New England College

AC5240: Cost Accounting

Text-Only Week One
AC5240: Cost Accounting
Text-Only Week One
Introduction, Assignments, and Objectives
Week-At-A-Glance:
Week One: Cost
Accounting Information
for Decision Making,
Cost Concepts, and
Behavior

Lesson One: Cost

Accounting Information
for Decision Making
Lesson Two: The Nature
of Cost Terms
Lesson Three: Financial
Statements in the
Manufacturing
Environment

Read Chapters 1 and 2, including

the Appendix
Assignment 1.1.1 Discussion:
Welcome/Who's Who
Homework Samples Week One
Chapter 1 and 2
Assignment 1.1.2 Graded
Exercise: Chapter 1 Textbook
Problems1-23, 1-24, 1-34, 1-36, 137
Assignment 1.3.1
Graded Exercise: Chapter 2
Textbook Problems 2-25, 2-27, 233, 2-36, 2-39

Week One: Cost Accounting Information for Decision Making, Cost Concepts, and
Behavior
Many students wonder what the essential difference is between cost or management
accounting and financial accounting. The key to cost accounting is that it is always needed. The
financial statements provided to the stockholders and the external users might be generated
monthly or quarterly, but the information generated by cost accountants has no due date. It is
necessary when someone in the organization thinks it is. In this first area of our course, we will
discuss the differences between financial and management (cost) accounting. We will focus on
who uses the material generated from each area.
We will then discuss the relationship between cost accounting and adding value to a product or
service. Many costs in a business add value and are clearly important. But what about the 15
minutes you spent trying to clear a jam at the copying machine the other day? Those types of
situations need to be minimized, when possible. Cost accounting provides not only an alert that
they are happening, but also data to support actions that managers can take to minimize them.

New England College

AC5240: Cost Accounting
Text-Only Week One
Ethics is also an important consideration that pervades all management decision-making. In
todays business world, there are too many examples of individuals or companies acting
unethically. Enron, Worldcom, and Bernie Madoff all acted in ways that gave business a less
than stellar image. We will explore the role of cost accounting in avoiding such episodes and
supporting ethical business practices.
As we roll into Lesson Two, we will study a chapter in our textbook that reviews topics from your
Management Accounting courses. What makes up the difference between a product cost and a
period cost? When we manufacture a product, we know that there are costs for Direct Materials,
Direct Labor, and Manufacturing Overhead. Do service companies have these costs too? Once
we understand these topics, we will need to put them into a packagethe financial
statementsand learn how to interpret their meaning for the firm. For instance, we will note the
differences between the statements of the merchandising company and the manufacturer, and
study what the information in the statement communicates about the firm operating in each
environment.
During Week One, well set the stage for all of these considerations, and more.
Learning Objectives
By the end of Week One, you should be able to:

Describe the difference in the uses of financial accounting and cost accounting
Define the term value chain
Define the term cost driver
List the important financial officers in an organization
Describe how the management accountant is placed in a position where ethics may be
questioned
Explain the basic concept of cost
Discuss how the components of a manufactured cost become part of a companys
inventory
Describe how the financial statements differ when preparing them for a manufacturing
firm or a merchandising firm

Lesson One: Cost Accounting Information for Decision Making

There are specific and separate uses for financial accounting information and cost accounting
information. We need to know why this occurs. Who wants the information generated by
financial accountants? What about the need for information from the cost accountants?
The value chain is important as it helps us understand how a product emerges from the original
raw material and becomes a product ready for the customer to buy. As we recognize how
production systems work, we also need to understand how costs work. Cost drivers give us an
indication of why the cost of something might go up over time. In some cases, the costs of an
item will stay the same.
As we are put into positions of responsibility, our ethics will be challenged. How do we go about
understanding what it takes to be ethical? What are the guidelines, and how do they relate to
cost accounting?

