CHAPTER 13 COST ACCOUNTING AND REPORTING SYSTEMS McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002

CHAPTER 13

COST ACCOUNTING AND REPORTING SYSTEMS

McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002

Learning Objectives

1. What is the role of cost accounting as it relates to financial and managerial accounting?

2. How does cost management play a strategic role in the organization’s value chain?

3. What is the difference between direct and indirect costs, and how do they relate to a product or activity?


Learning Objectives4. What is the difference between

product costs and period costs, and what are the three components of product cost?

5. What is the general operation of a product costing system, and how do costs flow through the inventory accounts to cost of goods sold?

6. How are predetermined overhead application rates developed and used?


Learning Objectives

7. What is the presentation and interpretation of a statement of cost of goods manufactured?

8. What is the difference between absorption and direct (or variable) costing?

9. What are activity based costing and activity based management?


Learning Objective 1

• What is the role of cost accounting as it relates to financial and managerial accounting?


Cost Accounting• Cost accounting is a subset of

managerial accounting

• Deals primarily with the accumulation and determination of product, process, or service costs

• The primary purpose is income measurement and inventory valuation in accordance with generally accepted accounting principles for external financial reporting


Uses of Costing Systems

• Need accurate costing information for:

– Pricing decisions

– Evaluating productivity and efficiency

– Developing operating budgets

– Determining which product parts will be manufactured internally

– Analyzing production technology

– Appraising performanceMcGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002


• How does cost management play a strategic role in the organization’s value chain?


Strategic, Operational, and

Financial Planning

Planning and Control Cycle

Performance Analysis: Plans vs. Actual Results (Controlling)

Executing Operational Activities (Managing)

Rev

isit

Pla

nsImplement Plans

Data Collection and Performance Feedback


Cost Management

• Cost management is the processof using cost information from the accounting system to manage the activities of the organization

• Accurate and timely information is critical to the success of the decision-making process

• An organization’s value chain is the sequence of functions and related activities that adds value for the customer


Value Chain Functions• Research and Development – cost of generating

new ideas

• Design – can we make a product at a reasonable cost?

• Production – cost of making the product

• Marketing – cost of promoting the product

• Distribution – cost of delivery

• Customer service – cost of after-sales supportMcGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002

Cost Accumulation and Assignment

• Costs are incurred in carrying out each activity in the value chain

• A cost object is a reference point (job, machine, product line, etc.) where a need to understand costs exists

• Cost accumulation is the process of collecting and recording transaction data

• Cost assignment is the process of attributing an appropriate amount of cost in the cost pool to each cost object


Cost Object$$$’s Cost Pool

Cost Object

Cost Object

Cost Assignment



• What is the difference between direct and indirect costs, and how do they relate to a product or activity?


Cost Relationship to Product or Activity

• Direct cost and indirect cost classifications depends on the context

• A direct cost is a cost that would NOT be incurred if the product or activity were discontinued

• An indirect cost is one that would continue to be incurred even if the product or activity were discontinued



• What is the difference between product costs and period costs, and what are the three components of product cost?


Costs for Cost Accounting Purposes

• Product costs are used in manufacturing and merchandising firms to determine inventory values

– Raw materials– Direct labor– Manufacturing overhead

• Period costs as those costs not included in inventory as product costs

• Period costs are reported on the income statement as they are incurred


Product Costs

• Raw materials – the ingredients of a product

• Direct labor – the effort provided by workers who are directly involved with the manufacture of the product

• Manufacturing overhead – includes all manufacturing costs except raw materials and direct labor



• What is the general operation of a product costing system, and how do costs flow through the inventory accounts to cost of goods sold?


Cost Accounting Systems

• Every manufacturing firm uses a cost accounting system to accumulate the cost of products made

• The system involves three inventory accounts:

– Raw material inventory– Work in process inventory– Finished goods inventory


Inventory Accounts

• Raw materials – cost of parts used in the manufacturing process

• Work in process – used to accumulate all manufacturing costs (raw materials, direct labor, manufacturing overhead) while the product is in processing

• Finished goods – cost of goods completed


Raw Materials Inventory Work in Process Inventory

Finished Goods Inventory Cost of Goods Sold

Purchases of raw materials

Materials used in production

Materials used

Direct labor incurred

Manufacturing overhead applied

Cost of products manufactured

Cost of goods manufactured

Cost of manufactured goods sold

Cost of goods sold as an expense on the income statement



• How are predetermined overhead application rates developed and used?


