Prelim Day1 Overview of Cost Accounting 1. Definition

PRELIM
DAY1
OVERVIEW OF COST ACCOUNTING
1. Definition
-Cost accounting examines the cost structure of a business. It does so by collecting information
about the costs incurred by a company's activities, assigning selected costs to products and
services and other cost objects, and evaluating the efficiency of cost usage. Cost accounting is
mostly concerned with developing an understanding of where a company earns and loses money,
and providing input into decisions to generate profits in the future.
-Cost accounting is a source of information for the financial statements, especially in regard to the
valuation of inventory. However, it is not directly involved in the generation of financial statements.
2. Scope
Cost accounting addresses business expenditures, or sums that your company spends to operate its
infrastructure and provide customers with products and services. The cost accounting process
tracks variable costs, or expenditures such as materials and payroll that go directly into the
products and services you provide. Cost accountants also tally fixed costs, or other expenses such
as rent and utilities that do not change much regardless of sales volume.
3. Objectives
The objective of cost accounting is to document and understand the ways your business spends its
money. This process is important for tax purposes, so the returns you file accurately reflect your
company's expenses. Cost accounting information is also valuable for internal company operations,
giving you the tools to analyze trends and make strategic decisions. Calculating unit costs, or the
amount you spend to create each unit you sell, provides you with a benchmark for evaluating
overall profitability and break-even points.
4. Significance
The significance of cost accounting is its capacity to shed light on the overall profitability of
company operations. The better you understand the financial workings of your business, the better
you can fine-tune processes and limit unnecessary waste. Cost accounting allows you to look past
the day-to-day mechanics of managing cash flow to assess whether your company is actually
making money or whether you need to tighten systems and reassess priorities.
5. Relationships of Cost Acctg to Financial Acctg and Management Acctg
Internal users
(PRIMARY USERS)
Management: for analyzing the organization's

performance and position and taking appropriate
measures to improve the company results.
Employees: for
assessing
company's
profitability and its consequence on their future

remuneration and job security.
Owners: for
analyzing
the
viability
and
profitability of their investment and determining

any future course of action.
Accounting information is presented to internal users
usually in the form of management accounts, budgets,
forecasts and financial statements.
External users
(SECONDARY USERS)
Creditors: for determining the credit worthiness of the
organization. Terms of credit are set by creditors according to
the assessment of their customers' financial health. Creditors
include suppliers as well as lenders of finance such as banks.
Tax Authourities: for determining the credibility of the tax
returns filed on behalf of the company.
Investors: for analyzing the feasibility of investing in the
company. Investors want to make sure they can earn a
reasonable return on their investment before they commit any
financial resources to the company.
Customers: for assessing the financial position of its
suppliers which is necessary for them to maintain a stable
source of supply in the long term.
Regulatory Authorities: for ensuring that the company's
disclosure of accounting information is in accordance with the
rules and regulations set in order to protect the interests of the
stakeholders who rely on such information in forming their
decisions
COSTS AND COST CONCEPTS

6. Terminologies
COST- measurement in monetary terms of the amount of resources used for some purpose. When
notified by a term that defines the purpose, cost becomes operational. Ex. Selling cost, acquisition
costs etc.
- the value of money that has been used up to produce something, and hence is not available
for use anymore. In business, the cost may be one of acquisition, in which case the amount of
money expended to acquire it is counted as cost.
- In business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4)
time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and
delivery of a good or service. All expenses are costs, but not all costs (such as those incurred in
acquisition of an income-generating asset) are expenses.
COST POOL- is an accounting term that refers to groups of accounts serving to express the cost of
goods and service allocable within a business or manufacturing organization. It is a group of costs
associated with an activity.
- Examples of cost pools include factory rent, insurance, machine maintenance cost,
factory fuel, etc. Selection of cost pool depends on the cost allocation base used. For example if a
company uses just one allocation base say direct labor hours, it might use a broad cost pool such as
fixed manufacturing overheads. However, if it uses more specific cost allocation bases, for example
labor hours, machine hours, etc. it might define narrower cost pools.
COST OBJECT - Cost object is an item for which a business need to separately estimate cost.
Examples of cost object include a branch, a product line, a service line, a customer, a department, a
brand, a project, etc.
COST DRIVER - Cost driver is any variable that drives some cost. If increase or decrease in a
variable causes an increase or decrease is a cost that variable is a cost driver for that cost.
Examples:
o
Number of payments processed can be a good cost driver for salaries of Accounts Payable
section of accounting department
o
o
o
Number of purchase orders can be a good cost driver for cost of purchasing
department,
Number of invoices sent can be a good cost driver for cost of billing department,
Number of units shipped can be a good cost driver for cost of distribution
department, etc.
7. Nature, classification & Purpose of costs
Example
FOREVER 22 is a university caf owned and operated by a student. While it has plans for
expansion it currently offers two products: (a) tea & coffee and (b) shakes. It employs 2 people:
Mr. A, who looks after tea & coffee and Mr. B who prepares and serves shakes & desserts.
Its costs for the first quarter are as follows:
Mr. A salary
Mr. B salary
Rent
Electricity
16,000
12,000
10,000
8,000
Direct materials consumed in making tea & coffee

