ACCOUNTING

Grade 12

CHAPTER 9
COST ACCOUNTING
Theory

Compiled by
Mrs CW Brimecombe
 TABLE OF CONTENTS Page
1. Manufacturing business 1

2. Terminology 3

3. Illustration of baking cupcakes 5

4. Stock accounts 6

5. Manufacturing departments 8

6. Closing transfers 9

7. Production cost statement 11

8. Fixed cost and variable cost 18

9. Break-even point 18

10. Analysis and interpretation 20

11. Cost effect of importing raw materials 21

12. Internal control processes on manufacturing accounts 21

13. Ethics related to manufacturing accounts and corporate 22

governance
14 Types of problems normally encoutered in the 22
manufacturing business

THIS BOOKLET CONSIST OF 22 PAGES

1. MANUFACTURING BUSINESS

§ A business that produces products from raw

materials.
§ Raw materials are transformed into finished or
completed goods that will be available for sale or
consumption.

2. TERMINOLOGY

Raw •All the materials needed in the manufacturing process.

(direct)materials •All the materials directly involved in the process of
manufacturing the goods.
cost

•All the labour directly involved in the manufacturing

Direct labour cost process.

•"#$%&' )*'%$#*+ &,-' + "#$%&' )*'%$#*+ &,-' = 0$#)% &,-'

Prime cost •This is the fist cost to all production.

Indirect material •It does not form part of the manufacturing process but are
still necessary in the production process.
cost •Example: Cleaning materials

•All the labour not directly involved in the manufacturing

Indirect labour cost process.
•Example: Factory floorman, cleaning staff.

Factory overhead •All cost involved in running the factory.

•These cost are not directly involved in the manufacturing
cost process

Selling and •Getting the finished product out to the customers

•Handling of returns
distribution cost •Marketing the finished goods
Administration •It is also known as fixed cost
•Cost incur on running the business.
cost •Example, interest on loan, bank charges.

•These cost remains the same irrelevant of the number of

units produced.
Fixed cost •The cost will be the same even if the business decides to
increase or decrease the number of units.

•These costs vary in direct proportion to the amount of

Variable cost goods produced.
•If the business decides to increase or decrease the number
of units produces, then these costs will change

Cost per unit •The cost for one item.

!"#$% '"(# ") *+",-'#."/
(Unit cost) •0-123+ ") -/.#( *+",-'3,

Break-even •How many units must be produced and sold before the
point business can start making a profit.

Contribution •1%++#23 4$#&% 4%$ 52#' − 7*$#*8+% &,-' 4%$ 52#'

per unit

Mark-up •The profit that will be added to the cost

•9,-' 4$#&% + )*$: 54 = 1%++#23 4$#&%

Selling price •How much we will sell each unit for.

Economies for •The total fixed cost increased but the fixed cost per unit
decreased.
scales •The number of units produced increased, hence, the fixed
cost per unit decreased.
3. ILLUSTRATION OF BAKING CUPCAKES

Raw material or direct material We need to pay for example:

cost. All the ingredients required Water and electricity, stationery,
to make the cupcakes telephone,rates and taxes,
salaries and wages, packing
materials, insurance etc.
Direct labour cost - employees All cost involved in keeping the
making the cupcakes. business operating in the bakery,
Indirect labour cost - the factory office and sales department.
foreman, employees cleaning .
Salaries and wages for office staff
Commission expense for sales staff
Indirect material - we need to
keep the bakery, office and
This is regarded as an ASSET and sales department clean.
will not form part of the cost.
The DEPRECIATION calculated
on equipment and vehicles will be All cost involved in making the
regarded as an expense. cupcakes must be included:
Direct material cost, Direct
labour cost and all indirect cost.
If we are renting, it will form part of Once we know the total cost, we
our cost. can work out the cost per
Floor space will be divided into the cubcake.
baking area, office area and A mark-up will be added to
selling area. calculate the selling price
4. STOCK ACCOUNTS

