Cost Concept and Cost Flow

Process of management
● Managers need cost information to perform each of these functions
➢ Strategy formulation
➢ Planning
➢ Control
➢ Decision making
➢ Directing
● In each function perform by the management or company we need cost information

Cost
● Is the measure of resources given up to achieve a particular purpose
● It can be an asset and an expense
● It will be an asset if you will pay cash to acquire other good and not yet used
● It will be an expense if you pay for a utilities you have already consumed

In manufacturing firm we have various departments

● production/factory/ manufacturing department
➢ When having an expense we use the account work in process, factory overhead, and raw
materials
➢ Factory overhead is used when the expense is an indirect material or labor
➢ Work in process is used when the expense is a direct material or labor
➢ Raw material is the accounts used when the asset is used to manufacture the good
➢ Expenses incurred from factory overhead and work in process is debited to an inventory
account
➢ The inventory account that was debited will only be an expense once the goods are sold
➢ Expenses incurred here will be considered as cost of goods sold
● Administrative department
➢ Once the expense is incurred we debit the expense
● Selling department/ marketing department
➢ Once the expense is incurred we debit the expense
example :

Manufacturing department Administrative department Selling department

Initial entry: Initial entry: Initial entry:

Raw material xx Office supplies xx Office supplies xx

Cash xx Cash xx Cash xx

Used asset entry: Paying labor: Paying labor:

Work in process xx Office supplies expense xx Office supplies expense xx

Raw material xx Office supplies xx Office supplies xx

Paying direct labor: Paying labor: Paying labor:

Work in process xx Salaris expense xx Salaries expense xx

 Salaries payable xx Salaries payable xx Salaries payable xx

Paying indirect labor: Paying indirect labor: Paying indirect labor:

Factory overhead xx Salaris expense xx Salaris expense xx

Salaries payable xx Salaries payable xx Salaries payable xx

Product cost
● Are cost associated with goods for sale until the time period during which the product are sold, at
which time the cost become expenses
● Includes direct material, direct labor and factory overhead
● Are inventoriable cost

Period cost
● Are costs that are expensed during the time period in which they are incurred

Expenses
● Are the consumption of assets for the purpose of generating revenue

Cost classifications on financial statements - income statement

● Product cost → once sold becomes → cost of goods sold
● Period cost → once sold becomes → operating expense

Cost classifications on financial statements - balance sheet

Merchandising Manufacturing

Current asset Current asset

● Cash ● Cash
● Receivables ● Receivables
● Prepaid expense ● Prepaid expenses
● Merchandise inventory ● Inventories
➢ Raw materials (incurred by the
factory, those materials waiting to be
processed)
➢ Work in process (different costs:
direct material, direct labor and
factory overhead)
➢ Finished goods (also composed of
direct material, direct labor and
factory overhead)

Types of production processes

Types of production process Description process Example of
manufacturer

Job shop Low volume Disney

Little standardization (used for product that are
Unique products made to order)

Batch Multiple products Caterpillar

Low volume
 Assembly line A few major products Ford
Higher volume

Mass customization High volume Dell

Many standardized components
Customized combination of components

Continuous flow High volume Exxon

Highly standardized commodity products

Manufacturing costs
● The product (cost)
➢ Direct labor
- Cost of salaries, wages, and fringe benefits for personnel who work directly on
manufactured products
- Example: wages paid to an automobile assembly worker and supervising the making
of the automobiles is not considered as direct labor x
➢ Direct material
- Cost of raw material that is used to make, and can be conveniently traced, to the
finished product.
- Example: steel used to manufacture the automobile
➢ Manufacturing overhead
- All other manufacturing cost
- Indirect material - materials used to support the production process. Example is
lubricants and cleaning supplies used in an automobile assembly plant
- Indirect labor - examples are maintenance workers, janitors, and security guards
- Other cost - examples are depreciation on the plant and equipment, property taxes,
insurance, utilities, overtime premium, and unavoidable idle time.

Classification of costs in manufacturing Companies

● Manufacturing cost are often combined as follows:
➢ Prime cost = direct material and direct labor
➢ Conversion cost = direct labor and manufacturing overhead
➢ Product cost = direct material, direct labor and manufacturing overhead
➢ Product cost is not a combination of rime cost and conversion cost because it doubles the
direct labor cost

Manufacturing cost flows

● The total debit of factory overhead account will be closed and be transferred to the work in process
account
● Work in process inventory = direct material, direct labor and manufacturing overhead
● Finished goods inventory = the progress of the materials, labor and other costs has to be 100%
accumulated to be considered done
● Cost of good sold - when the finished good is already sold

Schedule of cost of goods manufactured

Comet Computer Corporation
Schedule of Cost of Goods Manufactured

Raw material inventory, January 1 6,000

Add. purchase of raw materials 134,000

Equals. Raw materials available for use 140,000

 Less. raw material inventory, December 31 5,020

Equals. Raw materials used 134,980

Add. Direct labor (includes all direct labor costs 50,000

incurred during the current period)

Add. Total manufacturing overhead 230,000

Equals. Total manufacturing cost (incurred in 414,980

the current period)

Add. work in process inventory, January 1 (direct 120

material, direct labor and factory overhead -
incurred last period)

Equals. Subtotal (total cost place into process) 415,100

Less. work in process inventory, December 1 100

(unfinished goods)

Cost of goods manufactured 415,000

Computation of Total manufacturing overhead

Total manufacturing overhead

Indirect material 10,000

Add. Indirect labor 40,000

Add. Depreciation on factory 90,000

Add. Depreciation on equipment 70,000

Add. Utilities 15,000

Add. Insurance 5,000

Equals. Total manufacturing overhead 230,000

Cost of goods sold

Comet Computer Corporation
Schedule of cost of goods sold
For the year ended December 31, 20X2

Finished goods inventory, January 1 200

Add. cost of goods manufactured 415,000

Equals. Cost of goods available for sale 415,200

Less. finished goods inventory, december 31 190

Equals. Cost of goods sold 415,010

Income Statement for a Manufacturer

Comet Computer Corporation
Income Statement
 For the year ended December 31, 20X2

Sales revenue 700,000

Less. cost of goods sold 415,010

Equals. Gross margin 284,990

Less. Selling and administrative expenses 174,490

Equals. Income before taxes 110,500

Less. Income tax expense 30,000

Equals. Net income 80,500