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Chapter 2

Cost Concepts and the Cost Accounting Information System

Discussion Questions

1) (a) Cost is the current monetary value of economic resources given up or to be given up in obtaining goods and services. Economic resources may be given up by transferring cash or other property, issuing capital stock, performing services, or incurring liabilities. Costs are classified as unexpired or expired. Unexpired costs are assets and apply to the production of future revenues. Examples of unexpired costs are inventories, prepaid expenses, plant and equipment, and investments. Expired costs, which most costs become eventually, are those that are not applicable to the production of future revenues and are deducted from current revenues or charged against retained earnings. Expense in its broadest sense includes all expired costs; i.e., costs which do not have any potential future economic benefit. A more precise definition limits the use of the term “expense” to the expired costs arising from using or consuming goods and services in the process of obtaining revenues; e.g., cost of goods sold and marketing and administrative expenses.

(b) (1) Cost of goods sold is an expired cost and may be referred to as an expense in the broad sense of the term. On the income statement, it is most often identified as a cost. Inventory held for sale which is destroyed by an abnormal casualty should be classified as a loss. (2) Uncollectible accounts expense is usually classified as an expense. However, some authorities believe that it is more desirable to classify uncollectible accounts as a direct reduction of sales revenue (an offset to revenue). An uncollectible account which was not provided for in the annual adjustment, such as bankruptcy of a major debtor, may be classified as a loss. (3) Depreciation expense for plant machinery is a component of factory overhead and represents the reclassification of a portion of the machinery cost to product cost (inventory). When the product is sold, the depreciation becomes a part of the cost of goods sold which is an expense.Depreciation of plant machinery during an unplanned and unproductive period of idleness, such as during a strike, should be classified as a loss. The term “expense” should preferably be avoided when making reference to production costs. (4) Organization costs are those costs that benefit the firm for its entire period of existence and are most appropriately classified as a noncurrent asset. When there is initial evidence that a firm’s life is limited,

the organization costs should be allocated over the firm’s life as an expense or should be amortized as a loss when a going concern foresees termination. In practice, however, organization costs are often written off in the early years of a firm’s existence. (5) Spoiled goods resulting from normal manufacturing processing should be treated as a cost of the product manufactured.When the product is sold, the cost becomes an expense. Spoiled goods resulting from an abnormal occurrence should be classified as a loss.

2) Cost objects are units for which an arrangement is made to accumulate and measure cost. They are important because of the need for multiple dimensions of data (e.g., by product, contract, or department) to accomplish the various purposes of cost accounting, including cost finding, planning, and control.

3) A cost system is a combination of procedures and records designed to provide the various types of information required in the conduct of the enterprise; including cost finding, planning, and control.

4) A good information system requires the establishment of (a) long-range objectives; (b) an organization plan showing delegated responsibilities in detail; (c) detailed plans for future operations, both long- and short-term; and (d) procedures for implementing and controlling these plans.

5) A chart of accounts is necessary to classify accounting data, so that the data may be uniformly recorded in journals and posted to the ledger accounts.

6) Advantages of the electronic data processing system for record keeping are: speed, larger storage, single entry of multiple transactions, automatic control features, and flexibility in report formats.

7) Costs are most commonly classified based on their relationship to (a) the product (a single batch, lot, or unit of the good or service); (b) the volume of activity; (c) the manufacturing departments, processes, cost centers, or other subdivisions; (d) the accounting period; (e) a proposed decision, action, or evaluation.

8) Indirect materials are those materials needed for the completion of the product but whose consumption

is either so small or so complex that their treatment as direct materials would not be feasible. For example, nails used to make the product are indirect materials.

9) Indirect labor, in contrast to direct labor, is labor expended that does not affect the construction or the composition of the finished product. For example, the labor of custodians is indirect labor.

10) (a) A service department is one that is not directly engaged in production, but renders a particular type of service for the benefit of other departments. Examples of service departments are receiving, storerooms, maintenance, timekeeping, payroll, and cafeteria. (b) Producing departments classify their share of service department expenses as indirect overhead expenses.

