Cost Accounting Lecture 102-Sept.

10, 2022

Senior high school subjects discuss the common types of business organizations. A service business
offers its service for a fee. A merchandising business buys finished goods for resale to customers. A
manufacturing business produces the products for sale to customers. This course Cost Accounting is
most applicable to a manufacturing business. There are three elements of costs to manufacture a
product. These are direct raw material cost, direct labor cost and manufacturing overhead. Direct
material cost and direct labor cost are prime cost while conversion cost is the total of direct labor cost
and manufacturing overhead.

Direct materials, also called raw materials, are those materials used in the manufacturing process that
become a significant part of the finished goods. It is identifiable to the finished product. Take note that a
finished product to one manufacturer is considered raw materials to another manufacturer. The cloth is
a direct material to manufacture a dress and wood or plywood is a direct material to produce a chair.

Direct labor costs are salaries or wages of employees who work directly with the raw materials in
converting them to finished goods. The salaries of cutter and sewer to produce a dress while the salary
or wage of a carpenter who assemble the parts to produce a chair are direct labor.

Manufacturing overhead are all costs incurred in producing the finished goods that can neither be
classified as direct materials or direct labor. Other accounting terminologies to describe this cost
classification are factory overhead, manufacturing expenses, or factory burden. Further this cost is sub-
categorized into indirect materials, indirect labor and other manufacturing overhead. To produce a
dress a dressmaker uses buttons, thread. To manufacture a chair a carpenter needs a helper to paint or
varnish the chair.

Indirect materials are factory supplies usually small in amounts used in the manufacturing process that
cannot easily be traced to specific products. Thread in manufacturing dresses and glue to assemble a
chair are just some examples of indirect materials. The preceding indirect materials formed part of the
finished product but there are factory supplies that are not identifiable to the finished product but are
necessary in the manufacturing process like lubricants for factory machineries and needle in the
dressmaking business.

Indirect labor pertains to wages of factory personnel who do not work directly on raw materials. The
wages and salaries of factory helpers, storeroom clerks, and factory supervisors are examples of indirect
labor costs.

Other manufacturing overhead includes depreciation of factory machineries; insurance on factory

INVENTORIES FOR A MANUFACTURING COMPANY

A manufacturing company has three distinct inventory accounts. These are Raw materials, Work in
Process, and Finished Goods. The balances of these inventory accounts at the end of the fiscal periods
are presented in the Current assets section of the Statement of Financial Position and in the Cost of
goods manufactured section of the Statement of Financial Performance for the period.

Raw Materials Inventory account reflects the costs of direct materials and factory supplies at year end
for the preceding and current periods. The beginning inventories are additions to costs for the period
while the ending inventories are deductions from total costs placed in process during the period. Once
direct materials are discharged from the storeroom for use in production, their costs are no longer part
of the raw materials inventory. Instead, these costs are then added to the work in process. In the same
way, the costs of factory supplies from the storeroom to the factory are charged to manufacturing
overhead. Significant amounts for both inventories may require two separate accounts.

Work in Process Inventory account represents the costs of direct materials, direct labor and
manufacturing overhead, which are partly finished goods or manufacturing process has begun but has
not been completed at the end of the fiscal period.

Finished Goods Inventory account represents the costs of goods that has been completed and are ready
for sale. This account is presented in the Statement of Financial Performance as Cost of goods
manufactured for the period.

SYSTEM OF COST ACCUMULATION

Manufacturing business either uses non-costing or costing method to determine unit cost of products
produced. Non-cost method uses physical count of raw materials and factory supplies unused at the
end of the fiscal year to compute raw materials used and manufacturing supplies charged to production.
This non-costing method is discussed in Basic Accounting course. The cost system charged to production
all the three elements of costs at actual cost or predetermined rate as needed and requisitioned by the
factory or as incurred.

COST SYSTEM

Cost accounting has three cost accumulation systems. They are Historical Cost System, Standard Cost
System and Normal Cost System.

Historical Cost is also called Actual Cost System, whereby all elements of cost to produce are charged to
production at actual costs as they are incurred and is determined only after the operation has been
completed. This system is the subject proper of this course.

Normal Cost System is a combination of Historical Cost System and Standard Cost System. This system
accumulated actual costs for direct materials and direct labor while the manufacturing overhead
charged to production is at pre-determined overhead rate. This system will be discussed in the
succeeding topic after the historical cost system.

Standard Cost System uses pre-determined rate for the elements of costs to produce. Under this system
standard unit cost for direct materials, direct labor and manufacturing overhead are computed in
advance before production. The finished good inventory is valued using standard costs rather than
actual costs. This system will be the subject of Cost Accounting 2.

TYPES OF COST SYSTEMS

Job order Cost System accumulates costs to produce when the finished product is specific or when
products are produced in jobs or lots of similar goods of varying quantities or types for a customer of for
stock. When production for a job order begins a pre-numbered job cost sheet is provided to
accumulate costs. The job cost sheet shows the total costs of the completed job. The cost per unit is
determined by dividing the total costs per job cost sheet by the number of units completed.
Manufacturers that produce furniture, dresses, curtains, shoes use job order cost system.

Process Cost System accumulates costs as manufacturing processes progress without any attempt to
allocate the cost as incurred to specific units of goods being manufactured. The unit cost of the
homogenous product is computed by dividing total accumulated costs by total units produced. For this
technique it is also called average costing. Cement, petroleum products, sardines, milk, juices, flour are
products produced using process costing.
Many types of business that use process costing, manufacturing consists of progressive series of distinct
operations or processes, which are carried out in successive departments. Unit cost is computed for
each department. The total costs to produce are determined by adding up the departmental costs.

WORK FLOW IN MANUFACTURING OPERATIONS

The steps in a cycle of operations of a firm using Job Order Costing are: Procurement, Production,
Warehousing and Selling. This cycle is in parallel with the flow of products through the manufacturing
operations.

Procurement: Materials and supplies needed for manufacturing are ordered, received, and stored.
Direct and indirect factory labor and services are obtained.

Production: Materials are requisitioned, withdrawn from the storeroom and delivered to the factory.
Labor tools, machines, power and other costs are applied to complete the product.

Warehousing: Completed goods are transferred from the factory to the warehouse until they are sold.

Selling: Customers are billed then merchandise is shipped from the warehouse to the showroom or
delivered to the residence of customers

The cost accountant’s job is to design a system of cost accumulation from procurement to completion
of the manufactured product as the work flows through the operating cycle.

RECORDING COSTS AS INCURRED

Procurement: Accounts are Materials, Factory payroll, Manufacturing overhead control

Production: Account is Work in process

Warehousing: Finished goods

Selling: Cost of goods sold