ACCOUNTING: NATURE AND SCOPE

Cost accounting is being discussed as applicable to manufacturing operations. This is not true.
Every type and kind of activity in which monetary value is involved should consider the use of
cost accounting concepts and techniques whether they are manufacturing, wholesale and retail
businesses, construction companies, banks and other financial institutions, transportation
companies, railroad, airlines, shipping companies, bus companies, schools, colleges and
universities, hospitals, government units or local and national levels, churches and welfare
organizations, all should employ cost accounting in order to operate efficiently.

Cost accounting is the art of determining the cost of a manufactured product or a service. While
originally developed as an outgrowth of financial accounting serving to supplement the regular
financial accounting system, today, it is identified with managerial accounting whose objective is
to advise management on current and future costs as an aid in control and decision making.

Objectives of Cost Accounting:

1. To establish inventory level values for costing and pricing purposes and at times, control
physical quantities;
2. To determine cost and profit for an accounting period
3. To develop methods and procedures that permit control and at the same time reduce and
improve costs.
4. To aid and participate in the creation and execution of plans and budgets for managements5.
To provide management with data necessary to effectively choose the best from among two
or more alternatives courses of action (decision making).

Related Fields cost accounting data cannot be collected by the cost accountant alone. It is the
joint responsibility of all those who have a need for cost data. The cost accountant must
anticipate the needs of those who use cost data and must present these in a way that the user
can understand. Those outside the accounting department should know what information they
can expect cost accounting will provide and understand how the cost accountant will go about
getting it.
The cost accountant must therefore work closely with the following departments:

A. Treasury - the treasurer uses the budgets and related accounting reports in order to
forecast cash and working capital requirements. The cost accountant supplies this information.

B. Financial Accounting - the cost accountant also works closely with the accountants in
financial accounting since cost information is generally integrated in the financial accounting
system.
In determining the cost of inventory, the cost accountant provides input for income
determination.
C. Production - Cost accountants work closely with production personnel to measure and
report manufacturing costs.Cost accounting measures the efficiency with which the production
department has scheduled and converted materials into finished units.

D. Engineering - In establishing standards for the quality and quantity of materials to be

used in production and for the direct and indirect labor hours required to produce each unit, the
engineering staff must sample materials and conduct time and motion studies on which to
develop the standards. Together, the cost accountant and the engineer translate these product
specifications into estimated cost of materials, labor and overhead.

E. Marketing - before the production schedule can be prepared, the marketing department
must develop sales forecasts. Cost estimates among other data supplied to marketing are used
to establish selling prices and sales policies.

F. Personnel - Cost accounting uses the wage rates and pay methods supplied by
personnel to the payroll department in computing the earnings of employees. Adequate labor
records must be maintained for legal and cost analysis purposes.

ROLE OF CONTROLLER AND COST ACCOUNTANT

The controller is responsible for establishing the cost accounting system to provide
management with appropriate analytical data and operating results. He is concerned with
internal reporting and external reporting to the public and to the government. As a member of
the controller's department, the cost accountant is responsible for accumulating product costs
and preparing accurate and timely reports to aid in evaluating and controlling company
operations.

CLASSIFICATION OF COSTS

Cost represents an expenditure (a monetary outlay or commitment to make such an outlay in

the future) to secure some form of benefit which may be in tangible for such as materials, or it
may take the form of a service such as wages, rent or power.

Cost classification is needed for the development of cost data that are useful to management.
Cost to make and sell = in a manufacturing concern, the total cost is divided into (1) factory
cost and (2) operating expenses.

a. Factory Overhead = is the sum of the cost of direct materials, direct labor and factory
overhead.
b. Operating Expenses:
1. Selling (Distribution or Marketing Expenses) covers the expenses of making
sales and delivering products.
 2.General (Administrative) covers expenses incurred in the direction, control and
administration of the company.
II. Costs in Relation to the Product =
Direct materials and direct labor are combined into another classification called Prime Costs.
Direct labor and factory overhead can be classified as Conversion Cost.