11) (a) Capital expenditures are intended to benefit more than one accounting period.The expenditures should therefore be recorded by a charge to an asset account for allocation to the periods benefited. Revenue expenditures benefit the operations of the current period only.They should be recorded by charges to the appropriate expense accounts. (b) If a capital expenditure is improperly classified as an expense, assets, retained earnings, and income for the period will be understated. In future periods, income will be overstated by any amount that would have been amortized had the expenditure been properly capitalized. Assets and retained earnings will be understated on future balance sheets by successively smaller amounts until the error has been fully counterbalanced. If revenue expenditure is improperly capitalized, assets, retained earnings, and income for the period will be overstated. Income will be understated in subsequent periods as the improperly capitalized item is charged to the operations of those periods. Assets and retained earnings will continue to be overstated in subsequent balance sheets by successively smaller amounts until the improperly capitalized item has been completely written off. (c) The basic criterion for classifying outlays as revenue or capital expenditures is the period of benefit. The amount of detail necessary to maintain subsidiary records, the materiality of the expenditures, and the consistency with which various expenditures recur from period to period are other criteria generally considered in establishing a capitalization policy. Firms frequently establish an arbitrary amount below which all expenditures are expensed, irrespective of their period of benefit. The

level at which this amount is set is determined by its materiality in relation to the size of the firm. The objective of such a policy is to avoid the expense of maintaining excessively detailed subsidiary records. Expenditures for items that fall below the set amount but are material in the aggregate should be capitalized, if total expenditures for these items vary significantly from period to period. A capitalization policy that reasonably applies these criteria, although it disregards the period of benefit and is therefore lacking in theoretical justification, will not significantly misstate periodic income.

12) The five parts are: Direct material Direct labor Factory overhead Work in process inventories Finished goods inventories

13) The balance sheet is a statement of financial position, whereas income stamen is a stamen of activities. The income statement is a complementary to the balance sheet, accounting in particular for the change in the equity as a result of operations during the year. In that respect, the income statement s essentially nothing more than a major section of the retained earnings account, therefore the revenue and expenses account in the income statement have been termed “explanatory” accounts, explaining the ebb and flow of revenues and expenses that lead to the new income (loss) and to the new retained earnings balance in the balance sheet.14) The ordinary balance sheet and income statement are intended to provide information as to financial position and results of operations of a business in accordance with several assumptions which are made in preparing the statements. From the standpoint of the criticism made, the most important of these assumptions are that cost less appropriate amortization of cost measures unexpired cost, and that a business may be assumed may be going to continue operations indefinitely into the future. Accounting statements are usually prepared on the theory that a sale or some other definite event is essential before revenue is recognized. Basically the asset side of balance sheet contains a presentation of the amount of cost incurred which can be presumed to benefit future periods. An income statement presents the amount of revenue recognized as having been realized during the period, less the portion of all costs incurred which does not appear to be fairly deferrable to future periods.

Exercises

E-1

1- Identify the conversion cost per unitConversion cost = Direct labor + factory Over head

= 20 + (15+6) = 41 /- units2- Identify the prime cost

Prime cost= direct material + Direct labor= 32 + 20 = 52 /-units

3- Determine the estimated total variable cost per unit= 32+20+15+3 = $70

4- Total cost for production 12,000 units and sale 8,000 units:(($32 + $20 +$15 + $6 + $4) × 12,000) + ($3 × 8,000) = $924,000 + $24,000= $948000

E-2

Determine Mercado Company’s expected operating income or loss for 19B.

Sale decease to 15% Rs

19950,000 × 15%

1950,000 – 2992500 16957500

Less: cost of goods sold

Fixed cost 7623000

Variable cost (W) 9835350 1745835

Net loss (500850)

(w) Variable cost varies with sales

VC Sales

19A 11571000 1950,000

19B x 16957500

1950,000 x = (1157100) (1695750)

x = 9835350

E- 3:

Crockett Company

Cost of Goods Sold Statement

For The Year Ended On Dec, 31B

Rs. Rs.