There are FOUR stock accounts in a Manufacturing business

Raw material Work in process Finished goods Consumables on

stock stock stock hand
• Unprocessed • Unfinished • Products • Indirect
material used goods or finished and material like
to produce partially ready for sale. cleaning
finished goods. completed. • Cost of sales materials
• Raw material • It is still in the calculated in leftover.
issued to the manufacturing the finished
factory to be process goods stock
processed • Used to account.
calculate the
finished goods

+A -
Raw material stock

Balance b/d Returns to suppliers

Purchases, carriage on purchase, Creditors control CJ
import duties, “any additional cost”
Loss of stock GJ
Bank CPJ
Raw materials GJ
Creditors control CJ issued
Balance c/d

Balance b/d

+A -
Work in process stock (Unfinished goods)
Balance b/d Finished goods GJ
GJ stock
Direct material cost
Direct labour cost GJ Balance c/d

Factory overhead cost GJ

Balance b/d
 +A -
Finished goods stock (Ready for sale)

Balance b/d If sales given, use mark-up%

Work in process GJ Cost of sales GJ
stock Balance c/d

Balance b/d

+A -
Consumables on hand/ Indirect materials on hand
Balance b/d Consumables stores/ GJ
Consumables Indirect materials/
Indirect GJ
stores/ materials/
Balance c/d

Balance b/d
b/d

+E -
Consumables stores/ Indirect materials
Consumables GJ Creditors control CAJ
on hand
Bank CPJ Consumables on hand GJ
HCJ Factory overhead cost GJ
Creditors control
Administration cost GJ
Selling and distribution cost GJ
5. MANUFACTURING DEPARTMENTS

The manufacturing process is divided into THREE different departments

FACTORY ADMINISTRATION SELLING AND

DEPARTMENT DEPARTMENT DISTRIBUTION
DEPARTMENT

Office duties are performed in the This department is responsible for

Raw materials are processed
department and include financing advertising, selling and delivery of
to produce finished goods
and investing activities the finished goods to customers

Direct material
Prime cost

cost issued to the factory.

Raw materials Administration Selling and distribution
Examplecost
of cost incurred:
Salaries and wages (Gross and cost
Direct labour cost contributions), Cleaning staff, Office Example of cost incurred: Salaries and
Gross salary and wages + contributions rent, Office telephone, Depreciation on wages (Gross and contributions),
office equipment, Office insurance, Commission paid, Stationery cost,
Water and electricity, Stationery, rates Telephone, Advertising, Delivery
Factory overhead and taxes, bank charges etc. charges, Bad debts, Rent, Depreciation
on delivery vehicle, Water and electricity
cost
Example of cost incurred: Indirect labour
etc.
cost; Indirect material cost; Factory rent,
Factory insurance, Factory maintenance,
Depreciation on factory, Water and
electricity, rates and taxes etc.

TOTAL MANUFACTURING COST

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6. CLOSING TRANSFERS
All EXPENSES is closed off to a cost account AFTER completing adjustments
All COST is closed off to the Profit and Loss account and Work in progress
stock account. Account credit: Expense account
Account debit: Cost account

+E -
Raw materials issued
Direct material cost GJ
Raw materials stock GJ

+E -
Salaries and wages
Total b/f Direct labour cost GJ
Factory overhead cost GJ
Administration cost GJ
Selling and distribution cost GJ

+E -
Example: Insurance / Rent expense / Water and electricity/ “All expense
account”
Total b/f Factory overhead cost GJ
Administration cost GJ
Selling and distribution cost GJ

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 FACTORY DEPARTMENT
Factory overhead cost
Expense Work in progress stock GJ
GJ
Direct material cost
Raw materials issued GJ Work in progress stock GJ

Direct labour cost

Salaries & Wages GJ Work in progress stock GJ
Contributions GJ

+A -
Work in process stock (Unfinished goods)

Balance b/d Finished goods stock GJ

Direct material cost GJ Balance c/d
Direct labour cost GJ
Factory overhead cost GJ
Balance
b/d

ADMINISTRATION DEPARTMENT
Administration cost
Expense GJ Profit and Loss GJ
account

SELLING AND DISTRIBUTION DEPARTMENT

Selling and distribution cost
Expense GJ Profit and Loss GJ
account

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7. PRODUCTION COST STATEMENT
PRODUCTION COST STATMENT
l Prime cost = µ

