CHAPTER 3 COST ACCOUNTING CYCLE LEARNINGS OBJECTIVES Upon completion of this chapter, you should be able to e Understand the cost accounting cycle © Differentiate service, merchandising, and a- manufacturing entities Distinguish between and account for direct and indirect materials and labor as they are used in the production process Prepare the different financial statements for a service entity merchandising entity and manufacturing entity The objective of accounting, in general, is the accumulation of financial information that is useful in making economic decisions. Financial accounting focuses on the gathering of information to be used in the preparation of financial statements that meet the needs of investors, creditors, and other external users of financial information. The statements include a balance sheet, income statement, and statement of cash flows. Although these financial statements are useful to management as well as external users, additional reports, schedules, and analyses are required for internal use in planning and control. Cost accounting provides the additional information required by management, and also provides data necessary for the preparation of external financial statement. For example, cost accounting procedures are necessary for the determination of cost of goods sold on the income statement and the valuation of inventories on the balance sheet. Manufacturing Inventory Accounts Most manufacturing companies use the perpetual inventory approach. In the remaining sections of this book, you are to assume that a company uses the perpetual. inventory system unless otherwise indicated. Accounting for inventories is the more {Hificult part of manufacturing accounting when compared with merchandising accounting. Instead of dealing with one account — Merchandise Inventory — three accounts must be used: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. 5152 Cost Accounting Materials Inventory * i jal: rol account, is made The’Materials Inventory account, also Materiais Inventory Control a a a is maintained in up of the balances of materials and supplies on hand. This account Bi ms ie much the same way as the Merchandise Inventory account. The mai pee signed. For the merchandisin the way that the costs of items in inventory are assigned. For the merchat Ig company, goods taken out Vhet of inventory are items that have been sold. When a sale is made, an entry is needed to debit Cost of Goods Sold and to credit Merchandise Inventory for the cost of the item. Materials, on the other hand, are usually not purchased for resale but for use in m anufacturing a product. Therefore, an item taken out of Materials Inventory and requisitioned into production is transferred to the Work in Process Inventory account ( not Cost ef Goods Sold). Figure 3-1 Merchandise Inventory vers Materials Inventory Goods costing 45,300 were sold Merchandise Inventory Cost of Goods Sold Balance 1/1 24,600 45,300 ——¥ go1g 45,300 Purchases 53,200 Balance 32,500 Materials costing 45,300 were issued to production “ Materials Inventory Work in Process Balance 1/1 25,100 at. Used . 45,300 Baiance 32,500 Balance 1/1. 24,600 | issued 45,300 Purchases 53,200Chapter 3 Cost Accounting Cycle 53 Work in Process Inventory All manufacturing costs incurred and assigned to products being produced are classified as Work in Process Inventory costs. This inventory account has no counterpart in merchandise accounting. A thorough understanding of the concept of Work in Process Inventory is vital in manufacturing accounting. Figure 3-2 shows the various costs that become part of Work in Process Inventory and the way costs are transferred out of the account. ‘The issuance of materials production, shown in Figure 3-1, begins the production process. These materials must be cut, molded, assembled, or in some other way chahged into a finished product, To make this change, people, machines, and other factory resources (buildings, electricity, supplies, and so on) must be used. All of these costs are manufacturing cost elements (product costs), and all of them enter imto accounting for Work in Process Inventory Direct labor earned by factory employees are also product costs. Since these people werk on specific products, their labor costs are assigned to those products by including the labor peso earned as part of the Werk in Process Inventory account. Overhead