Direct Material

Material Opening 176000

Add: purchases (Net) 2400,000

Add: Freight in 32000 2432000

Material available for use 2608000

Less: Material Ending 196000

Direct Material used 2412000

Add: Direct Labor 3204000

Add: Factory Overhead 188560O

Total current manufacturing cost 7501600

Add: Work - in – process opening 129800

Cost of goods available for manufacturing 7631400

Less: Work - in – process ending 136800

Cost of goods manufactured 7494600

Add: Finished goods opening 620,000

Cost of goods available for sale 8114600

Less: Finished goods ending 567400

Cost of goods sold 7547200

E- 4 Prepare journal entries for above transactions.

JOURNAL Dr. Rs. Cr. Rs.

1- Work - in – process 24500 Factory overhead 4500

Material 29000_____________________________

2- Payroll 44000 Accrued payroll 33700

Income tax withheld 7000 FICA tax at 7.5% 33000

Accrued payroll 33700 Cash 33700

___________________________3- Work- in – process 30,000

Factory Overhead 6000Marketing expenses 8000

Payroll 44000

Factory overhead 4932Marketing expenses 1096

Unemployment Insurance 2376 Federal unemployment 352 FICA Tax payable 3500

WorkingTotal cost =2376+352+3500 = 6028FOH (direct & indirect labour)

=6028+36000/44000 = 4932Marketing expenses

=6028×8000/44000= 1096

4- Factory overhead 7500Voucher payable 7500____________________________________

5- Work - in – process 22932Factory overhead applied 22932____________________________________

6- Finished goods 60,000Work - in – process 60,000

____________________________________7- Material 50,000

Voucher P/A 50,000____________________________________

8- Cost of goods sold 20,000Finished goods 20,000

Account Receivable 26000

Sales 26000

_____________________________________

E - 5 Dr Cr

Date Particulars Rs. Rs.

(a) Material

Account payable

120,000

120,000

(b) Payroll

FICA Tax payable

Income Tax payable

Accrued payroll

Work in process

Factory overhead

Marketing expenses

Administrative expenses

Payroll

90,000

45,000

9,000

15,000

21,000

6750

15750

675000

90,000

(c) Material

Account payable

26250

26250

(d) Factory overhead

Marketing expenses


State unemployment

Federal unemployment

FIACA Tax

6156

1710

2394

2790

720

6750

(working)

Total cost = 10260

W.I.P = 10260×(54000)/90,000

=6156

Mark. Exp = 10260×(15000)/90,000

=1710

Admin exp = 1026×(21000)/90,000

=2394

(e) Work in process

Factory overhead

Marketing expenses

Material

60,000

15,000

4,500 79500

(f) Account payable

Material

900

900

(g) Account payable

Accrued payroll

Cash

75000

67500

142500

(h) Factory overhead

Accumulated Depreciation -Machinery

1000

1000

(i) Factory overhead

Account payable

9600

9600

(j) Finished goods

Work in process

126000

126000

(k) Cost of goods sold

Finished goods

Account receivable

Sales

96000

150,000

96000

150,000

(l) Factory over head

Account payable

38056

38056

E - 6 Dr Cr

Date Particulars Rs. Rs.

(a) Work in process

Factory overhead

Material

18500

2800

21300

(b) Finished goods

Work- in- process

51000

51000

(c) Material

Account payable

32000

32000

(d) Payroll

FICA Tax payable

Federal Income Tax payable

State Income Tax payable

Accrued payroll

50,000

3750

8750

2500

35000

(working)

Let total payroll = 100

Accrued payroll = 100- 7.5- 17.5-5

=70%

Accrued payroll 35,000

Cash 35000

(e) Work- in- process

Factory over head

Marketing expenses


Payroll

27500

9000

8500

5,000

50,000

(f) Factory over head

Marketing expenses


FICA tax payable

Federal unemployment tax p/a

State unemployment tax p/a

5000

1165

685

3750

400

2700

(working)