Direct Materials refers to all materials that form an integral part of the finished product and that
can be included directly in calculating the cost of the product.

Direct Labor is labor expended directly upon the materials comprising this finished product.
The cost of wages paid to skilled or unskilled workers alike that can be assigned to that
particular unit produced.

Factory Overhead or Manufacturing Overhead/manufacturing expenses or factory

burden refers to the cost of indirect materials, indirect labor and all other manufacturing
cost that cannot be classified either as direct materials or direct labor.

Indirect Materials refers to materials needed for the completion of the product but whose
consumption with regards to the product is either so small or so complex that it would be futile to
treat it as a direct material item. Examples are glue, thread, nails, tacks, rives. Factory supplies,
a form of indirect material, consists of lubricating oils, grease, cleaning rugs and brushes
needed to maintain the working area and factory in a workable and safe condition.

Indirect Labor labor expended which does not affect the construction or completion of the
finished product. The term includes the labor of foremen, shop clerks, general helpers, cleaners
and those employees engaged in maintenance work or other service work not directly related to
physical production.

III. Cost Related to Volume or Activity

Some costs vary directly in relation to changes in the volume of output (production), while
others, as they are incurred in relation to time, remain more or less fixed in amount. Unless a
cost system pays due regard to this distinction, cost accumulated and reported for planning the
company's strategy or for costing individual products or services will not be of significant value
to management.

Direct materials and direct labor are generally listed among the variable costs. Factory overhead
and non manufacturing costs must be examined with regard to items of a variable and fixed
nature.

Characteristics of Variable Costs:

 ● Variability of total amount in direct proportion to volume.
● Comparability constant per unit in the face of changing volume.
● Easy and reasonably accurate assignments to operating departments and
● Control of their incurrence and consumption by the reasonable department head

Characteristics of Fixed Costs:

● Fixed amount within a relative output range.
● Decrease of fixed cost per unit with increased output.
● Assignment to department often made by managerial decisions or cost allocation
methods; and
● Control for incurrence rests with top management rather than departmental supervisors
Some factory overhead items are semi variable in nature; that is, they vary with
production but not in direct proportion to the volume. Example, one foreman may be
sufficient to supervise effectively the work of three up to a certain number of workers in
production. With additional production requiring additional labor and working hours, a
second foreman will have to be added, a condition that will repeat itself at certain
intervals.
For practical purposes, it is desirable to resolve each semi-variable cost into variable
and fixed.

Costs Related to Departments

A factory is generally organized along departmental lines for production
purposes.

The departments of a factory are categorized into two:

● Producing Departments = whose costs may be charged to the product because they
have contributed directly to its production, such as: the machining, forming, upholstering or
assembling department,
● Service Department = one that is not directly engaged in production but renders a
particular type of service for the benefit of other departments. The costs incurred in the
operation of the service department represent a part of the total factory overhead that must be
absorbed in the cost of the product. Examples of manufacturing concerns are: receiving,
inspection, storeroom, maintenance, timekeeping, payroll, cost accounting, factory office,
cafeteria and plant protection.

Costs in Relation to Analyses for Decision Making:

A. Opportunity Costs = when managements is faced with the problem of abandoning one
product and substituting another, the decision will demand the consideration of opportunity
costs.
B. Sunk Costs = should a project be abandoned or capital costs never fully recovered a
company's management will face a cost situation.

VI. Costs in Relation to Persons Regulating them

A. Controllable Costs = are those costs which a person at any level of management can
regulate. Examples are labor cost and supplies used in a foreman's department are
associated with his responsible assignment
B. Non controllable Costs = costs that cannot be regulated. Examples are rent and
depreciation in equipment.

VIl. Cost in Relation to Time of Preparation

Cost can be determined after the event or before the event. Costs that are determined after the
event are called Historical cost or more often referred to as Actual Cost. They are based on
recorded data and are readily verifiable by events that have taken place. Actual Cost does not
denote a higher degree of accuracy nor is it used to describe the "correct" cost.

Predetermined costs are costs that are set up from the analyses and forecasts made before
the event and represent not what has happened but rather what is expected to happen or
someone's opinion on what should take place. They take many forms: Budgeted cost, estimated
costs, standard cost and normal cost.