Direct raw materials for shakes
Music rentals paid
Internet & wi-fi subscription
Magazines
7,000
6,000
800
500
400
Total tea and coffee sales and shakes sales were $50,000 & $60,000 respectively. Number of
customers who ordered tea or coffee were 10,000 while those ordering shakes were 8,000.
The owner is interested in finding out which product performed better.
Solution
Salaries of Mr. A & B and direct materials consumed are direct costs which do not need any
allocation. They are traced directly to the products. The rest of the costs are indirect costs and
need some basis for allocation.
Cost objects in this situation are the products: hot beverages (i.e. tea & coffee) & shakes. Cost
pools include rent, electricity, music, internet and wi-fi subscription and magazines.
Appropriate cost drivers for the indirect costs are as follows:
Rent
Electricity
Music rentals paid
Internet & wifi subscription
Magazines
10,000
8,000
800
500
400
19,700
Number of customers
United consumed by each product
Number of customers
Number of customers
Number of customers
Since number of customers is a good cost driver for almost all the costs, the costs can be
accumulated together to form one cost pool called manufacturing overheads. This would simply
the cost allocation.
Total manufacturing overheads for the first quarter are $19,700. Total number of customers who
ordered either product are 18,000. This gives us a cost allocation base of $1.1 per customer
($19,700/18,000).
A detailed cost assignment is as follows:
Revenue
Costs:
Salaries
Direct materials
Manufacturing overheads allocated
Total costs
Profit earned
Tea & Coffee

50,000
Shakes
60,000
16,000
7,000
11,000
34,000
16,000
12,000
6,000
8,800
26,800
33,200
Manufacturing overheads allocated to Tea & Cofee = $1.110,000

Manufacturing overheads allocated to Shakes = $1.18,000
COST ACCOUNTING AND COST MANAGEMENT

EXERCISE 1
1. FOREVER 22 is a caf owned and operated by the newly passed CPAs. While it has
plans for expansion it currently offers two products: (a) tea & coffee and (b) shakes. It
employs 2 people: Mr. A, who looks after tea & coffee and Mr. B who prepares and serves
shakes & desserts.
Its costs for the first quarter are as follows:
Mr. A salary
Mr. B salary
Rent
Electricity
Direct materials consumed in making tea & coffee
Direct raw materials for shakes
Music rentals paid
Internet & wi-fi subscription
Magazines
Total tea and coffee sales and shakes sales were P50,000 & P60,000 respectively.
Number of customers who ordered tea or coffee were 10,000 while those ordering
shakes were 8,000.
The owner is interested in finding out which product performed better.
Required:
1.
2.
3.
4.
5.
6.
How
How
How
How
How
How
much
much
much
much
much
much
is the Direct Costs?

id the Indirect Costs?
MOH is allocated to Tea and coffee?
MOH is allocated to shakes?
is total production cost allocated to Tea and coffee?
is total production cost allocated to shakes?
2. Eastside Manufacturing produces small electric engines.

A. Identify the following costs as direct materials (DM), Direct labor (DL),
manufacturing overhead (MOH), or period cost (PC)
16,000
12,000
10,000
8,000
7,000
6,000
800
500
400
B. Indicate whether the cost is variable (V) or fixed (F) with respect to
behaviour.
A
[DM/DL/M
OH]
1. Commissions paid to sales people
2. Straight-line depreciation on the factory
building
3. Salary of the plant supervisor
4. Wages of the assembly-line workers
5. Machine lubricant(oil) used in production
activities
6. Engine casings used in production activities
7. Advertising placed in trade journals
8. Lease payments for the presidents
automobile
9. Property taxes paid on the factory facilities
B
[V/F]

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PRELIM

Management: for analyzing the organization's

profitability and its consequence on their future

profitability of their investment and determining

COSTS AND COST CONCEPTS

7. Nature, classification & Purpose of costs

Direct materials consumed in making tea & coffee

Tea & Coffee

Manufacturing overheads allocated to Tea & Cofee = $1.110,000

COST ACCOUNTING AND COST MANAGEMENT

is the Direct Costs?

2. Eastside Manufacturing produces small electric engines.

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