Copy Cost Accting-1

Cost and Management Accounting-I
Unit 1
Introduction to Cost and Management Accounting
Learning Objectives:
At the end of this unit lesson, you will be able to:
1. Explain the role of accounting in decision making;

2. Identify the relationship between accounting and management process;
3. Differentiate among cost accounting, management accounting and financial accounting;
4. Distinguish accounting system from any other systems;
5. Distinguish the position of management accounting in an organization;
6. State the use of management and cost accounting in service and not for profit
organizations;
7. Apply a code of conducts to management accountants.
1.1. Basics of Accounting
Dear learner, let’s start from your prior understanding of accounting. What is accounting? I hope
you remember the definition of accounting from the lesson of your perquisite course “Principles
of Accounting”. Accounting can be defined as the process of identifying, measuring, recording,
classifying, summarizing, and communicating or reporting financial information to users or
interested parties to make sound decisions. This information is primarily financial and generally
stated in monetary terms. Accounting, then, is a measurement and communication process used
to report on the activity of profit-seeking business organizations and not-for-profit organizations.
As a measurement and communication process for business, accounting supplies information that
permits informed judgments and decisions by users of the data. In general, the basic purpose of
accounting information is helping users to make more informed and better decisions.
How do you classify the users of accounting information? The users of accounting information are
internal users (managers at different levels who may use such information for routine operations
and non routine decisions) as well as external users. In business organizations, management is
entrusted with the responsibility of using available resources as effectively and efficiently as
possible to accomplish organizational objectives. To this end, managers must make decisions
regarding desirable organizational objectives, resource utilization and personnel effectiveness.
1.2. The Management Process and Accounting
What is the relationship between management process and accounting? The purpose of
management has been described as making people capable of joint performance through
common goals, common values, the right structure, and providing the training and development
they need to perform and to respond to change. The central purpose, then, of the management
process is to secure, as it faces change, the vitality and endurance of an organization through the
ongoing co-ordination of activities, efforts and resources.
The management process can be defined as a series of activities in a cycle of planning and control.
It summarizes the major activities performed by management in leading an organization. Thus,
the management process as cycle generally involves the following activities.
1. Setting organizational objectives.
2. Formulating an operating plan.
3. Implementing the plan & monitoring the action on a day- to –day basis.
4. Measuring results and
5. Evaluating the results to see if the plan was properly implemented & the objectives of the
organization are being accomplished.
Decision making is the core of the management process. It is a purposeful choice from among a
set of alternative courses of action designed to achieve specific objective. It is the core of the
management process. Decisions range from routine (e.g., making daily production schedules) to
the non-routine operations (e.g., launching a new product line). The necessary reports required for
those decisions are the end product of accounting system. Decisions within an organization are
often divided into two types: Planning decisions and Control decisions.
1. Planning - refers to setting objectives and outlining how they will be attained. Thus planning
provides answers to two questions: What is desired and when and how is it to be
accomplished? And accounting formalizes plans by expressing them as budgets. A budget is a
quantitative expression of a plan of action. It is also an aid to coordinating and implementing
the plan.
2. Controlling - is a managerial activity of monitoring a plan of implementation and taking
corrective action as needed. It also refers to implementing plans and using feedback to attain
objectives. Feedback is crucial to the cycle of planning and control. Accounting formalizes
control by presenting performance reports, which provide feedback by comparing results with
plans and highlighting variances. Planning determines action; action generates feedback, and
feedback influences further planning. Timely and systematic reports provided by the internal
1 Addis Ababa University/School of Commerce/ Department of Accounting & Finance

accounting system are the chief source of useful feedback. None of this cycle would be
possible without accounting.
Performance reports - stimulate investigation of exception items for which actual amounts differ
significantly from budgeted amounts. Operations are then brought into conformity with the plans,
or the plans are revised this is often called management by exception. Management by exception
means concentrating on areas that deviate from the plan and ignoring areas that presumed to be
running smoothly. Thus the management-by- exception approach frees managers from needless
concern with those phases of operations that are adhering to plans.
Accounting Information - is the basis for each management activity. It is the basis for identifying
organizational objectives and developing an annual budget. The accounting process measures the
results of operations and compares them to the budget. The difference between the two helps
management to identify areas of business where corrective action is required. Business managers
are charged with business planning, controlling, and decision making. As such, they may desire
specialized reports, budgets, product costing data, and other details that are generally not
reported to external parties. Let us see how accounting assists those management activities.
Activity 1
Answer the following questions.
1. How does accounting assist the management of an organization?
2. Briefly explain the planning and control functions in management accounting. How are these
two activities linked to each other?
1.3. Essentials of Accounting System
Can you differentiate accounting system from any other systems? A System is a set of two or more
interrelated components that interact to achieve a goal. Systems are almost always composed of smaller
subsystems, each performing a specific function important to and supportive of the larger system of which
it is a part.
Every organization needs good records that show, where its money comes from; where it goes;
and how the organization is performing financially. The system used for this purpose is called an
accounting system or accounting information system (AIS). Reports on how the organization has
performed and how it stands financially are the end products of an accounting system. You obtain
these financial statements by summarizing the detailed data entered whenever an event occurs
that has an effect on the organization’s financial situation.
An accounting system consists of people, procedures and information technology. It may be

defined as the combination of personnel, records and procedures that a business uses to meet its
need for financial data. It performs three important functions in any organization.
1. It collects and stores data concerning activities and transactions so that the organization can
review what has happened.
2. It processes data into information that is useful for making decision that enable
management to plan, execute and control activities.
3. It provides adequate controls to safeguard the organization’s assets, including its data.
These controls ensure that the data is available when needed and that it is accurate and
reliable.
A good accounting system helps an organization achieve its goals and objectives by helping
to answer three types of questions.
1. Scorekeeping: Am I doing well or poorly? Scorekeeping is the accumulation and

classification of data. This aspect of accounting enables both internal and external parties
to evaluate organizational performance. Examples: Daily recording of material purchase
vouchers, Posting daily cash collections to customer's accounts, allocating factory service
department costs to production departments, Recording overtime hours of the Product
finishing department, Recording overtime hours of the Product finishing department,
etc.
2. Attention directing: Which problems should I look into? Attention directing means
reporting and interpreting information that helps managers to focus on operating
problem, imperfections, inefficiencies and opportunities. This aspect of accounting helps
managers to concentrate on important areas of operations promptly enough for effective
action. Examples: Preparing a report of overtime labor costs by production departments,
Interpreting increases in nursing costs per patient-day in a hospital, Analyzing deviations
from the budget of the factory maintenance department, Compiling data for a report
showing the ratio of advertising expenses to sales for each branch store, Investigating
reasons for increased returns and allowances for purchases, etc.
3. Problem solving: Of the several ways of doing a job, which is the best? The problem
solving aspect of accounting quantifies the likely results of possible courses of action and
often recommends the best course to follow. Problem solving is commonly associated
with nonrecurring, non-routine decisions, situations that require special accounting
reports. Examples: Analyzing the costs of acquiring and using each of two alternate types
of equipment, Estimating the costs of moving corporate head-quarters to another city,
Assisting in a study to determine whether to buy or make certain parts for manufacturing
products, etc.

Notes:
1. The scorekeeping and attention- directive uses of information that closely relate the
same information may serve as a scorekeeping function for a manager and an attention-
directing function for the manager's superior. (e.g. performance reports)
2. Sometimes all three facets of accounting overlap, making it difficult to classify a
particular accounting task as a scorekeeping, attention directing, a problem-solving task.
Nevertheless, attempts to make these distinctions provide insight into the objectives and
tasks of both accountants and managers
What are the two key issues to be considered in designing an accounting system? Managers should
keep two basic ideas in mind when designing accounting systems: Cost benefit balances and
behavioral implications.
1. Cost Benefit Philosophy- It states that the aggregate benefit should exceed the total cost of
maintaining the system. Weighting estimated cost against probable benefits is the primary
consideration in choosing among accounting systems and methods.
2. Behavioral Consideration- It states that the people who operate the system should be
convinced and accept the system. It also requires that the system must provide accurate and
timely budgets and performance reports in a form useful to managers.
Activity 2
1. Discuss the cost-benefit approach guideline management accountants use to provide value in
strategic decision making.
2. Discuss the potential behavior implications of performance evaluation.
1.4. Management Accounting, Financial Accounting and Cost Accounting
Can you differentiate among Management Accounting, Financial Accounting and Cost Accounting?
According to the Chartered Institute of Management Accountants (CIMA), Management
Accounting is "the process of identification, measurement, accumulation, analysis, preparation,
interpretation and communication of information used by management to plan, evaluate and
control within an entity and to assure appropriate use of and accountability for its resources. It
also comprises the preparation of financial reports for non-management groups such as
shareholders, creditors, regulatory agencies and tax authorities. Management accounting
measures, reports financial and non financial information that managers use to make decisions so
as to achieve organizational goals. It includes both historical and estimated data that
management uses to manage day-to-day operations and plan the future. Management accounting

is wider in scope and overlaps with financial accounting to the extent that management uses the
financial statements in directing current operations and planning the future. Management
accounting focuses on internal reporting, and the reports of management accounting are not
strictly governed by GAAP as they are meant for internal purposes only. The ruling criterion in
management accounting is cost benefit analysis instead of generally accepted accounting
principles. The end products of management accounting are tools of managerial planning and
control.
Exhibit 1.1 Comparison of Management Accounting and Financial Accounting

Criteria Management Accounting Financial Accounting
Purpose of Help managers make decisions to fulfill Communicate organization’s
information an organization’s goals financial position to investors,
banks, regulators, and other
outside parties
Primary users Managers of the organization External users such as investors,
banks, regulators, and suppliers
Focus and Future-oriented (budget for 2011 Past-oriented (reports on 2010
emphasis prepared in 2010) performance prepared in 2011)
Rules of Internal measures and reports do not Financial statements must be
measurement have to follow GAAP (IFRS) but are based prepared in accordance with
and reporting on cost-benefit analysis GAAP and be certified by external,
independent auditors
Time span and Varies from hourly information to 15 to Annual and quarterly financial
type of 20 years, with financial and nonfinancial reports, primarily on the company
reports reports on products, departments, as a whole
territories, and strategies
Behavioral Designed to influence the behavior of Primarily reports economic events
implications managers and other employees but also influences behavior
because manager’s compensation
is often based on reported
financial results
Financial Accounting is the process of identifying, measuring, recording, analyzing, summarizing

and communicating (reporting) financial information to external users to make sound decisions. It
is directly related to external reporting because it provides investors and other outsiders with the
financial information they need for decision making. It is constrained by generally accepted
accounting principles. These principles restrict the set of revenue and cost measurement rules and
the types of items that are classified as assets, liabilities, and owners’ equity in balance sheet. In

contrast, management accounting is not restricted to those accounting principles acceptable for
financial reporting. For example, a consumer products company may present a particular
estimated “value” of a brand name (such as the Coca-Cola brand name) in its internal financial
reports for marketing, although doing so is not in accordance with generally accepted accounting
principles. Financial accounting takes a historical perspective. The reports it generates focuses on
what has happened in the past. In contrast, management accounting emphasizes the future,
providing budgets and other future projections in addition to historical reports. Both
management and external parties share an interest in accounting information but the emphasis
differ. Internal reporting focuses on management planning and controlling. This area is known as
management accounting, focusing on internal customers, measures and reports financial and
other information that assists managers in fulfilling goals of the organization.
Cost Accounting is part of the accounting information system that records, measures, and reports
information about costs. It is concerned with identifying, measuring and reporting the cost of
acquiring or consuming resources by an organization. It records, classifies and summarizes costs
for determination of costs of products or services, planning and controlling and furnishing of
information to management for decision making. As a form of management accounting, cost
accounting need not to follow standards such as Generally Accepted Accounting Principles
(GAAP) because its primary use is for internal managers, rather than outside users, and what to
compute is instead decided pragmatically. Every business operates with the motto of making
profit for its owners, which is revenue generated less cost of producing that revenue; the higher
the operational costs are the lesser the profit, and the lesser the costs are the higher the profit.
Thus, managers keep an eye on costs to count their successes. It is accounting that supplies the
tool that management needs to monitor cost. Cost information is, thus, very essential for
managers to make decision that contributes to the profitability of the organization they are
managing.
Exhibit 1.2 Comparison of Cost Accounting and Management Accounting
Criteria Cost Accounting Management Accounting

Applicability It is generally applicable to Its methods and techniques are
manufacturing concerns applicable to all concerns
Accounting Principles It is used in accordance with It is not constrained by GAAP
GAAP (IFRS). Double entry (IFRS). Double entry accounting
accounting principles can be principles are not applied in the
applied in CA. case of MA
Future Activities It does not attach importance to It is primarily concerned with
future activities. future activities.

Cost accounting is indistinguishable from management accounting. Thus it interfaces with both
managerial and financial accounting. The major purpose of cost accounting is to record, classify,
accumulate and allocate the costs of company's products and services. This product costing is
useful to managers for instance in setting prices. And it is also useful for inventory valuation and
income determination (external purposes). Viewed from this angle, cost accounting is a part of
management accounting plus a part of financial accounting.
Data provided by the cost accounting function have a variety of uses, some of which serve the
controllership function as well as the manufacturing function.
1. Guide to business policy - Cost data provides guidelines for various managerial decisions like
make or buy special sales orders, utilization of idle plant capacity, introduction of a new
product, etc. Cost accounting plays an important role in providing the information needed for
such decisions.
2. Cost Control- It aims at improving efficiency by controlling and reducing cost. This objective is
becoming increasingly important due to growing competition. Cost control is exercised by
creating a series of budgets annually to project business activity anticipated during the coming
year. The budget is the principal tool by which members of management measure where they
have been, where they are now, and where they are going. Changing conditions, such as a
radical increase or decrease in the business, can render some of the budgets obsolete. In such
cases the budget is revised or replaced by a forecast.
3. Cost Estimating and Price Setting- In a business where the price of a product is based upon its
estimated cost, cost accounting plays a vital role in ensuring that an accurate estimate is
prepared. Direct material and labor hours are generally supplied by engineering. Cost
accounting takes these data and ads anticipated variances based upon historical performance
of similar products to arrive at a selling price. Cost accounting is also responsible for using the
proper labor rates, taking into consideration anticipated inflationary factors resulting from
fluctuations in the economy. Other items, such as overhead and engineering, are generally
added by cost accounting.
4. Ascertainment of cost: - this is the primary objective of cost accounting and involves different
techniques and systems under different circumstances.
To be more specific, cost accounting can help management achieve the following:
1. Formulating and implementing plans and budgets that motivate employees toward the
achievement of company goals.
2. Establishing cost tracking methods that allow control of operations, cost savings, and
improvements in quality.

3. Controlling inventory cost, minimizing inventory investment, and determining the cost of
each product or service.
4. Pricing products and services in ways that are congruent with organizational goals.
5. Making prudent decisions that impact both short-term and long-term revenues and expenses.
State-of-the-art cost accounting in today's competitive global marketplace does not resemble the
cost accounting systems in place two decades ago. Production automation has grown at a rapid
pace as efficient production processes have become the real economic comparative advantage of
the late 20th and early 21st centuries. Production technology includes the use of robotics and
computers to perform the tasks executed by humans in decades past. Tracking the costs of these
technologies along with their effect on overhead costs is a major challenge of today's cost
accountant. Technology and a new type of cost accounting called activity based costing, have
allowed cost accountants to directly trace more costs to particular jobs or batches of products,
thereby lowering the amount of estimating used to put a cost on overhead costs consumed.
Other changes in production technology that have affected cost accounting practices include just-
in-time (JIT) production and computer-integrated manufacturing.
Technological changes and management innovations are drastically changing the nature of costs.
Many technologically advanced companies have lower inventory levels, use less labor, and often
experience increasing levels of fixed costs. These developments are interesting and exciting, but
they are also challenging cost accounting systems to provide reliable, useful information, data
that can be used to keep a company efficient and, most of all, competitive in the global market.
Activity 3
Answer the following question.
1. Describe management accounting and financial accounting.
2. Briefly describe how managers make use of management accounting information.
1.5. The Position of Management Accounting in the Organization
What is the position of management accounting in an organization? To assist other managers in

the decision making vital to an organization’ s success , most companies (and many not for profit
organizations and government agencies) employ a variety of accounting personnel with various
types of authority and responsibility such as managerial accountants, cost or industrial
accountants, tax accountants, financial vice president, controller, Treasurer , budget officers,
account clerks and the like. Distinction is made between line and staff positions in most
organizations.

Exhibit 1.3 Typical Organizational Structure and the Management Accountant
Line position refers to the positions that are directly responsible for conducting the basic
activities of an organization. It implies the authority exerted downward over subordinates called
line authority and the departments are called line departments. The managers in line positions are
the ones who set policy and make the decisions that impact production. E.g. Sales and production
executives and their subordinates fill line roles.
Staff position refers the positions whose principal task is to support or service the line
departments. It implies the authority to advice but not command called staff authority and may
be exerted downward, laterally or upward. The top accounting officer of an organization and
everyone in an accounting function fill a staff role. The accounting department including cost
accounting department does not exercise direct authority over line departments but provides
other managers with specialized services including advice and help in budgeting, analyzing
variances, pricing, and making special decisions
Although management accountants, such as controllers & cost accounting managers, may have
considerable influence in the organization, they have no authority, over the managers in

production area. Controller (Comptroller) is the top accounting officer of an organization holds
delegated authority from top line management. In theory, controllers have no line authority
except over the accounting department. Yet, by reporting and interpreting relevant data,
controllers do exert a force or influence that leads management toward logical decisions that are
consistent with the organizations objectives.
Exhibit 1. 4 Structure of Accounting Function in atypical Organization
Chief Financial Officer (CFO)
Controller Functions Treasurer Functions
 Provision of capital
 Planning for control
 Investor relations
 Reporting and interpreting
 Short-term financing
 Evaluating and consulting
 Banking and custody
 Tax administration
 Credits and collections
 Government reporting
 Investments
 Protection of assets
 Risk management
 Economic appraisal
(insurance)
1.6. Management & Cost Accounting in Service & Not for Profit Organizations
Do you think that management and cost accounting are practiced in service and not for profit
organizations? How? The basic ideas of cost accounting were developed in manufacturing
organizations. These ideas, however, have evolved so that they apply to all types of organizations
including service organizations. Service organizations, for our purposes, are all organizations
other than manufacturers, wholesalers and retailers. Public accounting firms, law firms,
management consultants, real estate firms, transportation companies, banks, insurance
companies, and hotels are profit-seeking service organizations.
The characteristics of both profit-seeking and nonprofit service organizations include the
following: Labor Intensive; Output is usually difficult to define and Major inputs and outputs
cannot be stored.
Almost all not for profit organizations, such as hospitals, schools, libraries, museums, and
government agencies, are also service organizations. Managers and accountants in not for profit
organizations have much in common with their counterparts in profit-seeking organizations.
There is money to be raised and spent. There are budgets to be prepared and control systems to
be designed and implemented. There is obligation to use resources wisely. If used intelligently,

accounting contributes to efficient operations and helps nonprofit organizations achieve their
objectives.
Simplicity is the motto for installation of systems in service industries and not for profit
organizations. In fact, many professionals such as physicians, professors or government officials
resist even filling out a time card. In fact, simplicity is a fine slogan for the design of any
accounting system. Complexity tends to generate costs of gathering and interpreting data that
often exceed prospective benefits.
Activity 4
1. Is financial accounting or management accounting more useful to an operation manager? Why?
2. What areas of responsibility does a chief financial officer have in a typical organization?
1.7. Standards of Ethical Conduct for Management Accountants
Is there any code of conduct to be adhered by management accountants? Practitioners of

management accounting and financial management have an obligation to the public, their
profession, the organization they serve, and themselves to maintain the highest standards of
ethical conduct. In recognition of this obligation, the Institute of Management Accountants
(IMA)-the largest association of management accountants in the United States – provides a
program leading to the Certified Management Accountants (CMA) certificate has promulgated
the following standards of ethical conduct for practitioners of management accounting.
Adherence to these standards, both domestically and internationally, is integral to achieving the
Objectives of Management Accounting. Practitioners of management accounting shall not
commit acts contrary to these standards, nor shall they condone the commission of such acts by
others within their organizations.
IMA STATEMENT OF ETHICAL PROFESSIONAL PRACTICE

Practitioners of management accounting and financial management shall behave ethically. A
commitment to ethical professional practice includes overarching principles that express our
values and standards that guide our conduct.
PRINCIPLES
IMA’s overarching ethical principles include: Honesty, Fairness, Objectivity, and Responsibility.
Practitioners shall act in accordance with these principles and shall encourage others within their
organizations to adhere to them.

STANDARDS
A practitioner’s failure to comply with the following standards may result in disciplinary action.
COMPETENCE
Each practitioner has a responsibility to:
1. Maintain an appropriate level of professional expertise by continually developing knowledge
and skills.
2. Perform professional duties in accordance with relevant laws, regulations, and technical
standards.
3. Provide decision support information and recommendations that are accurate, clear, concise,
and timely.
4. Recognize and communicate professional limitations or other constraints that would
preclude responsible judgment or successful performance of an activity.
CONFIDENTIALITY
1. Keep information confidential except when disclosure is authorized or legally required.
2. Inform all relevant parties regarding appropriate use of confidential information. Monitor
subordinates’ activities to ensure compliance.
3. Refrain from using confidential information for unethical or illegal advantage.
INTEGRITY
1. Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid
apparent conflicts of interest. Advise all parties of any potential conflicts.
2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
3. Abstain from engaging in or supporting any activity that might discredit the profession.
CREDIBILITY
1. Communicate information fairly and objectively.
2. Disclose all relevant information that could reasonably be expected to influence an intended
user’s understanding of the reports, analyses, or recommendations.
3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls in
conformance with organization policy and/or applicable law.

1.8. Resolution of Ethical Conflicts

In applying the standards of ethical conduct, practitioners of management accounting and
financial management may encounter problems in identifying unethical behavior or in resolving
an ethical conflict. When faced with significant ethical issues practitioners of management
accounting and financial management should follow the established policies of the organization
bearing on the resolution of such conflict. If these policies do not resolve the ethical conflict,
such practitioner should consider the following course of action.
1. Discuss such problems with the immediate superior except when it appears that superior is
involved, in which case the problem should be presented to the next higher managerial level;
2. If a satisfactory resolution cannot be achieved when the problem is initially presented, submit
the issue to the next higher managerial level. If the immediate superior is the chief executive
officer or equivalent, the acceptable reviewing authority may be a group such as the audit
committee, executive committee, board of directors, board of trustees, or owners. Contact
with a level above the immediate superior should be initiated only with the superior’s
knowledge, assuming the superior is not involved. Except where legally prescribed,
communication of such problems to authorities or individuals not employed or engaged by
the organization is not considered appropriate;
3. Clarify relevant ethical issues by confidential discussion with an objective adviser to obtain a
better understanding of possible course of action. Consult your own attorney as to legal
obligations and rights concerning the ethical conflict;
4. If the ethical conflict still exists after exhausting all levels of internal review, there may be no
other recourse on significant matters than to resign from the organization and to submit an
informative memorandum to an appropriate representative of the organization. After
resignation, depending on the nature of the ethical conflict, it may also be appropriate to
notify other parties.
Activity 5
1. List the four standards of ethical conduct for management accountants. For each standard, give
an example that demonstrates compliance with that standard.
2. You have been employed as an entry-level management accountant for a little under a year. You
suspect that your immediate supervisor is involved in a significant fraud involving diverting of
company assets to personal use. Briefly describe the steps you might take to resolve this dilemma.

Self Assessment Question-1

Dear learner, if you understood this unit very well, attempt the following questions and evaluate
yourself against the answers given at the end of this unit.
Part I: Multiple Choice Questions

Choose the best answer among the given alternatives.
1. What is the criterion for the preparation of managerial accounting reports?
A. Relevance of the reports D. Cost of the reports
B. Meet the manager needs E. All of the above
C. Timing of the report F. None of the above
2. Which one of the following is constrained by generally accepted accounting principles (GAAP)?
A. Management Accounting D. Management process
B. Financial Accounting E. All of the above
C. Cost Accounting F. None of the above
3. All of the following employees hold line positions in the given organization except:
A. Vice president of production D. Vice president of marketing
B. Manger of the production E. All of the above
C. Vice president of finance F. None of the above
4. Which one of the following characteristics does not indicate the difference between
management accounting and financial accounting?
A. Freedom of Choice D. Origin of the field of study
B. Behavioral implications E. All of the above
C. Time focus F. None of the above
5. Management accountants have a responsibility to:
A. Maintain an appropriate level of professional competence by ongoing development of
their knowledge and skills.
B. Avoid actual or apparent conflict of interest and advise all appropriate parties of any
potential conflict.
C. Refrain any gift, favor or hospitality that would influence or would appear to influence
their actions.
D. Refrain from disclosing confidential information acquired in the course of their work
except when authorized legally obligated to do so.
E. All of the above F. None of the above
6. Accounting information is the basis for each management activity and thus accounting assists
management activities in all except:
A. Planning function D. Performance evaluation
B. Controlling function E. All of the above
C. Business decision making F. None of the above

7. Which of the following is not true about financial accounting?
A. Cost accounting is a subfield of financial accounting.
B. Financial accounting serves the needs of management, investors, creditors, and other
external parties.
C. Financial accounting is governed by generally accepted accounting principle
D. Financial accounting principles have evolved from customs that have been adopted
over time and procedures and rules put forth by the Financial Accounting Standards
Board.
8. Cost accounting can help management achieve all of the following except:
A. Formulation and implementation of plans and budgets that motivate employees
toward the achievement of company goals
B. To mischief the payment of taxes to government.
C. Controlling inventory cost, minimizing inventory investment, determining the cost of
each product or service
D. The pricing of products and services in ways that are congruent with organizational
goals
E. All of the above
F. None of the above
9. Which one of the following is true about cost accounting?
A. Cost accounting is a subfield of financial accounting.
B. Cost accounting is governed by generally accepted accounting principles.
C. Cost accounting is used by management for planning and controlling operations
D. There is no link between cost accounting and financial accounting.
E. All of the above
10. Identify the activity that does not belong to the cycle of management process.
A. Setting organizational objectives
B. Formulating an operating plan
C. Implementing the plan and monitoring the action on a day- to –day basis.
D. Preparing accounting reports
E. All of the above

Part II: Discussion Questions
1. What competitive advantage could a company obtain from a successful cost management
program?
2. Generally, companies follow one of two broad strategies: offering a quality product at a low
price, or offering a unique product or service priced higher than the competition. Assume you
are opening a small food outlet across the street from your campus. How might that business
be operated under each of the two broad strategies? Consider the following specific
operational areas:
a) target customers d) location choice
b) products offered e) advertising content
c) product pricing f) advertising media
3. Generally, companies follow one of two broad strategies: offering a quality product at a low
price, or offering a unique product or service priced higher than the competition. Is it possible
to follow a strategy that is "in the middle"?
4. In most organizations, customer satisfaction is one of the top priorities. As such, attention to
customers is necessary for success. Briefly describe the four types of demands customers are
currently placing on organizational performance.
5. Explain how a budget can help management implement strategy.
6. Explain how a customer focus can result in increased profits for a company.
7. How does a controller help "control" a company?
8. For each report listed below, identify whether the major purpose of the report is for (1) routine
internal reporting, (2) nonroutine internal reporting, or for (3) external reporting to investors
and other outside parties.
Item:
a) Study detailing sale information of the top-ten selling products
b) Weekly report of total sales generated by each store in the metropolitan area
c) Annual Report sent to shareholders
d) Monthly report comparing budgeted sales by store to actual sales
9. Which questions do management accountants help answer in the strategy formulation
process?
10. For each type of report listed below, identify one planning decision and one controlling
decision for which the information would be helpful.
Item:
a) annual financial statements for the past three years
b) report detailing sales by department by each hour of the day for the past week
c) special study regarding increased road traffic due to the construction of a new shopping
mall at a near-by intersection

Answer Key to Activities and Self Assessment Questions
Activities
Activity 1
1. Accounting Information is the basis for each management activity. It is the basis for identifying
organizational objectives and developing an annual budget. The accounting process measures
the results of operations and compares them to the budget. The difference between the two
helps management to identify areas of business where corrective action required.
2. Planning and control activities in management accounting are linked to each other in the
following ways.
a) Planning business operations relates to designing, producing, and marketing a product or
service. This includes preparing budgets and determining the prices and cost of products
and services. A company must know the cost of each product and service to decide which
products to offer and whether to expand or discontinue product lines.
b) Controlling business operations includes comparing actual results to the budgeted results
and taking corrective action when needed.
c) Feedback links planning and control activities. The control function provides information to
assist in better future planning.
Activity 2
1. Management accountants continually face resource allocation decisions. The cost-benefit
approach should be used in making these decisions. Resources should be spent if the
expected benefits to the company exceed the expected costs. The expected benefits and
costs may not be easy to quantify, but it is a useful approach for making resource allocation
decisions.
2. As measurements are made on operations and, especially, on individuals and groups, the
behavior of the individuals and groups are affected. People react to the measurements being
made. They will focus on those variables or the behavior being measured and spend less
attention on variables and behavior that are not measured. In addition, if managers attempt to
introduce or redesign cost and performance measurement systems, people familiar with the
previous system will resist. Management accountants must understand and anticipate the
reactions of individuals to information and measurements. The design and introduction of
new measurements and systems must be accompanied with an analysis of the likely reactions
to the innovations.
Activity 3
1. Management accounting vs. Financial accounting
Management accounting provides information to internal decision makers of the business such

as top executives, managers, sales representatives, and production supervisors. Its purpose is
to help managers predict and evaluate future results. Reports are generated often and usually
broken down into smaller reporting divisions such as department or product line. There are no
rules to be complied with since these reports are for internal use only. Management
accounting embraces more extensively such topics as the development and implementation of
strategies and policies, budgeting, special studies and forecasts, influence on employee
behavior, and nonfinancial as well as financial information.
Financial accounting, by contrast, provides information to external decision makers such as

investors and creditors. Its purpose is to present a fair picture of the financial condition of the
company. Reports are generated quarterly or annually and report on the company as a whole.
The financial statements must comply with GAAP (generally accepted accounting principles). A
CPA audits, or verifies, that the GAAP are being followed.
2. Managers make use of management accounting information for the following purposes.
a) To choose strategy, to communicate it, and to determine how best to implement it.
b) To plan business operations related to designing, producing, and marketing a product or
service. This includes preparing budgets and determining the prices and cost of products
and services. A company must know the cost of each product and service to decide which
products to offer and whether to expand or discontinue product lines.
c) To control business operations that includes comparing actual results to the budgeted
results and taking corrective action when needed.
Activity 4
1. Management accounting is more useful to an operations manager because management
accounting reports operating results by department or unit rather than for the company as a
whole, it includes financial as well as nonfinancial data
such as on-time deliveries and cycle times, and it includes quantitative as well as qualitative
data such as the type of rework that was needed on defective units.
2. The responsibilities vary among organizations, but generally include the following areas:
controllership, treasury, risk management, taxation, investor relations, and internal audit.
Activity 5
1. Please note that answers may vary, but may include the following:
a) Competence: Maintain an appropriate level of professional expertise by continually
developing knowledge and skills.
b) Confidentiality: Refrain from using confidential information for unethical or illegal
advantage.

c) Integrity: Abstain from engaging in or supporting any activity that might discredit the
profession.
d) Credibility: Communicate information fairly and objectively.
e) You have been employed as an entry-level management accountant for a little under a
year. You suspect that your immediate supervisor is involved in a significant fraud involving
diverting of company assets to personal use. Briefly describe the steps you might take to
resolve this dilemma.
2. The management accountant should first consult any internal company procedures concerning
the resolution of ethical issues, and make sure these procedures are followed as closely as
possible. At the same time, the management accountant should make sure that the facts are
accurate, and are not based on rumors or inaccurate information. If these policies do not
resolve the situation, present the facts to the next higher managerial level. Clarify the relevant
ethical issues with an objective advisor (e.g., Institute of Management Accountants hotline).
Consult your own attorney to be aware of your own rights and responsibilities. If all internal
review procedures have still not resolved the ethical situation, the managerial accountant
might have to resign and write an informative letter to an appropriate representative of the
organization, and perhaps notify other parties.


1. A 5. E 9. D
2. B 6. A 10. E
3. C 7. B
4. D 8. C
Part II: Discussion Questions

1. There are three broad outcomes from a successful cost management program:
a) Costs are reduced with no loss in customer value. In this scenario, a company might gain
a competitive advantage by lowering its price with no loss in profit, or maintain the
same price and increase profit;
b) Customer value is increased with no change in costs. This scenario might increase
customer satisfaction resulting in increased customer loyalty and perhaps increase the
overall demand for the product;
c) Customer value might be increased while costs are reduced simultaneously
2. The purpose of this question is to explore some of the differences in business operations as
a result of a broad strategic choice. Answers will differ from student to student, but you
should see some specific themes.
Operational Area Low Price Strategy Differential Strategy

Target customers Target customers might be Target customers might be more
students on a tight budget wealthy students, faculty, or
perhaps neighbors who live
nearby.
Products offered Few products, heavy emphasis on High quality products, probably a
tight cost control, probably set up reasonable choice, restaurant
as a high volume operation. might have a lot of ambience.
Product pricing Priced at or lower than the Higher priced products.
competition in the area.
Location choice Convenient to the target Not as convenient, perhaps in a
customers. higher-end shopping or
entertainment area. Customers
might seek out the high quality and
be willing to travel a bit for it.

Advertising Advertising would emphasize the Advertising would emphasize
content low price of the products offered. quality or ambience.
Advertising media Media that would be looked at by Media that would be looked at by
the target customers, such as the target customer, local
student newspapers. magazines and newspapers.
3. There is some dispute about the correct answer to this question. Some will argue that it is
not good for companies to get "caught in the middle" because the customer might get
confused as to whether or not the company is competing on price or is trying to make some
other appeal. If the customer is confused about how the company is giving them value, they
might perceive they are getting no value and abandon the product to a competitor with a
clearer customer value proposition. The other side of the argument is that cost management
is a necessary part of any strategy and even if the company chooses to pursue a differential
strategy, management of the company should always be seeking ways to manage costs and
increase customer value simultaneously regardless of their strategy. The student should be
able to articulate one or the other arguments coherently.
4. Four types of demands customers are currently placing on organizational performance are:
a) Cost: Organizations are under continuous pressure to reduce the cost of the products or
services they sell to their customers.
b) Quality: Customers are expecting higher levels of quality and are less tolerant of low
quality than in the past.
c) Time: Time has many components: the time taken to develop and bring new products to
market; the speed at which an organization responds to customer requests; and the
reliability with which promised delivery dates are met. Organizations are under pressure
to complete activities faster and to meet promised delivery dates more reliably than in
the past in order to increase customer satisfaction.
d) Innovation: There is now heightened recognition that a continuing flow of innovative
products or services is a prerequisite for the ongoing success of most organizations.
5. A budget is a planning tool, a quantitative expression of a plan of action. First, actions are
planned and then they are communicated to the entire organization. The budget also helps
with coordination.
6. If customers who provide a company with the most profits are attracted, satisfied, and
retained, profits will increase as a result.
7. By reporting and interpreting relevant data, the controller exerts a force or influence that
impels management toward making better-informed decisions. The controller of Caterpillar
described the job as "a business advisor to ...help the team develop strategy and focus the
team all the way through recommendations and implementation."
8. The major purpose of the report
a) (2) non-routine internal reporting

b) (1) routine internal reporting
c) (3) external reporting to investors and other outside parties
d) (1) routine internal reporting
9. Management accountants should answer the following questions in the strategy
formulation process.
a) Who are our most important customers, and how do we deliver value to them?
b) What substitute products exist in the marketplace, and how do they differ from our
product in terms of price and quality?
c) What is our most critical capability?
d) Will adequate cash be available to fund the strategy, or will additional funds need to be
raised?
10. Please note that answers will vary, but may include the following:
a) Planning: Decision by shareholder about whether to purchase more stock in the
company. Control: Decision by bank to determine if financial ratios maintained in the
line-of-credit (LOC) agreement warrant increasing the LOC amount.
b) Planning: Decisions regarding future staffing needs. Control: Decision regarding
whether the recent sales promotion led to an increase in revenue.
c) Planning: Decision of the store manager about whether to change the types of retail
items carried. Control: Decision of the store manager regarding performance of the
analyst that prepared the special study.

Unit 2
Introduction to Cost Concepts and Classifications

1. Identify the three basic manufacturing cost categories;
2. Distinguish between product costs and period costs;
3. Prepare a schedule of cost of goods manufactured;
4. Differentiate between variable costs and fixed costs;
5. Differentiate between direct costs and indirect costs;
6. Classify costs used in decision making:
7. Describe the relationship between costs and cost drivers.;
8. State the cost accumulation and assignment process;
9. Prepare financial statements of manufacturing enterprises.
2.1. Cost Concepts
Hello dear learner! What is Cost? In the previous unit, you discussed that the work of managers’
focuses on (1) planning which includes setting objectives and outlining how to attain these
objectives; and (2) control, which includes the steps to take to ensure that objectives are
realized. To carry out these planning and control responsibilities, managers need information
about the organization. From an accounting point of view, this information often relates to the
costs of organization.
The term ‘Cost’ indicates the amount of expenditure (actual or notional) incurred on or
attributable to, a specified thing or activity or cost unit. It is the cash or cash equivalent values
scarified for goods and services that are expected to bring current or future benefits to the
organization.
Can you differentiate expense, loss and asset from cost?

