CHAPTER 1

Cost Concepts, classifications and

Cost Accounting Cycle

LEARNING OUTCOMES:

After the end of the chapter, the learner will be able to:

• Differentiate financial accounting and cost accounting and

explain the uses of cost accounting information
• Identify and define the different classification of costs
• Raw Materials inventory system
• Flow of costs and the income statement of manufacturing
DM
firms.
DL
• Idenfty the three basic elements of product costs.
0H
_- • Identify the three inventory accounts of a manufacturing
TMC, , fro
wlp,to89 • Costaccounting cycle
FT+'iThopyDC{3g; . nlustrate basic cost accounting procedures using actual and
(wlp`€nd)
normal method of accumulating costs.
• Compute product costs using actual and normal costing
• Journafize acquisition and issuance of raw materials;
incurrence and distribution of factory labor and overhead
• Prepare cost of goods manufactured and sold
 - Cost Concept_s± classification and Accounting

WIIAT IS COST ACCOUNTING

Cost Accounthg is defined in many ways but its main function is to

deterfue hojv much an object, project or service cost. Cost accounthg is not
linritedonlytomanufacturingandconstructioncompaniesbutitisalsoapplicable
to service type of businesses, Eke hospitals, educational instifutious, hotels and
resorts,restaurants,legalandotherprofessionaloffices,medicalanddentalclirics
and many more.

Cost Accounting is a disciphae that focuses on techniques or method for

determiningthecostofaprojeet,process,orservicesforthepurposeofplanning
and controlling activities, improving quality and efficiency, and for making
decisions.Itprovidesinformationonacompany'scostandmaybeusedforboth
internal and external purposes.

AccordingtoHomgren,CostAccounthgmeasuresandreportsfinancial
and non-finandal inforrmtion relathg to the cost of acquiring or cons`iming
resources in an organization. It provides information on a company's cost and
maybeusedforbothinternalande>demalpurposes.

RaybumstatesthatCostAccounthgidentities,defines,mesures,reports,
and analyzes the various elements of direct and indirect costs associated with
producingandmarkethggoodsandservices,Italsomeasurestheperformance,
prorfuctqualtyandproductivity.

USES OF COST I)ATA

service,g€:`rfa:£Sig¥r°=:ti;::£ggp:gatti:::¥gchaocf°#:nzdeunsg£:=ha¥
thesamebasicfinancialstatementswhichnormallyconsisto£IncomeStatement,
Statementofcinangesowner'sEqufty,Balaneesheetandstatementofcashflows.

Cost accounting infor"tion is very useful in determining product and

service costs and in setthg prices for the product and the service. ELowing the
costsOfaproductorservicehelpsthemanagementsetthesellingpriceenoughto
recover the cost Of production, cost of perforfug a function, distribution,
administration and to provide allowance for reasonable profit These costs
informationalsohelpthemanagementindecidingwhethertorfutain,toreduce
or to increase the selling price Of the product to have a fair competition in the
market.

The accumulated costs information are summarized and reported to the

Chapter 1 ~ Cost Concepts, Classific_3tfj9g_and Accounting Cycle

rrLanagement for effdive planning to attain the company's goal and dyectives. In
manufacturing, if the management has sufficient information about the cost data,
it can prepare a detailed production plan, which usually includes the foHowin8:

(a) The number Of units to be produced

a}) The type of manufacturing operations to be performed
(c) The desired quality of the product
(d) The number of personnel to be utihized qaborers and non-laborers)
(e) The type of materials to be used
(f) The level of materials inventory to be maintained in order not to
encounter overstocking or stock - out of materials
(g) The delivery schedules
th) And other production schedules.

Once a production plan has been laid out, it would be easier for the
managementtoperformthe function of control where actual results are compared
with expected results set by the management to allow the management team to
make corrective measures on areas where significant differences are noted. h
contromng, respousibifity is assigned to different departments or group of
workers who has control over and accountable for the costs charged to that
department or group. In this manner, the accountability for costs or production
results is easily identified.

DIFFERENCE BTWEEN COST ACCOUP`ITING & FINANCIAL

ACCOUNTING

COST ACCOUNTING FINANCIAL Accour`ITING

AS TO NATURE
It relates to the \different- cos_ting It relates to the classifying,i recording
methods and techniques. in and analyzing of business transactions
ace-umulating the cost of a product, and events, the end product of which
p`rocess, project or service and also the are finarrdal statements. The actual
processes in reducing total costs to transactions of the entity are recorded,
improve the profitabifity o'f the entity: hot the -estiriates. THth-obk§ fequtred
This is not mandatory or appficable to to maintain are the general journals,
all entities. general ledgers and special journals.
Financial accounting is required in all
forms of entity like micro, small,
medium and large entities.

