MODULE 1: Introduction to Management and
Review of Cost Accounting
Cost accounting – focuses on manufacturing;
gives information to both internal and external
users.
-
Overlap of financial and managerial
accounting
Needs records of financial accounting to
project and compute product costs
But leans more towards managerial
accounting
Layman: Cost accounting is used both in financial
and managerial accounting, and at the same time,
uses information provided by the said two.
Financial accounting VS. Managerial
Accounting
Financial Accounting
Managerial Accounting
(where Cost accounting
leans more towards)
● External focus/users ● Internal focus
● Whole organization ● Segments or divisions
Entire financial
Different product
status
lines or departments
● Historical
● Current/projected
From beginning to
Future figures,
end of period,
budgets
chronological
● Quantitative
●Quantitative/qualitative
● Monetary
● Monetary and
nonmonetary
● Verifiable
● Timely/reasonable
estimate
● GAAP
● Benefits exceed costs
Follows standards
● Formal
● Formal (verifiable) and
recordkeeping
informal (not required by
(required by
government)
government)
recordkeeping
Cost – manufacturer’s perspective: monetary
value that a company spent in order to produce a
certain product.
Cost object – a product or a department of which
costs are accumulated.
-
-
Any product or department na
PINAGKAKAGASTUSAN, or nag-iipon ng
COSTS.
Things for or under which costs are
incurred.
EXAMPLES: Direct Material costs, Direct labor
costs, and overhead costs are accumulated
cost in producing a T-shirt, hence, the cost
object is the T-shirt.
Cost of maintenance supplies and cost of salary
of maintenance employees are cost
accumulated under Maintenance
Department, hence, cost object is the
Maintenance Department.
Assigning Costs to Cost Objects
There are two classes of PRODUCT costs that
accumulate in a cost object (if it is a product).
1. Direct costs
-
-
Costs that can be easily traced to a unit of
product or other cost object; PRIMARY and
OBVIOUS.
Include direct materials and direct labor.
How can we say costs can be easily traced to a
unit? If we can compute the cost incurred for the
material and labor used to make that certain unit.
In short, when you can determine how many or
how much. Costs are assigned in an economically
feasible way.
Tracing accurately – costs are assigned using a
causal relationship.
2. Indirect costs (RESIDUAL)
-
-
Costs that cannot be easily traced to a unit
of product or other cost object; NOT
PRIMARY, BUT NECESSARY.
Include manufacturing overhead like indirect
materials and labor.
How are indirect costs assigned? Through
allocation.
Classifications of Manufacturing/Product Costs
1. Direct Materials – raw materials that become an
integral part of the product and that can be
conveniently traced directly to it.
-
What a product is obviously made of.
EXAMPLE: radio, car seats installed in an
automobile, flour in bread
2. Direct Labor – labor costs that can be easily
traced to individual units of product.
-
Salaries for workers associated directly
with the conversion process.
Need to have direct involvement in the
production of the product.
EXAMPLE: Wages paid to automobile
assembly workers, factory assembly line
worker
Labor cost for a single unit = Hour rate /
no. of units produced
3. Manufacturing Overhead – all manufacturing
costs except direct material and direct labor;
RESIDUAL.
a) Indirect materials – not easily traced
to specific units, but are needed to
finish the product.
– Usually those that are used for
MULTIPLE BATCHES, not for a single
unit.
EXAMPLES: Wax paper in baking,
glue, screws
b) Indirect labor – not easily traced to
specific units and not directly
involved in production, but are
needed in the general manufacturing
(not conversion) process.
EXAMPLES: factory security guard.
c) Depreciation of equipment, utility
costs, property taxes for the
factory, insurance for
manufacturing facilities – Only
those indirect costs associated with
operating the factory are included.
Can’t be traced to product.
Prime Costs and Conversion Costs
1. Prime Costs
-
Primary costs in producing a product.
Direct materials + Direct labor
2. Conversion Costs
-
-
Costs incurred only in the process of
converting the raw materials into finished
product.
Direct labor + Manufacturing overhead
3. Total Manufacturing Costs/Product Costs
-
Direct materials + Direct labor + Overhead
Prime cost + Overhead
Conversion cost + Direct materials
NEVER: Prime cost + Conversion cost,
otherwise, direct labor will be doubled.
Financial Statement Costs: Product and Period
Costs
1. Product/Manufacturing Costs
-
-
Include all the costs involved in acquiring or
making a product.
Attach to a unit of product as it’s purchased
or manufactured (RM&WIP), and stay
attached to each unit as it remains unsold
(FG)—Inventory in BS.
When items are sold—COGS in Income
Statement.
Hence, not outright expensed. First asset,
second expense.
Product Cost (Inventory, BS) ------ > |> COGS (IS)
Types of Inventories in Manufacturing
Companies (in different stages of production)
a) Raw materials – any materials that go
into the final product.
b) Work in process – units of product that
are only partially complete and will
require further work before they are
ready for sale.
c) Finished goods – completed units of
product that remain unsold.
ALL THESE ARE REPORTED IN THE
BALANCE SHEET.
Transfer of Product Costs
1. Acquisition of direct materials
Cash → Raw Materials
2. Use of direct materials in production
– Costs are transferred from Raw
Materials to Work in Process.
Raw Materials → Work in Process
3. Conversion of materials into finished
goods – Direct labor and
manufacturing overhead costs are
added to Work in Process.
Direct labor and overhead → Work in
Process
4. Completion of product – Costs are
transferred from Work in Process to
Finished Goods
Work in Process → Finished Goods
5. Sale of finished goods – Costs of FG
sold are transferred from Finished
Goods to Cost of Goods Sold in the
INCOME STATEMENT.
Finished Goods → COGS
2. Period/Non-MFC Costs – associated with time
periods rather than manufacturing process;
OUTRIGHT EXPENSED, OUTSIDE FACTORY,
NOT PART OF OVERHEAD.
a) Selling costs – incurred to secure
customer orders and get the finished
product to the customer; Direct or indirect.
EXAMPLES: Sales commissions
Order-getting – advertising, sales
commission
Order-filling – warehouse, shipping, and
customer service
b) Administrative costs – associated with the
general management of an organization
rather than with manufacturing or selling;
Direct or indirect.
EXAMPLES: Depreciation of office
equipment, salaries of managers
Cost Classifications as to Cost Behaviors
Cost behavior – how a cost will react to changes
in the level of activity.
1. Variable Cost
In Total
Total variable cost
varies in proportion
to changes in the
activity level.
Per unit
Variable cost per unit
remains constant.
Cost driver – a measure of what causes the
incurrence of a variable cost; measure of level of
activity
- causes changes in resource usage
EXAMPLES: Units produced, Machine
hours (depreciation), Miles driven (car),
Labor hours.
In Total
Total fixed cost
remains constant
regardless of changes
in the level of activity
Per unit
Average fixed cost per
unit varies inversely
with changes in
activity.
Average fixed cost =
Total fixed cost / Level
of activity
Committed fixed cost – Long term, cannot be
significantly reduced in the short term.
Discretionary fixed cost – May be altered in the
short term by current managerial decisions.
Relevant range of activity – pertains to fixed cost
as well as variable costs.
At times, costs are fixed at just a relevant
range of activity. Beyond that level, costs
will already vary.
Relevant range of activity for a fixed cost –
range of activity over which the graph of the cost
or fixed cost is flat.
-
Fixed cost is only valid at a relevant range.
Beyond that level, fixed cost changes.
Low
production
Variable
Total: Falls
Ave: Constant
Fixed
Total: Constant
Ave: Rises
High
production
Total: Rises
Ave: Constant
Total: Constant
Ave: Falls
3. Mixed Costs - contains both variable and fixed
elements, like Utility costs (more of variable).
-
Per Unit
Vary (must separate
the fix and variable
component)
Total Mixed Cost Line Equation
Y = a + bX
Where:
2. Fixed Cost
-
In Total
Vary (must separate
the fix and variable
component)
Charges a base amount, but goes higher
with excess usage.
Y = The total (mixed) cost
a = The total fixed cost (the vertical intercept of
the line)
b = The variable cost per unit of activity (the
slope of the line)
X = The level of activity
Cost Classifications for Decision-Making
Goal of making decisions – identify those costs
that are either relevant or irrelevant to the
decision.
1. Differential cost and revenue – always
RELEVANT to decisions.
a) Differential revenue – difference in
revenue between two alternatives
b) Differential/Incremental/Decremental
cost – difference in cost between any two
alternatives; can be FIXED or VARIABLE.
2. Sunk Costs – IRRELEVANT; have already been
incurred and cannot be changed by any decision
made now or in the future.
PAST IS PAST.
3. Opportunity cost – potential benefit that is
given up when one alternative is selected over
another.
-
Not found in accounting records, but must
be considered in decisions—RELEVANT.
Income Statement Formats: Traditional and
Contribution
Traditional format – Used primarily for external
reporting; COMMON.
-
Used also in cost accounting (for financial
accounting)
Why do we need to separate the variable and
fixed cost components of mixed cost?