 Expense is a cost used up or expired in the production of revenues.
 Loss is a cost that expires without producing any revenue benefits.
 Asset is a cost incurred to receive future benefits.
What is the difference between costing and cost accounting? Costing is the technique and
process of ascertaining costs where as cost accounting is the process of accounting for costs,
which begins with recording of income and expenditure or the bases on which they are

calculated and ends with the preparation of periodical statements and reports for ascertaining
and controlling costs.
Activity 1
1. Differentiate between cost and costing.
2. Differentiate between cost accounting and cost accountancy.
2. 2. Classification of Costs
What do we mean by cost classification? Cost classification is the process of grouping costs
according to their common characteristics. A suitable classification of costs is of vital importance
in order to identify the cost with cost centers or cost units.
How do you classify costs? Why is it needed?

The term cost is used in many different ways in accounting. The reason is that there are many
types of costs, and these costs are classified differently according to the immediate need of
management. For example, managers may want cost data to prepare external financial reports,
to prepare planning budgets, or to make decisions. Each different use of cost data demands a
different classification and definition of cost. For example, the preparation of external financial
reports requires historical cost data, whereas decision making may require predictions about
future costs. In the following section we will discuss many of possible use of cost data and how
costs are defined and classified for each use.
A. Classification of Costs: By Function
What is the functional classification of costs? In manufacturing organizations, costs are

subdivided into two major functional categories as manufacturing costs and non manufacturing
costs.
1) Manufacturing costs refer to those costs associated with the production function in the
plant or factory. They can be further subdivided into direct manufacturing costs and indirect
manufacturing costs.
a) Direct manufacturing costs refer to those manufacturing costs directly traceable to the
product being manufactured. They are further classified into direct material and direct
labor. Direct material refers to raw materials that actually become part of the product and
directly traceable to the product. E.g. Steel in Automobile, Wood in furniture, etc where as
Direct labor refers to the cost of labor used to convert raw materials into finished product
and directly traceable to the product. E.g. Wages and fringes benefits paid to machine
operators and assembly line workers.

b) Indirect manufacturing costs refer to all other manufacturing costs that cannot be traced
to any one product. They are further classified in to indirect materials and indirect labor.
They are lumped in to one category called manufacturing over head / factory over head/
indirect product costs. Indirect material generally refers to materials necessary for
production but cannot be directly traced to the product. E.g. lubricating oil for machinery,
factory utilities, depreciation, rents, etc where as indirect labor refers to all factory labor
other than those workers who actually transform the raw materials in to finished goods.
E.g. wages of janitors, supply clerks, maintenance workers and etc.
2) Non manufacturing costs refer to those costs associated with the function of selling and
administration. They are categorized in to Selling costs which refer to those costs necessary
to market and distribute a product or service. E.g. salaries and commission for sales
personnel, advertising, warehousing, and customer service, etc. and Administrative costs
refer to those costs associated to the general administrative of the organization that cannot
be reasonably assigned to either marketing or manufacturing, e.g. Top executive salaries,
legal fees, corporate taxes and others.
Activity 2
Hi-tech Furniture Factory manufactures office furniture. Recently, the company decided to
develop a formal cost accounting system and classify all costs into two categories. Categorize
each of the following items as being appropriate for Manufacturing cost or Non manufacturing
cost.
Manufacturing Non manufacturing

Item Cost Cost
Carpenter wages ________ ________
Depreciation - office building ________ ________
Glue for assembly ________ ________
Machining department supervisor ________ ________
Factory Machine depreciation ________ ________
Factory Machine maintenance ________ ________
Factory Machine operator wages ________ ________
Lumber ________ ________
Samples for trade shows ________ ________
Metal brackets for drawer ________ ________
Factory washroom supplies ________ ________

B. Classification of Cost: In Combination
How do you classify costs in combination? Costs are classified into prime costs and conversion
costs in combination.
1) Prime costs refer to are all direct manufacturing costs. The term prime cost indicates the
sum of direct materials and direct labor used in production. Since it includes direct material
and direct labor, prime costs are also called direct manufacturing costs.
2) Conversion costs refer to all manufacturing costs other than direct material costs.
Conversion costs are the combination of direct labor and manufacturing overheads. They
are the costs of converting direct materials into finished manufactured part. Conversion
costs are sometimes called processing costs
C. Classification of Costs: Assignment to a Cost Object
How do you classify costs based on assignment to a costs object? A major question concerning
cost is whether they have direct or an indirect relationship to a particular cost object. Cost object
is any item or activity such as product, department, and project and so on to which costs are
assigned E.g. Product, Service, Customer, Brand, Activity, Program, Department, etc.
The term Cost assignment encompasses both cost tracing and cost allocation. According to
traceability criteria, costs are classified into direct and indirect costs. Costs such as direct
material, direct labor those related to a particular cost object and traced to it in an economically
feasible (cost-effective) way are called direct costs and the term cost tracing depicts the
assigning of direct costs to the chosen cost object. Costs related to a particular cost object but
cannot be traced to it an economically feasible (cost effective) way are called indirect costs and
the term cost allocation portrays the assigning of indirect costs to the chosen cost object.
Several factors affect the classification of a cost as direct or indirect. They include:
i. The materiality of the cost in question: The higher the cost in question, the more likely
the economic feasibility of tracing that cost to a particular cost object.
ii. Availability of information gathering technology: Improvement in this area is enabling an
increasing percentage of costs to be classified as direct.
iii. Design of operations: Facility design can impact cost classification. For instance, costs
that can be commonly shared by different facilities depending on their layout have the
tendency to be classified as indirect.
iv. Contractual arrangement: a contract setting that a given component can be used only in
a specific product makes it easier to classify the component as a direct cost of the
product.

Activity 3
Hi-tech manufacturing company wants to estimate costs for each product they produce at its
West plant. The plant produces three products at this plant, and runs two flexible assembly lines.
Each assembly line can produce all three products.
Required: Classify each of the following costs as either direct or indirect for each product.
Direct Indirect
a. Assembly line labor wages ________ ________
b. Plant manager's wages ________ ________
c. Depreciation on the assembly line equipment ________ _______
d. Component parts for the product ________ ________
e. Wages of security personnel for the factory ________ ________
D. Classification of Cost: By controllability
How do you classify costs based on controllability? From the point of view of controllability, costs
are classified in to two categories as controllable cost and uncontrollable cost.
1) Controllable cost is a cost heavily influenced by a manager, in effect, a cost a manager is
authorized to incur. Controllable Cost: These costs are regulated or controlled by specified
member of an organization. Most of the variable costs are controllable. Generally direct
material, direct labor and direct expenses are controlled by the lower level of the
management.
2) Uncontrollable cost is a cost over which a manager has no significant influence. These costs
cannot be regulated or controlled by specified member of an undertaking. Most of the
fixed costs are uncontrollable. Examples of uncontrollable costs are, factory rent,
managers’ salary, etc.
E. Classification of Costs: By Cost Behavior
How do you classify costs based on behavior? Cost behavior is the relationship between cost and
activity or cost driver. Cost driver is a factor that causes (drives) activity costs such as volume of
production, level of service, labor hours, etc. Costs are classified in to Variable Cost and Fixed
Cost based on cost behavior. The divisions of variable costs and fixed costs have important
underlying assumptions: These include:
i. Costs are defined as variable or fixed to a specific cost object.
ii. The time span must be specified.
iii. Total costs are linear
iv. There is only one cost driver.
v. Variation in the level of the cost driver is within a relevant range.

1) Variable/Flexible cost refers to costs that change in total in proportion to the changes in a
cost driver. It varies in direct proportion to the level of activity such as the volume of output.
Examples of variable costs are cost of raw materials, labor, factory utilities, etc. In general,
variable costs have the following characteristics:
i. Variability of total amount in direct proportion to volume.

ii. Relatively constant costs per unit as volume changes within a relevant range
iii. Assignable with reasonable ease and accuracy to operating departments.
iv. Controllable by a specific department head.
2) Fixed/Capacity related cost refers to costs that do not change in total despite changes in a
cost driver or level of activity. It is fixed only in relation to a given relevant range (usually
wide) of the cost driver and a given time span (usually a particular budget period). A
relevant range is the range of the cost driver in which a specific relationship between cost
and cost driver is valid. Fixed costs include rental costs, factory depreciation, property tax,
salary of the office manager and others. The characteristics of fixed costs are:
i. Fixed total amount with in a relevant output range.
ii. Decrease in per unit costs as volume increases with in a relevant range
iii. Assignable to departments on the basis of arbitrary managerial decisions or cost
allocation methods.
iv. Control responsibility resting with executive management rather than operating
supervisions.
Activity 4
Hi-tech manufacturing wants to estimate costs for each product they produce at its West
plant. The plant produces three products at this plant, and runs two flexible assembly lines.
Each assembly line can produce all three products.
Required: Classify each of the following costs as either fixed or variable with respect to the
number of units produced of each product.
Fixed Variable
a. Assembly line labor wages ________ ________
b. Plant manager's wages ________ ________
c. Depreciation on the assembly line equipment ________ ________
d. Component parts for the product ________ ________
e. Wages of security personnel for the factory ________ ________
3) Semi variable/Semi-fixed Costs refer to some costs that contain fixed and variable elements.
These semi variable costs include an amount that is fixed with in a relevant range and an
amount that variable proportionately with output changes. These costs are partly fixed and

partly variable. Examples of semi variable costs are telephone rent. It includes partly fixed
charge up to a certain level and then varies according to the calls made.
F. Classification of Cost : By aggregation
Can you distinguish between total cost and unit cost? Costs can also be classified as total cost and
unit cost.
(1) Total cost refers to aggregate cost of a cost object.
(2) Unit cost is called average cost and computed by dividing some total cost by some
number of units.
G. Classification of Cost : External Reporting Purposes
What is the classification of costs for external reporting purpose? For external reporting purpose,
costs can be classified as product and period costs.
1) Product cost refers to those costs of production having potential to produce revenues
beyond the current period. They are sometimes called manufacturing or inventriable
costs. E.g. DM, DL, FOH costs. They refer to all costs of a product that are regarded as
assets when incurred and then become COGS when the product is sold.
2) Period costs refer to costs that are expensed in the period in which they are incurred.
They are sometimes called operating or non manufacturing costs. All selling and
administrative costs are viewed as being period related.
Activity 5
each of the following items as being appropriate for Product cost or period cost.
Product Period
Item Cost Cost
Lumber ________ ________
Metal brackets for drawers’ ________ ________

H. Classification of Cost: In relation to Decision Making
How do you classify costs in relation to decision making? You will discuss the concept of
relevant information and decision making in the succeeding course called Management
Accounting. However in relation to decision making, costs can be classified as relevant and
irrelevant costs.
1) Relevant costs refer to those costs which are relevant for decision making. They can be sub
classified into Marginal cost which is the total variable costs or additional costs of
producing one additional unit. Incremental or differential cost is arising out of a decision to
change the level of activity. Opportunity cost is the benefit or contribution forgone due to
not choosing an alternative course of action. Out-of-pocket-costs are cost associated with
activity which involves actual cash outlay. Examples are wages, material cost, insurance etc.
Imputed costs are hypothetical or notional costs which do not involve any cash outlay.
Replacement cost is the current market cost at which an asset or material can be replaced
with an identical one.
2) Irrelevant costs refer to those costs which have no bearing on decision making. Sunk costs
are historical costs incurred or sunk in the past and are not relevant to the specific decision
being considered. Committed costs are costs committed by the management are irrelevant
for decision making. Absorbed fixed costs are fixed costs which do not change with
changes in the volume of output are irrelevant for decision making.
I. Classification of Cost: On Financial Statements

Costs included in the Income Statement or Balance sheet of manufacturing and merchandising
entities are classified as follows:
1) Capitalized costs refer to costs first recorded as an asset (capitalized) when they are incurred
and presumed to provide further benefits to the entity. E.g. Costs of equipment, Inventory,
etc. Capitalized costs of manufacturing and merchandising companies can be classified as:
a) Capitalized inventoriable costs/ Inventoriable costs refer to those capitalized costs
associated with the purchase of goods for resale or costs associated with the acquisition
and conversion of materials and all other manufacturing inputs into goods for sale ( in the
case of manufacturing inventories). Capitalized inventoriable costs become part of goods
in the period in which inventory item is sold. Typical examples of these costs include direct
material, direct labor and factory overhead costs in manufacturing companies but cost of
purchase, freight-in, insurance in transit, etc in merchandising companies
b) Capitalized non inventoriable costs refer to those capitalized costs associated with any
aspect of business other than inventory such as cost plant assets, intangible assets and
others.

2) Non capitalized costs refer to costs recorded as expense of the accounting period when they
are incurred. E.g. Administration and selling expenses.
Activity 6
each of the following items as being appropriate for Capitalized or Non-capitalized Cost.
Capitalized Non Capitalized

Item Cost Cost
Lumber ________ ________
Metal brackets for drawers’ ________ ________
J. Classification of Cost: By Business Function in Value Chain

What is the classification of costs based on business functions in value chain? Value chain refers to
the sequence of business functions in which customer usefulness is added to products or
services and Value added activities refer to those activities customers perceive as adding value
to the products or services they purchase. The six business functions in the value chain are
discussed below.
1. Research and development-Generating and experimenting with ideas related to new

products, services or processes. It is the first and key activity helpful to meet customer
demand.
2. Design of products, services and processes –Detailed planning and engineering of
products, services, or processes. Design involves determining the number of components
parts and the effect of alternative designs on quality and manufacturing costs.
3. Production-Acquiring, coordinating and assembling resources to produce a product or
deliver a service. It includes the processing activities and the packaging used for shipping.

4. Marketing-Promoting and selling products or services to customers or prospective
customers through trade shows, advertisements in news papers and magazines, and on the
Internet.
5. Distribution-Delivering products or services to customers. It includes such activities as
shipping to retail outlets, vendors, direct sales via the Internet, and other channels through
which customers purchase products or services.
6. Customer service-Providing after-sale support to customers in the form of customer-help
telephone lines, support on the internet, and warranty repair work.
Exhibit 2.1 Business Functions in the Value Chain

Development
Distribution
Production
Research &
Products &
Marketing
Customer
Processes
Design of
Service
Each of these business functions are essential to ever manufacturing company satisfying its
customer and keeping them satisfied (and loyal) over time. Different purposes can result in
different measures of product cost as discussed below.
1. Pricing and product-mix decisions. For the purposes of making business decisions about
pricing and which products provide the most profits, managers are interested in the overall
(total) profitability of different products and, consequently assign costs incurred in all
business functions of the value chain to the different products.
2. Contracting with government agencies. Government contracts often reimburse contractors
on the basis of the “cost of a product” plus a pre-specified margin of profit. These agencies
want to reimburse contractors for only those costs most closely related to delivering
products under the contract. For this purpose, product costs calculation for a specific
contract may allow for all design and production costs but only part of R & D costs.
3. Preparing financial Statements for external reporting under GAAP. Under GAAP, only
manufacturing costs can be assigned to inventories in the financial statements. For the
purposes of calculating inventory costs, product costs include only inventoriable
(manufacturing) costs.

2.3. Costs and Cost Drivers
What is cost driver? A cost driver also called cost generator or cost determinant is any factor that
affects total costs. It is output measure of resources and activities; i.e. a change in the level of the
cost driver will cause a change in the level of the total cost of related cost object.
Exhibit 2.2 Examples of cost drivers of business functions in the value chain
Business Functions Cost Driver (e.g.)

1. Research and Development Number of research project
2. Design of products, services and processes Number of products in design
3. Production Number of units produced
4. Marketing Number of sales personnel
5. Distribution Number of customers
6. Customer services Number of products serviced
2.4. Cost Accumulation and Application to Cost Object
How do you determine cost of cost objects? A costing system typically accounts for costs in two
basic stages:
Stage 1: Cost Accumulation is the collection of cost data in some organized way through an
accounting system. It accumulates costs by some natural (often self descriptive) classification
such as materials, labor, fuel, advertising or shipping.
Stage 2: Cost Assignment applies those costs to cost objectives. It is a general term that
encompasses both tracing accumulated cost to a cost object and allocating accumulated cost to
a cost object. Costs that are traced to a cost object are direct costs and costs that are allocated
to cost object are indirect costs.
Activity 7
Answer the following question in the space provided.
develop a formal cost accounting system and classify all costs into three categories. Categorize
each of the following items as being appropriate for (1) cost tracing to the finished furniture, (2)
cost allocation of an indirect manufacturing cost to the finished furniture, or (3) as a non
manufacturing item.
Cost Cost Non Manu-
Item Tracing Allocation factoring

Carpenter wages ________ ________ ________
Depreciation - office building ________ ________ ________
Glue for assembly ________ ________ ________
Machining department supervisor ________ ________ ________
Factory Machine depreciation ________ ________ ________
Factory Machine maintenance ________ ________ ________
Factory Machine operator wages ________ ________ ________
Lumber ________ ________ ________
Samples for trade shows ________ ________ ________
Metal brackets for drawers’ ________ ________ ________
Factory washroom supplies ________ ________ ________
2.5. Financial Statements of Manufacturing Enterprises
Do you think that manufacturing companies and merchandising companies prepare the same
financial statements? Like any other type of businesses, manufacturing enterprises produce their
financial reports at the end of the period. Financial statements of a Manufacturing company are
more complex as compared to financial statements of Merchandising and Service companies.
Particularly, the Balance sheet, and Income statement of a Manufacturing enterprise are
somewhat different from their Merchandising and Service counterpart. For comparison purpose,
look at the schedules of manufacturing business (a hypothetical data) discussed below.
Schedule of COGM is a detailed listing of the manufacturing costs incurred during an accounting
period and showing the change in work in process inventory. To determine the cost of goods
manufactured, three factors are necessary: cost of direct materials used, cost of direct labor, and
manufacturing overhead.
Schedule 1: Schedule of Cost of Goods Manufactured
Bravo Medical Instruments

Schedule of Cost of Goods Manufactured
For The Year Ended December 31,20x1
Direct Material:
Raw material inventory, January 1 Br 10,000
Add: purchases of raw material 100,000
Raw material available for use 110,000
Deduct: Raw material Inventory, December 31 5,000
Raw materials used Br 105,000
Direct labor: 200,000

Manufacturing Overhead:
Indirect material Br 85,000
Indirect labor 30,000
Total manufacturing overhead 115,000
Current manufacturing costs Br 420,000
Add: Work in process inventory, January 1 25,000
Manufacturing costs incurred to date Br 445,000
Deduct: Work in process inventory, December 31 30,000
Cost of goods manufactured(COGM) Br 415,000
Schedule 2: Schedule of Cost Goods Sold
Schedule of COGS is a detailed schedule showing the costs of goods sold and change in finished
goods inventory during an accounting period. The cost of goods sold represents the cost of
goods that are sold during a given year. The cost of goods sold is computed using the following
formula: COGS = Beg Finished Goods Inventory + Cost of Goods Manufactured – End Finished
Goods Inv.
Schedule of cost of Goods sold
For the year Ended December 31,20x1
Finished-goods inventory, January 1 Br 80,000
Add: cost of goods manufactured 415,000
Cost of goods available for sale Br495,000
Finished-goods inventory, December 31 70,000
Cost of goods sold Br 425,000
Schedule 3: Income Statement

The income statement presents revenues, gains, expense and losses recognized by the firm for a
specified period of time. The income statement is an important financial statement because it
provides investors and creditors with information that helps them predict the amount, timing,
and uncertainly of future cash flows. Through use of the income statement, investors and
creditors are able to evaluate the past performance of an enterprise and determine the risk of
achieving particular cash flows
Income statement of a manufacturing firm differs from income statement of a merchandising

firm by the cost of goods manufactured section. A merchandising firm sells goods after buying it
from a manufacturing firm. But a manufacturing firm sells goods that are internally produced.
Hence, the costs of goods sold caption contains cost of goods manufactured instead of
purchase. The amount of purchase can easily be found from the ledger, but cost of goods

manufactured cannot. Cost of goods manufactured must first be computed before the income
statement is prepared. All the above schedules are inputs one to the other. The ultimate goal of
making all the schedules is to prepare the income statement.
Income Statement
For The Year Ended Dec. 31,20x1
Sales Br825,000
Cost of goods sold:
Finished goods Inv. Jan. 1, 19xx Br80,000
Add: Cost of goods manufactured 415,000
Cost of goods available for sale 495,000
Less: Finished. Goods Inv. Dec. 31,19xx 70,000
Cost of goods sold Br425,000
Gross profit Br400,000
Operating expense:
Selling expense 200,000
Administrative expenses 100,000
Total Operating expense 300,000
Net Income Br100,000
The income statement contains three main elements, and these are: Sales Cost of goods sold,
and Operational expenses. The cost of goods sold is deducted from sales to arrive at gross profit
or gross margin. From the gross margin, operational expenses are deducted to determine net
income assuming no income tax.
Schedule 4: Balance Sheet

Balance Sheet or Statement of Financial Position presents the financial position of a
business enterprise on a specific date. It provides a historical summary of assets, liabilities
and capital on specific date usually at the end of the fiscal year The classifications, group
headings and number of items on the balance sheet vary considerably depending on the
size of the enterprise, the nature of its operations and whether the finical statements are
intended for wide distribution or for the use of a few owners and creditors. Balance sheet
accounts are classified so that similar items are grouped together to arrive at significant
sub totals. Furthermore, the material is arranged so that important relationships are
shown.
The Balance sheet of a manufacturing firm differs from the Balance sheet of a merchandising
firm principally by the types of inventories reported. A manufacturing firm carries three types of
inventories namely, Direct Materials, Work-In-Process, and Finished good. Inventory of Direct

Material represents the costs of materials that are not yet entered into a manufacturing process.
Such materials may be purely raw materials that have not received any processing before such as
agricultural outputs, or they may be semi processed or fully processed products of another firm
like wheat flour directly going into Biscuit in Food Complex industries.
Inventories of work in process represent all goods that are undergoing some manufacturing
process but yet not finished to be dispatched for use by customers. The costs of work in process
inventory include all the manufacturing costs incurred so far in the manufacturing process; the
cost of direct materials, the costs of labor, and applied manufacturing overhead. The finished
goods inventory embodies the final product that is not yet sold. The cost of finished goods
inventory includes all manufacturing costs, direct material, direct labor, and manufacturing
overhead incurred to produce that product.
The balance sheet contents of manufacturing and merchandising enterprise’s are the alike
except that three inventory items are indicated in the current asset section of the balance
sheet of the latter as shown below.
Inventories:
Materials Br5,000
Work in process 30,000
Finished goods 70,000
Br105,000
//////////////////////
Activity 8
Molar Sporting Goods Company manufactured 100,000 units in 20X5 and reported the following
costs:
Sandpaper………………Br 32,000 Leasing costs-plant…………Br 384,000
Materials handling……….320,000 Depreciation-equipment…….....224, 000
Coolants & lubricants……...22,400 Property taxes-equipment………32,000
Indirect manufacturing labor…275,200 Fire insurance-equipment………...16,000
Direct manufacturing labor…2,176,000 Direct material purchases……..3,136,000
Direct materials, 1/1/X5……….384,000 Direct materials, 12/31/X5………275,200
Finished goods, 1/1/X5…..……672,000 Sales revenue……………..12, 800,000
Finished goods, 12/31/X5……1,280,000 Sales commissions………..….640, 000
Work-in-process, 1/1/X5………..96,000 Sales salaries…………….……576,000
Work-in-process, 12/31/X5……..64,000 Advertising costs……………480, 000
Administration costs…………800,000
Required:
a. What is the amount of direct materials used during 20X5?
b. What manufacturing costs were added to WIP during 20X5?
c. What is cost of goods manufactured for 20X5?
d. What is cost of goods sold for 20X5?

Dear learner, if you understood this unit very well, attempt the following questions and
evaluate yourself against the answers given at the end of this unit.

1) Cost objects include:
A. Products D. All of the above.
B. Customers E. None of the above
C. Departments
2) The general term used to identify both the tracing and the allocation of accumulated costs to a
cost object is:
A. Cost accumulation D. Conversion costing
B. Cost assignment E. All of the above.
C. Cost tracing F. None of the above
3) Which of the following does NOT affect the direct/indirect classification of a cost?
A. the level of budgeted profit for the next year
B. the materiality of the cost in question
C. available technology to gather information about the cost
D. the design of the operation
E. All of the above. F. None of the above
4)Classifying a cost as either direct or indirect depends upon:
A. the behavior of the cost in response to volume changes
B. whether the cost is expensed in the period in which it is incurred
C. whether the cost can be easily identified with the cost object
D. whether an expenditure is avoidable or not in the future
5) Which one of the following items is a direct cost?
A. Customer-service costs of a multiproduct firm; Product A is the cost object.
B. Printing costs incurred for payroll check processing; payroll check processing is the cost
object.
C. The salary of a maintenance supervisor in a multiproduct manufacturing plant; Product B is
the cost object.
D. Utility costs of the administrative offices; the accounting department is the cost object.
6) Which of the following is a mixed cost?
A. monthly rent payment D. direct materials
B. manager's salary E. All of the above.
C. monthly telephone bill F. None of the above

7) An understanding of the underlying behavior of costs helps in all of the following EXCEPT:
A. costs can be better estimated as volume expands and contracts
B. true costs can be better evaluated
C. process inefficiencies can be better identified and as a result improved
D. sales volume can be better estimated
8)The MOST likely cost driver of direct material costs is the:
A. number of parts within the product D. number of production hours
B. number of miles driven E. All of the above.
C. number of products manufactured F. None of the above
9) A relevant range is:
A. The range of activity within which variable costs are constant per unit.
B. The range of activity within which the assumptions about variable costs and fixed costs are
valid.
C. The range of activity within which fixed costs are constant in total.
D. All of the above
E. Only B and C F. None of the above
10) Which one of the following is a reason for the difficulty associated with assigning
manufacturing overhead to products?
A. Manufacturing overhead is an indirect cost.
B. Manufacturing overhead consists of many different items.
C. Manufacturing overhead costs tend to remain constant.
D. Manufacturing overhead costs are known at the time of the calculation of the
predetermined overhead rate.
11) The Work in Process account contains the summarized balance of all units of :
A. Completed at a given point in time.
B. Unfinished at a given point in time
C. Transferred to Finished Goods Inventory and in the process of being sold.
D. Sold and in the process of being recorded in the financial records.
12) A cost that has been incurred but cannot be changed by present or future decisions is called:
A. Differential cost D. Sunk cost
B. Opportunity cost E. All of the above
C. Marginal cost F. None of the above
13) The following information pertains to the CDD Corporation:
 Beginning work-in-process inventory…Br 50,000
 Ending work-in-process inventory………48,000
 Beginning finished goods inventory……180,000

 Ending finished goods inventory……….195,000
 Cost of goods manufactured………….1,220,000
What is cost of goods sold?
A. Br1,235,000 D. Br1,222,000
B. Br1,205,000 E. All of the above
C. Br1,218,000 F. None of the above
Answer the following questions using the information below:
 Beginning finished goods, 1/1/20X3…..Br 80,000
 Ending finished goods, 12/31/20X3…..….67,000
 Cost of goods sold……………………..270,000
 Sales revenue…………………………..500,000
 Operating expenses…………………….145,000
14) What is cost of goods manufactured for 20X3?
A. Br230,000 D. Br355,000
B. Br257,000 E. All of the above
C. Br283,000 F. None of the above
15) What is gross margin for 20X3?
A. Br283,000 D. Br257,000
16) What is operating income for 20X3?
A. Br85,000 D. Br230,000
WT Company manufactures several different products. Unit costs associated with Product WT23
are as follows:
 Direct materials…………………. Br 40
 Direct manufacturing labor……..........8
 Variable manufacturing overhead…...12
 Fixed manufacturing overhead……..23
 Sales commissions (2% of sales)…..…6
 Administrative salaries………………9
 Total……………………………… Br98
17) What are the variable costs per unit associated with Product WT23?
A. Br60 D. Br48
B. Br83 E. All of the above
C. Br66 F. None of the above
18) What are the fixed costs per unit associated with Product WT23?
A. Br23 B. Br32

C. Br35 E. All of the above
D. Br44 F. None of the above
19) What are the inventoriable costs per unit associated with Product WT23?
A. Br60 D. Br83
20) What are the period costs per unit associated with Product WT23?
A. Br15 D. Br27
Part II: Discussion & Work out Questions

Answer the following questions
1) The list of representative cost drivers in the right column below are randomized with respect
to the list of functions in the left column. That is, they do not match.
Function Representative Cost Driver
1. Purchasing A. Number of employees
2. Billing B. Number of shipments
3. Shipping C. Number of customers
4. Computer Support D. Number of invoices
5. Personnel E. Number of desktop computers
6. Customer Service F. Number of purchase orders
Required: Match each business function with its representative cost driver.
2) SF Manufacturing produces electronic storage devices, and uses the following three-part
classification for its manufacturing costs: direct materials, direct manufacturing labor, and
indirect manufacturing costs. Total indirect manufacturing costs for January were Br300
million, and were allocated to each product on the basis of direct manufacturing labor costs
of each line. Summary data (in millions) for January for the most popular electronic storage
device, the Big Bertha, was:
Big Bertha
Direct manufacturing costs Br9,000,000
Direct manufacturing labor costs Br3,000,000
Indirect manufacturing costs Br8,500,000
Units produced 40,000
Required:
a) Compute the manufacturing cost per unit for each product produced in January.
b) Suppose production will be reduced to 30,000 units in February. Speculate as to whether
the unit costs in February will most likely be higher or lower than unit costs in January; it
is not necessary to calculate the exact February unit cost. Briefly explain your reasoning.
3) During 20x9, FD Corporation incurred manufacturing expenses of Br20, 000,000 to produce

400,000 finished units. At year-end, it was determined that 370,000 units were sold while
30,000 units remained in ending inventory.
Required:
a) What is the cost of producing one unit?
b) What is the amount that will be reported on the income statement for cost of goods
sold?
c) What is the amount that will be reported on the balance sheet for ending inventory?
4) Axle and Wheel Manufacturing currently produces 1,000 axles per month. The following per
unit data apply for sales to regular customers:
Direct materials……………………..Br200
Direct manufacturing labor……….....30
Variable manufacturing overhead….. 60
Fixed manufacturing overhead…….40
Total manufacturing costs….…Br330
The plant has capacity for 2,000 axles.
Required:
a) What is the total cost of producing 1,000 axles?
b) What is the total cost of producing 1,500 axles?
c) What is the per unit cost when producing 1,500 axles?
5) GT Company had the following activities during 20X5:
Direct materials:
Beginning inventory Br 40,000
Purchases 123,200
Ending inventory 20,800
Direct manufacturing labor 32,000
Manufacturing overhead 24,000
Beginning work-in-process inventory 1,600
Ending work-in-process inventory 8,000
Beginning finished goods inventory 48,000
Ending finished goods inventory 32,000
Required:
a) What is the cost of direct materials used during 20X5?
b) What is cost of goods manufactured for 20X5?

c) What is cost of goods sold for 20X5?
d) What amount of prime costs was added to production during 20X5?
e) What amount of conversion costs was added to production during 20X5?
6) MG Manufacturing Company had the following account balances for the quarter ending
March 31, unless otherwise noted:
 Work-in-process inventory (January 1) Br 140,400
 Work-in-process inventory (March 31) 171,000
 Finished goods inventory (January 1) 540,000
 Finished goods inventory (March 31) 510,000
 Direct materials used 378,000
 Indirect materials used 84,000
 Direct manufacturing labor 480,000
 Indirect manufacturing labor 186,000
 Property taxes on manufacturing plant building 28,800
 Salespersons' company vehicle costs 12,000
 Depreciation of manufacturing equipment 264,000
 Depreciation of office equipment 123,600
 Miscellaneous plant overhead 135,000
 Plant utilities 92,400
 General office expenses 305,400
 Marketing distribution costs 30,000
Required:
a) Prepare a cost of goods manufactured schedule for the quarter.
b) Prepare a cost of goods sold schedule for the quarter.
7) Several costs incurred by MB Inc. are listed below. For each cost, indicate which of the
following classifications best describe the cost. More than one classification may apply to the
same cost item .For example; a cost may be both a variable cost and a product cost.
Group A: Cost Items Group B: Cost Classifications

1) Metal used in MB Inc. a) Variable
2) Salary of plant manager b) Fixed
3) Cost of natural gas used to heat factory c) Period
4) Commissions paid to sales personnel d) Product
5) Wages paid to employees assemblers e) Administrative
6) Salary of engineer who is working on a proto-type f) Marketing
of a new solar-powder. g) Manufacturing
7) Depreciation on the word processing equipment h) Research and development
used by the company president’s secretary i) Direct material

j) Direct labor
k) Manufacturing overhead
8) Summit company had inventories for January 19x3 as follows:

Beginning Ending
Direct materials Br30,00 Br40,000
Work in process 15,000 20,000
Finished goods 65,000 50,000
 The income statement for January 19x3 showed:
Cost of goods manufactured Br515,000
Factory overhead 150,000
Direct material used 190,000
Required: Compute:
A. Direct materials purchased during January 19x3
B. Direct labor cost incurred during January 19x3
9) PT Company manufactures furniture including tables. Selected costs associated with the
manufacturing of the tables and the general operations of the company are given below.
Match the following two groups.
Group A: Cost Items Group B: Cost
1) The tables are made of wood that costs Br100 per table Classification
2) The tables are assembled by workers, at a wage cost of a) Variable cost
Br440 per table b) Fixed cost
3) Workers assembling the table are supervised by a factory c) Period cost
supervisor who is paid Br25,000 per year d) Selling and
4) Electrical costs are Br2 per machine- hours. Four machine- administrative
hours are required to produce a table e) Direct labor
5) The department cost of machine used to make the tables f) Sunk cost
Br10,000 per year g) Product cost
6) The salary of the president of porter Company is h) Manufacturing
Br100,000 per year i) Non manufacturing
7) Porter Company spends Br250, 000 per year to advertise j) Direct material
its products. k) MOH
8) Sales persons are paid a commission of Br30 for each l) Opportunity cost
table sold
9) Instead of producing the tables, porter Company could
rent its factory space out at a rental income of Br50, 000
per year.

10) Determine the missing amounts in each of the following independent cases.
Details Case A Case B Case C

Beginning inventory, raw material Br18,000 Br 19,000 ?
Ending inventory, raw material 330,000 ? Br89,000
Purchase of raw material (Net) ? 85,000 100,000
Direct material used ? 95,000 70,000
Direct labor 125,000 100,000 ?
Manufacturing overhead 160,000 ? 250,000
Current manufacturing cost 340,000 345,000 520,000
Beginning inventory, working process ? 20,000 35,000
Ending inventory, working process 5,000 35,000 ?
Cost of goods manufactured 350,000 ? 525,000
Beginning inventory, finished goods ? 40,000 50,000
Cost of goods available for sale 370,000 ? ?
Ending inventory, finished goods 25,000 ? ?
Cost of goods sold ? 330,000 545,000
Sales 480,000 ? ?
Gross Margin ? 170,000 255,00
Selling and administrative expenses ? 75,000 ?
Income before tax expense 60,000 ? 150,000
Income tax expense ? 45,000 40,000
Net income 20,000 ? ?
11) You are asked to prepare financial statements for Rift Valley trading for a fiscal year ended
Dec.31, 19x2. The necessary accounting data are not maintained properly. However, you
collected the following incomplete information.
Details Jan 1, 19x2 Dec.31,19x2
Raw Materials Inventory Br50,000 ?
Finished Goods Inventory 100,000 ?
Additional Information
The following estimated data are available for the year:
 Purchases of Direct Materials………………………………………….Br300,000
 Cost of Goods Available for Sale………………………..………………900,000
 Net Sales...………………………………………………………………1,000,000

 Operating Expenses……………………………………………………..200,000
 Gross profit percentage on Sales…………………………………………….40%
 Direct Manufacturing Costs………………..75% of Cost of Goods Manufactured
 Indirect Manufacturing Cost……………….…….…….40% of Conversion Costs
 The entity has no semi-completed units both at the beginning & end of the year.
Required: Compute:
a) Cost of Goods Manufactured.
b) Ending Finished Goods Inventory.
c) Direct Labor Cost.
d) Factory Overhead Applied.
e) Direct Material Inventory.

