Chapter 1

Introduction to Cost Accounting

Learning Objectives

LO1 Explain the uses of cost accounting

data.

LO2 Describe the ethical responsibilities

and certification requirements for

management accountants.

LO3 Describe the relationship of cost

accounting to financial and

managerial accounting.

Learning Objectives

LO4 Identify the three basic elements of

manufacturing costs.

LO5 Illustrate basic cost accounting

procedures.

LO6 Distinguish between the two basic

types of cost accounting systems.

LO7 Illustrate a job order cost system.

The Need for Cost

Accounting

Cost accounting provides the detailed cost

data that management needs to control current

operations and plan for the future.

Companies must control costs in order to keep

prices competitive.

In today’s global environment, cost information

is more crucial than ever in remaining

competitive.

Types of Businesses That

Use Cost Accounting

Manufacturers (Ford, General Motors)

Merchandisers (WalMart, Kmart)

Wholesalers (Beverage Distributors)

For-profit Service Businesses (CPAs,

Attorneys)

Not-for-profit Service Agencies (United

Way, Red Cross)

The Manufacturing

Process

This process involves the conversion of

direct (raw) materials, direct labor, and

factory overhead into finished goods.

Product quality is an important competitive

weapon in manufacturing.

Many companies require their suppliers to

be ISO 9000 certified.

ISO 9000 Certification

The International Organization for Standardization created a set of five international standards for quality management, ISO 9000-9004.

These standards require that manufacturers have a well-defined quality control system and they consistently maintain a high level of quality.

Determining Product

Costs and Pricing

Cost accounting is used to determine

products costs and help with marketing

decisions.

1. Determining the selling price of a

product.

2. Meeting competition.

3. Bidding on contracts.

4. Analyzing profitability.

Planning and Control

Planning is the process of establishing objectives or goals for the firm and determining the means by which the firm will attain them. Effective planning is facilitated by the following:

1. Clearly defined objectives of the manufacturing operation.

2. A production plan that will assist and guide the company in reaching its objectives.

Planning and Control

(cont.)

Control is the process of monitoring the

company’s operations and determining

whether the objectives identified in the

planning process are being accomplished.

Effective control is achieved through the

following:

1. Assigning responsibility.

2. Periodically measuring and comparing

results.

3. Taking necessary corrective action.

Responsibility Accounting

Responsibility accounting is the assignment

of accountability for costs or production results

to those individuals who have the most

authority to influence them.

A cost center is a unit of activity within the

factory to which costs may be practically and

equitably assigned. The manager of a cost

center is responsible for those costs that the

manager controls.

Reporting

Cost and production reports for a cost center reflect all cost and production data identified with that center.

The performance report will include only those costs and production data that the center’s manager can control.

A variance is the favorable or unfavorabledifference between actual costs and budgeted costs.

Performance Report

Example

Renaldi’s Restaurant

Performance Report

September 30, 2006

Budgeted Actual Variance

Expense September Year-to-Date September Year-to-Date September Year-to-Date

Kitchen Wages $5,500 $47,000 $5,200 $46,100 $300 F $900 F

Food 17,700 155,300 18,300 157,600 600 U 2,300 U

Supplies 3,300 27,900 3,700 29,100 400 U 1,200 U

Utilities 1,850 15,350 1,730 16,200 120 F 850 U

Total $28,350 $245,550 $28,930 $249,000 $580 U $3,450 U

F = Favorable

U = Unfavorable

Management Accounting

The Institute of Management Accountants (IMA) is the largest organization of accountants in industry. The Certified Management Accountant (CMA) is comparable to the Certified Public Accountant (CPA) for public accountants.

For more information, please visit the IMA’s website at www.imanet.org

Cost Accounting vs.

Financial and Managerial

Accounting

Characteristics Financial Accounting Managerial Accounting

Users: •External Parties

•Managers Managers

Focus: Entire business Segments of the business

Uses of Cost Information: Product costs for

calculating cost of goods

sold and finished goods,

work in process, and raw

materials inventory using

historical costs and GAAP.

•Budgeting

•Special decisions such as

make or buy a component,

keep or replace a facility,

and sell a product at a

special price.

•Nonfinancial information

such as defect rates, % of

returned products, and on-

time deliveries

Cost Accounting System

Cost Accounting vs.