As To oBTEonvE
The main objective is to determine the Its otryective is to reflect the correct
.cost to produce a unit, process or financial picture/information Of the
Chapter___1_ - Cost Concepts, classification and Accounting CyFl_e_

prdyect or cost to deliver a service. The entfty to the different stakeholders.

actual costs incurred is usually The stakeholders are the owners,
compared with estimates or budgeted employees, supphiers, customers, the
costs to guide the management in general public and the government
making relevant decisions. regulatory bodies.

AS To REpoRTS/FINANaAL STATEMEr\us
The reports required by management The basic financial statements as the
are the Cost of Production Report and end product of financial accounting
Statement of Cost of Goods are (1) Statement of Financial Position
Manufactured and Sold. The Cost of or Balance Shedy (2) Statement of
Production Report summarizes the Comprehensive Income 9r simply
total costs incurred in production like Income Statement, (3) Statement of
the direct materials, direct costs and Changes in Equity, and (4) Statequent
overhead. Of Cash Flows.

erAssmcA;TION OF cOsTs
Costclassificationisveryessentialin8ummarizingthecostdatagathefed.
The' costs of an otryect, product, project or service rep.resent the cash or cach
equlvalentofresourcesusedinacquiringthegoods,manufacturingaproductand
performing a function. It also includes the cost Of distributing the products or
services to the ultimate consumers. The cash equivalent is used because noncash
assets can be exchanged for the desired goods or services.

Product Cost

::f=Vtr::¥a¥:r=+¥ct:°::iois]:?O±¥¥[!gor:otdinu¥etsp#rueg::o:fsfc£;s[:ud;sein::?£
Of direct materiai5,-`airect labor ariala`ctory overhead. The accumulated cost of
direct maLterials, direct labor and factory overhead is summarized in a work in
processaccount.Attheendofaperiod,thecostofcompletedgcodsistransferred
to the finished goods accout. The sold portion of the finished goods is reported
as expense in the Income Statement, as Cost of Goods Sold, while the unsold
goodsarereportedinthebalancesheetasfinishedgoods.ThecostOfunfinished
goodsisleftintheWorkinProcessaccountwhichisalsoreportedinthebalance
sheet as current assets.

A manufacturing company normally maintains three inventory accounts.

These are: Finished goods, Work in Process and Raw Materials. The finished
goods and work in process accounts are already discussed in the preceding
paragraph while the Raw Materials represent the unused portion of direct and
 Chapter 1. ~ Cost C±g±£se_pts,Classificationand

indirect materials.

Foraretailingormerchandisingcompany(acompanyengagedinbuying
•-_i_-E_-. __1 _\ 1 . _ . \ -_ -
goods ready for sale), p=:g±±±€± c_e|ts in-clude-de urdrse rice of bought
for resa/e p±±s the transporfatl.on__€qLts ancr other ctrect costs fnourre d in±inI±8
tlR8QQdi±er.
For a construction company (a company engaged in constructing
buildings, bridges and other related stmctures), the product costs indude the cost
of construction labor of car and overhead incurred in
constructionlikecostofpower,1ight & water, insurance, hospitalization and other
health benefits for workers, ma±n±enance of construction equipment,
cost of coustructin house for the workers
and for constmction materials, de reciation of e ment, ELtalsand other
expenses incurred in the construction site.

For a service organizations, its prc] costs are classified either as direct
or indirect costs. Their inventory accounts are usually for supplies like -OfL{5a
lies for accountin firms or law firms, medical su lies for hos itals and
medical clinics,d±apprli_e±for utilityfirmsandfoodsupphiesforrestaurants
and bars. They don't maintain work in process account nor finished goods
inventory account hike the manufacturing company because thgir \pperation
requires only service. The most si ortion of their costs is '1ab`or because
the workers utilized their own efforts in ddivering the service. \`Berow is the
classificationofproductcostsinamanulacturingcompany.