Activities
Activity-1
1. ‘Cost’ indicates the amount of expenditure (actual or notional) incurred on or attributable to,
a specified thing or activity or cost unit. It is the cash or cash equivalent values scarified for
goods and services that are expected to bring current or future benefits to the organization
where as ‘Costing’ is a process for determining the cost. It may be called a technique for
ascertaining cost of production of any product or service in business organization. The real
scope of this term can best be understood in the context of big manufacturing concerns that
produce hundreds of products and spend lot of money on material, labor and other
overheads. Cost of each product in those organizations requires recording expenses with to
each product or process, classifying expenses like direct material, labor, overheads etc,
allocating direct expenses and suitable apportionment of overheads to each product for most
correct determination of per unit cost of production of each product.
2. Cost Accounting is basically the next step to costing. Cost accounting involves analyzing
relevant costing data, interpret it and present various management problems to
management. The scope of cost accounting involves preparation of various budgets for an
organization, determining standard costs based on technical estimates, finding and
comparing with actual costs, ascertaining the reasons of by variance analysis etc where as
Cost Accountancy is over and above costing and cost accounting. It envisages application of
costing and cost accounting in a business setup. Cost Accountancy facilitates management
with cost control initiatives, ascertainment of profitability and informed decision making. It
also includes determination of selling price for the products, division and unit wise
profitability. Forecasting of expenses and future probable incomes is also a part of the
practice of Cost Accountancy.
Activity-2
Manufacturing Non manufacturing

Item Cost Cost
Carpenter wages X
Depreciation - office building X
Glue for assembly X
Machining department supervisor X
Factory Machine depreciation X
Factory machine maintenance X
Factory machine operator wages X
Lumber X
Samples for trade shows X
Metal brackets for drawers X
Factory washroom supplies X
Activity-3
Direct Indirect
a. Assembly line labor wages X

b. Plant manager's wages X
c. Depreciation on the assembly line equipment X
d. Component parts for the product X
e. Wages of security personnel for the factory X
Activity 4
Fixed Variable
a. Assembly line labor wages X

b. Plant manager's wages X
c. Depreciation on the assembly line equipment X X
d. Component parts for the product X
e. Wages of security personnel for the factory X
Activity 5
Product Period
Item Cost Cost
Carpenter wages X
Glue for assembly X
Lumber X

Activity 6
Capitalized Non Capitalized

Item Cost Cost
Carpenter wages X
Glue for assembly X
Lumber X
Activity 7
Cost Cost Non manu-

Item Tracing Allocation facturing
Carpenter wages X
Glue for assembly X
Machining deparment department supervisor X
Lathe depreciation X
Lathe maintenance X
Lathe operator wages X
Lumber X
Activity 8
a) Br3,244,800
b) Br6,726,400
c) Br6,758,400
d) Br6,150,400

Self Assessment Questions-2
1. D 8. C 15. C
2. B 9. D 16. A
3. A 10. E 17. C
4. C 11. B 18. B
5. B 12. D 19. D
6. C 13. B 20. A
7. D 14. B

1.
No. Function (A through F)

1. Purchasing F
2. Billing D
3. Shipping B
4. Computer Support E
5. Personnel A
6. Customer Service C
2.
a) Br512.50 per unit
b) Unit costs should be higher in February if only 30,000 units are to be produced.
Indirect manufacturing costs most likely include both fixed and variable components.
Since fewer units are expected to be produced in February, total fixed costs will be
spread over fewer units. This will result in an increase in total cost per unit since
variable costs per unit will most likely not change with the decreased production.
3.
a) Br50.00
b) Br18,500,000
c) Br1,500,000
4.
a) Br330,000
b) Br475,000
c) Br316.67 per unit

5.
a) Br142,400
b) Br192,000
c) Br208,000
d) Br174,400
e) Br56,000
6.
a.
MG Manufacturing Company
Cost of Goods Manufactured Schedule
For quarter ending March 31
Direct materials used Br 378,000
Direct manufacturing labor 480,000
Manufacturing overhead
Depreciation of manufacturing equipment Br264,000
Indirect manufacturing labor 186,000
Indirect materials 84,000
Miscellaneous plant overhead 135,000
Plant utilities 92,400
Property taxes on building 28,800 790,200
Manufacturing costs incurred Br1,648,200
Add beginning work-in-process inventory 140,400
Total manufacturing costs Br1,788,600
Less ending work-in-process inventory 171,000
Cost of goods manufactured Br1,617,600
b.
MG Manufacturing Company
Cost of Goods Sold Schedule
For the quarter ending March 31
Beginning finished goods inventory Br 540,000
Cost of goods manufactured 1,617,600
Cost of goods available for sale 2,157,600
Ending finished goods inventory (510,000)
Cost of goods sold Br1,647,600

Unit 3
Job Order, Process and Operation Costing
Section 3.1: Job Order Costing System
At the end of this section lesson, you will be able to:
1. Describe nature of job-order costing system;

2. Identify the documents used in job order costing system;
3. Compute predetermined overhead rates;
4. Explain why estimated overhead costs rather than actual overhead costs are used in the
costing process;
5. Explain the flow of costs in a job order costing system;
6. Prepare appropriate journal entries to record costs;
7. Apply overhead cost to work in process using a predetermined overhead rate;
8. Prepare a schedule of cost of goods manufactured and cost of goods sold;
9. Prepare T-accounts to show the flow of costs in a job order costing system;
10. Dispose over or under applied overheads;
3.1.1. Introduction to Cost Accounting System
Why do companies need cost accounting system? Every organization needs records that show,
where its money comes from; where it goes; and how the organization is performing financially.
The system used for this purpose is called the organization’s accounting system. Reports on how
the organization has performed and how it stands financially are the end products of an
accounting system.
An accounting information system (AIS) consists of people, procedures and information

technology. Thus, an accounting information system (or simply an accounting system) may be
defined as “the combination of personnel, records and procedures that a business uses to meet
its need for financial data”.
Cost Accounting System is an accounting system or technique used to determine the cost of
a product, service, or other cost objective by collecting and classifying costs and assigning
them to cost objects. For manufacturing firms, cost accounting system will systematically
determine the three manufacturing cost elements - cost of direct materials, cost of direct
labor, and cost of manufacturing overheads incurred to produce items.
The knowledge of determining cost of a product is a prerequisite to the use of cost data for
different purposes. Most users of cost data are interested in making use of unit cost data.
Thus, any cost accounting system, to fulfill the desires (needs) of users, will try to determine
unit cost data. Unit cost data are highly useful in various decisions such as inventory valuation,
pricing company products, preparing financial statements, and planning and control decisions.
Depending upon the nature of manufacturing process, cost accounting system is divided in two
categories as Job order costing system and Process costing system. The former is discussed in this
section but the later will be discussed in the next section.
3.1.2. Basics of Job order Costing
What kinds of industries use job order costing system? A job order costing system is used in
situations where many different products are produced each period. For example clothing
factories make many different types of jeans for both men and women during a month. In a job
order costing system, costs are traced to the jobs and then the costs of the job are divided by the
number of units in the job to arrive at an average cost per unit.
Job order costing system is also extensively used in service industries. Hospitals, law firms, movie
studios, accounting firms, advertising agencies and repair shops all use a variety of job order
costing system to accumulate costs for accounting and billing purposes. The details here deal with
a manufacturing firm, the same concept and procedures are used by many service organizations.
The record keeping and cost assignment problems are more complex in a job order costing
system when a company sells many different products and services than when it has only a single
product or service. Since the products are different, the costs are typically different.
Consequently, cost records must be maintained for each distinct product or job. For example an
attorney in a large criminal law practice would ordinarily keep separate records of the costs of
advising and defending each of her clients. And a clothing factory would keep separate track of
the costs of filling orders for particular styles, sizes, and colors of jeans. A job order costing system
requires more effort than a process costing system. Companies classify manufacturing costs into
three broad categories: (1) direct materials), (2) direct labor, (3) manufacturing overhead. As we
study the operation of a job costing system, we will see how each of these three types of costs is
recorded and accumulated.
Job order costing system accumulates costs by job, by specific unit, or by specific batch of units.
Therefore, the costs of individual jobs must be kept separate. This is accomplished by the use of a
job-order cost sheet or job-order sheet. On the job order cost sheet, all the three manufacturing
cost elements - cost of direct materials, cost of direct labor, and cost of manufacturing overhead
attributable to the job are recorded. It also provides information such as summary of total and
unit cost of inputs and outputs, date started and completed, job number, number of units
completed and description.
Activity 1
1. What is the primary objective in job order costing system?
2. What is a job cost sheet?
3.1.3. Advantages and Disadvantages of Job Order Costing System
What are the advantages and disadvantages of job order costing system? One of the primary
advantages of job order costing system is that the management team has ready access to all the
costs incurred for each job being completed. This allows the team to examine each cost incurred,
finding out why it happened, and determine how it can be controlled better in the future, thereby
contributing to better ongoing levels of profitability. For example, a proper job record contains
any special reworking costs, which a manager can then use to trace back to the specific reason
why the rework was needed. Similarly, overhead allocations based on machine usage reveal
problems with excess use, which might be the result of lengthy machine setups or break downs as
well as longer than expected machine cycle times.
Another reason for using job order costing system is that it yields ongoing results for each job. In
today's world of fully computerized production tracking data bases, one can use a job order
costing system to track costs as they are added rather than waiting until the job has been
completed. This gives a company several advantages. One is that the accounting staff can monitor
job accounts to see if costs are being posted to the wrong accounts and corrects them right away,
rather than waiting until the job closes and having to frantically review records to see why the
results are different from expectations. Another advantage is that a company can monitor the
costs incurred for longer jobs and have enough time to make changes before they close, based on
the costing information revealed by the job costing system. For example, a lengthy new product
development project might be over budget after just 25% of the work has been completed; If the
management team is made aware of this costing problem early in the project, it will still have 75%
of the project in which to make corrections and bring costs back down to budgeted levels. Yet a
third advantages is that changes in the cost of a job can result in negotiations with cost-plus
customers who are paying for all the costs incurred, so that they are fully aware of cost overruns
well in advance and are prepared to pay the additional amounts. All these factors are the main
advantages of using job order costing system in a computerized environment.
There are also several problems with job order costing system. One is that it focuses attention
primarily on products rather than on departments or activities. This is not an issue if there are
supplemental systems in place that record information about these other cost categories, but it
leaves management with inadequate information if this is not the case. Another difficulty is that
overhead is generally allocated based on rates that are changed only about once a year.

Considerable fluctuation in overhead costs over the course of a year can result both in over and
under allocation of overhead costs to jobs during that period. Another problem is specific to the
use of normal costing. This practice involves the use of standards overhead rate rather than one
that is based on actual costs and requires adjustment from time to time. If it is management's
intention to charge individual jobs for the variance between standard and actual overhead rates,
this may not be possible if some jobs have already been closed by the time the variance allocation
takes place.
Another issue is that job costing has little relevance in some environments. For example, the soft
ware industry has high development costs but almost zero direct costs associated with the sale of
its products. The use of a job order costing system to records these costs makes little sense if the
associated costs represent only a few percent of the total revenue gained from each one. The
same problem arises in service industries, such as retailing, where there is no discernible product.
These situations limit the most effective use of job order costing system to two areas--production
and professional services. The first case, production is an obvious use for the concept since there
are high material costs that can be specifically identified with a job. The same is true of
professional services, but here the main cost is direct labor rather than direct materials. In most
other cases job costing does not provide management with sufficient quantity of information to
be useful.
The most important problem with job order costing is that it requires a major amount of data
entry and data accuracy in order to yield effective results. Data related to materials, labor, and
overhead, indirect labor, scrap, spoilage, and supplies must be entered into system capable of
accurately assigning these costs to the correct jobs every time. In reality such systems are rife with
mistakes due to the sheer volume of data transactions, keying errors, misidentification of jobs,
and the like. Problems can be resolved with a sufficient amount of error tracing by the accounting
staff, but there may be so many that there are not enough staff members to keep up with them.
Though these issues can to some degree be resolved through the use of computerized data entry
system outweighs the benefits to be gained from it. A final issue is that a large proportion of the
costs assigned to a job, frequently more 50%, come from allocated overhead. When there is no
fully proven method for accurately allocating overhead, such as through an activity based costing
system the results of the allocation yield meaningless information. This has been a particular
problems for the companies that persist in allocating overhead costs based on the direct labor
used by each job, Since a small amount of labor is generally being used to allocate a much larger
amount of overhead, resulting in large shifts in overhead allocations based on small amount of
labor is generally being used to allocate a much larger amount of overhead, resulting in large
shifts in overhead allocations based on small changes in labor costs. Some companies avoid this
problem by ignoring overhead for job order costing purposes or by reducing overhead cost pools

to include only overhead directly traceable at the job level. In this way, many costs are not
allocated to jobs at all, but those that are allocated are fully justifiable.
Clearly, one must weigh the pros and cons of using a job order costing system to see if the
benefits outweigh the costs. This system is a complex one that is prone to error, but it does yield
good information about production-specific costs.
3.1.4. Work flow and Cost flow in Job order costing System
What is the difference between cost flow and workflow? The flow of costs parallels the flow of
work in the production settings even though different companies have different production and
costing systems. The work flow or physical flow of production can be defined as the sequence of
operating activity that begins with the decision to order direct materials and ends with finished
product being sold to customers and the cost flow will be discussed in detail in the forthcoming
section. The basic steps may vary from firm to firm, but they share a common feature. The
following procedures may show the physical flow of production.
1. A decision is made to order basic direct materials. Specialized direct materials may be
ordered as needed. The store room clerk fills a purchase requisition form when the basic
input has reached some point which is commonly called as the reorder point. The reorder
point is the point where the stock level has reached the allowable minimum amount. The
manufacturer does not allow stock levels below that to avoid stock out situations because
of unexpectedly high use of direct materials.
2. Direct materials and supplies are ordered from vendors.
3. Direct materials are received and placed in the store room.
4. A decision is made to manufacture a specific product.
5. Direct materials and supplies are issued from the store room and placed into production.
6. Direct labor employees work on transforming the direct materials into work in process/
7. Other indirect and common costs are incurred in the process of transforming the direct
materials into work in process.
8. The work in process is completed and becomes finished goods.
9. The finished goods are sold and become cost of goods sold.
In general, a firm’s cost accounting system parallels its flow of operation. The nine procedures
mentioned above are summarized below.
1. Procurement – raw materials and supplies needed for manufacturing are ordered, received,
and stored.
2. Production – raw materials are transferred from storeroom to factory. Labor, tools,
machines, power, and other costs are applied to transform the raw material into finished
product.

3. Warehousing – finished goods are moved from the factory to the ware house to be held
until they are sold.
4. Selling– products are shipped from the warehouse, and customer accounts are charged.
It is possible to show the physical flow of operation and cost flow by using diagrams. Mind you
that costs are attached to products as products flow sequentially through production and the
following diagrams show how the flow of production parallels with the cost flow.
Exhibit 3.1 .1 Work flow in Job order costing System
Procurement Production Warehousing Selling
Exhibit 3.1.2 Cost flow in Job order costing System
Direct Material
Direct Labor Finished Goods Cost of Goods Sold
Work In Process
Inventory
Factory Overhead
Activity 2
Put a tick mark ( ) in the appropriate cell as ‘True’ if the statement is correct and
‘False’ if the statement is incorrect
Statement True False
1. Job costing is commonly used to estimate costs in beverage
production.
2. Job-costing may only be used by manufacturing companies.
3. In a job-costing system the cost object is an individual unit, batch, or

lot of a distinct product or service.
4. The flow of costs parallels the physical flow of work in the
production settings.
5. Job-cost record is a source document, but individual items of the job-
cost record may also have source documents.

3.1.5. Accounting for Manufacturing Costs under Job Order Costing System
3.1.5.1.Measuring Direct Materials Costs in Job order Costing System
How direct material costs are measured in job order costing system?
Bill of Materials:
At the beginning of production process a document known as bill of materials is used for standard
products. "A bill of materials is a document that lists the type and quantity of each item of
materials needed to complete a unit of standard product".
In case where it is not possible to use a bill of materials, the production staff determines the
materials requirements from the blueprints submitted by the customer.
Exhibit 3.1.3 Sample Bill of Materials
Materials Requisition Form:
When an agreement is reached with the customer concerning the quantities, price and shipment
date for the order, a production order is issued. The production department then prepares a
material requisition form. The materials requisition form is a detailed source document that
specifies the type and quantity of materials to be drawn from the storeroom, and identifies the
job to which the costs of the materials are to be charged". The form is used to control the flow of

materials into production and also for making entries in the accounting records. The completed
form is presented to the storeroom clerk who then issues the necessary raw materials. The
storeroom clerk is not allowed to release materials without such a form bearing an authorized
signature. Following is an example of a material requisition form.
Exhibit 3.1.4 Sample materials requisition form:
Materials Requisition Number:14873 Date March 2, 20x9

Job Number to Be Charged :2B47
Department Molding
Description Quantity Unit Cost Total Cost
M46 Housing 2 Br124 Br248
G7 Connector 4 103 412
-------
Br660
Authorized Signature: Dave Bruno
3.1.5.2. Measuring Direct Labor Cost under Job Order Costing System
How direct labor costs are measured under job order costing system?
Labor Time Ticket:

Direct labor cost is handled in much the same way as direct materials. Direct labor consists of
labor charges that are easily traced to a particular job. Labor charges that cannot be easily traced
directly to any job are treated as part of manufacturing overhead. The latter category of labor cost
is known as indirect labor and includes tasks such as maintenance, supervision, and cleanup.
Workers use time tickets to record the time they spend on each job and task. Following is an
example of employees’ time ticket.
Exhibit 3.1.5 Sample Employee Time Ticket

Time Ticket No. 843 Date March 3,20x9
Employee Merry Johnson
Started Ended Time Completed Rate Amount Job Number
7:00 12:00 5.0 Br9 Br45 2B47

12:30 2:30 2.0 9 18 2B50
2:30 3:30 1.0 9 9 Maintenance

A completed labor time ticket is an hour by hour summary of the employees activities
throughout on a specific job, the employee enters the job number on the time ticket and notes
the amount of time spent on that job. When not assigned to a particular job, the employee
records the nature of the indirect labor task (such as cleanup and maintenance) and the amount
of time spent on the task. The daily time tickets are also used as the basis for labor cost entries
into the accounting records.
Job Cost Sheet:
After being notified that the production order has been issued, the Accounting Department
prepares a job cost sheet. A job cost sheet is a form prepared for each separate job that records
the materials, labor and overhead costs charged to the job. After direct materials are issued, the
Accounting department records their costs directly on the job cost sheet.
In addition to serving as a means for charging costs to jobs, the job cost sheet also serves as a key
part of a firm's accounting records. The job cost sheets form a subsidiary ledger to the work in
process (WIP) account. They are detailed records for the jobs in process that add up to the
balance in the work in process (WIP).
At the end of the day, the time tickets are gathered and accounting department enters the direct
labor hours and costs on individual job cost sheets. Following is an example of a job cost sheet.
The system we have just described is a manual method for recording and posting labor costs.
Many companies now rely on computerized system and no longer record labor time by hand on
sheet of paper. One computerized approach uses bar codes to enter the basic data into the
computer. Each employee and each job has a unique bar code. When an employee begins work on
a job, he or she scans three bar codes using a hand-held device much like the bar code readers at
grocery store check-out stands. The first bar code indicates that a job is being started; the second
is the unique bar code on his or her identity badge; and the third is the unique bar code of the job
itself. This information is fed automatically via an electronic network to a computer that notes the
time and then records all of the data. When the employee completes the task, he or she scans a
bar code attached to the job. This information is relayed to the computer that again notes the
time, and a time ticket is automatically prepared. Since the entire source data is already in
computer files, the labor costs can be automatically posted to job cost sheets (or their electronic
equivalents). Computers, coupled with technology such as bar codes, can eliminate much of the
drudgery involved in routine bookkeeping activities while at the same time increasing timeliness
and accuracy. Following is an example of a job cost sheet.

Exhibit 3.1.6 Sample Job Cost Sheet
JOB COST SHEET

Job Number 2B47 Date Initiated March 2,20xx9
Department Molding Date Completed March 8,20x9
Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br660 843 5 Br45 27 Br8/DLH Br216
14875 506 846 8 60
14912 238 850 4 21
--------- 851 10 54
Br1,404 -------- --------
===== 27 Br180
===== =====
Cost Summary Units Shipped
Direct Materials Br1,404 Date Number Balance
Direct Labor 180 March 8 -- 2
Manufacturing Overhead 216
Total Cost 1800
Unit Product Cost 900
Activity 3
Answer the following questions in the space provided.

1. How is the control over prime costs achieved in job-order costing system?
2. What is the function of work in process (WIP) account in job order costing system?
3. For each item below indicate the source documents that would most likely authorize the journal
entry in a job-costing system.
Required:
a. direct materials purchased___________________________________________
b. direct materials used_______________________________________________
c. direct manufacturing labor___________________________________________
d. indirect manufacturing labor_________________________________________
e. finished goods control______________________________________________
f. cost of goods sold _________________________________________________

3.1.5.3. Application of Manufacturing Overhead Cost in Job Order Costing
How manufacturing overhead cost is measured under job order costing system?
[
Predetermined Overhead Rate:
Manufacturing overhead must be included with direct labor on the job cost sheet since
manufacturing overhead is also a product cost. However, assigning manufacturing overhead to
units of product can be a difficult task. There are three reasons for this:
1. Manufacturing overhead is an indirect cost. This means that it is either impossible or difficult
to trace these costs to a particular product or job. \
2. Manufacturing overhead consists of many different items ranging from the grease used in
machines to the annual salary of production manager.
3. Even though output may fluctuate due to seasonal or other factors, manufacturing overhead
costs tend to remain relatively constant due to the presence of fixed costs.
Given these problems, about the only way to assign overhead costs to production is to use an
allocation process. This allocation of overhead cost is accomplished by selecting an allocation base
that is common to all of the company's products and services. An allocation base is a measure
such as direct labor hours or machine hours that is used to assign overhead costs to products and
services. The most widely used allocation bases are direct labor hours, and direct labor cost, with
machine hours and even units of product (where a company has only a single product) also used
to some extent. To compute the predetermined overhead rate, the following four basic steps can
be followed:
Step 1: Select an appropriate activity base or cost driver.
Step 2: Determine total budgeted manufacturing overhead costs for the period.
Step 3: Determine total budgeted units of activity base or cost driver for the period.
Step 4: Divide the budgeted manufacturing overhead costs by the budgeted total unit in the
activity base or cost driver. It is the division of step 2 by step 3.
Formula and Calculation of Predetermined Overhead Rate:
Pre determined = Estimated Manufacturing Overhead Costs
Overhead Rate (POR) Estimated Units of Cost-Driver

Example: If a company has estimated that its total manufacturing overhead cost will be Br320,
000 for the year and its total direct labor hour will be 40,000. Its predetermined overhead rate for
the year will be Br8 per direct labor hour, as calculated below:
=Br320, 000 / 40,000 direct labor hours
= Br8 per direct labor hour
Predetermined Overhead Rate is based on estimates rather than actual results. This is because
the predetermined overhead rate is computed before the period begins and is used to apply
overhead cost throughout the period. The process of assigning overhead cost to jobs is called
overhead application. The formula for determining the amount of overhead cost to apply to a
particular job is:
Applied Manufacturing = Pre-determined x Actual Cost Driver

Overhead Over-head Rate Used
Note that the job cost sheet in the example below indicates that 27 labor hours have been worked.
Therefore a total of Br216 of manufacturing overhead cost would be applied to the job. See the
following calculation:
Overhead applied to job 2B47 = Predetermined overhead rate × Actual direct labor hours charged
to job 2B47
= Br8 per DLH × 27 DLHs
= Br216 of overhead applied to job 2B47
The amount of overhead has been entered on the job cost sheet above. Note that this is not the
actual amount of overhead caused by the job. There is no attempt to trace actual overhead costs
to jobs--if that could be done, the costs would be direct costs, not overhead costs. Overhead
assigned to the job is simply a share of the total overhead that was estimated at the beginning of
the year. When a company applies overhead cost to jobs as we have done--it is called normal cost
system. The overhead may be applied as direct labor-hours are charged to jobs, or all of the
overhead can be applied at once when the job is completed. The choice is up to the company. If a
job is not completed at the year-end, however, overhead should be applied to value the work in
process inventory.
The Need for Predetermined Overhead Rate:
Instead of using a predetermined overhead rate, a company could wait until the end of the
accounting period to compute an actual over head rate based on actual total manufacturing costs
and the actual total units in the allocation base for the period. However, managers cite several
reasons for using predetermined over head rates instead of actual overhead rates:

i. Managers would like to know the accounting system's valuation of completed jobs before the
end of the accounting period. Suppose, for example a company waits until the end of the year
to compute its overhead rate. Then there would be no way for managers to know the cost of
goods sold for a job until the close of the year. The job may be completed and shipped before
the end of the year. The seriousness of this problem can be reduced to some extent by
computing the actual overhead more frequently, but that immediately leads to another
problem as discussed below.
ii. If actual overhead rates are computed frequently, seasonal factors in overhead costs or in the
allocation base can produce fluctuations in the overhead rates. For example, the cost of
heating and cooling a production facility will be highest in the winter and summer months and
lowest in the spring and fall. If an overhead rate were computed each month or each quarter,
the predetermined overhead rate would go up in the winter and summer and down in the
spring and fall. Two identical jobs, one completed in winter and one completed in spring,
would be assigned different costs if the overhead rate were computed on a monthly or
quarterly basis. Managers generally feel that such fluctuations in overhead rates and costs
serve no useful purpose and are misleading.
iii. The use of predetermined overhead rate simplifies the record keeping. To determine the
overhead cost to apply to a job, the accounting staff simply multiplies the direct labor hours
recorded for the job by the predetermined overhead rate.
Activity 4
1. What is factory overhead?
2. Explain briefly: (a) actual factory overhead (b) applied factory overhead.
3.1.6. The Flow of Costs under Job Order Costing System
How do costs flow under job order costing system? To understand the flow of costs in job order
costing system, we shall consider a single month's activity for a company, a producer of product A
and product B. The company has two jobs in process during April, the first month of its fiscal year.
Job 1, of 1000 units of product A was started in March. By the end of March, Br30, 000 in
manufacturing costs had been recorded for the job 1. Job 2 an order for 10,000 units of product B
was started in April.
The Purchase and Issue of Materials:
On April 1, 20x9 the ND engineering had Br7, 000 in raw materials on hand. During the month, the
company purchased an additional Br60, 000 in raw materials. The purchase is recorded in journal
entry (1) below:

(1)
Raw Materials 60,000
Accounts Payable 60,000
Raw materials are an asset account. Thus, when raw materials are purchased, they are initially
recorded as an asset--not as an expense.
Issue of Direct and Indirect Materials:
During April, Br52, 000 in raw materials was requisitioned from the storeroom for use in
production. These raw materials include both direct and indirect materials. Entry (2) records
issuing the materials to the production department.
(2)
Work in Process 50,000
Manufacturing Overhead 2,000
Raw Materials 52,000
The materials charged to work in process (WIP) represent direct materials for specific jobs. As
these materials are entered into the work in process account, they are also recorded on the
appropriate job cost sheets. This point is illustrated in Exhibit 3.1.7 were Br28, 000 of the Br50, 000
in direct materials is charged to Job 1 cost sheet and the remaining Br22, 000 is charged to job 2
cost sheet. (In this example, all data are presented in summary form and the job cost sheet is
abbreviated.)
The Br2, 000 charged to manufacturing overhead in entry (2) represents indirect materials used in
production during April. Observe that the manufacturing overhead account is separate from work
in process account. The purpose of the manufacturing overhead account is to accumulate all
manufacturing overhead costs they are as they are incurred during a period.
Before leaving Exhibit 3.1.7 we need to point out one additional thing. Notice from the exhibit that
the job cost sheet for job 1 contains a beginning balance of Br30, 000. We stated earlier that this
balance represents the cost of work done during March that has been carried forward to April.
Also note that work in process account contains the same Br30, 000 balances. The reason the
Br30, 000 appears in both places is that the work in process account is a control account and the
job cost sheets form a subsidiary ledger. Thus, the work in process account contains a summarized
total of all costs appearing on the individual job cost sheet for all jobs in process at any given point
in time. (Since the company had only job 1 in process at the beginning of April, job 1's Br30, 000
balances on that date is equal to the balance in the work in process account.

Exhibi.3.1.7 Materila Cost Flow
Issue of Direct Materials Only:
Sometimes the materials drawn from the raw materials inventory account are all direct materials.
In this case, the entry to record the issue of the materials into production would be as follows:
Work in process XXX

Raw materials XXX
Labor Cost:
As work is performed each day in various departments of the company, employee time tickets are
filled out by workers, collected, and forward to the accounting department. In the accounting
department, wages are computed and the resulting costs are classified as either direct or indirect
labor. This costing and classification for April resulted in the following summary entry:
(3)
Salaries and wages payable 75,000
Only direct labor is added to the work in process account. In this example, direct labor is Br60,000
for April. At the same time the direct labor costs are added to work in process, they are also added
to the individual job cost sheets, as shown in the Exhibit 3.1.8. During April, Br40, 000 of direct
labor cost was charged to job 1 and the remaining Br20, 000 was charged to job 2. The labor cost
charged to manufacturing overhead represent the indirect costs of the period, such as
supervision, janitorial work, and maintenance.
Exhibit 3.1.8 Labor Cost Flow
Manufacturing Overhead Costs:
All costs of operating the factory other than direct materials and direct labor are classified as
manufacturing overhead costs. These costs are entered directly into the manufacturing overhead
account as they are incurred. To illustrate, assume that the company incurred the following
general factory costs during April:
Utilities (heat, water, and power) Br21,000

Rent on factory equipment 16,000
Miscellaneous factory costs 3,000
Total Br40,000
The following entry records the incurrence of these costs:

(4)
Accounts Payable 40,000
In addition, let us assume that during April, the company recognized Br13, 000 in accrued property
taxes and that Br7,000 in prepaid insurance expired on factory buildings and equipment. The
following entry records these items:
(5)
Property taxes payable 13,000
Prepaid insurance 7,000

Finally let us assume that the company recognizes Br18, 000 in depreciation on factory equipment
during April. The following entry records the accrual of this depreciation:
(6)
Accumulated Depreciation 18,000
In short, all manufacturing overhead costs are recorded directly into the manufacturing overhead
account as they are incurred day by day through a period. It is important to understand that
manufacturing overhead is a control account for many--perhaps thousands--of subsidiary accounts
such as indirect materials, indirect labor, factory utilities, and so forth. As the manufacturing
overhead account is debited for costs during a period the various subsidiary accounts are also
debited. In this example we omit the entries to the subsidiary accounts for the sake of brevity.
Calculation of Predetermined Overhead Rate and Application of Manufacturing Overhead to

Work in Process (WIP):
Since actual manufacturing costs are charged to the manufacturing overhead control account
rather than work in process account. How are manufacturing costs assigned to work in process?
The answer is, by means of the predetermined overhead rate. A predetermined overhead rate is
established at the beginning of each year. The predetermined overhead rate is calculated by
dividing the estimated total manufacturing overhead cost for the year by the estimated total units
in the allocation base (measured in machine hours, direct labor hours, or some other base).
Thus, the formula to compute predetermined overhead rate (POR) is as follows:
Pre determined = Estimated Manufacturing Overhead Costs

Overhead Rate (POR) Estimated Units of Cost-Driver
After the predetermined rate is computed, the manufacturing overhead cost is applied to work-in-
process based on actual units of the activity base (application base), i.e., the rate multiplied by
actual units of application base for the period concerned.
Applied Manufacturing = Pre-determined x Actual Cost Driver
Overhead Over-head Rate Used
To illustrate assume that the company has used machine hours to compute predetermined
overhead rate and that this rate is Br6 per machine hour. Also assume that during April, 10,000
machine hours were worked on Job 1 and 5,000 machine hours were worked on Job 2 (a total of
15,000 machine hours). Thus, Br90, 000 in overhead cost (15,000 machine hours Br 6 per machine
hour = Br90, 000) would be applied to work in process. The following entry records the
application of manufacturing overhead to work in process:
(7)
The actual overhead cost in the manufacturing overhead account in Exhibit is the costs that were
added to the account in entries (2)--(6). Observe that the incurrence of these actual overhead
costs and the application of overhead to work in process represent two separate and entirely
distinct processes.
Exhibit 3.1.9 Manufacturing Overhead Cost Flow
The Concept of Clearing Account:
The manufacturing overhead account operates as a clearing account. As we have noted, actual
factory overhead costs are debited to the accounts as they are incurred day by day through the
year. A certain intervals during the year, usually when a job is completed, overhead cost is applied
to the job by means of the predetermined overhead rate, and work in process is debited and
manufacturing overhead is credited. This sequence of events is illustrated below:
Manufacturing Overhead
(a clearing account)
Actual overhead costs are charged to Overhead is applied to work in process sing
this account as they are incurred
throughout the period. the predetermined overhead rate.
As we emphasized earlier, the predetermined overhead rate is based on estimates of what
overhead costs are expected to be, and it is established before the year begins. As a result, the

overhead cost applied during a year will almost certainly turn out to be more or less than the
overhead cost that is actually incurred. For example, notice from Exhibit 1.3 that the company's
actual overhead costs for the period are Br5,000 greater than the overhead cost that has been
applied to work in process (WIP), resulting in a Br5,000 debit balance in the manufacturing
overhead account. This debit balance in manufacturing overhead account is called under-applied
overhead. Any credit balance in manufacturing overhead account is called over-applied overhead.
Any balance in the manufacturing overhead account (under or over-applied overhead) is treated
in one of the following ways:
1. Closed out to cost of goods sold
2. Allocated between work in process, finished goods, and cost of goods sold in proportion
to the overhead applied during the current period in the ending balance of these accounts.
These two methods are illustrated on Disposition of Under- or Over-applied Overhead section.
For the moment, we can conclude by nothing from Exhibit 3.7 that the cost of a completed job
consists of the actual materials cost of the job, the actual labor cost of the job, and the overhead
cost applied to the job. Pay particular attention to the following subtle but important point: Actual
overhead costs are not charged to jobs; actual overhead costs do not appear on the job cost sheet
nor do they appear in the work in process account. Only the applied overhead cost, based on the
predetermined overhead rate, appear on the job cost sheet and in the work in process account.
Study this point carefully.
Non-manufacturing Costs:
In addition to manufacturing costs, companies also incur marketing and selling costs. These costs
should be treated as period expenses and charged directly to the income statement and therefore
should not go into the manufacturing overhead account. To illustrate the correct treatment of
non-manufacturing costs, assume that the company (in this example) incurred Br30, 000 in selling
and administrative salary costs during a months, the following entry records these salaries.
(8)
Salaries expense 30,000
Depreciation on factory equipment is debited to manufacturing overhead account but
depreciation on office equipment is considered a period expense and is not included in
manufacturing overhead. Assume that depreciation of office equipment during the month was
Br7, 000. The entry is as follows.
(9)
Depreciation expense 7,000
Accumulated depreciation 7,000

Finally assume that advertising was Br42, 000 and that other selling and administrative expenses
during the month were Br8, 000. The following journal entry records these items:
(10)
Advertising expenses 42,000
Other selling and administrative expense 8,000
Accounts payable 50,000
Since the amounts in entries above all go directly into expense accounts, they will have no effect
on the costing of the company's production for the month. The same will be true of any other
selling and administrative expenses incurred during the month including sales commission,
depreciation on sales equipment, rent on office facilities, insurance on office facilities, and related
costs.
Cost of Goods Manufactured (COGM):
When a job has been completed, the finished output is transferred from the production
department to the finished goods warehouse. By this time, the accounting department will have
charged the job with direct materials and direct labor cost and manufacturing overhead will have
been applied using the predetermined overhead rate. A transfer of costs is made within the costing
system that parallels the physical transfer of the goods to the finished goods warehouse. The costs
of the completed jobs are transferred out of the work in process (WIP) account and into the
finished goods account. The sum of all amounts transferred between these two accounts
represents the cost of goods manufactured for the period.
Let us assume that the job 1 was completed during the period. The following entry transfers the
cost of job 1 from work in process (WIP) to finished goods.
(11)
The Br158,000 represents the completed cost of job 1, as shown on the job cost sheet in Exhibit 1.3.
Since job 1 was the only job completed during April, the Br158,000 also represents the cost of
goods manufactured for the month.
The job 2 was not completed by month-end, so its cost will remain in the work in process (WIP)
account and carry over to the next month. If a balance sheet is prepared at the end of April, the
cost accumulated thus far on the job 2 will appear as "work in process inventory" in the assets
section.
[

Cost of Goods Sold (COGS):
As units in the finished goods are shipped to the customers, their costs are transferred from the
finished goods account into the cost of goods sold account. If complete job is shipped, as in the
case where a job has been done to a customer's specification then it is a simple matter to transfer
the entire cost appearing on the job cost sheet into the cost of goods sold account. In most cases,
only a portion of the units involved in a particular job will be immediately sold. In these situations
the unit cost must be used to determine how much product cost should be removed from finished
goods and charged to cost of goods sold.
Assume that the company has completed 1000 units and 750 out of 1000 units have been shipped
to customers for a price of Br225, 000. The unit product cost is Br158. Following journal entries
would record the sales (all sales are on account).
(12)
Accounts receivable 225,000
Sales 225,000
(13)
Cost of goods sold 118,500*
(Br158 × 750units = Br118, 500*)
With entry (13), the flow of cost through our job order costing system is completed.
T accounts for the aforementioned journal entries and schedules of cost of goods manufactured
and cost of goods sold are presented as follows:

T Accounts:
Accounts Receivable Accounts Payable Capital Stock
xx xx xx
(12) 225,000 (1) 60,000
(4) 40,000
(10) 50,000
Prepaid Insurance Salaries and Wages Retained Earnings
Payable
Xx xx xx
(3) 75,000
(5) 7,000 (8) 30,000
Raw Materials Property Taxes Payable Sales
Bal. 7,000 (20) 52,000 xx (12) 225,000
(1) 60,000 (5) 13,000
Bal. 15,000
Cost of Goods Sold

Work in Process Salaries expenses (13) 118500
Bal. 30,000 (11) 158,000 (8) 30,000
(2) 50,000 Depreciation expenses
(3) 60,000 (9) 7,000
(7) 90,000
Bal. 72,000
Finished Goods Advertising Expenses
Bal. 10,000 (13) 118,500 (10) 42,000
(11) 158,000
Bal. 49,500
Accumulated Depreciation Other Selling and
Administrative expenses
xx (10) 8,000
(6) 18,000
(9) 7,000
Manufacturing Overhead
(2) 2000 (7) 90,000
(3) 15,000
(4) 40,000
(5) 20,000
(6) 18,000
Bal. 5,000

ND Engineering
Schedule of Cost of Goods Manufactured and Cost of Goods Sold
For the Month ended April 30, 20x9
Cost of Goods Manufactured:
Direct materials Br50,000
Direct labor Br60,000
Manufacturing overhead applied to work in process Br90,000*
Total Manufacturing cost Br200,000
Add: Beginning work in process Br30,000
Br230,000
Deduct: Ending work in process inventory Br72,000
Add: Finished goods inventory beginning Br10,000
Goods available for sale Br168,000
Deduct: Finished goods inventory ending Br49,500
Unadjusted cost of goods sold Br118,500
Add: Under applied overhead Br5,000*
-----------
Adjusted cost of goods sold Br123,500
=======
*Overhead applied = Br90,000 (15,000 Direct labor hours × Br6.00
Predetermined overhead rate) Actual overhead = Br95,000
Under applied overhead = Br95,000 (actual) - Br90,000 (applied) = Br5,000
Entry to close the Br5,000 of under applied to cost of goods sold
would be as follows:
Cost of goods sold--------------------------------- 5,000 Dr

Manufacturing overhead------------------------ 5,000 Cr
Note that the under applied overhead is added to cost of goods sold.
If overhead were over applied, it would be deducted from cost of
goods sold.