costs are product cosis and must be assigned to specific products. Thus, they, too, are included in the Work in Process Inventory account. As discussed earlier, there are many overhead costs to account for on an individual basis. To. reduce the amount.of work needed to assign these costs to products, they are accumulated and accounted for under one account title: Factory Overhead Control. These costs are then assigned to products by using an overhead rate. Using this rate, called -a_ predetermined overhead rate, costs are charged to Work in Process Inventory account. In the example in Figure 3-2, factory overhead costs of P 65,000 were charged to the Work in Process Inventory account. The predetermined’ overliead rate Will be discussed in Chapter 8. As products are completed, they are put into the finished goods storage area. These products now have materials, direct labor, and factory overhead costs assigned td them, When products are completed, their costs no longer belong to work in process. Therefore, when the completed products are sent to the storage area, their costs are transferred from the Work in Process Inventory account to the Finished Goods Inventory. The balance remaining in the Work in Process Inventory account (P 13.500 in Figure 3-2) represents the costs that were assigned to products partly completed and still in process at the end of the period.Bd Cost Accounting Figure 3-2. Ty i ventory ft ig he Work in Process Inventory Account ee were completed and transferred to finished goods inventory Work in Process Inventory Account Finished Goods Inventory Balance 1/1 25,100 ‘ompleted during the period 201,600 Balance 1/1 70,000 Materials 45,300 Completed 2 600 Labor 79.700 Overhead 65,000 Balance 13,500 Finished Goods Inventory The Finished Goods Inventory account, like Materials Inveny characteristics of the Merchandise Inventory account tory, has same i YAN have already seen how costs are moved from the Work in Process Inventory acy Fi area ‘Count to the Finished joods Inventory account. At this Point Finished Goods Inventory takes S the characteristics of Merchandise Inventory. If We compare the Merchandise inven account in Figure 3-1 with the accounting for Finished Goods Inventory in Figure 3. 3 we will see that the credit side of both accounts is handled in the same. way. Both examples show that when goods or products are sold, the Costs of those meagre moved from the Finished Goods Inventory account to the Cost of Goods Sold account. However, the accounting procedures affecting the debit side aro Finished Goods Inventory account differ from those for the Merchandise Inventory account. In a manufacturing firm salable Products are Produced rather’ the, urchased. All costs debited to the Finished Goods Inventory account represent transfers from the Work in Process Inventory acco period, the balance in the Finished Goods Invento; unt. At the end of ah e ry account is made us eounting of products completed but unsold as of that date. © UP of the costChapter 3 Cost Accounting Cycle 55 Accounting for Finished Goods Inventory Products costing P 240,500 Figure 3-3. were sold during the period Finished Goods Inventory Cost of Goods Sold Balance 1/1 70,000 |Sold 240,500 old 240,500 Completed 201,600 Balance 31,100 For the merchandising concern, the cost of goods sold is computed as follows: Beginning merchandise inventory Plus: Purchases (merchandise) Merchandise available for sale Less: Merchandise inventory end Costof goods sold ‘The amount of purchases represents the cost of the goods which were acquired during the period for resale. Since the manufacturing concem makes rather than buys the product it has available for sale, the term “finished goods inventory” replaces “merchandise inventory” and the term “cost of goods manufactured” replaces “purchases” in determining the cost of goods sold. Beginning finished goods inventory Plus:_Cost of goods manufactured Total goods available for sale Less: Finished goods inventory end Cost.of goods sold eee Regardless of which costing system is used, a cost of goods manufactured (CotGM) statement is prepared to summarize the manufacturing activity of the period, Cost of Goods Manufactured for a manufacturing firm is equivalent to purchases for a merchandising firm, Although it may take different forms, essentially the CofGM Statement is a summary of the direct materials, direct labor, factory overhead, and work-in-place (WP) account.