Chapter 1

Introduction to Cost Accounting

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Learning Objectives

LO1 Explain the uses of cost accounting data.

LO2 Describe the ethical responsibilities, and certification requirements for management accountants, as well as corporate governance.

LO3 Describe the relationship of cost accounting to financial and management accounting.

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Learning Objectives (cont.)

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.

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Cost Accounting

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

Management uses cost accounting information to decide how to allocate resources to the most efficient and profitable areas of the business.

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Types of Businesses EntitiesThat Use Cost Accounting

Manufacturers (Ford, General Motors)

Merchandisers/Retailers (WalMart, Kmart)

Wholesalers (Beverage Distributors)

For-profit Service Businesses (CPAs, Attorneys)

Not-for-profit Service Agencies (United Way, Red Cross)

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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.

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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.

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Determining ProductCosts 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.

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Planning and Control

Planning is the process of establishing objectives or goals for the firm and determining the means by which they will be met. 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.

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Planning and Control (cont.)

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

1. Assigning responsibility.

2. Periodically measuring and comparing results.

3. Taking necessary corrective action.

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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.

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Reporting

Cost and production reports for a cost center reflect its costs, in dollars, and its production activity.

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

A variance is the favorable (F) or unfavorable (U) difference between actual costs and budgeted costs.

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Performance Report Example

Leonardo’s Italian Cafe

Performance Report - Kitchen

September 30, 2011

Budgeted Actual Variance

Expense September Year-to-Date September Year-to-Date September Year-to-Date

Kitchen Wages $5,500 $47,000 $5,200 $46,100 $300 F $900 F

Food 17,700 155,300 18,300 157,600 600 U 2,300 U

Supplies 3,300 27,900 3,700 29,100 400 U 1,200 U

Utilities 1,850 15,350 1,730 16,200 120 F 850 U

Total $28,350 $245,550 $28,930 $249,000 $580 U $3,450 U

F = Favorable

U = Unfavorable

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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 IMA’s website at www.imanet.org

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Corporate Governance

Corporate governance is the means by which a company is directed and controlled.

The Sarbanes-Oxley Act (SOX) of 2002 was written to reduce abuse and improve corporate governance.

The Public Company Accounting Oversight Board (PCAOB) was established to provide oversight of the accounting profession.

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Relationship of Cost Accounting to Financial and Managerial Accounting

Characteristics Financial Accounting Managerial Accounting

Users: •External Parties

•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

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 on-

time deliveries

Cost Accounting System

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Relationship of Cost Accounting to Financial and Managerial Accounting

(cont.)

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

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Cost of Goods Sold

Merchandiser Manufacturer

Beginning

merchandise inventory

Plus:

Purchases (merchandise)

Merchandise

available for sale

Less:

ending merchandise inventory

Cost of good sold

Beginning

finished goods inventory

Plus:

cost of goods manufactured

Finished goods

available for sale

Less:

ending finished goods inventory

Cost of good sold

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Inventories

Manufacturer

Current assets:

Cash

Accounts receivable

Inventories:

Finished goods

Work in process

Materials

Merchandiser

Current assets:

Cash

Accounts receivable

Inventories:

Merchandise

inventory

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Inventories (cont.)

Most manufacturers maintain a perpetual inventory system that provides a continuous record of purchases, issues, and balances of all goods in stock.

A periodic inventory system does not provide a continuous record.

An inventory ledger is a subsidiary ledgermaintained to provide support for the control accounts.

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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.

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Prime Cost and Conversion Cost

Direct Materials

Direct Labor

Factory Overhead

Prime Cost

Conversion Cost

Elements of Cost

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Flow of Manufacturing Costs

Direct MaterialsDirect LaborFactory Overhead

Work in Process(Assets)

Finished Goods(Assets)

Cost of Goods Sold(Expenses)

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Illustration of Accounting for Manufacturing Costs

Materials xx

Accounts Payable xx

Work in Process

(Direct Materials) xx

Factory Overhead

(Indirect Materials) xx

Materials xx

Payroll xx

Wages Payable xx

Wages Payable xx

Cash xx

Work in Process

(Direct Labor) xx

Factory Overhead

(Indirect Labor) xx

Selling & Admin Exp

(Salaries) xx

Payroll xx

Factory Overhead

(Depr. Bldg) xx

Selling & Admin Exp

(Depr. Bldg) xx

Accum. Depr. – Bldg xx

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Illustration of Accounting for Manufacturing Costs (cont.)

Finished Goods xx

Work in Process xx

Accounts Payable xx

Cash xx

Accounts Receivable xx

Sales xx

Cost of Goods Sold xx

Finished Goods xx

Cash xx

Accounts Receivable xx

Factory Overhead

(Depr. Mach & Eq) xx

Accum. Depr. –

Mach & Eq xx

Factory Overhead

(Utilities) xx

Selling & Admin Exp

(Utilities) xx

Accounts Payable xx

Selling & Admin Exp xx

Accounts Payable xx

Work in Process xx

Factory Overhead xx

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Cost Accounting Systems

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

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.

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Job Order Cost System

Direct MaterialsDirect LaborFactory Overhead

Work in Process Account

Finished GoodsAccount

Job Cost Sheets

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Process Cost System

Work in ProcessDept. 1

Work in ProcessDept. 2 Finished Goods

FactoryOverhead

DirectLabor

Direct Materials

Direct Materials

DirectLabor

FactoryOverhead

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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.

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AppendixIMA Statement of Ethical Professional Practice

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

1. Competence

2. Confidentiality

3. Integrity

4. Credibility

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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 issues with your immediate supervisor except when it appears that the supervisor is involved.

2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics Counselor or other impartial advisor to obtain a better understanding of possible courses of action.

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

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