Contribution format – Used primarily by
management in internal planning and decisionmaking.
-
Categorizes expenses as to their behavior
(variable and fixed)
What’s used in cost and managerial
acco
untin
g.


Because only through that, we can identify
the constant average variable cost (b) and
constant total fixed cost (a).
With these values, we can compute total
mixed cost for a prospect level of activity
using y = a + bx formula.
Constant components of variable and
fixed costs are needed to predict future
mixed costs.
Understanding Mixed Cost
1. Identify if the cost is a variable, fixed, or
mixed cost.
2. If it is a mixed cost, separate the Variable
from the Fixed component thru 2 methods.
3. Why do we need to separate? So we can
use the variable rate and fixed cost
component in predicting the future mixed
cost
MODULE 2: Cost Behavior, Cost Function, and
methods for analyzing Mixed cost
High-Low Method
Variable rate = Highest Cost – Lowest Cost /
Why do we need to know whether a cost is
fixed, variable, or mixed?

Because businessmen want to budget, and
they do so by predicting future costs.
ESTIMATION.

We can only predict such if we know how a
cost would behave.
Highest activity – Lowest Activity
1. Determine the highest and lowest activity
and the highest and lowest costs associated
with them (2 pairs).
2. Divide the change in cost over the change
in activity (formula above). You’ll get the
variable rate.
3. Get the total fixed cost by using the total
cost function (y = a + bx) and working back.
Predicting Future Cost
For y and x,
Get a pair of total cost and corresponding
units/level of activity from the table (any).
1. Predicting variable cost

Through using the constant variable rate or
variable cost per unit
Total fixed cost must be constant in every
try.
YOU’RE LOOKING FOR A.
Predicted variable cost = Variable rate x planned
level of activity
2. Predicting fixed cost

Through using the constant total fixed cost
Predicted fixed cost = total fixed cost (constant
every period)
3. Predicting future mixed costs


Tougher because this class doesn’t have
constants. Both total and per unit mixed
cost vary.
No constant amount can be relied on for
prediction. What to do, then? Separate the
variable and fixed components first.
4. Now that you have the constant variable
rate and total fixed cost, predict future
mixed cost by substituting the constants in
the cost function. The (x) level of activity
here must be the one estimated.
YOU’RE LOOKING FOR Y.
Issue on finding the HC, LC, HA, and LA.

