Principles of Cost Principles of Cost Accounting 14EAccounting 14EEdward J. VanDerbeckEdward J. VanDerbeck

Chapter 1Chapter 1

Introduction to Cost AccountingIntroduction to Cost Accounting

Learning ObjectivesLearning Objectives

LO1LO1 Explain the uses of cost accounting Explain the uses of cost accounting data.data.

LO2LO2 Describe the ethical responsibilities Describe the ethical responsibilities and certification requirements for and certification requirements for management accountants.management accountants.

LO3LO3 Describe the relationship of cost Describe the relationship of cost accounting to financial and accounting to financial and

managerial accounting.managerial accounting.

Learning ObjectivesLearning Objectives

LO4LO4 Identify the three basic elements of Identify the three basic elements of manufacturing costs.manufacturing costs.

LO5LO5 Illustrate basic cost accounting Illustrate basic cost accounting procedures.procedures.

LO6LO6 Distinguish between the two basic Distinguish between the two basic types of cost accounting systems.types of cost accounting systems.

LO7LO7 Illustrate a job order cost system.Illustrate a job order cost system.

The Need for Cost The Need for Cost AccountingAccounting

Cost accounting provides the detailed cost Cost accounting provides the detailed cost data that management needs to control current data that management needs to control current operations and plan for the future.operations and plan for the future.

Companies must control costs in order to keep Companies must control costs in order to keep prices competitive.prices competitive.

In today’s global environment, cost information In today’s global environment, cost information is more crucial than ever in remaining is more crucial than ever in remaining competitive.competitive.

Types of Businesses That Types of Businesses That Use Cost AccountingUse Cost Accounting

Manufacturers (Ford, General Motors)Manufacturers (Ford, General Motors) Merchandisers (WalMart, Kmart)Merchandisers (WalMart, Kmart) Wholesalers (Beverage Distributors)Wholesalers (Beverage Distributors) For-profit Service Businesses (CPAs, For-profit Service Businesses (CPAs,

Attorneys)Attorneys) Not-for-profit Service Agencies (United Not-for-profit Service Agencies (United

Way, Red Cross)Way, Red Cross)

The Manufacturing The Manufacturing ProcessProcess

This process involves the conversion of This process involves the conversion of direct (raw) materials, direct labor, and direct (raw) materials, direct labor, and factory overhead into finished goods.factory overhead into finished goods.

Product quality is an important competitive Product quality is an important competitive weapon in manufacturing.weapon in manufacturing.

Many companies require their suppliers to Many companies require their suppliers to be ISO 9000 certified.be ISO 9000 certified.

ISO 9000 CertificationISO 9000 Certification

The International Organization for The International Organization for Standardization created a set of five Standardization created a set of five international standards for quality international standards for quality management, ISO 9000-9004.management, ISO 9000-9004.

These standards require that These standards require that manufacturers have a well-defined quality manufacturers have a well-defined quality control system and they consistently control system and they consistently maintain a high level of quality.maintain a high level of quality.

Determining Product Determining Product Costs and PricingCosts and Pricing

Cost accounting is used to determine Cost accounting is used to determine products costs and help with marketing products costs and help with marketing decisions.decisions.

1.1. Determining the selling price of a Determining the selling price of a product.product.

2.2. Meeting competition.Meeting competition.

3.3. Bidding on contracts.Bidding on contracts.

4.4. Analyzing profitability.Analyzing profitability.

Planning and ControlPlanning and Control

PlanningPlanning is the process of establishing is the process of establishing objectives or goals for the firm and objectives or goals for the firm and determining the means by which the firm will determining the means by which the firm will attain them. Effective planning is facilitated by attain them. Effective planning is facilitated by the following:the following:

1.1. Clearly defined objectives of the Clearly defined objectives of the manufacturing operation.manufacturing operation.

2.2. A production plan that will assist and guide A production plan that will assist and guide the company in reaching its objectives.the company in reaching its objectives.

Planning and Control Planning and Control (cont.)(cont.)

ControlControl is the process of monitoring the is the process of monitoring the company’s operations and determining company’s operations and determining whether the objectives identified in the whether the objectives identified in the planning process are being accomplished. planning process are being accomplished. Effective control is achieved through the Effective control is achieved through the following:following:

1.1. Assigning responsibility.Assigning responsibility.

2.2. Periodically measuring and comparing Periodically measuring and comparing results.results.

3.3. Taking necessary corrective action.Taking necessary corrective action.

Responsibility AccountingResponsibility Accounting

Responsibility accountingResponsibility accounting is the assignment is the assignment of accountability for costs or production results of accountability for costs or production results to those individuals who have the most to those individuals who have the most authority to influence them.authority to influence them.

A A cost centercost center is a unit of activity within the is a unit of activity within the factory to which costs may be practically and factory to which costs may be practically and equitably assigned. The manager of a cost equitably assigned. The manager of a cost center is responsible for those costs that the center is responsible for those costs that the manager controls.manager controls.

ReportingReporting

Cost and production reportsCost and production reports for a cost for a cost center reflect all cost and production data center reflect all cost and production data identified with that center.identified with that center.