Elements Of Product Costs : Manufacturing Company

I, Mterieis. Materials include the rF_y__pi~a_te±_als and other factory

`E¥.pp_I_e_s used in manufacturing operation. They are classified as:

(a) Dz.recf M¢fe7i.¢Zs, Direct materials are those materialji_i:!}g±±l.£

Trc]cecib|c fanthfa:£deucotfb#e fr:;dugcfginaeE:a::|esid]u=:eT £ a:

manufacture of jeepneys and trucks; leather in the manufacture
of bags, belts, wallets and shoes; fabrics in the manufacture of
shirts, dresses, coats and other related gents and ladies apparels;
flour, sugar and butter in the manufacture of bread and other
pastries and many more ..,.. '

¢) J7tdi'recf h4¢fe7i.¢Js. ` These are materials pe.cs!ssary in

manufacturing operations but are` not direcfty included in\,or not
Wordl`recrty a significant part of the product. They include operathg,
}ndu|ded !r
 C_bapter 1 - Cost Classification and

/jaultorialandfacto,?s=?pu:suedin,::a?s:=:=sy
screws, washers, glue, Sand paper, Iubricathg o#, `grea§e,
needed to malnrfu the
d:±g£2ts#tl§antlillexREwhtlB I[ccdcd
q''
•. ,
e® I]b-„.
"-h]o o@d GO(©
a
working area and plant equipments in a usable and safe
condition. The costs of indirect materials are relatively small in
relation to the cost Of all other raw materials.

2. I.¢bor. Labor represents the cLgRE2E±a±gn and `Qth£.r_b?~n_efit§_Pap to the

wo_Ike`rs im_th_e f?ctgry. They are classified as:

g:'nefipj#aldz%OrinosD±tgr`:ah?y°srisr±Pyrew=kts_Q:_:Ee¥ousn:tii°s:onanodf
raw materials into a finished product and are easily traceable to
a specific process or job order. They indude the bLag!ap_aLy, cost
9_f__Evingallowance,13.q_.xpQ!n+j2ayan`dcachequivalentsofnon-
cash incentives given on a regular basis.

@) J#di'rec£ Leaor. thdirect labor represents wages of persormel

other than the direct laborers, which are necessay to the
ihanufacturing process or service J±±±gt. ape_not_ d±r.equy r=1at?d_ to
the actual conversion of raw materials into ?_fidsL±roduct.

They indude supervisor's fee, wages paid to other workers such

as janitors, inventory control clerks, guards, and other personnel
fFo:}ecnt}`);T#`:`;,;`Ltlb°9:`:(,:Jr~°+"°S+
in the factory, employee benefits such as employers share in SSS,
ic7,.kery,.i}or\;I,zf;i`dIJfric,,(-i
Philhealth. and Pag-ibig, vacation and honday pay, health
insurance Of workers, educational benefits, overtine and richt
*sT`;i:f:i",;;:`!`:::`:I;b€iigf+
££?ancd°Sp:rf::n£:einfn:gsfaocrc:=£a:°wnorfk°:.Stay-in
Most manufacturing companies frLd it more convenient to tr.eat
employee benefit costs accruing to direct labor workers.

Prime costs - is the sum Of direct materials and direct labor.

3. Mfl7t#/achaH.ng oz7e7iife¢d. Manufacturing overhead is an indirect product

costanditincludesproductions.costsotherthandirectmaterialsanddirect
labor. They indude:

lr,c%lr{cr (a)``F;apry.s_uppEe;\suchasoflandotherdeaningmaterials
inalt"`ch\c' iis6d in the factory.

(b) Wages of ;upervisors; factory maintenance personnel,

raw materials handlers and security-officers stationed in
 Cha_p_t_€[_ 1_ -_ Cost Concepts, Classification end Accounting Cycle

the factory prendses.

(:ifep=:::eti`°:°df\f`;:to°#:i:sd:qn¥a=eon;piantand
equiprilent.
(e) Maintenanc6\and repairs on factory plant and equipment
(I) Qower,J'fight`and water I
(g) Telephone/ and _prailing costs
th)` Cost of regulatory compliance such as greeting factory
safety reqqirements and disposal of waste materials.
(i)- Idle time b\y factory workers due to madine breakdowns`
dr- new set ups which are unavoi-dable in production
process. During their idle time, the workers are n6t
productive therefore the cos`t is spread over the entire
production not to a specific product.

Conversion costs - is the sum of direst labor and factory

overhead. J7L i hhlc+i

Period Costs

Period costs are operating expenses that are associated with time periods,
rather than with the production of goods and services.. Period costs are
ed directl elrse accounts on the assumptionthattheirbenefitis
recognized endrely in the eriod when the cost is incurred. They are non-
manufacturing costs and non inventoriable costs. They include:

(a) Marketing and Selling Costs. These are the costs of getto8 aLnd
filhag orders such as cost of customer cost of
salaries and commissions of sales persoquel;
advertising costs and other e enses assCi=iated with the sale of the
goods and services.