New England College

AC5240: Cost Accounting
Text-Only Week One
Learning Objectives
By the end of this lesson, you should be able to:

Describe the difference in the uses of financial accounting and cost accounting
Define the term value chain
Define the term cost driver
List the important financial officers in an organization
Describe how the management accountant is placed in a position where ethics may be
questioned

Content
Financial Accounting vs. Cost Accounting
When we migrate from the topics of financial accounting to those related to cost accounting, we
leave behind an orientation toward outside factors. That is, the statements generated by the
financial accountants are prepared, by necessity, to meet the needs of those who are external
to the company stockholders, banks, creditors, and even the government. Each of these
groups requires that this information be provided to them. Companies that are fairly large and
have stock that is traded publicly are required to present statements, so that their shareholders
will know how well (or poorly) the company is doing. On the far end of things, the government
wants to know how the company is faring, as a significant indicator of the tax revenues it seeks
to gain on this companys earnings.
Cost accounting has a very different set of goals. It is only required for those within the company
(its management) who need to make decisions based on how the business is doing financially.
Here are a few examples to think about. The company may decide that it needs to prepare an
annual budget so that it can keep its costs in check. If it chooses to do so, there is not one
group or faction of those external users identified above that would gain any significant
knowledge by having this information.
We could also think of a decision a company might need to make related to whether or not to
continue producing an item. In order to get a handle on this decision, we would arrange our
costs and our revenues for this specific product in an analysis that would make clear its overall
results. Is it profitable? If it is not profitable, then does it attract other business that is profitable?
Think here of something ordinary, such as milk or bread at a grocery store. These products are
often sold at a loss, but how often does a consumer walk into a store to buy only one thing, such
as bread?
So, while much of what is done in cost accounting is not mandated by outside entities, it is
necessary to ensure the companys success.
Value Chain
Where does your companys product start? And, once you have that initial input, what does your
company do to it to make it into something more valuable? This is what the value chain is about.
The initial input is the raw materials that the company buys, and on which it will work. Think
about the tree that might be outside your window. If someone cuts down that tree and several

New England College

AC5240: Cost Accounting
Text-Only Week One
others like it, that would supply the basic input for a lot of wood or paper products. Tree farms
would be part of a supply chain, because they begin the production process by supplying the
raw materials.
Lets continue the example as we see the tree logs turned into paper. A paper mill would create
different types of paper for use by customers. Some want envelopes; others want notebook
paper; still others want paper to put into the newspapers they produce. As we look at the value
chain from the other end, where the end user resides, we shift our focus to the distribution
chain that enables products to reach all of the end users or customers who want to buy finished
products. It is up to the company to make these items, using a process that will be differentiated
for each of the end products envelopes, newspaper, and so forth and conveying them to
customers.
Along the way, we hope that all of the activities related to making our paper products add
value to the finished product. When workers take the tree logs off the trucks and begin working
on the wood, these tasks add value. When other workers are packaging the products ready to
be consumed, this activity also adds value.
But sometimes, there are tasks called nonvalue added activities. For instance, our employees
begin work at 8 a.m. each day. What happens if the logging truck has not reached us either the
night before or earlier in the day? Then, we have to pay our workers, even though they have
nothing to do. This is a nonvalue added activity. Some of these activities will occur within any
business entity. The job of the cost accountant will be to identify them and enable management
to either eliminate or minimize them.
Cost Drivers
Your business will have many costs to account for. Some of them will be small and others large.
Some will be incurred infrequently, while others will affect your business all the time. What we
would like to know is what exactly makes some costs go up.
For instance, suppose you run a restaurant that just opened. Factor #1 is that you opened the
business, which means the following costs are now incurred: licensing, signage, menus, and
some food and beverages. As customers begin to come in, Factor #2 comes into play: namely,
more food and beverages are needed. The restaurant that served 200 people in Week 2 will
have its food costs doubled in comparison to Week 1 when 100 customers were served.
While this relationship between costs and customers might be accepted at face value as
intuitively to be expected, we need to know whether all the reasons our food costs doubled are
directly related to serving double the number of customers. The cost accountant makes sure
that cost drivers are fully understood that the assumptions built into our understanding of cost
drivers are valid.
The Financial Officers in the Organization and Ethics in Cost Accounting
Check out the chart on page 17 of our text. As you do so, think about the opportunities that
present themselves to those in our field. Then, go on to consider how these officers function
within the organization, and the implications of their roles and the relationships they have with
others as they carry out their responsibilities.