The The performance reportperformance report will include only will include only those costs and production data that the those costs and production data that the center’s manager can control.center’s manager can control.

A variance is the A variance is the favorablefavorable or or unfavorableunfavorable difference between actual costs and difference between actual costs and budgeted costs.budgeted costs.

Performance Report Performance Report ExampleExample

Renaldi’s RestaurantRenaldi’s RestaurantPerformance ReportPerformance ReportSeptember 30, 2006September 30, 2006

BudgetedBudgeted ActualActual VarianceVarianceExpenseExpense SeptemberSeptember Year-to-DateYear-to-Date SeptemberSeptember Year-to-DateYear-to-Date SeptemberSeptember Year-to-DateYear-to-Date

Kitchen WagesKitchen Wages $5,500$5,500 $47,000$47,000 $5,200$5,200 $46,100$46,100 $300 F$300 F $900 F$900 FFoodFood 17,70017,700 155,300155,300 18,30018,300 157,600157,600 600 U600 U 2,300 U2,300 USuppliesSupplies 3,3003,300 27,90027,900 3,7003,700 29,10029,100 400 U400 U 1,200 U1,200 UUtilitiesUtilities 1,8501,850 15,35015,350 1,7301,730 16,20016,200 120 F120 F 850 U850 UTotalTotal $28,350$28,350 $245,550$245,550 $28,930$28,930 $249,000$249,000 $580 U$580 U $3,450 U$3,450 UF = FavorableF = FavorableU = U = UnfavorableUnfavorable

Management AccountingManagement Accounting

The Institute of Management Accountants The Institute of Management Accountants (IMA) is the largest organization of (IMA) is the largest organization of accountants in industry. The Certified accountants in industry. The Certified Management Accountant (CMA) is Management Accountant (CMA) is comparable to the Certified Public comparable to the Certified Public Accountant (CPA) for public accountants.Accountant (CPA) for public accountants.

For more information, please visit the For more information, please visit the IMA’s website at IMA’s website at www.imanet.orgwww.imanet.org

Cost Accounting vs. Cost Accounting vs. Financial and Managerial Financial and Managerial AccountingAccounting

CharacteristicsCharacteristics Financial AccountingFinancial Accounting Managerial AccountingManagerial Accounting

Users:Users: •External PartiesExternal Parties•ManagersManagers ManagersManagers

Focus:Focus: Entire businessEntire business Segments of the businessSegments of the business

Uses of Cost Information:Uses of Cost Information: Product costs for Product costs for calculating cost of goods calculating cost of goods sold and finished goods, sold and finished goods, work in process, and raw work in process, and raw materials inventory using materials inventory using historical costs and GAAP.historical costs and GAAP.

•BudgetingBudgeting•Special decisions such as Special decisions such as make or buy a component, make or buy a component, keep or replace a facility, keep or replace a facility, and sell a product at a and sell a product at a special price.special price.•Nonfinancial information Nonfinancial information such as defect rates, % of such as defect rates, % of returned products, and on-returned products, and on-time deliveriestime deliveries

Cost Accounting System

Cost Accounting vs. Cost Accounting vs. Financial and Managerial Financial and Managerial Accounting (cont.)Accounting (cont.)

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

Cost of Goods SoldCost of Goods Sold

MerchandiserMerchandiser ManufacturerManufacturer

Beginning merchandise Beginning merchandise inventoryinventory

Plus Plus purchasespurchases

Merchandise available for saleMerchandise available for sale

Less ending merchandise Less ending merchandise inventoryinventory

Cost of good soldCost of good sold

Beginning finished goods Beginning finished goods inventoryinventory

Plus Plus cost of goods cost of goods manufacturedmanufactured

Finished goods available for Finished goods available for salesale

Less ending finished goods Less ending finished goods inventoryinventory

Cost of good soldCost of good sold

InventoriesInventories

Most manufacturers maintain a Most manufacturers maintain a perpetual perpetual inventory systeminventory system that uses FIFO, LIFO, or that uses FIFO, LIFO, or moving average methods of costing.moving average methods of costing.

An An inventory ledgerinventory ledger is maintained to provide is maintained to provide support for the control accounts.support for the control accounts.

Some manufacturers may use a Some manufacturers may use a factory factory ledger,ledger, which contain all of the accounts which contain all of the accounts relating to manufacturing.relating to manufacturing.

InventoriesInventories

MerchandiserMerchandiser

Current assets:Current assets:

CashCash

Accounts receivableAccounts receivable

Merchandise Merchandise inventoryinventory

ManufacturerManufacturer

Current assets:Current assets:

CashCash

Accounts receivableAccounts receivable

Inventories:Inventories:

Finished goodsFinished goods

Work in processWork in process

MaterialsMaterials

Elements of Elements of Manufacturing CostsManufacturing Costs

Direct materialsDirect materials Materials that become part of the finished Materials that become part of the finished

good and can be readily identified.good and can be readily identified.

Direct laborDirect labor Labor of employees who work directly on the Labor of employees who work directly on the

product manufactured.product manufactured.

