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Costcon Chapt 1-3

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Costcon Chapt 1-3

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P| Chapter 1 INTRODUCTION TO COST ACCOUNTING . LEARNING OBJECTIVES Upon completion of this chapter, you should be able to: Distinguish between financial, managerial, and cost accounting Distinguish between merchandising and manufacturing operations Identify the uses of cost accounting data Distinguish between job order costing and process costing eee 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 interests in the operations of theof the entity. Cost Accounting is an expanded phase of general or financial accounting which ‘management. promptly with the cost of rendering a particular service, buying and selling a product, and producing a product. It is the field of accounting that measures, records, and reports information about costs. All types of business entities - manufacturing, merchandising, and service businesses - require information systems which provide the necessary financial data. Because of the nature of the manufacturing process, the information systems of manufacturing entities must be designed to accumulate detailed cost data relating to the production process. Thus, it is common today for small, medium, and large manufacturing companies to have structured costs accounting systems. These systems should show what costs were incurred and where and how these costs were utilized. Cost accounting today is recognized as being essential to efficient cooperation of business and industry. In ordet to, appreciate the importance of an efficient cost system, it is necessary to understand the nature of the manufacturing process, In many ways, the activities of @ manufacturing organization are similar to those of a merchandising business. Both are concerned with purchasing, storing, and selling goods; both must have efficient management and adequate sources of capital; both may employ hundreds. or thousands of workers, In the manufacturing process itself, we see the distinction ~ :ACTURING COSTS/PRODUCT COST: LEC Direct materials Direct materials are the basic ingredients that are transformed into finished products through the use of labor and factory overhead in the production process. Direct materials are those that can be traced to the finished product can they form part of the product. All manufactured products are made from basic direct materials. The basic material may be iron ore for steel, sheet steel for automobiles, flour for bread wood tables and chairs,. Theses examples show the link between a basic raw material and a final product. The way a company buys, stores, and uses materials is important, Timely purchasing is important because if the company runs out of materials, the manufacturing process will be forced to shut down. Shutting down production results in no products, unhappy customers, and loss of sales and profits. Buying too many direct materials, on the other hand, can lead to high storage costs, Proper storage of materiais will avoid waste and spoilage. Large enough storage space and orderly storage procedures are esséntial. Materials must be handled and stored properly to guarantee their satisfactory use in production. Proper records, the materials stockcars, make it possible to find goods easily. Such records reduce 22 Cost Accounting Direct materials are materials that become part of a finished product and can be conveniently and economically traced to specific product units. The costs of these materials are direct costs. In some cases, however, even though a material becomes part of a finished product, the expense of actually tracing the cost of a specific material is too great. Some examples of this include nails in furniture, bolts in automobiles, and rivets in airplanes. These minor materials and other production supplies that cannot be conveniently or economically traced to specific products are accounted for as indirect materials. Indirect materials costs are part of factory overhead costs. Direct labor Direct labor represent the amount paid as wages.to_those. working directly.on the Labor services are, in essence, purchased from employees working in the factory, In addition, other types of labor are purchased from people and ‘organizations outside the company. The labor costs usually associated with ‘manufacturing include machine operators, maintenance workers; managers and supervisors; support personnel; and people who handle, inspect, and store materials, Because these people are all connected in some way with the production process, their wages and salaries must be accounted for as production costs and, finally, as costs of products. However, tracing many of these costs directly to individual products is difficutt. To help overcome this problem, the wages of machine operators and other workers involved in actually shaping the product are classified as direct labor costs. Direct labor costs include all labor costs for specific work performed on products that can be conveniently and economically traced to end products. Labor costs for production related activities that cannot be conveniently and economically traced to end products are called indirect labor costs, These costs include the wages and . salaries of such workers-as_machine_ helpers, supervisors, and_other_ support personnel. Like indirect materials costs, indirect labor costs are accounted for as factory overhead costs. Payroll related costs, such as payroll taxes, group insurance, sick pay, vacation and holiday pay, and other fringe benefits can be considered as part of direct labor costs, but are usually included as factory overhead. Direct labor plus direct materials = prime costs, while direct labor plus factory overhead = conversion costs, Prime costs and conversion costs may be diagrammed as shown on the next page Total manufacturing cost = direct materials, + direct labor + factory overltead Chapter 2 Cost - Concepts and Classification 23 _——Prime Costs Direct Direct Factory Materials Labor Overhead Conversion Costs Factory Overhead ‘The third manufacturing cost element is a catchall for manufacturing costs that cannot be classified as direct materials or direct labor costs. Factory overhead costs are a varied collection of production-related.costs.that cannot be practically or conveniently traced directly to end products. This collection of costs is also called manufacturing overhead, factory burden, and indirect manufacturing costs. Examples of the major classifications of factory overhead costs are: Indirect materials and supplies: nails, rivets, lubricants, and small tools. Indirect labor costs: lift-ruck driver’s wages, maintenance and inspection labor, engineering labor, machine helpers, and supervisors. Other indirect factory costs: building maintenance, machinery and tool maintenance, property taxes, property insurance, pension costs, depreciation on plant and equipment, rent expense, and utility expense, NON-MANUFACTURING COSTS/PERIOD COSTS Marketing or selling expenses Marketing or selling expenses include all costs necessary to secure eustomet orders and get the finished product.or.service into the hands of the customer. Since marketing expenses relate to contacting customers and providing for their needs, these expenses are often refered to as order-getting and order-filling costs. Examples of marketing expenses include advertising, shipping, sales travel; sales commissions, sales salaries, and expenses associated with finished goods ‘warehouses. All organizations have marketing costs, regardless of whether the ‘organizations are manufacturing, merchandising, or service in nature. 