ND Engineering
Income Statement
For the Month ended April 30, 20X9
Sales Br225,000
Less: Cost of goods sold (Br 118,500 + Br5,000) 123,500
Gross margin 101,500
Less : Selling and administrative expenses:
Salaries Br30,000
Depreciation 7,000
Other expense 8,000 87,000
Net operating income Br14,500
=======
Recording Non-manufacturing Costs in a Job Order Costing System
In addition to manufacturing costs, companies also incur marketing and selling costs. These costs
should be treated as period expenses and charged directly to the Income Statement and
therefore should not go into the manufacturing overhead account.
To illustrate the correct treatment of non-manufacturing costs, assume that a company incurred
Br30,000 in selling and administrative salary costs during a month, the following entry records
these salaries.
Salaries expense 30,000

Depreciation on factory equipment is debited to manufacturing overhead account but
depreciation on office equipment is considered a period expense and is not included in
manufacturing overhead. Assume that depreciation of office equipment during the month was
Br7,000. The entry is as follows:

Finally assume that advertising was Br42,000 and that other selling and administrative expense
during the month was Br8,000. The following journal entry records these items:

Other selling and administrative expense 8,000
Since the amounts in entries above all go directly into expense accounts, they will have no effect
on the costing of the company's production for the month. The same will be true of any other
selling and administrative expenses incurred during the month including sales commission,
depreciation on sales equipment, rent on office facilities, insurance on office facilities, and related
costs.
Activity 5
1. Name four control accounts concerned primarily with cost determination.
2. What subsidiary record or ledger supports each of the control accounts mentioned in answering
Question 1?
3.1.7. Problems of Overhead Application
What problems do exist in overhead application? We need to consider two complications relating
to overhead application. These are:
1. Under applied overhead and over-applied overhead calculation.
2. Disposition of any balance remaining in the manufacturing overhead account at the end of
a period.
3.1.7.1. The Concept of over applied and under applied Overhead
Since the predetermined overhead rate is established before a period begins and is based entirely
on estimated data, the overhead cost applied to work in process (WIP) will generally differ from
the amount of overhead cost actually incurred during a period. The difference between the
overhead cost applied to work in process (WIP and the actual overhead costs of a period is termed
as either under applied or over applied. For example if a company calculates its predetermined
overhead rate Br6 per machine hour. 15,000 machine hours are actually worked and overhead
applied to production is therefore Br90, 000 (15,000 hours × Br6). If actual factory overhead is
Br95,000 then under applied or over applied is Br5,000 (Br95,000 – Br90,000). If the situation is
reverse and the company applies Br95,000 and actual overhead is Br90,000 the over applied
would be Br5,000.
Causes of under applied or over applied overhead:
Why under applied or over applied overhead? There are a number of reasons why actual overhead

costs do not coincide with the budgeted (applied) overhead costs. Some contributing factors are:
 Poor forecasting in estimating the budgeted manufacturing overhead costs
 Inefficient use of overhead items during the period.
 Unexpected price changes in individual overhead cost items.
 Calendar variation from month to month.
 Operating at different level of volume than the level used as a denominator in calculating
the budgeted manufacturing overhead application rate
The causes / reasons of under or over-applied overhead can be complex. Nevertheless the basic
problem is that the method of applying overhead to jobs using a predetermined overhead rate
assumes that actual overhead costs will be proportional to the actual amount of the allocation
base incurred during the period. If, for example, the predetermined overhead rate is Br6 per
machine hour, then it is assumed that actual overhead cost incurred will be Br6 for every machine
hour that is actually worked. There are actually two reasons why this may not be true. First, much
of the overhead often consists of fixed costs that do not grow as the number of machine hours
incurred increases. Second, spending on overhead items may or may not be under control. If
individuals who are responsible for overhead costs do a good job, those costs should be less than
were expected at the beginning of the period. If they do a poor job, those costs will be more than
expected.
Example: Suppose that two companies A and B have prepared the following estimated data for
the coming year:
Company
A B
Predetermined overhead rate based on Machine-hours Direct materials cost
Estimated manufacturing overhead Br300,000 Br120,000
Estimated machine-hours 75,000 --
Estimated direct materials cost Br80,000
Predetermined overhead rate, (a) ÷ (b) Br4 per machine hour 150% of direct materials cost
Now assume that because of unexpected changes in overhead spending and changes in
demand for the companies' products, the actual overhead cost and the actual activity recorded
during the year in each company are as follows:
Company
A B
Actual manufacturing overhead costs Br290,000 Br130,000
Actual machine-hours 68,000 --
Actual direct materials costs -- Br90,000

For each company, note that the actual data for both cost and activity differ from the
estimates used in computing the predetermined overhead rate. This results in under applied
overhead and over applied overhead as follows:
Company
A B
Actual manufacturing overhead costs Br290,000 Br130,000
Manufacturing overhead cost applied to work in process
during the year:
68,000 actual machine hours × Br4 per machine hour 272,000
Br90,000 actual direct materials cost × 150% of direct
135,000
materials cost
------------- -------------
Under applied (Over applied) overhead Br 18,000 Br (5,000)
For company A, notice that the amount of overhead cost that has been applied to work in
process (Br272, 000) is less than the actual overhead cost for the year (Br290, 000). Therefore
the overhead is under applied. Also notice that original estimate of overhead in company A
(Br300, 000) is not directly involved in this computation. Its impact is felt only through the Br4
predetermined overhead rate that is used.
For B company the amount of overhead cost that has been applied to work-in-process (WIP)
(Br135, 000) is greater than the actual overhead cost for the year (Br130, 000), and so overhead
is over applied. A summary of the concepts discussed so for is presented below:
At the beginning of the period
Estimated total
Estimated total units in the Predetermined overhead
manufacturing overhead ÷ =
allocation base rate
cost
During the period
Actual total units of the
Predetermined overhead Total manufacturing
× allocation base incurred =
rate overhead applied
during the period
At the end of the period
Total manufacturing Under applied
Actual total manufacturing
– overhead = (over applied)
overhead cost
applied overhead

What disposition should be made of any under or over applied overhead balance remaining in the
manufacturing overhead account at the end of a period? To understand the procedure of
disposing off any under or over applied overhead, see disposition of any balance remaining in the
manufacturing overhead account at the end of a period page.
3.1.7.2. Disposition of under applied or over applied Overhead Balances
How do you clear any under applied or over applied overhead balances at the end of the period?
Any balance at the end of a period on manufacturing overhead control account should be cleared.
Manufacturing overhead control account is meant to accumulate overhead costs incurred during
the period which will be applied to work-in-process inventory account. The over applied or under
applied overhead is disposed off in one of the two ways of disposition. The choice between the
two methods depends largely on the amount of under-applied or over applied overhead.
Method 1: Direct Write off Method: -this method directly closes out any under or over applied
balance to the cost of goods sold. If the amount of under or over applied is relatively small, it may
be included in cost of goods sold
Method 2: Proration Method: - If the amount of over applied or under applied is relatively large,
the usual procedure is to prorate among Finished Goods Inventory, Work-in-Process Inventory and
Cost of Goods Sold in proportion to their account balances. This procedure essentially results in
the firm's actual overhead costing for the year.
This which allocates the under or over applied overhead among ending inventories and cost of
goods sold is equivalent to using an "actual" overhead rate and is for that reason considered by
many to be more accurate than the first method. Consequently, if the amount of under applied or
over applied overhead is material, many accountants would insist that the second method be
used.
Closed Out to Cost of Goods Sold:

Closing out the balance in manufacturing overhead account to cost of goods sold is simpler than
the allocation method. Where the overhead is under applied, the following journal entry is made:
Cost of goods sold Dr

Manufacturing overhead Cr
Where the overhead is over applied, the following journal entry is made:
Manufacturing overhead Dr
Cost of goods sold Cr

After passing one of these journal entries, cost of goods sold is adjusted. Consequently cost of
goods sold is increased by the amount of under applied and decreased by the amount of over
applied overhead.
Example:
Cost of Goods Manufactured:
Direct materials Br50,000
Direct labor Br60,000
Manufacturing overhead applied to work in process Br90,000*
Total Manufacturing cost Br200,000
Add: Beginning work in process Br30,000
Br230,000
Deduct: Ending work in process inventory Br72,000
========
Cost of Goods Sold:
Finished goods inventory beginning Br10,000
Add: Cost of goods manufactured Br158,000
Cost of goods available for sale Br168,000
Deduct: Finished goods inventory ending Br49,500
Unadjusted cost of goods sold Br118,500
Add: Under applied overhead Br5,000*
Adjusted cost of goods sold Br123,500
*Overhead applied = Br90,000 (15,000 Direct labor hours × Br6.00 Predetermined overhead rate)
Actual overhead = Br95,000
Under applied overhead = Br95,000 - Br90,000 = Br5,000
Entry to close the Br5,000 of under applied to cost of goods sold would be as follows:
Cost of goods sold-------------------------- 5,000

Manufacturing overhead------------------------- 5,000
Allocated Between Accounts:
Allocation of under or over applied overhead between work in process(WIP), finished goods and
cost of goods sold (COGS) is more accurate than closing the entire balance into cost of goods sold.
The reason is that allocation assigns overhead costs to where they would have gone in the first
place had it not been for the errors in the estimates going into the predetermined overhead rate.

If the amount of under-applied or over-applied overhead is significant, it should be allocated
among the accounts containing applied overhead: Work in Process Inventory, Finished Goods
Inventory, and Cost of Goods Sold. A significant amount of “under-applied” or “over-applied”
overhead means that the balances in these accounts are quite different from what they would
have been if actual overhead costs had been assigned to production.
Allocation restates the account balances to conform more closely to actual historical cost as
required for external reporting by generally accepted accounting principles. The above
figure uses assumed data for the Cutting and Mounting Department to illustrate the proration of
over-applied overhead among the necessary accounts; had the amount been under-applied, the
accounts debited and credited in the journal entry would be the reverse of that presented for
over-applied overhead. A single overhead account is used in this illustration.
Theoretically, under-applied or over-applied overhead should be allocated based on the amounts

of applied overhead contained in each account rather than on total account balances. Use of
total account balances could cause distortion because they contain direct material and direct
labor costs that are not related to actual or applied overhead. In spite of this potential distortion,
use of total balances is more common in practice for two reasons: First, the theoretical method is
complex and requires detailed account analysis. Second, overhead tends to lose its identity after
leaving Work in Process Inventory, thus making more difficult the determination of the amount of
overhead in Finished Goods Inventory and Cost of Goods Sold account balances.
Activity 6
Palma Corporation applies overhead based upon machine-hours. Budgeted factory overhead was
Br266,400 and budgeted machine-hours were 18,500. Actual factory overhead was Br287,920 and
actual machine-hours were 19,050. Before disposition of under/over applied overhead, the cost of
goods sold was Br560,000 and ending inventories were as follows:
Direct materials Br 60,000
WIP 190,000
Total Br500, 000
Required:
a. Determine the budgeted factory overhead rate per machine-hour.
b. Compute the over/under applied overhead.
c. Prepare the journal entry to dispose of the variance using the write-off to cost of goods sold
approach.
d. Prepare the journal entry to dispose of the variance using the proration approach.

Self Assessment Questions-3.1
yourself against the answers given at the end of this section.

1. Of the following production operations, the one most likely to employ job order cost
accumulation is:
A. Ship building D. Candy manufacturing.
B. Soft drink manufacturing E. All of the above
C. Crude oil refining F. None of the above
2. Under job order cost accumulation, the dollar amount of the entry involved in the
transfer of inventory from Work In Process ( WIP) to Finished goods is the sum of the
costs charged to all jobs:
A. Started in process during the period
B. In process during the period
C. Completed and sold during the period
D. Completed during the period
3. The source of the data for debiting Work-in-Process for direct materials is the:
A. Purchase order D. Receiving report
B. Purchase requisition E. All of the above
C. Materials requisition F. None of the above
4. In a job order cost accounting system, the entry to record the flow of direct materials
into production is:
A. Debit Materials, credit Work in Process
B. Debit Factory Overhead, credit materials
C. Debit Work in Process, credit Supplies
D. Debit Work in Process, credit material
5. A difference in quantity of materials used on two comparable jobs may be caused by:
A. Inadequately trained employees
B. Poor quality materials C. Employee carelessness
D. Inefficient production process
6. The three categories of manufacturing costs comprising the cost of work in process are
direct labor, direct materials, and:
A. Administrative costs B. Indirect expenses

C. Direct expenses E. All of the above
D. Sales salaries expense F. None of the above
7. The amount of time spent by each employee and the labor cost incurred for each individual
job or for factory overhead are recorded on:
A. Time tickets D. Employees’ earnings records
B. Clock cards E. All of the above
C. In-and-out cards F. None of the above
8. The entry to record direct labor costs into production in a job order cost accounting system
is:
A. Debit Factory Overhead, credit Work in Process
B. Debit Work in Process, credit Wages Payable
C. Debit Finished Goods, credit Wages Payable
D. Debit Factory Overhead, credit Wages Payable
9. The recording of the application of factory overhead costs to jobs would include a credit to:
A. Factory Overhead E. Cost of Goods Sold
B. Wages Payable F. All of the above
C. Factory Overhead G. None of the above
D. Work in Process
10. When job-711 was completed, direct materials totaled Br3, 000; direct labor, Br3, 500; and
factory overhead, Br1, 500, respectively. Units produced totaled 1,000. Unit costs are:
A. Br8,000 D. Br8

Read the instructions provided carefully and answer the following questions.
Exercise 1: Job Order Costing: Journal Entries, T Accounts, Income Statement
Hi-tech Company is a manufacturing firm that uses job order costing system. On January 1, the
beginning of its fiscal year, the company's inventory balances were as follows:
Raw materials Br20,000

Work in process Br15,000
Finished Goods Br30,000
The company applies overhead cost to jobs on the basis of machine-hours worked. For the current
year, the company estimated that it would work 75,000 machine-hours and incur Br450, 000 in
manufacturing overhead cost. The following transactions were recorded for the year.

1. Raw materials were purchased on account, Br410, 000.
2. Raw materials were requisitioned for use in production, Br380, 000 (Br360,000 direct
materials and Br20,000 indirect materials).
3. The following costs were incurred for employee services: direct labor, Br75, 000; indirect
labor, Br110, 000; sales commission, Br90, 000; and administrative salaries, Br20, 000.
4. Sales travel costs were Br17, 000.
5. Utility costs in the factory were Br43, 000.
6. Advertising costs were Br180, 000.
7. Depreciation was recorded for the year, 350,000 (80% relates to factory operations, and
20% relates to selling and administrative activities).
8. Insurance expired during the year, Br10, 000 (70% relates to factory operations, and 30%
relates to selling and administrative activities).
9. Manufacturing overhead was applied to production. Due to greater than expected demand
for its products, the company worked 80,000 machine-hours during the year.
10. Goods costing Br900, 000 to manufacture according to their job cost sheets were
completed during the year.
11. Goods were sold on account to customers during the year at a total selling price of Br1,
500,000. The goods cost Br870, 000 to manufacture according to their job cost sheets.
Required:
1. Prepare journal entries to record the preceding transactions.
2. Post the entries in (1) above to T-accounts (don't forget to enter the beginning balances in
the inventory accounts).
3. Is manufacturing overhead under applied or over applied for the year? Prepare journal
entry to close any balance in the manufacturing overhead account to cost of goods sold
(COGS). Do not allocate the balance between ending inventories and cost of goods sold
(COGS).
4. Prepare an income statement for the year.

Activities
Activity-1
1. The primary objective in job order costing is to determine the cost of materials, labor, and
factory overhead used to produce a specific order or contract. Cost estimates are made
when the order is taken, and the job order procedures are designed to reveal costs as the
order goes through production, thereby giving an opportunity to control costs.
2. A job cost sheet is a convenient printed form for collecting classifying and summarizing the
costs incident to a particular job, lot, or contract. In essence, it is a statement of profit or loss
for each job, prepared as the work progresses, and is therefore a guide to management in
controlling costs.
Activity-2
1. False 3. True
2. False 4. True
Activity-3
1. Job order cost sheet serve a control function. Comparisons are made between estimates of
a job costs and costs actually accumulated for the job. In addition, cost control is enhanced
by accumulating direct material and labor as well as factory overhead costs by cost centers
or departments, and by comparing the actual costs to cost center budgets.
2. The work in process account is a control account in the general ledger, reflecting total costs
assigned or applied to jobs. The individual job cost sheets form the work in process (WIP)
account’s subsidiary ledger, indicating the direct material, direct labor and factory overhead
charged to job.
3. Documents:
a. purchase invoice d. labor time card

b. materials requisition record e. job-cost record
c. labor time card/record f. sales invoice
Activity-4
1. Factory overhead is all the production costs, other than direct materials and direct labor,
necessary to manufacture a product.
2. Actual factory overhead is the actually experienced used-up cost that occurs during a
specific time period. Applied factory overhead is an estimated amount of overhead that is
assigned to work done

Activity-5
1. Four control accounts concerned primarily with cost determination are: materials; factory
overhead; work in process and finished goods.
2. Materials--materials ledger cards or other forms of perpetual inventory. Factory overhead
control--expense ledger and departmental expense analysis sheet. Work in process (WIP)--
cost sheets or cost of production reports. Finished goods--finished goods ledger cards.
Activity-6
a. Br266,400/18,500 hrs. = Br14.40 per hour

b. Br14.40 × 19,050 hours = Br274,320 - Br287,920 = Br13,600 under applied overhead
c. Cost of Goods Sold 13,600(Dr.)
Factory Department Overhead Control13,600(Cr.)
d. Computation:
Denominator: Br560,000 + Br190,000 + Br250,000 = Br1,000,000
Cost of Goods Sold: Br560,000/Br1,000,000 = 56% × Br13,600 = Br7,616
WIP: Br190,000/Br1,000,000 = 19% × Br13,600 = Br2,584
Finished Goods: Br250,000/Br1,000,000 = 25% × Br13,600 = Br3,400
Cost of Goods Sold 7,616 (Dr.)

WIP Inventory 2,584 (Dr.)
Finished Goods Inventory 3,400 (Dr.)
Factory Department Overhead Control 13,600 (Cr.)

1. A 5. E 9. C
2. D 6. F 10. D
3. D 7. A
4. D 8. B

Exercise 1: Job Order Costing: Journal Entries, T Accounts, Income Statement
1. Journal Entries
1 Raw materials 410,000
2 Work in process 360,000
Raw materials 380,000
3 Work in process 75,000
Sales commission expense 90,000
Administrative salaries expense 200,000
4 Sales travel expense 17,000
5 Manufacturing overhead 43,000
6 Advertising expense 180,000
Insurance expense 3,000
Prepaid insurance 10,000
9* Work in process 480,000
10 Finished Goods 900,000
11 Accounts Receivable 1,500,000
Sales 1,500,000
Cost of goods sold 870,000
*The predetermined overhead rate for the year would be computed as follows:
Predetermined overhead rate = Estimated total manufacturing overhead cost

Estimated total units in the allocation base
= Br450, 000 / 75,000 machine-hours

= Br6 per machine-hour

Based on the 80,000 machine-hours actually worked during the year, the company would have
applied Br480, 000 in overhead cost to production: 80,000 machine-hours × Br6 per machine-
hour = Br480, 000.
2. T- Accounts
Accounts Receivable Raw Materials Work in Process

(11) 1,500,000 Bal. 20,000 (2) 380,000 Bal. 20,000 (10)900,000
(1) 410,000 (2) 360,000
Bal. 50,000 (3) 75,000
Finished Goods (9) 480,000
Bal. 30,000 (11) 870,000 Prepaid Insurance Bal. 30,000
(10 ) 900,000 (8) 10,000 Accumulated Depreciation
(7) 350,000
Accounts Payable Salaries and Wages Payable
(1) 410,000 (3) 475,000
(4) 17,000 Manufacturing Overhead
(5) 43,000 (2) 20,000 (9)80,000
(6) 180,000 Cost of goods sold (3) 110,000
(11) 870,000 (5) 43,000
(7) 280,000
(8) 7,000
Sales Administrative Salary Expense 460,000 480,000
(11) 1,500,000 (3) 200,000 Bal. 20,000
Sales Commissions Depreciation Expenses Insurance Expense

Expenses (7) 70,000 (8) 3,000
(3) 90,000
Sales Travel Expense

Advertising expense (4) 17,000
(6) 180,000
3. Under or over applied manufacturing overhead:
Manufacturing overhead is over applied for the year. The entry to close it out to cost of goods
sold is as follows:

Cost of goods sold 20,000

4. Income Statement
Hi-tech Company
Income Statement
For the Year Ended December 31
Sales Br1,500,000
Less: Cost of goods sold (Br870,000 - Br20,000 over applied FOH 850,000
-------------
Gross margin: 650,000
Less selling and administrative expenses:
Commission expense Br90,000
Administrative salaries expense 200,000
Sales travel expense 17,000
Advertising expense 180,000
Insurance expense 3,000 560,000
------------ -------------
Net operating income Br90,000
=====

Section 3.2: Process Costing System
1. Distinguish between job-order costing and process costing;

2. Explain how process costing system tracks costs to products;
3. Prepare a cost of production report under process costing;
4. Differentiate between weighted average costing method and first in, first out costing method
when they are used in process costing system;
5. Apply standard costs in product costing.
3.2.1. Basics of Process Costing
What kind industries use process costing system? A process costing is a cost accounting system in
which the cost of a product or service is obtained by assigning costs to masses of like or similar
units. Unit costs are then computed on an average basis. Process costing system is used in
industries that cost like or similar units of products, which are often mass produced. In these
industries, relatively homogenous products are produced in a very similar manner and are hence
assumed to receive the same amount of direct materials, direct labor and factory overhead costs.
Industries using process costing in their manufacturing area include cement factory, textile
industries, chemical factories, oil refinery, pharmaceuticals, plastics, beverage, and the like.
The principal difference between process costing and job order costing is the extent of averaging
used to compute unit costs of products or services. The cost object in a job costing system is a job
that constitutes a distinctly identifiable product or service. Individual jobs use different quantities
of manufacturing resources, so it would be incorrect to cost each job at the same average
manufacturing cost. In contrast, when like or similar units are mass produced, and not produced
as individual jobs, process costing average manufacturing costs over all units produced. In
contrast, when like or similar units are mass produced, and not processed as individual jobs,
process costing averages manufacturing costs over all units produced.
Knowing what product cost is important information for inventory valuation, pricing decision, and
profitability analysis .Companies also use product costs to measure how well they are doing in
managing and reducing costs.

3.2.2. Characteristics of Process Costing
What are the major characteristics of process costing system? The main characteristics of process
costing system may be summarized as follows:
1. A cost of production report is used to collect, summarize and compute total and unit costs.
2. Production is accumulated and reported by departments.
3. Costs are posted to departmental work in process accounts
4. Production in process at the end of a period is restated in terms of completed units.
5. Total cost charged to a department is divided by total computed production of the
department in order to determine a unit cost for a specific period.
6. Costs of completed units of a department are transferred to the next processing
department in order to arrive at the total costs of the finished products during a period. At
the same time, costs are assigned to units still in process.
The procedures of process costing are designed to:
1. Accumulate materials, labor, and factory overhead costs by departments.
2. Determine a unit cost for each department.
3. Transfer costs from one department to the next and to finished goods.
4. Assign costs to the inventory of work in process (WIP)
If accurate units and inventory costs are to be established by process costing procedures, costs of
a period must be identified with units produced in the same period.
Activity 1
1. What is the primary objective in process costing?
2. What are the distinguishing characteristics of process costing procedures?
3.2.3. Comparison of Process Costing and Job order Costing
What are the similarities and differences between process costing and job order costing?
Similarities:
1. The same basic purposes exist in both systems, which are to assign material, labor and
overhead costs to products and to provide mechanisms for computing unit costs.
2. Both systems maintain and use the same basic manufacturing accounts including
Manufacturing Overhead, Raw materials, Work-In-Process and Finished Goods
3. The flow of costs through the Manufacturing accounts is basically the same in both systems.
Differences:

The differences between job order and process costing arise from two factors. The first is the flow
of units in a process costing system is more or less continuous and the second is that these units
are indistinguishable from one another. A further difference between the two costing systems is
that the job cost sheet has no use in process costing since the focal point of that method is on
departments. Instead of using job cost sheets, a document known as a production report is
prepared for each department in which work is done on products.
Exhibit 3.2.1 Comparison of Process Costing and Job order Costing
Job Order Costing Process Costing
1. Collects manufacturing costs and assigns 2. Collects manufacturing costs and groups
them to specific jobs or batches of them in department, work center or work
product. cell.
3. Many different jobs are worked on 4. A single product is produced either on a
during each period with each job having continuous basis or for long periods of
different production requirements. time. All units of products are identical.
5. The job cost sheet is the key document 6. The departmental production report is the
controlling the accumulation of costs by key document showing the accumulation
a job. and disposition of costs by a department.
7. Unit costs are computed by a job on the 8. Unit costs are computed by department
job-cost sheet. on the production report.
9. Measures costs for each completed job. 10. Measures costs in terms of units
completed in specific time periods.
11. Utilizes one Work-In-Process inventory 12. Utilizes several Work-In-Process inventory
control account supported by a accounts, one for each department, work
subsidiary ledger of job-order cost cards. center, or work cell.
//////////////////////////////////////////////////////
Activity 2
1. Job order and process costing procedures are used by different types of industries. Discuss the
procedure appropriate for each type.
2. For the following products indicate whether job order costing or process costing procedures
would be required Gasoline.
A. Sewing machines
B. Chocolate syrup
C. Text books
D. Dacron yarn

E. Cigarettes
F. Space capsules
G. Men's and women's suites
3. Classify these industries with respect to the type of cost accumulation procedure generally
used--job order costing or process costing.
a. Meat k. Pianos
b. Sugar l. Linoleum
c. Steel m. Leather
d. Breakfast cereal n. Nylon
e. Paper boxes o. Baby foods
f. Wooden furniture p. Locomotives
g. Toys and novelties q. Office machines equipment
h. Coke r. Luggage
i. Cooking utensils s. Paint
j. Caskets t. Tires and tubes
3.2.4.Preparation of Cost of Production Report (CPR) under Process Costing

System
How the Cost of Production Report (CPR) is prepared under process costing system? In process
costing, costs are accumulated by department for a period of time. A departmental cost of
production report (CPR) shows all costs chargeable to a department. It is not only the source for
summary journal entries at the end of the month but also a most convenient vehicle for
presenting and disposing of costs accumulated during the month. The production cost report is
the document that summarizes the manufacturing activity that takes place in a process dept for
given period of time. The production report also serves as a source document for transferring
costs. Thus cost of production report shows:
1. Total unit costs transferred to it from a preceding department.
2. Materials, labor, and factory overhead added by the department.
3. Unit cost added by the department.
4. Total and unit costs accumulated to the end of operations in the department.
5. The cost of the beginning and ending work in process inventories.
6. Cost transferred to a succeeding department or to a finished goods storeroom.
The accounting of process costing can be analyzed by three different situations.

Case 1: Process costing with zero beginning and ending work in process
Case 2: Process costing with no beginning but with ending work-in-process
Case 3: Process costing with some beginning and some ending work in process
Regardless of the cases, product costing under this system or preparation of production cost
report involves five steps.
Step 1: Summarize the flow of physical units. It is sometimes called quantity schedule or physical
flow schedule and tracks the physical units of output and determines:
 The number of units started, completed, and transferred to the next process
 Work in process both beginning and ending inventory in terms of units and
 Total number of physical units to account for
Step 2: Calculate output in terms of equivalent units. Estimate how much of a given resource was
applied to units in process. Equivalent units are calculated separately for each cost category
depending upon percentage of completion. Thus equivalent units for each cost category can be
determined by multiplying the number of units in process by the percentage of completion.
Step 3: Summarize total costs to account for. Summarize total costs to account for i.e. all debits
to work in process during the period. They are the summary of costs transferred from the prior
period in beginning work-in-process and currently added in order to complete the production
process.
Step 4: Compute equivalent unit costs. Equivalent unit cost is obtained by dividing the costs in
step 3 by the respective equivalent units of work done in step 2. The computation depends on
whether weighted average (WA) or first-in-first out (FIFO) is used.
Step 5: Assign costs. Cost assignment involves the application of costs to units completed and
units in ending work in process inventory by using the unit cost determined in step 4.
In order to illustrate process costing, assume the following data for the next three cases. ND
Engineering produces several items to be used as replacement tools for various types of
machineries. We will focus our analysis on one product which is ND used as spare part for
construction machineries. The product costing system for ND has a single direct cost category
(direct materials) and a single indirect cost category (conversion costs). Each ND unit passes
through two departments- the molding department and the finishing department.
 Direct materials are added at the start of the process in molding department.

 Additional direct materials are added at the end of the process in the finishing department.
 Conversion costs are added evenly during the process. Conversion costs are all
manufacturing costs other than direct material costs.
 When the finishing department completes work on each unit, it is immediately transferred
to Finished Goods Inventory.
Case 1: Process Costing with No Beginning or Ending Work-In-Process Inventory. This case
assumes that all units are started and completed in the same period. This case assumes that all
units are started and completed in the same period and introduces the computation of unit costs.
In process costing, the unit cost of a product is obtained by assigning total costs to many identical
or similar units. Thus, there is a kind of averaging the cost among the units of output.
To illustrate this case, assume that on July 1, 20x1 there was no beginning WIP inventory of ND
units. During July, the entity started, completed molding and transferred to the finishing
department 600 ND units.
Data for the Molding Department for July 20x1 are:

Physical Units:
Work-in-Process Inventory, July 1……………….…………. 0 units
Started during July………………………………….….…..600 units
Completed and transferred……………………..……….….600 units
Work in process inventory, July 31………………….……......0 units
Total Costs:
Direct materials…………………………………………..Br. 36,000
Conversion costs…………………………………………….. 30,000
Total Molding Department costs………………….…… Br. 66, 000
Required:
a. Compute equivalent unit costs.

b. Pass the necessary journal entries.
Computation of Equivalent Unit Costs
By averaging, the molding cost per unit of ND would be Br.66, 000/600 units = Br. 110 per unit
itemized as follows:
Direct material cost per unit (Br.36, 000/600 units)………………………Br.60
Conversion cost per unit (Br.30, 000/600 units)……………………………...50
Molding department cost per unit…………………………….…………..Br. 110

As shown above, the unit cost is calculated by dividing the total cost during a period by the total
units produced in that period. Because each unit is identical, we assume that all units receive the
same amount of direct material and conversion costs. This approach can be used by organizations
such as service sector industries like banks those mass produce standard units or services and do
not have incomplete units when each accounting period ends.
Journal Entries
Once the preparation of production cost report is completed the necessary journal entries are
passed. The basic entries are almost the same in the three cases to described in the forthcoming
section and include:
Recording Direct Materials purchased and used: Like job order costing system, material
requisitions form the basis for issuing material for production. The number of requisition depends
on how often a batch of product is started. The entry to record the issuance of direct material is
the same as job order costing system, but since costs are assigned to a department than a job, it is
important to departmentalize the work in process account. In the above example, direct material
cost purchased and used in molding department can be recognized as follows:
20x1 Work in process – Molding Department 36, 0000.
July 31 Accounts Payable/Cash 36,000
Recording Conversion Costs incurred and used: It recognizes the labor cost of production
employees and the manufacturing overhead costs incurred and used in the processing
department. The following entry illustrates how to record conversion costs charged in to the
molding department in the above example.
20x1 Work in process – Molding Department 30,000
July 31 Various Accounts 30,000
Recording Completed and Transferred out units. In process costing system when units completed
the process of the preceding department, they are directly transferred in to the next department
for further processing. As units move from one department to the other, the related costs are also
transferred by using journal entries. A cost transferred from a preceding department is called
Transferred in cost, or cost of the preceding department or previous department cost. In the
above example, the items which completed the molding process and transferred to finishing
department will have the cost of Br.66, 000, i.e. 600 units @ Br.11. Thus the entry to clear this
cost from the work-in-process-molding department and transfer to work in process – finishing
department is recognized as follows:

20x1 Work in process – Finishing Department 66,000
July 31 Work in process – Molding department 66,000
Activity 3
1. What is the purpose of a cost of production report?
2. What are the equivalent units of production? Explain in terms of its effect on computed
unit costs.
Case 2: Process Costing with No Beginning but with Ending Work-in-Process Inventory. This case
introduces the concept of equivalent units. Equivalent units are the number of completed units
that could have been produced from the inputs applied. Equivalent units are determined by
multiplying physical units by the percent of completion. For example, four units that are each one
half (50%) completed represent two equivalent units.
Where there are WIP inventories at the beginning and/or end of an accounting period, the output
must be computed in terms of equivalent units in order to determine the cost of goods
transferred and the cost of goods remaining in the ending WIP inventory. To compute equivalent
units we need to estimate how much of a given resource was applied to units in process and this is
not always an easy task. Some estimates like materials may be easier to make but others like
energy or maintenance labor used in a given unit are not easy to estimate. Conversion costs
generally involve a number of hard to measure resources which leads to estimating how much
total effort is required to complete the unit and how much of that effort is already put into the
units in process.
In industries where no exact estimate is possible or where vast quantities in process prohibit
making costly physical estimates, all work in process in every department is assumed to be
complete to some reasonable degree ( one-third, one-half, or two-third). In some cases where
continuous processing is assumed to leave roughly the same amount at the end of each month,
work in process is ignored altogether and all monthly production cost is assigned to units
completed. A good example for those situations is the textile industry. In some cases the goods in
process may have been fully processed in terms of materials (all materials required are added) but
the conversion process is not yet completed. Under such circumstances the material cost is taken
100% and conversion costs are accounted for on the basis of percentage of total cost added.
To illustrate this case, assume that not all the ND started were not completed during July 31 but
500 units are completed and transferred to the finishing department while 100 units of ND are still
in process in the molding department. As direct materials are fully added to the units at the start

of the process, 100% of the direct material costs are added to the units in process. In terms of
conversion costs it is assumed that each unit is 60% complete.
Required:
a. Prepare a cost of production report for the month ended July 31, 20x1
Preparation of a Cost of Production Report
Step1 & 2: Physical Units and Equivalent units
The table below shows the physical flow of goods and equivalent units under for ND Engineering
for the month of July:
Molding Department
Production Cost Report
For the Month Ended July 31, 20x1
_______________________________________________________________________
Equivalent Units (Step 2)
Flow of Production (Step1) Physical Direct Conversion
Units Materials Costs
_______________________________________________________________________
Completed and transferred 500 500 500
Plus: Ending WIP 100
100*100%; 100*60% 100 60
Total accounted for 600 600 560
Deduct: Beginning WIP 0 0 0
Started during current period 600
Work done during current period 600 560
The physical unit is about the work started during the period. In the illustration, 600 units are
started but only 500 units are completed. The remaining 100 units represent the work in process
at the end of the month. The ending work in process inventory does not represent full units with
respect to the two manufacturing costs like units completed and transferred out. Such partially
completed units must first be changed in to equivalent units. Equivalent units of production
represent the number of units that could have been manufactured from start to finish given that
quantity of each input placed in production.