@) Disatlbctti.o" costs. These are costs of warehousing, transpQ±:!±!±g

and deliverin roduct or service.

(cJ Ad7#{.7t{.sfr¢fe.oc Cos fs. These are costs associated with theg§!±g±:gal
administration of the organization that carmot be
assigned to either marketing or production such as salaries and
wages Of administrative officers and employees, power and water
consun`ption, transportation and representation expenses,
maintenance cost of office equipment, depreciation of office
furniture and equipment, taxes and licenses, gas and oil expenses
and other expenses in the administrative offices.
 8

Chape_a__r 1 - Cost Concepts, Classifilcation and Accounting Cycle

Direct and Indirect Costs

Dfrec£ Cos£. Direct costs are costs that can be obviously and physically
a manufacturing process, job or order, business unit, segment or
epartrrtent. These costs are often described as those that would be saved
if ire segment or business unit would be discontinued or if .the product
would not be manufactured. Direct costs are not only direst materials and
direct labor but it also includes the cost to a run a business unit. They
indude:

(ai) Salary of auto mechanics in Automotive Servicing Co.

Q>) Salary Of a binder in a Printing Company
(c) Oil and lubricants in a Trucking Company
(d) Steel bars used by a Constniction Company.
(e) Bond papers and telephone expense in a Law Office.
(f) Cost of detergents in a laundry shop.
(g) Cost of x-ray, doctor's fee, laboratory fee & medicine in a
hospital.

JHdzr€cf costs. These are costs related to a particular cost otyeet but carmot
be traced to that cost ortyect in an economically feasible way. They are
normally incured for the benefit Of several- segments within the
organization. In a manufacturing company, these are the overhead costs
incurred in the process of production.

Common and Joint Costs

Cormfflor Costs. Comlnon costs are mutually beneficial costs, which occur

#u£;:#arec:-O#:amb#iso::
departments or operations. Examples Of common costs are:
alloco+ed equitably (a) Building repairs and maintenance costs
ap) Rent of a building occupied by different departments
(c) Power and utilities costs
(d)•Salaries & wages of . personnel serving two or more
deparments

(e) Real Estate Taxes for land and building

(f) Perfuts & Licerues

/or.#£ Costs. Joint costs are costs incurred in a sL±±g±ei2±ggess that yields two
or more products. They are production costs (direct materials, direct labor
and factory overhead) incurred up to the point where products are
 Chapter 1 :_I,ost Cg_p_cepts, C/ass/fi/icat/on and Account/ng Cyc/a

=paratelyidentifi_ed.
For Example: The cost Of dough, labor Of baker and overhead incurred by
a bakeshop.

Cxpportunity and Sunk Costs

Ogivme'fy Cdsts. Opportunity costs represent the benefits foregone

because one course of action is chosen over another. Examples are:
ndL.ben€fi+
9Jven MP
(a) The rent revenue foregone if a company decides to use part
Of a building rather than leasing it.

(b) The salary foregone if a student decides to be a full tine

student rather than a working student.

Szt7!k Costs. Sunk costs are costs that have alread been incurred and will
be changed or avoided byanyfuturedecision.Theyarep_aptcos_t±s|;§j±±±±Le±:Le
unavoidable because th carmot be char ed no matter what action is taken
dy` the~minagement. Examples are:

(a) The acquisition cost Of an office equipment

a) The manufacturing costs Of finished goods on hand.

Committed_and Discretionary Co st

Cor#ffl2.#ed Costs. Committed costs. are costs resulting from an

_organizapon's stry£_Ere or use of facilities and ij§_ basic orgap_tion
structure.Examples are:

(a) Property taxes

a) Depreciation on building & equipment
(c) Salaries of management persormel
(d) Cost of renting facilities.

D..sc7iefr`owary Costs. These are_Costs resulting from management decision to

enda articular amount of mone for a s Examples are:

Ophonal (a) Amount of money to spend on Research and

Development
C Rod -0 n ) @) Management development program and contributions
to charitable institutions.
(c) Advertising and promotic)ns.
 10

Chapter 1 - Cost Concepts,_ Classification and Account_i!±g_ Cycle

Controllable and Nomcontrollable Costs

rimarfu to
Confrofhabze costs. Controllable costs are costs that are
theindrienceofagi_venresponsibilityfssfttermang_gerfora given period Of
time. Examples are:

a. The cost of raw materials used in manufacturing leatheL' products.