24 Cost Accounting Administrative or general expenses Administrative expenses include all executive, organizational, and clerical ‘expenses that cannot logically be included under either production or marketing. Examples of such expenses include executive compensation, general accounting, secretarial, public relations, and similar expenses having to do with the overall, general administration of the organization as a whole. As with marketing expenses, all organizations have administrative expenses COSTS CLASSIFIED AS TO VARIABILITY Fixed, Variable, and mixed ‘One of the most important cost classifications involves the way a cost changes in relation to changes in the activity of the organization. Activity refers to a measure of the organization's output of products or services. In specifying cost behavior, the managerial accountant often limits the description to a specific range of activity. This is called the relevant range. Fixed cost Items of cost which remain constant in total, irrespective of the volume of production, Fixed cost are not related to activity within the relevant range. If activity increases or decreases by 20 percent, total fixed cost remains the same. Cost per unit decreases as volume increases, and increases as volume decreases, Fixed costs are assignable to departments based on difference allocation methods. Examples are salaries of production executives, depreciation of equipment computed ona straight-line basis, periodic rent payments, and insurance. Fixed costs may classified into two categoriex, depending on the ability of ‘management to influence the levels of these costs in the short-term. 1) Committed fixed costs - costs that represent relatively long term Commitments on the part of management as a result of a past decision. Example ~ depreciation on equipment, 2). Managed fixed costs (also known as discretionary, programmed, or planned fixed costs) ~ costs that are incprred on a short-term basis and can be more easily modified in response to changes in management objectives. Examples - advertising, research and development and costs of training of employees auertiring Chapter 2 Cost - Concepts and Classification 25 ‘Shown on below is a graph of fixed cost. It is clearly shown that total fixed cost remains unchanged as activity changes. When activity triples, from 10 to 30 units, total fixed cost rem: constant at P1,500. If activity level is only | unit, then the fixed cost per unit is P1,500. Ifthe activity level is 10 units, then the fixed cost per unit declines to P150 per unit. So we can conclude that fixed cost per unit will decrease as we increase the volume or units of production and fixed cost per unit will Increase as we decrease the volume of production. Total fixed cost 1,500 I 1 1 10 20 30 Activity Graph of total fixed cost Activity Fixed cost per unit Total Fixed Cost 1 P 1,500 1,500 2 750 1,500 5 300 1,500 10 150 1,500 20 8 1,500 30 50 1,500 Variable costs ‘These are the items of cost which vary directly, in total, in relation to volume of production. If activity increases by 20 percent, total variable cost increases by 20 percent also, Cost per unit remains constant as volume changes within a relevant range, Examples are: direct materials, direct labor, royalties, and commission of salesmen, Shown on the next page is a graph of total variable cost, As this graph shows total variable cost increases proportionately with activity. When activity doubles from 10 to 20 units, total variable cost doubles, from P1, 000 to P2, 000. However, the variable cost per unit remains the same as activity changes. The 6 Cost Accounting variable cost associated with each unit of activity is P100, whether itis the first unit, tthe fourth, or the tenth, To summarize, as activity changes, total variable cost increases or decreases proportionately withthe activity change, but unit variable cost remains the same. Total Variable Cost 3,000 2,000 1.000 Activity 10 2 30 Graph of total variable cost TABULATION OF VARIABLE COST Activity Variable Cost per Unit Total Variable Cost 1 P 100 P 100 10 100 1,000 20 100 2,000 30 100 3,000 Mixed cost Items of cost with fixed and variable components, Mixed costs vary with the level of production, though not in direct relation to it, probably because part of the cost is fixed while the ret is variable. Two types of mixed costs exist - semivariable costs and step costs Semivariable cost, The fixed, portion of a semi-variable cost usually represents ‘minimum fee for making a particular item or service available. The variable portion is the cost charged for actually using the service. The cost of electricity where there is a basic minimum charge plus a specified cost per kilowatt hour above the Chapter 2 Cost- Concepts and Classification 27 minimum is an example of such a semi-variable cost, ‘The cost charged for using cell phone under a plan is also an example of a somi-variable cost.. The cost of the plan is fixed and it is for a specified time used, however ifthe user exceeds the time allowed, then charges will be made on a per minute basis, Semi-variable cost 35,000 empl-variable costs, 30,000 Variable 25,000 (P'15,000) 20,000 15,000 10,000 Fixed 5,000 (20,000) 0 5,000 KILOMETERS 1,000 ‘Assume that a company rents a delivery truck at a flat rate of P 20,000 per month plus P 1.50/km.driven. The fixed portion is the P20,000 monthly rental fee; the variable portion js the P1.50/km driven. If 10,000 km. are driven during the month, the total monthly cost of the delivery truck is P 35,000, computed as follows: Flat fee (fixed portion) 20,000 Variable portion - 10,000 km. x P 1.50 15,000 Total cost 235,000 Step costs - the fixed part of step costs changes abruptly at various activity levels because these costs are acquired in indivisible portions. A step cost is similar to a fixed cost within a very small relevant range. 180,000 ea 150,000 120,000 90,000 60,000 30,000 0 Re ) 28 Cost Accounting The supervisor's salary is an example of step cost. Assume that one supervisor with a salary of P 30,000 is needed for every 10 workers, then if 15 workers are used, 2 supervisors (with salaries of P60,000) will be needed. If 18 workers are used, still 2 supervisors would be needed. If the number of workers increases to 22, three supervisors would be needed. Ideally, for both planning purposes and for making certain types of decisions, all costs would be classified as either fixed or variable, with semi-variable costs being separated into-their-fixed-and-variable-components—One-of the-most-imporiant steps in estimating the variable and fixed components of a mixed cost is to examine the cause and effect relationship between activities that affect costs,. There are different methods of separating mixed costs into fixed and variable components: (1) scattergraph, (2) high-low point, (3) method of least square. We will illustrate the use of high-low point method and method of least square (1) HIGH-LOW POINT METHOD jum mat icity costs and Jabor hours Month Direct labor hrs. Cost of electricity January 28 P 625 February 24 565 March 30 630 April 3 640 May 38 685 June 34 640 July 35 655 ‘August 40 700 September * 2 ns October 41 726 November B 700 December 2 630 Direct Iaborhrs, Cost Highest month (Oct.) 47 P 726 Lowest month (Feb.) 24 565 Difference 23 P 161 ‘Variable rate per direct labor hour = P_161 23 hours = P Tidirect labor hour Chapter 2 Cost — Concepts and Classifi jon 29 Fixed cost can be computed from either the high or low data, High low Total cost of electricity P 726 P 565 Less: variable proportion 7x47) 329 (P 7x24) ~oiocay 168 ‘Monthly fixed cost Pao b222 ‘The formula for projecting the total monthly cost of electricity based on these data would be P 397 plus P7 multiplied by the direct-labor hours expected to be worked during the period (Y= FC +VC or Y = FC + VX) where Y = Total cost VC = Total variable cost V = Variable cost per unit FC = Fixed cost X = Activity level (2) METHOD OF LEAST SQUARE The three formulas to be used in least-square method are: Equation 1 Y = atbx Equation 2 EY = na+b3x Equation 3 EXY = Exa+bEx? Using the same data as in the high-low method the following have been. computed DLHrs. —_Electticity Cost — xt a x 28 625 784 4 565. 