VIII. Cost in Relation to Cost Accumulation Procedures

A. Job Order Cost System, the focal point of costing is a particular quantity of finished
product. Known as a job or lot. The cost of the raw materials, direct labor and factory overhead
applicable to each job is compiled and divided by the number of finished units to arrive at
average unit cost.

The cost of each order produced for a given customer of the cost of each lot to be placed in
stock is recorded on a summary sheet called a job order sheet or cost sheet. This master sheet
is designed to collect the cost of materials, labor and factory overhead applicable to a specific
job.

B. Process Cost System - the focal points in costing are the various departments or
processes in the production cycle.

● The cost of raw materials, labor and factory overhead applicable to each department or
process for a given period of time is complied.
● Then the average cost of running a unit of product through each department is
determined by dividing the total departmental cost by the number of units produced
during the period.
 ● When a product moves through two or more departments, the total unit cost of the
finished product is built up by tracing the costs incurred in each department to the
product as it moves from process to process.
●
Each kind of cost system (job order and process) has advantages in particular manufacturing
situations. Both are widely used; sometimes a combination of the two systems is found within
the same product.
Actual Cost System
Cost findings or cost determination involves systems and procedures which lead to accounting
entries and summary reports designed to enable management to control the cost of materials,
labor and factory overhead.

Management must decide as to the type of costs to be collected. Basically, three types of
systems can be followed:

ACTUAL COST SYSTEM - actual product cost for labor, materials and overhead are
accumulated. Overhead is distributed to products on the basis of actual overhead expenses
incurred. This method of allocating factory overhead is difficult to accomplish promptly and
accurately because a time lag exists between the completion of the products and the
recognition of the overhead. Furthermore, it is difficult to trace actual overhead to specific
products.

CHARACTERISTICS
● Factory supplies and selling supplies are charged to expense upon purchase.Unused
supplies are determined by physical count at the end of the period.
● Inventories for raw materials, work in process and finished goods are determined by
physical count at the end of the period.
● Purchases of raw materials are recorded in the books at gross amounts. Purchase
discounts are recorded when availed.
● Since periodic inventory is used, taking and pricing inventories is oftentimes a difficult
and time consuming task.
● Raw materials and factory supplies lost from theft, shrinkage, wastage are undisclosed
and simply absorbed in the cost of manufactured accounts.
● Losses on finished goods are concealed in the cost of sales account.
● Calculation of the work in process reflects a very crude estimate.
● Due to lack of detailed information, frequent preparation of financial statements is
unlikely if not impossible.
● The system has as its goal the determination of the total cost of goods manufactured
during the period.
● It is usually adopted by small to medium size manufacturing companies.
While both the direct materials and direct labor can be specifically identified with individual jobs,
it is difficult and often impossible to identify factory overhead costs with specific jobs. When
actual overhead costs are allocated, all overhead items are charged to factory overhead control
and at the end of the month, the total amount allocated to work in process is based on direct
labor cost or direct labor hours.

Then actual overhead costs are allocated to production, there are always delays in product
costing because of the need to wait until after the end of the month to determine actual
overhead costs.
NORMAL COST SYSTEM - factory overhead is allocated to products on a predetermined basis
rather than on an actual basis. Actual overhead data are still accumulated, but overhead is
estimated and allocated to products as the products are completed rather than when actual
overhead costs are collected. At the start of the accounting period, a predetermined overhead
rate is computed which is rate at which overhead costs are allocated toi the unit of produced
during the period, periodic comparison are made between the amount of overhead allocated to
products and the actual amount incurred any difference called "variance" are handled through
an adjustment to the cost of sales.

STANDARD COST SYSTEM - both actual and predetermined labor, material and overhead
cost are collected and reported.. It is different from the two systems because it establishes a
predetermined cost for materials for materials and labor and overhead.
By determining all cost elements, management can calculate a standard cost per unit and actual
cost per unit. This system is beneficial to management in planning and control in general and in
product and pricing.