I. Definition Of Cost Accounting
The board definition of cost accounting is an internal reporting system designed to identify,
summarize, and interpret information needed for:
(1) Planning and Control.
(2) Management Decisions,
(3) Product Costing.

II. Objectives Of Cost Accounting
• Product Costing
• Inventory Valuation
• Income Determination
• Assessing Departmental Efficiency
• Planning, Evaluating, and Controlling Operations

III. Cost Classifications
Classification of costs is necessary inorder to determine the most suitable method of
accumulating and allocating costs. The principle methods of accumulating costs are
described below.
a) Classification by Nature
b) Classification by Variability
c) Classification by Department
d) Classification by Inventoriable
e) Classification by Period Covered
f) Classification by Controllability

A) Classification by Nature
1. Manufacturing Costs
Cost associated with the manufacturing activities which include:
a. Direct Materials
The costs of raw materials that can feasibly be traced to a particular product or job.
Examples include wood used in making furniture and iron used in making steel.
b. Direct Labor
The costs of wages paid to labor that can feasibly be traced to a particular product or jobs.
Examples include wages to workers who assemble furniture or operate melting machine.
c. Factory (Manufacturing) Overhead
All manufacturing costs other than direct materials and direct labor. It includes both fixed and variable costs.
Examples include indirect materials (supplies), indirect labor, repairs and maintenance on machinery, taxes, factory utilities, rent of factory building, insurance, and depreciation on factory equipment and plant.

Other Costs Concepts
* Direct Costs: Costs that can be identified with or traced to a specific cost object
(product, service, or activity). Examples include direct materials and direct labor.
* Indirect Costs: Costs that can not be identified with or traced to a specific cost object
(product, service, or activity). Examples include factory overhead.

2. Nonmanufacturing Costs
All Costs that are not related to the manufacturing activities such as:
* Administrative and office (management) salaries.
* Sales personnel salaries and commissions.
* Advertising
* Freight - out Expense
* Depreciation on management building
* Legal Expenses
* Other selling and administrative Expenses

B) Classification by Variability
1. Variable Costs
* Costs that change in total, directly in proportion to changes in the level of
activities (volume).
* The unit cost remains the same over a wide range of volume
(referred to as the relevant range).
* Relevant Range is the range of activity (production volume) within which variable
unit costs are constant and fixed costs are constant and fixed costs are constant
in total. In this range, the incremental cost of one additional unit of production is
the same.
* Examples include direct materials, direct labor, and part of manufacturing

2. Fixed Costs
* Costs that do not change in total regardless of changes in activity.
* The unit cost decreases as volume increases.
* Examples include rent, taxes, and insurance on manufacturing plant.

3. Semivariable (Mixed) Costs
* Costs that contain both variable and fixed costs.
* Examples include: light, heat, and power.

C) Classification by Department
1. Production
* A unit in which operations are performed on a product.
* Example: manufacturing department.

2. Service
* A unit not directly engaged in production and whose costs are ultimately allocated to
a production unit.
* Examples include: maintenance and personnel department.

D) Classification by Inventoriability
1. Inventoriable (product) costs
* Inventoriable (product) costs are included in inventory when the product is produced
and in cost of sales when the product is sold.
* It includes: direct materials, direct labor, and manufacturing overhead.

2. Noninventoriable (Period) Costs
* Costs associated with the passage of time rather than with the product.
* These costs are not inventoried and are charged to income as incurred since no
future benefits are expected.
* Examples include: selling, general, and administrative expenses.

E) Classification by Period Covered
1. Capital Costs
Costs that are expected to benefit future periods and are classified as assets.
2. Revenue Costs
Costs that benefit only the current period and are thus expensed as incurred.

F) Classification by Controllability
1. Controllable Costs
* Costs that directly regulated by management at a given level of production within a
given time span.
* All variable costs such as direct materials, direct labor, and variable overhead, are
usually controllable.
* Fixed costs are not usually controllable.

2. Noncontrollable Costs
* Costs that are not regulated by management at a given level of production within a
given time span.
* All fixed costs are usually not controllable.

Summary Of Cost Classifications

Cost Period
Direct Materials (DM) Yes No
Direct Labor (DL) Yes No
Factory (Manufacturing) Overhead (MOH) Yes No
Selling, General, & Administrative Expenses (S,G,&A) No Yes

Cost Conversion
Direct Materials (DM) Yes No
Direct Labor (DL) Yes Yes
Factory (Manufacturing) Overhead (MOH) No Yes
Selling, General, & Administrative Expenses (S,G,&A) No No
Prime Cost = DM + DL
Conversion Cost = DL + MOH
Cost Fixed
Direct Material (DM) Yes No
Direct Labor (DL) Yes No
Factory (Manufacturing) Overhead (MOH) Yes Yes
Selling, General, & Administrative Expenses (S,G,&A) Yes Yes

Other Costing Concepts
A. Practical Capacity
* The maximum level at which output is produced efficiently.
* Allows for unavoidable delays in production for maintenance, holidays, etc.