Financial and Managerial

Accounting (cont.)

Cost accounting

includes those parts

of both financial and

management

accounting that

collect and analyze

cost information.

Cost of Goods Sold

Merchandiser Manufacturer

Beginning merchandise

inventory

Plus purchases

Merchandise available for sale

Less ending merchandise

inventory

Cost of good sold

Beginning finished goods

inventory

Plus cost of goods

manufactured

Finished goods available for

sale

Less ending finished goods

inventory

Cost of good sold

Inventories

Most manufacturers maintain a perpetual

inventory system that uses FIFO, LIFO, or

moving average methods of costing.

An inventory ledger is maintained to provide

support for the control accounts.

Some manufacturers may use a factory

ledger, which contain all of the accounts

relating to manufacturing.

Inventories

Merchandiser

Current assets:

Cash

Accounts receivable

Merchandise

inventory

Manufacturer

Current assets:

Cash

Accounts receivable

Inventories:

Finished goods

Work in process

Materials

Elements of

Manufacturing Costs

Direct materials Materials that become part of the finished good

and can be readily identified.

Direct labor Labor of employees who work directly on the

product manufactured.

Factory overhead Includes all costs related to production other

than direct materials and direct labor.

Prime Cost and

Conversion Cost

Direct Materials

Direct Labor

Factory Overhead

Prime Cost

Conversion

Cost

Elements

of Cost

Flow of Manufacturing

Costs

Direct Materials

Direct Labor

Factory Overhead

Work in Process

(Assets)

Finished Goods

(Assets)

Cost of Goods Sold

(Expenses)

Illustration of Accounting

for Manufacturing Costs

Materials xx

Accounts Payable xx

Work in Process (Direct Materials) xx

Factory Overhead (Indirect Materials) xx

Materials xx

Payroll xx

Wages Payable xx

Wages Payable xx

Cash xx

Work in Process (Direct Labor) xx

Factory Overhead (Indirect Labor) xx

Selling & Admin Exp (Salaries) xx

Payroll xx

Factory Overhead (Depr. Bldg) xx

Selling & Admin Exp (Depr. Bldg) xx

Accum. Depr. – Bldg xx

Factory Overhead (Depr. Mach & Eq) xx

Accum. Depr. – Mach & Eq xx

Factory Overhead (Utilities) xx

Selling & Admin Exp (Utilities) xx

Accounts Payable xx

Selling & Admin Exp xx

Accounts Payable xx

Work in Process xx

Factory Overhead

xx

Finished Goods xx

Work in Process xx

Accounts Payable xx

Cash xx

Accounts Receivable xx

Sales xx

Cost of Goods Sold xx

Finished Goods xx

Cash xx

Accounts Receivable xx

Cost Accounting Systems

Job Order Cost System

Output consists of special or custom-made products.

Provides a separate record for the cost of each quantity of these special or custom-made products.

Process Cost System

Accumulates costs for each department or process in the factory.

Job Order Cost System

Direct Materials

Direct Labor

Factory Overhead

Work in Process

Account

Finished Goods

Account

Job Cost Sheets

Process Cost System

Work in Process

Dept. 1

Work in Process

Dept. 2 Finished Goods

Factory

Overhead

Direct

Labor

Direct

Materials

Direct

Materials

Direct

Labor

Factory

Overhead

Standard Cost System

May be used with either a job order or a

process cost system.

Uses predetermined standard costs to furnish a

measurement that helps management make

decisions regarding the efficiency of operation.

Standard costs are costs that would be incurred

under efficient operating conditions and are

forecast before the manufacturing process

begins.

Appendix

Standards of Ethical Conduct for

Management Accountants

Members of the IMA have an obligation to the public, their profession, the organizations they serve, and themselves to maintain the highest standards of ethical conduct.

1. Competence

2. Confidentiality

3. Integrity

4. Credibility

Appendix (cont.)

Resolution of Ethical Conflict

When applying the standards of ethical

conduct, IMA members may encounter

problems in identifying unethical behavior or

in resolving an ethical conflict.

1. Discuss problems with the immediate superior except

when it appear that the superior is involved.

2. Clarify relevant ethical issues by confidential discussion

with an objective advisor.

3. Consult your own attorney as to legal obligations and

rights concerning the ethical conflict.