Module in Cost

Accounting and Control

 Preface

This course is designed to orient the students to cost accounting and

control framework of business. It exposes the students to different product costing
procedures. It includes accounting procedures for main products and incidental
products that are manufactured simultaneously in a common process. It
encompasses the costing techniques and procedures for companies that use
standard costs as a benchmark for costing the products. The students must be able
to assemble financial statements prepared under standard costing procedures. While
its emphasis particularly dwells on the manufacturing concern, it also highlights the
elements and features applicable to the non-manufacturing concerns. The course
aims to help the student understand the factors and aspects necessary to come up
with an effective cost system. It explores on the details of the key components of
manufacturing from one department to the next, specifically materials, labor, and
overhead and transcends into the understanding the flow of costs during the work in
process stage until the completion of goods. It will aid them in the production of the
necessary deliverables and reports pertinent to the cost system. It will enhance the
analyzing and problem solving skills of students whilst teaching them the requisites of
assessing the role of cost accounting as an indispensable tool for management in
planning and control for decision making. Also discussed is the impact of
environmental concerns on cost.

This module is designed for the students to be able to achieve the following
learning outcomes:

1) Discuss the importance and use of the different cost accounting methods in
formulating financial reports.

2) Explain in detail how different costing systems add materials, labor, and
overhead costs to a product at each stage of the manufacturing cycle.

3) Apply cost accounting methods and technics used to predict and analyze
costs, and analyze cost variances arising from the production process.

4) Demonstrate knowledge and skills of cost accounting as a management tool

for planning, controlling, and making decisions.

This module consists of twelve parts where modules 1-7 are the topics for the
midterm and modules 8-12 covers topics for the finals. Discussions provided are
not extensive so the students are still advised to read additional references as
suggested at the end of this module.
 Table of Contents

Preface

Module 1: Cost Accounting Fundamentals

Module 2: Cost Terms, Concepts, Classifications

Module 3: Cost Behavior, Analysis, and Use

Module 4: Cost-Volume-Profit Analysis

Module 5: Accounting for Cost-Flows

Module 6: Job Order Costing

Module 7: Process Costing

Module 8: Special Production Issues

Module 9: Just-In-Time and Backflush Costing

Module 10: Activity-Based Costing

Module 11: Accounting for Joint and By-Products

Module 12: Standard Costing

References
 Module 1

INTRODUCTION TO COST ACCOUNTING

Introduction

Because it supplies vital financial and economic information, accounting is

often considered as the language of business. It provides necessary information
needed by various users such as business managers and owners in decision-
making. Accounting has many areas which provides different information both to
external and internal users. Cost accounting provides useful inputs in the both
planning and controlling functions of management since it gives us valued
information in strategy setting and in its implementation.

This section introduces the students to the definition of cost accounting, how
cost accounting differs from and relates to the other fields of accounting and the
importance of cost accounting to business organizations in providing information for
decision-making. This section will also discuss management and cost accounting
standards as well as ethics for management accounting professionals.

Learning Objectives:

At the end of the lesson, the student should be able to:

1. Define cost accounting and relate cost, financial and management accounting
to each other.
2. Identify the scope and objectives of cost accounting.
3. Enumerate the different uses of cost accounting data.
4. Compare cost accounting from other field of accounting

Cost Accounting Defined

Cost Accounting is an expanded phase of general or financial accounting
which informs management promptly with the cost of rendering particular services,
buying and selling a product, and producing product. It is the field of accounting that
measures, records, and reports information about costs.
It is also an area of accounting concerned with cost determination and cost
control.
Scope of Cost Accounting

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 Cost accounting covers the all types of business entities such as
manufacturing, merchandising and service businesses that require information
systems which provide the necessary financial data.
Objectives of Cost Accounting
1. Cost determination. Cost accounting accumulates cost data by products,
processes or services to be able to arrive at unit cost or cost per work
unit.
2. Cost control. Cost accounting sets standards for costs per unit and per
work and are subsequently compared with the figures per actual
operations so that remedial measures may be adopted.
In addition, cost accounting facilitates the evaluation of performance by
management of its planning and control functions. It establishes cost standards for
materials, labor and factory overhead. These standards subsequently serve as
bases in measuring performance and as deterrents to pilferages and unnecessary
wastages of materials and inefficiency of manpower.

Use of Cost Accounting Data

In general, cost data gathered from manufacturing or production provides
management with a basis in making decisions and these may involve the following:
1. Price setting.
2. Choice of product line
3. Make or buy
4. Contraction or expansion
5. Temporary shutdown
In addition, the information produced by a cost accounting system provides a
basis for determining product cost and aids management in planning and controlling
operations.
In management accounting, cost data is beneficial to evaluate the
performance of operations or personnel or as a basis for decision making and to
evaluate the performance of the top management and make decisions about the
organizations.
One of the most important functions of cost accounting is the development of
information which can be used by management in planning and controlling
operations.
Role of Cost Accounting
1. Creating and executing plans and budgets for operating under expected
competitive and economic conditions.

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 2. Establishing costing methods that permit control of activities.
3. Controlling physical quantities of inventory, and determining the cost of
each product or service produced for the purpose of pricing and for
evaluating the performance of a product, department, or division.
4. Determining company costs and profit for an annual accounting period or
a shorter period.
5. Choosing among two or more short-run or long-run alternatives that might
alter revenues or costs.

Comparison of cost accounting from other field of accounting

Financial Accounting is the use of accounting information for reporting to
external parties, including investors and creditors. It primarily concerned with
financial statements for external use by those who supply funds to the entity and
other persons who may have vested interest in the financial operations of the firm.
Management Accounting focuses on the needs of parties within the
organization, such as the managers and/or business administrators.
Cost Accounting, as depicted by the illustration below, is the intersection
between financial and management accounting. Cost accounting provides product
cost information to external parties for credit and investment decisions which can be
taken from the financial statements, the end product of the financial accounting
function. It also provides cost information also to internal parties for planning and
controlling such as standard costs and variances, relevant costs, and budgeting
inputs.

Financial
Cost
Management
Accounting Accounting
Acctg

The following table summarizes the differences between financial accounting and
management accounting
Financial Accounting Management
Accounting
Primary Users External Internal
Primary Organizational Whole (aggregated) Parts (Segmented)
focus
Information Must be: May be:

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 characteristics  Historical
 Quantitative  Current or
 Monetary Forecasted
 Verifiable  Quantitative or
Qualitative
 Monetary or Non-
monetary
 Timely and, at a
minimum,
reasonably
estimated.
Overriding criteria Generally Accepted Situational relevance
Accounting Principles (usefulness)

Consistency Benefits in excess of cost

Verifiability Flexibility
Record keeping Formal Combination of Formal
and Informal

Management and Cost Accounting Standards

Although management and cost accounting do not necessarily need to
conform with GAAP, still, there are standards established and issued as which serve
as directives on the practice of cost and management accounting. These standards
are called “Statements on Management Accounting”, or SMAs issued by the Institute
of Management Accountants or IMA. IMA is a professional organization of cost and
management accounting practitioners recognized internationally. The SMAs do not
necessarily require business organizations to conform to its directives but the
statements are widely recognized and accepted by many accounting professionals.

Ethics for Management Accountant Professionals

Management accounting is pervasive in nature including the organizational
level at which accountants work. Because of this fact, the IMA has come up with
some guidelines to help accountants resolve ethical dilemmas which are called
Standards of Ethical Conduct for Management Accountants. These standards include
the areas of competence, confidentiality, integrity, and objectivity. In the Philippines,
the code of ethics for professional accountants is adopted from the Code of

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Professional Ethics issued by the International Ethics Standards Board for
Accountant (IESBA)

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Name: _________________________________Student #________Score:________
Exercise 1
I – True or False. Indicate whether the following statements are true or false by
inserting in the blank space provide a capital “T” for true of “F” for false.
____ 1. Reports prepared in financial accounting are general - purpose reports,
whereas reports prepared in managerial accounting are usually special
- purpose reports.
____ 2. Managerial accounting internal reports are prepared more frequently
than are classified financial statements.
____ 3. Determining the unit cost of manufacturing a product is an output of
financial accounting.
____ 4. Managerial accounting applies to all forms of business organizations.
____ 5. Controlling is the process of determining whether planned goals are
being met.
____ 6. Managerial accounting information generally pertains to an entity as a
whole and is highly aggregated.
____ 7. Cost account procedures help management in gathering the data
needed to determine product costs and thus generate meaningful
financial statements and other reports.
____ 8. Operation costing is a hybrid costing system often used in repetitive
manufacturing where finished products have common as well as
distinguishing characteristics.
____ 9. Cost accounting is useful to both financial accounting and
management accounting.
____ 10. Management accountants would not prepare reports primarily for
external users.

Exercise 2
II - Multiple Choice Questions. Write the letter of your answer on the space
provided before each number. Choose the best answer.
_____1. In comparing financial and management accounting, which of the
following more accurately describes management accounting information?
a. historical, precise, useful
b. required, estimated, internal
c. budgeted, informative, adaptable
d. comparable, verifiable, monetary

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_____2. Management and financial accounting are used for which of the
following purposes?
Management accounting Financial accounting
a. external external
b. internal external
c. internal internal
d. external internal
_____3. One significant distinction between financial and management
accounting is that
a. financial accounting prepares reports that are primarily for external users.
b. management accounting does not need to comply with SEC
Requirements
c. management accounting is free from government regulations
d. all of the above are true.
_____4. Which of the following statements about financial accounting or
management accounting is incorrect?
a. Financial accounting must follow GAAP.
b. Management accounting is not subject to regulatory reporting standards.
c. Both management and financial accounting are subject to mandatory
recordkeeping requirements.
d. Management accounting needs to be flexible
_____5. Which of the following is true about management accounting?
a. It’s concern is more with the future than is financial accounting.
b. It is less concerned with segments of a company than is financial
accounting.
c. It is more constrained by rules and regulations than is financial
accounting.
d. all of the above are true.
_____6. Modern management accounting can be characterized by its
a. Standardization
b. Complexity
c. Precision
d. Flexibility
_____7. Cost accounting is a broad term that refers to a/an
a. system used for providing the government and creditors with information
about a company’s internal operations.
b. external reporting system that is based on activity-based costs.

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 c. internal reporting system needed by manufacturers to be in compliance
with Cost Accounting Standards Board pronouncements.
d. internal reporting system that provides product costing and other
information used by managers in performing their functions.
_____8. Cost accounting is directed toward the needs of
a. external users. c. regulatory agencies
b. Internal users. d. standard users
_____9. Cost accounting standards
a. are legal standards set by the Institute of Management Accountants for
use in all manufacturing and professional businesses.
b. are set by the Cost Accounting Standards Board and are legally binding
on all manufacturers, but not service organizations.
c. do not exist except for those legal pronouncements for companies bidding
or pricing cost-related contracts with the government.
d. are developed by the Cost Accounting Standards Board, issued by the
Institute of Management Accountants, and are legally binding on CMAs.
_____10. Cost and management accounting
a. require an entirely separate group of accounts than financial accounting
uses.
b. focus solely on determining how much it costs to manufacture a product
or provide a service.
c. provide product/service cost information as well as information for internal
decision making.
d. are required for business recordkeeping as are financial and tax
accounting.

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 Module 2
COST TERMS, CONCEPTS, AND CLASSIFICATIONS

Introduction
Material, labor, and overhead expenditures are all part of every product or
service. The monetary value of resources sacrificed to achieve a goal, such as
acquiring a good or service, is referred to as cost.
The term “Cost” may have different definitions as it is utilized in a variety of
settings and for a variety of purposes. In communicating cost accounting information,
it is but necessary for an accountant to recognize the distinctions between several
types of costs, its computation, and use. This module will provide the important
terminologies for better understanding of cost and management accounting
information.