The variable rate formula requires pairs of
values. But what if highest cost isn’t
associated with highest level of activity?
And the lowest cost with the lowest level of
activity?
ANSWER: Get the pair with the highest or lowest
activity, even if it isn’t associated with the highest or
lowest cost.
Activity is superior over cost because it is the
independent variable (x) dictating the total cost (y).
Order of cost can be compromised but order of
activity can’t.
formulas. Use principles in Systems of Two
Unknowns.
a) Multiply both sides of equation 1 by the
quotient of ∑x/n, or the needed multiple
to make the coefficient beside a (total
fixed cost) equal.
b) Eliminate the a with its coefficient by
subtracting the said values from the two
equations. Position (top or bottom)
doesn’t matter in subtraction.
Cost Function in General
∑y = na + b ∑x
y = bx + a
∑xy = ∑x a + b ∑x²
If asked what the cost function is, the answer
should be a formula, not a single total cost value.
EXAMPLE: Y = 2.8(x) + 550, only the values of
variable rate and total fixed cost are present.
Why is total cost Y and units/level of activity x?
Because Y, total cost, is the dependent variable in
the Y axis.
And x, level of activity, is the independent variable
in the X axis.
Least Square Regression Method
1. Prepare a table calculating x (activity), y
(total cost), xy, and x2.
Get the sum for every column, and the
number of observations or the sample (n)
x
y
xy
X2
∑x
∑y
∑xy
∑ X2
2. Substitute the computed amounts or sums
in the cost function versions of Least
Square method, which are the following:
∑y = na + b ∑x
(equation 1)
∑xy = ∑x a + b ∑x²
(equation 2)
Where:
y = total cost (dependent Variable)
x = Activity (independent variable)
a = Fixed cost
b = Variable cost per unit
n = number of observations
3. To find the variable rate, eliminate the
variable a (total fixed cost) from the
M=
Nb
c) Subtract the other remaining values to
get M = Nb (self-made).
d) Get b from evaluation M = Nb.
M=
N
Nb
N
M/N = b
4. Substitute b or the variable rate to any of
the two equations to get the fixed cost:
∑y = na + b ∑x
(equation 1)
∑xy = ∑x a + b ∑x²
(equation 2)
Costing system in Assigning costs – how
inventoriable costs are assigned to each product or
batch.
Job Order Costing – assumes that there is a
possibility of physically identifying the jobs
produced and of charging each with its own cost.
- Like specific identification in terms of identifying
COGS
Terms:
Cost unit – distinct “job” or a “work order” or a
“contract”.
JOB – a product or item to which cost is allocated
LOT – quantity of product that can be economically
produced or costed.
Job order number – means by which materials,
labor and overhead can be assigned.
- The identification number of each job.
Job order costing
Used by companies that
provide unique
products/services.
Each customer is receiving
something either slightly
or greatly different from
what the other customers
receive (customized)
Process Costing
Used by companies
who produce nearly
identical units
through a series of
production steps of
processes
Usually mass
productions on big
factories (for
companies producing
large quantities of
similar products)
Materials Stock card – Perpetual book inventory of
cost and quantities of (raw) materials on hand.
Finished Goods Stock card – Perpetual book
inventory of cost and quantities of completed
goods ready to be sold.
Factory Overhead Control – Records detailed
manufacturing cost by department.
These 3 documents record the usage/charging of
costs to jobs. Goal is to give sense of accountability
to workers.
1. Materials Requisition – made by employees
to request materials
- Enables tracking of quantities requested
2. Time Ticket – Record of how much a
worker spent on a job.
- Enables assessment whether or not
standard hours of work is reached.
3. Clock Card – record of attendance and
hours worked in a day
- Needed to determine overtime
Journal Entries
1. Purchase of Materials
Raw Materials
Cash/Accounts Payable
2. Issuance of Direct Material for production
WIP
Raw materials (Direct portion)
3. Issuance of Indirect Material
Examples: Accounting
Firms, Healthcare
providers, Building
Contractors, Custom
Guitar Manufacturers.
Examples: Soft drinks
company, Food
Processing company,
Toothbrush
manufacturer
FOHC (Suspends transfer of indirect cost to
WIP)
Raw materials (Indirect portion)
Compound entry
This system accumulates
cost by each job or each
unique batch
This system
accumulates cost by
each process
WIP (Direct)
FOHC (Indirect)
Raw Materials (Direct)
Documents Used
Job Order Cost Sheet – Accumulates product costs
of specific units or small batches. Separate cost
sheet is prepared for each job.
4. Incurrence of Labor
Payroll Expense (Gross)
Cash/Accrued Payroll Payable (Net)
Other Government Payable (Taxes
deducted from payroll to be remitted to the
government)
However, this entry is not ENOUGH. Assignment
entry is a MUST.
5. Assigning Direct and Indirect Labor cost to each
job
WIP (Direct)
FOHC (Indirect – Suspended)
Cash/Accrued Payable
Instead of debiting different types of expense, you
can directly debit FOHC as these will eventually be
transferred to such control account anyway.
8. Recording of assigned / estimated / applied /
allocated overhead on a job (while actual overhead
not yet entirely available)
WIP
Payroll Expense (Gross)
However, this entry is not ENOUGH.
Recognition/Incurrence entry is a MUST.
Compound entry (Incurrence of labor + assigning
cost to job)
WIP (Direct portion)
FOHC (Indirect portion)
FOH Applied
Remember that FOC estimated is on the credit side
of the FOHC control account, so that when actual
FOH is determined, whatever their difference is
what’s inputted in the ADJUSTING entry.
9. Job is completed
Finished Goods Inventory
WIP
Cash/Accrued Payable
Government payables
This entry is ENOUGH.
KEY NOTE: Direct materials and labor go to WIP,
while Indirect materials and labor go to FOHC.
6. Payment of Payroll (Different from
Incurrence/Accrual)
Accrued Payroll Payable
10. Sale of goods (Perpetual)
At Selling Price:
AR/Cash
Sales
At Cost:
COGS
Cash
7. Incurrence of actual overhead (besides indirect
labor and materials)
Example: Depreciation
Depreciation Expense
Accumulated Depreciation
Assignment
Finished Goods Inventory
11. Entry upon availability of the actual overhead
(monthly)
Monthly – when a firm monthly closes COGS
Account: Over or underapplied
Underapplied – You need to add to COGS.
COGS
FOHC
Over/underapplied
Depreciation Expense
OR (Recognition + Assignment)
FOHC (Direct assignment)
Overapplied – You need to deduct from COGS.
Over/underapplied
COGS
Accumulated Depreciation
Example: Utilities Expense, Salaries Expense
FOHC
12. Closing entry at the end of the year (when
there is no monthly adjustment made, FOH is
accumulated every year)
Underapplied:
FOH Applied
P250,000 Direct labor cost actual * 50% = P125,000
(Applied OH)
COGS (Difference)
FOHC
SILENCE: Estimated Overhead is based on the
direct labor cost.
Overapplied:
FOH Applied
FOHC
COGS (Difference)
Where we CLOSE both the FOH applied (credit
normal) and FOHC (debit normal) and their
difference go to COGS.
Pre-determined Rate Given Previous Actual
Activity and FOH Applied
= Applied Overhead of previous period / Actual
direct labor cost or activity of previous
Then, we can proceed to get the applied OH for the
current period.
Formula for Cost per Unit: Normal Costing (Silent)
Part 10, number 2 method
= Total Manufacturing Cost (Using FOH Applied) /
Units produced/manufactured for the period
Anong overhead balance sa WIP, FG, at COGS ang
tinutukoy? Yung applied? Yung for the period
lang? Or kahit yung previous na naaccumulate?
Formula for Cost per Unit: Actual Costing
Total Manufacturing Cost (Using FOH Actual) /
Units produced for the period
Predetermined Allocated Overhead Rate
= Estimated or budgeted overhead / Estimated
Activity
(150% of Direct Labor Cost)
Estimated activity – estimated number of machine
hours, units produced
Predetermined rate may be in the form of Peso
value.
Applied Overhead
= Actual Activity * Predetermined overhead rate
Actual activity – actual number of machine hours,
unit produced
P200,000 / 20,000 machine hours = P10 (rate)
50,000 machine hours * P10 = P500,000 (Applied
OH)
P200,000 / P400,000 Direct labor cost estimated =
0.5
For the period lang.
Accounting for Materials
BUSINESS PAPERS USED TO SUPPORT MATERIAL
TRANSACTIONS
1. Purchase requisition – a written request,
usually sent by production department to
inform the purchasing department of a
need for materials or supplies
2. Purchase Order – a written request to
supplier for specified goods at an agreed
upon price. It also serves as the supplier’s
authorization to deliver goods and submit a
bill.
3. Receiving Report – when the goods we
ordered are delivered, the receiving
department will unpack and count them
and prepare a receiving report. It should be
noted that the quantity ordered should not
be shown on the copy of the purchase order
sent to the receiving department. (Blind PO
Copy)
4. Materials requisition slip – a written order
made by the production site to the
storekeeper to deliver materials or supplies
to the place designated or to issue the
materials to the person presenting a
properly executed requisition.
Accounting for Trade and cash discount for
materials purchased
1. Trade Discounts – trade discounts are used
to convert list price into invoice price. Trade
discounts are not recorded in the books
because purchases recorded in the books
are already net of trade discount.
2. Cash Discounts – granted to customers to
motivate them to pay promptly
a. Gross method (when taken method) –
records purchase and liability initially in
gross amount
b. Net method (when not taken method) –
records purchase and liability initially in
net amount
Gross
Purchases
AP
Net
Purchases (N)
AP (N)
AP (G)
Cash (N)
Purchase Disc
AP (N)
Cash (N)
Allowance
Purchases (N)
All. For PD
AP (G)
AP (G)
Cash (N)
All. for PD
invoice price. Thus, this method increases
the unit cost.
Purchases (Price + freight-in)
Accounts Payable (Price + freight-in)
Methods for allocating the amount of freight-in if
two or more materials are purchased at the same
time:
I.
Relative peso value method – freight is
allocated on the basis of peso value of the
items purchased
II.
Relative weight method – freight is
allocated on the basis of the weight of the
items purchased. More logical in practice,
since courier services consider the weight of
