Principles of Cost

Accounting
Introduction to Cost Accounting
The Need for Cost
Accounting
 Cost accounting provides the detailed cost
data that management needs to control current
operations and plan for the future.
 Companies must control costs in order to keep
prices competitive.
 In today’s global environment, cost information
is more crucial than ever in remaining
competitive.
Types of Businesses That
Use Cost Accounting
 Manufacturers (Ford, General Motors)
 Merchandisers (WalMart, Kmart)
 Wholesalers (Beverage Distributors)
 For-profit Service Businesses (CPAs,
Attorneys)
 Not-for-profit Service Agencies (United
Way, Red Cross)
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.
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.
Determining Product
Costs 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.
Planning and Control
 Planning is the process of establishing
objectives or goals for the firm and
determining the means by which the firm will
attain them. 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.
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.
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.
Reporting

 Cost and production reports for a cost

center reflect all cost and production data
identified with that center.
 The performance report will include only
those costs and production data that the
center’s manager can control.
 A variance is the favorable or unfavorable
difference between actual costs and
budgeted costs.
Performance Report
Example
Renaldi’s Restaurant
Performance Report
September 30, 2006
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
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
Cost Accounting vs.
Financial and Managerial
Accounting Cost Accounting System

Characteristics Financial Accounting Managerial Accounting

Users: External Parties

•External
•Managers Managers
Focus: Entire business Segments of the business
Uses of Cost Information: Product costs for Budgeting
•Budgeting
calculating cost of goods Special decisions such as
•Special
sold and finished goods, make or buy a component,
work in process, and raw keep or replace a facility,
materials inventory using and sell a product at a
historical costs and GAAP. special price.
Nonfinancial information
•Nonfinancial
such as defect rates, % of
returned products, and on-
time deliveries
Cost Accounting vs.
Financial and Managerial
Accounting (cont.)
 Cost accounting
includes those parts
of both financial and
management
accounting that
collect and analyze
cost information.
Cost of Goods Sold

Merchandiser Manufacturer
Beginning merchandise Beginning finished goods
inventory inventory

Plus purchases Plus cost of goods

manufactured
Merchandise available for sale
Finished goods available for
Less ending merchandise sale
inventory Less ending finished goods
Cost of good sold inventory
Cost of good sold
Inventories

 Most manufacturers maintain a perpetual

inventory system that uses FIFO, LIFO, or
moving average methods of costing.
 An inventory ledger is maintained to provide
support for the control accounts.
 Some manufacturers may use a factory
ledger, which contain all of the accounts
relating to manufacturing.
Inventories
Merchandiser Manufacturer
Current assets:
Current assets:
Cash
Cash Accounts receivable
Accounts receivable Inventories:
Finished goods
Merchandise Work in process
inventory
Materials
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.
 Prime Cost and
Conversion Cost

Direct Materials
Elements Prime Cost
Direct Labor
of Cost Conversion
Factory Overhead Cost
Flow of Manufacturing
Costs

Direct Materials
Work in Process Finished Goods Cost of Goods Sold
Direct Labor
(Assets) (Assets) (Expenses)
Factory Overhead
Illustration of Accounting
for Manufacturing Costs
 Materials xx  Factory Overhead (Utilities) xx
 Accounts Payable xx  Selling & Admin Exp (Utilities) xx
 Work in Process (Direct Materials) xx  Accounts Payable xx
 Factory Overhead (Indirect Materials) xx  Selling & Admin Exp xx
 Materials xx  Accounts Payable xx
 Payroll xx  Work in Process xx
 Wages Payable xx  Factory Overhead
 Wages Payable xx xx
 Cash xx  Finished Goods xx
 Work in Process (Direct Labor) xx  Work in Process
 xx
Factory Overhead (Indirect Labor) xx
 Accounts Payable xx
 Selling & Admin Exp (Salaries) xx
 Cash xx
 Payroll xx
 Accounts Receivable xx
 Factory Overhead (Depr. Bldg) xx
 Sales xx
 Selling & Admin Exp (Depr. Bldg) xx
 Cost of Goods Sold xx
 Accum. Depr. – Bldg xx
 Finished Goods
 Factory Overhead (Depr. Mach & Eq) xx
xx
 Accum. Depr. – Mach & Eq xx
 Cash xx
 Accounts Receivable xx
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.
Job Order Cost System

Direct Materials Work in Process Finished Goods

Direct Labor Account Account
Factory Overhead

Job Cost Sheets

Process Cost System

Work in Process
Work in Process
Dept. 2 Finished Goods
Dept. 1

Direct Direct Direct Direct

Materials Labor Materials Labor

Factory Factory
Overhead Overhead
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.
Appendix
Standards of Ethical Conduct for
Management Accountants
 Members of the IMA 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
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 problems with the immediate superior except
when it appear that the superior is involved.
2. Clarify relevant ethical issues by confidential discussion
with an objective advisor.
3. Consult your own attorney as to legal obligations and
rights concerning the ethical conflict.