516 30 630 300 33 640 1,089 38 685 1,444 4 640 1,156 35 655 12225 40 700 1600 42 ms 1,764 47 6 2209 43 700 1,849 —2 630 —Lo24 z= 426 79 15,620 30 Cost Accounting By substitution: Equation? = Sy) = na +bEx (7911 = 12a +b426) 35.5 (426/12) Equation 3 xy ‘Ixa + bEx? 284,207 426a + b15,620 Equation2x35.5 280,840.5 oe 15,123 3y 36 3 497 = 3; sest97 b = 677 ‘Substituting the value for Equation 2, we can compute for a as follows 2a + (6.77)(426) 2a + 2,884 12a = 7,911-2,884 a = 5,027/12 = 418.92 Formula using ne -low method + bx 97 + 7x Formula using least square method Y=a +bx = 419 +6.77x In most cases the amounts derived using high/low point and method of least square are not the same. Common cost vs. Joint cost Common cost Costs of facilities or services employed in two or more accounting periods, operations, commodities, or services, Just like indirect costs, these costs are subject to allocation, Example ~ if two departments are occupying the same building, the depreciation of the building id a common cost subject to allocation based on floot ‘area occupied. Chapter 2 Cost - Concepts and Classification 31 Joint cost Costs of materials, labor, and overhead incurred in the manufacture of two or more products at the same time, A major difficulty inherent to joint costs is that they are indivisible and they are not specifically identifiable with any of the products being simultaneously produced. These costs are also subject to allocation. Example ~ direct materials, direct labor, and factory overhead cost incurred to manufacture two ‘or more products up to the point of split-off (or where they will go separate ways) Capital expenditure vs, Revenue expenditure Capital expenditure Expenditure intended to benefit more than one accounting periods and is recorded as, an asset. The allocation of the cost to the different periods is ~ depreciation for fixed tangible assets, amortization for intangible assets and depletion for wasting assets. Revenue expenditure Expenditure that will benefit current period only and is recorded as an expense. Direct vs. Indirect departmental charges Direct departmental charges Costs that are immediately, charged to the particular. manufacturing department(s) ‘that incurred the costs since the costs can be conveniently identified or associated with the department(s) that benefited from said costs Indirect departmental charges Costs that are originally charged to some other manufacturing. department(s).or ‘account(s) but are later allocated or transferred to another department(s) that indirectly benefited from said costs. Costs for Planning, control and analytical processes Standard costs Predetermined costs for direct materials, direct labor, and factory overhead. They are established by using information accumulated from past experience and data secured from research studies. In essence, a standard. cost is a budget forthe production of one unit of product or service. It is the cost chosen by the managerial ‘accountant to serve as the benchmark in the budgetary control system, suc 32 Cost Accounting Opportunity cost The benefit given up when one alternative is chosen over another. Opportunity costs are not usually recorded in the accounting system. However, opportunity costs should be considered when evaluating alternatives for decision-making. If an asset can be used to perform only one function and cannot be sold or used in other ways, the opportunity cost of that asset is zero. Example 1 Michelle has a part-time job that pays her P1, 000 per week. She would like to spend a week in Boracay during summer vacation from school, but she has no vacation time available. If she takes the trip anyway, the P1, 000 in lest wages will be an opportunity cost of doing so. Example 2 Marco is employed with a company that pays him a salary of P20, 000 a month, He is thinking about leaving the company and returning to school. Since returning to school would require that he give up his P240, 000 salaries, the forgone salary would be an opportunity cost of seeking further education. Differential cost Cost that is present under one alternative but is absent in whole or in part under another alternative. An jncrease in cost fom one altemative to another is known as incremental cost, while a decrease in cost is known as decremental cost. Differential cost is a broader term, encompassing both cost increases (incremental cost) and cost deereases (decremental costs) between alternatives. ‘The accountant’s differential cost concept is basically the same as the economist’s marginal cost concept. In speaking of changes in cost and revenue, the economist employs the terms marginal cost and marginal revenue. ‘The revenue that can be obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is called marginal cost. Differential costs can be either fixed or variable, To illustrate, assume that Avon Corp. is thinking about changing its marketing method from distribution through retailers to distribution by direct sale, Present costs and revenues are compared to projected costs and revenues in the table on the next page, Chapter 2 Cost— Concepts and Classification 33 Retailer Direct sale | Differential Distribution | Distribution | Cost and (present) (proposed) Revenues Revenues (V) 900, P.1,200,000 P 300,000 Cost of goods sold (V) 450,000 600,000 730,000 ‘Advertising (F) 80,000 45,000 | (35,000) Commission (Vy 40,000 40,000 ‘Warehouse depreciation (F) 30,000 80,000 30,000 ‘Other expenses (F) 60,000 60,000 Total 640,000 T 825,000 185,000 ‘Net Income P.260,000 P.375,000 | P_115,000 V = Variable F = Fixed The differential revenue is P 300,000, and the differential costs total P 185,000, leaving a positive differential net income of P 115,000 under the proposed marketing plan, As noted earlier, those differential costs representing cost increases could have been referred to more specifically as incremental costs, and those representing cost decreases could have been referred to more specifically as decremental costs, Relevant cost A future cost that changes across the alternatives, In the example above, the relevant costs are cost of goods sold, advertising, commissions, and warchouse depreciation. ehange in cosh glow caused by adecivion. Out-of-pocket cost Cost that requires the payment of money (or other assets) as a result of their incurrence. Sunk cost 34 Cost Accounting future decision, they are not differential costs, and therefore they should be used in analyzing future courses of action, To illustrate the notion of a sunk cost, assume that a firm has just paid P 250,000 for ‘a special purpose machine, Since the cost outlay has been made, the P250,000 investment in the machine is a sunk cost. Even though the purchase may have been unwise, no amount of regret can relieve the company of its decision, nor can any future decision cause the cost to be avoided. Controllable and Non-controllable Costs ‘A cost is considered to be a controllable cost at a particular level of management if that level has power to authorize the cost. For example, entertainment expense ‘would be controllable by a sales manager if he or she had power to authorize the amount and type of entertainment for customers. On the other hand, depreciation of warehouse facilities would not be controllable by the sales manager, since he or she ‘would have no power to authorize warehouse construction. In some situations, there is a time dimension to controllability. Costs that are controllable over the long run may not be controllable over the short run. A. good example is advertising. Once an advertising program has been set and a contract signed, management has no power to change the amount of spending. But the contract expires, advertising costs can be renegotiated, and thus management can exercise control over the long run. COST FLOW - MANUFACTURING FIRMS Cost incurrence Expense Category Direct materials } Work in _, Finished __, Cost of goods sold process goods Direct labor Factory overhead — Selling and Administrative ______, Operating expenses Chapter 2 Cost - Concepts and Classification 35 ‘Work in process consists of goods that are started but not completed, Finished goods are goods that are complete and ready for sale, T FLOW - HANDISING FIRM Cost incurrence cate Finished goods Cost of goods sold Selling and Administrative Operating expense ‘COST FLOW - SERVICE FIRM Expense category } } } > Cost of services } } Factory overhead — Selling and Administrative Operating expense The essential purpose of any organization is to transform inputs into outputs. The activity for merchandising, manufacturing, and service organizations are shown in the previous and current page . These organizations have many similarities, all require labor and capital as inputs, and all transform them into a product or service for the market. These organizations also differ from one another in many respects. ‘The differences between these organizations are reflected in their accounting systems, ‘A merchandising organization starts with a finished product and markets it. Because inventory is acquired in finished form, its cost is easily ascertained. The accounting system for a manufacturing organization is more complex because t materials are first acquired and then converted to finished products, A manufacturer's accounting system focuses on work in process, which is the account that reflects the costs involved in transforming input materials into finished goods. 