B. Theoretical (Ideal) Capacity
* The maximum capacity assuming continuous operations with no holiday, downtime, etc

C. Sunk Cost
* Is a past or historical cost that the entity has irrevocably committed to incur.
* Because it is unavoidable and will therefore not vary with the option chosen, it is not
relevant to future decisions.
* Examples include: research and development costs and fixed assets costs.

D. Opportunity Cost
• Is the maximum benefit foregone by rejecting an alternative.

E. Relevant Costs
* Are those expected future costs that vary between alternatives.
* Examples include: direct materials, direct labor, variable manufacturing overhead,
and variable selling and administrative costs.
• Fixed costs and sunk cost are considered irrelevant to decision making.

Cost Flow

Direct Materials Work - in - process Finished Goods

BI DM Used BWP C of GM BI C of GS

Pur. DM Used C of GM

EI D Labor EI

Direct Labor Cost of Goods Sold



Factory Overhead

Actual Supplies
FOH Indirect Labor FOH Applied
Cost Depreciation
Other Indirect Costs

Under Applied FOH Over Applied FOH

VI. Factory (Manufacturing) Overhead
A. Factory overhead consists of all indirect manufacturing costs (all costs other than direct
materials and direct labor).
It includes both fixed and variable costs.
It includes indirect materials and indirect labor.

B. Factory overhead is usually allocated to products based upon an activity base.
An activity base should have a high correlation (cause - and - effect relationship) with the
incurrence of overhead.
Examples of activity base include machine hours, direct labor costs, and units produced.

VII. Journal Entries (Job-Order and Process Costing)
Direct materials, labor, and overhead are debited to the work-in-process (WIP) account.
When Raw Materials are purchased
Raw Materials Inventory xxx
Accounts Payable or Cash xxx
When Raw Materials are transferred to work-in-process (WIP)
Work-in-process (WIP) xxx
Raw Materials Inventory xxx

Direct Labor is usually debited to WIP when the payroll is recovered. Any wages not
attributed directly to production, e.g., those for janitorial services, are considered indirect
labor and debited to overhead.
Work-in-process (WIP) xxx
Factory overhead xxx
Wages Payable xxx
Payroll Taxes Payable xxx

When Factory Overhead is Applied
Work-in-process (WIP) xxx
Factory overhead xxx

When Charging Factory Overhead with All Indirect Costs
Factory overhead xxx
Insurance Expense xxx
Supplies Expense xxx
Depreciation Expense xxx

When Goods are Completed
Finished Goods Inventory xxx
WIP xxx

When Finished Goods are Sold
Cost of Goods Sold xxx
Finished Goods Inventory xxx

Statement of Cost of Goods Manufactured

Direct Materials
Beginning Inventory Material xx
Purchases xx
Total xxx
Less: Ending Inventory Material (xx)
Cost of Direct Materials Used xxx

Cost of Goods Manufactured
Beginning Work-in-process Inventory xx
Direct Material Used xx
Direct Labor xx
Manufacturing Overhead xx
Total xxx

Less: Ending Work-in-process Inventory (xx)

Cost of Goods Manufactured xxx

Cost of Goods Sold
Beginning Finished Goods Inventory xx
Cost of Goods Manufactured xx

Goods Available for Sale xxx

Less: Ending Finished Goods Inventory (xx)

Cost of Goods Sold xxx

VIII. Costing System
A) Job-Order Costing
B) Process Costing
C) Activity - Based Costing
D) Just-in-Time

A) job-Order Costing
1. Concerned with accumulating costs by specific job.
2. Used when units are relatively expensive and costs cannot be identified to units or
3. Direct material, direct labor, and manufacturing overhead applied are charged to
work-in-process (WIP) account of a specific job using job-cost sheet .Job-cost sheets
serve as a subsidiary ledger.
4. Costs of completed units removed from WIP and charged to Finished Goods.
5. Costs of units sold removed from Finished Goods and charged to Cost of Goods Sold.
6. Source documents for costs incurred include:
* Stores' requisitions for Direct Materials.
* Work (or time) Tickets for Direct Labor.
* Overhead is usually assigned to each Job through a predetermined Overhead Rate.