Theproductionmanagerhastheabfitytocontrolthematerialsto
beusedinproductionbyselectingonlymaterialswithhighquality,
thus, reducing waste and spoilage.
b. Cost Of food in the factory canteen The. canteen manger has the
ability to control losses in terms of spoilage and theft by canteen
persormd.

Nonrcontrollal9le costs. These aHe costs that cannot be controlled or

irduencedbyaresporLsibhityc_enter_map±ger.Examplesare:

Cost of renthg equipment. The owner of the equipment has the

controlovertheamountOfrentnottheproductionmanager.

CostOfrawmaterials.ThesupplierhascontroloverthecbstOfraw
materials.
Out Of Pocket and Budgeted Costs

OutIfpocketcosts. These costs refer to the cash rrie_qtocQrdete

ovlt of bM4gcr .i±'p-o;;d p_roieft or to extend an activi

B#dgefed costs. These costs;±s±s±±gj2±±±±£Ld or costs.

CapitalExpendifuresandRevenueExpenditures

#:"dzsEan¥ard;::?pS;rfe¥easseas::t:nxpeth:galftyane=¥h:tfeEdx£SbL=€::future
(a) Cost of overhauling heavy equipment.
q>)Co§tofreplacingwomoutwallOfabuilding

Reue7tne fxpe#dzf#res. These are expenditures that benefit only the current
period and are reported as expense.

Fixed, Variable and Mixed Costs

Vary per uniL F{.aed co§f§. These are costs that aet`coutant in total within the relevant
Ctwshonr \hhhal
 11

Chapter. 1. _I_ _C_o_st Conce_pts, Classification and Accounfjng Cycle

range of activity but variable on a per unit basis.` As the aLctivity level
increases or decreases, ig~tal_. fixed__cost remains constant but unit cost
declines or goes. up, Examples are:

(a) Depreciation using the straight line method

@) Factory Rent & factory taxes
(c) Factory insurance
(d) Supervision Fee
(e) Wages of indirect laborers

nlustration 1. Assume the following:

Total fixed cost for the period P100,000

Production in units:
Case 1 8,000
Case 2 9,000
Case 3 9,500
Relevant Range 8,000-10,000 units

Cdse 1 Case 2 Case 3

Production 8,000 9,000 9,500
Total Fc Fioo,coo P100;000 P100,000
FC per unit 12.50 11.11 10.53

Take note that the total fixed costs remain the_same but the fixed cost per
H_Pit__±§£rea§es ap |2rogucqgn_ ?cr_e?ses within the relevant range.

Va77'¢bze Costs. These are costs that`Valy in total,in direct proportion to

changes in the volume of production. Variable c-ost is a constant amount
on a per unit basis as activity changes within a relevant range. As activity
changes,totalvariablecostsincreasesordecreasesproportionatelywiththe
activity change, but unit variable costs remain the same. Examples are:

(a) Direct materials and direct labor

@) Fuel and other factory suppfies
(c) Overtime prendun
(d) Materials handling costs
(e) Maintenance costs
Chaps_a_L1 - Cost Concepts, Classlflcatlon and Account!gg_

mustration 2. Assume the following:

Variable cost per unit:
Direct matedals P5.00
Direct labor 6.00
Overhead 3.00
Total variable costs P14.00

Case A Case B Case c

Production in ults 8,000 9,000 9,500

¥oaflia%]=fa°£[e¥ors¥t ;41.102,ooo £€.%,ooo #.3030,OcO

ThevariablecostperunitisconstantatP14.00perunit,butasproduction
increases, total variable costs also increase.

RezctJ¢%£R¢ngeisdefinedasalimitedrangeofactivitywithin
which expenditures can be accurately classified as fixed cost
or variable or the range over which an assumed cost
rdatiorshipisvalidforthenormaloperationsofafirm.

M!.xed costs or sowf.-ti¢rinbfe costs. These are costs that have both fixed and
variablecomponentlikeheat,lightandwaterexpeuse.

SEPARATING M"ED COSTS

When cost is classified as nrixed, it is appropriate to separate the fixed cost from
the variable cost One Of the methods in separating mixed costs is the_high-low
method. The procedue starts from selecthg the highest and lowest levels Of
activfty in a given set Of data within the relevant range. Then, determine the
changes in activity and cost by subtracting low values from high values. These
changesareusedtocalculafethevariableunitcostcontainedinthemixedcostThe
fixedpordonOfthemixedcostiscalculatedbysubtractingtotalvariablecostfrom
total nrixed costs.

