are assigned to audit engagements. For consulting and architectural firms, costs are assigned to contracts; for universities, it may be for every research project. 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. 2) It measures costs for each completed job rather than for set time periods. 3) It uses just one Work in Process Inventory Control accounting in the general ledger. This account is supported by a subsidiary ledger of job order cost cars of 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 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. Many manufacturing firms have production systems not suited for strictly job-order costing or process costing. Instead, they require a costing system that 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 Hybrid Process Product-costing costing system product-costing systems system An organization's costing system will mainly depend on its underlying production system. Operation costing is a hybrid costing system often used in repetitive manufacturing where finished products have common and distinguishing characteristics. For example, in the manufacture of clothing, basic suits can be assembled in 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 costs are identified by batches or by production runs. A television assembly plant, which produces a basic chassis and component system but which varies options such as remote control and cabinetry would be a logical user of operation costing. Some companies process large orders of identical units as a group through the same production sequence. Each of these orders is called a batch. In batch production, costs are allocated to each batch. Whenever a 01 Handout 1 *Property of STI Page 7 of 8  BM2404 change in the production line is required to continue production, a new batch is created. A furniture manufacturer may produce a batch of chairs, then a batch of tables, then a batch of drawers, and so forth. Generally, job costing concepts are used to account for batch production, and each batch is treated as a job for costing purposes. Major Differences between Process & Job Order Costing PROCESS COSTING JOB ORDER COSTING 1 Homogeneous units pass through a series of 1 Unique jobs are worked on during a time similar processes. period. 2 The processing department accumulates costs. 2 Individual jobs accumulate costs. 3 Unit cost is computed by dividing the individual 3 Unit costs are determined by dividing the total departments’ costs by the equivalent costs on the job cost sheet by the number of production. units on the job. 4 The cost of production report provides each 4 The job cost sheet provides the details for the department's details of the Work-in-Process. Work-in-Process account. In job costing, costs are accumulated for each job or batch produced. In process costing, costs are accumulated by a department for an accounting period (for example, a month). Process costing has less detailed recordkeeping; hence, if a company was choosing between job and process costing, it would generally find that recordkeeping costs are lower under process costing. 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. The choice of process versus job costing systems involves a comparison of the costs and benefits of each system. Generally, job systems are usually more costly than process systems. So managers and accountants must decide whether to use job costing or process costing. Recordkeeping costs must be compared with additional benefits derived from knowing each unit's actual cost. If recordkeeping costs were equal under job and process systems for the units in a product line, then the job costing systems would be better because they provide all of the data that process systems do. References Cabrera, E. (2021). Cost Accounting and Control. EESM Bookstore. DeLeon, N. (2022). Cost Accounting and Control. Readers Knowledge Bookstore. Natter, E. (2019, February 19). What Are the Differences Between a Merchandising Company & a Manufacturing Company? Retrieved from smallbusiness.chron.com: https://smallbusiness.chron.com/differences-between-merchandising-company-manufacturing- company-21423.html Piper, M. (2022). Cost Accounting Made Simple. Simple Subjects LLC. Raiborn, C. (2021). Cost Accounting and Control. Cengage Learning. 01 Handout 1 *Property of STI Page 8 of 8