Direct material cost l + µ

+ Direct labour cost l µ

l Factory overhead cost µ

= Total manufacturing cost µ

+ Work in progress in the beginning µ

µ
− Work in progress at the end of the year (µ )

= Cost of finished goods produced µ

+A -
Work in process stock (Unfinished goods)
Balance b/d Finished goods stock GJ
Direct material cost GJ Balance c/d
Direct labour cost GJ
Factory overhead cost GJ

Balance b/d

NOTE:

§ If the work in progress at the end of the year and the cost of finished goods produced
is not given, then you will need to solve the cost of finished goods produced first by
completing the finished goods note to the production cost statement.

§ If you are not required to complete the COST OF FINISHED GOODS SOLD, then
complete the finished goods stock account by drawing a T-Account.

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NOTES TO THE PRODUCTION COST STATEMENT

Periodic inventory system

DIRECT MATERIAL COST
Opening stock µ
+ Net purchases µ
(Gross purchases minus returns)
+ Carriage on purchases µ
+ Custom duty µ
+ “Any additional cost” µ

µ
− Closing stock (µ)

= Direct material cost µ

+A -
Raw material stock
Balance b/d Returns to suppliers
Purchases, carriage on
purchase, import duties, “any Creditors control CJ
additional cost” Loss of stock GJ
Bank CPJ Raw materials GJ
Creditors control CJ issued
Balance c/d
Balance b/d

NOTE
§ Raw materials issued is equal to the direct material cost.
§ If the raw materials issued is given, and the closing stock balance is not given,
then closing stock becomes the balancing figure.
§ Inventory systems can be incorporated into calculating the value of the closing
stock using:
* First-in-First-Out
* Weighted average

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DIRECT LABOUR COST

Factory wages µ
+ Pension fund contribution µ
+ Medical aid contribution µ
+ UIF contribution µ
+ “Any other contribution” µ

= Direct labour cost µ

+E -
Salaries and wages (Gross)

Total b/f Factory overhead cost GJ

Administration cost GJ
Selling and distribution cost GJ
Direct labour cost GJ

+E -
Contributions
Total b/f Factory overhead cost GJ
Administration cost GJ
Selling and distribution cost GJ
Direct labour cost GJ

Direct labour cost

Salaries & Wages GJ Work in progress stock GJ

Contributions GJ

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Note:
Gross Posted to the salaries and wages account – an EXPENSE to
the business.
− Deductions Indicated in the FUND account – LIABILITY to the business.
Examples: SARS (PAYE), Medical Aid, Pension fund, UIF
etc.
= Nett Indicated IN CREDITORS FOR SALARIES AND WAGES –
LIABILITY to the business.
+ Contributions Always ADDED to the FUND account – any
CONTRIBUTIONS is an EXPENSE to the business. The
business can contribute to all except for SARS(PAYE).
§ Only the gross and contributions is included into the direct labour cost.
§ The deductions will go the fund account which is a liability.
FACTORY OVERHEAD COST
Indirect material cost µ
+ Indirect labour cost µ
+ Depreciation on factory equipment µ
+ Rent for the factory µ
+ Factory water and electricity µ
+ “Any other factory expenses” µ

= Factory overhead cost µ

Factory overhead cost

Indirect material cost GJ Work in progress stock GJ
Indirect labour cost GJ
Depreciation on factory GJ
equipment

Rent for the factory GJ

Factory water and GJ
electricity
“Any other factory GJ
expense”

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ADMINISTRATION COST

Salaries and wages µ

+ Office rent µ
+ Depreciation on office equipment µ
+ Interest on loans µ
+ Insurance µ
+ Bank charges
+ “Any other administration expenses” µ

= Administration cost µ

Administration cost
Salaries and wages GJ Profit and Loss GJ
Office rent GJ
Depreciation on office GJ
equipment
Interest on loans GJ
Insurance GJ
Bank charges GJ
“Any other admin expense” GJ

SELLING AND DISTRIBUTION COST

Commission income µ
+ Rent: Sales department µ
+ Depreciation on sales vehicles µ