Learning Objectives:

After finishing this module, the student should be able to:

1. Define the term cost.

2. Explain the nature of cost, cost pools, cost objective, and cost drivers.
3. Identify and explain the various classifications of cost.

Cost defined

Cost is defined as the monetary measure of the amount of resources given up

or used for some purpose. It also the monetary value of goods and services
expended to obtain current or future benefits.

Cost can also be defined as the cash or cash equivalent value sacrificed for
goods and services that are expected to bring a current or future benefit to the
organization.

Cost Pools - Refers to the certain groups where costs are collected into. Cost pools
may be classified by:

1. Type of cost (labor cost in one pool, materials costs in another)

2. By source (department 1, department 2, and so on)
3. Be responsibility manager (manager 1, manager 2, and so on)
Cost Object - A cost object refers to any product, service, or organizational unit to
which costs are assigned for some management purpose. Any item to where costs

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can be traces and that has a key role in management strategy can be considered a
cost object.

Cost Drivers – A cost driver is any factor that has the effect of changing the level of
the total cost. The management of the key cost drivers in the organization is essential
for a firm that competes on the basis of cost leadership.

Classification of Costs:

Cost categories or classifications are required for the production of cost data
to meet management's needs.

1. As to type
a. Product cost - it is a cost cash or cash equivalent value sacrificed for
goods and services that are expected to bring a current or
future benefit to the organization. The product cost of the unit
sold during the period is recognized as expense in the
statement of comprehensive income. The product cost of the
unsold units become the costs of inventory and treated as asset
in the statement of financial position.
b. Period cost - it is a nonmanufacturing cost that include selling,
administrative, and research and development costs. This cost
is expense in the period of incurrence and do not become part
of the cost of inventory.
2. As to function
a. Manufacturing cost
1. Direct manufacturing cost - material and labor. This is also
called as prime cost.
2. Indirect manufacturing cost - manufacturing overhead or
factory overhead cost.
 Prime Cost = Materials + Labor
 Conversion Cost = Labor + Factory overhead
b. Nonmanufacturing cost - all costs which are not incurred in
transforming materials to finished goods.
1. Research and development - incurred in designing and
bringing new products to the market
2. Marketing cost - advertising and promotion expenses
3. Distribution cost - costs incurred in delivering the products to
the customers

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 4. Selling cost - salaries and commission of sales staff and other
selling expenses
5. After-sales cost - costs incurred in dealing with customers
after sales
6. General and administrative cost - all the manufacturing costs
that do not fall under categories above
3. As to traceability/ assignment to cost object
a. Direct cost - cost that is related to a particular cost object and can
economically and effectively be traced to that cost object.
b. Indirect cost - cost that is related to a cost object, but cannot
practically, economically, and effectively be traced to such cost
object. Cost assignment is done by allocating the indirect cost
to the related cost object.
4. For decision-making
a. Relevant cost - future costs that will differ under alternative course of
action
b. Differential costs - difference in costs between any two alternative
courses of action.
1. Incremental cost - increase in cost from one alternative to
another
2. Decremental cost - decrease in cost from one alternative to
another
c. Opportunity cost - income or benefit given up when one alternative is
selected over another.
d. Sunk/past or historical cost - already incurred and cannot be changed
by any decision made now or to be made in the future.
5. As to behavior
a. Variable cost - within the relevant range and time period under
consideration, the total amount varies directly to the change in
activity level or cost driver, and per unit amount is constant. It
means that it increases proportionately when the activity level
increases and decreases when the activity level decreases.
b. Fixed cost - within the relevant range and time period under
consideration, the total amount remains unchanged, and per
unit amount varies inversely with the change in the cost driver.
1. Committed fixed cost - long-term in nature and cannot be
eliminated even for short period of time without

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 affecting the profitability or long-term goals of the
firm.
2. Discretionary or managed fixed cost - usually arise from
periodic decisions by management to spend in
certain fixed costs area. It may be changed by
management from period to period or even during
the period, if circumstances demand such change.
c. Mixed cost - cost that has both variable and fixed component.
d. Step cost - shifts upward or downward by a certain interval or step,
when the activity changes.
Note: Other references may provide additional classifications of costs.

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 Exercises

Exercise 1

Definition of terms. Following are the number of cost terms. Choose the term/s
below that are most appropriately describe the cost identified in each of the following
situations. A cost term can be used more than once.
Variable cost Product cost
Fixed cost Sunk cost
Prime cost Conversion cost
Opportunity cost Period cost

1. Lake Company produces a populate tote bag. The cloth used to manufacture
the tote bag is direct materials and for financial accounting purposes is
classified as a(n) _________________.
2. The direct labor cost required to produce the tote bags, combine with
manufacturing overhead cost, is called _______________________.
3. The company could have taken the funds that is has invested in production
equipment and invested them in interest-bearing securities instead. The
interest foregone on the securities is a(n) _________________________.
4. Taken together, the direct materials cost and the direct labor cost required to
produce tote bags is called ______________________.
5. Formerly, the company produced a smaller tote bag that was not very
popular. Three hundred of these smaller bags are stored in one of the
company’s warehouses. The amount invested in these bags is called a(n)
__________________.
6. Tote bags are sold through agents who are paid a commission on each bag
sold. For financial accounting purposes, these commissions are classified as
a(n) _____________. In terms of cost behavior, commissions are classified
as a(n) ______________.
7. For financial accounting purposes, depreciation on the equipment used to
produced tote bags is a(n) ____________. However, for financial accounting
purposes, depreciation on any equipment used by the company in selling and
administrative activities is classified as a(n) ________________. In terms of
cost behavior, depreciation is usually a(n) ____________________.
8. A(n) __________________ is also known as an inventoriable cost, because
such costs go into the Work in Process inventory account and then into the

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 Finished Goods inventory account before appearing on the income statement
as part of Cost of Goods Sold.
9. For financial accounting purposes, the salary of Lake Company’s president is
classified as a(n) __________________, because the salary will appear on
the income statement as an expense in the time period in which it is incurred.
10. Costs are often classified in several ways. For example, Lake Company pays
P 5,000 rent each month on its factory building. The rent is part of
manufacturing overhead. In terms of cost behavior, it would be classified as
a(n) _______________. The rent can also be classified as a(n)
________________ and as a(n) ___________.

Exercise 2
Classification of Costs as Variable or Fixed and as Selling and Administrative
or Product.
Below are listed various costs that are found in organizations.
1. Hamburger buns in a Wendy’s outlet.
2. Advertising by a dental office.
3. Apples processed and canned by Del Monte.
4. Shipping canned apples from a Del Monte plant to customers.
5. Insurance on a Bausch & Lomb factory producing contact lenses.
6. Insurance on IBM’s corporate headquarters.
7. Salary of a supervisor overseeing production of printers at Hewlett-Packard.
8. Commission paid to Encyclopedia Britannica salespersons.
9. Depreciation of factory lunchroom facilities at a General Electric plant.
10. Steering wheels installed in BMWs.

Required: Classify each cost as being either variable or fixed with respect to the
number of units produced and sold. Also classify each cost as either a selling and
administrative cost or a product cost. Place an X in the appropriate columns to show
the proper classification of each cost.
Cost Behavior Selling and
No Product
Cost Item Administrative
. Variable Fixed Cost
Cost
1
2
3

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 4
5
6
7
8
9
10

Exercise 3
Cost Classification. Listed below are costs found in various organizations.
1. Property taxes, factory
2. Boxes used for packaging detergent produced by the company
3. Salespersons’ commissions
4. Supervisor’s salary, factory
5. Depreciation, executive autos
6. Wages of workers assembling computers
7. Insurance, finished goods warehouses
8. Lubricants for production equipment
9. Advertising costs
10. Microchips used in producing calculators
11. Shipping costs on merchandise sold
12. Magazine subscriptions, factory lunchroom
13. Thread in a garment factory
14. Billing costs
15. Executive life insurance
16. Ink used in textbook production
17. Fringe benefits, assembly-line workers
18. Yarn used in sweater production
19. Wages of receptionist, executive offices
Required: For each item, indicate whether it would be variable or fixed with respect
to the number of units produced and sold; and whether it would be a selling cost, and
administrative cost, or a manufacturing cost. If it is a manufacturing cost, indicate
whether it would typically be treated as a direct cost or an indirect cost with respect to
units of product.

Variable Selling Administrative Product Cost

No. Cost Item
or Fixed Cost Cost Direct Indirect

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Ex. Direct labor V X
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19

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 Module 3
COST BEHAVIOR: ANALYSIS AND USE

Introduction
A given cost’s behavior pattern refers to the way its total cost changes
whenever there is a change in activity level or volume of production, whether it
increases, decreases, or remains constant. In analyzing and identifying cost
behavior, a specific time frame is set and a particular range of activity must be
assumed to be able to use the cost behavior information properly.
There are some costs which may show mixed behavior patterns that’s why it
becomes necessary to separate them into specific behavioral classifications for more
relevant use to decision-makers. Methods to separate mixed costs will be discussed
and some illustrations will be provided in the module.

Learning Objectives:
Upon completing this module, the student should be able to:
1. Discuss and explain the meaning of cost behavior.
2. State how important it is for accountants to understand how costs behave.
3. Describe the behavior of variable costs, fixed costs, and mixed costs in
relation to volume of activity.
4. Compute for the variable cost rate and fixed costs using the high-low method
and method of least squares.

Lesson 1 – Cost Behavior and Cost Behavior Patterns

Cost Behavior Defined

Cost behavior means how a cost will react as changes take place in the level
of business activity. For managers to properly estimate what costs will be under
various operating conditions, they must first grasp how costs behave.

Importance of Understanding Cost Behavior

An understanding of how costs behave is useful for managers in performing
the following functions or activities:
1. Planning – This requires management to make decisions based in part on
expectations as to the future.

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 2. Control – The practice of comparing feedback information to expectations and
then taking action based on the results of that comparison.
3. Cost analysis – This is an important aspect of the planning and control
process. Understanding cost behavior patterns is essential for accurate cost
forecasting.