New England College

AC5240: Cost Accounting
Text-Only Week One
If you prepare financial statements (or any financial reports, for that matter), you must realize
that others are relying on your work to make decisions. Wouldnt you hate to think that you
prepared a financial statement that misled hundreds of investors? Maybe they thought that your
company was in great financial shape, while only you and a few others knew that the business
revenue figures were inflated! Taking this scenario further, assume you hear later that some
friends, and maybe some relatives, lost a few thousand dollars because of your transgression.
As accountants, we have a responsibility to present the information we work with in a fair and
unbiased way. When we do not, many others are affected. In the appendix to the first chapter of
our textbook, there is a Code of Ethics from The Institute of Management Accountants (IMA).
While some people think that codes of ethics are a restatement of the obvious, in this day and
age it makes sense for us to familiarize ourselves with such codes and, more importantly, put
them into practice. As you review the IMA code, consider how vulnerable the cost accountant is
by virtue of information he or she provides to others in the company.
Reading 1.1.1
Read: Chapter 1, in your textbook, including the Appendix.
Homework Sample - Week one
This ungraded homework sample gives you the opportunity to practice what you learned in this
week's lessons.
Week 1 Homework Samples - Chapter 1 and 2
Chapter 1 Additional Homework Samples
Chapter 2 Additional Homework Samples
Please note that these samples are from a previous edition of the textbook.

Lesson One: Summary

Cost accounting is a subject that focuses on the managers need for information. Understanding
concepts such as the value chain and cost drivers provides us with a good place to begin to
grasp the role the cost accountant plays within the organization. Cost accountants need to
understand the extent to which the information they provide drives decisions made within the
organization and on its behalf. Acting ethically in all of our dealings as accountants is important,
now more than ever.
Lesson Two: The Nature of Cost Terms
You need to be familiar with many terms in Cost Accounting. We hope that these terms will be a
review of those seen in your Management Accounting class, but it is essential to have a clear
and functional understanding of these basic terms before going on. You will see that we label
costs in many different ways. Without a working knowledge of these terms, you will have
problems with the remainder of the course, so you are urged to make sure you have mastered
them during this week.

New England College

AC5240: Cost Accounting
Text-Only Week One

Learning Objectives
By the end of this lesson, you should be able to:

Explain the basic concept of cost

Describe how the components of a manufactured cost become part of a companys
inventory
Distinguish between a product cost and a period cost
Explain the difference between a direct cost and an indirect cost
Discuss how cost behavior affects our costs

Content
Direct Materials, Direct Labor, & Overhead
The concept of cost object refers to any item having a cost that we hope to measure. It can be
anything that accumulates cost. Maybe it is the cost incurred for a restaurant to make a dinner
of linguine and clam sauce. Or maybe it is the cost incurred by the Assembly Department to
make Ford Explorers in February. Whatever the nature of the business, the cost accountant
needs to be able to identify a cost object accurately.
With that concept in hand, it is important for us to understand the related concept of cost
traceability. We want to understand how closely costs relate, or how easily they can be traced,
to the finished product. A direct cost is any cost that can be directly traced to the finished
product. Direct costs are easily recognized as a part of the finished product. For example, think
about the linguine in the "linguine and clam sauce" dinner. Consider also the steel that would be
used to build Ford Explorers, and the idea becomes clear that steel is a direct cost that is
traceable to the final product.
We also have costs that are indirectly identified with the finished product. These costs are
identified because the accountant sees the entire production process behind the finished
product, and can infer cost objects associated with it. For example, some of you know that
making linguine and clam sauce requires you to place some garlic into the pan to start the
sauce. Without actually seeing this done, would you know that it was there? Maybe not.
Therefore, this is considered to be an indirect cost necessary to producing the finished
product, but not obviously and directly associated with it alone. Put the cost of inspecting the
Ford Explorers before they leave the manufacturing plant into the same category. Indirect costs
would also include those costs that are arbitrarily allocated to the product. An example here
would be the cost of paying the presidents salary at Ford Motor Corp. These costs are
particularly necessary to account for in a service environment. Distinguishing direct and indirect
costs depends on an accurate understanding of cost traceability to the cost object.
Our manufacturing cost terms also include direct materials, one type of direct cost. It reflects the
cost of any material that is of the utmost importance to the finished product. This items cost
would also be a significant portion of the cost of the finished product. Think of the bricks to make
a building, or the cement necessary for its foundation. Direct labor is the other type of direct
cost. Here, we are referring to that labor which is of the utmost importance to preparing the
finished product. We should think here about the work of carpenters or bricklayers in a