— 56 Cost Accounting NTS OF MANUFACTURING CosT Manufacturing or Production costs are classified into three basic elements; (| materials, (2) dire ) direct ct labor, and (3) factory overhead, Direct materials bags, Materials tha adily identified wi Examples are: sandpaper used in sq chinery. Classified also as ind © part of the finished Product by ‘ant, such as thread, Screws, rj WS, Tivets, bolts, ng Direet labor The cost of labor for those employ manufactured. are classifi ied as direct Ig operators or assembly line workers, called indirect material lubricants used on ma actually becom insignific Is. nding furniture, and rect materials are materials that ils, nMOS costs are relatively ails, and glue, tly on the product © salaries of machine The wages and salaries of employees Who Process but who do ate required for ‘rin hot work directly on he units bein, magmanefatrng considered indirect labor, Examples are: wa inspectors, supervisors, and BES and sal ‘8 Manufactured are - and salari maintenance Personnel, Anes Of department heads, Factory overhead Includes all costs related to the meamufacturing of a py od 0% and direct labor, Examples are: indirect Product rial, cept direct materials i 5 lals, ini manufacturing expenses, such as depreciation ©n the snaitect labor, and other and equipment, supplies, heat, light, Power, maintenance insura, uilding, ache > ce, rent and taxes. Manufacturing Cost Flow : Product costing, inventory Valuation, and Financial reno: Structured flow of manufacturing costs This manus Poti ing = 4ebend pn a defined, Acturing COSt flow aeChapter 3 Cost Accounting Cycle 57 outlined in the discussion of the three manufacturing inventory accounts. Figure 3-4 summarizes the entire cost-flow process as it relates to accounts in the general Jedger. The journal entries to make this cost flow operational will be illustrated in the latter part of this chapter. . Figure 3-4 Manufacturing Cost Flow Materials Inventory Factory Payroll Factory Overhead Control Bal.1/124,000|ssued 45,300 DL 79,700 79,700 Total mfg... 65,900 Purch, 53,200 cost 65,000 Bal. 31,900 Work in Process Inventory Bal. 1/1 25,100 |Completed 201,600 Materials 45,300 Labor 79,700 > OH 65,000 Bal. 13,500 Se Bal. 1/1. 70,000 Sbld 240,500 ——Sekd240,500 ‘ompleted 201,600 Bal. 31,100 trate on the general pattern of manufacturing cost flow, as shown in Meese. The cost flow begins with costs being incurred. Manufacturing costs sat in many ways. They may be cash payments, incurred liabilities, fixed asset depreciation, or expired prepaid expenses. Once these costs have been incurred they are recorded as either direct materials, direct labor, or58 factory overhead cost: to the Work in Proc: assigned to fii In much the Cost Accounting s. As the resources are used up, the company transfers is a ess Inventory account. When production is comp A . nished units are transferred to the Finished Goods ser (cana Same way, costs attached to units sold are transferred toll . — x TO0ds Sold account. Before going on, compare the cost flow as it moves d ne the general ledger ace, ounts in Figure 3-4 with the general pattern shown in Figure 3- 5. Both figures show the same type of cost flow. Figure 3-5 COST FLOW MANUFACTURI G FIRMS Cost ineurrence Expense Category Direct materials } —Work in } process Direct labor ---. —+ Finished —+ Cost of goods sold goods Factory overhead -~ Selling and Administrative ——___, Operating expenses The Manufacturing Statement Financial statements of. manufacturing companies qj 7 merchandising companies Depending onthe nds aie from those of the balance sheet are the same in most Corporation, xan a titles foun on Accounts Receivable, Buildings, Machinery, Accounts Payable © * include Cash, Even the income statements for @ merchandiser and a man ae Capital Stock.) However, a closer look shows that the head Cost of Goods 7 Sees are similar. place of the Purchases account. Also, era Merchandise Ynyeutctured is used in replaced by Finished Goods Inventory, ‘entory account is he key to preparing an income Statement for ; eee Gost of goods sold. The amon ig reteeturing company is to manufacturing statement, the statement of e Cost of p0, Tesult of a ‘special prepared to support the figure on the income Statement, "@"Ufactured, which is Statement of Cost of Goods Ma nufactuy, is ed a