36 Cost Accounting Service organizations are different from manufacturing and merchandising because they have no inventory of goods for sale. Costs are charged to responsibility centers for performance evaluation, In a public accounting firm, for example, costs are charged to the audit department, the tax department, and so forth, Costs are also charged to jobs, The assignment of costs facilitates performance evaluation, The manager of each department is held responsible for the costs of the department, the manager of each job is held responsible for the cost of that job .Of the three kinds of operations, manufacturers require the most complex and comprehensive cost accounting system. All three uses cost information for decision making and formance evaluation, But in addition, manufacturers need product costing for inventory valuation and to measure cost of goods sold reported on external financial statements, Many manufacturers also have service and merchandising activities, costs of which must be recorded. SUMMARY OF IMPORTANT FORMULAS J, Total variable costs = Variable cost per unit x total output 2. Total cost = Total variable COst toa xed cow 3. Variable rate = highest point cost - lowest point cost Highest output - lowest output 4, Fixed cost = Total cost at highest - (variable rate x output at highest point) or 5. Fixed cost = Total cost at lowest — (variable rate x output at lowest point ) CHAPTER wu EB tt ee COST ACCOUNTING CYCLE LEARNINGS OBJECTIVES Upon completion of this chapter, you should be able to © Understand the cost accounting cycle ‘© Differentiate service, merchandising, and a- manufacturing entities ‘© Distinguish between and account for direct and indirect materials and labor as they are used in the production process Prepare the different financial statements for a service entity merchandising entity and manufacturing entity The objective of accounting, in general, is the accumulation of financial information that is useful in making economic decisions. Financial accounting focuses on the gathering of information to be used in the preparation of financial statements that meet the needs of investors, creditors, and other external users of financial information. The statements include a balance sheet, income statement, and statement of cash flows. Although these financial statements are useful to ‘management as well as extemal users, additional reports, schedules, and analyses are required for internal use in planning and control, Cost accounting provides the additional information required by management, and also provides data necessary for the preparation of extemal financial statement. For example, cost accounting procedures dre necessary for the determination of cost of goods sold on the income statement and the valuation of inventories on the balance sheet. Manufacturing Inventory Accounts Most manufacturing companies use the perpetual inventory approach. In the remaining sections of this book, you are to assume that a company uses the perpetual inventory system unless otherwise indicated. Accounting for inventories is the more difficult part of manufacturing accounting when compared with merchandising accounting. Instead of dealing with one account ~ Merchandise Inventory ~ three accounts must be used: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. SI 22 Cost Accounting Materials Inventory ‘The Materials Inventory account, also Materials Inventory Control account, is made up of the balanc terials and supplies on hand, This account is maintained in much the same way as the Merchandise Inventory account. The main difference is the way that the costs of items in inventory are assigned. For the merchandising company, goods taken out of inventory are items that have been sold. When a sale is made, an entry is needed to debit Cost of Goods Sold and to credit Merchandise Inventory for the cost of the item. Materials, on the other hand, are usually not purchased for resale but for use in manufacturing a product. Therefore, an item taken out of Materials_Inventory and requisitioned into. production is transferred to the Work in Process Inventory account ( not Cost of Goods Sold). Figure 3-1 Merchandise Inventory versus Materials Inventory Goods costing 45,300 were sold Merchandise Inventory Cost of Goods Sold Balance 1/1 24,600 | Sold 45,300 ——*Sold 45,300 Purchases $3,200, Balance 32,500 Materials costing 45,300 were issued to production Materials Inventory Work in Process Balance 1/1 24,600 Issued 45,300 Balance 1/1 25,100 Purchases 53,200 lat. Used 45,300 Balance 32,500 Chapter 3 Cost Accounting Cycle 53 Work in Process Inventory All. manufacturing-costs incurred and.assigned to_products being produced are classified as. Work in Process Inventory. costs, This inventory account has no counterpart in merchandise accounting. A thorough understanding of the concept of ‘Work in Process Inventory is vital in manufacturing accounting. Figure 3-2 shows the various costs that become part of Work in Process Inventory and the way costs, are transferred out of the account. The issugnce of materials production, shown in Figure 3-1, begins the production process. These materials must be cut, molded, assembled, or in some other way changed into a finished product. To make this change, people, machines, and other factory resources (buildings, electricity, supplies, and so on) must be used. All of these costs are manufacturing cost elements (product costs), and all of them enter {nto accounting for Work in Process Inventory Direct labor earned by factory employees are also product costs, Since these people work on specific products, their labor costs are assigned to those products by including the labor peso earned as part of the Work in Process Inventory account, Overhead costs are product costs and must be assigned to specific products, Thus, they, too, are included in the Work in Process Inventory account. As discussed earlier, there are many overhead costs to account for on an individual basis. To reduce the amount. of work needed to assign these costs to products, they are accumulated and accounted for under one account title: Factory Overhead Control. These costs are then assigned to products by using an overhead rate, Using this rate, called -a predetermined overhead rate, costs are charged to Work in Process Inventory account. In the example in Figure 3-2, factory overhead costs of P 65,000 were charged to the Work in Process Inventory account. The predetermined overtiead rate will be discussed in Chapter 8, AAs protuets are completed, they are put into the finished goods storage area. These products now have materials, direct labor, and factory overhead costs assigned to them, When products are completed, their cosis no longer belong to work in process. Therefore, whea the completed products.are sent to the storage area, their costs are transferred from the Work in Process Inventory account to the Finished Goods Inventory. The balance remaining in the Work in Process Inventory account (P 13,500 in Figure 3-2) represents the costs that were assigned to prodiicts partly completed and stil in process at the end of the period, 54 Cost Accounting Figure 3-2. The Work in Process Inventory Account Products costing P201,600 ‘were