CHAPTER 13
COST ACCOUNTING AND
REPORTING SYSTEMS
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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?
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Learning Objectives
4. 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?
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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?
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Learning Objective 1
• What is the role of cost
accounting as it relates to
financial and managerial
accounting?
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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
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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 performance
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Learning Objective 2
• How does cost management
play a strategic role in the
organization’s value chain?
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Strategic,
Operational, and
Financial Planning
Implement Plans
Planning and Control Cycle
Performance
Analysis:
Plans vs.
Actual Results
(Controlling)
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Data Collection and
Performance Feedback
Executing
Operational
Activities
(Managing)
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Cost Management
• Cost management is the process
of 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
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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 support
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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
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Cost
Object
$$$’s
Cost
Pool
Cost Object
Cost
Object
Cost Assignment
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Learning Objective 3
• What is the difference between
direct and indirect costs, and
how do they relate to a product
or activity?
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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
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Learning Objective 4
• What is the difference between
product costs and period costs,
and what are the three
components of product cost?
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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
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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
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Learning Objective 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?
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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
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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
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Raw Materials Inventory
Purchases
of raw
materials
Work in Process Inventory
Materials used
Materials used
in production
Direct labor
incurred
Manufacturing
overhead
applied
Finished Goods Inventory
Cost of goods
manufactured
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Cost of
manufactured
goods sold
Cost of
products
manufactured
Cost of Goods Sold
Cost of goods
sold as an
expense on
the income
statement
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Learning Objective 6
• How are predetermined
overhead application rates
developed and used?
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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
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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
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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
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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
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Learning Objective 7
• What is the presentation and
interpretation of a statement of
cost of goods manufactured?
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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
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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
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Firm XYZ
Statement of Cost of Goods Manufactured
For the Month of XX
Raw Materials:
Inventory, Beginning
$XX
Purchases for the month
XX
Raw materials available for use
$XX
Less: Inventory, Ending
XX
Cost of raw materials used
Direct labor costs incurred for the month
Manufacturing overhead applied for the month
Total manufacturing cost for the month
Add: Work in process, beginning
Less: Work in process, ending
Cost of goods manufactured for the month
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$XX
XX
XX
$XX
XX
XX
$XX
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Cost of Goods Sold
• Cost of goods manufactured is
added to beginning finished goods
inventory to arrive at cost of goods
available for sale
• Ending finished goods inventory is
subtracted from cost of goods
available for sale to arrive at cost of
goods sold
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Firm XYZ
Statement of Cost of Goods Sold
For the Month of XX
Beginning inventory
Cost of goods manufactured
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
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$XX
XX
$XX
XX
$XX
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Firm XYZ
Income Statement
For the Month of XX
Sales
Cost of goods sold
Gross profit
Selling, general, and admin. expenses
Income from operations
Interest expense
Income before taxes
Income tax expense
Net income
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$XX
XX
$XX
XX
$XX
XX
$XX
XX
$XX
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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
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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
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Learning Objective 8
• What is the difference between
absorption and direct (or variable)
costing?
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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
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Learning Objective 9
• What are activity based costing
and activity based management?
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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
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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
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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
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