Factory overheadFactory overhead Includes all costs related to production other Includes all costs related to production other

than direct materials and direct labor.than direct materials and direct labor.

Prime Cost and Prime Cost and Conversion CostConversion Cost

Direct MaterialsDirect Materials

Direct LaborDirect Labor

Factory OverheadFactory Overhead

Prime Cost

Conversion Cost

Elements of Cost

Flow of Manufacturing Flow of Manufacturing CostsCosts

Direct MaterialsDirect LaborFactory Overhead

Work in Process(Assets)

Finished Goods(Assets)

Cost of Goods Sold (Expenses)

Illustration of Accounting Illustration of Accounting for Manufacturing Costsfor Manufacturing Costs

MaterialsMaterials xxxx Accounts PayableAccounts Payable xx xx

Work in Process (Direct Materials)Work in Process (Direct Materials) xxxx Factory Overhead (Indirect Materials)Factory Overhead (Indirect Materials) xxxx

MaterialsMaterials xx xx PayrollPayroll xxxx

Wages PayableWages Payable xx xx

Wages PayableWages Payable xxxx CashCash xx xx

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

PayrollPayroll xx xx Factory Overhead (Depr. Bldg)Factory Overhead (Depr. Bldg) xxxx Selling & Admin Exp (Depr. Bldg)Selling & Admin Exp (Depr. Bldg) xxxx

Accum. Depr. – BldgAccum. Depr. – Bldg xx xx Factory Overhead (Depr. Mach & Eq)Factory Overhead (Depr. Mach & Eq) xxxx

Accum. Depr. – Mach & EqAccum. Depr. – Mach & Eq xx xx

Factory Overhead (Utilities)Factory Overhead (Utilities) xxxx Selling & Admin Exp (Utilities)Selling & Admin Exp (Utilities) xxxx

Accounts PayableAccounts Payable xx xx Selling & Admin ExpSelling & Admin Exp xxxx

Accounts PayableAccounts Payable xx xx Work in ProcessWork in Process xxxx

Factory OverheadFactory Overhead xx xx

Finished GoodsFinished Goods xxxx Work in ProcessWork in Process

xx xx Accounts PayableAccounts Payable xxxx

CashCash xx xx Accounts ReceivableAccounts Receivable xxxx

SalesSales xx xx Cost of Goods SoldCost of Goods Sold xxxx

Finished GoodsFinished Goods xx xx

CashCash xxxx Accounts ReceivableAccounts Receivable xx xx

Cost Accounting SystemsCost Accounting Systems

Job Order Cost SystemJob Order Cost System Output consists of special or custom-Output consists of special or custom-

made products.made products. Provides a separate record for the cost Provides a separate record for the cost

of each quantity of these special or of each quantity of these special or custom-made products.custom-made products.

Process Cost SystemProcess Cost System Accumulates costs for each Accumulates costs for each

department or process in the factory.department or process in the factory.

Job Order Cost SystemJob Order Cost System

Direct MaterialsDirect LaborFactory Overhead

Work in Process Account

Finished GoodsAccount

Job Cost Sheets

Process Cost SystemProcess Cost System

Work in ProcessDept. 1

Work in ProcessDept. 2 Finished Goods

FactoryOverhead

DirectLabor

Direct Materials

Direct Materials

DirectLabor

FactoryOverhead

Standard Cost SystemStandard Cost System

May be used with either a May be used with either a job orderjob order or a or a processprocess cost system. cost system.

Uses predetermined Uses predetermined standard costsstandard costs to furnish a to furnish a measurement that helps management make measurement that helps management make decisions regarding the efficiency of operation.decisions regarding the efficiency of operation.

Standard costsStandard costs are costs that would be incurred are costs that would be incurred under efficient operating conditions and are under efficient operating conditions and are forecast before the manufacturing process forecast before the manufacturing process begins.begins.

AppendixAppendixStandards of Ethical Conduct for Standards of Ethical Conduct for Management AccountantsManagement Accountants

Members of the IMA have an obligation to Members of the IMA have an obligation to the public, their profession, the the public, their profession, the organizations they serve, and themselves organizations they serve, and themselves to maintain the highest standards of to maintain the highest standards of ethical conduct.ethical conduct.

1.1. CompetenceCompetence2.2. ConfidentialityConfidentiality3.3. IntegrityIntegrity4.4. CredibilityCredibility

Appendix (cont.)Appendix (cont.)

Resolution of Ethical ConflictResolution of Ethical Conflict When applying the standards of ethical When applying the standards of ethical

conduct, IMA members may encounter conduct, IMA members may encounter problems in identifying unethical behavior problems in identifying unethical behavior or in resolving an ethical conflict.or in resolving an ethical conflict.

1.1. Discuss problems with the immediate superior except Discuss problems with the immediate superior except when it appear that the superior is involved.when it appear that the superior is involved.

2.2. Clarify relevant ethical issues by confidential discussion Clarify relevant ethical issues by confidential discussion with an objective advisor.with an objective advisor.

3.3. Consult your own attorney as to legal obligations and Consult your own attorney as to legal obligations and rights concerning the ethical conflict.rights concerning the ethical conflict.