the products delivered for the price
2. Indirect charging method – the freight incurred
in the purchase of raw materials is charged to
factory overhead. Won’t have effect on the
material cost.
Purchases (Price)
AP (G)
Cash (G)
AP (N)
Purchase Disc
Lost
Cash (G)
AP (G)
Purchase Disc
Lost
Cash (G)
All. for PD
FOHC (freight-in)
Accounts Payable (Price + freight-in)
Costing method for Materials
c. When offered method (allowance
method) – purchases are recorded at
net, and liability is recorded at gross.
Allowance for Purchase Discount – a contraliability account deducted from AP just like
Allowance for Sales Discount to AR
- Is cancelled when the MOTHER Accounts Payable
is paid, whether or not discount is taken.
- Normal balance: Debit
Purchase Discount Lost – is a loss or expense
reported in the Income statement?
- Counterpart of Sales Discount Forfeited in seller’s
POV
1. FIFO – First-in, First-out – this method is
based on the assumption that cost should
be charged to manufacturing cost or cost of
goods sold in the order in which incurred.
Herein, there is NO SINGLE cost per unit for
inventory balances. It must be like:
P14 for 800
P15 for 200
Cost of ending inventory – sourced from those
purchased MOST RECENTLY.
Cost of materials issued/used – sourced from
BEGINNING balance and those EARLIEST
purchases.
- Recognized if discount is not taken under the
allowance and net method.
FIFO table
Methods for Accounting for Freight-in
1. Direct Charging Method – freight incurred
to purchase raw materials is added to the
Units
Beginning
Purchases
Issued
Pesos
(Depends on the
beginning
balance cost and
EARLIEST
purchases)
(Depends on
LATEST
purchases)
Ending
2. Average Cost
The values for cost of inventories using FIFO under
the periodic and perpetual systems are THE SAME.
But for average method, there will be a difference,
since different sub-methods will be used for each
of the systems.
Materials Inventory Management
a) Weighted average method (Periodic) –
this method is based on the assumption
that units issued should be charged at
an average cost, such average being
influenced or weighted by the number
of units acquired at each price.
Weighted Average Unit Cost = Total Cost of
Materials Inventory (Beginning + Purchases) /
Total Units of Materials Inventory (Beginning +
Purchases)
Cost of Inventory Issued or Ending = Ending or
Issued Units x WAUC
Objective – to minimize cost; minimizing cost
doesn’t mean too little inventory because it can
make ordering cost high due to frequent ordering
and it also doesn’t mean too much inventory
because it can make your carrying or storage cost
high.
Total Inventory cost = Carrying/storage cost +
Ordering Cost
Carrying Cost includes:
1) Storage Costs
2) Interest Cost (on what?)
3) Spoilage
Units
Beginning
Purchases
Issued
Pesos
x Official prices = Cost
Cost of
xWAUC Inventory
Issued
Ending
xWAUC Inventory Cost
Ending
b) Moving average method (Perpetual) –
under this method a new weighted
average unit cost is computed after
each new purchase, and this amount is
used to cost each subsequent issuance
until another purchase is made.
Purchased
(always at
purchase
price)
xxx
Issued
Balance
Beginning balance
4) Insurance (on building or goods?)
Ordering Cost includes:
1) Transportation/delivery cost
2) Administrative cost of purchasing
3) Cost of Receiving
4) Cost of Inspecting goods
MINIMIZATION SOLUTION: Economic Order
Quantity / Economic Lot Size
EOQ – tells us how many UNITS to order to
minimize inventory cost.
Assumptions under EOQ:
1) Demand is uniform and known
2) Delivery is perfectly reliable and instant
xxx @ 1st
WAUC
xxx
xxx @ 2nd
WAUC
First WAUC
Decreased units @
First WAUC
Second WAUC
Decreased units @
Second WAUC
Distinction in methods happen because prices of
materials change. Hence, the cost in which the
materials are recorded also vary.
3) Carrying cost, ordering cost and unit price
are constant
Example:
Annual Demand – 4,000 units per year
Carrying cost – P0.8 per unit
Ordering cost – P100 pesos per order
EOQ
Square root of
2*Demand*OC per order/
Carrying cost per unit
Average
Inventory
(Maximum inventory point +
Lowest Inventory point or
just the EOQ or order size)
/2
Total Holding or
Carrying Cost
Average Inventory * Carrying
cost per unit
Frequency of
order (For the
year?)
Annual Demand / Order size
(may be EOQ or actual order
made)
Total Order cost
Frequency of Order * Order
cost per order
lead time
Safety stock / average usage
Maximum lead
time
Reorder point
(if no SS)
Reorder Point (if
with SS)
Normal lead time + delay
Normal lead time usage
SS + Normal lead time usage
(or Maximum lead time X
Average Usage)
Answer: IN UNITS, when will you order?
When the remaining units is equal to the normal
lead time usage.
or when there is safety stock, NLU + Safety stocks
Under EOQ, ordering cost and carrying cost must
be EQUAL—equilibrium of the EOQ.
Order size—Holding cost: Direct
The higher the order size, the higher the holding
cost.
Order size—Ordering cost: Indirect
The higher the order size, the lower the order cost.
Accounting for Overhead
Computation of overhead rate uses different bases.
1.
2.
3.
4.
5.
Material Cost
Units Produced
Machine Hours
Direct Labor costs
Direct labor hours
On which factor will be the choice of base
depend?
AND VICE VERSA.
Reorder Point
Usual Inventory Management Problem: the
quantity on hand must last until the next order is
received. Otherwise known as the Stock-out
problem.
Stock out occurs when:
-
Demand is greater than expected during the
lead time.
-
The order time exceeds the lead time.
Lead time
period between the time the
order is placed and received
Normal Lead
Time usage
Normal Lead time x Average
Usage (daily = Annual
demand/365 or 360)
Safety stock
(Maximum lead time-Normal
lead time) x average usage
Delay x Average usage
These bases are used depending on the orientation
of the factory operation
Formulas:
Estimated or Budgeted OH / Estimated Base = OH
rate or predetermined OH rate
Actual base x pre-determined OH rate = Applied
OH
Budgeted FOH (Work Back) = Estimated base x
Overhead rate
Factory Overhead Control and Factory Overhead
Applied
Factory Overhead Control – used to accumulate all
actual factory overhead costs. (Debit)
Factory Overhead Applied – the estimated
amount charged to production was credited to this
account. (Credit)
Rules
Delay
Maximum lead time – Normal
FOH Control > FOH Applied = Under-applied factory
overhead
- It supports the producing department and other
servicing departments with auxiliary services
FOH Control < FOH Applied = Over-applied factory
overhead
- Examples are maintenance, personnel, employee
services and the provision of heat, power and light.
Accounting Treatment for Over and Under-applied
FOH
1. Closed or absorbed by COGS
2. Closed or absorbed by COGS, FG inventory
and WIP Inventory (proportionately)
Sample:
a) COGS normal – uses FOH applied in the
formula
b) COGS actual if over or under-applied is
immaterial – COGS can absorb the entire
amount alone.
Overhead variance will be added to or deducted
from COGS unadjusted only.
Alternatively, the FOH actual amount can be used
in the formula arriving at the TMC.
c) COGS actual if over or under-applied is
material – COGS cannot absorb alone,
hence, WIP and FG and COGS must share
the burden of absorbing the FOH variance.
a. Overhead balances – prioritized if
OH balances FOR THE PERIOD are
given.
b. Ending balances – will be used if
only the ending balances of
inventory accounts are available.
Overhead variance will be PROPORTIONATELY
added to/deducted from each inventory’s ending
balance.
Once the ADJUSTED balances are obtained, the
cost flow formula can be done again using the FOH
actual amount and the ADJUSTED inventory ending
balances (FG and WIP).
Departmentalized Overhead
Producing department – this is the production
lines of the manufacturing process.
- Work is performed directly on the goods being
produced.
Servicing department – these costs are necessary
for the entire factory to remain in operation.
Accounting problem: Both departments will incur
costs but we compute predetermined overhead
rates only for producing departments.
Inference: Any cost incurred by the servicing
department must be transferred to the producing
department because the former cannot have a
separate predetermined OH rate.
Departmentalized overhead rates are for
producing departments only.
KEY NOTE: Only the Servicing departments
allocate their direct costs among the other
departments. Producing departments have their
direct costs exclusive for them only.
Rationale: Because servicing departments
SERVE the other departments. Technically, costs
that they incur are INVENTORIABLE.
Methods of allocating service department cost to
producing department
1. Direct method – this ignores any services
rendered by one service department to
another, it allocates each service
department’s total cost directly to the
producing departments.
Producing OH estimated adjusted = Producing OH
estimated + Service OH estimated
This sum is what will be divided by the Estimated
Base to get the PD OH rate. The service OH will be
zeroed out.
2. Step method / Sequential method – this
recognizes services rendered by service
departments to other service departments.
- Allocates the costs of servicing departments with
priority
- Priority:
a) Expressed – what’s mentioned in the
problem
b) Implied – Servicing department that
allocates the HIGHEST number of
departments served
c) Implied – Servicing department with
HIGHEST costs
S1 (prioritized) will allocate to P1, P2, and S2
S2 will allocate to P1 and P2 only since S1 has
already been zeroed out and it will be
counterproductive to put costs into it again.
3. Algebraic method / reciprocal method –
this method allocates costs by explicitly
including the mutual services rendered
among all departments
- Similar with step but different in process
- Reciprocally/Simultaneously transfers the
costs of a service department to the
producing and other servicing departments
S1 will allocate to P1, P2, and S2
S2 will allocate to P1, P2, and S1
Algebra Approach is the MOST ACCURATE.
Algebraic amounts to be allocated
S1 = Direct costs + Rate given by other SD (Other
SD’s cost formula)
Sample:
S1 = 90,000 + 20% (S2)
S2 = 60,000 + 80% (S1)
Evaluation:
S1 = 90,000 + 20% [60,000 + 80% (S1)]
KEY NOTE: A servicing department may be given
costs by more than one other servicing
department. In that case:
S1 = 90,000 + 20% (S2) + 30% (S3) + 10% (S4)
ABC Costing or System