New England College

AC5240: Cost Accounting
Text-Only Week One
construction company, or the chefs in a restaurant. You can see how that type of work directly
on the product would be distinguished from the work done by the companys president.
We also sometimes combine our direct materials cost plus our direct labor cost, and refer to the
combination as our prime cost.
Factory overhead (manufacturing overhead) refers to all other costs needed in the production of
the product or service. It would include the indirect costs plus some of the arbitrarily allocated
costs. Two components of factory overhead are indirect laborand indirect materials, and there
are several more.
If we return to our restaurant example, we would not expect our chef to be cleaning the kitchen
once he or she was done cooking. A kitchen helper, who would wash dishes and perform other
support duties, would be indirect labor to our restaurant. When making our Ford Explorers, the
rivets that are put into the vehicles that hold parts of it together would be considered indirect
materials, because they are not purchased strictly to make the Explorer, and because keeping
count of how many rivets are used to make Explorers would probably not be worth the effort of
accounting for them.
If we add direct labor to factory overhead, we can call the total our conversion costs, because
that is the total cost necessary to convert our direct materials into completed products.
Three Inventories: Direct Materials, Work in Process, and Finished Goods
Now, lets look at these costs in a different way. When we begin our process to make our
product, we begin with some raw or unrefined materials. Strands of spaghetti are not going to
become someones dinner very easily without being processed. Pieces of glass are not going
to become a cars windshield unless they are placed on the vehicle correctly. These are
examples of our direct materials (also called raw materials) inventory what we start out with
in the production process.
Direct materials enter production and begin to be worked on. Once they do so, they transform
into the work in process inventory. The best way to think of work in process is that we have
goods that are at some stage of unfinished completion. Lets focus on our car example. Maybe
the day ended, and five cars did not yet have engines put into them. Possibly, they were not
painted. Or maybe, our cars did not have their doors installed. Clearly, we would not be ready to
offer these cars for sale, and they would sit at the end of the day in our work in process
inventory.
During the time that our cars are in process, we keep adding to them. Each of these items we
call inventoriable costs. This is because, at each stage, what we do will add to the value of our
car until the point at which it is ready to be sold. The cost of adding each item affects inventory
and total production cost. Once the cars are ready to be sold, we refer to them as part of the
finished goods inventory. There is no more work to be done on these products. They are ready
for customers to buy.
We see that materials and costs move through the three different inventories in step with the
process, until we reach the point of having a finished product.

New England College

AC5240: Cost Accounting
Text-Only Week One
When we are dealing with a manufacturer, many costs are involved with the creation of the
finished product. However, keep in mind that there will still be some costs that are not. Selling
expenses, delivery expenses, and office-related expense will still need to be accounted for.
They are not inventoriable, but are necessary to the total operation of the business. These are
non-manufacturing or administrative costs.
Fixed & Variable Costs
We have yet another way to look at our costs as fixed or variable. Variable costs are costs
that change in proportion to some level of activity, such as units produced or units sold. Direct
labor will increase in direct relation to the need for more cars to be produced. As a restaurant
becomes more popular, it will require the purchase of more groceries (direct materials) every
day. These items are great examples of variable costs, as is the electric bill that varies with the
rate of use in production.
Fixed costs are costs that remain constant, despite changes in activity levels, for an extended
period. Think of the assembly plant at Ford Motor Co. We will depreciate this asset for the life of
the building a significant commitment. The restaurant pays a salary to the restaurant
manager. He earns the same amount each week, regardless how busy or slow the restaurant is.
It is also possible to have a hybrid of the two a semi-variable cost. These costs require a
fixed fee to be paid, plus an additional charge based on usage. Think here of your phone bill.
Pay $30 per month (fixed) plus $0.10 per phone call (variable), and you have a semi-variable
cost. In Chapter 5 of our textbook, which we will read next week, we will see why the ability to
break down these costs into their individual elements will be important.
Reading 1.2.1
Read: Chapter 2, in your textbook.
Note: In Assignment 1.3.1, you will be asked to combine what you have learned from this
lesson, Lesson Two, with the concepts from Lesson Three. Please be sure to complete the
reading for this lesson before going on to Lesson Three.
Lesson Two: Summary
We need to understand many terms in Cost Accounting. The terms that we discussed in this
lesson are terms that you will see repeatedly during the entire course. This is because the ability
to identify various types of cost and their relationships to how a company earns its revenues is
essential to producing useful cost accounting information.
Lesson Three: Financial Statements in the Manufacturing Environment
The costs that we discussed in Lesson Two are organized into the financial statements. Several
statements that we will need to be able to prepare are the Cost of Goods Manufactured
Statement, the Cost of Goods Sold Schedule, and the Contribution Format and the Traditional
Format Income Statements. The nice part for us is that one statement feeds into the next. We
will review each of them in this lesson.