The flow of manufacturing costs, shown in Figy, S31 th nd Sold basis for accounting for manufacturing costs, In this Process gut 34, provides the ° ‘anufacturingChapter 3 Cost Accounting Cycle 59 costs incurred are considered product costs. They are used to compute ending inventory balances and cost of goods sold. The costs flowing from one account to another during the year have been combined into one number in the illustrations to help show the basic idea. In fact, hundreds of transactions occur during a year, and each transaction affects part of the cost flow process. At the end of the year, the flow of all manufacturing costs incurred during the year is summarized in the statement of cost of goods manufactured and sold. The statement gives the peso amount of costs for products completed and moved to Finished Goods Inventory during the year. The amount for cost of goods manufactured should be the same as the amount transferred from the Work in Process Inventory account to the Finished Goods Inventory account during the year. In the same way, the amount of cost of goods sold should be the same as the amount transferred from the Finished Goods Inventory account to the Cost of Goods Sold account during the year. The statement of cost of goods sold for Figure 3-1 through 3-4 is shown below. Even though this statement is rather complex, it can be pieced together in four steps. The first step is to compute the cost of materials used. Add the materials for the period to the beginning balance in the Materials Inventory account. This subtotal represents the cost of materials available for use during the year. Then subtract the balance of the ending Materials Inventory from the materials available for use. The difference is the cost of materials used during the accounting period. Name of Company Cost of Goods Sold Statement For the year ended December 31, 2019 Direct materials used Materials Inventory, January 1 P 24,600 Add: Purchases 53.200 Total available for use 77,800 Less: Materials Inventory, December 31 32,500 P 45,300 Direct labor 79,700 Factory Overhead 65,000 Total manufacturing costs 190,000 Add: Work in process, January 1 25,100 Cost of goods put into process 215,100 Less: Work in process, December 31 “13.500 Cost of goods manufactured 201,600 Add: Finished goods, January | 70,000 271,600 Total goods available for sale 2 Less: Finished goods, December 31 31'100 Cost of goods sold — normal P 240,500Cost Accounting 60 facturing costs for the Year, The second step is the computation of the total dad ty el fs overhead cost ‘The costs of materials used and direct labor are adde i js is . total manufacturing costs into total applied during the year. The third step charges snnine “Weta Cost of goods manufactured for the year. Add the beginning Work in Process Inventory balance t ‘0 total manufacturing costs for the period to arrive at the total Sost of work in process during the year. From this amount, subtract the ending Work in Process Inventory balance for the year to get the cost of Boods manufactured, The term total manufacturing costs must not be confused with the Cost of goods manufactured. Total manufacturing costs are the total costs for materials used, direct labor, and factory overhead incurred and ol Production durin harged. to an accounting period. ‘Toial Manufacturing costs of P 190,000 incurred during the current yet re added to the beginning balance of the Work in Process Inventory costs of P25 -100 beginning . The costs of two accounting the of goods put into Process during the year.The cost of ill in process (P31,100) are then subtracted. from the total cost of during the year, ‘The Remainder, P201,600.is the cost of (completed) during th Iti 4 Ne year. It is assuy e items in "Y Were completed first, Cost attached os oo Work in Process Inventory are Part of the current Period’s toy Manufactuss iS an they will not become Part of the cost oj 800ds manufactured Ss Cot: accounting period when the Products are Completed, The! until the next computation of the during . balance, by definition, Periods are now being Cost of goods sold fourth step is the manufactured is added to the beginning balance 7 fthe poet The cost of goods Bet the total cost of goods avaiable Sale during tne hed Goods Inventory to sold — normal is then com, Ne peri © Cost of goods Finished Goods. . © total cost of o0ds 1S Cons; g were sold, "dered an PeNse for the period in available for sale, which the related products ‘The ‘Nosled Products Company ig @ smaly manufactures dining tables and chairs. ‘The compen’'Y organized OF wholesale distributors, who in ‘UM Sell them 4a 8 Products ate sold to jobbers company’s manufacturing re nes SE 8S Follow Tetailers, The basic steps in the 1. Lumber is cut to size for table tops, legs, 3 The individual pieces of cut nce !8S, seq 'S, arms, a i" T are pain, ? 