Emphasizes tracing over allocation.
Accounting for Materials
BUSINESS PAPERS USED TO SUPPORT MATERIAL
TRANSACTIONS
5. Purchase requisition – a written request,
usually sent by production department to
inform the purchasing department of a
need for materials or supplies
6. Purchase Order – a written request to
supplier for specified goods at an agreed
upon price. It also serves as the supplier’s
authorization to deliver goods and submit a
bill.
7. Receiving Report – when the goods we
ordered are delivered, the receiving
department will unpack and count them
and prepare a receiving report. It should be
noted that the quantity ordered should not
be shown on the copy of the purchase order
sent to the receiving department. (Blind PO
Copy)
8. Materials requisition slip – a written order
made by the production site to the
storekeeper to deliver materials or supplies
to the place designated or to issue the
materials to the person presenting a
properly executed requisition.
Accounting for Trade and cash discount for
materials purchased
3. Trade Discounts – trade discounts are used
to convert list price into invoice price. Trade
discounts are not recorded in the books
because purchases recorded in the books
are already net of discount.
4. Cash Discounts – granted to customers to
motivate them to pay promptly
d. Gross method (when taken method) –
records purchase and liability initially in
gross amount
e. Net method (when not taken method) –
records purchase and liability initially in
net amount
Gross
Purchases
AP
Net
Purchases (N)
AP (N)
AP (G)
Cash (N)
Purchase
Disc
AP (G)
Cash (G)
AP (N)
Cash (N)
Allowance
Purchases (N)
All. For PD
AP (G)
AP (G)
Cash (N)
All. for PD
invoice price. Thus, this method increases
the unit cost.
Purchases (Price + freight-in)
Accounts Payable (Price + freight-in)
Methods for allocating the amount of freight-in if
two or more materials are purchased at the same
time:
III.
Relative peso value method – freight is
allocated on the basis of peso value of the
items purchased
IV.
Relative weight method – freight is
allocated on the basis of the weight of the
items purchased. More logical in practice,
since courier services consider the weight of
the products delivered for the price
2. Indirect charging method – the freight incurred
in the purchase of raw materials is charged to
factory overhead. Won’t have effect on the
material cost.
Purchases (Price)
AP (N)
Purchase Disc
Lost
Cash (G)
AP (G)
Purchase Disc
Lost
Cash (G)
All. for PD
FOHC (freight-in)
Accounts Payable (Price + freight-in)
Costing method for Materials
f. When offered method (allowance
method) – purchases are recorded at
net, and liability is recorded at gross.
Allowance for Purchase Discount – a contraliability account deducted from AP just like
Allowance for Sales Discount to AR
- Is cancelled when the MOTHER Accounts Payable
is paid, whether or not discount is taken.
- Normal balance: Debit
Purchase Discount Lost – is a loss or expense
reported in the Income statement?
- Counterpart of Sales Discount Forfeited in seller’s
POV
3. FIFO – First-in, First-out – this method is
based on the assumption that cost should
be charged to manufacturing cost or cost of
goods sold in the order in which incurred.
Herein, there is NO SINGLE cost per unit for
inventory balances. It must be like:
P14 for 800
P15 for 200
Cost of ending inventory – sourced from those
purchased MOST RECENTLY.
Cost of materials issued – sourced from
BEGINNING balance and those purchases
EARLIEST.
- Recognized if discount is not taken under the
allowance method.
FIFO table
Methods for Accounting for Freight-in
2. Direct Charging Method – freight incurred
to purchase raw materials is added to the
Units
Beginning
Purchases
Issued
Pesos
(Depends on the
beginning
balance cost and
EARLIEST
purchases)
(Depends on
LATEST
purchases)
Ending
4. Average Cost
Weighted Average Unit Cost = Total Cost of
Materials Inventory (Beginning + Purchases) /
Total Units of Materials Inventory (Beginning +
Purchases)
Cost of Inventory Issued or Ending = Ending or
Issued Units x WAUC
Units
Pesos
x Official prices = Cost
Cost of
xWAUC Inventory
Issued
Ending
xWAUC Inventory Cost
Ending
But for average method, there will be a difference,
since different sub-methods will be used for each
of the systems.
Materials Inventory Management
c) Weighted average method (Periodic) –
this method is based on the assumption
that units issued should be charged at
an average cost, such average being
influenced or weighted by the number
of units acquired at each price.
Beginning
Purchases
Issued
The values for cost of inventories using FIFO under
the periodic and perpetual systems are THE SAME.
Objective – to minimize cost; minimizing cost
doesn’t mean too little inventory because it can
make ordering cost high due to frequent ordering
and it also doesn’t mean too much inventory
because it can make your carrying or storage cost
high.
Total Inventory cost = Carrying/storage cost +
Ordering Cost
Carrying Cost includes:
5) Storage Costs
6) Interest Cost (on what?)
7) Spoilage
8) Insurance (on building or goods?)
Ordering Cost includes:
5) Transportation/delivery cost
6) Administrative cost of purchasing
7) Cost of Receiving
8) Cost of Inspecting goods
d) Moving average method (Perpetual) –
under this method a new weighted
average unit cost is computed after
each new purchase, and this amount is
used to cost each subsequent issuance
until another purchase is made.
Purchased
(always at
purchase
price)
xxx
Issued
Balance
Beginning balance
MINIMIZATION SOLUTION: Economic Order
Quantity / Economic Lot Size
EOQ – tells us how many UNITS to order to
minimize inventory cost.
Assumptions under EOQ:
4) Demand is uniform and known
xxx @ 1st
WAUC
xxx
xxx @ 2nd
WAUC
First WAUC
Decreased units @
First WAUC
Second WAUC
Decreased units @
Second WAUC
Distinction in methods happen because prices of
materials change. Hence, the cost in which the
materials are recorded also vary.
5) Delivery is perfectly reliable and instant
6) Carrying cost, ordering cost and unit price
are constant
Example:
Annual Demand – 4,000 units per year
Carrying cost – P0.8 per unit
Ordering cost – P100 pesos per order
EOQ
Square root of
2*Demand*OC per order/
Carrying cost per unit
Average
Inventory
(Maximum inventory point +
Lowest Inventory point or
just the EOQ or order size)
/2
Total Holding or
Carrying Cost
Average Inventory * Carrying
cost per unit
Frequency of
order (For the
year?)
Annual Demand / Order size
(may be EOQ or actual order
made)
Maximum lead
time
Reorder point
(if no SS)
Reorder Point (if
with SS)
Normal lead time + delay
Normal lead time usage
SS + Normal lead time usage
(or Maximum lead time X
Average Usage)
Answer: IN UNITS, when will you order?
When the remaining units is equal to the normal
lead time usage.
or when there is safety stock, NLU + Safety stocks
Total Order cost
Frequency of Order * Order
cost per order
Under EOQ, ordering cost and carrying cost must
be EQUAL—equilibrium of the EOQ.
Order size—Holding cost: Direct
Material 7 Pt. 1-6
The higher the order size, the higher the holding
cost.
Process Costing