Variable cost per unit is computed as:

Costathighlevel-costatlowestlevel(withinrelevantrange)
Highest activfty - lowest activfty

Cia: Change in total costs / Change in activity level = Vc per unit

 13
Chapter_1_=__C_gstconc_e_pf±jc;!±sssificationandAccountingcycle

Illustration: Separating mixed cost

Machine hours and electricity costs for DKNY Industries for the current year we.re
as follows:

Month Machine Hours Utiti

January 2,500 P36,800
February 42,000
March (i_:gF` •`?_ZL'9gQ `\
April 3,100 46,000
May 3,800 56500
une 3,300 44,000
July 4,100 49'500
August 3,500 45,500
September 2,000 31'000
October 3;700 P52,000
November ``.4'700 \ --6_?'9ap . `\
December 4,200 55,500

Procedures:

1. Select the highest and lcywest levels o and costs (within relevant ran
Machine Hours Utid
Highest P62,000
Lowest 27,000
Difference 35,000

2. Col,n:pute the variable cost element

VC per unit = Change in costs/Change in rmchine hours

= P35,000 / 2,800
= RI2.50 per machine hour

3. Compute the variable cost at the highest and lowest level Of actwity.
Highest level = 4,700 x 12.50 = P58,750
Lowest level = 1,900 x 12.50 = P23,750

4. Deterrline the f ixed cost at each level of ackvity.

Hghest level = P62,000 - 58,750 = P3,250
Lowest level = P27,000 - 23,750 = P3,250
chape§_r 1 - Cost Conce ClassificatlonandAccountingQ[_£tse_

INVENTORY ACCOUNTS

Manufacturingcompaniesmaintainthreeinventoryaccounts,namely:

Raw Materials Inventory. This account shows the raw materials available for use
in the manufacturing process. It serves as a controlling account if the company
maintains only one account for its direct and indirect materials. However, if the
company maintains a separate account for its ~direct and indirect materials or
supplies,theaccountmaybechangedtoD}recfM¢fer!.¢JsJ#zie#£or]/whichismeant
to include only direct materials. Facfap/ SxppJz'es J#oe7ifony account inrfudes
indirect materials such supplies to be used in the production including janitorial,
operating and repairs suppnes intended for use in the factory.

¥:I;le]£d::°£SsSo[nnvweffiry;rod¥o:cea:ti:£tti::P£;een=:es£°:tsd3fjtpn¥¥Z
completed as of a certain period.

Finished Goods Inventory. This account summarizes the costs of completed

jobsstoredinthewarehousereadyfordeliverytothecustomers.

INVENTORY SYSTEMS

Perpetual inventory system. .' Under this system, purchases of raw materials is
directry debited to Raw Materials inventory account. The expenses related to the
purchase like freicht, insurance and other expenses are also debited to inventory
account. When raw materials are issued to, production, the raw materials
inventory account is credited. Tis system provides a running balance of the raw
matedals available for use and this is reflected in the stock card maintains for each
typeofmaterials.`Thebalanceoftheinventoryaccountattheendofanaccounting
period shows the cost Of raw materials inventory on hand. To determine the
accuraeyofthisbalance,aphysicalcountisperiodicallymaLdeusuallyonceayear.
If a difference is found between the balance in inventory account and aL physical
count, it is corrected by making a suitable journal entry. The common reasons of
such difference include inaccurate record keeping, normal shrinkage, and
shopELg etc.

Pro-forma ]ournal Entries:

a. When raw materials are purchased on account or cash

Raw Materials Irrveutory 000
Aceo:ants paythle/cach ` 000
 15

Ctl.a_P|j§r:1 -Cost Concepts,. classification and Accounting Cycle

b. When expenses are paid ttke f rctghi

Raw Materials Inventory coo
Cdsh 000.
c. When goods are.retwmed to supplier
Accountspayable/Cash 000
Raw Materials Inventory 000

Fedodic Inventory system. Under periodic inventory system, the entity

rfutaius temporary accounts like purchases, purchase returns and froigivt in. It
Hfl not record inventory additious directly to invnentory accounts but instead
purchase of raw materials is debited to purchases account.
For the transportation expenses related to the purchases, the amount is debited to
Height In account and returns to suppliers is credited to purchases returns and
anowances account. Physical inventory count (also called stock taking) at the end
aftheperiodismandatory.Withoutsuchcount,costofrawrmterialsusedcannot
be determined therefore manufacturing companies have to conduct this activity at
least once a year or at every period end.