Total = 6850

F-O-H = 6850×36500/50,000

=5,000

Marketing exp = 6850×8500/50,000

= 1165

Admin exp = 6850×5,000/50,000

= 685

(g) Factory overhead

Accumulated Depreciation-Equip

Prepaid insurance

Account payable

11300

9450

600

1250

(h) Work in process

Factory overhead applied

28100.50

28100.50

(i) Account receivable

Sales

92120

92120

(j) Cost of goods sold

(92120×100/140)Finished goods

Cash A/C

Account receivable

65800

76000

65800

76000

E - 7

Tuornton Company

Cost of goods manufactured statement

For the month of October, 19A

Direct Material

Opening Inventory

Add: purchases

Cost of material available

Less: closing Inventory

Cost of material used

Add: Direct labour

Prime cost

Add: Factory overhead

Current manufacturing cost

Add: Work –in- process Opening

Cost of goods to be manufactured

Less: Work-in-process closing

Cost of goods manufactured

Rs.

16200

29,000

36200

17000

Rs.

19200

16500

35700

8580

44280

3600

47880

7120

40760

E - 8

Pensacola Corporation

Cost goods sold statement

For the year ended…….

Direct material

Opening inventory

Add: Net purchases

Add: Direct expenses

Cost of material available

Add: closing inventory

Cost of material used

Add: Direct labour

Prime cost

Add: Factory overhead (468,400+104,400)

Current Manufacturing cost

Work in process

Add: Opening inventory


Less: closing inventory


Finished goods

Add: opening inventory

Cost of goods available for sale


Rs.

88,000

366,000

6,600

460,600

64,000

Rs.

396600

523600

920200

572800

149300

29800

1522800

38800

1484000

54200

1538200

66000

Problems

P - 1

Mat. Company

Cost of goods manufactured statement

For the month of March,

Direct Material

Opening inventory

Add: purchases

Cost of material available for use


Direct material used

Direct Labour:

Add: Direct Labour cost

Prime cost

Factory overhead:

Add: Factory Overhead

Current manufacturing cost

Work in process:





Finished good:


Rs.

20,000

110,000

130,000

26,000

Rs.

104,000

160,000

264,000

80,000

344,000

40,000

384,000

36,000

348,000

102,000

Cost of goods available for sale


Cost of goods sold

450,000

105,000

345000

(Working)

F-O-H = 50% of direct labour

= direct labour×50/100

Current manufacturing cost = Direct material + direct labor + factory Overhead

344,000 = 104,000+ x +(x × 50/1000)

344,000 – 104,000 = x + 50x/100

240,000 = 100x + 50x/100

240,000 × 100/150 = x

160,000 = x

(a) cost of goods manufactured = 348,000(b) prime cost = 264,000(c) conversion cost = direct labour + F-O-H

= 160,000 + 80,000 = 240,000

P - 2

Company - A

Rs.


Finished goods:

Add: opening inventory 600,000

Cost of goods available for sale 4400,000

Less: closing inventory 1200,000

Cost of goods sold 3200,000

(Working)

Cost of goods sold = sale -- G.P

= $ 4000,000 -- (40, 00,000 ×20/100)

= $ 320,000

Company-B

Rs.


Less: Finished goods closing 190,000

Cost of goods sold 13, 00,000

P – 2 (cont.)

Company-C

Rs.

Sales 429,000

Less: cost of goods sold 333,000

Gross profit 96,000

(Working)

$

Cost of goods manufactured 340,000

Add: Finished goods opening 45,000


Less: Finished goods closing 52,000

Cost of goods sold 333,000

P - 3

(1)

Material A/C

Bal. b/d 20,000

A/P 65,000

85,000

W-I-P(Bal) 70,000

Bal. c/d 15,000

85,000

Material issue to production = 70,000

(2)

Payroll A/C

Accrued payroll 6000

6000

W-I-P 6000

6000

Direct labour cost = 6000

(3)

F-O-H A/C

Supplies exp 20000

Ind lab exp 55000

Acc: Dep 10000

Prep Ins 2000

Misc: exp 13000

100,000

W-I-P (Bal) 100,000

100,000

Total F-O-H = 100,000

(4)