Overhead Application• Manufacturing overhead is all costs

of a product except raw materials and direct labor

• Assigning overhead costs presents a challenge

• Most systems apply overhead by using a single, or few, surrogate measures of overhead behavior

• The assumption is that since products are being made, overhead costs are being incurred


Overhead Application Bases• An estimate of total overhead is made a

the beginning of the year

• A base is selected to apply overhead– Direct labor hours– Direct labor dollars– Machine hours– The estimated overhead cost is divided by

the total estimated base for the year – thus producing an overhead rate


Overhead Application Rates

• The overhead application rate may be stated in dollars - $6.00 per machine hour used

• The overhead application rate may be stated in percentages – 130% of direct labor dollars

• These overhead rates are assigned to the costs of the products produced


Differences Between Actual and Applied Overhead

• The overhead rate is multiplied by the actual base used during the year

• Any difference between the total applied overhead and the actual cost of overhead is transferred to cost of goods sold if immaterial

• If the difference is material, the difference is divided between cost of goods sold and ending inventory



• What is the presentation and interpretation of a statement of cost of goods manufactured?


Statement of Cost of Goods Manufactured

• Manufacturing costs are summarized and reported in the statement of cost of goods manufactured

• Total manufacturing costs include:– Raw materials used– Direct labor cost incurred– Manufacturing overhead applied


Statement of Cost of Goods Manufactured – Continued

• Total manufacturing costs incurred are added to beginning work in process inventory

• Then ending work in process inventory is subtracted to arrive at cost of goods manufactured


Firm XYZStatement of Cost of Goods Manufactured

For the Month of XXRaw Materials:Inventory, Beginning $XX

Purchases for the month XXRaw materials available for use $XXLess: Inventory, Ending XXCost of raw materials used $XX

Direct labor costs incurred for the month XXManufacturing overhead applied for the month XXTotal manufacturing cost for the month $XXAdd: Work in process, beginning XXLess: Work in process, ending XXCost of goods manufactured for the month $XX


Cost of Goods Sold

• Cost of goods manufactured is added to beginning finished goods inventory to arrive at cost of goods available for sale

• Ending finished goods inventory is subtracted from cost of goods available for sale to arrive at cost of goods sold


Firm XYZStatement of Cost of Goods Sold

For the Month of XX

Beginning inventory $XXCost of goods manufactured XXCost of goods available for sale $XXLess: Ending inventory XXCost of goods sold $XX


Firm XYZIncome Statement

For the Month of XX

Sales $XXCost of goods sold XXGross profit $XXSelling, general, and admin. expenses XXIncome from operations $XXInterest expense XXIncome before taxes $XXIncome tax expense XXNet income $XX


Cost Accounting Systems

• Job order costing systems are used when discrete products are manufactured

• Costs are accumulated for each job in a job order system

• Process costing systems are used when producing homogeneous products

• Costs are accumulated by department in a process costing system


Equivalent Units of Production

• In a process costing system, costs are accumulated by department

• The costs of the department are divided by the equivalent units processed by that department to find a cost per unit

• The equivalent units of production is the number of units that would have been produced if all production efforts had resulted in complete products



• What is the difference between absorption and direct (or variable) costing?


Absorption Costing and Direct Costing

• In absorption costing systems, all manufacturing costs incurred are absorbed into the product cost

• Direct costing (or variable costing) assigns only variable costs to products

• In direct costing, fixed manufacturing overhead is treated as an operating expense

• Absorption costing must be used for financial reporting and tax purposes



• What are activity based costing and activity based management?


Activity-Based Costing

• Overhead costs have become increasing significant due to technological innovations

• As a result, overhead application rates have been applied using activity-based costing

• In activity-based costing, an activity must be identified that causes the incurrence of a cost


Cost Drivers

• Examples of cost drivers include:• Machine setup• Quality inspection• Production order preparation• Materials handling activities

• Activity-based costing is a complex process

• Activity-based costing had led to more accurate costing


Activity-Based Management

• Activity-based management is the use of activity-based costing information to support the decision making process

• Can be relevant to customer satisfaction, operational productivity and efficiency, product or process design, product mix

• Activity-based management has led to better decisions


Documents

CHAPTER 13 COST ACCOUNTING AND REPORTING SYSTEMS McGraw-Hill/Irwin©The McGraw-Hill Companies, Inc., 2002