+ Delivery expense µ
+ Bad debts µ
+ Water and electricity µ
+ “Any other selling and distribution expense” µ

= Selling and distribution cost µ

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 Selling and distribution cost

Commission income GJ Profit and Loss GJ

Rent: Sales department GJ
Depreciation on sales GJ
vehicles
Delivery expense GJ
Bad debts GJ
Water and electricity GJ
“Any other selling and GJ
distribution expense”

COST OF FINISHED GOODS SOLD

Opening stock finished goods µ

+ Cost of finished goods produced during the year µ

µ
− Closing stock of finished goods (µ)

= Cost of finished goods sold/ Cost of sales µ

+A -
Finished goods stock (Ready for sale)

Balance b/d If sales given, use mark-up%

Work in process GJ Cost of sales GJ

stock Balance c/d

Balance b/d

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ABRIDGED STATEMENT OF COMPREHENSIVE INCOME

COST OF FINISHED GOODS SOLD STATEMENT OF COMPREHENSIVE INCOME

Opening stock finished goods µ Sales µ
Cost of finished goods produced during the year µ − Cost of finished goods sold/ Cost of sales (µ)
µ = Gross profit µ
Closing stock of finished goods (µ) + Other cost µ
Cost of finished goods sold/ Cost of sales µ Administration costs µ

ADMINISTRATION COST Selling and distribution costs µ

Salaries and wages µ = Net profit µ

Office rent µ Trading account

Bank charges µ Cost of sales GJ Sales GJ
Profit and loss GJ
“Any other administration expenses” µ account
Administration cost µ Profit and loss account
Administration cost GJ
SELLING AND DISTRIBUTION COST Trading account GJ
Selling and GJ
Commission income µ distribution cost
(Net profit) GJ
Rent: Sales department µ
Sole Trader – the net profit will be closed off to Capital
“Any other selling and distribution expense” µ Companies – the net profit will be closed off to the
Appropriation account
Selling and distribution cost µ

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8. FIXED COST AND VARIABLE COST

FIXED COST VARIABLE COST

The cost remains the same The cost varies in direct proportion
irrespective of the number of units to the amount of goods produced
produced

Factory overhead cost (FOHC) Direct material cost (DMC)

Administration cost (AC) Direct labour cost (DLC)

Selling and distribution cost (SDC)

9. BREAK-EVEN POINT
CALCULATING THE BREAK-EVEN POINT
%&'"( *+,-
!"# =
*+.-/&!0-&+. #"/ 0.&-
(,233456 78492 728 :54; − =>84>?32 9@A; 728 :54;)
= :54;A
PROOF THE BREAK-EVEN POINT

.:E?28 @F :54; A@3G × A233456 78492 728 :54;

Contribution
.:E?28 @F :54;A A@3G × I>84>?32 9@A; 728 :54;
-@;>3 F4J2G 9@A;
#8@F4;/D@AA = 0

ADDITIONAL PROFIT
C((&-&+.CD #/+%&-
*+.-/&!0-&+. #"/ 0.&-
(,233456 78492 728 :54; − =>84>?32 9@A; 728 :54;)
= :54;A

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 or
%&'"( *+,- + C((&-&+.CD #/+%&-
*+.-/&!0-&+. #"/ 0.&-
(,233456 78492 728 :54; − =>84>?32 9@A; 728 :54;)
= :54;A
∴ "#$ &'()*' +,,-.-)/+0 1*)(-. − "#3 +(.'* +,,-.)/+0 1*)(-.
= 5,,-.-)/+0 6/-.7

NOTE: ALWAYS ROUND UP

COMMENTING ON THE BREAK-EVEN POINT

§ Compare the BEP from last year to this year.

§ Compare the number of units produced from last year to this year.

§ Compare the BEP with the number of units produced to determine if the business is
breaking even or making a profit/loss.

§ Quote figures to support your answer.