New England College

AC5240: Cost Accounting
Text-Only Week One

Learning Objectives
By the end of this lesson, you should be able to:

Explain how the components of a manufactured cost become part of a companys

inventory
Describe how the financial statements are different when preparing them for a
manufacturing firm or a merchandising firm
Explain how the cost of goods manufactured statement interfaces with the cost of goods
sold statement
Explain how the cost of goods sold statement interfaces with the income statement

Content
Cost of Goods Manufactured Schedule
Here is a completed schedule of cost of goods manufactured:
Please log into the course to view the image.
If a company buys its products ready-to-sell, this schedule is unnecessary, as the account
"Purchases" replaces this schedule for those items. This schedule determines the cost put into
making finished goods in a specific period. Note that the schedule must take into account the
three components of a manufactured product: direct materials, direct labor, and overhead.
The amount of direct materials used has to be determined. A beginning value is carried over
from last period's ending balance. The purchases made may be of any raw materials. In our
case, we are assuming that one storeroom is used to house direct and indirect materials.
Therefore, after we have found the "Materials Available for Use," we must subtract out indirect
materials, as well as the ending count of the materials inventory. (In other cases, indirect
materials will be kept in a different location, and thus will enter into this part of the computation.)
For simplicity, we have shown Factory Overhead in a summarized total. Remember that
overhead may either be accumulated through its actual costs or applied into production. If actual
costs are listed, they may include items such as indirect labor, indirect materials, factory
depreciation, line supervisor salary, factory utilities, and other documented costs.
Total manufacturing cost is the total of all labor, materials, and overhead. Realize also that,
even though it is the total of these costs expended this period, it is not the conclusion to our
schedule. This is because the beginning work in process inventory needs to have some of these
items incurred, in order for this inventory's units to become finished goods.
Ending work in process is another concept for us to understand here. All the costs included in
"Total Manufacturing Cost" represent work on items that either became finished goods or did
not. The adjustment was already made to recognize the completion of the beginning work in
process inventory, but there are costs that have been incurred to begin work on some units that
have not been completed. Since this value is subtracted out of a total work in process inventory,
the remainder is for completed units, the cost of goods manufactured.

New England College

AC5240: Cost Accounting
Text-Only Week One

Cost of Goods Sold Schedule

Next, we need to know about the Cost of Goods Sold schedule. Here is a sample that draws
information from the Cost of Goods Manufactured Schedule we prepared above.
Please log into the course to view the image.
As you know, a manufacturer has three different inventories: Direct Materials, Work in Process,
and Finished Goods. The Finished Goods Inventory reflects those units ready for the
customers. We may have had an amount of this inventory left over from last year reflected in
our beginning inventory amount. Then, we add the cost of goods manufactured value that we
got from the schedule with which we began this lesson. The two values together give us our
cost of goods available for sale amount. By subtracting the inventory that we did not sell (ending
inventory), we will arrive at our cost of goods sold.
The Income Statements Two Different Formats
There is a traditional format income statement and a contribution format income statement.
Many income statements are prepared in what we might call a "traditional" format. This means
that we have a format like this:
Please log into the course to view the image.
While this format is entirely acceptable and, in fact, is required for most external reporting
purposes, it is not entirely beneficial to management.
The contribution format income statement separates out all costs into their fixed and variable
elements. Using this format, the statement looks like this:
In this format, only the variable production costs are included in the total variable costs. To shift
from one format to another, all we have done is to rearrange how costs are classified; the total
costs are the same, and the same net income is provided. But why should we bother?
In the short run, a company could remain in business as long as it could cover its immediate or
variable costs. In the most extreme situations, if workers could not be paid for their efforts, they
would have to be dismissed and, often, the company folds. If the variable costs can be covered,
the contribution margin recognizes this, as well as the fact that there is some money left over to
cover fixed costs and to "contribute" to a profit. However, in the long run, all costs will have to be
covered for an entity to remain in business.
Lesson Three: Summary
The financial statements are like the ribbon on a present. They show how everything gets put
together. However, without understanding all the individual pieces along the way, users of those
final results would find the final results essentially meaningless.
End of Week One

New England College

AC5240: Cost Accounting
Text-Only Week One

Preparation for Week 2 Discussion

Your discussion next week relies heavily on materials covered this Week. Be sure to give
yourself enough time to complete this week's readings and exercises to be prepared. I
encourage you to work ahead and take a peek at the Discussion question in Week 2.