Step 3 & 4: Summarizing Costs and Calculation of Equivalent Unit Costs. The typical aspect of this
case is how to assign costs to the work in process as of July 31. The table below shows the total
cost to account for and equivalent unit costs.
_______________________________________________________________________
Direct Conversion
Materials Costs
_______________________________________________________________________
Costs added during July (Step3) Br 36,000 Br 30,000
Divided by equivalent unit of work done (Step 2) 600 560
Cost per equivalent unit (Step 4) Br 60.00 Br. 53.57
Step 5: Assign costs. It is the application of costs to units completed and units in ending work in
process inventory. The total cost of units completed and transferred out is computed by
multiplying the equivalent unit cost by total units completed. Likewise, the cost of ending work in
process is computed by multiplying the equivalent units with respect to direct material and
conversion costs by the respective equivalent unit cost. The table below display cost assignment.
______________________________________________________________________
Completed units Ending Work in Process
______________________________________________________________________
Equivalent Cost per Total Equivalent Cost per Total
Units unit cost Units unit cost
Direct Material 50 60 Br 30,000 100 60 Br 6,000
Conversion Costs 500 53.57 26,785 60 53.57 3,215
Total Br 56,785 Br 9,215
Journal Entry:
The cost of goods transferred out to the finishing department equals Br.56, 785.00, and thus the
unit cost is Br 113.57, where as the work in process inventory at the end of the period amounts to
Br. 9,215.00. The following journal entry is required to record the transfer of the units completed
and transferred out to the next department:
20x1 Work in process – Finishing Department 56,785
July 31 Work in process – Molding department 56,785
Case 3: Process Costing with Beginning and Ending Work-in-Process Inventory .
How do we account for product costs when there are units in beginning WIP inventory? This case
describes the effect of weighted average (WA) and first-in, first-out (FIFO) cost flow assumptions
on cost of units completed and cost of work-in-process inventory. In determination of the product
costs to be accounted for, the same five steps described earlier, are used but the result depends
upon the inventory system used. The two most popular methods are weighted average (WA) and
the first in, first out (FIFO) method.
To illustrate this case assume that the WIP inventory in the molding department at the end of July,
20x1 is transferred to August 20x1. Accordingly:
Physical Units:
WIP August 1, (100% complete for materials and 60% complete for conversion
costs)…………………………………………………………………...100 units
Units started in August…………….…………………………………700 units
Units completed……………………………………….………………650 units
WIP August 31, (100% complete for materials and 40% complete for conversion
costs)……………………………….……….….…………………………150 units
Total Costs:
WIP August 1: Direct materials….………………………Br.6, 000
Conversion costs……………….………….….3, 215…...Br.9, 215
Direct material costs added during August………………………........45, 000
Conversion costs added during August ………………………..………37,650
Total costs to account for….……….…………..……Br. 91,865
With the above data, we look at how the product costs are going to be determined under the two
methods of inventory valuation viz. the weighted average (WA) method and the first in, first out
(FIFO) methods.
Required:
a) Prepare a cost of production report for the month ended August 31, 20x1 under Weighted
Average (WA) and first in, first out (FIFO) methods.
b) Pass the necessary journal entries under Weighted Average (WA) and first in, first out (FIFO)
methods.
A. Weighted Average Method
How the Weighted Average Method is used in preparation of Cost of Production Report (CPR)
under process costing? The weighted average method accumulates costs incurred to date (both
the work in process cost at the beginning of the period as well as production costs incurred during
the current month). The total cost accumulated then is assigned to the equivalent units
completed and transferred out and units in the ending work in process inventory. The weighted

average cost is the total cost entered the work in process account to date divided by the total
equivalent units of work done to date. Like the previous cases, the five basic steps are followed in
the preparation of production cost report.
Preparation of a Cot of Production Report
Step 1: Summarize the flow of physical units. The summary of the physical flow of outputs shows
from where the units came and where they go.
Step 2: Calculate output in terms of equivalent units. All units that entered the manufacturing
process are complete with respect to direct material as direct materials are placed at the
beginning of the production process in the department. However, it is only the completed and
transferred amount that is 100% complete with respect to conversion costs. Thus the ending work
in process is only partially complete with respect to conversion costs. The underneath table shows
the physical flow of goods and equivalent units under weighted average method for ND
engineering for the month of August:
Molding Department
Production Cost Report, Weighted Average Method
For the Month Ended August 31, 20x1
_______________________________________________________________________
Flow of Production Physical Equivalent Units (Step-2)
Units (Step-1) DM CC
_______________________________________________________________________
WIP, August 1 100
Stated in August 700
To account for 800
Completed and t- out, August 650 650 650
WIP, August 31 150 150 60
Units to account for 800
Work done to date 800 710
Step 3: Summarize total cost to account for. The total cost to account for is the sum of the three
manufacturing costs of the beginning work in process and manufacturing costs added to
production in the month of July.
Step 4: Compute equivalent unit costs. The weighted average equivalent unit cost is obtained by
dividing the sum of costs in the beginning work in process inventory and cost of work done in the
current period by total equivalent units of work done to date. The equivalent unit cost for direct
material is equal to the direct material cost of the work in process at the beginning of the month
plus direct material cost placed in production during August divided by total equivalent units to

date with respect to direct material. Similarly, the equivalent unit cost for conversion costs is
calculated by dividing total cost conversion costs to date by work done to date or equivalent units
of production to date with respect to conversion costs. The table below shows the equivalent unit
production with respect to direct material and conversion costs.
_______________________________________________________________________
Total Direct Conversion
Cost Materials Costs
_______________________________________________________________________
WIP, August 1 Br 9,215 6,000 3,215
Costs added, August 82,650 45,000 37,650
Total costs to account for (Step 3) 91,865 51,000 40,865
Divided by equiv. units of work done to date (Step2) 800 710
Unit Costs (Weighted Averages/Step 4) Br 121.31 63.75 57.56
The total cost to account for is the sum of the two manufacturing costs of the beginning work in
process and manufacturing costs added to production in the month of August.
Step 5: Assign costs. This one involves the application of costs to units completed and units in
ending work in process inventory. The total cost of units completed and transferred out is
computed by multiplying the equivalent unit cost by total units completed. Likewise, the cost of
ending work in process is computed by multiplying the equivalent units with respect to direct
material and conversion costs by the respective equivalent unit cost. The table below exhibits cost
assignment.
______________________________________________________________________
______________________________________________________________________
Completed and transferred out
650 units@ Br 121.31 Br 78,851.50
WIP August 31: 150 units
Direct materials 9,562.50 Br 150@63.75
Conversion costs 3,453.60 Br 60 @57.56
Total WIP 13,016.10
Total costs to account for Br 91,867.60*
*Br. 2.60 round off error.

B. Fist-in, First-out (FIFO) Method
How the Fist-in, First-out (FIFO) Method is used in preparation of Cost of Production Report (CPR)
under process costing? The first in, first out method assume that the first units to be completed
are from the beginning work in process, and thus assign the cost of the beginning work in process
to the first units completed. This method sharply distinguishes the current work done from the
previous work done on the beginning WIP inventory. The calculation of equivalent units is
confined to the work done in the current period. The cost of equivalent units worked during the
current period is assigned first to complete the beginning work in process, and then to start and
complete new units, and finally to units in ending work in process.
Under the first in, first out method, the cost of the work in process at the beginning of the period
is kept separate from the work done in the current period. Costs incurred in the current period
and equivalent units produced in the same period are used to calculate unit cost per equivalent
unit of work done in the current period. To illustrate the first in, first out method of process
costing, we assume the previous data for the month of August and the five steps are restated.
Preparation of a Cot of Production Report
Step 1: Summarize the flow of physical units. The summary of the physical flow of outputs shows
from where the units came and where they go. In our illustration, the first units to be completed
are the 100 units of work in process at the beginning of the period i.e., August 1. From the 700
units started during August, 650 units are completed during the month, 150 units are left as work
in process at the end of the Month, August 31.
Step 2: Calculate output in terms of equivalent units. The equivalent unit calculation under the
first in first out method is different from that of the weighted average method. The equivalent
unit of the beginning work in process will be kept separate from the equivalent units of the
current month work done. The equivalent unit of the current month work done includes the
equivalent units used to complete the beginning work in process, the equivalent units of the
goods started and completed during the current month, and the equivalent units of work in
process at the end of the month. The following table shows the physical flow of goods and
equivalent units under FIFO method for ND Engineering for the month of August.

Molding Department
Production Cost Report, FIFO Method
_______________________________________________________________________
Flow of Production Physical Equivalent Units
Units DM CC
WIP, August 1 100
Stated in August 700
To account for 800
Completed and t-out during current period650 650 650
WIP, August 31 150 150 60
Units to account for 800
Less: equivalent units of work done
in previous periods on beginning WIP 100 60*
Work done in current period 700 650
* WIP inventory of July 31, 100 units. 100% complete for materials and 60% complete for conversion
costs.
Step 3: Summarize total cost to account for. The total cost to account for is the summation of
cost of work in process at the beginning of the period, and the total manufacturing cost incurred
during the current period.
Step 4: Compute equivalent unit costs. The total manufacturing costs incurred during the current
month, and the equivalent units of production during the same period are used to calculate the
equivalent unit.
_______________________________________________________________________
______________________________________________________________________
WIP, August 1 Br 9,215
Costs added, August (Step 3) 82,650 45,000 37,650
Total costs to account for 91,865
Divided by current work done, August (Step 2) 700 650
Unit costs (FIFO/Step 4) Br 122.21 64.29 57.92
Step 5: Assign costs to units completed and to units in ending work in process

The equivalent unit costs for the work done in the current period are first used to complete the
beginning work in process, then to units started and completed during the current period, and
then to the ending work in process. The table below exhibits cost assignment.
_______________________________________________________________________
Assignment of costs (Step 5)
_______________________________________________________________________
WIP, August 31
Direct materials Br 9,643.50 150@64.29
Conversion costs 3,475.20 60@57.92
Total WIP (150) units 13,118.70
Completed and transferred out
650 units: 91865-13,118.7 78,746.30
Total costs accounted for Br 91,865
Proof:
WIP, August 31 9,215
Additional costs to complete
100*40%@57.92 2,316.80
Started and completed: 700-150
550@122.21 67,215.50
Total cost transferred 78,747.30*
*Br. 1 rounding off error
Activity 4
1. Separate cost of production reports are prepared for each producing department under
process costing. Why is this method used in preference to one report for the entire firm?
2. Are month-to-month fluctuations in average unit cost computed in a cost of production
report meaningful data in attempting to control costs?
3.2.5. Transferred in cost in Process Costing
What does it mean by transferred in cost in process costing? Transferred-in costs or Prior
department costs are costs incurred in a previous department in process costing for items that
have been received by a subsequent department. Transferred-in costs are accounted for as direct
material costs but they are kept separate from direct material costs added in the department. The
costs of the next department then contain three elements: transferred in costs, direct material
cost and conversion costs.

Transferred in costs are considered as a separate type of direct material added at the beginning of
the process. In other words, when successive departments are involved, the cost of the preceding
department become part of the direct material cost of the next department. However,
transferred in costs are not considered as cost of direct material. The total unit cost will be the
sum of all three types of unit costs. The five steps of process costing are also used here to
account for and assign costs under both weighted average (WA) and first- in-first-out (FIFO)
method.
In our illustration, once the units completed the process in finishing department, then they are
transferred into finished goods inventory. Assume that the completed units having the costs of Br.
160,000 have been transferred from finishing department to finished good warehouse then the
following journal entry can be recognized.
20x1 Finished Goods Inventory 160,000

August 31 Work in process – Finishing department 160,000
Example: Data for the Finishing Department for August 20x1:

Physical units:
WIP-beginning (August 1) --------------------------------------------- 240 units
 TIC (100% complete)
 DM (0% complete)
 CC (62.5% complete)
Transferred-in ------------------------------------------------------------ 400 units
Completed and transferred out during March ------------ 440 units
WIP-ending (August 31) -------------------------------------------- 200 units
 TIC (100% complete)
 DM(0% complete)
 CC (80% complete)
Total Costs:
WIP-beginning (August 1):
 TIC (240 units × Br140) ----------------------------------------- Br33,600
 DM ----------------------------------------------------------------- 0
 CC (150 units ×Br120) -------------------------------------------- 18,000
Br51, 600
Transferred-in cost:
 Weighted average ---------------------------------------------------- 52,000
 FIFO ---------------------------------------------------------------------- 52,480
 DMs ----------------------------------------------------------------------- 13,200
 CC --------------------------------------------------------------------------- 48,600

Additional information for the Finishing department:
 Additional DMs (e.g. packaging material and box) are added at the end of the process.
 Conversion costs are added evenly.
 Units completed in this department are transferred to Finished Goods.
Required:
a) Prepare a cost of production report for the month ended August 31, 20x1 under Weighted
Average (WA) and first in, first out (FIFO) methods.
b) Pass the necessary journal entries under Weighted Average (WA) and first in, first out
(FIFO) methods.
Finishing Department
Production Cost Report, WA Method
Physical flow:
WIP- beginning -------------240
Transferred in Aug. ---- 400
To account for --------------640 units Equivalent Units
TIC DM CC
Completed units -------- 440 -------------- 440 440 440
WIP-ending-----------------200 ------------ 200 0 160
Accounted for ---------- 640 units -------- 640 440 600
Equivalent Unit cost and total cost to account for:

TC TIC DM CC
. WIP-beginning ------------ Br51,600* Br33,600 Br0 Br18,000
Added in March ----------- 113,800 52,000 13,200 48,600
TC to account for-------- Br165,400 Br85,600 Br13,200 Br66,600
Divide by ----------------------------------- ÷ 640 ÷ 440 ÷ 600
Unit cost Br274.75 Br133.75 Br30 Br111
Cost Assignment:
To: Completed and transferred out units (440 units × Br274.75) -------- Br120, 890
WIP- ending
TIC (200 units × Br133.75) ------------- Br26, 750
DM -------------------------------------------------- 0
CC (160 units ×Br111) ----------------- 17,760 -------- 44,510
TC accounted for ---------------------------------------------------------------- Br165, 400
Journal entries for the transfer from Finishing Department to Finished Goods:


Finishing Department
Production Cost Report, FIFO Method
Physical flow:
WIP- beginning ---------------- 240
Transferred in Aug. --------- 400
To account for -------------- 640 units Equivalent Units
TIC DM CC
Completed:
From WIP-beg. --------------- 240 --------------- 0 240 90
From currently started --- 200 -------------- 200 200 200
WIP-ending ------------------------- 200 --------------- 200 0 160
Accounted for --------------------- 640 units ----------- 400 440 450
Equivalent Unit cost and total cost to account for:

TC TIC DM CC
WIP-beginning -------------------- Br51, 600 (prior period costs)
Added in March ------------------- 114,280 52,480 13,200 48,600
Total cost to account for------ Br165, 880 Br52, 480 Br13, 200 Br48, 600
Divide by --------------------------------------- ÷ 400 ÷ 440 ÷ 450
Unit cost Br269.20 Br131.20* Br30 Br108
Cost Assignment:
To: Completed and transferred out units (440 units):
240 units from WIP-beg.:
Beginning balance ---------------- Br51,600
TIC ------------------------------------------ 0
DMs (240 units × Br30) ------------- 7,200
CC (90 units × Br108) --------------- 9,720 Br68,520
200 units (started and completed)
(200 units × Br269.20) ----------------------------------- 53,840
Total cost of completed --------------------------------------- Br122, 360
To: WIP- ending
TIC (200 units × Br131.20) -------------- Br26,240
DM ------------------------------------------ 0
CC (160×Br108) -------------------------- 17,280 43,520
Total cost accounted for ------------------------ Br165,880
Journal entries for the transfer from Finishing Department to Finished Goods:


Notice that there is no pure application of FIFO. In practice, the units transferred in (Finishing
Department) are usually carried at a single average unit cost. i.e at Br131.20 (Br52,480/400) per ND
unit. If this averaging were not done, the attempt to track costs on a pure FIFO basis throughout a
series of processes would be cumbersome. As a result the FIFO method should really be called a
Modified or Department FIFO Method.
Note that units may be measured in different denominations in different departments. We should
consider each department separately. For example, unit costs could be based on kilogram in the
first department and liters in the second department. Accordingly, as units are received in the
second department, their measurement must be converted to liters.
3.2.6.Standard Costs and Process Costing
How standard costs used in process costing? Companies that use process costing systems produce
masses of identical or similar units of output. Setting Standards for quantities of inputs needed to
produce output is often relatively straight forward in such companies. Standard costs per input
unit may then be assigned to these physical standards to develop standard costs per output unit.
The weighted average (WA) method and first-in-first-out (FIFO) methods become very
complicated when used in industries that produce a variety of products like still rolling mills,
rubber products, textiles, ceramics and others. The standard- costing method of process costing is
especially useful in these situations.
Historical cost FIFO and weighted average methods calculate single average cost for all products
produced resulting in inaccurate product costs. Under standard costing, teams of design and
process engineers, operations personnel, and cost accountants determine separate standard unit
costs on the basis of the different technical processing specifications for each product there by
overcoming the disadvantage of costing all products at a single average amount.
In order to illustrate the standard costing method of process costing, let’s take the following data.
ND engineering applies the standard costing system in process. The same standard costs for ND in
molding department that apply in August and September of 20x1 are given below:

Standard costs for:
Direct Materials ………………………………………………………Br. 24/ unit
Conversion costs …………………………………………………….. Br 19/ unit
Total standard manufacturing costs………………………………....Br 43/ unit
Data for the Molding Department are:
Physical Units:
Work in process, beginning inventory (Sep 1)……………………….1, 250 units
Direct materials (100% complete)
Conversion costs (80% complete)
Started during September ...................................................................4,000 units
Completed and transferred out during Sep………………………….. 4,250 units
Work in process, ending inventory (Sep, 31)………………………….1, 000 units
Direct Materials (100% complete)
Summary of Costs:
Work in process, beginning inventory at standard costs:
Direct Materials………1,250 equivalent units @ Br 24
Conversion costs...........1,000 equivalent units @ Br 19…….……….Br. 49,000
Actual direct material costs added during Sep……………………………..100,000
Actual conversion costs added during Sep………………………………….72, 300
Required:
a. Prepare a cost of production report for the month ended August 31, 20x1 under standard
costing method of process costing system.
Preparation of Cost of Production Report
Step 1 & 2: Compute output in physical units and equivalent units by use of standard costs in
process costing. It follows the same steps described earlier for computation physical movement
of units and to determine equivalent units. However, the costs to be applied to units completed
and units in WIP inventory is the standard cost.

Molding Department
Production Cost Report, Standard Costing
For the Month Ended July 31, 2001
_______________________________________________________________________
(Step 1) (Step 2)
Flow of Production Physical units Equivalent units
_______________________________________________________________________
Direct Conversion
Material Costs
_______________________________________________________________________
Work in process, beginning 1,250
Started during current period 4,000
To account for 5,250
Completed and t- out during current period
From beginning work in process
1250x (100%-100%) ;( 1250x (100%-80%) 1,250 0 250
Started and Completed 3,000 3,000 3,000
4250x100%, 4250x100%
Work in process ending 1,000
1000x100%; 1000x 60% 1,000 600
Accounted for
Work done in current period only 5,250 4,000 3,850
Step 3, 4 & 5: Compute standard per equivalent costs, total cost to accounts for and assign costs
to completed and end work in process.
Production Costs Materials Costs
_______________________________________________________________________
(Step 3/4) Standard cost per equivalent unit Br. 24 Br. 19
Work in process, beginning
Direct materials: 1,250 @ 24
Conversion cost: 1,000 @ Br.19 49,000
Costs added in current period at standard costs
Direct materials 4000 @ 24 169,150 96,000 73150
Conversion costs 3,850 @ 19
(Step 3/4) Costs to account for 218,150
(Step 5) Assignment of costs @ standard costs:
Completed and transferred out (4,250 units)
Work in process, beginning (1,250 units) 49,000
Direct materials added in current period 0 0 @ 24

Conversion costs added in current period 4,750 250 @19
Total from beg, inventory 53,750
Started and completed (3,000units) 129,000 (3,000 @ 24) + (3,000 @19)
Total costs of units transferred out 182,750
Work in process, ending (1,000 units):
Direct materials 24,000 (1000 @ 24)
Conversion costs 11,400 (600 @19)
Total work in process, ending 35,400
Total costs accounted for Br 218,150
{{{
Summary of variances for current performance:

Costs added in current period
At standard prices Br. 96,000 Br 73,150
Actual cost incurred Br. 100,000 Br 72,300
Variance Br 4000 (U) Br 850 (F)
Accounting for Variances

Process costing systems using standard costs usually accumulate actual costs separately from the
inventory accounts. The following journal entries are usually true.
1. Purchases of direct material are recorded at actual costs as debit to direct material control and
credit to cash or accounts payable
2. Conversion costs also are debited to conversion costs control account as incurred or
recognized with a credit to proper accounts like Cash, Accounts Payable , Accumulated
Depreciation, etc
3. When direct materials are released to WIP, WIP is debited for the standard cost and Direct
Material Control is credited for the actual cost the difference being debited or credited to a
Direct Materials Variance account.
4. The same procedure is followed for conversion costs too. WIP is debited for the standard cost
and Conversion Cost Control credited for the actual cost with the difference debited or
credited to a Conversion Cost Variances account.
5. Variances are then measured and analyzed for feedback, control, and decision making
purposes and finally disposed of as per the organization’s policy.
Journal Entries:
20x1 Raw Materials-Control (actual) /molding department 100,000
Sep. 30 Accounts Payable- control 100,000
(To record direct materials purchased and used)
30 Conversion costs-control(actual)/molding department 72,300
Various accounts 72,300

(To records conversion costs incurred and used)
30 Work in process – molding department ( Std cost) 96,000

Direct material variance 4,000
Raw materials-control/molding department 100,000
(To record actual direct Materials used and total direct
materials variances)
30 Work in process – assembly (Std, cost) 73,150
Conversion cost variances 850
Conversion cost control- molding department 72,300
(To record actual conversion costs and conversion cost
variances)
30 Work in process – finishing department (Std costs) 182,750
Work in process – molding department ( Std cost) 182750
(To record costs of units completed and transferred out at
standard cost from molding to finishing)
Activity 5
1. Compare the cost accumulation & summarizing procedures of job order & process costing
2. Can predetermined overhead rates be used in process costing?
3. Would one expect to find service departments in a firm using process costing? If so, how
would they be handled? Would cost of production reports be used for service departments?

Self Assessment Question-3.2
yourself against the answers given at the end of this section.

1. A characteristics which applies to process costing but not to job order costing system:
A. Equivalent units of production C. Averaging process
B. Identifiable batches of production D. Use of standard costs
2. Transferred in costs in a cost of production report are most similar to:
A. Conversion costs added during the process
B. Materials added at the beginning of the process
C. Costs transferred to the next process
D. Costs included in beginning inventory
3. In a process cost accounting, the costs of direct materials and direct labor are charged to:
A. Service departments C. Processing departments
B. Customer accounts receivable D. Job orders
4. In a process costing system, the journal entry used to record the transfer of units from
Department A, a processing department, to Department B, the next processing department,
includes a debit to:
A. Work in Process Department A and a credit to Work in Process Department B
B. Work in Process Department B and a credit to Materials
C. Finished Goods and a credit to Work in Process Department B
D. Work in Process Department B and a credit to Work in Process Department A
5. Which one of the flowing schedules exists in the Cost of Production Report under Process
Costing?
A. Physical Quantity Schedule C. Cost flow Schedule
B. Equivalent Units Schedule D. Equivalent Unit Costs Schedule
6. Which one of the following is not reported in production cost report under Process Costing?
A. The costs charged to the department
B. How the costs were assigned to the output
C. The physical units of production by the department
D. The equivalent units of production by the department

7. Which one of the following characterizes Process costing?
A. High production volume and homogeneous products
B. High production volume and heterogeneous products
C. Low production volume and heterogeneous products
D. Low production volume and homogeneous products
8. Which of the following statements is true?
A. Costs are traced to departments and then allocated to units of product when job-order
costing is used.
B. Companies that produce many different products or services are more likely to use job-
order costing systems than process costing systems.
C. Job-order costing systems are used by service firms only and process costing systems
are used by manufacturing concern only.
D. Companies that produce many different products or services are more likely to use
process costing systems than Job order costing systems.
9. Identify the wrong statement about process costing.
A. Completed units and their costs transfer to the next department as computed.
B. Process costs are charged to each department’s Work-In-Process Inventory account.
C. Unit costs are computed only at the end of the entire manufacturing process.
D. Units not completed must be stated in terms of equivalent units.
E. All of the above
10. Under which of the following conditions will FIFO method of process costing yield the same
equivalent unit costs as the Weighted-Average Method?
A. When units produced are homogenous in nature.
B. When there is no ending inventory
C. When beginning and ending inventories are each 50% complete.
D. When there is no beginning inventory.
E. All of the above

Exercise-1: Process Costing: Cost of production Report under WA Method
At the beginning of September 20x3, Dan Inc. had 1250 units partially assembled units in the
Machining Department. During September 20x3, Dan Inc placed another 4000 units into
production. Data for the Machining Department for Sept, 20x3 are:

Physical units for September, 20x3
Work in process, beginning inventory (Sep 1)……………….. 1250 units
Conversion costs (80% Complete)
Started during September ……………………………………. 4000 units
Completed and transferred out during September…………... 4250 units
Work in process, ending inventory (Sep 30)…………………. 1000units
Conversion cost (60% complete)
Total Costs for Sep 2003
Work in Process, beginning inventory
Direct Materials (1250 equivalent unit x Br25 per unit ……… 31250
Conversion cost (1000, equivalent units x Br15 per unit)…….. 15000
46250
Direct materials costs added during September 100000
Conversion costs added during September. 72300
Total costs to account for 218550
Required: Prepare the Cost of Production Report under WA Method and journalize the necessary
entries.
Exercise 2: Process Costing: Cost of production Report under FIFO Method
Required: Prepare the Cost of Production Report under FIFO Method and journalize the necessary
entries.

Activities
Activity-1
1. The primary objective in process costing is to determine the costs of materials, labor, and
factory overhead (FOH) used to process units of production through each department,
thereby determining the cost of a finished unit. The ultimate objective is to control costs.
2. The distinguishing characteristics of process cost procedures are:
a) A cost of production report is used.
b) Production is accumulated and reported by departments.
c) Costs are posted to departmental work in process accounts.
d) Production in process at the end of a period is restated in terms of completed units.
e) Total departmental costs are divided by total departmental production to complete
unit costs.
f) Costs are transferred from one department to another to arrive at a final unit cost for
the completed product.
Activity-2
1. The nature a firm's manufacturing operations determines whether job order costing or
process costing procedures are used. If costs can be associated and accumulated by
orders, job order costing will be used; if operations are more or less continuous and
identity of orders is lost, process cost is applicable.
2. (a) Process (b) Process - for stock items (c) Process (d) Job order (e) process (f) process
(g) Job order (h) process
3. Job order cost procedure: (e), (f), (g), (i), (j), (k), (p), (q), (r) & Process costing procedure:
(a), (b), (c), (d), (h), (l), (m), (n), (o), (s), (t)
Activity-3
1. A cost of production report is an effective weekly or monthly summary of materials, labor,

and factory overhead consumed by each department or cost center, along with a record of
units of output. It provides essential data to those responsible for cost control.
2. The equivalent production figure for a department represents the number of units that
could have been completed from materials, labor, and overhead used during a period. It is
computed by restating units in process at the end of a period in terms of completed units
and adding this figure to the number of units actually completed. This explanation assumes
no beginning work in process inventories. A department's equivalent production is divided
into its costs to compute departmental unit costs. Therefore, production figures have a
direct effect on computed unit costs.

Activity-4
1. Separate departmental cost of production reports are used to control costs successfully
and to accumulate costs more accurately. In many instances total company cost of
production reports could not be used because of the various stages of work in process.
2. As long as fluctuating average unit costs are not caused by fluctuating production
volumes, they are meaningful data in the control of costs. In such cases the fluctuations
can be traced to improved or decreased efficiencies, which could lead to improve cost
control.
Activity-5
1. Process Costing Vs. Job order Costing
a. Materials costs - In job order costing, materials requisitions are used and charges made to
order; in process costing, charges are to departments, with infrequent use of materials
requisitions.
b. Labor Costs - Time tickets are used in job order costing to accumulate costs by jobs; In
process costing, labor costs are charged to departments, and therefore detailed time
records are not necessary.
c. Factory Overhead - Job costing requires the use of predetermined overhead rates for
charging overhead to orders; In process costing, actual overhead may be used, and the
need to distinguish carefully between direct and indirect materials and labor does not
exist. However, predetermined rates are desirable under certain conditions.
d. Summarizing Costs - A job order cost sheet is used to accumulate the costs of an order in
job order costing system; a cost of production report is used in process costing system. In
job order costing, costs are summarized on completion of an order; in process costing,
periodic weekly or monthly summaries determine unit costs.
2. Predetermined overhead rates can and should be used if production is not stable or if
factory overhead is significant cost. As stated frequently, the charging of actual overhead to
orders or products may result in improper costs Furthermore, the clerical detail connected
with actual overhead can become quite cumbersome and cause delay in the execution of
efficient and timely costing.
3. The existence of service departments does not depend on a company's order or process
cost procedures. It depends mainly on the needs of the manufacturing operations.
Therefore, in process costing, service departments are also used and handled. In the same
way as in job order costing. Of course, no cost of production reports for service
departments would be needed, but departmental expense analysis sheets would still be
used.

1. A 5. E 9. C
2. B 6. F 10. D
3. C 7. A
4. D 8. B

Exercise-1
1. Computation of equivalent units. (Step 1 and 2)
Step 1 Step 2
Physical unit Equivalent units
Flow of Production Direct Conversion
Materials Costs
Work in process beginning 1250

Started during September 4000
Total account for 5250
Completed and transferred
out during current period 4,250 4,250 4,250
Work in process, ending * 1000
1000 x 100; 1000 x 60% 1000 600
Accounted for 5250
* Degree of competition in this department, direct materials 100%, conversion costs 60%
Computation Equivalent unit costs, Summarize total costs to account for, and assign costs to
units completed and to units in ending work in process: (Step 3, 4, and 5)
Production Materials Costs
Costs
(Step 3) Work in process, beg 46250 31250 15000

Cost added to current period 172300 100000 72300
Cost incurred to date 31250 87300
Divide by equivalent units
of work done to date  5250  4850
Cost per equivalent unit of
work done to date Br 25 Br 18

Cost and Management Accounting-I Cost and Management Accounting-I
(Step 4) Total costs to account for 218550
(Step 5) Assignment of costs:
Completed and transferred 182750 (4250x25) + (4250x18)
Out (4250 units)
Work in Process ending
(1000 units)
Direct materials 25000 (1000 x 25)
Conversion costs 10800 (600x18)
Total work in process 35800
Total costs accounted for Br 218550
Journal entries: Debit Credit

_______________________________________________________________________
1. Work in process - Machining Br 100,000
Accounts payable control Br 100,000
(To record direct materials purchased and used in production during September)
2. Work in process – Machining 72300
Various accounts 72300
(To record Machining department Conversion cost for September)
3. Work in process- Testing 182750
Work in process – Machining y 182750
(To record cost of goods completed and transferred from Machining to Testing during
September)
Exercise-2
Computation of equivalent units (Step 1 and 2)
(Step 1) (Step 2)
Flow of Production Physical units Equivalent units
Direct Conversion
Material costs
Work in process beginning 1250 (work done before current period)
Started during current period 4000
To account for 5250
Completed and transferred
out during current period:
(a) From the beginning work in process 1250
(1250 x (100% -100%); 1250x (100%-80) 0 250
Started and completed 3000
(3000x100%, 3000x100) 3000 3 000
(b) Work in process ending 1000
1000 x 100%; 1000x60% 1000 600
Accounted for 5250
Work done in current period only 4000 3850
(a) Degree of completion in this department (Beginning): direct materials 100% conversion
costs 80%: only 20% of the conversion costs are completed in the current period.
(b) 4250 physical units completed and transferred out minus 1250 physical units completed
and transferred out from beginning work in process inventory.(current period completed
units)
(c) Degree of completion in this department (current period): direct materials, 100%
conversion costs 60%.
Computation Equivalent unit costs, Summarize total costs to account for, and assign costs to
units completed and to units in ending work in process: (Step 3, 4, and 5)
Production Costs Materials Costs
Work in process, beginning 46250 (costs of work done before Current period)
(Step3) costs added in current period 172300 Br 100000 Br 72300
Divide by equivalent unit
of work done in current period 4000 3850
Cost per equivalent unit of Br 25 Br 18.78
Work done in current period
(Step 4) Total costs to account for Br 218,550
(Step 5) Assignment of costs to:
A) Completed and transferred
out (4250 units)
i) From work in process, beg, (1250units) 46250
Direct materials added in current period 0 0 x 25
Conversion cost added 4695 250xBr 18.78
Total from beginning inventory 50945
ii) From started and completed
(3000 units) 131340 (3000x25) + (3000x18.78)
Total costs of units completed 182285
& transferred out
Work in process ending (100units)
Direct materials 25000 (1000x25)
Conversion costs 1265 (600x18.78)
Total work in process, ending 36265
Total costs accounted for Br 218550

Journal entries: Debit Credit
1. Work in process - Machining Br 100,000
Accounts payable control Br 100,000
(To record direct materials purchased and used in production during September)
2. Work in process – Machining 72300
Various accounts 72300
(To record Machining department Conversion cost for September)
3. Work in process- Testing 182285
Work in process – Machining 182285
(To record cost of goods completed and transferred from Machining Department to Testing
Department during September)

Section 3.3: Operation Costing System
1. Describe nature of operation costing system;

2. Identify the application areas of operation costing system;
3. Illustrate operation costing system.
3.3.1. Nature of Operation Costing System

What is operation costing? Operation costing is a hybrid costing system that employs aspects of
both job order and process costing. In both cases, you use a mix of job costing and process costing
to compile the cost of a product; this mixed costing environment is called operation costing. The
job costing element is based on the concept that you can assign costs to specific products, which
is the case when something is produced in units of one or in very small quantities. The process
costing element is based on the concept that you allocate the cost of producing a large group of
products equally to all the products in that group, since they are manufactured in an identical
manner. In short, operation costing is most applicable to the more complex manufacturing
environments that require a mix of different types of production processes in order to create
goods.
3.3.2. Application Areas of Operation Costing System
Operation costing system is used in situations where products have some common characteristics
and also some individual characteristics. Shoes, for example, have some common characteristics
in that all styles involve cutting and sewing that can be done on a repetitive basis, using the same
equipment and following the same basic procedure. Shoes also have individual characteristics.
Some are made of expensive leathers and others may be made using inexpensive synthetic
materials. In a situation such as this, where products have some common characteristics but also
must be handled individually to some extent, operation costing may be used to determine
product costs.
Products are typically handled in batches when operation costing is in use, with each batch
charged for its own specific materials. In this sense, operation costing is similar to job order
costing. However, labor and overhead costs are accumulated by operation or by department, and
these costs are assigned to units as in process costing.

Examples of other products for which operation costing may be used include electronic
equipments (such as semi conductors), textiles, clothing, and jewelry (such as rings, bracelets, and
medallions). Products of this type are typically produced in batches, but they can vary
considerably from model to model or from style to style in terms of the cost of raw materials
inputs. Therefore, an operation costing system is well suited for providing cost data.
3.3.3. Illustrating Operation Costing System
A company manufactures watches in lots of 1,000. The watch casings and workings for all 1,000
units are identical, so the company simply adds up the cost of the production run and divides by
1,000 units to arrive at the per-unit cost. In addition, watch bands are custom-made for the wrist
size of the customer, and use a variety of unique materials. These costs are compiled for each
individual watch. Thus, we have process costing for one portion of the production process (the
watch casings and workings) and job costing for another portion (the watch bands). When
combined, this is operational costing.
An example of the reverse situation is when a product initially has unique raw materials, but is
then finished using a common process. For example, a company builds unique, custom-designed
race cars. It uses job costing to compile the cost of each car. However, all cars are then run
through a paint shop, which is essentially a fixed cost. The cost of the paint booth is allocated
equally to all of the cars run through it, which is process costing. Thus, we use job costing for the
first part of the production process and process costing for the second part. Again, this is an
example of operation costing.
To illustrate, also assume the following operation costing in batch manufacturing processes. The
main features of operation costing are illustrated in Exhibit 3.3.1.Notice in the Exhibit that
products pass sequentially through production departments A and B. Direct-material costs are
traced directly to each batch of goods, but conversion costs are applied on a departmental basis.
Direct labor and manufacturing overhead are combined in a single cost category called conversion
costs, rather than separately identifying direct labor. Moreover, under operation costing,
conversion costs are applied to products using a predetermined application rate. This
predetermined rate is based on budgeted conversion costs, as follows:

Exhibit 3.3.1 Operation Costing
As an illustration of operation costing, we will focus on the one division of a certain Sports
Equipment Company. This division manufactures two different grades of basketballs: professional
balls, which have genuine leather exteriors, and scholastic balls, which use imitation leather. The
cutting and stitching operations for the two different products are identical. Scholastic balls are
sold without special packaging, but professional balls are packaged in an attractive cardboard
box.
During October two batches were entered into production and finished. There was no beginning
or ending inventory of work in process for October. Cost and production data are given in Exhibit
2. Notice in Exhibit 2 that the direct-material costs are identified by batch. The conversion costs,
however, are associated with the two production departments and the Packaging Department.


The product cost for each of the basketballs is computed as follows:
Notice in the preceding display that each ball receives the same conversion costs in the
Preparation Department and the Finishing Department, since these operations are identical for
the two products. Direct-material costs and packaging costs, though, differ for the products. The
total costs of $104,500 are accounted for in the product costs, as shown below.
The following journal entries are made to record the Ontario Division’s flow of costs. The first
entry is made to record the requisition of raw material by the Preparation Department, when
batch P19 is entered into production. (This amount excludes the $1,000 in packaging costs to be
incurred subsequently for batch P19.)
The following entry is made to record the requisition of raw material by the Preparation
Department, when batch S28 is entered into production:

Conversion costs are applied in the Preparation Department with the following journal entry:
The following entry records the transfer of the partially completed professional and scholastic
basketballs to the Finishing Department:
The conversion costs applied in the Finishing Department are recorded as follows:
Next, the professional balls are transferred to the Packaging Department, and the scholastic balls
are transferred to finished goods:
Raw-material (packaging) costs and conversion costs are recorded in the Packaging Department
as follows:
Finally, the professional basketballs are transferred to finished goods:
Suppose that at the end of an accounting period, applied conversion costs differ from the actual
conversion costs incurred. Then the difference, called over applied or under applied conversion
costs, would be closed into Cost of Goods Sold. This accounting treatment is similar to that
described in prior part of this unit for over applied or under applied overhead.

