Principles of Cost

Accounting 14E
Edward J. VanDerbeck

Chapter 1
Introduction to Cost Accounting

Learning Objectives
LO1 Explain the uses of cost accounting
data.
LO2 Describe the ethical responsibilities
and certification requirements for
management accountants.
LO3 Describe the relationship of cost
accounting to financial and
managerial accounting.

Learning Objectives
LO4 Identify the three basic elements of
manufacturing costs.
LO5 Illustrate basic cost accounting
procedures.
LO6 Distinguish between the two basic
types of cost accounting systems.
LO7 Illustrate a job order cost system.

The Need for Cost

Accounting
Cost accounting provides the detailed cost
data that management needs to control current
operations and plan for the future.
Companies must control costs in order to keep
prices competitive.
In todays global environment, cost information
is more crucial than ever in remaining
competitive.

Types of Businesses
That Use Cost
Accounting
Manufacturers (Ford, General Motors)
Merchandisers (WalMart, Kmart)
Wholesalers (Beverage Distributors)
For-profit Service Businesses (CPAs,
Attorneys)
Not-for-profit Service Agencies (United
Way, Red Cross)

The Manufacturing
Process
This process involves the conversion of
direct (raw) materials, direct labor, and
factory overhead into finished goods.
Product quality is an important competitive
weapon in manufacturing.
Many companies require their suppliers to
be ISO 9000 certified.

ISO 9000 Certification

The International Organization for
Standardization created a set of five
international standards for quality
management, ISO 9000-9004.
These standards require that
manufacturers have a well-defined quality
control system and they consistently
maintain a high level of quality.

Determining Product
Costs and Pricing

Cost accounting is used to determine

products costs and help with marketing
decisions.
1. Determining the selling price of a
product.
2. Meeting competition.
3. Bidding on contracts.
4. Analyzing profitability.

Planning and Control

Planning is the process of establishing

objectives or goals for the firm and
determining the means by which the firm will
attain them. Effective planning is facilitated by
the following:
1. Clearly defined objectives of the
manufacturing operation.
2. A production plan that will assist and guide
the company in reaching its objectives.

Planning and Control

(cont.)

Control is the process of monitoring the

companys operations and determining whether
the objectives identified in the planning process
are being accomplished. Effective control is
achieved through the following:
1.
2.
3.

Assigning responsibility.
Periodically measuring and comparing results.
Taking necessary corrective action.

Responsibility
Accounting
Responsibility accounting is the assignment
of accountability for costs or production results
to those individuals who have the most
authority to influence them.
A cost center is a unit of activity within the
factory to which costs may be practically and
equitably assigned. The manager of a cost
center is responsible for those costs that the
manager controls.

Reporting
Cost and production reports for a cost
center reflect all cost and production data
identified with that center.
The performance report will include only
those costs and production data that the
centers manager can control.
A variance is the favorable or unfavorable
difference between actual costs and
budgeted costs.

Performance Report
Example
Expense

Kitchen Wages
Food
Supplies
Utilities
Total

F = Favorable
U=
Unfavorable

Renaldis Restaurant
Performance Report
September 30, 2006
Budgeted
Actual

September

$5,500
17,700
3,300
1,850
$28,350

Year-to-Date

$47,000
155,300
27,900
15,350
$245,550

September

$5,200
18,300
3,700
1,730
$28,930

Year-to-Date

$46,100
157,600
29,100
16,200
$249,000

Variance

September

$300 F
600 U
400 U
120 F
$580 U

Year-to-Date

$900 F
2,300 U
1,200 U
850 U
$3,450 U

Management Accounting
The Institute of Management Accountants
(IMA) is the largest organization of
accountants in industry. The Certified
Management Accountant (CMA) is
comparable to the Certified Public
Accountant (CPA) for public accountants.
For more information, please visit the
IMAs website at www.imanet.org

Cost Accounting vs.

Financial and Managerial
Accounting Cost Accounting System
Characteristics

Financial Accounting

Managerial Accounting

Users:

External Parties
Managers
Managers

Managers

Focus:

Entire business

Segments of the business

Uses of Cost Information:

Product costs for

calculating cost of goods
sold and finished goods,
work in process, and raw
materials inventory using
historical costs and GAAP.

Budgeting
Special decisions such as
Special
make or buy a component,
keep or replace a facility,
and sell a product at a
special price.
Nonfinancial information
such as defect rates, % of
returned products, and ontime deliveries

Cost Accounting vs.