Types of Cost Behavior Patterns

The assumed range of activity that reflects the company’s normal operating
range is referred to as the relevant range. Within the relevant range, the two most
common cost behaviors are variable and fixed.
1. Variable Costs
A cost that varies in total in direct proportion to changes in activity is a
variable cost. Examples include the costs of materials, wages, and sales
commissions. The total cost varies in direct proportion to changes in activity
while, variable cost is a constant amount per unit.
2. Fixed Costs
In contrast, a cost that remains constant in total within the relevant
range of activity is considered a fixed cost. Many fixed costs are incurred to
provide a firm with production capacity. Fixed costs include salaries (as
opposed to wages), depreciation (other than that computed under the units-
of-production method), and insurance. On a per-unit basis, a fixed cost varies
inversely with changes in the level of activity: the per-unit fixed cost
decreases with increases in the activity level, and increases with decreases in
the activity level.
Types of Fixed Costs
For planning purposes, fixed costs can be classified into (see
definitions in Module 2):
a. Committed Fixed Costs
b. Discretionary fixed costs

3. Mixed Costs (Semi-variable costs)

There are some costs that are neither variable nor fixed. A mixed cost,
for example, contains both a variable and a fixed component. A mixed cost
does not fluctuate in direct proportion to changes in activity or remain
constant with changes in activity on a per-unit basis. A mixed cost is reflected
in an electric bill that includes a fixed payment for basic service (the fixed

21
 component) and a specified amount for each kilowatt-hour of usage (the
variable component).
Linearity Assumption of Cost as to function

Total
Fixed
Variable

Within the relevant range, total variable cost varies directly with the change in
the activity level whereas; the variable cost per unit remains constant.
Within the relevant range, the total fixed cost remains unchanged but the
fixed cost per unit varies indirectly with the change in the activity level.
Lesson 2 – Analysis of Mixed Costs

In understanding costs behavior, costs are assumed to be linear by

accountants rather than curved as viewed by economists. Because of this
assumption, any type of cost within a relevant range of activity can be described
using the general formula for a straight line. The straight-line formula is
y = a + bX
where y = total cost (dependent variable)
a = fixed portion of total cost
b = unit change of variable cost relative to unit changes in activity
X = activity base to which y is being related (the predictor, cost driver,
or independent variable)
Mixed cost have variable and fixed costs component. For purposes of
decision making, mixed cost must be segregated or separated from its variable
component and fixed component.
Formula: TC = FC + VC
Where: TC = Total cost
FC = Total fixed cost
VC = Total variable cost
Formula: VC = variable cost per unit x cost driver; or
VC = bx
Where: b = variable cost per unit
x = cost driver

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 Hence, mixed cost function can also be expressed as:
Formula: TC = FC + bx

Methods of segregating the fixed and variable component of a mixed cost

include:
1. High - Low Method
2. Scattergraph Method
3. Least Square Method
High - Low Method
The high - low method is analyzed in two different points - high and low
points. The determination of the points is based on the activity level and not their
cost.
Steps to compute the fixed and variable cost using high-low method:
1. Identify the highest and lowest activity level or cost driver.
2. Subtract the activity level and the cost of each point.
3. Compute for the variable cost.
Formula:
Variable cost per unit = Difference of cost / Difference in activity level
Total Variable Cost = Variable cost per unit x activity level
4. Compute for the fixed cost.
Formula: Total Cost - Variable cost = Fixed Cost
Example:
Cos Hours
t
January 640 34,00
0
February 620 30,00
0
March 620 34,00
0
April 590 39,00
0
May 500 42,00
0
June 530 32,00
0
July 500 26,00

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 0
August 500 26,00
0
Septembe 530 31,00
r 0
October 550 35,00
0
November 580 43,00
0
December 680 48,00
0
Step 1:
Cost Activity Level
High P 680 48,000 hours
Low 500 26,000 hours

Step 2:
Cost Activity Level
Step 3:
High P 680 48,000 hours
Difference in cost
Low by: difference in activity level
Divided 500 26,000 hours
Difference
Variable cost per unit P 180 22,000 hours

Step 4:
High Low
Total Cost 680 500
Less: Variable Cost
(48,000 x 0.0082) 393.6
(26,000 x 0.0082) ____ 213.2
Total Fixed Cost 286.4 286.4

Scattergraph Method
Under this method, the cost being analyzed is called the dependent variable
plotted in the vertical line called the y-axis while, associated activity is called the
independent variable and plotted in the horizontal line called x-axis.
A linear equation, the cost function, will then be extracted out of the lines
produced by plotting the values in the graph. This method is less commonly used
compared to the high-low method and least squares method.

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Method of Least Square
It is sometimes called as regression analysis. It determines mathematically a
line of best fit, or linear regression line, through a set of points. The regression line
minimizes the sum of the squares of the deviations of each actual plotted point from
the point directly above or below it on the regression line.
Formula:
(1) Y = a + bx

∑ Y =na+b ∑ x
(2)

(3) ∑ XY =∑ xa+ b ∑ x
2

Steps:
1. Compute for the variable cost by the process of elimination or substitution.
2. Compute for the fixed cost using cost formula.
3. Compute for the total cost.
Example:
Using the Cutting and Mounting Department data for the Indianapolis Division of
Alexander Polymers International the following calculations can be made:
x y xy x2
4,800 $ 192 $ 921,600 23,040,000
9,000 350 3,150,000 81,000,000
4,900 186 911,400 24,010,000
4,600 218 1,002,800 21,160,000
8,900 347 3,088,300 79,210,000
5,900 248 1,463,200 34,810,000
5,500 231 1,270,500 30,250,000
∑ 43,600 $1,772 $11,807,800 293,480,000
The mean of x is 6,228.57 (43,600 / 7) and the mean of y is 253.14 (1,772 / 7). Thus,

25
 Thus, the b (variable cost) and a (fixed cost) values for the department’s utility
costs are $0.035 and $35.14, respectively. By using these values, one can now
predict costs for each actual activity level.

26
 Exercise 1

True or False. Identify the following statements as either true or false. Write “T”
for true and “F” for false in the space provided before each item.

_____1. Expired cost refers to the portion of an asset's value that appears on
the balance sheet.
_____2. Expired cost refers to the portion of an asset that has been consumed
over time.
_____3. As output increases, a variable cost remains constant per unit.
_____4. Fixed costs, on a per unit basis, do not alter as production changes.
_____5. It's easy to trace an indirect cost back to a cost object.
_____6. Variable costs are seen as linear by accountants and economists.
_____7. On a per unit basis, fixed cost varies directly with production.
_____8. As long as you remain within a certain range, the variable cost per unit
is constant.
_____9. Variable cost per unit does not change with changes in production
volume.
_____10. A mixed cost is a cost that rises or falls when activity varies by a
specified interval.

Exercise 2

Instructions: Give what is/are required under each of the given problem
below. Show your complete solution, in good form, using a separate sheet
of paper.

1. The Del Luna Hotel, has accumulated records of the total electrical costs of
the hotel and the number of occupancy-days over the last year. An
occupancy-day represents a room rented out for one day. The hotel’s
business is highly seasonal, with peaks occurring during the ski season and
in the summer.
Occupancy-Days Electrical Costs
January 1,904 4,207
February 1,736 4,127
March 960 2,857
April 2,356 5,083
May 744 2,696
June 360 1,871
July 2,406 5,148

27
 August 2,108 4,670
September 124 1,588
October 840 2,691
November 1,364 3,529
December 720 2,454
Required: Estimate the fixed cost of electricity per month and the variable cost of
electricity per occupancy-day using the high-low method.

2. Diego Rental Car offers rental cars in an off-airport location near a major
tourist destination. Management would like to better understand the behavior
of the company’s cost. Out of those costs is the cost of washing cars. The
company operates its own car wash facility in which each rental car that is
returned is thoroughly cleaned before being released for rental to another
customer. Management believes that the costs of operating the car was
should be related to the number of rental returns. Accordingly, the following
data have been compiled.
Month Rental/Returns Car Wash Cost
January 2,421 11,865
February 2,380 10,825
March 2,725 12,422
April 2,586 11,332
May 3,281 14,419
June 2,968 13,850
July 3,489 15,738
August 3,353 14,935
September 2,876 11,889
October 3,057 13,536
November 2,983 13,796
December 2,735 12,683

Required: Estimate the fixed cost and variable cost elements of monthly car
wash costs using least-square method. Round the fixed cost element to the
nearest dollar and the variable cost element to the nearest centavo.

28
 Module 4

COST-VOLUME-PROFIT RELATIONSHIPS

Introduction

An understanding of Cost-Volume-Profit relationships is helpful for managers

when deciding over product pricing, estimating future costs, appropriate product mix
and even as to what marketing strategy to employ, among others. Hence, an analysis
of how the cost, volume, and profit of a product relates to each other is vital tool used
in many business organizations. This section will help students be able to
understanding the how cost, volume ad profit relates to each other, explain the
meaning of contribution margin, breakeven point, and margin of safety, compute for
their amounts, construct the break-even chart and explain the significance of the
breakeven point.

Learning Objectives:

Upon completing this module, the student should be able to:

1. Discuss the concept of cost-volume-profit relationship and the importance of

understanding them.
2. Compute contribution margin, breakeven point, and margin of safety and
analyze the results.
3. Construct the break-even chart and explain the significance of the breakeven
point.
4. Make decisions based on CVP analysis conducted.

Lesson 1 – Basics of Cost-Volume-Profit Analysis

Cost-Volume-Profit analysis is one of the most powerful tools used by managers

to help them understand the interrelationship between cost, volume, and profit. In
applying the CVP analysis, the following relationships are established:

a) Contribution margin per unit or marginal income per unit

Priority is given to covering fixed expenses from the contribution margin. Any
remaining contribution margin means contribution to the operating income.
The formula used is:
CM per unit = Unit selling price – unit variable costs

Contribution margin is shown in the example statement as follows:

29
 Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles) $ 250,000
Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000

b) Contribution Margin Ratio

This is the percentage of contribution margin to total sales. This shows

how contribution margin will be affected by a given peso change in total sales.
This ratio is computed as follows:

CM Ratio = Contribution Margin / Sales

CVP Analysis and Breakeven Point

Many business plans usually start with the determination of the break-even
point. Breakeven point is the level of sales volume where total revenues and total
expenses are equal. At this point, there is neither profit nor loss. This point can be
determined using the relationships established using the CVP analysis. The following
formula can be used to compute the breakeven point.

1) Breakeven point (units) ¿ Total ¿ Costs ¿

Contribution Margin Per Unit
2) Breakeven point (pesos) =

Total ¿Costs ¿
1−(Variable costs/ Sales)
Variations of the formula derived for breakeven point computation for multiple
product firms are discussed in managerial accounting subjects.

The Breakeven Graph

An example of the breakeven graph is shown on the following page.

The break-even point is where the total revenue and total expenses lines
intersect. In this case, break-even is 400 bikes sold, or sales revenue of $200,000.
The profit or loss at any given sales level is measured by the vertical distance
between the total revenue and the total expenses lines

30
Illustrative Problem:

GOT Corporation provided the following information:

Total Per Unit

Net Sales 500,000 10
Variable Costs 300,000 6
Contribution Margin 200,000 4
Fixed Costs 150,000 3
Net Profit 50,000 1

Computation of the Breakeven Point is:

P 150,000
BEP (units) =
P 10−P 6

= 37,500 units

P 150,000
BEP (peso) =
40 %

= P375,000

The Breakeven Graph is constructed as follows:

31
 Lesson 2 – Margin of Safety

The margin of safety helps management assess how far above or below the
break-even point the company is currently operating. To calculate the margin of
safety in dollars, we take total current sales and subtract break-even sales.

The margin of safety can also be used as a ratio, a percentage of sales:

safety ratio = Margin of safety / Actual or Planned Sales

Illustrative Problem:

Hidilyn Company’s budget for the coming year revealed the following unit data:

Budgeted net income for the year P875,000

Unit costs:
Variable Fixed
Manufacturing cost 14.00 12.00
Selling cost 2.50 5.50
General cost 0.25 7.00
Total 16.75 24.50
Unit Selling price P50
Required:

1. Determine the budgeted sales volume in units.

2. Determine the margin of safety in peso amount and percentage.

Solution:

1. Budgeted sales volume (units) = Total Budgeted Net Income / Net Income per unit
= P875,000 / P50 – P41.25
= P875,000/P8.75
= 100,000 units
2. a. Margin of Safety = Budgeted Sales – Breakeven Sales
= P5,000,000 – {(P24.50 x 100,000) / 66.5%}
= P5,000,000 – P3,684,211
= P1,315,789

b. Margin of Safety Ratio = P1,315,789 / P5,000,000

= 26%

32
 Exercises

I – TRUE/FALSE. Write True if the given statement is correct and False if the
statement is incorrect.