Unit 4
Spoilage, Rework and Scrap

1. Distinguish among spoilage, rework and scrap.
2. Describe the accounting procedures for normal and abnormal spoilage.
3. Account for spoilage in process costing using the weighted-average method.
4. Account for spoilage in process costing using the first-in, first-out method.
5. Account for spoilage in job costing
6. Account for rework in job costing
7. Account for rework in process costing
8. Account for scrap.
4.1. Concepts of Spoilage, Rework and scrap
What do we mean by the terms spoilage, rework and scrap in product costing? Managers are
focusing increasingly on improving the quality of and reducing the defects in their products,
services and activities. A rate of defects regarded as normal in the past is no longer tolerable.
Managers know that reducing defects reduces costs and makes their company competitive.
Highlighting and recording the cost of defects as they occur help managers better determine
what to do about defects and their costs. The terms used in this chapter may seem familiar, but be
sure you understand them in the context of cost accounting.
Spoilage is the units of production, whether fully or partially completed that do not meet the
standards required by customers for good units and that are discarded or sold for reduced prices.
Examples of spoilage are defective shirts, jeans, shoes and carpeting sold as “seconds” and
defective aluminum cans sold as Aluminum manufacturers for remolding the production of
Aluminum foils.
Two key objectives when accounting for spoilage are determining the magnitude of the costs of
spoilage and distinguishing between the costs of normal and abnormal spoilage. Managers use
this information both to cost of products and to control and reduce costs by improving the quality
of products and processes. There are two different types of spoilage named as normal spoilage
and abnormal spoilage.
Normal Spoilage is spoilage inherent in a particular production process that arises even under
efficient operating conditions. The cost of normal spoilage is charged to the good units

completed. The rate of normal spoilage rate is calculated on the good units and not on the units
started in production because total units started also include any abnormal spillage in addition to
normal spoilage.
Abnormal Spoilage is spoilage that would not arise under efficient operating conditions. It is
considered as avoidable and controllable. Line operators and other plant personnel can generally
decrease or eliminate abnormal spoilage by identifying reasons for machine breakdowns,
accidents and the like and taking steps to prevent their occurrence. The costs of abnormal
spoilage are written off as losses of the accounting period in which detection of the spoiled units
occurs and appears as a separate line item in the income statement in Loss from abnormal
spoilage account.
Rework is units of production that are inspected, determined to be unacceptable, repaired and
sold as acceptable finished goods. For example, defective units ( such as computers and
telephone apparatus) detected during or after production but before units are shipped to
customers can sometimes be reworked and sold as good products.
Scrap is material left over when making a product. It has low sales value compared with the sales
value of the product. Example are shavings and short lengths from wood working operations,
steel edges left over from stamping operations and frayed clothes and end cuts from suit-making
operations.
The emphasis on quality, and the high cost of spoilage, reworked units, and scrap has resulted in
managers paying close attention to these costs. Recording and identifying the costs of spoilage,
rework, and scrap helps managers make more informed decisions, especially concerning
production systems. Some amount of spoilage, rework, or scrap appears to be an inherent part of
many production processes.
Steps taken by managers to improve quality and reduce costs could be:
 Designing better products and processes
 Training and motivating workers
 Properly maintaining machines
Activity 1
1. Differentiate between normal spoilage and abnormal spoilage.
2. Differentiate between rework and scrap.

4.2. Process costing and Spoilage
How does process costing system account for spoiled units? Two key objectives of accounting for
spoilage are determining the magnitude of the costs of spoilage and distinguishing between costs
of normal and abnormal spoilage. Managers use this information for product costing, cost control
and then cost reduction by improving the quality of the product and the process. Improved quality
and intolerance for high spoilage have lowered overall costs and increased sales. The accounting
for spoilage highlights spoilage costs so that they are not ignored and buried as an unidentifiable
part of the costs of the good units produced.
Under process Costing system, spoiled units can either be counted (approach A) or not counted
(approach B) when computing actual or equivalent output units in a process costing system.
Approach A makes visible the costs associated with spoilage where as Approach B spreads
spoilage costs over good units, potentially resulting in less accurate product costs. Spoilage is
typically assumed to occur at the stage of completion where inspection takes place and it is
detected called inspection point.
In order to illustrate process costing and spoilage in the above two approaches, assume the
following data. ND engineering produces several items to be used as replacement tools for
various types of machineries. We will focus our analysis on one product which is ND used as spare
part for construction machineries. The product costing system for ND has a single direct cost
category (direct materials) and a single indirect cost category (conversion costs). All direct
materials are added at the beginning of the process. Each ND unit passes through two
departments- the molding department and the finishing department. Assume also that there is no
beginning Work in Process Inventory in the month of May.
Direct materials introduced………………………………….Br. 270,000

Units started....................................................................................10, 000
Good units completed ……………………………………… 5,000
Units spoiled (all normal spoilage)………………………………..1,000
Ending WIP (100% complete for direct materials)……………..… 4,000
Spoilage is detected upon completion of the process.
The direct material costs are computed and assigned using approaches A and B as follows:
 Approach A recognizes spoiled units when computing output in equivalent units

 Approach B does not count spoiled units when computing output in equivalent units

Approach A Approach B
Costs to account for 270,000 270,000
Divide by equivalent units 10,000 9,000
Cost per equivalent unit 27 30
Assigned to:
Good units transferred out:
(5000*27); (5000*30) 135,000 150,000
Add: Normal spoilage (1000*27) 27,000 0
Good units transferred out 162,000 150,000
WIP ending
(4,000*27);( 4000*30) 108,000 120,000
Costs accounted for 270,000 270,000
Note the following:

 Not counting equivalent units for spoilage decreases equivalent units, resulting in a higher
cost of each good unit (Br. 30 instead of Br. 27)
 The direct material costs assigned to good units completed, which include the cost of
normal spoilage, are too low under approach B Br.150, 000 instead of Br. 162,000.
 The 4,000 units in ending work in process contain costs of spoilage of Br. 12,000 (Br.
120,000-Br.108, 000) that do not pertain to those units.
 Approach B causes cost distortions in that Work in Process is charged for spoilage in the
current period as well as the subsequent period when the process is completed and
inspection conducted.
 Thus, approach A will be used to present process costing with spoilage. However, the five
basic steps of process costing which discussed in unit four (3) are used with a slight
modification to accommodate spoilage.
Step 1: Summarize the flow of physical units. It is sometimes called quantity schedule or physical
flow schedule and tracks the physical units of output and determines:
 The number of units started, good units completed, & transferred out to the next process
 Both beginning and ending work in process inventory units
 Both normal and abnormal spoilage and
 Total number of physical units to account for
Total Spoilage = (Beg. WIP units + Started Units) – (Good units transferred out + End WIP units)
Abnormal Spoilage = Total Spoilage – Normal Spoilage
Step 2: Calculate output in terms of equivalent units. Estimate how much of a given resource was
applied to units in process. Equivalent units are calculated separately for each cost category

depending upon percentage of completion. Thus equivalent units for each cost category can be
determined by multiplying the number of units in process by the percentage of completion.
Step 3: Summarize total costs to account for. Summarize total costs to account for i.e. all debits
to work in process during the period. They are the summary of costs transferred from the prior
period in beginning work-in-process and currently added in order to complete the production
process.
Step 4: Compute equivalent unit costs. Equivalent unit cost is obtained by dividing the costs in
step 3 by the respective equivalent units of work done in step 2. The computation depends on
whether weighted average (WA) or first-in-first out (FIFO) is used.
Step 5: Assign costs. Cost assignment involves the application of costs to units completed, spoiled
units and units in ending work in process inventory by using the unit cost determined in step 4.
In order to illustrate process costing and spoilage, assume the following data for the month of
January. ND engineering produces several items to be used as replacement tools for various types
of machineries. We will focus our analysis on one product which is ND used as spare part for
construction machineries. The product costing system for ND has a single direct cost category
(direct materials) and a single indirect cost category (conversion costs). All direct materials are
added at the beginning of the process but conversion costs are added evenly during the cycle.
Some units are spoiled as a result of defects only detectable at inspection of finished units.
Normally, the spoiled units are 5% of the finished output of good units. That is for every five good
units produced, there is one unit of normal spoilage. Summary data for January 2007 are given
below.
Physical Units for January 20x7:
WIP January 1, 20x7……………………………………………..2,500 units
Direct materials 100% complete
Conversion costs 60% complete
Started during January…………………………………………8,500 units
Good units completed and transferred out………………….7, 500 units
WIP inventory, January 31, 20x7………………………………3,000 units
Direct materials (100% complete)
Total Costs for January 20x7:
WIP January 1, 20x7
Direct materials……………………..…Br.15, 000
Conversion costs…………………………. 9,000……....Br.24, 000
Direct material costs added in January…………………………….67, 500
Conversion costs added in January…………………………………51,000

Total costs to account for………………………………………… 142,500
Solution:
First of all, let’s compute the spoiled units.
The number of total spoiled units is computed as follows:
Total Spoilage = (Beg. WIP units + Started units)
– (Good units transferred out + End WIP units)
= (2,500 + 8,500) – (7,500 + 3,000)

= 11,000 – 10,500
= 500 units
Normal spoilage rate is 5% of the good units produced. That is 7,500*5% = 375 units
Abnormal spoilage = Total spoilage – Normal spoilage
= 500 – 375 = 125 units

The above data is used to illustrate how the weighted average and FIFO methods can incorporate
both normal and abnormal spoilage in their computations.
Steps 1 and 2: Summarize output in physical units and compute equivalent units (weighted
average method.)
ND Engineering
Processing Department Production Cost Report, WA Method
January 20x7
Physical Equivalent Units
Units Direct Conversion
Flow of Production Material Costs
Good units completed 7,500 7,500 7,500
Normal spoilage 5% 375
(375*100%); (375*100%) 375 375
Abnormal spoilage 125
(125*100%); (125*100%) 125 125
WIP, ending 3,000
3000*100%, 3000*50% 3,000 1,500
Total accounted for 11,000 11,000 9,500
Less: WIP, beginning 2,500
(2500*100%) ;( 2500*60%) 2,500 1,500
Started during current period 8,500
Work done in current period 8,500 8,000

 Normal and abnormal spoilage are assumed to have 100% complétion for materai and
conversion costs.
Case 1: Weighted Average Method and Spoilage
How the Weighted Average Method is used in preparation of Cost of Production Report (CPR)
under process costing with spoilage? The total costs incurred in the previous period on the
beginning WIP and on work done in the current period are divided by the equivalent units of work
done to date. Accordingly, total costs are summarized, unit cost computed and assigned to good
units, spoilage and WIP as follows.
Step 3, 4 and 5: Equivalent unit costs, total costs to account for, and cost assignment to units
completed, spoilage units and ending WIP.
Direct Conversion
Total Materials Costs
WIP, Jan. 1 24,000 15,000 9,000
Costs added in Jan 118,500 67,500 51,000
Equivalent unit of work done to date 11,000 9,500
Equivalent Unit costs (Step 4) Br 7.50 Br 6.32
Assignment of Costs (Step 5)
Direct Materials Conversion Costs
EQU UC TC EQU UC TC TC
Good Units c & t-out before
Spoilage 7,500 7.50 56,250 7,500 6.32 47,400 103,650
Normal spoilage 375 7.50 2,812.50 375 6.32 2,370 5,182.50
Total 59,062.50 49,770 108,832.50
Abnormal spoilage 125 7.50 937.50 125 6.32 790 1,727.50
WIP ending 3,000 7.50 22,500 1,500 6.32 9,480 31,980
Accounted for 11,000 82,500 9,500 60,040 Br142,540*
* Br. 40 rounding off error.

 The cost of abnormal spoilage Br. 1,727.50 is assigned to the Loss from Abnormal Spoilage
account.
 The cost of normal spoilage of Br. 5,182.50 is added to the cost of the related good units.
Hence, the cost per good unit completed and transferred out equals the total costs
transferred out (including the cost of normal spoilage) divided by the number of good units
produced i.e. 108,832.50÷7,500=14.51. It is not equal to the sum of the unit costs of direct

materials and conversion costs 7.50+6.32=13.82 as the unit includes a share of normal
spoilage.
Case 2: FIFO Method and Spoilage

How the Fist-in, First-out (FIFO) Method is used in preparation of Cost of Production Report (CPR)
under process costing with spoilage? The first two steps are going to be the same for the two basic
inventory valuation methods. Therefore, the computation of physical movement of units and
equivalent unit of work done shall be used in both cases. Steps 3 to 5 shall be computed for each
method independently.
Step 3, 4 and 5: Equivalent unit costs, total costs to account for, and cost assignment to units
completed, spoilage units and ending WIP.
National Defense Engineering

Processing Department Production Cost Report, FIFO Method
January 20x7
_______________________________________________________________________
_______________________________________________________________________
WIP, Jan. 1 24,000
Costs added in Jan 118,500 67,500 51,000
Equivalent unit of work done to date 8,500 8,000
Equivalent unit costs (Step 4) Br 7.94 Br 6.34
Assignment of Costs (Step 5)

_______________________________________________________________________
EQU UC TC EQU UC TC TC
______________________________________________________________________
Good Units c & t-out -
before spoilage. 7,500
WIP beginning 2,500 6.00 15,000 1,500 6.00 9,000 24,000
Work done to complete WIP 0 7.94 0 1,000 6.38 6,380 6, 380
Total from WIP 2,500 15,000 2,500 15,380 30,380
Started & completed
(7,500-2,500) 5,000 7.94 39,700 5,000 6.38 31,900 71,600
Normal spoilage 375 7.94 2,977.50 375 6.38 2,392.50 5,370
Total 57,677.50 49,672.50 107,350
Abnormal spoilage 125 7.94 992.50 125 6.38 797.50 1,790
WIP ending 3,000 7.94 23,820 1,500 6.38 9,570 33,390
Accounted for 11,000 82,490 9,500 60,040 Br 142,530*
*Br. 30 rounding off error.
 All spoilage costs are assumed to relate to units completed in this period and computed at
the unit cost of the current period. With the exception of accounting for spoilage, the FIFO
method is the same as presented in Unit 3.
Journal Entries
Weighted Average FIFO
Finished Goods 108,832.50(Dr.) 107, 732.50(Dr.)
WIP-Processing 108,832.50(Cr.) 107,732.50(Cr.)
(To transfer completed goods)
Loss from Abnormal Spoilage 1,727.50(Dr.) 1,790(Dr.)
WIP-Processing 1,727.50(Cr.) 1,790(Cr.)
(To recognize abnormal spoilage detected)
Case 3: Standard Costing and Spoilage

Standard costing method can also be used to account for normal and abnormal spoilage. We
continue our illustration of ND Engineering. Assume that standard costs for processing
department for the month of January.
Direct Materials 8.00 per unit

Conversion Costs 6.50 per unit
Total production costs 14.50 per unit
ND Engineering,
Processing Department Production Cost Report, Standard Costing Method
January 20x7
____________________________________________________________________
EQU UC TC EQU UC TC Total Cost

_______________________________________________________________________
Total costs to account for
WIP beginning 2,500 8.00 20,000 1,500 6.50 9,750 29,750
Work done in Jan 8,500 8.00 68,000 8,000 6.50 2,000 120,000
To Account for 11,000 88,000 9,500 61,750 149,750
Assignment of Costs
Good units completed 7,000 units
Cost before normal
Spoilage 7,500 8.00 60,000 7,500 6.50 48,750 108,750
Normal Spoilage 375 8.00 3,000 375 6.50 2,437.50 5,437.50
Total 63,000 51,187.50 114,187.50
Abnormal Spoilage 125 8.00 1,000 125 6.50 812.50 1,812.50
WIP-ending 3,000 8.00 24,000 1,500 6.50 9,750 33,750
Accounted for 11,000 Br 88,000 9,500 Br 61,750 Br 149,750
 The costs used here are standard costs and differ from actual costs. Variances can be
measured and analyzed as described in Unit 3.
Activity 2

1. What are the various sections of a cost of production report under process costing with
spoilage?
2. In process costing, physical inventories of work in process must be taken at the end of each
accounting period. Ordinarily, all department heads are responsible for their own inventories,
and the methods they use to determine such data are crude by comparison with procedures
used for determining year end physical inventory. It is not unusual for a department head to
estimate rather than count inventories is process. Consequently, figures are bound to save
errors. Is this good practice or should more accurate methods be used, such as having
inventory teams determine inventories?
4.3. Job Costing and Spoilage
How do you account for spoilage under job costing? The concepts of normal and abnormal
spoilage also apply to job costing systems. Costs of abnormal spoilage are not considered as
product manufacturing costs and are written off as costs of the period in which detection occurs.
When assigning normal spoilage costs, job costing systems generally distinguish normal spoilage
attributable to a specific job from that common to all jobs.
In order to illustrate job costing and spoilage, we will use the following example to illustrate the
accounting for spoilage in job costing. In Dallas Machine shop, 5 auto parts out of a lot of 50 are
spoiled. Costs assigned up to the point of inspection are Br. 100 per unit. The current disposal

price of the spoiled parts is estimated to be Br. 30 per part and they are recorded when the
spoilage is detected.
Case 1: Normal Spoilage Attributable to a Specific Job

When normal spoilage occurs because of the specifications of a specific job, that job is charged
with the cost of the spoilage reduced by the current disposal value of that spoilage. The journal
entry to recognize disposal value is:
Materials Control (at current disposal value of spoiled goods 150 (Dr.)
Work-in-Process (specific job) 150 (Cr.)
The effect of the above journal entry is that the net cost of the normal spoilage Br. 350 (Br.500-
Br.150) becomes a direct cost of the good units produced.
Case 2: Normal Spoilage Attributable to All Jobs
Spoilage inherent in a given production cycle and only accidentally occurs when a specific job is
being worked upon is not attributable to the specific job. The normal spoilage cost is included in
the budgeted manufacturing overhead. Thus, normal spoilage cost common to all jobs is spread
through overhead allocation over all jobs rather than loaded to one specific job.
Materials Control (at current disposal value of spoiled goods) 150 (Dr.)
Manufacturing Overhead Control (normal spoilage, 5*70) 350 (Dr.)
WIP Control (specific job, 5*100) 500(Cr.)
Case 3: Abnormal Spoilage
If spoilage is abnormal, the net loss is charged to an abnormal loss account. Unlike normal
spoilage costs, abnormal spoilage costs are not included as part of the costs of good units
produced. The journal entry is:
Materials Control (at current disposal value of spoiled goods) 150 (Dr.)
Loss from abnormal spoilage (5*70 350 (Dr.)
WIP Control (Specific Job) 500(Cr.)
Activity 3: Describe the condition when accounting for normal spoilage under job costing differs
from process costing.
4.4. Accounting for Rework
How do you account for rework under both job costing and process costing? Reworked units are
unacceptable units of production that are subsequently reworked into good units and sold.

Rework is also distinguished in job costing context as normal rework attributable to a specific job,
normal rework common to all jobs and abnormal rework. To illustrate, assume that the five units
in Dallas Machine Shop are reworked. The rework cost is Br. 190 and consisting of raw materials of
Br. 40, direct labor of Br.100 and MOH cost of Br. 50. The journal entry for the total costs of Br.
500 (detail assumed) assigned to the spoiled units before considering rework is:
WIP Control 500 (Dr.)

Materials Control 200 (Cr.)
Wages Payable Control 200(Cr.)
MOH allocated 100(Cr.)
Case1: Normal Rework Attributable to a Specific Job
If the rework is normal but occurs because of the requirements of a specific job, the rework costs
are charged to the specific job. The journal entry is:
WIP Control (specific job) 190 (Dr.)

Materials Control 40(Cr.)
Wages Payable 100(Cr.)
MOH Allocated 50(Cr.)
Case 2: Normal Rework Common to All Jobs
When rework is normal and not attributable to any specific job, the costs of rework are charged to
manufacturing overhead and spread over all jobs through allocation.
Manufacturing Dept OH Control 190(Dr.)

Case 3: Abnormal Rework
If the rework is abnormal, it is highlighted to management by charging abnormal rework to a

separate loss account.
Loss from abnormal rework 190(Dr.)


Accounting for rework in process costing only requires abnormal rework to be distinguished from
normal rework. Abnormal rework is accounted for as in job costing. Accounting for normal rework
follows the accounting described for normal rework common to all jobs since mass of similar units
are manufactured. Some companies expense all rework including the costs of normal rework as
an expense of the current period to emphasize the importance of eliminating rework and to
simplify the accounting.
Activity 4
Describe the condition when accounting for normal rework under job costing and process costing
similar.
4.5. Accounting for Scrap
How do you account for scrap under both job costing and process costing?
Scrap is a product that has minimal (frequently zero) sales value compared with the sales value of
the main or joint product. No distinctions are made between normal and abnormal scrap because
unlike spoilage and rework, there is no cost attached to the scrap. The only distinction made is
between scrap attributable to a specific job and scrap common to all jobs. Scrap is either sold or
disposed of quickly, or stored for later sale, disposal or reuse.
There are two major aspects of accounting for scrap:
1. Planning and control, including physical tracking.

2. Inventory costing, including when and how to affect operating income.
Initial entries to scrap records are most often in physical or non financial terms such as in KGs or
units. Scrap records not only help measure efficiency, but often focus on tempting source for
theft. Scrap reports also compare actual scrap with budgeted norms or standards. When should
any value of scrap be recognized in the accounting records: at the time of production or sale of
scrap? How should revenue from scrap be accounted for?
To illustrate, we continue to use the Dallas Machine Shop example by assuming that the
manufacture of auto parts generates scrap and the normal scrap from a job lot has Br. 45 sales
value.
Approach 1: Recognizing Scrap at the Time of Sale of Scrap
When the value of scrap is immaterial, the simplest accounting is to make a notation of the
quantity of scrap returned to the store and to regard the scrap sales as a separate line item of
other revenue in the income statement. The only journal entry is:

i. Sale of Scrap:
Cash or A/R 45(Dr.)

Scrap Revenues 45(Cr.)
When the value of scrap is material in size, the accounting will be:
Case 1: Scrap Attributable to a Specific Job

Job costing systems trace the sales of scrap to the jobs that yield the scrap if it is economically
feasible to do so. Journal entry under such cases would be:
i. Scrap returned to store. No journal entry. Memorandum of quantity received and
related job entered in the inventory record.
ii. Sale of scrap.
Cash or A/R 45 (Dr.)

WIP – Specific Job 45(Cr.)
All scrap sales are credited to the specific job b.
Case 2: Scrap Common to All Jobs

This method does not link scarp with any particular job or product. Instead, all products bear
production costs without any credit for scrap revenues except in an indirect manner. The
expected scrap revenues are considered when setting the budgeted manufacturing overhead
rate. Thus the budgeted overhead rate is lower than it would be if the overhead budget had not
been reduced by thee expected scrap revenues. This accounting for scrap is used in both job
costing and process costing.
The journal entry in this case is:
i. Scrap returned to store. No journal entry. Memo of quantity received and related job
entered in the inventory record.
ii. Sale of scrap. Scrap sales is regarded as a separate line item of other revenues.
Cash or A/R 45(Dr.)
Sales of Scrap 45 (Cr.)
Many companies’ record sales of scrap as offset against manufacturing overhead.
Cash or A/R 45(Dr.)

MOH Control 45(Cr.)
Approach 2: Recognizing Scrap at the Time of Production of Scrap

Some companies delay material scrap sales until the market price is most attractive. Under these
circumstances, the companies inventorize scrap at a conservative estimate of net realizable value
so that production costs and related scrap recovery may be recognized in the same accounting
period.
The journal entry in this case is:
Case 1: Scrap Attributable to a Specific Job
i. Scrap returned to store:
Materials Control 45 (Dr.)

WIP Control 45(Cr.)
ii. When the scrap is sold:
Cash or A/R 45(Dr.)
Case 2: Scrap Common to all Jobs

Materials Control 45(Dr.)
MOH Control 45(Cr.)
ii. When the scrap is sold:

Cash or A/R 45(Dr.)
Scrap is sometimes used as direct material rather than sold as a scrap. The entries when the scrap
generated is common to all jobs are:

Materials Control 45(Dr.)
MOH Control 45(Cr.)
ii. Reuse of Scrap:

WIP Control 45(Dr.)
Accounting for scrap under process costing follows the accounting for jobs when scrap is
common to all jobs since process costing is used to cost the mass manufacture of similar units.
The high cost of scrap focuses management’s attention on ways to reduce scrap and use it more
profitably.
Activity 5

Describe the condition where accounting for scrap under job costing and process costing similar.

Self Assessment Questions -4
yourself against the answers given.

Choose the best answer among the given alternatives
1. Managers often cite reductions in the costs of spoilage as a (n)
A. A major justification for implementing a just-in-time production system
B. Measurement of improved output quality
C. Immaterial item that is not to be tracked
D. Indication of improvement in the accounting system
E. None of the above
2. Unacceptable units of production that are discarded or are sold for reduced prices
are referred to as
A. Reworked units D. Defective units
B. Spoilage E. None of the above
C. Scrap
3. Unacceptable units of production that are subsequently repaired and sold as
acceptable finished goods are
C. Scrap
4. Costs of poor quality production include
A. The opportunity cost of the plant and workers
B. The effect on current customers
C. The effect on potential customers
D. All of the above are costs of poor quality production
5. Material left over when making a product is referred to as
C. Scrap
THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 6 THROUGH 10.
Astoria Computer Systems, Inc., manufactures printers. All direct materials are added
at the inception of the production process. During January, the accounting department
noted that there was no beginning inventory. Direct materials purchases totaled
Br.100, 000 during the month. Work-in-process records revealed that 4,000 cards were
started in January, 2,000 cards were complete, and 1,500 units were spoiled as

expected. Ending work-in-process units are complete in respect to direct materials
costs. Spoilage is not detected until the process is complete.
6. What are the respective direct material costs per equivalent unit, assuming spoiled
units are recognized or ignored?
A. Br.20.00; Br.35.00 D. Br.35.00; Br.50.00
B. Br.25.00; Br.40.00 E. None of the above
C. Br.30.00; Br.45.00
Recognized Ignored
Cost to account for: Br.100, 000 Br.100, 000
Divided by equivalent units 4,000 2,500
Cost per equivalent unit Br.25.00 Br. 40.00
Assigned to:
Good units completed
(2,000 x Br.25; Br.40) Br. 50,000 Br. 80,000
Normal spoilage
(1,500 x Br.25) 37,500 0
Costs transferred out 87,500 80,000
WIP ending inventory (500 x Br.25; Br.40)12,500 20,000
Cost accounted for: Br.100,000 Br.100,000
[
7. What is the direct material cost assigned to good units completed when spoilage
units are recognized?
A. Br.50, 000 D. Br.87, 500
B. Br.100, 000 E. None of the above
C. Br.80, 000
8. What is the cost transferred out assuming spoilage units are ignored?
A. Br.87, 500 D. Br.77, 500
C. Br.50, 000
9. What are the amounts allocated to the work-in-process ending inventory assuming
spoilage units are recognized and ignored, respectively?
A. Br.20, 000; Br.24, 500 D. Br.37, 500; Br.40, 000
B. Br.30, 000; Br.34, 250 E. None of the above
C. Br.12, 500; Br.20, 000
10. Spoilage costs allocated to ending work in process are larger by which method and
by how much?
A. When spoiled units are recognized by Br.2, 500
B. When spoiled units are recognized by Br.4, 250
C. When spoiled units are ignored by Br.7, 500

____________________________________________________________________________________
D. When spoiled units are recognized by Br.7, 500
11. Quantity schedule in process costing having spoilage and tracks the physical units
of output and determines:
A. The number of units started, good units completed, and transferred out to the next
process
B. Both beginning and ending work in process inventory units
C. Both normal and abnormal spoilage
D. Total number of physical units to account for
12. Which one of the following does not exist in the Cost of Production Report under
Process Costing having Spoilage?
A. Physical Quantity Schedule D. Equivalent Unit Costs Schedule
B. Equivalent Units Schedule E. All of the above
C. Cost Schedule F. None of the above
13. Identify the wrong statement about process costing.
A. Completed units and their costs transfer to the next department as computed.
B. Process costs are charged to each department’s Work-In-Process Inventory account.
C. Units not completed must be stated in terms of equivalent units.
D. Unit costs are computed only at the end of the entire manufacturing process.
14. Under which of the following conditions will FIFO method of process costing yield
the same equivalent unit costs as the Weighted-Average Method?
A. When units produced are homogenous in nature.
B. When there is no ending inventory
C. When there is no beginning inventory.
D. When beginning & ending inventories are each 50% complete.
15. If ABC Company detects, reprocess and sells a certain product which was defective
before then what do we call that product?
A. Quality Product. D. Scarp
B. Rework E. All of the above
C. Spoilage F. None of the above
16. In job –costing system, the net cost of spoilage that is normal and common to all
jobs should be charged to:
A. Materials Control C. Factory Overhead Control
B. Work In Process Control D. Finished goods Inventory

____________________________________________________________________________________
17. Actions that can be taken by managers to improve quality and reduce costs could
be:
A. Designing better products and processes
B. Properly maintaining machines
C. Training workers E. All of the above
D. Motivating workers F. None of the above
18. If the rework is abnormal, it is highlighted to management by charging abnormal
rework to:
A. Materials Control D. Loss account.
B. Work In Process Control E. All of the above
C. Factory Overhead Control F. None of the above
19. When the value of scrap is immaterial, the appropriate accounting is to make a
notation of the quantity of scrap returned to the store and to regard the sc rap sales
as:
A. Materials D. Other revenue
B. Work In Process E. All of the above
C. Factory Overhead F. None of the above
20. Domain Manufacturing Shop produces motorcycle parts. Typically, 10 pieces out of
a job lot of 1,000 parts are spoiled. Costs are assigned at the inspection point,
Br.50.00 per unit. Spoiled pieces may be disposed of at Br.10.00 per unit. The
spoiled goods must be inventoried appropriately when the normal spoilage is
detected. Job 101 requires the production of 2,500 good parts. Which of the
following journal entries would be correct if the spoilage occurred due to
specifications required for Job 101?
A. Work-in-Process Control Br.100
Materials Control Br.100
B. Materials Control Br.100
Work-in-Process Control Br.100
C. Materials Control Br.250
Work-in-Process Control Br.250
D. Work-in-Process Control Br.250
Materials Control Br.250

Exercise 1: Process Costing and Spoilage

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The Antique Shop manufactures pottery products. All direct materials are included at
the inception of the production process. For April, there was no beginning inventory in
the processing plant. Direct materials totaled Br.310,000 for the month. Work-in-
process records revealed that 5,000 tons were started in April and that 3,000 tons
were finished; 1,000 tons were spoiled as expected. Ending work-in-process units are
complete in respect to direct materials costs. Spoilage is not detected until the process
is complete.
Required:
a. What is the cost per equivalent unit if spoiled units are recognized or ignored?
b. What are the costs assigned to completed units when spoilage units are
recognized or when they are not recognized?
c. What are the costs transferred out if spoilage units are recognized or ignored?
d. What are the amounts allocated to the work-in-process ending inventory when
spoilage units are recognized or ignored?

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Activities
Activity 1
1. Normal Spoilage is spoilage inherent in a particular production process that arises even
under efficient operating conditions where as Abnormal Spoilage is spoilage that would be
avoidable and controllable and does not arise under efficient operating conditions
2. Reworks are unacceptable units of production that are subsequently reprocessed and sold
as acceptable finished goods where as Scrap is a material left when making a main or joint
product and has minimal (frequently zero) sales value.
Activity 2
1. The various sections of a cost of production report are: (a) cost transferred from a
preceding department, (b) materials, labor, and factory overhead added by a department,
(c) unit costs added by a department, (d) unit and total costs accumulated to the end of
operations in a department, (e) the cost of beginning and ending work in process
inventories, spoilage and (f) cost transferred to a succeeding department or to a finished
goods storeroom.
2. The need for accuracy in determining work in process is in a large part determined by the
materiality of the inventory which, in many instances, is rather small or insignificant.
Whenever an inventory figure is needed, the quantitative data will ordinarily come from
departmental supervisors. The cost department will apply cost data. Quantitative data
based on actual physical counts are desirable, but estimates based on the capacity of various
equipment, such as holding tanks, can be quite acceptable. The validity of estimates can be
determined through analysis of reasons for higher or poor estimate of work in process. In
most instances, the use of a permanent inventory team is impractical not only because work
in process values are usually not substantial, but because determination of the quantity of
work in process can be performed best by departmental personnel familiar with the product
and factory operations.
Activity 3
1. When normal spoilage is attributable to as specific job.
Activity 4
1. When normal rework is common to all jobs.
Activity 5
1. When scrap is common to all jobs.

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Part I: Multiple Choices

1. A 8. C 15. B
2. B 9. C 16. C
3. A 10. C 17. E
4. D 11. E 18. D
5. C 12. F 19. D
6. B 13. D 20. C
7. D 14. C
Exercise-1: Process Costing and Spoilage

a. Recognized Ignored
Cost to account for Br.310,000 Br.310,000
Cost per equivalent unit Br. 62 Br. 77.50
b. Assigned to good units completed:

(3,000 x Br.62) Br.186,000
(3,000 x Br.77.50) Br.232,500
c. Transferred out - Finished Br.186,000 Br.232,500

Normal spoilage (1,000 x Br.62) 62,000 0
Total Br.248,000 Br.232,500
d. Ending work-in-process inventory:
(1,000 x Br.62) Br. 62,000
(1,000 x Br.77.50) Br. 77,500
PRODUCTION COST WORKSHEET
Flow of Production Physical units Direct materials Conversion

Work in process, beginning 20,000
Started during period 40,000
To account for 60,000
Good units completed 50,000 50,000 50,000
Normal spoilage 2,000 2,000 2,000
Work in process, ending 8,000 8,000 4,800
Accounted for 60,000 60,000 56,800

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Costs Totals Direct Materials Conversion
Work in process, beginning Br. 16,000 Br.12,000 Br. 4,000
Costs added during period 90,000 60,000 30,000
Total costs to account for 106,000 72,000 34,000
Equivalent unit costs Br. 1.80 Br. 1.20 Br. 0.60
Assignment of costs
Costs transferred out (50,000 x Br.1.80) Br. 90,000
Normal spoilage (2,000 x Br.1.80) 3,600
Work in process, ending
Direct materials (8,000 x Br.1.20) 9,600
Conversion (8,000 x Br.0.60 x 0.60) 2,880
Costs accounted for Br.106,080
(Differences may be due to rounding)

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Unit 5
Income Effect of Alternative product Costing Methods
1. Distinguish between variable costing and absorption costing;

2. Identify the flow of costs under variable costing;
3. Identify the flow of costs under absorption costing;
4. Determine the effect of alternative costing methods on income measurement;
5. Reconcile the difference in income measurement between variable costing and absorption
costing.
5.1. Basics Overhead Application
How does overhead cost application affect income measurement? One of the tasks of a
management accountant is to provide an accounting system to determine the cost of inventory so
as to determine net income for a firm. There are different methods of inventory costing, and
managers and accountants face decision of which method to use. This decision will affect
reported income, which is part of the measure of performance as viewed from inside and outside
the organization. The main difficulty is how to treat the fixed manufacturing overhead costs.
These costs are troublesome in product costing because they tend to remain the same in total
within various range of production output. This creates problem in determining the cost to
manufacture a unit of product. The unit cost depends upon how many units are produced in the
fiscal period. In this unit, the methods of inventory costing and related topics are discussed. These
methods are Variable Costing and Absorption Costing
These methods of inventory costing differ in only one conceptual respect. This concept is how
fixed manufacturing overhead cost is treated in the inventory cost determination. That is, whether
the fixed manufacturing overhead cost is inventoriable cost or not. It should be recalled here that
inventoriable cost was defined as cost associated with acquisition of materials used and
conversion of materials and all other manufacturing inputs necessary to produce final output.
Here, the cost of inventory will differ with the method to be followed in determining the cost.
Even if standard costing system is used for illustrative purposes here, the variations can be used in
non standard product costing systems too.