Order size—Ordering cost: Indirect
The higher the order size, the lower the order cost.
AND VICE VERSA.

One method for collecting and assigning
manufacturing costs to the units
produced
Used when nearly identical units are
mass produced.
Job order – furniture
Reorder Point
Usual Inventory Management Problem: the
quantity on hand must last until the next order is
received. Otherwise known as the Stock-out
problem.
Stock out occurs when:
-
Demand is greater than expected during the
lead time.
-
The order time exceeds the lead time.
Lead time
period between the time the
order is placed and received
Normal Lead
Time usage
Normal Lead time x Average
Usage (daily)
Safety stock
(Maximum lead time-Normal
lead time) x average usage
Delay
Maximum lead time – Normal
lead time
Safety stock / average usage
Process – bottled ketchup
Accounting for Process Costing
A bit time consuming due to the computation
of EUP or Equivalent unit of production and
the generation of the CPR or the Cost of
Production Report.
The manufacturing process under this costing
is continuous. The same level of completion
is achieved for every product, since all
products go through the same process at the
same time (ideally, normally).
EUP – expression of the amount of work done
by a manufacturer on units of output that are
partially completed in a department at the end
of an accounting period.
 Completion expressed in percentage
 Goods are still partially completed –
only the certain department considered
has finished applying a process on the
products.
It then transfers the units to another
department, which will perform a different
process on them.
Answers: How many units are partially
completed units? Of course, they are not
“whole” numbers, because they’re not 100%
complete.
Hence, in physical sight, the PCU may be 4,
but EQUIVALENT COMPLETION may indicate
that they are just 2 (EUP).
GOAL OF EUP:
Output must be measured so that it reflects
the effort expended on both completed and
partially completed units
Cost production report – summarizes the
manufacturing activity for a department
during a period and discloses physical flow,
equivalent units, total costs to account for, unit
cost computation, and costs assigned to goods
transferred out and to units in ending work in
process
Contents of Cost of Production Report
Upper Portion (number of units)
1. UTAF – units to account for; TOTAL
units that you tried making for the month
Composition: WIP, beginning + Units started
during the month
May be equal to:
Units completed + WIP, E units
Abnormal Spoilage
3. EUP – Equivalent unit of production;
computed based on UAF and
percentages of completion.
 Complete units that could have
been produced given the total
amount of productive effort
expended for the period under
consideration.
Lower (Cost of units or EUP)
1. Cost/EUP – Cost per EUP or this is
the Cost per unit
 Will be used in computing for
Transferred-out cost, WIP Ending
cost, or CAF.
2. CTAF – Cost to Account for; peso
amount of UTAF
3. CAF – Cost Accounted for; peso
amount of UAF; Transferred out cost +
WIP, Ending cost
Methods used in Process Costing
1. FIFO Method – Previous period’s cost
per unit or cost per EUP must not be
mixed with the cost per unit of the
current period.
2. Weighted Average Method (WAVE) –
Units from previous period can be mixed
with the units from current period in
computing for the average cost per unit
of the month.
FIFO vs. WAVE
For FIFO, the transferred-out units are
segregated into those coming from WIP
beginning and those started during current
month.
For WAVE, there is no such distinction as this.
2. UAF – Units accounted for; DETAIL of
the UTAF or breakdown of allocation
Timing of Materials Consumption
Either: Transferred out FIFO (Completed)
From WIP beginning
or Units Started
Transferred out WAVE (No distinction)
WIP, ending (Not yet completed)
Normal Spoilage
1. All materials are added at the start of
the process
Meaning 100% of materials are consumed at
the start of PROCESS or MONTH. Hence, for
transferred-out units from WIP, beginning, no
materials would be used for the month, as
such has already been consumed for those
units LAST MONTH.
Units started and finished or unfinished
(WIP, E) – 100% for materials
2. All materials are added at the end of
the process
Meaning 100% of materials are consumed at
the end of PROCESS or MONTH. Hence, for
transferred-out units from WIP, beginning,
100% of materials would be used for the
current month, when the units finally finished
the prices.
Units started and finished – 100% for
materials
Units in WIP, ending – 0% for materials
LOSSES
Normal lost units – expected spoilage; rejects in
the manufacturing process
(inspec
tion)
mal
Spoilag
e
Total
UT
AF
uni
ts
 Added in the first column of the matrix
as it is one of the DESTINATIONS of
the Units to Account For
 added to Transferred-out cost
Lost units are detected at the inspection point
of 75% - at the 75% completion of its conversion
cost (since materials are outright added), it will be
discovered that they are rejects, thus taken out of
production
EUP
for
materi
als
EUP Matrix (WAVE)
UAF
#
of
uni
ts
Mater
ials
%
 All lost units will only be completed up
to 75%
Abnormal lost units/spoilage – unexpected
rejects, or the excess over the normal/expected
spoilage; Separate LOSS
 Normal – 1000, Actual – 1500
 1500 – 1000 = 500 abnormal lost
units/spoilage
EUP Matrix (FIFO)
UAF
#
of
uni
ts
Mater
ials
%
Transfe
rredout
xxx
WIP,
ending
(n%)
Normal
Spoilag
e
Conver
sion
Cost %
Units x
%
WIP,
Beginni
ng
(m%)
Current
Equiv
alent
xxx Alwa
ys
100
xxx
Equiva
lent
Always
100
Equiv
alent
Transfe
rredout
WIP,
ending
(n%)
Normal
Spoilag
e
Abnor
mal
Spoilag
e
Total
100%
always
xxx
s% (at
inspec
tion)
s% (at
inspec
tion)
n%
xxx
UT
AF
uni
ts
Equiva
lent
Units x
%
xxx 100%
alway
s
xxx
EUP
for
materi
als
EUP
for
Conver
sion
Cost
*Not identified which came from WIP, beginning
and current month
All of the items in the first column, except for the
transferred-out, are assumed to have been started
only during the month.
n%
COST PRODUCTION REPORT
xxx
s%
(inspec
tion)
Getting the EUP
FIFO – WIP Beginning cost:
Abnor
Conver
sion
Cost %
Units x
%
Units x
%
(100m) %
EUP
for
Conver
sion
Cost
xxx
s%
Cost/EUP
R1 EXCLUDE in:
R2 INCLUDE in: CAF
CTAF = Material Costs (WIPB and Added this
Month) + Conversion costs (WIPB and Added this
Month)
Cost/EUP for material = Cost added this month
(material) / EUP for material RULE 1
Cost/EUP for CC = Cost added this month (CC) /
EUP for CC RULE 1
CAF
Transferred out Cost (for both WIPB and Started
this month)
*WIP, B costs are not added to transferred out
costs RULE 2
RECONCILIATION:
Costs in beginning work in process and the
costs incurred during the current period should
equal the transferred-out costs and ending
work in process costs.
or
CTAF = Total CAF
Equivalent Units for material x Cost/EUP for
material
Equivalent Units for CC x Cost/EUP for CC
Add: WIP, B Materials and Conversion Costs
(from cost data) RULE 2
Add: Normal spoilage cost
Equivalent Units for material x Cost/EUP for
material
Equivalent Units for CC x Cost/EUP for CC
GENERAL STEPS on MAKING CPR:
1. Identify UTAF and UAF.
2. Get the EUP.
3. Get the Cost/EUP for material and CC.
COST PER EUP FORMULA
FIFO
= Current DM
costs / EUP for
Material
WAVE
= (WIPB
costs for
material +
Current DM
costs) / EUP
for Material
Cost/EUP for
CC
= Current CC
costs / EUP for
CC
= (WIPB
costs for CC)
+ Current CC
costs / EUP
for CC
Cost/EUP for
T-In
= Current T-IN
costs / EUP for
Transferred-In
= (WIPB
costs for TIN) + Current
T-IN costs /
EUP for T-IN
Total Unit cost
Sum of the unit costs per each
category
Cost/EUP for
Material
+
WIP, Ending cost (same for both FIFO and
WAVE)
Equivalent Units for material x Cost/EUP for
material
Equivalent Units for CC x Cost/EUP for CC
Abnormal spoilage cost (same formula with the
others) – NOT added to Transferred-out cost, but
a LOSS
WAVE – WIP Beginning cost:
Cost/EUP
R1 INCLUDE in:
R2 EXCLUDE in: CAF
CTAF = Material Costs (WIPB and Added this
Month) + Conversion costs (WIPB and Added this
Month)
Cost/EUP for material = WIPB material cost +
Cost added this month (material) / EUP for material
RULE 1
Cost/EUP for CC = WIPB CC cost + Cost added
this month (CC) / EUP for CC RULE 1
4. Get the T-O cost
a. For the units that completed the
process = (EUP for material x
Cost/EUP for material) + (EUP for
CC x Cost/EUP for CC)
5. Get the WIP, Ending cost
6. Cost reconciliation: T-O and WIP Ending
costs must add up to CTAF.
CAF
Transferred out Cost
Equivalent Units for material x Cost/EUP for
material
Equivalent Units for CC x Cost/EUP for CC
Add: Normal spoilage cost
Job costing
Accumulates
production costs by
job
Process Costing
Accumulates production
costs by process
Each job incurs
distinct costs as
heterogenous
Each unit in each process
receives a similar dose of
costs.
products have
different production
needs.
Uses a single workin-process (WIP)
account,
Assigns
manufacturing costs
to jobs and transfer
these costs directly
to the finished goods
when the job is
completed.
direct materials, direct labor, and overhead costs,
Encapsulating department sees only the
powder—a direct material, costing $15,000
Has a WIP account for
every process.
When units are finished for
a process, manufacturing
costs of partially completed
units are transferred from
one process department's
account to the next.
Transferred-in cost – cost
transferred from a prior
process to a subsequent
process
TRANSFERRED-IN GOODS