_____1. A company’s break-even point is the level where total revenues equal total
costs.
_____2. Absorption costing is more useful than variable costing in determining a
company’s break-even point.
_____3. Variable costing is more useful than absorption costing in determining a
company’s break-even point.
_____4. Total variable costs vary directly with levels of production.
_____5. Variable costs per unit vary directly with levels of production.
_____6. Variable costs per unit remain unchanged with levels of production.
_____7. Total fixed costs remain unchanged with levels of production.
_____8. Total fixed costs vary inversely with levels of production.
_____9. Fixed costs per unit vary inversely with levels of production.
_____10. Fixed costs per unit remain constant with levels of production.
_____11. Break-even point may be expressed in terms of units or dollars.
_____12. Dividing total fixed costs by the contribution margin ratio yields break-
even point in sales dollars.
_____13. Dividing total fixed costs by the contribution margin ratio yields break-
even point in units.
_____14. After the break-even point is reached, each dollar of contribution
margin is a dollar of before-tax profit.
_____15. After the break-even point is reached, each dollar of contribution
margin is a dollar of after-tax profit.
_____16. When using CVP analysis to determine sales level for a desired
amount of profit, the profit is treated as an additional cost to be covered.
_____17. When computing profit on an after-tax basis, it is necessary to divide
the pretax profit by the effective tax rate.
_____18. When computing profit on an after-tax basis, it is necessary to divide
the pretax profit by (1 - effective tax rate).
_____19. On a CVP graph, the total cost line intersects the y-axis at zero.
_____20. On a CVP graph, the total variable cost line intersects the y-axis at
zero.

33
II – COMPLETION. Fill in the blank provided with the correct word or phrase.

1. The level of activity where a company’s total revenues equal total costs is
referred to as the ______________________________.
2. Contribution margin divided by revenue is referred to as the
_______________________.
3. A process that focuses only on factors that change from one course of action
to another is referred to as __________________________________.
4. The excess of budgeted or actual sales over sales at break-even point is
referred to as _________________________________.
5. The relationship between a company’s variable costs and fixed costs is
referred to as its ______________________________.
6. The __________________________________ is computed by dividing the
contribution margin by profit before tax.
7. The formula for margin of safety is
________________________________________.
III – Problems

1. Panko's Pickles Inc. estimates sales of 500,000 units at $5 per unit. Variable
costs generally equal $1 per unit. Fixed expenses for this planned sales level
would equal $2 per unit.
Required: Compute the following (round all answers to the nearest whole
number):
c) Estimated profit for the planned level of sales
d) Break-even point in units and dollars
e) Margin of safety ratio (M/S)
f) Increase in profit that would result from a 10% increase in sales
g) Profit as a percentage of the planned level of sales
h) Construct the Breakeven Graph.

2. Contribution Margin; Break-Even Sales in Dollars. The management of Ivory

Coast Products Co. is presented with the following data:

Sales........... $500,000
Direct materia$................................................................60,000
Direct labor.....................................................................90,000
Factory overhead 100,000 250,000

34
Gross profit 250,000

Marketing expense......................................................................70,000
General expenses.....................................................................100,000 170,000
Net income............................................................................................. $ 80,000

Fifty percent of factory overhead is fixed, while 40% of marketing expenses and all
general expenses are fixed.
Required:
1. Compute the contribution margin ratio.
2. Compute the break-even point in sales dollars.
3. New factory equipment may be purchased that will not affect total costs at this
sales level but will increase fixed factory overhead costs to 75% of factory
overhead. Assuming that this purchase is made, show its effect by re-
computing the answer to (1).
4. Assuming that the new factory equipment is purchased, show its effect by
recomputing the answer to (2).
(Round all percentages to the nearest tenth of a percent and all dollar amounts to the
nearest whole doll.

35
 Module 5
ACCOUNTING FOR COST FLOWS
Introduction
Every business organization utilizes an accounting system that serves people
both inside and outside the organization. Cost accounting systems are generally
used for cost accumulation and cost assignment to products and services. Cost
accounting is concerned with recording and measuring cost elements as the related
resources flow through the production process. Information gathered from cost
accounting provides data necessary for the preparation of financial statements. This
chapter will introduce us to the cost accounting cycle and to the different methods of
cost accumulation. Though all types of business organizations adopt a cost
accounting system, the focus of the discussions would be for a manufacturing type of
business organization.

Learning Objective:
After completing the module, the student should be able to:
1. Discuss the cost accounting cycle.
2. Present and discuss the flow of manufacturing costs.
3. Prepare the cost of goods sold statement for a manufacturing entity.
4. Distinguish the different kinds of cost systems.

Lesson 1 – The Cost Accounting Cycle

The manufacturing process involves the physical arrangement of the factory

and the decision-making needs of manager constitute the basis for determining how
costs will be accumulated.

The cost accounting cycle starts when the entity acquires assets, raw
materials, to be used for in the production of a certain product. During production,
raw materials are purchased and held in Material Inventory. Materials needed in the
production are requisitioned to be placed in process. Some other manufacturing cost
such as direct labor and factory overhead are incurred and during the conversion
process. Upon completion of the process, it will be moved to finished goods inventory
and once sold it will be accounted for as Cost of Goods Sold.

36
 Typically, the general ledger accounts for manufacturing costs are Materials,
Payroll, Factory Overhead Control, Work in Process, Finished Goods and Cost of
Goods Sold. These accounts are used to recognize and measure the flow of costs,
from the acquisition of materials, to factory operations to the cost of products sold.

MANUFACTURING COST FLOW

The figure below shows the flow of cost through the accounting system. Each
arrow depicts a specific type of accounting entry. It illustrates relationship between
the general accounts and cost accounts. When assets are purchased, it corresponds
the recognition in the general accounts. As the factory operates, the accumulated
cost of materials, labor and factory overhead are transferred into work in progress
and it is then transferred to finished goods as the goods are completed. Then it will
be recognized in the cost of goods sold in the general account when the goods are
sold.
The transactions below illustrate the flow of transactions depicted by the
arrows in the figure and its accounting entries:
Transaction Accounting Entries
a. Payments on account Materials
Accounts payable
b. Expenses paid in advance Prepaid Expense
Cash
c. Purchases and improvements of assets Building and equipment
Cash
d. Various payments for resources Various Expenses
Cash

37
e. Payments of wages and salaries Payroll
Accrued Expense
f. Purchase of raw materials and factory Raw Materials
supplies on credit Accounts Payable
g. Recording of payroll Payroll
Accrued Payroll
h. Issuing factory supplies Factory overhead Control
Materials/Factory supplies
i. Incurring various indirect manufacturing Factory overhead Control
costs on credit Materials
Payroll
j. Manufacturing portion of any Factory overhead Control
prepayments that have expired Prepaid expense
k. Manufacturing portion of depreciation Factory overhead Control
Accumulated Depreciation
l. Manufacturing portion of various other Factory overhead Control
resources used Various accounts
m. Charging all types of indirect labor cost Work in process
to production Factory overhead Control
n. Issuing direct materials to production Work in process
Materials
o. Charging manufacturing overhead cost Work in process
to production Payroll
p. Charging direct labor cost to production Work in process
Factory overhead Control
q. Charging cost of completed units to Finished Goods Inventory
finished goods account Work in process
r. Charging cost of goods sold units to the Cost of Goods Sold
cost of goods sold account Finished Goods Inventory

38
 Lesson 2 – Cost of Goods Sold Statement for a Manufacturing Company

The result of operation in a manufacturing concern is reported in the

statement of comprehensive income. The statement summarizes the period’s
operations and show financial performance at the end of the period.
The cost elements incurred during the production is reported in the statement
of comprehensive income as Costs of Goods Sold. Below is the pro-forma statement
of the cost of goods sold:
Raw materials, beg xx
Add: Purchases xx
Materials Available for use xx
Less: Indirect materials used xx
Raw materials, ending xx xx
Raw materials used xx
Direct Labor xx
Factory Overhead xx
Total Manufacturing Cost xx
Add: Work in process, beg xx
Cost of Goods placed in process xx
Less: Work in process, end xx
Cost of Goods Completed xx
Add: Finished Goods, beg xx
Goods available for sale xx
Less: Finished Goods, end xx
Cost of Goods Sold xx

The inventories that are left unsold at the end of the period will be reported in
statement of financial position as part of the current assets.

Lesson 3: The Cost Systems and Cost Accumulation Methods

Costs assigned to units of production may be through the actual cost system,
or normal cost system, or standard cost system.
In an actual cost system, actual direct material and direct labor costs are
accumulated in Work in Process Inventory as the costs are incurred. Actual
production overhead costs are accumulated separately in an Overhead Control

39
account and are assigned to Work in Process Inventory at the end of a period or at
completion of production.
An alternative to an actual cost system is a normal cost system, which uses
actual direct material and direct labor costs and a predetermined overhead (OH) rate
or rates. This costing system uses a predetermined overhead rate (or overhead
application rate) which is a budgeted and constant charge per unit of activity. The
overhead rate is used to assign overhead cost from an Overhead Control account to
Work in Process Inventory for the period’s production or services.
In a standard cost system¸ products, operations, and processes are costed
based on predetermined quantities of resources to be used and predetermined prices
of those resources. The actual costs are compared to the standard costs. If such has
different amounts, a variance will also be recorded and analyzed.
The costs allocated to production may include all manufacturing costs (full
absorption costing) or only the variable manufacturing costs (variable or direct
costing). Full absorption costing includes direct materials, direct labor and factory
overhead whether fixed or variable. Whereas, variable costing includes direct
materials, direct labor and only variable factory overhead.
COST ACCUMULATION
The costs incurred in production may be accumulated based on the following:
1. Job order costing
2. Process costing
3. Blended costing
4. Backflush costing

Job order costing

In job order costing, costs are accumulated for each batch, lot or customer
order. It is used when the products manufactured within a department or cost center
are heterogeneous. It requires that it be practical to physically identify each job
produced and to charge each job with at least some element(s) of its own cost.
Businesses who apply this cost accumulation type are those involved in made-to-
order work in factories, workshops, and repair shops; construction and service
businesses such as medical, legal, architectural, accounting and consulting firm.

Process costing
In process costing, costs are accumulated by production process or by
department. It is used when all worked within a department or other work area are

40
homogeneous, or when there is no need to distinguish among units, or when it is not
practical to do so.
It accumulates all costs of operating a process for a period of time and then
divides the cost by the number of units of product that passed through that process
during the period; the result is a unit cost.
Process costing is applicable to industries such as flour mills, breweries,
chemical plants and textile factories where large quantities of one product or a few
products are produced.

Blended method
In blended method, it is a combination of the above costing methods. In some
manufacturing processes, different units have significantly different direct material
costs, but all units undergo identical conversion in large quantities. In this case, direct
materials costs are accumulated using job order costing, and conversion costs are
accumulated using process costing.

Backflush costing
It is a workable way to accumulate manufacturing costs in a factory or part of
a factory in which processing speeds are extremely fast, such as in a mature Just-in-
Time system.
It is workable because it bypasses the routine cost accounting entries that are
required in subsidiary records for job order and process cost accumulation, thus
saving considerable data processing time.
Comparison of Cost Accumulation Methods
Aspects of
Typical Job order Blended Process Backflush
System
Cost object to Material, to a A process or
A specific
which cost are specific job, to department of A production
job, batch, lot
physically a process or a production facility
or contract
traced department facility
Amount of One job, Material may Thousands or Unlimited
output batch, lot or change for hundreds of
produced contract each job thousands of
before units of output
processing

41
 may change
Material may
Cost elements All cost
All cost differ
that differ in elements may Only material
elements dramatically;
one output to differ by small cost differs
may differ conversion, by
another degree
small degrees
Amount of Moderate
detailed (summarized
accounting High High for each None
done for work department or
in process process)
Source of
Financial and Financial and Financial and
information Visual
physical data physical data physical data
used to control observation
recorded recorded recorded
processing

Enrichment Activity!
Select one product that you usually use everyday. Research on the
manufacturing process of the product you selected and list the possible sources of
material, labor, and overhead cost incurred its production. Your output should include
a short background information about your product.