Summary of Accounting Cycle of Job - Order System

Cost Element Source of Data
Direct materials Materials Requisitions

Direct Labor Time Tickets Job - Cost Sheet
(Stored in work -
in -Process File)

Factory Overhead Predetermined Rate
based on Estimated Costs

Work is Complete Job - Cost Sheet
(Stored in FG File)

When Good are Sold Job - Cost Sheet
(Store in CGS File)

B) Process Costing
1. Process cost accounting is used to assign costs to inventoriable goods or services. It is
applicable to relatively homogeneous products that are mass - produced on a continuous
basis (e.g., refined oil).

2. The objective is to determine the portion of manufacturing cost that is to be expensed
because the goods or services were sold and the portion to be deferred because the
goods are still on hand or the services have not been rendered.

3. Process costing is an averaging process that calculates the average cost of all
units. Thus, the costs are accumulated by departments or cost centers rather than
by jobs.

4. Work in process (WIP) is started in terms of Equivalent Finished Units (EFU), and unit
costs are established on a departmental basis.

5. Process Costing Procedures:
a. Accounting for all units (Physical Flow of Quantities).
b. Compute the Equivalent Finished units (EFU).
c. Compute Unit Cost per (EFU).
d. Prepare Cost of Production Report .

Step (1): Accounting for All Units (Quantities)
Beginning WIP x x
Started units x x
Total Units to Account for x x x

Finished Goods or Ending WIP Spoilage (Lost)
Transferred Out

• This step is very important to determine any missing information
(normally spoilage units).
• This step is the same in the FIFO and Weighted Average.
• This step ignores the percentage of completion for beginning and ending WIP.

Step (2): Compute Equivalent Finished Units (EFU)
a. EFU is the amount of direct materials or conversion costs produce (DL & MOH)
required to produce one unit of finished goods .
b. The objective is to allocate direct materials and conversion (DL & MOH) cost of
goods, ending WIP and Spoilage.
c. EFU is separately computed for direct materials and conversion (DL & MOH) costs.
Step (3): Compute Unit Cost

Comparison between job order costing and process costing

Job Order costing Process Costing
1. Cost unit
2. Costs are accumulated
3. Subsidiary record
4. Used by Job order, or contract
By jobs
Job cost sheet
Custom manufacturing Physical Unit
By departments
Cost - of - production report
Processing industries

c. Activity - Based Costing (ABC)
1.A method of analyzing and reducing manufacturing overhead (MOH) costs through using
multiple predetermined overhead rates .
2.Assumes that all costs are caused by the activities (Cost drivers).
3.Cost driver is an activity that cause costs to increase as the activities increase . Examples
include direct labor hours, machine hours, beds occupied, or miles driven .
4.Establishes cost pools related to individual drivers .
5.Applies cost to product on the basis of resources consumed (Cost drivers)
6.Advantages of ABC include promoting improved quality and continuos improvement .
7.ABC may be used with job - order or process costing methods .
8.ABC can be used in all types of business organization (Manufacturing and service)

d. Just -in -Time (JIT)
1. Costs reduce through :
• Elimination of nonvalue added activities (movement, storage, set up, inspection, defective rework).
• Corrections made as defects occurs
• Reduction in inventory quantities (Fewer venders)
2. Problems of JIT system:
*Difficult to find suppliers able to accommodates .
* Potential problems due to delays in delivers .
* High shipping costs due to smaller orders .

XI. Allocation of Service Department Costs
A. Service department provides services to other departments . Its costs should be
allocated to departments benefited.

1. Direct Method
The direct method simply allocates the costs of each service department to each of the
producing departments based on relative level of the apportionment base.

2. Step Method
1. Begin allocation of service department serving most other departments or that incurred
the greatest dollar amount .
2. Allocation based on that department's cost driver.
3. Costs allocated to all remaining service departments and production departments.
4. Costs never charged back to service departments already allocated.

Departments K, L, and M provide services to each other and to producing departments
Y and Z . For the sake of simplicity, a single-rate allocation is assumed.

Department Total cost Percentage of services
K $ 100,000 0 15% 5% 55% 25%
L 70,000 10% 0 9% 18% 63%
M 50,000 0 0 0 20% 80%
$ 220,000

Department K's costs are allocated first because it provides service to two service
departments, provides a greater percentage of its service to other service departments,
and has the highest costs. L's costs are then allocated, followed by M's.