Last process transfers the
costs to Finished Goods.
More costly
Less expensive for there
are no individual jobs, no
job-order cost sheets, and
no need to track materials
to individual jobs.
There are far fewer
processes than jobs.
MAIN ISSUES IN PROCESS COSTING
1. How to deal with the prior-period costs and
work (WIP, beginning)
2. Non-uniform application of production costs
(All DM applied at the beginning or end of
the process)
PATTERNS OF APPLICATION
WAVE PERCENTAGE OF COMPLETION =
ALWAYS 100% for both T-OUT and WIP,
END
FIFO PERCENTAGE OF COMPLETION =
ALWAYS 100% for both Started T-OUT and
WIP, END;
0% for WIP, B T-OUT (because current
period is not the beginning of the process
for these units)
THREE IMPORTANT POINTS
1. Cost of T-in goods is the cost of the goods
transferred out computed in the prior
department.
Since laborers typically
work their entire shift within
a particular process, no
detailed tracking of labor is
needed.
Labor costs are simply
combined with OH—
Conversion Costs.
Type of direct material for the subsequent
process
Always treated as a separate material
category, as MATERIALS ADDED AT THE
BEGINNING OF THE PROCESS
Previous department’s transferred-out cost
= Receiving Department’s CURRENT T-in
cost.
2. Units started in the subsequent department
correspond to the units transferred out from
the prior department.
3. Units of the transferring department may be
measured differently than the units of the
receiving department. (Conversion of unit
measurement may be needed)
4. Transferred-in units will not affect the
computational procedures for T-OUT cost or
WIP, E cost, other than being a separate
material category (EUP for T-IN x Cost/EUP
for T-IN)
EUP MATRIX FOR WITH T-IN
UAF
CONCEPT OF TRANSFERRED-IN
These transferred-in costs are (from the
viewpoint of the process receiving them) a type
of direct materials cost. This is true because the
subsequent process receives a partially completed
unit that must be subjected to additional
manufacturing activity—more direct labor, more
overhead, and, in some cases, additional direct
materials.
Example: Thus, while blending department sees
the active and inert powders as a combination of
#
of
un
its
Tin
Mate
rials
%
Transf
erredout
WIP,
Begin
ning
(m%)
Curre
Equi
valen
t
Conv
ersio
n
Cost
%
Units
x%
xx 0%
x
xx Alw
x ays
Units
x%
(100m) %
Alw
ays
Equiv
alent
Alway
s
100
%
nt
WIP,
endin
g
(n%)
Norm
al
Spoila
ge
Abnor
mal
Spoila
ge
Total
100
%
CS – has FG and COGS only
xx 100
x %
n%
xx
x
s%
(inspe
ction)
xx
x
s%
(inspe
ction)
UT
AF
un
its
EU
P
for
Tin
PS – has RIP and COGS only
100%
EUP
for
mate
rials
S – Has COGS only
Any difference and discrepancies from the records will
BACKFLUSH to the appropriate inventory accounts.
Happens when not all purchases were sold or
something like that
Backflush accounting – the accounting method
used for JIT systems
EUP
for
Conv
ersio
n
Cost
Just in Time and Backflush Accounting
Just-in-Time System
JIT – eliminates not only inventory, but also the process
(includes accounting).