Exercises

Review Questions
1. Discuss and explain the cost accounting cycle in a manufacturing business
organization.
2. Discuss the complementary relationship between the balance sheet and
income statement.
3. Distinguish actual cost system from normal cost system.
4. Distinguish among the process, job order, blended and backflush cost
accumulation method.

Exercise Problems
1. Marvin Co. has developed the following information for the year ended
December 31, 2018.

42
 Raw materials inventory, January 1 175,000
Purchases 250,000
Raw materials, December 31 125,000
Direct labor 270,000
Factory overhead (120% of direct labor cost)
Work in process inventory, January 1 90,000
Work in process inventory, December 31 120,000
Finished goods inventory, January 1 100,000
Finished goods inventory, December 31 80,000

Required: Prepare a cost of goods sold statement.

2. Ram Co. completed the following transactions for October, 2018.

a) Purchased on account direct materials of P 180,000.
b) The factory payroll was recorded. Direct labor P 60,000; indirect labor P
20,000. Employee payroll deductions were recorded as follows:
Withholding Taxes P 11,200
SSS Premiums 2,400
PhilHealth Contribution 375
Pag-ibig Funds Contribution 1,620
c) Indirect materials of P 20,000 were purchased.
d) Employer payroll tax expense is recorded as follows:
SSS Premiums P 3,600
PhilHealth Contribution 375
Pag-ibig Funds Contribution 1,620
e) Materials issued: Direct materials – P 120,000; indirect materials – P 10,000.
f) Defective materials P 5,000 were returned to vendors.
g) Accounts payable totaling P 148,300, including accrued payroll, were paid.
h) Sundry factory expenses of P 24,900 were recorded as liabilities.
i) Factory overhead was charged to production at 120% of direct labor costs.
j) Goods completed with a total cost of P 180,000 were transferred to finished
goods.
k) Sales were P 210,000 and cost P 140,000 to produce.

Required:
1. Journal entries to record the transactions given above.
2. Statement of cost of goods sold.

43
44
 Module 6
JOB ORDER COSTING

Introduction

Product cost determination is one of the primary roles of cost accounting and
cost accounting systems. Different methods are available to assign value to inventory
and compute for the cost of a product or service. The method chosen depends on the
product or service and the company’s conversion processes. A cost flow assumption
is required for processes in which costs cannot be identified with and attached to
specific units of production. This chapter is the first of a sequence of chapters that
will present methods of product costing.

Learning Objectives:
After finishing this module, the student should be able to:
1. Explain the concept of product costing.
2. Enumerate and explain the factors that should be considered in designing the
product costing systems.
3. Apply the accounting procedures using job-order costing in a manufacturing
company.
4. Prepare journal entries to account for cost flows under job order costing.

Lesson 1 – Product Costing and Job Order Costing System

Product Costing is a process of accumulating, classifying, and assigning

direct materials, direct labor and factory overhead costs to products or services. To fit
a specific firm need, management should keep in mind the following points in
designing the details of product costing systems.

1. The cost-benefit approach is essential.

2. Costing systems should be tailored to the underlying operations
3. Costing systems accumulate costs to facilitate decisions.
4. Costing systems are only one source of information for managers.

The accountant must make three choices, one for each of the three
following categories of costing methods:

45
 (1) The cost accumulation method – job costing or process costing
(2) The cost measurement method – actual, normal, or standard costing
and
(3) The overhead assignment method – volume – based or activity –
based.

The choice of a particular system depends on the nature of the

industry and the product or service, the firm’s strategy and management
information needs, and the costs and benefit of acquiring, designing,
modifying, and operating a particular system.

Job Order Costing - A job order costing system is used by entities that make
(perform) relatively small quantities or distinct batches of identifiable, unique products
(services). For example, job order costing is appropriate for a publishing company
that produces educational textbooks, an accountant who prepares tax returns, an
architectural firm that designs commercial buildings, and a research firm that
performs product development studies. In each instance, the organization produces
tailor-made goods or services that conform to specifications designated by the
purchaser of those goods or services.
The other primary product costing system, a process costing system, is
used by entities that produce large quantities of homogeneous goods. Process
costing is appropriate for companies that mass manufacture products such as bricks,
gasoline, detergent, and breakfast cereal. The output of a single process in a mass
manufacturing situation is homogeneous; thus, within a given period, one unit of
output cannot be readily identified with specific input costs.

Job Order Cost Sheet

This is where the details of a job’s costs for materials, labor, and overhead is
recorded. Each cost sheet collects details for one specific job. A sample form is
presented below but the format may differ from one business organization to another.

46
 Figure 1: Sample Job Order Sheet

In job order costing, cost of direct materials, direct labor, and overhead are
accumulated and charged to each job. As, a result, job costing can be viewed in
three related parts:
 Materials accounting - this maintains material inventory records, charges
direct material to jobs, and charges indirect material to overhead.
 Labor accounting - maintains payroll-related accounts, charged direct labor to
jobs, and charges indirect labor to overhead.
 Overhead accounting accumulates overhead costs, maintains overhead detail
records and charges a share of overhead to each job.
The basics of job order costing involves the following types of accounting
entries:
1. Material purchased
2. Factory labor costs incurred
3. Factory overhead costs incurred
4. Materials used
5. Factory labor costs distributed
6. Estimated factory overhead applied
7. Job completed
8. Product sold

47
The typical flow of costs in a job order costing system is shown by the T-accounts
below.

Figure 2: Production Flow

Lesson 2: Accounting for Cost Flows under Job Order Costing System
___________________________________________________________________

Accounting for Materials

A common practice to account for materials is to use the perpetual inventory
system. Cost accounting for materials involves:
1. Purchase of materials; and
2. Issuance of materials to production.
Purchase of Materials
The journal entry to record purchase of materials is as follows:
Materials xx
Cash or Accounts Payable xx

Issuance of Materials to Production

Direct materials for a job are issued to the factory on the basis of material
requisitions, specifying the job number and type of quantity of materials required.
Entry is as follows:
Work in Process xx
Materials xx
When requisitions are used in issuing indirect materials or supplies the
following is made:
Factory overhead Control xx
Materials xx

Accounting for Labor

Cost accounting transaction for labor involves the:
1. Labor cost incurred
2. Labor cost distribution

48
Labor cost Incurred
For each pay period, the liabilities for wages and other payments are
journalized and posted in the general ledger. The journal entry is:
Payroll xx
Accrued Payroll xx

Labor Cost Distribution

To distribute labor costs to production, labor time tickets are sorted by job,
entered on job cost sheets, and recorded by summary general journal entries. Entry
is as follows:
Work in Process xx
Payroll xx
To distribute indirect labor costs to production, the entry is as follows:
Factory overhead Control xx
Payroll xx
Any indirect labor which is not used for manufacturing will be accounted for
either marketing or administrative expense.

Accounting for Factory Overhead

Cost accounting transactions involving factory overhead are:
1. Actual factory overhead incurred
2. Estimated factory overhead applied
Actual Factory Overhead Incurred
Entry to record the actual incurrence of indirect materials and indirect labor
are as follows:
Factory overhead Control xx
Materials xx
Payroll xx
To record other overhead incurrences which are not in the form of indirect
materials or indirect labor, the appropriate account is credited.

Applied Factory Overhead

Most of the overhead expenses actual costs cannot be readily determined at
the time of the completion of a job. Hence, a predetermined overhead rate is used to
assign cost to factory overhead. This rate is multiplied to the applicable base that a
job uses and the result is the amount of overhead charged to the job. Entry to
charged applied factory overhead to production is as follows:

49
 Work in process xx
Applied factory overhead xx

Applied factory overhead usually is closed to factory overhead control at year-

end. The difference between the actual and applied overhead is accounted for as
either under or over applied factory overhead. If insignificant, the difference is closed
to Cost of goods sold at year-end, otherwise it will be prorated to Work in process,
Finished goods and Cost of Goods Sold. The entries are:
Applied Factory Overhead xx
Under applied FOH
Factory Overhead Control xx
Over applied FOH

Cost of Goods Sold xx

Under/over applied FOH xx

Accounting for Jobs Completed and Product Sold

As jobs are completed, their cost sheets are moved from in-process category
to a finished work file.
Finished Goods xx
Work in process xx
A job for a specific customer can be shipped when completed and thus never
enter finished goods inventory the entry is as follows:
Cost of Goods Sold xx
Work in process xx

When stock on hand is shipped to customer, the finished goods record cards
are updated, sales invoices prepared, and sales and the cost of goods sold recorded,
just as in any perpetual inventory system. The entry is as follows:
Accounts Receivable xx
Sales xx

Cost of Goods Sold xx

Finished Goods xx

50
Illustrative Problem. Job – order costing in a Manufacturing Company
Palmera Company is a manufacturing firm that uses job – order costing. On January
1, the beginning of its fiscal year, the company’s inventory balances were as follows:
Raw materials inventory………. P200,000
Work in process inventory…….. P150,000
Finished goods inventory……… P300,000
The company applies overhead cost to jobs on the basis of machine – hours worked.
For the current year, the company estimated that it would work 750,000 machine –
hours and incur P4,500,000 in factory overhead cost.
I. Prepare journal entries to record the following transactions.
a. Raw materials purchased on account, P 4,100,000.
Raw Materials Inventory……………………4,100,000
Accounts Payable…………………………………4,100,000
b. Raw materials inventory requisitioned and issued for use in
production, P3,800,00 (3,600,000direct materials and P200,000 indirect
materials).
Work in Process Inventory…………………………. 3,600,000
Factory Overhead Control…………………………. 200,000
Raw Materials Inventory……………………. 3,800,000
c. Costs were incurred for employee services: direct labor, P750,000;
indirect labor, P1,100,000; sales commissions, P900,000; and
administrative salaries, P2,000,000.
Work in Process Inventory………………………… 750,000
Factory Overhead Control…………………………1,100,000
Sales Commissions Expense…………………… 900,000
Administrative Salaries Expense………………. 2,000,000
Salaries and Wages Payable…………………….. 4,750,000
d. Sales travel costs, P170,000.
Sales travel Expense……………………………….170,000
Account Payable………………………………… 170,000
e. Utility costs in the factory, P430,000.
Factory Overhead Control…………………….. 430,000
Accounts Payable……………………………. 430,000
f. Advertising costs, P1,800,000.
Advertising Expense………………………… 1,800,000
Accounts Payable……………………… 1,800,000

51
g. Depreciation for the year, P3,500,000 (80% relates to factory
operations, and 20% relates to selling and administrative activities).
Factory Overhead Control………………..2,800,000
Depreciation Expense…………………… 700,000
Accumulated…………………………… 3,500,000
h. Insurance expired during the year, P100,000 (70% relates to factory
operations, and the remaining 30% relates to selling and administrative
activities).
Factory Overhead Control………………. 70,000
Insurance Expense………………………….. 30,000
Prepaid Insurance………………….. 100,000
i. Factory overhead applied to production. Due to greater than expected
demand for its products, the company worked 800,000 machine – hours
during the year.
The predetermined overhead rate for the year would be computed as follows:
Estimated total factory overhead control cost
=Predetermined ∨¿
Estimated total machine hours (allocation base )
P4,500,000 / 750,000 machine hours = P6 per machine hour
Based on the 800,000 machine hours actually worked during the year, the
company would have applied P4,800,000 in overhead cost to production;
800,000 machine hours x P6 per machine hour. The following entry records
the application of overhead cost:
Work in Process Inventory 4,800,000
Factory Overhead Applied 4,800,000
j. Goods costing P9,000,000 to manufacture according to their job cost
sheets were completed during the year.
Finished goods inventory 9,000,000
Work in Process Inventory 9,000,000
k. Goods sold on account to customers during the year at a total selling
price of P15,000,000. The goods cost P8,700,000 to manufacture
according to their job cost sheets.
Accounts Receivable 15,000,000
Sales 15,000,000
Cost of Goods sold 8,700,000
Finished Goods Inventory 8,700,000

52
 II. Is factory overhead underapplied or overapplied for the year? Prepare a
journal entry to close any balance in the Factory Overhead Applied
account to Cost of Goods Sold.
Factory overhead is overapplied during the year. To close the
overapplied factory overhead of P200,000 (Actual 4,600,000 – Applied
4,800,000), the journal entry will be:
Factory Overhead Applied 200,000
Cost of goods sold 200,000
III. Prepare an income statement for the year.