completed and transferred to finished ‘goods inventory Work in Process Inventory Account Finished Goods Inventory Balance 1/1 25,100 ‘ompleted during / Balance 1/1 period 70,000 Materials 45,300 201,600 Completed 600 Labor 79.700 Overhead 65,000 Balance | 13,500 Finished Gcods Inventory The Finished Goods Inventory account, like Materials Inventory, has same characteristics of the Merchandise Inventory account. We have already seen how costs are moved from the Work in Process Inventory account to the Finished Goods Inventory account, At this point Finished Goods Inventory takes on the characteristics of Merchandise Inventory. If we compare the Merchandise Inventory ceount in Figure 3-1 with the accounting for Finished Goods Inventory in Figure 3- 3 we will se that the credit side of both accounts is handled in the same way. Both ‘examples show that when goods or products are sold, the costs of those goods are moved from the Finished Goods Inventory account to the Cost of Goods Sold account. However, the accounting procedures affecting the debit side of the Finished Goods Inventory account differ from those for the Merchandise Inventory account. In a manufacturing firm salable, products are produced rather than purchased. All costs debited to the Finished Goods Inventory account represent transfers from the Work in Process Inventory account. At the end of an accounting period, the balance in the Finished Goosis Inventory account is made up of the cost of products completed but unsold as ofthat date. Chapter 3 Cost Accounting Cycle 55 Figure 3-3. Accounting for Finished Goods Inventory Products costing P 240,500 were sold during the period Cost of Goods Sold_ Id 240,500 Balance 1/1 70,000 |Sold 240,500 Completed 201,600 Balance 31,100 For the merchandising concer, the cost of goods sold is computed as follows: Beginning merchandise inventory Plus: Purchases (merchandise) Merchandise availabe for sale Cost of goods sold __ The amount of purchases represents the cost of the goods which were acquired during the period for resale, Since the manufacturing concem makes rather than ‘buys the product it has available for sale, the term “finished goods inventory” replaces “merchandise inventory” and the term “cost of goods manufactured” replaces “purchases” in determining the cost of goods sold. Beginning finished goods inventory Plus: Cost of goods manufactured Total goods available for sale s: Finished goods inventory end Cost of goods sold ‘Regardless of which costing system is used, a cost of goods manufactured (CofGM) statement is prepared to summarize the manufacturing activity of the period. Cost of Goods Manufactured for a manufacturing firm is equivalent to purchases for a merchandising firm. Although it may take different forms, essentially the CofGM. statement is a summary of the direct materials, direct labor, factory overhead, and work-in-place (WP) account, 56 Cost Accounting ELEMENTS OF MANUFACTURING COST Manufacturing or production costs are classified into three basic elements: (1) direcs materials, (2) direct labor, and (3) factory overhead. Direct materials The cost of material which become part of the product being manufactured and which can be readily identified with a certain product. Examples are: lumber used in making furniture, fabric used in the production of clothing, crude oil used to make ‘gasoline and leather used to make shoes and bags. Materials that cannot be readily identified with any particular item manufactured are called indirect materials. Examples are: sandpaper used in sanding furniture, and lubricants used on machinery. Classified also as indirect materials are materials thet actually become part of the finished product but whose costs are relatively insignificant, such as thread, screws, rivets, bolts, nails, and glue. Direct labor The cost of labor for those employees who work directly on the product manufactured. are classified as direct labor. Examples ere: salaries of machine ‘operators or assembly line workers. ‘The wages and salaries of employees who are required for the manufacturing process but who do not work directly on the units being manufactured are considered indirect labor. Examples are: wages and salaries of department beads, inspectors, supervisors. and maintenance personnel. Factory overhead Includes all costs related to the manufacturing of a product except direct materials and direct labor. Examples are: indirect materials, indirect labor, and other manufacturing expenses, such as depreciation on the factory building, machinery and equipment, supplies, heat, light, power, maintenance, insurance, rent and taxes. t low. Manu! Product costing, inventory valuation, and financial reporting depend on a defined, structured flow of manufacturing costs, ‘This manufacturing cost flow was Chapter 3 Cost Accounting Cycle 57 ‘outlined in the discussion of the three manufacturing inventory accounts. Figure 3-4 summarizes the entire cost-flow process as it relates to accounts in the general ledger. The journal entries to make this cost flow operational will be illustrated in the latter part of this chapter. Figure 3-4 Manufacturing Cost Flow Materials Inventory Factory Payroll___Factory Overhead Control Bal.1/124,000}ssued 45,300 DL 79,700 | 79,790 Total mfg. Purch. 53,200 Bal, 31,900 Bal. 1/1 25,100 Completed 201,600 Materials 45,300 Labor 79,700 OH — 65,000 Bal. 13,500 Bal. 1/1 70,000 pleted 201,600 Bal. 31,100 Id 240,500 + —Sekd240,500 Here we concentrate on the general pattern of manufacturing cost flow, as shown in Figure 3-5 . The cost flow begins with costs being incurred. start in many ways, They may be cash payments, incurred liabil depreciation, or expired prepaid expenses. Onco these costs have been incurred they are recorded ‘as either direct materials, direct labor, or 58 Cost Accounting factory overhead costs. As the resources are used up, the company transfers its costs to the Work in Process Inventory account, When production is completed, cost assigned to finished units are transferred to the Finished Goods Inventory account, In much the same way, costs attached to units sold are transferred to the Cost of Goods Sold account. Before going on, compare the cost flow as it moves through the general ledger accounts in Figure 3-4 with the general pattem shown in Figure 3- 5. Both figures show the sume type of cost flow. Figure 3-5 COST FLOW - MANUFACTURING FIRMS Cost incurrence Expense Category Direct materials ————- } —,Work in _, Finished __, Cost of goods sold } process” goods Factory overhead -—-} Direct labor ~-------- Selling and Administrative The Manufacturing Statement Financial statements of manufacturing companies differ little from those of merchandising companies. Depending on the industry, the account titles found on the balance sheet are the same in most corporation. (Examples include Cash, Accounts Receivable, Buildings, Machinery, Accounts Payable and Capital Stock.) Even the income statements for a merchandiser and a manufacturer are similar. However, a closer look shows that the head Cost of Goods Manufactured is used in place of the Purchases account. Also, the Merchandise Inventory. account is replaced by Finished Goods Inventory. The key to preparing an income statement for a manufacturing company is to determine the cost of goods sold, The amount is the end result of a special manufacturing statement, the statement of cost of goods manufactured, which is prepared to support the figure on the income statement. Operating expenses Statement of Cost of Goods Manufactured and Sold The flow of manufacturing costs, shown in Figures 3-1 through 3-4, provides the basis for accounting for manufacturing costs. In this process all manufacturing, Chapter 3 Cost Accounting Cycle 59 costs incurred are considered product costs. They are used to compute ending inventory balances and cost of goods sold. ‘The costs flowing from one account to ‘nother during the year have been combined into one number in the illustrations to help show the basic idea. In fact, hundreds of transactions occur during a year, and cach transaction affects part of the cost flow process. At the end of the