Costs prior to allocation $100,000 $70,000 $50,000 0 0
Allocation of K (100,000) 15,000 5,000 $55,000 $ 25,000
Allocation of L (85,000) 8,500 17,000 59,500
Allocation of M (63,500) 12,700 50,800
$ 84,700 $135,300
• All $220,000 is allocated to producing department Y and Z.
• When L's costs are allocated, no costs are assigned to K. L's total cost of $85,000 is allocated in the proportions 9/90, 18/90, and 63/90.

XI. Just-In-Time (JIT) Inventory System
A. Raw materials are obtained "just-in-time" and placed directly in production.
B. Finished goods are produced "just in time" for delivery to customers.
C. JIT minimizes or eliminates inventory ( nonvalue added activity) and its related costs.
D. Problems of JIT System.
1. Difficult to finds suppliers able accommodates.
2. Potential problems due to delays in deliveries.
3. High shipping costs due to smaller orders.

Joint Products

I. Joint Product And By Products
A. Joint Products
a. Joint products are two or more separate products separate by a common manufacturing
process from a common input

b. Joint product costs are incurred in the production of two or more products simultaneously
from processing the same raw material by a single process. They are incurred prior to
the spilt-off point and are not separately identifiable. They may be allocated to the joint
products based upon their, sales value, net realizable value, or physical measure at
the point they become separate.

c. Spilt-off point represents the stage of production at which joint products become identifiable
as separate products. These products can be further processed or sold at the
spilt-off point.

d. Separable Costs are additional costs incurred for a specific product after the spilt- off point.

e. Net Realizable Value (NRV) equals sales value less estimated cost to complete and sell.

2. Allocation of joint costs
a. Allocation of Joint Costs is essential for valuing inventory and determining cost of cost of
goods sold.

b. Joint Product Cost allocation should not be used in deciding whether to further process or
sell the products at the spilt- off point, i.e, join costs are irrelevant for the decision.

c. Methods of Allocating Joint Costs
Three methods of allocating joint costs
1) Quantitative (physical- unit) method .
2) Relative sales - value method .
3) Estimated net realizable value (NRV), based on final sales value minus separable costs
after spilt- off point .

1) Quantitative (Physical- unit) Method
This method allocates joint costs based on some physical measure, such as volume
(units) or weight (tons, pounds, or gallons).

2) Relative Sales- Value Method
This method allocates joint costs based on the relative sales values of separate products
at spilt-off point.
Sales Value of Each Joint Product Joint Costs
Total Sales value of all joint product

3) Estimated net realizable value (ENR)
Frequently, joint products have no sales value at the spilt- off point.
i.e., this method is used when further processing is needed.
It allocates joint costs based on net realizable value (final sales value less separable
costs after spilt- off point).

NRV of each Joint product
X Joint Costs
Total NRVs of all Joint Product

d. Sell or Process Decisions
1) The cost of additional processing (Incremental costs) should be weighted against the benefit received (Incremental revenues).
2) Joint cost is irrelevant in determining this decision because it is a sunk (already expended cost).

Lambers company produces two products, A and B from same raw material. Joint
product costs are $54,000. The process Yields 15,000 gallons of product A and 22,500
gallons of product B.Sales value at spilt- off are estimated to be $1,5 and $2 per
gallon, respectively .

Required: Allocate joint costs on the basic of physical unit and
relative sales value at spilt- off point methods.

Physical - Unit Method

Product Gallons % of
Total Allocated
Joint Cost
A 15,000 40% $21,600
B 22,500 60% 32,400
Totals 37,500 $54.000

Relative Sales - Value Method

Product Sales Value at Split-off % of
Total Allocated
Joint Cost
A $1,5 x 15,000 = $22,500 33,34%

B $2 x 22,500 = $45,000 66,66% 36,000
Totals 67,500 $54.000

Assume the same facts as above, except that products A and B
have no sales value at spilt- off point. Additional processing
yields the following results:

Product Separable costs Sales Value
A $6000 $36,000
B 8000 78, 000

Required: Allocate joint costs on the basis of net realizable value .

Net Realizable Allocated

Product Sales
Value Separable
Cost Value Ratio Joint Cost
A $ 36,000 $ 6,000 $ 30,000 30% $16,200
B $ 78,000 8,000 70,000 70% 37,800
Totals $ 114,000 $100,000 $54,000

B. By- Products
1. Definition
By- products are one or more products that (1) have minor sales
value as compared with the sales value of the main joint products (2)
are produced simultaneously from a common manufacturing
process, and (3) are not identifiable as separate products until split-
off point.

2. Accounting Methods
a. The value of by- products is treated as a reduction of the cost of goods sold, of joint costs, or as a revenue .
b. The value to be reported for by- products may be sales revenue, sales revenue minus a normal profit, or estimated net realizable value (sales minus costs of disposal