PALMERA COMPANY
Income Statement
For the year ended December 31
15,000,00
Sales 0
Less: Cost of goods sold (P8,700,000 -
200,000) 8,500,000
Goss Margin 6,500,000
Less
: Selling and administrative expenses
2,000,00
Administrative salaries expense 0
1,800,00
Advertising expense 0
Commission expense 900,000
Depreciation expense 700,000
Sales travel expense 170,000
Insurance expense 30,000 5,600,000
Net Operating Income 900,000

53
 Chapter Exercises

Review Questions
1. When is job-order costing appropriate, and how are costs accumulated in a
job order cost system?
2. What is the purpose of the job cost sheet in a job-order costing system?
3. How is cost accounting related to financial accounting?
4. What are the primary cost-accumulation T accounts used in a job-order
costing system?
5. What documents constitute the supporting subsidiary ledger for work in
process when using a job-order costing system?

I – True or False. Write True if the statement is correct or False if the statement
is incorrect.
_______1. Product costs are historical figures and therefore are of little use to the
manager.
_______2. A company producing furniture would probably use a job-order cost
system.
_______3. Both job-order and process costing systems utilize averaging
concepts in computing unit costs.
_______4. The predetermined overhead rate is computed using estimates of
costs and activity.
_______5. Actual manufacturing overhead costs are charged directly to the Work
in Process account as the costs are incurred.
_______6. Selling and administrative expenses should be added to the
Manufacturing Overhead Account.
_______7. All of the raw materials purchased during a period are included in the
cost of goods manufacture figure.
_______8. If a job is not completed at year end, then no overhead cost should be
applied to that job.
_______9. The cost sheet is the support document for materials.
_______10. Job order cost sheets constitute the subsidiary ledger of the
control account Work in Process Inventory.

II – Problems
1. The following completed cost sheets were prepared for three jobs that were in
production during April in the Special Order Division of Byron Company:

54
 Job 097 Job 781 Job 946
Direct materials $ 6,000 $2,700 $4,100
Direct labor 9,200 7,300 8,200
Applied factory overhead 6,900 5,475 6,120
Allowance for commercial
expenses and profit 11,050 7,738 9,210

On April 1, Job 097 was 75% complete as to materials, labor, and overhead.
It was finished during the month. The other jobs were started and finished
during the month. Jobs 097 and 946 were sold on account at the end of the
month.

Required: Prepare general journal entries to be recorded in April to

accumulate these job costs for Work in Process as well as for Finished
Goods and for the sale of the two jobs.

2. Manufacturing Costs. The work in process account of Meyers Company

showed:

Work in Process
Materials $22,000 | Finished goods $68,000
Direct labor 37,000 |
Factory overhead 55,500 |

Materials charged to the one job still in process amounted to $5,000. Factory
overhead is applied as a predetermined percentage of direct labor cost.

Required: Compute the following:

a) The amount of direct labor cost in finished goods.
b) The amount of factory overhead in finished goods.

3. Aries Corporation manufactures eighteenth – century, classical – style

furniture. It uses a job costing system that applies factory overhead on the
basis of direct labor – hours. Budgeted factory overhead for the year 2014
was P1,235,475, and management budgeted 86,700 direct labor – hours.
These transactions were recorded during August:
a) Purchased 5,000 square feet of oak an account at P25 per square foot.
b) Purchased 50 gallons of glue on account at P36 per gallon (indirect material).
c) Requisitioned 3,500 square feet of oak and 30.5 gallons of glue for
production.
d) Incurred and paid payroll costs of P187,900. Of this amount, P46,000 were
indirect labor costs: direct labor personnel earned P22 per hour on average.

55
 e) Paid factory utility bill, P15,230 in cash.
f) August’s insurance cost for the manufacturing property and equipment was
P3,500. The premium had been paid in March.
g) Incurred P8,200 depreciation on manufacturing equipment for August.
h) Recorded P2,400 depreciation on an administrative asset.
i) Paid advertising expenses in cash, P5,500.
j) Incurred and paid other factory overhead costs, P13,500.
k) Incurred miscellaneous selling and administrative expenses, P13,250.
l) Applied factory overhead to production on the basis of direct labor – hours.
m) Completed goods costing P146,000 manufactured during the month.
n) Made sales on account in August, P132,000. The cost of goods sold was
P112,000.
Required:

1. Compute the firm’s predetermined factory overhead rate for the year.
2. Prepare journal entries to record the August events.
3. Calculate the amount of overapplied or underapplied overhead to be closed
to the Cost of Goods Sold account on August 31, 2019.
4. Prepare a schedule of cost of goods manufactured and sold.
5. Prepare the income statement for August.

56
 Module 7

PROCESS COSTING SYSTEM

Introduction

Process Costing accumulates all the costs of operating a process for a period
of time and then divides the costs by the number of units of product that passed
through that process during the period; the result is a unit cost. If the product of one
process becomes the material of the next, a unit cost is computed for each process.

The process cost method is applicable to industries such as flour mills,

breweries, chemical plants, and textiles factories where large quantities of one
product or a few products are produced. It is also applicable to industries that
produce commodities such as paper, lumber, pipe, plastic, petroleum, steel, cement,
flour and sugar.

Learning Objectives:

After finishing this module, the student should be able to:

1. Explain the concept of process costing system and recognize when process
costing system will be used.
2. Discuss the seven key steps in process costing.
3. Explain the significance of equivalent units and how they are computed.
4. Apply the methods used to prepare the departmental cost report, namely,
 Weighted-average method
 First-in, First-out (FIFO) method.
5. Prepare the cost of production report.

Lesson 1 – Definition and Nature of Process Costing

Process costing accumulates costs by production process or by department

on a period to period basis. It is also applicable when all the units are worked within a
department or when there is no need to distinguish among units.

When to use Process Costing.

This method is used when the products are manufactured under the conditions of
continuous processing or under mass production methods where the products
manufactured within a department or cost center are homogeneous.

57
Objective of Process Costing

Process costing is most often associated with accounting for the costs of
manufacturing inventoriable goods. The objective is to determine:

1. The portion of production cost to be expensed (because the goods were sold)
2. The portion of production cost to be deferred (because the goods were still on
hand)

Similarities and Differences Between Job Order Costing and Process Costing

Similarities:

 Both systems assign material, labor and overhead costs to products and they
provide a mechanism for computing unit product costs.
 Both systems use the same manufacturing accounts, including Manufacturing
Overhead, Raw Materials, Work in Process, and Finished Goods.
 The flow of costs through the manufacturing accounts is basically the same in
both systems.

Differences:

 Process costing is used when a single product is produced on a continuing

basis or for a long period of time. Job-order costing is used when many
different jobs having different production requirements are worked on each
period.
 Process costing systems accumulate costs by department. Job-order costing
systems accumulated costs by individual jobs.
 Process costing systems compute unit costs by department. Job-order
costing systems compute unit costs by job on the job cost sheet.

The following illustrations show the main distinction between job order costing
and process costing.

Cost Flow in Job Order Costing

58
 Direct materials, direct labor and manufacturing overhead are added to Work
in Process. When work in process is completed, the costs are transferred to Finished
Goods. When finished goods are sold, the costs are transferred to Cost of Goods
Sold.

Cost Flow in Process Costing

In a process costing systems, costs are traced to departments that process

the goods. In some companies there may be several processing departments that
goods must pass through to become finished goods. A separate Work in Process
account is maintained for each processing department. Material, labor and overhead
costs transferred from one department’s Work in Process account to another
department’s Work in Process account are called transferred-in costs.

(Illustrations are lifted from Power Point Presentations of Managerial

Accounting by Garrison & Noreen (13th ed.)

Cost Flows in Process Costing

Basically, costs (direct materials, direct labor and manufacturing overhead)

incurred in a process costing system are similar to that of job order costing. However,
such costs flow differently under the two costing methods. The following illustrations
show how costs flow in a process costing system.

59
 Direct materials can be requisitioned for use in both Department A and
Department B. These direct materials are likely to be different in nature.
Direct material costs are debited to the appropriate departmental Work in
Process account depending upon where the materials were added to the
production process. The Raw Materials Inventory account is credited for the
corresponding amounts.
 Direct labor is transferred from the Salaries and Wages Payable account into
the work in process account of Departments A and B depending upon where

60
 the individual employee worked. Direct labor costs are debited to the
appropriate departmental Work in Process account depending upon where
the labor was added to the production process. Salaries and Wages Payable
is credited for the corresponding amounts.
 Manufacturing overhead is applied to each processing department based on
a predetermined rate for each department. The predetermined rate does not
have to be based on the same cost driver for each processing department.
Manufacturing overhead costs are debited to the respective departmental
Work in Process accounts. Manufacturing overhead is credited by the
corresponding amounts.
 The cost of units completed as to processing in Department A are transferred
into Department B for additional work. Department B has incurred additional
costs to work on units that were in process at the beginning of the period. The
transferred-in costs from Department A are added to the manufacturing costs
incurred in Department B.
 Completed goods from Work in Process – Department B are transferred into
Finished Goods Inventory. The costs transferred represent the cost of good
manufactured.

Steps in Process Costing

The document which summarizes the units and costs incurred in a process
costing system is the cost of production report. Preparing the cost of production
report includes the following steps:

Step 1: The first step is to calculate the total physical units for which the department
is responsible or the total units to account for. This amount is equal to the total
number of whole and partial units worked on in the department during the current
period: beginning inventory units plus units started.

Step 2: Determine what happened to the units to account for during the period. This
step also requires the use of physical units. Units may fit into one of two categories:
(1) completed and transferred or (2) partially completed and remaining in ending
Work in Process Inventory

Step 3: Use either the weighted average or FIFO method to determine the
equivalent units of production for each cost component. If all materials are at the
same degree of completion, a single materials computation can be made. If multiple
materials are used and are placed into production at different points, multiple EUP
calculations may be necessary for materials. If overhead is based on direct labor or if

61
these two factors are always at the same degree of completion, a single EUP can be
computed for conversion. If neither condition exists, separate EUP schedules must
be prepared for labor and overhead

Step 4: Find the total cost to account for, which includes the balance in Work in
Process Inventory at the beginning of the period plus all current costs for direct
material, direct labor, and overhead.

Step 5: Compute the cost per equivalent unit for each cost component using either
the weighted average or FIFO equivalent units of production calculated in step 3.