W-I-P A/C

Bal. b/d 7000

Material 70000

Payroll(lab) 6000

F-O-H 100,000

183000

Fin goods 172,000

Bal. c/d 11000

183000

Cost of goods manufactured = 172000

(5)

Finished goods A/C

Bal. b/d 34000

W-I-P 172000

206,000

C.GS 176000

Bal. c/d 30,000

206,000

Cost of goods sold = 176000

(6)

A/P A/C

Cash 77000

Bal. c/d 6000

83000

Bal. b/d 18000

Material 65000

83000

Payment of A/P = 77000

(7)

A/R A/C

Bal. b/d 54000

Sales 500,000

554000

Cash 532000

Bal. c/d 22000

554000

Amount collected from account receivable = 548000

(8)

Accrued payroll A/C

Cash 10,000

Bal. c/d 9000

19000

Bal. b/d 13000

Payment A/C 6000

19000

Payment to A/P = 10,000

P - 4

Water Lux Company

1- For Purchase Of Material Dr. Rs Cr. RsMaterial 91,000 Account payable 91,000

______________________________________2- For Use Of Material

Work- in- process 84,000 Material 84,000 ___________________________________

3- For Direct Labour Work in process 50,000 Payroll 50,000 ________________________________

4- For Factory Overhead Factory overhead 25,000 Account payable 25,000 ________________________________

5- For Finished Goods Finished goods 157,000 Work in process 157,000 _____________________________

6- For Cost Of Goods Sold Cost of goods sold 140,000 Finished Goods 140,000 _____________________________

P – 4 (Working) Calculation of purchase, use of material, direct labour, FOH, Finished goods, cost of goods sold.Direct Material Rs.Opening inventory 17000Add: purchases 91,000Cost of material available 108,000

Less: Closing inventory 24,000

Cost of material used 84,000

Direct Labour+Direct labour cost 50,000Prime cost 134000Factory overhead+F-O-H 25000Current Material cost 150,000W-I-P+ Opening inventory 12000Cost of goods to be manufactured 1, 71,000-- Closing inventory 141000Cost of goods manufactured 1, 57,000 Finished Goods +opening inventory 29,000Cost of goods available for sale 185,000 -- Closing inventory 45,000Cost of goods sold 140,000____________________________________________________