3 » and backs, 3, The pests are assembled int whe ang ated in yanarnd Packs lai i Various bright colors. Company. that| | Chapter 3 Cost Accounting Cycle 61 The b current y Statement of Financial Position for the company on January | of the is presented below.. Noeled Products Company Statement of Financial Position January 1, 2019 Assets Liabilities and Stockholders’ Equity Cash P 80,000 Liabilities Po Building 750,000 Machinery & equipment _150,000 Capital stock 980,000 Total liabilities and Total assets 980,000 Stockholders’ equity __P980,000 To make things easy, let us assume that the company for the month of January makes only one style of table and no chairs. The following transactions are completed for January and recorded, in summary form as follows: i. Materials (lumber, paint, screws, lubricants, and solvents) are purchased on account at 2 cost of P 50,000. Materials 50,000 Accounts Payable 50,000 This procedure differs in two ways from the recording of purchases for a n. First, the debit is to a Material Inventory account instead of a Purchases account because the inventory system is perpetual. Second, the inventory account used is a control account. Some companies have hundreds of items in inventory, ‘To keep a separate account for each item in the general ledger would crowd the ledger and make it hard to work with. At the time that entry | is posted to the general ledger, the individual stock cards are also updated. th, direct materials (lumber and paint) costing P 40,000 and cants for machine, and solvents tor cleaning) merchandising 2. During the mon r indirect materials (screws, lubrie costing P 1,900 are issued to the factory. 40,000 1,900 Work in Proc Factory Overhead Comrol Materials 41,900Cost Accounting “62 i indirect mater; This entry shows that P40,000 of direct materials and pauaes in : an were issued, The debit to the Work in Process account : pede materials issued to production. Such costs can be ee y ayn Jot orders. As the direct materials costs are charged to work in Process, the amounts for individual jobs are entered on the job order cost sheets. Indirect materials are debited to the Factory Overhead Control account. 3. Total payroll for the month amounted laborers working on the product; P 7,0 and administrative employees, The en employees (ignoring to P36,000, consisting of P20,000 earned by 00 for factory supervision; P 9,000 for sales try to record the payroll and the payment to payroll deductions) would be: Payroll 36,000 Accrued Payroll 36,000 Accrued Payroll 36,000 Cash ; 36,000 Recording labor costs for g company requi : i The first labor cost entry re Deval abies ee soarpleaes second entry records the payment of ‘the Payroll liability est, Bae he fiat entry. The third entry (No. 4) is now needed to account Teens ts. The P36,000 debited to the Payroll account must be Properly for labor costs. accounts, Gross direct labor costs are debien to Work in proved '9 the production indirect labor costs (factory Supervision) are debited n Process account, and total Payroll is credited to show that the total accona > Factory Overhead Control. production accounts. Ount thas been distributed to the @ manufacturin, ‘cords the total 4. The entry to record the distributi . Work in Process "0M OF classifi Cation of the payroll would be: Factory Overhead Control 20,000 Pm Selling and Administrative F, 7,000 Payroll ‘Xpense Contro} 9,000 ork in es le the salaries ON the 10 no work directly on the Product, are V28°S Of the fa oduct are charged a Sales salaries and administrative dl TY Supervisor, wl Administrative Expense 36,000 Salar} Factory Oo ontrol- Control, laties are gy eon ‘aniChapter 3 Cost Accounting Cycle 63 5. Depreciation expense for the building is 6% per year. The office occupies one-tenth of the total building, and the factory operation is in the other nine- tenths. The depreciation expense for one month is recorded as follows: Factory Overhead Control 3,375 Selling and Administrative Expense Control 375 Accumulated Depreciation ~ Building 3,750 Depreciation for the portion of the building used for factory operations = 750,000 x 6% x 1/12 x 9/10; for the portion used by the office 750,000 x 6% x 1/12 x 1/10 6. Depreciation expense for machinery and equipment is 20% per year. All machinery and equipment is used in the factory for production purposes, so the depreciation expense is charged to Factory Overhead Control. Factory Overhead Control 2,500 Accumulated Depreciation - Mach. & Equipt. 