year, the flow of all manufacturing costs incurred during the year is summarized in the statement of cost of goods manufactured and sold. The statement gives the peso amount of costs for products completed and moved to Finished Goods Inventory during the year. The amount for cost of goods manufactured should be the same as the amount transferred from the Work in Process Inventory account to the Finished Goods Inventory account during the year. In the same way, the amount of cost of goods sold should be the same as the amount transferred from the Finished Goods Inventory account to the Cost of Goods Sold account during the year. The statement of cost of goods sold for Figure 3-1 through 3-4 is shown below. Even though this statement is rather complex, it can be pieced together in four steps. The first step is to compute the cost of materials used. Add the materials for the period to the beginning balance in the Materials Inventory account. This subtotal represents the cost of materials available for use during the year. Then subtract the balance of the ending Materials Inventory from the materials available for use. The difference is the cost of materials used during the accounting period ‘Name of Company ‘Cost of Goods Sold Statement For the year ended December 31, 2019 Direct materials used Materials Inventory, January 1 P 24,600 ‘Add: Purchases 53,200 Total available for use 77,800 Less: Materials Inventory, December 31 32:500 P45,300 Direct labor 79,700 Factory Overhead Applied 65,000 Total manufacturing costs 190,000 ‘Add: Work in process, January 1 25.100 Cost of goods put into process 215,100 Less: Work in process, December 31 13,5( Cost of goods manufactured 201,600 ‘Add: Finished goods, January 1 70,000 Total goods available for sale 271,600 Less: Finished goods, December 31 31.100 Cost of goods sold — normal P 240,500 60 Cost Accounting The second step is the computation of the total manufacturing costs for the year, ‘The costs of materials used and direct labor are added to total factory overhead costs, applied during the year. ‘The third step charges total manufacturing costs into total cost of goods manufactured for the year, Add the beginning Work in Process Inventory balance to total manufacturing costs for the period to arrive at the total cost of work in process during the year. From this amount, subtract the ending Work in Process Inventory balance for the year to get the cost of goods manufactured, The term total manufacturing costs must not be confused with the cost of goods manufactured. Total manufacturing costs are the total costs for materials used, direct labor, and factory overhead incurred and charged to production during an accounting period. Total manufacturing costs of P 190,000 incurred during the current year are added to the beginning balance of the Work in Process Inventory costs of P 25,100, The P25,100 beginning balance, by definition, are costs from an earlier period. The costs of two accounting periods are now being mixed to arrive at the total cost of goods put into process during the year. The cost of ‘ending products still in process (P31,100) are then subtracted from the total cost of goods put into process during the year. The remainder, P201,600,is the cost of goods manufactured (completed) during the year, It is assumed that the items in beginning inventory were completed first. Cost attached to the ending Work in Process Inventory are part of the current period’s total manufacturing costs. But they will not become part of the cost of goods manufactured until the next accounting period when the products are completed, The fourth step is the computation of the cost of goods sold during the year. The cost of goods manufactured is added to the beginning balance of the Finished Goods Inventory to get the total cost of goods available for sale during the period. The cost of goods sold ~ normal is then computed by subtracting the ending balance in Finished Goods Inventory (cost of goods completed but unsold) from the total cost of goods available for sale. Cost of goods sold is considered an expense for the period in which the related products were sold, USTRATION O1 IG ‘The Nocled Products Company is a small, newly organized company that manufactures dining tables and chairs. The company’s products are sold to jobbers ‘or wholesale distributors, who in turn sell them to retailers. ‘The basic steps in the company’s manufacturing process are as follows: 1. Lumber is cut to size for table tops, legs, seats, arms, and backs. 2. The individual pieces of cut lumber are painted in various bright colors. 3. The pieces are assembled into tables and chai Chapter 3. Cost Accounting Cycle 61 The beginning Statement of Financial Position for the company on January 1 of the current year is presented below. ‘Noeled Products Company Statement of Financial Posi January 1, 2019 Assets Liabilities and Stockholders’ Equity Cash P 80,000 Lisbilities Po Building 750,000 Machinery & equipment _150,000 Capital stock 980,000, Total liabilities and Total assets 980,000 Stockholders’ equity P980,000 To make things easy, let us assume that the company for the month of January makes only one style of table and no chairs. The following transactions are completed for January and recorded, in summary form as follows: 1, “Materials (lumber, paint, screws, lubricants, and solvents) are purchased on account at a cost of P 50,000. Materials 50,000 Accounts Payable 50,000 This procedure differs in two ways from the recording of purchases for a ‘merchandising firm. First, the debit is to a Material Inventory account instead of a Purchases account because the inventory system is perpetual. Second, the inventory account used is a control account. Some companies have hundreds of items in inventory. To keep a separate account for each item in the general ledger would ‘crowd the ledger and make it hard to work with. At the time that entry 1 is posted to the general ledger, the individual stock cards are also updated. 2. During the. month, direct materials (lumber and paint) costing P 40,000 and indirect materials (screws, lubricants for machine, and solvents for cleaning) costing P 1,900 are issued to the factory. Work in Process 40,000 Factory Overhead Control 1,900 Materials 41,900 62 Cost Accounting ‘This entry shows that P40,000 of direct materials and P1,900 of indirect materials were issued, ‘The debit to the Work in Process account records the cost of direct materials issued to production, Such costs can be directly traced to specific job orders. As the direct materials costs are charged to work in process, the amounts for individual jobs are entered on the job order cost sheets, Indirect materials are debited to the Factory Overhead Control account, “Total payroll forthe month amounted to P36,000, consisting of P20,000 earned by laborers working on the product; P 7,000 for factory supervision; P 9,000 for sales ‘and administrative employees. The entry to record the payroll and the payment to ‘employees (ignoring payroll deductions) would be: Payroll 36,000 Accrued Payroll 36,000 Accrued Payroll 36,000 Cash 36,000 Recording labor costs for a manufacturing company requires thre joural entries. ‘The first labor cost entry records the total payroll liability of the company. The second entry records the payment of the payroll liability established in the first entry, The third entry (No, 4) is now needed to account properly for labor costs. ‘The P36,000 debited to the Payroll account must be moved to the production accounts. Gross direct labor costs arc debited to Work in Process account, and total indirect labor costs (factory supervision) are debited to Factory Overhead Control. Payroll is credited to show that the total account has been distributed to the production accounts. 