Financial and Managerial
Accounting
(cont.)

Cost accounting
includes those parts
of both financial and
management
accounting that
collect and analyze
cost information.

Cost of Goods Sold

Merchandiser

Manufacturer

Beginning merchandise
inventory

Beginning finished goods

inventory

Plus purchases

Plus cost of goods

manufactured

Merchandise available for sale

Less ending merchandise
inventory
Cost of good sold

Finished goods available for

sale
Less ending finished goods
inventory
Cost of good sold

Inventories
Most manufacturers maintain a perpetual
inventory system that uses FIFO, LIFO, or
moving average methods of costing.
An inventory ledger is maintained to provide
support for the control accounts.
Some manufacturers may use a factory
ledger, which contain all of the accounts
relating to manufacturing.

Inventories
Merchandiser
Current assets:
Cash
Accounts receivable
Merchandise
inventory

Manufacturer
Current assets:
Cash
Accounts receivable
Inventories:
Finished goods
Work in process
Materials

Elements of
Manufacturing Costs
Direct materials
Materials that become part of the finished
good and can be readily identified.

Direct labor
Labor of employees who work directly on the
product manufactured.

Factory overhead
Includes all costs related to production other
than direct materials and direct labor.

Prime Cost and

Conversion Cost
Direct Materials
Elements
of Cost

Direct Labor
Factory Overhead

Prime Cost
Conversion
Cost

Flow of Manufacturing
Costs
Direct Materials
Direct Labor
Factory Overhead

Work in Process
(Assets)

Finished Goods
(Assets)

Cost of Goods Sold

(Expenses)

Illustration of
Accounting for
Manufacturing Costs

Materials

Accounts Payable
Work in Process (Direct Materials)
Factory Overhead (Indirect Materials)

Materials
Payroll

Wages Payable
Wages Payable

Cash
Work in Process (Direct Labor)
Factory Overhead (Indirect Labor)
Selling & Admin Exp (Salaries)

Payroll
Factory Overhead (Depr. Bldg)
Selling & Admin Exp (Depr. Bldg)

Accum. Depr. Bldg

Factory Overhead (Depr. Mach & Eq)

Accum. Depr. Mach & Eq

xx

xx

xx
xx

xx

xx
xx
xx
xx
xx
xx
xx

xx

xx
xx
xx

xx
xx

Factory Overhead (Utilities)

Selling & Admin Exp (Utilities)

Accounts Payable
Selling & Admin Exp

Accounts Payable
Work in Process

Factory Overhead
xx
Finished Goods

Work in Process
xx
Accounts Payable

Cash
Accounts Receivable

Sales
Cost of Goods Sold

Finished Goods
xx
Cash

Accounts Receivable

xx
xx
xx
xx
xx
xx

xx

xx
xx
xx
xx
xx

xx
xx

Cost Accounting
Systems
Job Order Cost System
Output consists of special or custommade products.
Provides a separate record for the cost
of each quantity of these special or
custom-made products.

Process Cost System

Accumulates costs for each
department or process in the factory.

Job Order Cost System

Direct Materials
Direct Labor
Factory Overhead

Work in Process
Account

Job Cost Sheets

Finished Goods
Account

Process Cost System

Work in Process
Dept. 1

Direct
Materials

Direct
Labor

Factory
Overhead

Work in Process
Dept. 2

Direct
Materials

Direct
Labor

Factory
Overhead

Finished Goods

Standard Cost System

May be used with either a job order or a
process cost system.
Uses predetermined standard costs to furnish a
measurement that helps management make
decisions regarding the efficiency of operation.
Standard costs are costs that would be incurred
under efficient operating conditions and are
forecast before the manufacturing process
begins.

Appendix

Standards of Ethical Conduct for

Management Accountants
Members of the IMA have an obligation to
the public, their profession, the
organizations they serve, and themselves
to maintain the highest standards of
ethical conduct.
1.
2.
3.
4.

Competence
Confidentiality
Integrity
Credibility

Appendix (cont.)
Resolution of Ethical Conflict

When applying the standards of ethical

conduct, IMA members may encounter
problems in identifying unethical behavior
or in resolving an ethical conflict.
1. Discuss problems with the immediate superior except
when it appear that the superior is involved.
2. Clarify relevant ethical issues by confidential discussion
with an objective advisor.
3. Consult your own attorney as to legal obligations and
rights concerning the ethical conflict.