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5.2. Comparison of Variable Costing and Absorption Costing
What is the difference between variable costing and absorption coating? The major distinction
between the variable and absorption costing approach is how to account for manufacturing costs.
Other costs of business function (marketing, distribution, administration, etc.) are written off as
periodic costs in both variable and absorption costing approaches. The question of which method
is correct can't be answered in a clear-cut because each method has its own advantage and
disadvantage. The following paragraphs will discuss in brief the advantages and disadvantages of
each product costing approach.
5.2.1. Variable Costing
Which cost items are inventoried under variable costing? Variable Costing some time times called
direct costing or marginal Costing or contribution margin approach. According to variable costing
concept, only the variable manufacturing costs should be assigned to the products. Therefore,
variable costing is a method of inventory costing in which all direct manufacturing costs and only
the variable manufacturing overhead costs are included as inventoriable costs. The fixed
manufacturing overhead costs are excluded from the inventoriable costs and treated as period
costs in the period incurred. It is true that an investment in facilities and other fixed production
factors is required before any products can be produced. These are fixed costs in the form of
depreciation, taxes, insurance, and salaries of plant supervisors, foremen that must be incurred
during the period. These fixed costs are not considered as product costs rather they are
considered as costs incurred in operating the plant. Hence, the fixed manufacturing overhead,
costs like selling and administrative costs, are too remotely related to the product to be assigned
as part of its cost. Thus, fixed manufacturing overhead costs should be expensed each fiscal
period and not included as part of the cost of an inventory. The flow of Costs under variable
costing can be summarized in the following table.
Exhibit 5.1 Cost flow under Variable Costing
Variable Costing
Costs to Account Inventoried on Expensed on Income Statement
for Balance Sheet
Direct Labor Initially applied to Become cost of goods sold
Direct Materials Inventory as product when the inventory is sold
Variable FOH costs
Fixed FOH Become expense immediately

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Variable costing provides useful information in various decision making areas. It is not approved
for external reporting or tax purposes but used by many firms for internal reporting purposes for
performance measurement and cost analysis. Among others, to enter a new market, to expand or
discontinue production of a product, to make parts internally or buy from external suppliers,
accepting special orders which may require price cutting, etc. are few to list. In cost-volume-profit
analysis, the variable costing approach provides useful data. Moreover, to prepare segment
reports in performance evaluation, it is the variable costing method which should be used. For
example, if a firm has a number of segments which share some fixed facilities, the contribution of
each segment should be considered before apportionment of the fixed costs. Because, fixed costs
are apportioned, probably a segment which contributes the highest amount may end up with a
loss figure and mislead the management. The variable costing approach, in preparing segment
reports, provides the detailed information managers need. In general, the variable costing is
superior to the absorption costing approach for internal users.
However, it has got limitations and sometimes disadvantages. According to the generally
accepted accounting principles (GAAP), the cost of a product is a cost incurred to produce it.
Manufacturing firms incur costs of materials, labor, and overheads (variable and fixed). In variable
costing approach the cost of the product does not include the fixed overhead cost. Therefore, for
external reporting, variable costing is not acceptable as per GAAP. Unless caution is made with
variable costing approach, there may be a disadvantage in using the information gathered from
reports prepared under variable costing method. For example, a firm may end up in setting a self
suiciding price for its product by using the variable costs only as an input pricing decision uses cost
as a basis. In variable costing, the cost of a product is lowered because the fixed element is
excluded. This may lead to set a price which may not cover the cost of the product. In the long-
run, all costs are variable. Therefore, in such cases all costs must be considered before making the
final decision.
5.2.2. Absorption Costing
Which cost items are inventoried under absorption costing? Absorption Costing some time times
called full costing or functional or traditional costing. It is a method of inventory costing in which
all direct and indirect manufacturing costs are considered to determine the cost of goods
manufactured. This method is in accordance with the generally accepted accounting theory which
underlines in the determination of income and cost of a product. In absorption costing method, a
product should absorb costs related to materials, labor and both variable and fixed manufacturing
overhead. Some costs are fixed such as salary of plant supervisor, factory deprecations, factory
insurance, and are unaffected by the volume of output produced. On the other hand costs like
factory supplies, fuel, and electric power to operate machines do vary with volume of output
produced.

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It is stated that fixed costs are not affected by the volume of output produced within the relevant
range. However, when the unit product cost is to be computed the volume of output affects it.
When few units are produced the unit product cost would be high. On the other hand, when more
units are produced the unit product cost would be low. The controversy lies here. Difference in
unit product cost means that the profit for the fiscal period would be influenced not only by the
volume of sales, the sales price, and the cost of production but also by the quantity of units
manufactured during the fiscal period. As discussed in the earlier chapters, fixed manufacturing
overhead cost is applied to production based on a predetermined rate which is developed on
budgeted fixed manufacturing overhead costs and budgeted denominator level. If the firm
operates below or above the budgeted denominator level the fixed overhead will be under or
over absorbed (applied). This over or under absorbed amount is the denominator variance and is
to be written off to operations for the period.
Absorption costing is accordance to the definition of inventoriable costs as per GAAP. Thus, for
external reporting purpose, the absorption costing approach should be used in preparing financial
statements. Absorption costing approach protects the firm not to cut prices very low which
destroys the firm probably forever. However, absorption costing method is less useful for internal
uses, particularly on short tern decisions. In some cases a report prepared under absorption
costing method may mislead the decision maker. This is because, in the short run, fixed costs
remain constant and are irrelevant in making any sort of decision. The other disadvantage of
absorption costing is that it pushes managers to buildup inventory. The fixed manufacturing
overhead cost included in the product cost and hence high inventory cost is generated. The higher
the end inventory figure the higher would be the profit (net income) reported which is one of the
inputs to evaluate manager's performance. The flow of Costs under absorption costing can be
summarized in the following table.
Exhibit 5.2 Cost flow under Absorption Costing
Absorption Costing
Costs to Account for Inventoried on Balance Sheet Expensed on Income
Statement
Direct Labor Initially applied to inventory as Become expenses when the
Direct Materials product costs inventory is sold
Variable FOH
Fixed FOH

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Activity-1
1. Differentiate between variable costing and absorption costing.
5.3. Income Measurement under Variable and Absorption Costing
How do you measure income under variable costing and absorption costing? In order to illustrate
Variable Costing and Absorption Costing, assume the following data for the next three cases.
ND Engineering produces hand tools in one of its manufacturing departments. It has the following
costs for one of its products, hammer. Basic Production data are stated in terms of standard costs
as given below.
1. Unit production cost are:

Direct material………………………….……… Br. 0.75
Direct labor………………………………………… 1.00
Variable manufacturing overhead………….……..0.20
Standard variable costs per unit ………………….2.00
2. The single cost driver for the Br. 0.25 variable overhead cost per hammer is the number of
hammer produced.
3. Also assume that budgeted and actual selling and administrative expenses are Br. 50,000
yearly fixed costs plus sales commission of 3% of Birr sales.
4. A fixed manufacturing overhead cost is budgeted to be at Br. 100,000 per year.
5. There are no variances for the standard variable manufacturing costs, and the actual fixed
manufacturing overhead incurred Br. 100,000 each year.
6. Production is budgeted to be 200,000 hammers and selling price is Br. 3 per hammer.
7. Actual production quantities are:
In units (hammer) 20x8 20x9

Opening Inventory -------- 20,000
Production 220,000 190,000
Sales 200,000 205,000
Ending Inventory 20,000 5,000
Required: Based on the information given above,

a) Prepare income statement for 20x8 and 20x9 under variable costing
b) Prepare income statement for 20x8 and 20x9 under absorption costing

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Let‘s see how to prepare income statements for the two years under variable costing and
absorption costing. First we shall discuss the former and then we shall come to the later.
Variable Costing Method

The variable costing income statement has the familiar contribution approach format but presents
a detailed calculation of cost of goods sold. The costs of the product are accounted for applying
all variable manufacturing costs to the goods produced at a rate of Br. 2 per unit thus valuing
inventories at standard variable cost. Fixed manufacturing costs are not applied to any products
but regarded as expenses in the period they are incurred. Variable cost of goods sold and variable
selling and administrative expenses are deducted in computing the contribution margin but
variable selling and administrative expenses are not inventoriable. Revenue less all manufacturing
and non manufacturing variable costs is the contribution margin. The income statement under
variable costing is given below.
ND Engineering
Comparative Income Statements under Variable Costing
For the years ended 20x8 and 20x9
20x8 20x9
Sales Br 600,000 Br 615,000
Less: Manufacturing COGS
Beginning Inventory - 40,000
Plus: Variable COGM 440,000 380,000
Variable COGAS 440,000 420,000
Less: Ending Inventory 40,000 10,000
Variable Manufacturing COGS* 400,000 410,000
Plus: Variable Selling Exp (3%) 18,000 18,450
Total Variable Expenses 418,000 428,450
Contribution Margin 182,000 186,550
Less: Fixed Expenses
Fixed FOH 100,000 100, 000
Fixed Selling & Admin Exp 50,000 50, 000
Total Fixed Expenses 150,000 150, 000
Operating Income, Variable Costing Br 32,000 Br 36,550
*all variable manufacturing costs are at the standard cost of Br 2 per unit.
Absorption Costing Method

The absorption costing framework differs from the variable costing format in three ways.
i. The unit production cost includes fixed manufacturing costs now and it is Br. 2.50 per unit. The
manufacturing overhead applied to each unit is the fixed overhead rate which is determined

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by dividing the budgeted fixed overhead by the expected cost driver activity for the budget
period. In this case the selected cost driver is the volume of production.
Fixed Overhead Rate = Budgeted Fixed Manufacturing Overhead/Expected Volume of

Production = Br 100,000/200,000 units = Br 0.50 per unit
ii. Fixed factory overhead does not appear as a separate line in an absorption costing income
statement as the fixed factory overhead is included in two places as part of cost of goods
sold and as production volume variance. Production volume variance is a variance that
appears whenever actual production deviates from the expected volume of production used
in computing the fixed overhead rate.
Production Volume Variance (PVV)

= Applied Fixed Overhead – Budgeted Fixed Overhead
= (Actual Volume-Expected Volume)* Fixed Overhead Rate
= (Actual Volume*Fixed POR) – (Expected Volume * Fixed POR)
When expected volume and actual production volume are identical, there is no production volume
variance. When actual volume exceeds expected volume, the production volume variance is
favorable because use of facilities is better than expected and fixed overhead is over-applied. This
happened in 20x8 to ND Engineering as indicated below.
Production Volume Variance = (220,000 – 200,000)* Br 0.50 = Br 10,000F

Br. 110,000 is charged through inventory but actual costs of Br. 100,000 are incurred.
Current expenses are reduced by the favorable variance of Br. 10,000 not to overstate
future expenses.
When actual volume is less than expected volume, the production volume variance is unfavorable
because facility usage is less than expected and fixed overhead is under-applied. In ND Engineering
example, in the year 2009 units produced was less than expected.
Production Volume Variance= (190,000- 200,000)*Br 0.50 = Br 5,000 U

Br 5,000 unfavorable production volume variance increases the manufacturing
cost shown on the income statement.
iii. The format of an absorption costing income statement separates costs to the major
categories of manufacturing and non manufacturing. Revenue less both fixed and variable
manufacturing costs is gross profit or gross margin. The income statement under absorption
costing is given below.

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ND Engineering
Comparative Income Statements under Absorption Costing
For the years ended 20x8 and 20x9
20x8 20x9
Sales Br 600,000 Br 615,000
Less: Variable Manufacturing COGS
Beginning Inventory - 50,000
Plus: COGM 550,000 475,000
COGAS 550,000 525,000
Less: Ending Inventory 50,000 12,500
Standard COGS 500,000 512,500
Gross profit at Standard 100,000 102,500
Plus/Less: Production Volume Variance 10,000F 5,000U
Gross Profit at Actual Cost 110,000 97,500
Less: Selling and Administrative Expenses 68,000 68,450
Operating Income Br 42,000 Br 29,050
5.4. Reconciliation of Variable Costing and Absorption Costing
How do you justify the difference in operating income between variable costing and absorption
costing? The difference between operating incomes under variable and absorption costing
methods is quickly explained by multiplying the fixed overhead product costing rate by the
change in the total units in the beginning and ending inventories. The difference in operating
income also equals the difference in the total amount of fixed manufacturing overhead charged as
an expense during a given under the two costing methods. It is the relationship between sales and
production that determines the difference between variable costing and absorption costing net
income. Whenever sales exceed production, that is, when inventory decreases, variable costing
income is greater than absorption costing income. When sales and production are almost equal
and inventories are minimal, the difference between variable and absorption net income is not
significant.

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Reconciliation of Operating Income under Variable and Absorption Costing
20x8 20x9 Together

Operating Income:
Absorption Costing Br 42,000 Br 29,050 Br 66,050
Variable Costing 32,000 36,550 68,550
Difference to be explained 10,000 -7,500 -2,500
Fixed Overhead Rate 0.50 0.50 0.50
Change in Inventory Units:
Beginning Inventory - 20,000 20,000
Ending Inventory 20,000 5,000 25,000
Change (Difference): 20,000 -15,000 -5,000
Difference explained Br 10,000 -7,500 -2,500
Activity 2
Explain the difference in operating income between variable and absorption costing.

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Dear learners, if you understood this unit very well, attempt the following questions.
1. Which of the following cost(s) are inventoried when using variable costing?
A. Direct manufacturing costs D. Both (a) and (b)
B. Variable marketing costs E. None of the above
C. Fixed manufacturing costs
2. Which of the following cost(s) are inventoried when using absorption costing?
A. Direct manufacturing costs D. Both (a) and (c)
B. Variable marketing costs E. None of the above
C. Fixed manufacturing costs
3. Absorption costing is required for all EXCEPT
A. Generally accepted accounting principles
B. Determining a competitive selling price
C. External reporting to shareholders
D. Income tax reporting E. None of the above
4. Absorption costing
A. Expenses marketing costs as cost of goods sold.
B. Treats direct manufacturing costs as a period cost
C. Includes fixed manufacturing overhead as an inventoriable cost
D. Is required for internal reports to managers
5. Variable costing
A. Expenses administrative costs as cost of goods sold
B. Treats direct manufacturing costs as a product cost
C. Includes fixed manufacturing overhead as an inventoriable cost
D. Is required for external reporting to shareholders
THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 6 AND 7.

Marie’s Decorating produces and sells a mantel clock for Br. 100 per unit. In 20x1, 100,000 parts
were produced and 80,000 units were sold. Other information for the year includes:
Direct materials Br. 30.00 per unit
Direct manufacturing labor Br. 2.00 Per unit
Variable manufacturing costs Br. 3.00 per unit
Sales commissions Br. 5.00 Per part
Fixed manufacturing costs Br. 25.00 per unit
Administrative expenses, all fixed Br. 15.00 per unit

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6. What is the inventoriable cost per unit using variable costing?
A. Br. 32 D. Br. 60
B. Br. 35 E. None
C. Br. 40
7. What is the inventoriable cost per unit using absorption costing?
A. Br. 32 D. Br. 80
B. Br. 35 E. None
C. Br. 60
THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 8 AND 9.

Gabe’s Auto produces and sells an auto part for Br. 30.00 per unit. In 20x1, 100,000 parts were
produced and 75,000 units were sold. Other information for the year includes:
Direct materials Br. 12.00 per unit
Direct manufacturing labor Br. 2.25 per unit
Variable manufacturing costs Br. 0.75 per unit
Sales commissions Br. 3.00 per part
Fixed manufacturing costs Br. 375,000 per year
Administrative expenses, all fixed Br. 135,000 per year
8. What is the inventoriable cost per unit using variable costing?
A. Br. 14.25 D. Br. 21.75
B. Br. 15.00 E. None
C. Br. 18.00
9. What is the inventoriable cost per unit using absorption costing?
A. Br. 15.00 D. Br. 21.75
B. Br. 18.00 E. None
C. Br. 18.75
10. The contribution-margin format of the income statement
A. Is used with absorption costing
B. Highlights the lump sum of fixed manufacturing costs
C. Distinguishes manufacturing costs from nonmanufacturing costs
D. Calculates gross margin
E. None
11. Identify the one that does not belong to others.
A. Traditional Costing D. Variable Costing
B. Marginal costing E. All of the above
C. Direct costing F. None of the above
12. Product cost under absorption costing is characteristically:
A. Lower than under variable costing.

B. Higher than under variable costing.
C. Equal to variable costing.
D. Higher sometimes and lower sometimes than variable costing.
13. Which one of the following lends itself well to internal decision making?
A. Full costing D. Traditional costing
B. Absorption costing E. All of the above
C. Variable costing F. None of these
14. When production is equal to sales, which one of the following is true?
A. No change occurs to inventories for either absorption costing or variable costing
methods.
B. The use of absorption costing produces a higher net income than the use of variable
costing.
C. The use of absorption costing produces a lower net income than the use of variable
costing.
D. The use of absorption costing causes inventory value to increase more than they would
through the use of variable costing.
15. Which one of the following is an element of product cost under absorption costing
approach?
A. Direct Material D. Fixed Factory Overhead
B. Direct Labor E. All of the above
C. Variable Factory Overhead F. None of the above
16. Which one of the following is wrong about variable costing?
A. It is not supported by GAAP.
B. It is used for internal reporting.
C. It is used in managerial decision making.
D. It is used in performance measurement and cost analysis.
17. Advantages of variable costing include which of the following?
A. Data that are required for CVP analysis can be taken directly from the contribution
margin format income statement.
B. All things being equal, profit for the period is not affected by changing inventories.
C. Profits tend to move in the same direction as sales.
D. The use of variable costing causes inventory value to increase more than they would
through the use of absorption costing.
18. Variable costing is attractive to managers as an alternative to absorption costing
because:

A. Absorption costing makes distinctions between fixed and variable product costs.
B. To generate data for CVP analysis, considerable time would have to be invested to
rework income statements constructed under absorption costing.
C. Absorption costing is well suited to CVP analysis techniques.
D. Absorption costing provides useful tools to managers for planning and control.
19. Using absorption costing, a unit of product includes:
A. Direct materials, direct labor, and fixed overhead.
B. Direct materials, direct labor, and variable overhead.
C. Direct materials, direct labor, variable overhead, and fixed overhead.
D. Only direct materials and direct labor.
20. Units produced = 2,000, units sold = 1,800, contribution margin ratio is 37%, fixed S
& A expenses are Br.90, 000. Fixed mfg. Expenses are Br.80, 200, by how much is
net income greater under full costing than variable costing?
A. Br.Br.80,200 D. Br.8,020
B. Br.9,000 E. All of the above
C. Br.17,020 F. None of the above
Part II – Workout Questions

1. For 20x4, Nichols, Inc. had sales of 75,000 units and production of 100,000 units.
Other information for the year included:
Direct manufacturing labor Br.187,500

Variable manufacturing overhead 100,000
Direct materials 150,000
Variable selling expenses 100,000
Fixed administrative expenses 100,000
Fixed manufacturing overhead 200,000
There was no beginning inventory.
Required:
A. Compute the ending finished goods inventory under both absorption and
variable costing.
B. Compute the cost of goods sold under both absorption and variable costing.
2.Buster Company sells its products for Br.66 each. The current production level is
25,000 units, although only 20,000 units are anticipated to be sold.
Unit manufacturing costs are:
Direct materials Br.12.00

Direct manufacturing labor Br.18.00
Variable manufacturing costs Br.9.00
Total fixed manufacturing costs Br.180, 000
Marketing expenses Br.6.00 per unit, plus Br.60, 000 per year
Required:
A. Prepare an income statement using absorption costing.
B. Prepare an income statement using variable costing.

Activities
Activity 1
Variable costing and absorption costing methods differ only in the treatment of fixed
manufacturing overhead cost in the inventory cost determination. Fixed manufacturing overhead
cost is recognized as expenses in the former method but capitalized as the cost of inventory in the
latter case.
Activity 2
The difference between operating incomes under variable and absorption costing methods is
explained by multiplying the fixed overhead product costing rate by the change in the total units
in the beginning and ending inventories.
1. D 8. B 15. B
2. B 9. B 16. C
3. D 10. B 17. E
4. C 11. E 18. D
5. B 12. F 19. D
6. B 13. D 20. C
7. C 14. C

Unit 6
Cost Allocation: Support Department Costs

1. Explain the major purposes of allocating costs;
2. Identify the criteria of allocating costs;
3. Allocate the costs support departments to operating departments;
4. Describe how cost allocation is used in cost planning and control.
6.1. Purposes of Cost Allocation
Dear learner, let’s start from your prior understanding of cost allocation. What do you know about
cost allocation? In previous units, we discussed that a costing system typically accounts for costs
in two basic stages i.e. cost accumulation and cost assignment.
Cost Accumulation refers to the collection of cost data in some organized way through an
accounting system where as Cost Assignment is the application of those cost to cost objectives.
The later is a general term that encompasses both tracing accumulated cost to a cost object and
allocating accumulated cost to a cost object. Costs that are traced to a cost object are direct costs
and costs that are allocated to a cost object are indirect costs. Let us define some relevant
terminologies before the discussion of purposes of cost allocation.
Cost allocation is the process of assigning common costs to two or more cost objects. It is a
proportional assignment of indirect costs to the chosen cost objects where as Cost tracing is the
assigning of direct costs such as direct material and direct labor to the chosen cost object.
Cost object is any item or activity to which costs are assigned. The cost object may be Product,
Service, Project, Customer, Brand, Customer, Activity, Program, Department, etc
Indirect Costs of a particular cost object are costs that are related to that cost objet but cannot
be traced to it in an economically feasible (cost effective) way. These costs often comprise a large
percentage of the overall costs assigned to such cost objects as products, customers, and
distribution channels. A common cost is an example of an indirect cost.
Why do managers allocate indirect costs to the chosen cost objects? The following table outlines
the four major purposes of allocating indirect costs.

Exhibit 6.1 Purposes of Cost Allocation
The allocation of a particular cost need not simultaneously satisfy all four purposes. Different
costs are appropriate for different purposes. Consider costs of a product in terms of the following
six business functions in the value chain.
 Research &development
 Design of products, services and processes
 Production
 Marketing
 Distribution
 Customer service
The same set of costs in these six business functions typically will not satisfy each of the four
purposes. For the economic decision purpose (for example, product pricing), the costs in all six
functions should be included. For the motivation purpose, costs from more than one function are
often included to emphasize to managers how costs in different functions are related to each
other.
6.2. Criteria to Guide Cost Allocation Decisions

Is there any criterion to allocate costs? Managers must first identify the purpose for a particular
cost allocation and then select the criteria to allocate costs. Ideally, cost allocation reflects a
cause-and-effect relation between costs and the objects to which they are allocated. However,
the four criteria used to guide cost allocation decisions are given below:
1) Cause and Effect: If possible, find a cause-and-effect relation between the cost object and the
cost and use a cost driver that reflects that cause-and-effect relationship. Using this criterion,
managers identify the variables that cause resources to be consumed in carrying out business
activities. For example, managers may use hours of testing as the variable when allocating the
costs of a quality-testing area to products. Cost allocations based on the cause-and–effect
criterion are likely to be the most credible to operating personnel.
2) Benefits Received: If a causal relation cannot be found, it is appropriate to select an allocation
base that reflects benefits received. Using this criterion, managers identify the beneficiaries of
the outputs of the cost object. The costs of the cost object are allocated among the
beneficiaries in proportion to the benefits each receives. For example, the cost of employee
training to improve quality is not necessarily caused by a particular product, but the quality of
the product might benefit if employees participate in a training program. In this case, the costs
of employee training might be allocated based on the reduction in defective units produced.
3) Fairness or Equity: If managers cannot come up with an allocation base that reflects causality
or benefits received, they select an allocation base that represents a "reasonable" cost
allocation. For most allocation decisions, fairness is difficult–to-achieve objective rather than
an operational criterion. For example, it is reasonable to allocate space-related costs, such as
housekeeping, on the basis of square feet cleaned.
4) Ability to Bear: This criterion advocates allocating costs in proportion to the cost object’s
ability to bear costs allocated to it. For example, the allocation of corporate executive’s
salaries on the basis of division operating income. The presumption is that the more-profitable
divisions have a greater ability to absorb corporate headquarters’ costs.
Activity-1
Put a tick mark ( ) in the appropriate cells as ‘True’ if the statement is correct
and ‘False’ if the statement is incorrect.
1. Indirect costs are costs that cannot be traced to cost
objects in an economically feasible.
2. One of the purposes of allocating indirect costs is to justify
costs or compute reimbursement amounts
3. To allocate a cost, it must satisfy all four purposes for which
costs are allocated.

4. Using the benefits received criterion, the costs are allocated
among the beneficiaries in proportion to the benefits each
receives
5. When using the cause-and-effect criterion, cost drivers are
selected as the cost allocation bases.
6.3. Allocating Costs of Support Department to Operating Departments
6.3.1. Distinction between Support Department and Operating Departments

Can you differentiate between support department and operating department? An Operating
Department, also called a Production Department in manufacturing companies, directly adds
value to a product or service where as a Support Department, also called a Service Department,
provides the services that assist other internal departments (Operating Departments and Other
Support Department in the company).
What are the key issues to be considered in allocating costs of support department to operating
departments? In many cases, the costs of a department will include costs allocated from other
departments. Three key issues that arise when allocating costs from one department to another
are:
1. Whether to use a single rate method or a dual rate method ,
2. Whether to use budgeted rates or actual rates ,and
3. Whether to use budgeted quantities or actual quantities.
Single Rate and Dual Rate Method
What is the difference between single rate method and dual rate method?
The Single-Rate Cost – Allocation Method allocates costs in each cost pool to cost objects using
the same rate per unit of the single allocation base. No distinction is made between fixed and
variable costs in the cost pool.
The Dual-Rate Cost-Allocation Method classifies costs in each cost pool into two pools- as variable
cost pool and fixed cost pool with each pool using a different cost-allocation base. A big benefit of
the dual-rate method is that it signals to division managers how variable costs and fixed costs
behave differently. This information would guide division mangers to make decisions that benefit
the organization as a whole, as well as each division.

Budget Rate versus Actual Rate
Is there any effect of using budget rate or actual rate in cost allocation? The decisions on whether
to use budgeted cost rates or actual rates affects the level of uncertainty user departments face.
Budgeted Rates - let the user departments know the cost rates they will be charged in advance.
Users are then better equipped to determine the amount of the services to request and–if the
option exists-whether to use the internal department source or an external vendor. They also help
motivate the manager of the support department to improve efficiency. During the budget
period, the support department, not the user departments, bears the risk of any unfavorable cost
variances. Why because the user department does not pay for any costs that exceed the
budgeted rates. The manager of the support department would likely view this as a con of using
budgeted rates especially when unfavorable cost variances occur because of price increases
outside the department’s control.
Actual Rates - the user department will not know the rates charged until the end of the period.
They cannot be used as an incentive mechanism to the management of the support department
to improve efficiency because it is the user department not the support department that will bear
the risk of any unfavorable cost variances.
Budgeted versus Actual Usage of Allocation Bases

How does cost allocation base affect manager’s behavior? The choice between actual usage and
budgeted usage for allocating department fixed costs also can affect a manager’s behavior.
When the actual usage is the allocation base, user divisions will not know how much cost is
allocated to them until end of the budget period.
When the budgeted usage is the allocation base, user divisions will know their allocation costs in
advance. This information helps the user divisions with both short-run and long-run planning. If
fixed costs are allocated on the basis of estimated long-run use, some managers may be tempted
to underestimate their planned usage. In this way, they will bear a lower fraction of the total costs
(assuming all other managers do not similarly underestimate their planned usage). Some
organizations offer rewards in the form of salary increases and promotions to managers who
make accurate forecasts of long run usage. Alternatively, some organizations impose cost
penalties for under predicting long-run usage. For instance, a higher cost rate may be charged
after a division exceeds its budgeted usage.
Activity 2

Put at tick mark ( ) in the appropriate cells as ‘True’ if the statement is correct
and ‘False’ if the statement is incorrect.
The only choices that a firm has for support department cost
allocation rates are to use either a budgeted rate or an actual rate.
1. The dual cost-allocation method classifies costs into two pools, a
budgeted cost pool and an actual cost pool
2. When budgeted cost-allocation rates are used, managers of the
supplier division are motivated to improve efficiency
3. When budgeted cost-allocation rates are used, variations in actual
usage by one division affect the costs allocated to other divisions
4. The single-rate method makes a distinction between fixed and
variable costs.
6.3.2. Allocating Costs of Multiple Support Departments
What techniques are used in allocation of multiple support departments to operating departments?
Allocating Costs of Multiple Support Departments create a special cost allocation problem when
they provide reciprocal support to each other as well as support to departments. An example of
reciprocal support is a corporate Human resource ( HR) department provides services to a
Corporate Legal Department (Such as advice about hiring attorneys) while the corporate Legal
Department provides services to the( HR) department (such as advice on compliance with labor
laws). More accurate support department cost allocations result in more-accurate product,
service, and customer costs.
There are three basic methods of allocating the costs of Support departments namely Direct
Method, Step down Method and Reciprocal Methods. To focus on concepts, I will use the single-
rate method to allocate the costs of each support department.
In order to illustrate these methods, assume the data given following. ND Engineering has two
production departments, Machining and Assembly, and two major service departments,
Warehousing Department and Power Supply. The following table shows the costs incurred by
each service departments as well as the distribution of output among the other departments.
Support Departments Operating Departments

Warehousing Power Machining Assembly
Department Supply
Support department costs Br.10,000 Br.4,000
Pounds of material used (%) __ 20 50 30
Power used, KW hr (%) 50 __ 40 10
Method 1: Direct Allocation Method:
Direct Allocation Method is the most widely used method of allocating support department costs.
It allocates each support department’s costs directly to the operating departments and ignores
any services used by other support departments.
 The benefit of the direct method is simplicity. There is no need to predict the usage of
support department services by other support departments.
 A disadvantage of this method is its failure to recognize reciprocal services provided among
the support departments.
Exhibit 6.1 Direct Method of Cost allocation

S u p p o r t D e p a r tm e n t s P r o d u c t io n D e p a r t m e n ts
I n f o r m a t io n S y s t e m s
M a n u f a c t u r in g
P a c k a g in g
A c c o u n t in g
Based on Direct Method, allocation of the support department costs to operating departments in
the above example will be as follows:
Machining:(5/8) (10,000) + (4/5) (4,000) = Br. 9,450

Assembly:(3/8) (10.000) + (1/5) (4,000) = Br. 4,550
Br. 14,000
Note that the Direct Method simply ignores interdependencies among the service departments,
i.e. the method ignores that material handling consumes 50% of the total power generated.
Method 2: Step–down /Sequential Allocation Method

Step–down /Sequential Allocation Method allows for partial recognition of the services provided
by support departments to other support departments. Under this method, once a support
department costs have been allocated, no subsequent support department costs are allocated
back to it. It does not recognize the total services that support departments provide to each
other. It may result in more reasonable allocations than the direct method because it recognizes
that some service departments use the services of other service departments. However, it does
not recognize reciprocal services. The step method is not necessarily better than the direct
method when both the costs and benefits of using cost allocation are considered. A company that
already uses the direct method may find it uneconomical to switch step-down method.
This method requires the support departments to be ranked (sequenced) in the order that the
step-down allocation is to proceed. Based on an allocation order, the step method allocates
service department costs to other service departments and then to operating departments. Once
an allocation is made from a service department, no further costs are allocated back to that
department. Different sequences will result in different allocations of support department costs
to operating departments.
Exhibit 6.2 Step-Down Cost allocation method

S u p p o r t D e p a r tm e n ts P r o d u c t io n D e p a r tm e n ts
I n fo r m a tio n S y s t e m s
P a c k a g in g
A c c o u n tin g
Two ways to determine the sequence to allocate support department costs are as follows:
Approach A: Rank support departments on the percentage of the support department’s total
support provided to other support departments. The sequence continues with the department
that renders the next- highest percentage and so on, ending with the support department that
renders the lowest percentage.
Approach B: Rank support departments on the total dollars (financial value) of service provided
to other support departments.
Based on Step–down method, allocation of the support department costs to operating

departments in the above example is as follows. Note that each of the two service departments

provides same service to the other service department. Therefore, there is no natural order for
sequentially allocating the service department costs.
Warehousing Power
Department Supply Machining Assembly
----------------------------------------------------------------------------------------------------------
A. Allocate Warehousing
Department first
Overhead costs beforeBr.10, 000 Br.4, 000
Allocation
*Warehousing cost (10,000) 2,000 Br.5,000 Br.3,000
(0.2, 0.5, 0.3)
*Power Supply Cost (6,000) 4,800 1,200
(0.8, 0.2)
Reallocated Costs Br.9,800 Br.4,200
B. Allocate Power
Supply first
Overhead Costs Br.10,000 Br.4,000
*Power Supply cost 2,000 (4,000) Br.1,600 Br. 400
(0.5, 0.4, 0.1)
Warehousing cost (12,000) 7,500 4,500
(0.625, 0.375)
Reallocated Costs Br.9,100 Br.4,900
Method 3: Reciprocal Allocation Method

How support department costs are allocated to operating departments by using reciprocal
allocation method?
Reciprocal Allocation Method allows for the simultaneous allocation of service department costs
to and from all other service departments. It is the method to allocate service department costs
that recognizes all services provided by any support department including the services provided
to other support departments.
Exhibit 6.3 Reciprocal Cost Allocation Method

S u p p o r t D e p a r t m e n t s P r o d u c t i o n D e p a r t m e n t s
I n f o r m a t io n S y s t e m s
P a c k a g in g
A c c o u n t in g

The total cost of service departments to be allocated to operating departments can be

determined as follows:
Complete reciprocated costs of each support department = Direct Costs of the Service
Department + Costs allocated from other Service Departments
It addresses a limitation of the step-down method by making a reciprocal cost allocation when
service departments provide reciprocal services (that is, they provide services to each other).
Both the step method and the direct method might understate the cost of running service
departments. They omit costs of certain services consumed by one service department that were
provided by other service departments. However, these limitations are solved in reciprocal
method and can be implemented by formulating and solving linear equations. These require three
steps.
Step 1: Express Support department Costs and Reciprocal Relationships in Linear equation. This
can be illustrated in the above example as follows
Define X1: Reallocated cost of the Warehousing Dept.
X2: Reallocated cost of the Power Supply Dept.
The reallocated cost of each service department is its basic cost plus its share of the reallocated
cost of the other service department:
Warehousing, X1 = 10,000 + 0.5X2
Power Supply, X2 = 4,000 + 0.2X1
Step 2: Solve the system of simultaneous equations to obtain the complete reciprocated costs of
each support department.
Solving these two simultaneous equations yields:

X1 = 120,000 / 9 = 13,333
X2 = 60,000 / 9 = 6,667
Step 3: Allocate the complete reciprocated costs of each support department to all other
departments (both Support Departments and Operating Departments) on the basis of the usage
percentages (based on total units of Service provided to all departments).
Let’s then allocate these costs to the two production departments using the appropriate
coefficients in the original table.

For the machining department this result is: Z1 = 0.5(13,333) + 0.4(6,667) = 9,333 and
For assembly: Z2 = 0.3(13,333) + 0.1(6,667) = 4,667.
Note that Z1 + Z2 = Br.14, 000.
Note also that this allocation is different from the three allocations obtained using the direct and
step down methods:
6.3.3. Comparison of Support Department Cost Allocation Methods
Do you think that the above three cost allocation methods always give different results? As a
general rule, when service departments provide services to each other, the amount of costs
allocated to operating departments such as production and marketing departments differ under
each method. However, if service departments do not provide services to each other, then all
three methods give identical results. Let’s see the summary results under the three methods.
Method Machining Assembly
Direct Method Br.9, 450 Br.4, 550
Step Down Method: Warehousing first 9,800 4,200
Step Down Method: Power supply first 9,100 4,900
Reciprocal Method 9,333 4,667
Activity 3
Answer the following questions using the information below in space provided.
Nathan Music Store has two service departments, Warehouse and Data Center. Warehouse
Department costs of Br.175, 000 are allocated on the basis of budgeted warehouse-hours. Data
Center Department costs of Br.75, 000 are allocated based on the number of computer log-on
hours. The costs of operating departments Music and Books are Br.125,000 and Br.150,000,
respectively. Data on budgeted warehouse-hours and number of computer log-on hours are as
follows:

Support Departments Production Departments
Warehouse Data Center
Music Books
Department Department
Budgeted costs Br.175,000 Br.75,000 Br.125,000 Br.150,000
Budgeted warehouse-hours NA 250 500 750
Number of computer hours 100 NA 400 500
a. Using the direct method, what amount of Warehouse Department costs will be allocated to
Department Books?
b. Using the direct method, what amount of Data Center Department costs will be allocated to
Department Music?
c. Using the step-down method, what amount of Warehouse Department costs will be allocated
to Department Books?
d. Using the step-down method, what amount of Data Center Department costs will be allocated
to Department Music?
e. Using the reciprocal method, what amount of Warehouse Department costs will be allocated
to Department Books?
f. Using the reciprocal method, what amount of Data Center Department costs will be allocated
to Department Music?

Dear learner, if you understood this unit very well, attempts the following questions.
Choose the best answer among the given alternatives
1. The support department allocation method that is the most widely used because of
its simplicity is the
A. Step-down method D. Sequential allocation method
B. Reciprocal allocation method E. None of the above
C. Direct allocation method
2. The method that allocates costs by explicitly including all the services rendered
among all support departments is
A. The direct method D. The sequential method
B. The step-down method E. None
C. The reciprocal method
3. Under which allocation method are one-way reciprocal support services recognized?
A. The direct method D. The step-down method
B. The artificial cost method E. All
C. The reciprocal method
4. The direct allocation method
A. Partially recognizes the services provided among support departments.
B. Is also referred to as the sequential method
C. Is conceptually the most precise method
D. Results in allocating only the support costs used by operating departments
E. None
5. The step-down allocation method
A. Typically begins with the support department that provides the highest
percentage of its total services to other support departments
B. Recognizes the total amount of services that support departments provide to
each other
C. Allocates complete reciprocated costs
D. Offers key input for outsourcing decisions
E. All
6. The reciprocal allocation method
A. Is the most widely used because of its simplicity
B. Requires the ranking of support departments in the order that the allocation is
to proceed
C. Is conceptually the most precise
D. Results in allocating more support costs to operating departments than actually
incurred.