Pro-forma Journal Entrie g:

a. When raw materials are purchased on account or cash

Purchases 000
Accounts P ayabhe/cash 000
b. When expenses are paid like f reighi
Frctghi In 000
Cash 000
c. When goods are returned to suppler
Accounts P aychltycash 000
P urchased Returns 000

To determine the cost of raw materials used:

Raw Materials, beg inventory 100,000

Add: Purchases P2,000,000
Freight ln 50,000
Gross purchases P2,050,000
Less: Purchase Returns 20,000
Net purchases P2,030'000
Raw materials available for use 2,130,000
Less: Raw materials inventory, end 200,000
Raw materials used P1,930,000
Cha_pl€_[1 - Cost Concepts, _I_I_a_Ssif i_C±±f!g± and Accountin_g Cycl_e

Take note that the raw materials used is not joumalized, This is determined only
after taking a physical count of the unused raw materials at the end of a given
period. On the other hand, the raw rmterials inventory, end is reflected in the
Balance Sheet.as part of the assets.

INVENTORy cO sTINGrvALUATION METHODs

First-In, FirstLOut (FIFO)

With first-in, fist-out, the oldest cost (i.e., the frst in) is issued first to production
andassigned.tocostofrawmaterialsused,Conversely,themostrecentpurchases
ae assigned to units in ending inventory, Example:

Beg, invty Net Purchases Issuances Of Raw Materials Invty'end

300 @20 200@22 500@25 400@24 1st 350 2nd 350 3rd 400 300@24

Inventory stock card:

h qurchases) Out ifesuances) Balance thventorv)

Units UC Ant Uhits UC Ant Units UC -Amt

Beg 300 20 6,OcO

1st 200 22 4400 2cO 22 4'400

1st 300 20 6,000
50 22 1,100 150 22 3300
•2nd 500 25 12pe 5cO 25 12,500
2nd 150 22 3£00
200 25 5,000 300 25 7500
trd 400 24 9,600 400 24 9,600
3rd 300 25 7FJm
100 24 2400 3cO 24 7,200
1'100 26joo 1,100 25,300
Beg 300 6J)00
Total |AcO 32joo 1,100 25'300 300 7ap

Units UC Amount
Inventory, beg 300 20 P6,000
Purchases 200 22 4,400
500 25 12500
400 24 9,600
RM available 1,400 P32,500
Less: RM issued 1,100 25,300
Inventory, end 300 7,200
 Chapte_[| - Cost Concepts£ classification and Accounting CyEJ£

THE FLow oF MANUFAcruRING cosTs

`=::#gdrinegu:;:#L:e:#e:i.a_£:rya_::sfi:at:°cnon°vferrtarwawmftaet:napal';`[£::r:
finishedproduct.TheflowofcostsOfamanutactuingcompanyisoutlinedbelow
togetherwiththepro-formaentriestorecordeachtransaction.

(A) Purchase Of Row Mawhals

The manufacturing process starts from the time raw materials are

gy¥e£.a¥e=;=¥u±%gtgrygscyosm=T:+e:=asff£`sTual=:::Ttroa¥
materials are recorded directly in the Raw Materials hventory account
as they occur. A purchases account is not used. The manufacturing
companies maintain a subsidiary ledger Of raw matedals inventory
accounts, one for each type Of raw materials. When the jounal entry is
posted to the general ledger account, the individual inventory accounts
in the subsidiary ledger are also updated. Normally, the cost of raw
materialsindudestheinvoicecostsplustransportationcoststobringthe
materials to the place Of the buyer. Below are pro-forma journal entries
under perpetual inventory system.

The entry would be:

Raw Materials (invoice cost + f reighi) 000

Accounts Payable or cash 000

Ifthecompanymaintainstwoseparateaccountsforrawmaterials,Direct
Materials account is debited for the invoice and freight cost of direct
materials while Factory Supplies account is debited for the invoice and
freightcostallocatedtoindirectmaterials.

pe) Issunce Of Raw Matinals

Raw materials are issued to production on the basis of a material

requisition slip properly accomplished and approved .by the
production manager. The cost of raw materials issued is then
transferred to a Work in Process and Manufacturing Overhead
Account. The pro-forma entry is:

Work in Process
Mamif ectwring overhead
Rarw Mterials 000
Chapter 1 - Cost Concepts, classification and Accounting Cycle

The Work in Process account is debited for the cost of direct materials
issued while Manufacturing Overhead account is debited for the cost
of indirect materials issued to production.