CURRENT YEAR PREVIOUS YEAR

BREAK-EVEN BREAK-EVEN
POINT POINT

NUMBER OF NUMBER OF
UNITS PRODUCED UNITS PRODUCED

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10. ANALYSIS AND INTERPRETATION

Direct material •
!"#$%& ()&$#")* %+,&
cost per unit -+&)* ./"&, 0#+1.%$1

Direct labour cost • !"#$%& *)2+.# %+,&

per unit -+&)* ./"&, 0#+1.%$1

Total direct cost •

-+&)* 1"#$%& %+,&
per unit -+&)* ./"&, 0#+1.%$1

Factory overhead • 3)%&+#4 +5$#6$)1 %+,&

cost per unit -+&)* ./"&, 0#+1.%$1

Cost of finished •
7+,& +8 0#+1.%&"+/ +8 8"/",6$1 9++1,
goods per unit -+&)* ./"&, 0#+1.%$1

Administration cost !"#$%$&'()'$*% ,*&'

per unit • -*'). /%$'& &*."

Selling and 01..$%2 )%" "$&'($3/$'*% ,*&'

distribution cost per • -*'). /%$'& &*."
unit

Variable cost per unit

• "#$ &'( )*+, + ".$ &'( )*+, +
/"$ &'( )*+,

Fixed cost per unit • 012$ &'( )*+, + 3$ &'( )*+,

0).1&
Selling price per unit •
4*. *6 /%$'& &*."

Note:
§ The total cost of finished goods is equal to the total manufacturing cost if there is no
opening balance and closing balance for work in progress.
§ Always look for instructions if the number of units sold is the same as the number of
units produced when completing unit cost.

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11. COST EFFECT OF IMPORTING RAW MATERIALS
[GDE Notes]

§ Exchange rate fluctuations

§ Import duties changing in future
§ Time lags for imports & returns
§ Customers may be lost if they have to wait for a long period
§ The quality of raw material may not meet the requirements of the business and that
will affect productivity
§ Possibility of job losses in local industries
§ Support for local businesses / negative effect on the economy
§ Transport costs may increase the cost price of goods

12. INTERNAL CONTROL PROCESSES ON MANUFACTURING

ACCOUNTS
[GDE Notes]

§ Strict control should be kept on the factory floor to prevent theft of goods/raw
material
§ The employees should be trained on the production process and be supervised to
prevent shoddy workmanship or waste of raw material
§ Material bought should be of good quality and that will minimise waist in the
manufacturing plant
§ Control of raw material bought ,goods in process and finished goods should follow
a strict procedure
§ The documents of different stages of material should be kept accurately, e.g. Raw
material, work-in process etc.
§ Internal audit of stock should be regularly conducted
§ The correct tendering process should be followed to avoid nepotism and delivery of
inferior material

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13. ETHICS RELATED TO MANUFACTURING ACCOUNTS AND
CORPORATE GOVERNANCE
[GDE Notes]
§ Manufacturing companies should prioritise safety of employees at all times.
§ Fair remuneration packages should be offered to employees.
§ The manufacturing factory should dispose the waist material responsibly in a way
that the community and environment will not be affected.
§ Natural resources should not be depleted, companies should use raw material in a
sustainable manner.
§ Companies manufacturing goods should at all cost avoid the price fixing.
§ Manufacturing industries are encouraged to buy raw material obtainable from local
industries if the quality is of good standard in order to improve local trade.
§ The deliberate product shrinkage to gain higher profits, this could lead to legal
action against the business.
§ The use of inferior material in order to gain higher profits.

14. TYPES OF PROBLEMS NORMALLY ENCOUTERED IN THE

MANUFACTURING BUSINESS
[GDE Notes]

INCREASE § Train the workers/ Skills development

IN DIRECT § Increase supervision
LABOUR § Control overtime/supervise normal time
COST § Set targets

INCREASE § Look for cheaper materials or suppliers

IN DIRECT § Buy in bulk
MATERIAL § Use local suppliers (closer)
COST § Control wastage of raw material
When responding to problem solving questions,
always quote and compare figures, percentages etc.
The cost of RAW MATERIAL can increase because of the following
factors:
§ Due to the effects of inflation, price of raw materials increased.
§ Storage costs.
§ Increase in carriage/transport cost
§ Increase in insurance of goods etc.
§ Increase in exchange rates
§ Increase in import duties

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