Step 6: Use the costs computed in step 5 to assign costs from the production
process to the units completed and transferred and to the units remaining in ending
Work in Process Inventory.

Equivalent Units of Production

The physical flow of units through a department and the manufacturing effort
expended in a department during a period normally occur in the following order:

 units started in the previous period and finished in the present period,
 units started in the present period and finished in the present period,
and
 units started in the present period and not finished in the present
period.

Because of these mixed manufacturing efforts, production cannot be

measured by counting whole units. Accountants use a concept known as equivalent
units of production to measure the quantity of production achieved during a period.

Equivalent units of production (EUP) are an approximation of the number

of whole units of output that could have been produced during a period from the
actual effort expended during that period. EUPs are calculated by multiplying the
number of actual but incomplete units produced by the respective percentage degree
of completion. Assume the cooking department of a company had no beginning
inventory in November. During November, the department worked on 220,000 units:
200,000 units were completed and 20,000 units were 40 percent complete at the end
of the period. The EUP for the period are 208,000 [(200,000 100%) + (20,000 40%)].

62
 The basic idea behind equivalent
units is quite easy to understand, but the
computation of equivalent can become
complex. Here we can say the two half-
completed units of production are equal
to one complete unit. Using this logic,
we can say that 10,000 units that are
70% complete are equivalent, or the
same as, 7,000 complete units.

Lesson 2 – Weighted Average and FIFO Process Costing Methods

The two methods of accounting for cost flows in process costing are (1)
weighted average and (2) FIFO. These methods relate to the manner in which cost
flows are assumed to occur in the production process.

a. Weighted Average Method – This method includes all costs in calculating

the unit cost, including both those costs incurred during the current period and
those incurred in the prior period that are shown in the beginning work-in-
process inventory of the current period. In this method, prior period costs and
current period costs are averaged. Under this method, all units completed in
the same period or in ending inventory of that period are treated the same.
a. FIFO Method – Under this method, what is included in calculating the unit
cost are only the costs incurred and work performed during the period. FIFO
considers the beginning inventory as a batch of goods separate from the
goods started and completed within the same period. It assumes that the first
work done is to complete the beginning inventory. Thus all beginning work in
process inventories are assumed to be completed before end of the current
period.

The status of the product at both the end and beginning of a period is
considered when the FIFO method is used to determine product cost.

Illustration: The Decorative Waxes Company makes a variety of sizes and types of
candles. One candle made by the Decorative Waxes Company is three inches wide
and six inches tall. The company views the manufacturing process of this product as
a single department with a single direct material: wax. The company treats the costs
of coloring, scent, and wicks as overhead, and candles are not packaged. Because

63
the wax is added at the start of processing, all inventories are 100 percent complete
as to material as soon as processing has begun. Labor and overhead are assumed
to be added at the same rate throughout the production process.

Production and Cost Information for the Month of April

Candles in beginning inventory (40% complete as to labor

and overhead or conversion) 25,000
Candles started during current period 510,000
Candles completed and transferred to finished goods 523,000
Candles in ending inventory (80% complete as to labor
and overhead or conversion) 12,000
Costs of beginning inventory:
Direct material $ 42,650
Direct labor 1,400
Overhead 15,752 $ 59,802
Current period costs:
Direct material $433,500
Direct labor 75,777
Overhead 263,913 $773,190
Weighted Average Method

Step 1: Calculate the total unit to account for

Candles in beginning inventory 25,000
Candles started during current period 510,000
Candles to account for 535,000
Step2: Calculate the total units accounted for

Candles completed and transferred 523,000

Candles in ending WIP inventory 12,000
Candles accounted for 535,000

The items detailed in this step indicate the categories to which costs will be
assigned in the final step. The number of candles accounted for in step 2 equals the
number of candles to account for in step 1.
Step 3: Determine the equivalent units of production.
The weighted average EUP computation uses the number of whole candles in
beginning inventory and the number of candles started and completed during the
period. (Units started and completed during a period equals the total units completed
during the current period minus the units in beginning inventory.) The weighted
average computation for equivalent units of production is as follows:

Conversion

64
 (Labor and
DM Overhead)
Beginning inventory (whole candles) 25,000 25,000
Candles started and completed 498,000 498,000
Ending inventory (whole candles x % complete) 12,000 9,600
Equivalent units of production 535,000 532,600

Step 4: Determine the total cost to account for

DM DL OH Total
Beginning Inventory Cost 42,650 1,400 15,752 59,802
Current period cost 433,500 75,777 263,913 773,190
Total Cost to account for 476,150 77,177 279,665 832,992
The total cost to account for equals beginning inventory cost plus current
period costs.

Total cost is assigned to the goods transferred to Finished Goods Inventory

(or, alternatively, to the next department) and to ending Work in Process Inventory in
relation to the whole units or equivalent whole units contained in each category.

Step 5: Calculate the cost per equivalent units of production

A cost per equivalent unit of production must be computed for each cost
component for which a separate calculation of EUP is made. Under the weighted
average method, the costs of beginning inventory and the current period are summed
for each cost component and averaged over that component’s weighted average
equivalent units of production. This calculation for unit cost for each cost component
at the end of the period is shown below:

( Beginning Inventory Cost +Current Period Cost )

Unit Cost =
Weighted Average EUP

Direct
Material Conversion Total
Beginning Inventory
Cost 42,650 17,152 59,802
Current period cost 433,500 339,690 773,190
Total cost per
component 476,150 356,842 832,992
Divided by EUP 535,000 532,600
Cost per EUP $0.89 $0.67 $1.56

65
Step 6 – Assign costs to inventories

This step assigns total production costs to units of product. Cost assignment
in a department involves determining the cost of (1) the goods completed and
transferred during the period and (2) the units in ending Work in Process Inventory

Cost of units completed and transferred

($1.56 x 523,000) $815,880
Ending inventory:
Direct material (12,000 $0.89) $10,680
Conversion (9,600 $0.67) 6,432
Total cost of ending inventory $17,112
The total costs assigned to units transferred and units in ending inventory
must
equal the total cost to account for.
The steps just discussed can be combined into a cost of production report
shown below:

Cost of Production Report

Production Data Equivalent Units of Production
Conversio
Whole Units Direct Material n
Beginning Inventory 25,000 25,000 10,000
Units started 510,000
Units to account for 535,000

Beginning Inventory completed 25,000 0 15,000

Started and Completed 498,000 498,000 498,000
Units Completed 523,000
Ending WIP Inventory 12,000 12,000 9,600
Units Accounted for 535,000 535,000 532,600

Cost Data
Conversio
Total Direct Material n
Costs in beginning inventory 59,802 42,650 17,152
Current period costs 773,190 433,500 339,690
Total costs to account for 832,992 476,150 356,842
Divided by EUP 535,000 532,600
Cost per EUP $1.56 $0.89 $0.67

Cost Assignment
Transferred (523,000 x $1.56) 815,880
Ending inventory:
Direct Materials (12,000 x 0.89) 10,680

66
 Conversion (9,600 x 0.67) 6,432 17,112
Total cost accounted for 832,992
FIFO Method

Steps 1 and 2 are the same for the FIFO method as for the weighted average
method because these two steps involve the use of physical units.

Step 3: Determine the equivalent units of production.

Under FIFO, the work performed last period is not commingled with work of the
current period.

The EUP schedule for FIFO:

DM Conversion
Candles in beginning inventory
completed in the current period 0 15,000
Units (Candles) started and completed 498,000 498,000
Ending inventory (whole candles % complete) 12,000 9,600
510,0
Equivalent units of production 00 522,600

Step 4: Determine the Total Cost to Account For

This step is the same as it was under the weighted average method; the total cost to
account for is $832,992.

Step 5: Calculate the cost per equivalent unit of production

Because cost determination is based on equivalent units of production, different

results will be obtained for the weighted average and FIFO methods. The
calculations for cost per equivalent unit reflect the difference in quantity that each
method uses for beginning inventory.

Direct Material Conversion Total

Current period cost 433,500 339,690 773,190
Divided by EUP 510,000 522,600
Cost per EUP $0.85 $0.65 $1.5

Step 6: Assign costs to inventories

Transferred

1 Beginning inventory (prior period cost) 59,802

Completion of beginning inventory:
Direct material 0

67
 9,7
Conversion (15,000 x 0.65) 50
Total cost of beginning inventory 69,552
2 Units started and completed (498,000 x 1.50) 747,000
Total Costs transferred 816,552

Ending Inventory

Direct Materials (12,000 x 0.85) 10,200

Conversion (9,600 x 0.65) 6,240
Total cost of ending inventory 16,440

The total cost of the candles transferred ($816,552) plus the cost of the
candles in ending inventory ($16,440) equals the total cost to be accounted for
($832,992).

The cost of production report using the FIFO method is shown below:

Cost of Production Report

Production data Whole Units Direct Material Conversion
Beginning Inventory 25,000
Units started 510,000
Units to account for 535,000

Beginning Inventory completed 25,000 0 15,000

Started and Completed 498,000 498,000 498,000
Units Completed 523,000
Ending WIP Inventory 12,000 12,000 9,600
Units Accounted for 535,000 510,000 522,600

Cost Data
Total Direct Material Conversion
Costs in beginning inventory 59,802
Current period costs 773,190 433,500 339,690
Total costs to account for 832,992 433,500 339,690
Divided by EUP 510,000 522,600
Cost per EUP 1.5 0.85 0.65

Cost Assignment
Transferred
Beginning Inventory costs 59,802
Cost to complete:
Conversion (15,000 x 0.65 9,750 69,552
Started & completed (498,000 x
1.5) 747,000

68
 Total cost transferred 816,552
Ending Inventory:
Direct Material (12,000 x 0.85) 10,200
Conversion cost (9,600 x 0.65) 6,240 16,440
Total cost accounted for 832,992

Lesson 3 – Process Costing in a Multi-Department Setting

Most companies have multiple, rather than single, department processing

facilities. In a multidepartment-processing environment, goods are transferred from a
predecessor department to a successor department. For example, if the candles at
the Decorative Waxes Company were boxed by the dozen, the company’s
manufacturing activities could be viewed as occurring in two departments:
Processing and Packaging.

The cost of completed units of predecessor departments are treated as input

material costs in successor departments. Such a sequential treatment requires the
use of an additional cost component element called “transferred-in” or “prior
department cost.” This element always has a percentage of completion factor of 100
percent, because the goods would not have been transferred out of the predecessor
department if they had not been fully complete.

Below is a sample problem which illustrates a multi-department setting.

Illustrative Example:

The Sporting Bag Company manufactures golf bags in a two-department

process: Assembly and Finishing. The Assembly Department uses weighted average
costing; the cost driver for overhead in this department is unrelated to direct labor.
The Finishing Department adds the hardware to the assembled bags and uses FIFO
costing. Overhead is applied to the bags in this department on a direct labor basis.
During June, the following production data and costs have been gathered:

69
Required:

a. Prepare a cost of production report for the Assembly Department.

b. Prepare a cost of production report for the Finishing Department.

Solution:

70
71
72
 Exercises

Review Questions

1. Under what conditions would it be appropriate to use a process costing

system?
2. How are costs accumulated in a process costing system?
3. In what ways are job-order costing and process costing similar? In what ways
are they different?
4. What is a quantity schedule and what purpose does it serve?

I - True or False. Identify the given statements as either true or false. If true,
write T in the space provided before each number, and F for false.