P - 5

Prepare T accounts with January 1 Balance.1- Cash

Bal b/d 20,000

A/P A/C 179379

199379


A/P A/C 104000

Bal c/d 20559

199379

2- Account Receivable

Bal b/d 25000Sales A/C 228800

253800

Cash A/C 179379Discount A/C 3661Bal c/d 70760 253800

3- Finished Goods

Bal b/d 9500W/P 188000

197500

CGS 176000

Bal c/d 21500 197500

4- W-I-P

Bal b/d 4500Payroll 60500Material 82500FOH applied 47330 194830

F. goods 188000

Bal. c/d 6830 194830

5- A/P

Cash 104000

Bal c/d 160000 264000

Bal b/d 15500Material 92000FOH A/C 18500Mark exp 18000Admin exp 120000 264000

6- Material

Bal b/d 10,000 A/P A/C 92000

102000

W/P 82500FOH 8300

Bal c/d 11200 102000

7-

Accrued payroll

Cash 74820

Bal c/d 2250

77070

Bal b/d 2250

Payroll 74820

77070

8-

Machinery

Bal b/d 40,000

40,000

Bal c/d 40,000

40,000

9-

Depreciation

Bal c/d 10,000

10,000

Bal b/d 10,000

10,000

10-

Common stock

Bal c/d 60,000

60,000

Bal b/d 60,000

60,000

11-

Retained Earnings

Bal c/d 21250

21250

Bal b/d 21250

21250

12-

With Holding

Bal c/d 8170

8170

Payroll A/C 8170

8170

13-

State unemployment

Bal c/d 2322

2322

Payroll 2322

2322

14-

F-O-H

A/P A/C 18500

Payroll 12500

FIAC Tax 5475

Material 8300

44775

Bal c/d 44775

44775

15-

Marketing expense

Payroll 8000

FIAC tax 600

A/P A/C 18000

26600

Bal c/d 26600

26600

16-

Admin expense

Payroll 5000

FIAC Tax 375

A/P A/C 120,000

125375

Bal c/d 125375

125375

17-

FIAC Tax

Bal c/d 6450

6450

FOH 5475

Mark exp 600

Admin exp 375

6450

18-

F-O-H Applied

Bal c/d 47330

47330

W/P 47330

47330

19-

C.G.S

F G 176000

176000

Bal c/d 176000

176000

20-

Sales

Bal c/d 228800

228800

Account receivable 228800

228800

21-

Discount

A/R A/C 3661

3661

Bal c/d 3661

3661

22-

Payroll

W.H.Tax 8170

State unemp tax 2322

Federal unemp tax 688


86000

W/P 60500

FOH 12500

Mark exp 8000

Admin exp 5000

86000

P – 5 (cont.)

TRAIL BALANCE

SR#

A/C TITLE Dr Cr

1-

2-

3-

4-

5-

6-

7-

8-

9-

10-

11-

12-

13-

14-

Cash

A/R A/C

F G A/C

W/P A/C

A/P A/C

Material A/C

Accrued payroll A/C

Machinery A/C

A/C Depreciation A/C

Common stock

R.E A/C

W.E Tax A/C

State unemp tax

Fedral unemp tax

20559

70760

21500

6830

11200

40,000

160,000

2250

10,000

60,000

21250

8170

2322

688

15-

16-

17-

18-

19-

20-

21-

22-

23-

Marketing exp

Admin exp

FICA Tax

FOH Applied A/C

C.G.S

Sales A/C

Discount A/C

Payroll A/C

FOH A/C

26600

125375

176000

3661

_

44775

6450

47330

28800

_

547260 547260

P- 5 (cont.)

JOURNAL ENTRIES

A. Material A/P

Rs

93,000

Rs

93,000

B. F-O-H A/P

18500

18500

C. Payroll Withholding tax

State un employment tax

Federal un employment tax

Accrued payroll

86000

8170

2322

688

74820

Accrued payroll Cash

74820

74820

W-I-P

F-O-H

Marketing expenses Payroll

60500

12500

8000

86000

F-O-H

Marketing expenses FICA Tax

5475

600

6450

D. Work -in -process

F-O-H Material

82500

8300

90800

E. W-I-P F-O-H Applied

47330

47330

F. Finished goods

W-I-P

188000

188000

G. Cost of goods sold

Finished goods

176000

176000

A/R

Sales A/C

228800

228800

H. Cash A/C

Discount (183040×2%) A/R (228800×80%)

179379

3661

183040

I. Marketing expenses

Admin expenses A/P

18000

120,000

300,000

J. A/P Cash

104000

104000

P - 6

MANDMENEYER COMPANY

COST OF GOODS SOLD STATEMENT

FOR THE YEARB ENDED ON 30-11-19B

Direct Material $ $

Opening inventory 4000

+purchases 1, 80,000

Cost of material available 22,000

-- Closing inventory 4250

Direct material used 17750

Direct Labour

+Direct labour 7500

Prime cost 225250

F-O-H

+F-O-H Applied 5000

Current manufacturing cost 30250

W-I-P

+Opening inventory 4000

Cost of goods to be manufactured 34250



Finished Goods

+Opening inventory 3500

Cost of goods available for sale 30250



________________________________________

P -6 (cont.)

MANDMEYER COMPANY

INCOME STATEMENT

FOR THE YEAR ENDED 30-11-19B

Rs Rs

Net sales 56000

Less: cost of goods sold (25150)

Gross Profit 30850

Less: Opening expenses

Marketing expenses 2800

56000×2%

Administration expenses 1120 (3920)

56000×2%

Operating Income 26,930

Less: Other expenses (560)

56000 ×1%

NET INCOME 26,370

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