4, The entry to record the distribution or classification ofthe payroll would be: 20,000 Workin Process Factory Overhead Control 7,000 Selling and Administrative Expense Control 9,000 Payroll 36,000 ‘The wages earned by laborers working directly on the product are charged to Work in Process, while the salaries and wages ofthe factory supervisor, who do no work directly on the product, are charged to Factory Overhead Control. Sales salaries and administrative salaries are charged to Selling and ‘Administrative Expense Control. Chapter 3 Cost Accounting Cycle 63 ‘5. Depreciation expense for the building is 6% per year. The office occupi¢s ‘one-tenth of the total building, and the factory operation is in the other nine- tenths. The depreciation expense for one month is recorded as follows: Factory Overhead Control 3,375 Selling and Administrative Expense Control 375 Accumulated Depreciation — Building 3,750 Depreciation for the portion of the building used for factory operations = 750,000 x 6% x I/12 x 9/10; for the portion used by the office= 750,000 x 6% x W12x 1/10 6. Depreciation expense for machinery and equipment is 20% per year. All machinery and equipment is used in the factory for production purposes, s0 the depreciation expense is charged to Factory Overhead Control. Factory Overhead Control 2,500 Accumulated Depreciation - Mach, & Equipt. 2,500 7. The cost of heat, light, and power for the month was P3,000. Factory Overhead Control 2,700 Selling and Administrative Expense Control 300 Accounts Payable 3,000 ‘The cost of heat, light, and power charged to Factory Overhead Control = 3,000 x 9/10 and charged to Selling and Administrative Expense = 3,000 x 1/0 8, Miscellaneous expenses for telephone, office supplies, travel, and rental of office furniture and equipment totaled P1,500 Selling and Administrative Expense Control 1,500 Accounts Payable 1,500 64 Cost Accounting yy be incurred by a manufacturing organization, but for purposes of simplicity, itis assumed there are no other expenses during the month, ‘After posting the journal entries to the appropriate ledger accounts, the factory ‘overhead account will reflect the following debits (as shown on the next page) Transaction Description Amount 2) "Indirect materials P1,900 (4) Indirect labor 7,000 (5) Depreciation of building 3375 ©) Depreciation of machinery and equipment 2,500 mM ‘Heat, light, and power 2.700 Total BLL475 14, Factory overhead is charged to production at 85% of direct labor cost: Work in Process 17,000 Factory Overhead Applied 17,000 The three elements of manufacturing cost - direct materials, direct labor, and factory ‘overhead — are now accumulated in Work in Process, and the debits in the account are as follows: ‘Transaction ‘Transaction Amount Q) Direct materials 40,000 (4) Direct labor 20,000 (9) Factory overhead _17,000 Total P.77,000 15, Assuming that all goods started in process have been finished, the following. entry is recorded: Finished Goods 77,000 Work in Process 77,000 the month, the unit cost is P77.00. 1g cost is calculated as in the Assuming that 1,000 tables were produced di ‘The unit cost for each element of manufact ‘computation on the next page. Chapter 3 Cost Accounting Cycle 65 Units Unit Total Produce Cost Direct materials P 40,000 1,000 P 40,00 Direct labor 20,000 1,000 20.00 Factory overhead 17,000 1,000 7.00 ‘B27.000 P77.00 Ifthe same type of table is produced in future periods, the unit costs of those periods can be compared with the unit costs determined above, and any difference can be analyzed so that management might take appropriate action. The unit cost also serves as a basis for establishing the selling price of the tables. After considering the anticipated selling and administrative expenses, a selling price can be established that should provide a reasonable profit. If management determines that « 40% gross profit percentage is necessary to cover the product’s share of selling and administrative expenses and earn a satisfactory profit, the selling price per unit, rounded to the nearest cent, would be computed as follows: ‘Manufacturing cost 77.00 Gross profit (40%) Selling Price To continue with the example, assume that the following transactions take place in January in addition to those already recorded. 11. Costs of materials, utilities, and selling and administrative expenses paid amounted to P 34,000 Accounts Payable 34,000 Cash 34,000 12, 800 tables are sold to jobbers at a net price of P86,240, Accounts Receivable 86,240 Sales 86,240 Cost of Goods Sold 61,600 Finished Goods 61,600 66 Cost Accounting 13, Cash totaling P55,000 is collected on accounts receivable Cash Accounts Receivable 55,000 55,000 ‘The accounts in the general ledger will reflect the entries as follows: Pee iS Ee Beg. 80,000 G3) 36,000 (13) 55,000 11) 34,000 65,000 Materials sap Tay 4.500 3,100 a 2 (10) 77,000 {12) 61,600 15,400 Buea oo 3,750 2800 Accounts Receivable (12) 86,240 (18) 55,000 31,240 ‘Work in Process 2) 40,000 (0) 77,000 20,000 9) 17,000 Building Beg. 750,000 | jachit Beg. 150,000 ————Aceounts_ Payable _ (11) 34,000 (1) 50,000 (7} 3,000 (@) 1,500 20,500 Chapter 3 Cost Accounting Cycle 67 ——Acorued Payro]| __ i S @) 36,000 bp 36,000 Be, 980,000 Factory Overhead Control ____ Selling and Adm, Exp, Control_ @) 1,900 i @ 9,000 @ 7,000 @) 395 © 3,375 @ 300 © 2,500 (+ 1,500 0) 2,700 17,475 4,175 Payroll Cost of Goods Sold @ 36,000 | (4) 36,000 (12) 61,600 Sales Factory Overhead Applied (12) 86,240 (| 17,000 Now let us compare the factory overhead of the two statements, the cost of goods sold statement on page 52 for Figure 3-1 through 3-4 and the statement of cost of goods sold for the illustrative problem which is shown on page 61. The factory overhead of the statement on page 61 is total actual factory overhead incurred for the period, while the factory overhead of the statement on page 71 is applied at 85% of direct labor cost, ‘The predetermined overhead rate (85% of direct labor cost) was used to apply overhead to production. Two overhead accounts are used in the illustrative problem: Factory Overhead Control and Factory Overhead Applied. Factory Overhead Control was used to accumulate all actual factory overhead costs. The estimated amount charged to production was credited to Factory Overhead Applied. After determining the balance of each general ledger account, a trial balance is’prepared to prove the equality of the debits and credits. 68 Cost Accounting ‘Noeled Products Company Trial Balance January 31, 2019 Cash P 65,000 Accounts Receivable 31,240 Finished Goods 15,400 Materials 8,100 Building 750,000 ‘Accumulated Depreciation - Building P 3,750 Machinery & Equipment 150,000 ‘Accumulated Depreciation —Mach. & Equipt. 2,500 ‘Accounts Payable 20,500 ‘Accrued Payroll 0 Capital Stock ‘920,000 Sales 36,240 Cost of Goods Sold 61,600 Factory Overhead Control 17,475 Factory Overhead Applied 17,000 Selling and Administrative Expense Control _11,175 1,109,990 P 1,109,990 From the trial balance, financial statements are prepared as follows: Noeled Products Company Statement of Comprehensive Income For the month ended January 31, 2019 Sales P 86,240 Less: Cost of Goods Sold (Schedule 1) 2.015 Gross Profit 24,165 Less: Selling and Administrative Expenses Selling and administrative salaries P-9,000 Depreciation ~ Building 375 Heat, Light and Power 300 Miscellaneous 150 LS, Net Income P12,990 Chapter 3 Cost Accounting Cycle Schedule 1 Nooled Products Company Cost of Goods Sold Statement For the month ended January 31, 2019 Direct materials used: Purchases P 50,000 Less: Materials, January 31 P 8,100 Indirect materials 1900 10,000 Direct labor Factory overhead Total manufacturing costs/Cost of goods manufactured Less: Finished Goods, January 31 ‘Cost of Goods Manufactured and Sold - normal Add: Under-applied fectory overhead Cost of goods sold —actual ‘Noeled Products Company Statement of Financial Position January 31, 2019 ASSETS ‘Current Assets Cash Accounts Receivable Finished Goods Materials Total current assets Plant and Equipment Building P 750,000 Less: Accumulated Depr'n 3,750 Machinery & Equipment 150,000 Less: Accumulated Depr'n, 2,500 Total Assets P 65,000 746,250 147,500 893,750 BL.013.490 70 Cost Accounting Liabilities and Stockholders’ Equity Current Liabilities Accounts Payable P 20,500 Stockholders’ Equity Capital Stock P 980,000 Retained Earnings 12,990. 