Because the raw materials bought are
immediately put in process.
And goods are not left unsold at EOP because
they already have customers to buy them
(those who previously ordered)
Raw materials will be translated immediately to
Cost of Goods Sold
Eliminating the taxing process, including RM,
WIP and FG accounts, even Labor and Overhead
The only accounts that will be used:
RIP – Raw and In Process
Labor and overhead are squeezed in a single account:
Conversion Cost, which also has Control/Actual and
Allocated.
MANTRA: Whatever you buy, you will sell (ideal).
Triggers – the points where the entry will be made;
basically, the ENTRIES that will be made
Accounting under JIT means you record sales first, then
work back on the inventory accounts you maintain.
Working back – depends on whether you have
RIP, FG, or COGS or your trigger points
PCS – has RIP (purchase), FG (completion),
COGS (sale)
Advantages
Reduces costs by
minimizing warehouse
needs.
Disadvantages
Potential disruptions in
the supply chain,
resulting in failure to
deliver goods on time.
Production runs are
short, which means that
manufacturers can
quickly move from one
product to another
Sudden unexpected
order for goods, for
which raw materials
were not ordered for,
may delay the delivery of
finished products to end
clients
Less money on raw
materials because they
buy just enough
resources to make the
ordered products and no
more.
Spend more on raw
materials, because
suppliers offer high
prices to small orders.
IMPORTANT NOTES:
1. For all sets of trigger points, you’ll need to
record CONVERSION COSTS.
2. Difference between CC Actual/Control and
Allocated can’t be closed to appropriate
inventories because under JIT, there is hardly
any balance in inventory accounts, or even
inventory accounts themselves.
CC Control
COGS (overapplied)
In real practice, JIT system is much simpler.
All materials and conversion costs at ACTUAL COSTS
are recorded under Cost of Goods Sold.
Because in the end, you’ve bought materials and
incurred labor costs since you’ll SELL them to a
customer who ALREADY ordered (sure sale).
Possible questions:
RIP, ending balance (Backflush amount to RIP)
FG, ending balance (Backflush amount to FG)
Total Backflush amount
Adjusted COGS (with OH variance)
COGS
Trigger points
1. Purchase, completion, sale
RIP (Actual)
CC (Actual)
Backflush amount
(Forwarded to RIP and FG
as ending balances)
Therefore,
RIP, ending + FG, ending
under PCS
Purchase (both at Actual Cost)
RIP Control
Accounts Payable
CC Control
Various Accounts
COGS (Standard)
+ underapplied CC
COGS (Actual/Adjusted)
(Accrued Payroll for labor,
Overhead credit entries)
Completion (At Standard Cost)
RIP Actual (purchase)
RIP
RIP Standard (entry
under completion)
RIP, ending
FG (Std)
RIP Control (Std)
CC Allocated (Std)
Why? Because Finished Goods are recorded at Standard
Cost.
FG Standard
(Standard produced units
x total standard average
cost)
FG, ending (unsold)
FG
COGS Standard
RIP & CC Std = Ave. Std cost for Mate/CC x units
produced
Sale (At Standard Cost)
COGS (Std)
FG
Common Value = Goods sold units x total standard
average cost (material and CC)
Adjustment (For Diff. between CC Actual from
Allocated)
2. Purchase, Sale
Purchase (both at Actual Cost)
RIP Control
Accounts Payable
CC Control
CC Allocated
Various Accounts
COGS (underapplied)
(Accrued Payroll for labor,
Overhead credit entries)
Sale (At Standard)
Even when there are completed goods, IGNORE THEM.
We’ll not make entries for them.
Sale (At Standard Cost)
COGS (Std)
FG
Common Value = Goods sold units x total standard
average cost-both material and CC
COGS (Std)
RIP (Std)
Adjustment
CC Allocated (Std)
CC Allocated
COGS Std = Goods sold units x total standard average
cost-both material and CC
COGS (underapplied)
CC Control
RIP Std = Goods sold units x standard average cost for
material
COGS (overapplied)
CC Allocated = Goods sold units x standard average cost
for CC
Adjustment
Shortcut
CC Allocated
COGS (underapplied)
COGS
RIP (Standard)
CC (Actual)
Backflush amount
(Forwarded to RIP and FG
as ending balances)
Therefore,
RIP, ending + FG, ending
CC Control
COGS (overapplied)
Question: Is it assumed that all CC Actual was used in
producing the goods sold?
Because under PCS, what was reconciled was CC
Allocated (for goods PRODUCED), but here, it is the CC
Allocated for goods SOLD.
COGS (Standard)
+ underapplied CC
COGS (Actual/Adjusted)
Herein, CC Control pertains to ALL that was incurred,
while CC Allocated is only for the goods sold, is that
appropriate?
Since we don’t FORMALLY entry the purchase of
materials (at actual cost), we assume in the T-accounts
that we only have the materials at standard cost data.
Short cut:
RIP is non-existent. Therefore, Backflush amount is only
forwarded to FG. Ending.
The same concept with PCS, only that, backflush
amount is only forwarded to RIP, Ending, since we
have no FG under this.
3. Completion and sale
For PCS and PS
Total BACKFLUSH = (COGS Std +/- Overhead variance) –
(RIP Act + CC Act)
Conversion (Actual)
CC Control
Various Accounts
For CS
Total BACKFLUSH = (COGS Std +/- Overhead variance) –
(RIP Std + CC Act)
Completion (Standard)
FG (Standard)
AP (for RIP purchased, Std)
Pricing Decisions: Alternative Costing and
Target costing approach
CC Allocated (Std)
What influences pricing decisions?
1) Customers – how much they are willing to
pay
2) Competitors – how much they price the
product; benchmark
Manufacturing costs – only material, labor, and
OH
3) Costs – Managers who understand the cost
of producing their companies’ products set
prices that make the product attractive to
customers while maximizing their income.
Full costs – manufacturing and other costs
- IDEAL: Balance between quality, cost, and
income
Product profitability = Gross profit [Sales – COGS
(manufacturing costs)] – other costs
Two Bases of Pricing
1) Market-based – prices are influenced
initially by what customers want and how
the products are valued at the market
(competitor prices, market value)
SHORT-RUN
Short-run pricing decisions – projects with time
horizon of less than a year; unlikely to place any
future sales orders
2) Cost-based / Cost-plus pricing – prices
are influenced initially by cost
computations within the company (looks
internally in the company, not solely in the
market; how much the company will spend
to produce. But consider the market forces
as well, reconcile.)
How to make Pricing decisions under Short-Run
Projects?
1. Compute the relevant costs for a pricing
decision.
2. Must consider relevant costs in all business
functions of the value chain, from R&D to
customer service (not just manufacturing
costs).
3. Price to be offered must not be lower than
the relevant cost (per unit). Price low
enough to beat competitors, but high
enough to earn income from relevant costs.
Relevant costs – the costs that will differ between
alternatives (ACCEPT/REJECT) being considered.

Answers: What will differ in material cost?
In labor cost? In overhead cost? In other
costs if we are going to enter the short-run
project?
Relevant cost per unit = total relevant costs / total
number of units
= Minimum price of project for it to be
acceptable to the seller/manufacturer
= Any price below will not be profitable;
Above will be acceptable
Operating Income = Sales (relevant revenue) –
Costs (relevant costs)
***Management must always consider market
forces regardless of which approach is used.
For competitive markets – Usually uses marketbased approach
EX: steel, oil, natural gas (necessities, market
decides prices, neck-in-neck competitions)
For lesser competitive markets – Can use either
market-based or cost-based
Ex: Automobiles, bags, computers
TARGET COSTING (MARKET-BASED
APPROACH)


Life-cycle cost – full cost of product; all future
costs of the product, fixed, variable, manufacturing
or non-manufacturing.
-
LONG-RUN
Long-run pricing decisions – designed to build
long-run relationships with customers based on
stable and predictable prices. A stable price builds
long-run buyer-seller relationships.

The Default pricing decision
Relevant costs for long-run – include ALL future
fixed and variable costs.
Approach to determine a product's lifecycle cost which should be sufficient to
develop specified functionality and quality,
while ensuring its desired profit.
Setting a Target cost – Target price –
Target operating income.
-
where balance of quality and desired profit
is attained
SWEET SPOT – balance among life-cycle
cost, quality, and desired profit
TARGET PRICING


Market based pricing starts with a
TARGET PRICE.
Target price – the estimated price for a
product or service that potential customers
will pay.
PROCEDURES
1. Choosing a target price (based on market
competition, from a competitor, benchmark)
2. Decide a target operating income (TOI).
(percentage based on sales or target price)
3. Derive a target cost per unit by subtracting
target operating income per unit from the
target price.
TC/U = TP/U – TOI/U
4. Compute how much the current full cost
should be decreased to attain target cost.
To cut costs = Current full cost – Target
cost
**Target cost per unit is often lower than the
existing full cost per unit of the product.
***Once Target Cost per unit is identified, company
must plan to achieve that costing.
Elaborative Notes:
Target cost per unit will be obtained from working
back.
From the prospect selling price, decide the target
profit, then deduct the latter from the former.
Seller then must plan properly to actually produce
the product incurring just the target cost.
By: reviewing supplier discounts, cost analysis, or
Reversed engineering: dissect the product of the
competitor, their suppliers, their material costs
(legal, except for phishing)
For target price, consult marketers.
COST-BASED APPROACH
Price = Cost + Markup amount
Markup percent = Gross profit / Cost
Markup amount = Cost x Markup percent
**Mark-up component is not a fixed number and
must be flexible, depending on the behavior of
customers and competitors.
Target Return on investment = Target operating
income
= Percentage of desired return on capital x
Invested capital
Target operating income per unit = Target
operating income / Number of units sold/to be sold