7. Complete reciprocated costs
A. Are less than the support department’s own costs
B. Include the support department’s costs plus any interdepartmental cost
allocations.
C. Are utilized for step-down allocations
D. Are also referred to as budgeted costs
E. None

Jake’s Battery Company has two service departments, Maintenance and Personnel.
Maintenance Department costs of Br. 160,000 are allocated on the basis of budgeted
maintenance-hours. Personnel Department costs of Br. 40,000 are allocated based on
the number of employees. The costs of operating departments A and B are Br. 80,000
and Br. 120,000, respectively. Data on budgeted maintenance-hours and number of
employees are as follows:
Support Departments Production Departments

Maintenance Personnel
A B
Department Department
Budgeted costs Br. 160,000 Br. 40,000 Br. 80,000 Br. 120,000
Budgeted
NA 400 480 320
maintenance-hours
Number of employees 20 NA 80 240
8. Using the direct method, what amount of Maintenance Department costs will be
allocated to Department B?
A. Br. 48,000 D. Br. 96,000
B. Br. 64,000 E. None
C. Br. 78,000
9. Using the direct method, what amount of Personnel Department costs will be
allocated to Department B?
A. Br. 10,000 D. Br. 30,000
B. Br. 16,000 E. None
C. Br. 24,000
10. Using the step-down method, what amount of Maintenance Department cost will be
allocated to Department B if the service department with the highest percentage of
interdepartmental support service is allocated first? (Round up)
A. Br. 32,000 C. Br. 57,334
B. Br. 42,667 D. Br. 64,000

___________________________________________________________________________________
E. None
11. Costs which are not economically feasible to trace but which are related to a cost
object are known as:
A. fixed costs D. variable costs
B. direct costs E. All of the above
C. indirect costs F. None of the above
12. Any item for which a separate measurement of cost is desired is known as:
A. cost allocation D. an indirect cost
B. a cost object E. all of the above
C. a direct cost F. none of the above
13. All of the following illustrate purposes for allocating costs to cost objects except
to:
A. provide information for economic decisions
B. motivate managers and employees
C. determine a selling price the market will bear
D. measure income and assets for reporting to external parties
E. all of the above F. none of the above
14. When the purpose of cost allocation is to provide information for economic
decisions or to motivate managers and employees, the best criteria are:
A. the cause-and-effect and the ability-to bear criteria
B. the cause-and-effect and the benefits-received criteria
C. the benefits-received and the fairness criteria
D. the fairness and the ability-to-bear criteria
E. all of the above F. None of the above
15. To guide cost allocation decisions, the benefits-received criterion:
A. generally uses the cost driver as the cost allocation base
B. results in subsidizing products that are not profitable
C. is the primarily used criterion in activity-based costing
D. may use an allocation base of division revenues to allocate advertising costs
E. all of the above F. None of the above
16. The method that allocates costs in each cost pool using the same rate per unit is
known as the:
A. incremental cost-allocation method C. single-rate cost allocation method
B. reciprocal cost-allocation method D. dual-rate cost-allocation method
17. Benefits of the dual-rate method include:
A. variable costs that are transformed into fixed costs for user decision making
B. the low cost of implementation
C. avoidance of expensive analysis for categorizing costs as either fixed or variable
___________________________________________________________________________________
D. information that leads to outsourcing decisions that benefit the organization as a whole
18. The support department allocation method that is the most widely used because of
its simplicity is the:
A. step-down method D. sequential allocation method
B. reciprocal allocation method E. all of the above
C. direct allocation method F. None of the above.
19. The method that allocates costs by explicitly including all the services rendered
among all support departments is the:
A. direct method D. sequential method
B. step-down method E. all of the above
C. reciprocal method F. none of the above
20. The step-down allocation method:
A. typically begins with the support department that provides the highest percentage of its
total services to other support departments
B. recognizes the total amount of services that support departments provide to each
other
C. allocates complete reciprocated costs
D. offers key input for outsourcing decisions
Part II: Work Out Questions

1. Addis Ababa University offers high-tech graduate-level programs. Addis Ababa has
two principal operating departments, Engineering and Computer Sciences, and two
support departments, Facility and Technology Maintenance and Enrollment
Services. The base used to allocate facility and technology maintenance is
budgeted total maintenance hours. The base used to allocate enrollment services
is number of credit hours for a department. The Facility and Technology
Maintenance budget is Br.350, 000, while the Enrollment Services budget is Br.950,
000. The following chart summarizes budgeted amounts and allocation-base
amounts used by each department.
Required:
Use the direct method to allocate support costs to each of the two principal
operating departments, Engineering and Computer Sciences. Prepare a schedule
showing the support costs allocated to each department.
Budget Services Provided: (Annually)

___________________________________________________________________________________
Computer F&T Enrollment
Engineering Sciences Maintenance Service
F&T
Maintenance Br.350, 000 2,000 5,000 Zero 1,000
(In hours)
Enrollment
Service Br.950, 000 24,000 36,000 2,000 Zero
(In credit hrs)
2. Addis Ababa University offers high-tech graduate-level programs. Addis Ababa has
two principal operating departments, Engineering and Computer Sciences, and two
support departments, Facility and Technology Maintenance and Enrollment
Services. The base used to allocate facility and technology maintenance is
budgeted total maintenance hours. The base used to allocate enrollment services
is number of credit hours for a department. The Facility and Technology
Maintenance budget is Br.350, 000, while the Enrollment Services budget is Br.950,
000. The following chart summarizes budgeted amounts and allocation-base
amounts used by each department.
Services Provided: (Annually)

Computer F&T Enrollment
Budget Engineering Sciences Maintenance Service
Engineering Br.3, 500,000
Computer
Br.1, 400,000
Sciences
F&T
Maintenance Br.350, 000 2,000 1,000 Zero 5,000
(In hours)
Enrollment
Service Br.950, 000 24,000 36,000 2,000 Zero
(In credit hrs)
Required:
a. Set up algebraic equations in linear equation form for each activity.
b. Determine total costs for each department by solving the equations from
part (a) using the reciprocal method.
(Engineering= Eng; Computer Sciences = CS; Facility and Technical
Maintenance = FTM; Enrollment Service = ES)

___________________________________________________________________________________
Activities
Activity 1
1. True 3. False 5. True
2. True 4. True
Activity 2
1. False 3. True
2. False 4. False
Activity 3
a. Br.105,000, Explanation: 750 / (500 + 750) × Br.175,000 =Br. 105,000
b. Br.33,333, Explanation: 400 / (400 + 500) × Br.75,000 = Br.33,333
c. Br.0 Explanation: Warehouse provided to Data Center: 250 / (250 + 500 + 750) = .167. Data
Center provided to Warehouse: 100 / (100 + 400 + 500) = .100. Warehouse provides the
greatest amount of service to support departments, so it is allocated first. Therefore, there
will be no cost from the Data Center allocated to the Warehouse department.
d. Br.58,333. Explanation: A) Warehouse provided to Data Center: 250 / (250 + 500 + 750) =
.167 Data Center provided to Warehouse: 100 / (100 + 400 + 500) = .100. Warehouse
provides the greatest amount of service to support departments, so it is allocated first.
Dept Music: 500 / (250 + 500 + 750) × Br.175,000 = Br.58,333
1. C 8. B 15. D
2. C 9. D 16. C
3. D 10. B 17. D
4. D 11. C 18. C
5. A 12. B 19. C
6. C 13. C 20. A
7. B 14. B

___________________________________________________________________________________
Unit 7
Cost Allocation: Joint Products and Byproducts
1. Differentiate between joint products and byproducts;

2. Allocate joint product costs according to the benefits-received approaches;
3. Allocate joint product costs according to the relative market value approaches;
4. Apply methods of accounting for by-products;
5. Apply the methods of accounting for by-products;
7.1. Nature of Joint Products and Byproducts
What do you know about joint products and byproducts? Consider a single process that a yields
two or more products (or services) simultaneously. The distillation of coal, for example, which
yields coke, natural gas, and other products. In this example, the cost of the distillation process
would be called a joint cost.
Exhibit 7.1 Joint Cost Allocation Model
Various terms have been arisen in conjunction with a joint production process as described below.
Joint cost is the cost of a single process that yields multiple products simultaneously.
Split-off point is the juncture in a joint production process when two or more products become
separately identifiable. An example is the point at which coal becomes coke, natural gas, and

___________________________________________________________________________________
other products. At or beyond the split off point, decisions relating to sale or further processing of
each identifiable product can be made independently of decisions about the other products.
Separable Costs are all costs of manufacturing, marketing, distribution, and so on incurred beyond
the split-off point that are assignable to each of the specific products identified at the split-off
point.
Product is any output that has a positive sales value or an output that enables an organization to
avoid incurring costs.
Joint products- When a joint production process yields two or more products with high sales value
compared with the sales values of the other products, those products are called joint products.
But they are not separately identifiable as individual products until the split off point. They are
produced as a direct result of the strategic planning process of the company. These products are
considered to be of major importance to the company and, therefore, represent a significant
focus for management, accounting, and financial reporting. The accounting allocation methods
are discussed later in this paper.
Main product - When a single process yields only one product with a relatively high sales value,
that product is termed as a main product.
Byproduct has a low sales value compared with the sales value of the main or joint product(s).
Byproducts emerge from a common process along with primary products but are not considered
to be important or valuable enough to be a major focus of management.
Scrap has a minimal sales value. It is on the other part is the waste or the residual pieces / parts of
the material used in the production process. It is the material left over when making a product and
has low sales value compared with the sales value of the product. Examples are short lengths
from woodworking operations, edges from plastic modeling operations, and frayed cloth and end
cuts from suit-making operations. Scrap has no cost and hence it can be considered as revenue
that should reduce the cost of either a specific job or the manufacturing overhead in common
when sold.
7.2. Purposes of Allocating Joint Cots
Why allocate joint costs? There are many contexts that require the allocation of joint costs to
individual products or services. The six areas mentioned below are illustrative rather than
exhaustive. Examples include:
1. Inventory costing and cost of goods sold computations for external financial statements and
reports for income tax authorities.

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2. Inventory costing and cost of goods sold computations for internal financial reporting. Such
reports are used in division profitability analysis when determining compensation for division
managers.
3. Cost reimbursement under contracts when only a portion of a business’s products or
services is sod or delivered to a single customer( such as government agency).
4. Customer profitability analysis where individual customers purchase varying combinations of
joint products or byproducts as well as other products of the company.
5. Insurance settlement computations when damage claims made by businesses when joint
products, main products, or byproducts are based on cost information.
6. Rate regulation when one or more of the jointly produced products or services are subject to
price regulation.
Activity 1
From the lists that follow, select the term that best completes each statement and write it in the
space provided.
Separable Costs Joint products Joint Cost

Byproduct Split-off point Scrap
1. __________________ is where the joint products become separate and identifiable.
2. __________________is the material left over when making a product and has low sales value
compared with the sales value of the product
3. __________________is the cost of a single process that yields multiple products
simultaneously.
4. __________________ has a relatively low sales value compared with the sales value of a joint
or main product. Some outputs of the joint production process have zero sales value.
5. ___________________are assignable after the split off point and include manufacturing,
marketing, distribution, and other costs.
7.3. Approaches to Allocating Joint Costs
How do you allocate joint costs? There are two basic approaches of allocating joint costs:
Approach 1: Allocate joint costs using physical measure data such as weight or volume
of the joint products. The typical method under this approach is discussed below.

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Method 1: Physical Measure Method
How joint costs are allocated by using Physical Measure Method? This method allocates joint costs
to joint products on the basis of the relative weight, volume, or other physical measure at the split
off point of the total production of each product. Under the benefits received criterion, the
physical-measure method is less preferred than the sales value at split-off method because it has
no relationship to the revenue producing power of the individual products. Computationally, the
physical units’ method allocates to each joint product the same proportion of joint costs. In order
to illustrate this method, assume the following data.
In order to illustrate these methods, let’s take the following data. Assume that ND Engineering
Wood Workshop processes logs into four types of lumber totaling 3,000,000 feet at a joint cost of
Br.186, 000.
Type A B C D Total
Feet 450,000 1,200,000 600,000 750,000 3,000,000
First, we find the proportion of each type of the total units. Then assign joint cost to each type
based on its proportion of joint costs.
Details A B C D Total
Production Units(feet) 450,000 1,200,000 600,000 750,000 3,000,000
Weighting/Ratio 15% 40% 20% 25% 100%
Joint cost allocated Br.27,900 Br.74,400 Br.37,200 Br.46,500 Br.186,000
(15%,40%,20%,25%) *Br.186,000
Joint product cost per unit Br.0.062 0.062 0.062 0.062
(Joint cost allocated /
Production units)
Activity 2
Geo Chemicals processes raw material into three products: A, B & C. During May, the joint costs
of processing were Br.240, 000. Production and sales information for the month is as follows:
Product Units Produced Sales Value at Split off Point
Product A 6,000 liters Br.60,000
Product B 6,000 liters 50,000
Product C 3,000 liters 25,000
Required: Determine the amount of joint cost allocated to each product if the physical-measure
method is used.

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Approach 2: Allocate joint costs using market-based data such as revenues. There are
three methods under this approach and include Sales Value at Split off Method, Net Realizable
Value (NRV) Method, Constant Gross Margin Percentage NRV Method.
In order to illustrate these methods, let’s take the following data. Assume that Family Milk
Processing Factory buys raw milk from local market and processes it until split off. Two products,
namely Cream and Liquid skim are produced from the process and are sold to customers.
Summary data for December 2009

Raw milk processed – 110,000 gallons: 10,000 gallons are lost in the production process. The
process results in 25,000 gallons of cream and 75,000 gallons of liquid skim. 20,000 gallons of
cream are sold at Br.8 per gallon and 30,000 gallons of liquid skim are sold at Br.4 per gallon.
Inventory (ending) of cream is 5,000 gallons and of liquid skim is 45,000 gallons. Cost of
purchasing 110,000 gallons of raw milk and processing it until the split off point is Br. 400,000.
Method 2: Sales Value at Split off Method
How joint costs are allocated by using Sales Value at Split off Method? This method allocates joint
costs to joint products on the basis of the relative total sales value at the split-off point of the total
production of these products during the accounting period. It uses the sales value of the entire
production of the accounting period. The reason is that the joint costs were incurred on all units
produced, not just the portion sold during the current period.
It is clear that this method follows the benefits-received criterion of cost allocation (costs are
allocated to products in proportion to their expected revenues). As such this method is simple,
straightforward, and intuitive. To apply this method, a company needs the market selling prices
for all products at the split-off point. This method considers market factors by recognizing that
joint or primary products produced from a joint or common process have different values.
Consequently, joint products with higher sales value are allocated relatively more joint cost than
joint products with lower sales values. The value at split-off point method takes into consideration
market factors when valuing the various joint or primary products produced from a common or
joint process. In some cases, one or more of the joint (primary) products produced may not be
salable at the split-off point but must be processed further before a sales value is available.
Using the value at split-off point method, we can substitute the estimated sales value for the
actual sales value at split-off point. The estimated sales value at split-off point is found by
computing the total sales value of a joint (primary) product at the point closest to the split-off
point and then subtracting the appropriate further processing cost from this total. This modified

___________________________________________________________________________________
approach accommodates situations where sales values are not available at the split-off point.
However it does not properly recognize the value added by the further processing cost.
The greater the further processing cost is for a joint (primary) product, the more the final selling
price is a result of that further processing cost. The result is that the estimated value at the split-
off point, for those products that have significant further processing costs, is overstated by the
gross profit associated with the further process cost. This weakness can be overcome by using the
net estimated total sales value at the split-off point. This is computed by subtracting both the
further cost and the gross profit associated with the further processing cost from the sales value
closest to the split-off point. The allocation of joint cost under this method is as follows:
Details Cream Liquid Skim Total

Sales value of production at split off point Br.200,000 Br.300,000 Br.500,000
(25,000 x Br.8; 75,000 x Br. 4)
200000 300000 40% 60%
Weighting ( 500000 , 500000 )
Joint cost allocated (40% x Br.400,000; 60% x 160,000 240,000 400,000
Br.400,000)
Joint product cost per gallon Br.6.40 Br.3.20
160000 240000
( 25000 , 75000 )
The calculation of gross margin is as follows:
Details Cream Liquid Skim Total

Revenue (20,000 x Br. 8, 30,000 x Br. 4) Br.160,000 120,000 280,000
Cost of goods sold (joint costs) Production 160,000 240,000 400,000
Cost (40% of Br.400,000 and 60% of Br.400,
000)
Deduct: Ending inventory (5,000 x Br.6.40, 32,000 144,000 176,000
45,000 x Br.3.20)
Cost of goods sold 128,000 96,000 224,000
Gross Margin 32,000 24,000 56,000
Gross Margin Percentage 20% 20% 20%

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Method 3: Net Realizable Value (NRV) Method
How joint costs are allocated by using Net Realizable Value (NRV) Method? This method allocates
joint costs to joint products on the basis of the relative NRV (the expected sales value in the
ordinary course of business minus the expected separable costs) of the total production of the joint
products during the accounting period. This method is typically used in preference to the sales
value at the split-off method only when we don’t know the market selling prices for one or more
products at split-off. Products may be processed beyond the split-off point in many cases to bring
these products to a marketable form or to increase their value above their selling price at the split-
off point. The net realizable value (NRV) method allocates joint costs to joint production on the
basis of the relative NRV (The final sales value minus the separable costs) of the total production
of the joint products during the accounting period. Thus, it requires the information about the
subsequent processing steps to be taken (and their expected separable costs).
This method is typically used in preference to sales value at split-off method only when we do not
know the market selling prices for one or more products at split-off. The NRV method is often
implemented using simplifying assumptions. Thus if the selling prices of joint products vary
frequently, a given set of selling prices may be consistently used throughout the accounting
period. Since the sales value at split-off point method does not require knowledge of the
processing steps beyond the split-off point, it is less complex than the NRV method simply
because market prices may only be available after processing occurs beyond the split-off point.
In order to illustrate this method, assume the following in the above data: Cream and Liquid
Skims are processed further.
 Cream is further processed and converted into Butter Cream: 25,000 gallons of Cream are
further processed to yield 20,000 gallons of Butter Cream at an additional cost of Br.280,
000. Butter cream is sold @ Br. 25 per gallon.
 Liquid Skim is further processed and converted into Condensed Milk: 75,000 gallons of
Liquid Skim are further processed to yield 50,000 gallons of Condensed Milk at additional
processing cost of Br.520, 000. Condensed Milk sells for Br.22 per gallon.
 12,000 gallons of Butter Cream and 45,000 gallons of Condensed Milk are sold. 8,000 gallons
of Butter Cream and 5,000 gallons of Condensed Milk are on the ending inventory.
The NRV method allocates joint costs on the basis of the relative NRV-the final sales value minus
the separable costs of the total production. The allocation of joint cost under this method is as
follows:

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Details Butter Cream Condensed Milk Total

Final sales value of total production Br.500,000 Br.1,100,000 Br.1,600,000
(20,000 x Br. 25; 50,000 x Br. 22)
Deduct: separable costs to complete 280,000 520,000 800,000
and sell
Net Realizable Value at Split off 220,000 580,000 800,000
220000 580000
Weighting 800000 ; 800000  27.5% 72.5% 100%
Joint costs allocated (27.5% x 110,000 290,000 400,000

Br.400,000; 72.5% x Br.400,000)
Prod. Cost per gallon Br.19.5/g Br.16.2/g
110000 280000 290000520000
20000gallons
; 50000
Product line income statement can be prepared as follows.
Details Butter Cream Condensed Milk Total

Revenue (12,000x Br. 25; 45,000 x 300,000 990,000 1,290,000
Br.22)
Cost of goods sold
Joint costs (27.5%x Br.400,000; 72.5%x 110,000 290,000 400,000
Br.400, 000)
Separable Costs. 280,000 520,000 800,000
Cost of goods available for sale 390,000 810,000 1,200,000
Deduct: ending inventory (8,000 156,000 81,000 237,000
xBr.19.5; 5,000 x Br.16.2)
Cost of goods sold 234,000 729,000 963,000
Gross Margin 66,000 261,000 327,000
Gross Margin Percentage 22% 26.4% 25.3%
Method 4: Constant Gross Margin Percentage NRV Method
How joint costs are allocated by using Constant Gross Margin Percentage NRV Method? This
method allocates joint costs to joint products in such a way that the overall gross-margin
percentage is identical for the individual products. The constant gross-margin percentage NRV
method takes account of profits earned either before or after the split-off point when allocating
the joint costs unlike the sale value at split-off method and the NRV methods. It entails three
steps.

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Step 1: Compute the overall gross margin percentage for all joint products together.
Sales value of total production (20000 x 25) + (50000 x 22)…..................Br.1, 600.000
Deduct: joint and separable costs (400000 + 280000 + 520000)……………1,200,000
Gross Margin……..………………………………………….………………..…400,000
400000
Gross Margin Percentage 1600000 ………………………………………..…….. 25%
Step 2: Compute gross margin percentage for each product. The gross margin of each product is
then subtracted to obtain the total costs of each product.
Step 3: Deduct the separable costs from the total costs that each product will bear to obtain the
joint cost allocated. The joint cost allocated to a product can be negative under this method.
Details Butter Condensed Total
cream Milk
Final sales value of total production (20,000 x Br. Br.500,000 Br.1,100,000 Br.1,600,000
25; 50,000 x Br. 22)
Less: gross margin (25%) 125,000 275,000 825,000
Less: Separable cost to obtain the joint cost 280,000 520,000 800,000
Joint costs allocated 95,000 305,000 400,000
375000 825000 Br.18.75 16.5
;
Cost per unit ( 20000 50000 )
Product line income statement can be prepared as follows.
Details Butter Cream Condensed Total

Milk
Revenue(12,000xBr.25;45,000x Br. 22) Br.300,000 Br.990,000 Br.1,290,000
Deduct: Cost of goods sold
Joint costs 95,000 305,000 400,000
Separable Costs. 280,000 520,000 800,000
Deduct ending inventory (8,000 x 150,000 82,500 232,500
Br.18.75; 5,000 x Br.16.5)
Cost of goods sold 225000 742500 967500
Gross Margin 75000 247500 322500
Gross Margin percentage 25% 25% 25%

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Activity 3
FC Plc processes a single material into three separate products A, B, and C. During Sep., the joint
costs of processing were Br.600,000. Production & sales value for the month were as follows:
Product Units Produced Final Sales Value per Unit Separable Costs
A 20,000 Br.25 Br.250,000
B 30,000 30 500,000
C 25,000 24 250,000
Required: Determine the amount of joint cost allocated to each product if the constant gross-
margin percentage NRV method is used.
7.4. Comparison of Joint Cost Allocation Methods
Which method is preferred? Why? The sales value at split-off point method is the most reliable
method if it is available for some reasons:
1. It has a meaningful basis for joint cost allocation which is revenues.
2. The sales value at split-off method is straight forward and simple to apply.
3. It measures the value of the joint product immediately at the end of the joint process.
4. This method does not require information on the processing steps after split-off point, if
there is further processing.
The NRV method assumes that all markup or profit margin is attributable to the joint process not
to the separable costs. NRV can be used when selling prices at split-off are not available. Thus this
method tries to approximate the sales value at split-off point by subtracting separable costs
incurred after the split-off point on each product from selling prices.
The constant gross-margin percentage method is easy to implement. This method avoids the
complexities in NRV method since it assumes that all products have the same ratio of cost to sales
value.
The physical measures method can be used in rate regulation. However there are difficulties in
using this method for other decisions.
7.5. Accounting for Byproducts
Can you differentiae byproducts from joint products? As we discussed in the earlier section, when
a joint production process yields two or more products with high sales value compared with the

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sales values of the other products, those products are called joint products. A byproduct has a
low sales value compared with the sales value of the main or joint product(s). Two methods for
accounting for byproducts can be applied as follows.
Method 1: The Production Method
How byproducts are accounted by using production method? This method recognizes by products
in the financial statements at the time production is completed. Recognition of byproducts at the
time of production is conceptually correct.
Method 2: Sales Method
How byproducts are accounted by using sales method? Under this method, the net realizable value
(NRV) of the byproduct produced is offset against the costs of the main product. The sales
method delays recognition of byproducts until the time of sale. The recognition at the time of
sales occurs in practice, it is usually rationalized on the grounds that the dollar amounts of by
products are immaterial.
Let’s see how to account for by products based on this illustration. Assume that Green view oil
mill produces oil and oil cake. Oil is the main product but oil cake is the byproduct. The selling
prices of those products are Br. 60 per kg and Br. 4 per kg respectively. Further details are as
follows for the month ended May 2009.
Details Production Sales Beg. Inv. End. Inv.

Oil 5,000 4,000 0 1,000
Oil Cake 1,000 300 0 700
The Joint manufacturing costs of these products in May were Br.250, 000, comprising Br.150, 000
for direct materials and Br.100, 000 for conversion costs. Both are sold at split off point.

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Green View oil mill
Income Statement
For the month ended May 31, 2009
Method 1 Method 2
On Production On Sale
Revenue:
Oil: 4,000 x Br.60 = Br. 240,000 Br.240,000 Br.240,000
Oil Cake: 300 x Br. 4 = 1,200 - 1,200
Total Revenue 240,000 241,200
Less: Cost of goods sold
Total Mfg costs 250,000 250,000
Deduct: Byproduct revenue (1,000 xBr.4) 4,000 -
Net Mfg cost 246,000 250,000
Deduct main product inventory 49,200 50,000
COGS 196,800 200,000
Gross Margin 43,200 41,200
Gross Margin Percentage 18% 17.08%
Inventoriable Costs
Main Product 49,200 50,000
Byproduct (700xbR.4) 2 ,800 -
Note: 1. Main product ending inventory (under Method 1) =

Net mfg cost = Br.250, 000 – Br.4, 000 =Br. 246,000
1000
Br.246, 000 x 5000 = Br.49, 200
2. Main product ending inventory (under Method 2) =
1000
Net mfg cost = Br.250000 x 5000 = Br.50, 000
3. Inventoriable cost of byproduct is at selling price.
Activity 4
Answer the following question in the space provided.
Harland Company prepares lumber for companies which manufacture furniture. The main product
is finished lumber with a byproduct of wood shavings. The byproduct is sold to plywood
manufacturers. For July, the manufacturing process incurred Br.332, 000 in total costs. Eighty
thousand board feet of lumber were produced and sold along with 6,800 pounds of shavings. The
finished lumber sold for Br.6.00 per board foot and the shavings sold for Br.0.60 a pound. There
was no beginning or ending inventories. Required: Prepare an income statement showing the
byproduct (1) as a cost reduction during production, and (2) as a revenue item when sold.

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Dear learner, if you understood this unit very well, attempts the following questions.
1. What type of cost is the result of an event that results in more than one product or
service simultaneously?
A. Byproduct cost D. Separable cost
B. Joint cost E. None of the above
C. Main cost
2. All costs incurred beyond the split off point that are assignable to one or more
individual products are called
A. Byproduct costs D. Separable costs
B. Joint costs E. All of the above
C. Main costs
3. When a single manufacturing process yields two products, one of which has a
relatively high sales value compared to the other, the two products are respectively
known as
A. Joint products and byproducts D. Main products and joint products
B. Joint products and scrap E. All of the above
C. Main products and byproducts
4. Byproducts and main products are differentiated by
A. Number of units per processing period
B. Weight or volume of outputs per period
C. The amount of sales value per unit
D. None of the above
5. The Arid Corporation manufactures widgets, gizmos, and turbots from a joint
process. May production is 4,000 widgets; 7,000 gizmos; and 8,000 turbots.
Respective per unit selling prices at split off are Br.15, Br.10, and Br.5. Joint costs up
to the split off point are Br.75, 000. If joint costs are allocated based upon the sales
value at split off, what amount of joint costs will be allocated to the widgets?
A. Br.30, 882 D. Br.28, 125
C. Br.17, 647
6. Product X is sold for Br.8 a unit and Product Y is sold for Br.12 a unit. Each product
can also be sold at the split off point. Product X can be sold for Br.5 and Product Y
for Br.4. Joint costs for the two products totaled Br.4, 000 for January for 600 units
of X and 500 units of Y. What are the respective joint costs assigned each unit of
products X and Y if the sales value at split off method is used?
A. Br.2.96 and Br.4.44 B. Br.4.00 and Br.4.55

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C. Br.4.00 and Br.3.20 E. None of the above
D. Br.4.55 and Br.4.55
7. A reason why a physical-measure to allocate joint costs is less preferred than the
sales value at split off is
A. A physical measure such as volume is difficult to estimate because of shrinkage
B. Physical volume usually has little relationship to the revenue producing power of
products
C. A physical measure usually results in the costs being allocated to the product
that weighs the most.
D. All of the above are reasons why the sales value at split off method is preferred
to a physical volume measure
E. All of the above

The Oxnard Corporation processes a liquid component up to the split off point where
two products, Mr. Dirt Out and Mr. Sink Clean, are produced and sold. The following
material was collected for the month of January. There was no beginning inventory.
Direct materials processed: 250,000 gallons (242,500 gallons of good
product)
Production: Mr. Dirt out 147,500 gallons
Mr. Sink Clean 95,000 gallons
Sales: Mr. Dirt out 140,500 at Br.110 per gallon
Mr. Sink Clean 91,000 at Br. 100 per gallon
The cost of purchasing 250,000 gallons of direct materials and processing it up to the
split off point to yield a total of 242,500 gallons of good product was Br.380, 000.
8. What are the physical-volume proportions to allocate joint costs for Mr. Dirt Out
and Mr. Sink Clean, respectively?
A. 59.00% and 41.00% D. 59.79% and 40.21%
B. 60.82% and 39.18% E. None of the above
C. 39.18% and 60.82%
9. When using a physical-volume measure, what is the approximate amount of joint
costs that will be allocated to Mr. Dirt Out and Mr. Sink Clean?
A. Br.231, 116 and Br.148, 884 D. Br.230, 626 and Br.149, 374
B. Br.224, 200 and Br.155, 800 F. None of the above
C. Br.227, 202 and Br.152, 798
10. When using the physical-volume method, what is Mr. Dirt Out’s approximate
production cost per unit?
A. Br.1.52 B. Br.1.54

C. Br.1.57 E. None of the above

D. Br.1.61
11. All costs incurred beyond the split off point that is assignable to one or more
individual products are called:
A. Byproduct costs D. Separable costs.
B. Joint costs E. All of the above.
C. Main costs F. None of the above
12. When a single manufacturing process yields two products, one of which has a
relatively high sales value compared to the other, the two products are respectively
known as:
A. Joint products and byproducts D. Main products and joint products
B. Joint products and scrap E. All of the above.
C. Main products and byproducts F. None of the above
13. Which of the following costs of a joint process would be allocated to the joint
products?
A. Labor and overhead only C. Materials and labor only
B. Materials, labor, and overhead D. Prime costs less by-product values
E. Conversion costs less by-product values
14. Which of the following is a true statement regarding joint costs?
A. Joint costs are easily traced to individual products.
B. The primary reason for allocating joint costs is to determine whether a product should be
sold immediately or processed further.
C. The primary reason for allocating joint costs is for inventory valuation for financial
reporting.
D. Joint costs consist only of overhead, never of materials or direct labor.
E. All of the above. F. None of the above.
15. The joint cost allocation method that yields the same gross margin percentage for
each product is the:
A. Net realizable value method. B. Sales-to-production-ratio method
C. .Physical units’ method.
D. Constant gross margin percentage method.
E. Sales-value-at-split-off method. F. None of the above
16. Which of the following is not a primary reason for allocating joint costs?
A. Cost justification and insurance settlement cost information requirements
B. Cost justification and asset measurement
C. Income measurement and rate regulation requirements
D. To calculate the bonus of the chief executive officer


17. The secondary product recovered in the course of manufacturing a primary product
during a joint process is:
A. A by-product
B. A joint product
C. A replacement product
D. A split-off product
E. All of the above
18. The joint cost allocation method that assigns joint production costs based on the proportionate
share of eventual revenues less further processing costs is the:
A. Sales-to-production-ratio method.
B. Net realizable value method.
C. Physical units’ method.
D. Sales-value-at-split-off method.
E. Constant gross margin percentage method.
19. The physical-measure method:
A. Allocates joint costs to joint products in a way that each product has an identical gross-
margin percentage
B. Allocates joint costs to joint products on the basis of a comparable physical measure at
the split off point
C. Allocates joint costs to joint products on the basis of the relative sales value at the split
off point
D. Allocates joint costs to joint products on the basis of relative NRV
E. All of the above
20. Which method of accounting recognizes byproducts in the financial statements at
the time their production is completed?
A. Production allocation method D. Physical units’ method.
B. Sale method E. All of the above
C. Production method F. None of the above.
Part II: Workout Questions
Exercise-1
Sugar Cane Company processes sugar beets into three products. During April, the joint
costs of processing were Br.120, 000. Production and sales value information for the
month were as follows:

Sales Value at
Product Units Produced Split off Point Separable costs
Sugar 6,000 40,000 12,000
Sugar Syrup 4,000 35,000 32,000
Fructose Syrup 2,000 25,000 16,000
Required: Determine the amount of joint cost allocated to each product if the sales
value at split off method is used.
Exercise-2
Oregon Lumber processes timber into four products. During January, the joint costs of
processing were Br.280,000. There was no inventory at the beginning of the month.
Production and sales value information for the month were as follows:
Sales Value at
Product Board feet Splitoff Point Ending Inventory
2 x 4's 6,000,000 Br.0.30 per board foot 500,000 bdft.
2 x 6's 3,000,000 0.40 per board foot 250,000 bdft.
4 x 4's 2,000,000 0.45 per board foot 100,000 bdft.
Slabs 1,000,000 0.10 per board foot 50,000 bdft.
Required: Determine the value of ending inventory if the sales value at split off
method is used for product costing. (Round to 3 decimal places when necessary)

Activities
Activity 1
1. Split-off point 4. Byproduct
2. Scrap 5. Separable Costs
3. Joint cost
Activity 2
Product Units Produced Percentage Joint Costs Allocated
Product A 6,000 liters 40 × Br.240,000 Br.96,000
Product B 6,000 liters 40 × 240,000 96,000
Product B 3,000 liters 20 × 240,000 48,000
Totals 15,000 100 Br.240,000

Activity 3
The gross margin percentage is 20% (Br.2, 000,000-Br.1,600,000)/Br.2,000,000
Final Sales Less Gross Total Production Less Separable Joint Costs
Product Value Margin Costs Costs Allocated
Br.
A Br. 500,000 Br.100,000 Br. 400,000 Br. 250,000 150,000
B 900,000 180,000 720,000 500,000 220,000
C 600,000 120,000 480,000 250,000 230,000
Total 2,000,000 400,000 1,600,000 Br.1,000,000 600,000
Activity 4
Answer: Cost reduction when produced Revenue when sold
Sales: Lumber Br.480,000 Br.480,000
Shavings 4,080
Total Sales: Br.480,000 484,080
Cost of Goods Sold:
Total manufacturing
costs Br.332,000 Br.332,000
Byproduct 4,080 0
Total COGS 327,920 332,000
Gross Margin Br.152,080 Br.152,080

1. B 6. C 11. D 16. D
2. D 7. D 12. C 17. A
3. C 8. B 13. B 18. B
4. C 9. A 14. C 19. B
5. B 10. B 15. D 20. C

Text Books
1. Horngren, Foster, &Datar. Cost Accounting: A Managerial Emphasis. 9th Ed & above.
2. Horngren, Sunden& Stratton. Introduction to Management Accounting. 11th Ed & above.
Reference Books
1. C.T Homgren, Introduction to Management Accounting 4th to 8th editions, 1999 USA
2. C.T. Homgren, Cost Accounting: A Managerial Emphasis 5th to 8th ecitionsprentice Hall Inc.
1982 to 1994
3. Homgren, foster, &Datar, Cost Accounting A Managerial Emphasis. 10 thEcition
4. L.E. Heitger Managerial Accounting 1th and 2 nd editions, McGraw Hill , 1998, India
5. GetuJemaneh, Management Accounting 1996.
6. Ray H.Garrison, Managerial Accounting. 6th edition
7. Caluinengler, Managerial Accounting 2nd edition
8. L. Gayle Rayburn Principles of cost Accounting using a cost Management Approach 4th
edition Richard DIR WIN Inc. 1989.
9. Robert X. Kaplan Advanced Management Accounting 1st and 2nd edition prentice Haill,
Inc, 1982 and 1989 (Chapters 2, 11,12, and 13 only)
10. Any book with title Cost Accounting, Managerial Accounting.
Grading Scale
Raw Mark Corresponding Fixed Corresponding Letter Remark
Interval-100% Number Grade grade
[90, 100] 4.0 A+
[83, 90) 4.0 A
[80, 83) 3.75 A-
[75, 80) 3.5 B+
[68, 75) 3.0 B
[65, 68) 2.75 B-
[60, 65) 2.5 C+
[50, 60) 2.0 C
[45,50) 1.75 C-
[40, 45) 1.0 D
[30, 40) 0 Fx
[0, 30) 0 F

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Cost and Management Accounting-I

At the end of this unit lesson, you will be able to:

1. Explain the role of accounting in decision making;

1.1. Basics of Accounting

1.2. The Management Process and Accounting

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1.3. Essentials of Accounting System

An accounting system consists of people, procedures and information technology. It may be

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1. Scorekeeping: Am I doing well or poorly? Scorekeeping is the accumulation and

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1.4. Management Accounting, Financial Accounting and Cost Accounting

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Exhibit 1.1 Comparison of Management Accounting and Financial Accounting

Financial Accounting is the process of identifying, measuring, recording, analyzing, summarizing

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Criteria Cost Accounting Management Accounting

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1.5. The Position of Management Accounting in the Organization

What is the position of management accounting in an organization? To assist other managers in

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Exhibit 1.3 Typical Organizational Structure and the Management Accountant

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Exhibit 1. 4 Structure of Accounting Function in atypical Organization

Chief Financial Officer (CFO)

Controller Functions Treasurer Functions

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1.7. Standards of Ethical Conduct for Management Accountants

Is there any code of conduct to be adhered by management accountants? Practitioners of

IMA STATEMENT OF ETHICAL PROFESSIONAL PRACTICE

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1.8. Resolution of Ethical Conflicts

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Self Assessment Question-1

Part I: Multiple Choice Questions

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Financial accounting, by contrast, provides information to external decision makers such as

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Part I: Multiple Choice Questions

Part II: Discussion Questions

Operational Area Low Price Strategy Differential Strategy

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At the end of this unit lesson, you will be able to:

2.1. Cost Concepts

Can you differentiate expense, loss and asset from cost?

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How do you classify costs? Why is it needed?

A. Classification of Costs: By Function

What is the functional classification of costs? In manufacturing organizations, costs are

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Manufacturing Non manufacturing

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