992,990 Total Liabilities and Stockholders’ Equity 21,013,490 The cost of goods manufactured/completed divided by the number of units produced/completed will give the cost to manufacture per unit of the product, which is equivalent to purchase price for a merchandising concer. ‘The format of the income statement for a manufacturer is not significantly different from that for a merchandiser. In the income statement of a manufacturing concem the cost of goods sold is usually shown as one figure, supported by the cost of goods sold statement, which is also the general procedure in a published report. At the end of the period, we compare the total of the Factory Overhead Control account and the Factory Overhead Applied account. In our example the factory overhead control(P17,475) is greater than the factory overhead applied (P17,000), that is why we have an underapplied factory overhead which is considered unfavorable because the tendency is to increase the cost of goods sold. An increase in the cost of goods sold will lead to a decrease in the gross profit. However, if the factory overhead control account is less than the factory overhead applied, then what we have is overapplied factory overhead which is considered favorable because the effect is a decrease in the cost of goods sold thereby increasing the gross profit. We assume, in our example, that the company is closing its underapplied/overapplied account at the end of the year, so no entry is made at the end of the month, If the company is closing the factory overhead control and factory overhead applied account at the end of each month, the following entry will be made at the end of the month, Factory overhead applied 17,000 Underapplied factory overhead 475 Factory overhead control 1747S At the end of the year, the total underapplied (or net under/overapplied overhead account is closed to Cost of Goods Sold account. If the amount of the under/overs applied overhead is significant, then the amount is prorated to the Cost of Goods Sold account, Finished Goods account, and Work in Process account, according to the balances at the end of the period. Chapter 3 Cost Accounting Cycle an From the cost of goods sold statement, the following different equations are derived: 1, Materials, beg. Total materials Materials used + = available for = + Purchases use Materials, end 2. WP, beg. Total cost of Cost of goods + = goods put into = manufactured Total mfg. cost process + ‘WP, end 3. FG, beg. Total goods Cost of goods + = available for = sold Cost of goods sale + manufactured FG, end ‘The following formulas are also of importance with regards to the costs of goods sold statement. 1, Prime cost = direct materials used + direct labor cost. . 2. Conversion cost = direct labor cost + factory overhead 3. Total manufacturing cost = direct mat used + direct labor cost + factory OH ‘Merchandising Companies compared to Manufacturers Retailer companies purchase finished goods in saleable form, ready for sale to clients. Usually these finished goods require no additional processing. Sometimes litle, if any, conversion before being sold to consumers, Example of retail companies are SHOEMART (SM), ROBINSON'S, AND RUSTAN'S. The retailers usually sell the products in the same form as when acquired if ever, what is added is the packaging. Manufacturers, like SAN MIGUEL CORPORATION, ASIA BREWERY, AND WESTINGHOSE convert the raw materials purchased, into finished goods by adding labor and overhead. Upon completion the finished goods are stored in the warchouse /and or displayed until sold. The cost accumulation begins when raw materials are placed into production, As work progresses on a product, the costs are accumulated in the firm's accounting books. At the point of sale, these products will flow from the inventory account to the Cost of Goods sold to the statement of comprehensive income. The output of manufacturers are the products sold by the retail companies. 2 Cost Accounting Manufacturers compared to Service companies ‘A manufacturer accounts for production using three inventory accounts namely (l)materials inventory (2) work in process inventory (3) finished goods inventory, ‘An acerual accounting system is essential so that total production costs can be accumlated as goods flow through the manufacturing process Upon completion, the units are transferred to Finished Goods Inventory. Upon the sale we transfer to Cost of Goods Sold, On the other hand, most service firms need only to track their work in process (incomplete jobs). Because services generally cannot be stored, cost of finished jobs are transferred immediately to the statement of comprehensive income 10 be matched against service revenue instead of being carried on the statement of financial position in a Finished Goods Inventory account. Example will be the accounting for audit firms and law firms Although there are differences in the accounting for manufacturers, retailers, and service firms, each type can use management and cost accounting. concepts and techniques in different ways, Managers in all firms engage in planning, controlling, evaluating performance, and dgcision making. Managers are also finding ways to reduce costs without sacrificing quality. Basically the accounting for merchandising and manufacturing firms is the same, ‘The main difference is the accounting for cost of goods sold. For the merchandising, we use Purchases (periodic inventory system} or Merchandise Inventory(perpetual inventory system) to record acquisition of merchandise for sale To determine the cost of goods we simply multiply the number of units sold by the acquisition cost (purchase price) COST FLOW - MANUFACTURING FIRMS . ‘Cost incurrence Expense Category Direct materials —— } } _.Work in _, Finished __, Cost of goods sold J process” goods Direct labor -~ Factory overhead ——} Selling and Administrative ________, Operating expenses Chapter 3 Cost Accounting Cycle 3 = MERCHANDISING FIRM Cost incurrence Expense category Finished goods Cost of goods sold Selling and Administrative Operating expense yw = ‘Cost incurrence e201 Direct materials} Direct labor ——-—-—- i Cost of services Factory overhead -—-- } Selling and Administrative Operating expense ILLUSTRATIVE PROBLEM FOR A SERVICE FIRM The Magic Glass is engaged in cleaning glass walls and windows of high rise buildings. The company incurs service overhead of P 200,000 per month. Magic Glass. has $0 workers who work 200 hours each per month. In addition they spend ‘180,000 on gasoline for their trucks. Advertising and other marketing expenses amount to P115,000. Administrative costs are P-150,000 per month. The workers are paid P1SO per hour . Revenues for the month amounted to P 4,450,000. All purchases, labor costs and revenues are on cash basis, The following transactions take place during January, 2019 1. Purchased direct materials 325,000 2, Incurred and paid labor costs - direct labor costs 1,800,000 Supervisory labor 50,000 4, Incurred and paid other service overhead costs 200,000 5. Paid gasoline for the trucks 180,000 6. Paid advertising and other marketing expenses 115,000 7, Paid administrative expenses. 150,000 8. All jobs were completed and collected 4,450,000 74 Cost Accounting Requirements 1 Prepare journal entries 2.Prepare the Statement of Comprehensive Incame SOLUTION 1.Journal entries 1. Purchases 325,000 Cash 325,000 Purchase of materials 2.Direct labor 1,500,000 Service overhead 50,000 Cash 1,550,000 Payment of labor costs 3.Service overhead 200,000 Cash 200,000 Overhead cost incurred 4.Gasoline expense 180,000 Cash 180,000 Gasoline expense paid 5 Selling Expenses 115,000 Cash 115,000 Advertising and other marketing expenses paid 6. Administrative Expenses 150,000 Cash 150,000 Administrative expenses paid 7.Cash 4,450,000 Revenues 4,450,000 Cash received from clients Chapter 3 Cost Accounting Cycle 75 2, Stitement of Comprehensive Income ‘Magic Glass Statement of Comprehensive Income For the month of January, 2019 Revenues Cost of providing services Materials P 325,000 Labor 1,500,000 Service overhead 250,000 Gasoline 0 Gross profit Operating expenses Administrative 150,000 Selling 115,000 _ _265,000 B.1,930,000 P 4,450,000 2,255,000 2,195,000 Net Income

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