(C) Return Of Excess Materials to Storerocrm

If materials issued to the production department are in excess Of the

requirements, the unused materials are returned to the storeroom.
The pro-forma entry to record the rettrm is:

Raw Materials 000

Work in Process
Manuf actwhng Overhead

ThecostsOfunuseddirectmaterialsandfactorysuppliesarereverted
back to Raw Materials account, while the Work in Prcreess is reduced
by the cost of unused direst materials while the Manufacturing
Overhead is reduced by the cost of unused factory suppfies.

a)) Factory Labor lmcuned

Thecompersationoffactoryworkersandotherworkersinthefactory
like the supervisors, janitors, maintenance personnel and inventory
clerks is temporarily accumulated in a Factory Payroll account at the
time it is incurred whether pald immediately or not. The
compensation norrmlly irdudes basic pay, 13th month pay, cost of
living allowance, performance bonuses, and other form of
compensation given on a regular basis. The entry to record the
incurrence of factory labor is:

Fas+ory Payroll (gross) 0000

Accruedwagespayalle or cash ,` i
WHT Payable
SSS Preminm Payable
Philhealth Paychle

q=) Distri:button Of Factory Lalbor

Aifer sorfug the time tickets of the workers in the factory, the
accountant will make an entry to segregate the direct labor and
indirect labor costs. The salary of direct laborers or factory workers is
debited to Work in Process account while the salary of indirect
laborers like the production manager, supervisor or foreman, raw
Chapter_1 - Cost Concepts, classification and Accountiri_g Cycle_

materials inventory clerk and maintenance personnel is debited to

manufacturing overhead. The entry to distribute the factory payron
is:
rid;tt";ftcyx#=iov;the;i-Y`.":-
Workinprocess -c` .`'r`T

Factory P ayrofl 000

(F) Manifectwing Overhead Incuned

TheactualoverheadcostinproductionischargedtoaManufacturing
Civerhead account at the time it is incurred. Oner manufacturing
costs such as expired insurance and depreciaton of factory plant and
equipment are charged to manufacturing overhead account only at
year end when adjusting entry is prepared. The debit side of this
accountisusedtoaccunulateactualoverheadincurred(whetherpaid
or not)

Examples Of manufacturing overhead are:

a. Repairs and maintenance
b. Depreciation of Factory plant and equipment
c. Insurance
d. Property taxes
e. Indirect labor
f. Indirect materials
g. Factory utilities (ficht, power, water and telephone)
h. Factory rent
i. Employers' share of sss, Philhealth and pag-ibig

The entry to record actual overhead incurred is:

Manrf ecturing overhead (total) 000

Accandated depreciedon
Prapdid Insurance
Cash
Accoundspayable(ifnotpald)

(G) Actual Factory Overhead Charged to the Job

Attheendofagivenperiod,theactualoverhead\istransferredtothe
Work in PrCh:ess account if a company adopts the ¢cfu¢Z cosft.7ig eysfe7#
of accumulating costs. The entry to transfer the ti;tal Qverhcad costs
to production is:
Chapter 1 ~ Cost €pncepts, classification andAccoun_t_ing Cycle

Work in Process 000

Manuf acturing Overhead 000

al) Coxpletich of the Job

Cia completion Of the production process, the accirmulated cost of

ProductionsununarizedinaWorkinProcessaccountistransfelTedto
the Finished Goods account. The entry to record the cost of gcnds
completed is:
000
Finished Goods
000
Work in Process

Aftertldsentryhasbeenposted,anybalanceremairingintheWork
inProcessaccountrepresentsthecostOfuncompletedjobsduringthe
period.

a) Sale Of the Coxpleted Job

ThemostcommonmethodOfsetthgpriceforthejobcompletedisthe
Cost-.Flu; Pricing method. Cost in this serrse does not mean only
production costs but also indudes adndnistrative and selling costs.
Normafly,entrepreneursormanagersgimplyconsiderthecostasthe
floorbasedatwhichthepriceoftheproductcannotbelowerthanthe
cost. Other factors to be considered are the desired profit and prices
of competitors.

The entry to record the sale is:

000
Accounts Receivthle or Cash
000
Sales

AccountsReceivableisdebitedifthebuyerdidnotpayincashupon
denveryOfthegoods.Thisaccountrepresentstheseuingpriceofthe
goods.Iftheperpetualinventorymethodofhandthginventoriesis
adoptedbythecompany,anotherentryismadetoremovethecosts
ofgoodssoldfromtheFirishedGoodsinventoryaccount.

The entry is:

000`
CastofSales
rFinished Goods Imeritory 000