2,500 7. The cost of heat, light, and power for the month was P3,000. Factory Overhead Control 2,700 Selling and Administrative Expense Control 300 Accounts Payable 3,000 The cost of heat, light, and power charged to Factory Overhead Control = 3,000 x 9/10 and charged to Selling and Administrative Expense = 3,000 x 1/10 8. Miscellaneous expenses for telephone, office supplies, travel, and rental of office furniture and equipment totaled P1,500 * Selling and Administrative Expense Control 1,500 Accounts Payable 1,500Cost Accounting 64 ing nization, but fe Many other expenses may be incurred bya Se See the month, Purposes of simplicity, it is assumed there are no other 4 ie accounts, the facts fier posting the joumal entries to the appropriate ledg: the next pa e) overhead account will reflect the following debits (as shown on the next pag Transaction Description Amount 2) Indirect materials 1,900 (4) Indirect labor 7,000 (5) Depreciation of building 3,375 (©) Depreciation of machinery and equipment 2,500 O) Heat, light, and power 2.700 Total P17,47 14. Factory overhead is charged to production at 85% Of direct labor cost: Work in Process 17,000 Factory Overhead Applica 17,000 The three elements of. manufacturing cost — di overhead ~ are now accumulated in Work in are as follows: irect mater ials, direct labor, and factory Process, and the debits in the account Transaction Transaction Athount (2) Direct materials ani (4) Direct labor P 40,000 (9) Factory overhead a Total P-77,000 15. Assuming that all goods started in Process have been f ara entry is recorded: inished, the following , Finished Goods . Work in Process 77,000 a 77,000 Assuming that 1,000 tables Were produced durin; the . The unit cost for each clement of manufacturing rca calent cost is 7 ee computation on the next page, Is calculated as in thChapter 3 Cost Accounting Cycle 65 Units Unit Total Produced Cost Direct materials P 40,000 1,000 P 40.00 Direct labor 20,000 1,000 20.00 Factory overhead 17,000 1,000 17.00 277,009 P_77..00 If the same type of table is produced in future periods, the unit costs of those periods can be compared with the unit costs determined above, and any difference can be analyzed so that management might take appropriate action. The unit cost also serves as a basis for establishing the selling price of the tables. After considering the anticipated selling and administrative expenses, a selling price can be established that should provide a reasonable profit. If management determines that a 40% gross profit percentage is necessary to cover the product's share of selling and administrative expenses and earn a satisfactory profit, the selling price per unit, rounded to the nearest cent, would be computed as follows: Manufacturing cost Gross profit (40%) Selling Price ‘To continue with the example, assume that the following transactions take place in January in addition to those already recorded 11. Costs of materials, utilities, and selling and administrative expenses paid amounted to P 34,000 Accounts Payable 34,000 Cash 34,000 12, 800 tables are sold to jobbers at a net price of P86,240 Accounts Receivable 86,240 Sales 86,240 Cost of Goods Sold 61,600 Finished Goods 61,600—_, 66 Cost Accounting 13. Cash totaling P55,000 is collected on accounts receivable Cash Accounts Receivable 55,000 55,000 The accounts in the general edger will Teflect the entries as follows: Cash Accounts Receivable Beg. 80,000 |3) 36,000 (12) 86,240 (1b) 55,000 (3) 55,000 11) 34,000 31,240 65,000 Materials Work in Process qa) 50,000 7) 41,500 (2) 40,000 ({L0) 77,000 8,100 (4) 20,000 ©) 17,000 Finished Goods Buildin (10) 77,000 {12) 61,600 Bes. 750.099 | 15,400 Accum. Depreciation-Buildin, — Accum. Depreciation-Building (S) 3,750 *n = Mach. & Equi —_—— eee Ty Stouts Payable : 34,000 } 50,000 3,000 (8) 1,500 20,500