_____1. Process costing is most appropriate when manufacturing large

batches of homogenous products.
_____2. Conversion costs include all manufacturing costs other than direct
materials.
_____3. Equivalent units are computed to assign costs to partially completed
units
_____4. The weighted average method combines beginning inventory and
current production to compute cost per unit of production.
_____5. The FIFO method combines beginning inventory and current
production to compute cost per unit of production.
_____6. The weighted average method separates beginning inventory and
current production to compute cost per unit of production.
_____7. The FIFO method separates beginning inventory and current
production to compute cost per unit of production.
_____8. The numerator in the formula for equivalent units includes all
beginning inventory costs when using the weighted average costing
assumption.
_____9. The numerator in the formula for equivalent units includes all
beginning inventory costs when using the FIFO costing assumption.
_____10. The weighted average costing method assumes that units in
beginning inventory are the first units transferred.
_____11. The FIFO costing method assumes that units in beginning inventory
are the first units transferred.
_____12. Standard costing is compatible with both FIFO and weighted average
methods of costing

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 _____13. A hybrid costing system would be appropriate for a company that
manufactures cake flour.
_____14. A hybrid costing system would be appropriate for a company that
manufactures several varieties of jam.
_____15. Using FIFO costing, equivalent units of production (EUP) can be
determined by subtracting EUP’s in Beginning work in process from weighted
average EUP.

II – Problem Solving. Give what is/are required in each of the given problem.
1. Landers Company has the following information available for May:

Beginning Work in Process Inventory

(25% complete as to conversion) 10,000 units
Started120,000 units
Ending Work in Process Inventory
(30% complete as to conversion) 30,000 units

Beginning Work in Process Inventory Costs:

Material $ 2,100
Conversion 2,030
Current Period Costs:
Material $ 33,000
Conversion 109,695

All material is added at the start of production and all products completed are
transferred out.
Required:
a. Prepare an equivalent units schedule using the (a) FIFO and (b)
weighted average method.
b. Prepare a schedule showing the computation for cost per equivalent
unit assuming the (a) FIFO and (b) weighted average method.
c. Prepare a schedule showing the assignment of costs assuming the (a)
FIFO and (b) weighted average method.

2. The Sweet Temptations Company has two processing departments, Cooking

and Packaging. Ingredients are placed into production at the beginning of the
process in Cooking, where they are formed into various shapes. When
finished, they are transferred into Packaging, where the candy is placed into
heart and tuxedo boxes and covered with foil. All material added in Packaging
is considered as one material for convenience. Since the boxes contain a
variety of candies, they are considered partially complete until filled with the

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appropriate assortment. The following information relates to the two
departments for February 20X7:

Cooking Department:

Beginning WIP (30% complete as to conversion) 4,500 units

Units started this period 15,000 units

Ending WIP (60% complete as to conversion) 2,400 units

Packaging Department:

Beginning WIP (90% complete as to material, 80% complete as to

conversion) 1,000 units

Units started during period ?

Ending WIP (80% complete as to material and 80% complete as to

conversion) 500 units

Required:

a. Determine equivalent units of production for both departments using

the weighted average method.
b. Determine equivalent units of production for both departments using
the FIFO method.

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 MODULE 8
Special Production Issues: Lost Units and Accretion

Introduction
Throughout the production process, units started may not be always equal to
finished units. There are units which may be lost due to spoilage, defects, or
wastage, or due to the nature of the process itself like evaporation, and shrinkage,
and some simply due to exposure to the atmosphere when perishable goods are
processed and stored. At other times, errors in the production process (either by
humans or machines) cause a loss of units through rejection at inspection for failure
to meet appropriate quality standards or designated product specifications.
There are also instances when units started increase in the succeeding
processes due to addition of materials or the conversion process. Just like in a multi-
department setting when a succeeding department adds additional inputs and
increases the number of units it receives from the preceding department.
This module will tackle on the above-mentioned production issues, on how to
account of losses and addition in units processed.

Learning Objectives:

After finishing this module, the student should be able to:

1. Define and identify the types of losses incurred in the production process.
2. Account for the costs to be assigned to normal or abnormal losses both under
job order costing and process costing.
3. Account for the effect of accretion in the equivalent units of production
schedule and cost per unit.

Lesson 1: Accounting for Production Losses

Loss of Units

Few, if any, processes combine material, labor, and overhead with no loss of units.
The different types of losses which a manufacturing entity may incur may be due to
defects, spoilage, and wastage. How these losses are accounted differ from one to
the other. Also, a loss may be classified as normal or abnormal. Such classification
also entails difference in its accounting treatment.

 Defective and Spoiled Units

Whether these lost units are considered defective or spoiled depends on their ability
to be economically reworked. Economically reworked means that (1) the unit can
be reprocessed to a sufficient quality level to be salable through normal distribution

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channels and (2) incremental rework cost is less than incremental revenue from the
sale of reworked units. A defective unit can be economically reworked, but a
spoiled unit cannot.

 Normal and Abnormal Loss

A normal loss of units falls within a tolerance level expected during production.
Management creates a range of tolerance of spoiled units specified by the accepted
quality level (AQL). If a company had set its quality goal as 98 percent of goods
produced, the company would have been expecting a normal loss of 2 percent. Any
loss in excess of the accepted quality level AQL is an abnormal loss. Thus, the
difference between normal and abnormal loss is merely one of degree and is
determined by management.

 Continuous and Discrete Losses

Realistically, units are lost in a production process at a specific point.

However, accounting for lost units requires that the loss be specified as being either
continuous or discrete. For example, the weight loss in roasting coffee beans and the
relatively continual breakage of fragile glass ornaments can be considered
continuous losses because they occur fairly uniformly throughout the production
process.

In contrast, a discrete loss is assumed to occur at a specific point. Examples

of discrete losses include adding the wrong amount of vinegar to a recipe for salad
dressing or attaching a part to a motor upside down.

The units are only deemed lost and unacceptable when a quality check is
performed. Therefore, regardless of where in the process the units were truly “lost,”
the loss point is always deemed to be an inspection point. Thus, units that have
passed an inspection point should be good units (relative to the specific
characteristics inspected), whereas units that have not yet passed an inspection
point may be good or may be defective/spoiled.

Accounting for Lost Units

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The method of accounting for the cost of lost units depends on whether the loss is
considered normal or abnormal and whether the loss occurred continuously in the
process or at a discrete point.

The table below summarizes the accounting for the cost of lost units.

Type Assumed to May be Cost handled Cost

Occur how? assigned to?

Absorbed by Product
all units in
ending
Normal inventory and

Uniformly transferred

throughout out on an
Continuous
process EUP basis

Written off as Period

a loss on an
Abnormal
EUP basis

Absorbed by Product
all units past
inspection
Discrete At inspection Normal point in
point or at the ending
end of process inventory and
transferred
out on an
EUP basis

Abnormal Written off as Period

a loss on an
EUP basis

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A summary of the treatment of various types of lost units in a process costing system
is shown in the table below.

Normal Abnormal

Do not include equivalent Must include equivalent

lost units in EUP schedule. lost units in EUP
Units effectively disappear; schedule. Assign cost to
Continuous unit costs of good lost units and charge as
production are increased. loss of period.

Must include equivalent lost Must include equivalent

units in EUP schedule. lost units in EUP
Assign cost to lost units. schedule. Assign cost to
Determine point of ending lost units and charge as
work in process: loss of period.

Discrete a) If before inspection

point, assign cost of
lost units only to
units transferred.

b) If after inspection
point, prorate cost of
spoiled units
between units
transferred and units
in ending inventory.

Defective Units

Some goods that do not meet quality specifications are merely defective rather than
spoiled, and thus have value. Such units are either reworked to meet product
specifications or sold as irregulars.

 If the rework is normal and actual costing is used, the rework cost is added
to the current period’s work in process costs for good units and assigned to all
units completed. In companies using predetermined overhead application

79
 rates, normal rework costs should be estimated and included as part of the
estimated factory overhead cost used in computing the overhead application
rates.
 If rework is abnormal, the costs should be accumulated and assigned to a
loss account. The units are included in the EUP schedule for the period and
only actual production (not rework) costs will be considered in determining
unit cost.

Reworked units may be irregular and have to be sold at less than the normal
selling price. The production costs of irregular items should be transferred to a
special inventory account and not commingled with the production costs of good
units. When the net realizable value (selling price minus cost to rework and sell) is
less than total cost, the difference is referred to as a deficiency. If the number of
defective units is normal, the deficiency should be treated as part of the production
cost of good units. If some proportion of the defective units is considered an
abnormal loss, that proportion of the deficiency should be written off as a period cost.

DEFECTS/SPOILAGE IN JOB ORDER COSTING

The previous discussions are related to spoilage issues in a process costing

environment. In a job order situation, the accounting treatment of spoilage depends
on two issues: (1) Is spoilage generally incurred for most jobs or is it specifically
identified with a particular job? (2) Is the spoilage normal or abnormal?

 Generally Anticipated on All Jobs. If normal spoilage is anticipated on all

jobs, the predetermined overhead application rate should include an amount
for the net cost of normal spoilage, which is equal to the cost of spoiled work
less the estimated disposal value of that work. This approach assumes that
spoilage is naturally inherent and unavoidable in the production of good
products, and its estimated cost should be proportionately assigned among
the good products produced.

Example Problem

Assume that Impervious produces a special paint for manufacturers. Each

production run is considered a separate job because each manufacturer indicates the
particular paint specifications it requires. Regardless of the job, there is always some
shrinkage because of the mixing process. In computing the predetermined overhead
rate related to the custom paints, the following estimates are made:

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Overhead costs other than spoilage $121,500
Estimated spoilage unit cost $10,300
Sales of improperly mixed paints to foreign distributors (4,300) 6,000
Total estimated overhead $127,500
Estimated gallons of production during the year /150,000
Predetermined overhead rate per gallon $0.85

During the year, Impervious Inc. accepted a job (#38) from General Electric to
manufacture 500 gallons of paint. Direct material cost for this job was $4,660, direct
labor cost totaled $640, and applied overhead was $425 ($0.85 x 500 gallons), giving
a total cost for the job of $5,725. Impervious Inc. put 500 gallons of paint into
production. Five gallons (or 1 percent) of the paint became defective during the
production process when a worker accidentally added a thickening agent meant for
another job into a container of the paint. The actual cost of the defective mixture was
$57.25 (0.01 x $5,725) and it can be sold for $22. The entry below is made to
account for the actual defect cost:

Disposal Value of Defective Work 22.00

Manufacturing Overhead 35.25
Work in Process Inventory—Job #38 57.25
To record disposal value of defective work incurred on Job #38 for General Electric.

 Specifically Identified with a Particular Job - If defects or spoilages are not

generally anticipated, but are occasionally experienced on specific jobs
because of job-related characteristics, the estimated cost should not be
included in setting the predetermined overhead application rate. Because the
cost of defects/spoilage attaches to the job, the disposal value of such goods
reduces the cost of the job that created those goods. If no disposal value
exists for the defective/spoiled goods, that cost remains with the job that
caused the defects/spoilage.

Example Problem

Assume that Impervious did not typically experience spoilage in its production
process. The company’s predetermined overhead would have been calculated as
$0.81 per gallon ($121,500 /150,000). Thus, the total cost for the General Electric job
would have been $5,705 [$4,660 + $640 + ($0.81 x 500)]. Five gallons of the batch
were thickened somewhat greater than normal at the request of General Electric.
After checking the stirability of the special paint, General Electric rejected the five
gallons and changed the formula slightly. The five gallons could be sold for $22; this
amount would reduce the cost of the General Electric job as shown in the following
entry:

81
 Disposal Value of Defective Work 22
Work in Process Inventory—Job #38 22
To record disposal value of defective work incurred on Job #38 for General Electric.

Abnormal Spoilage

The cost of abnormal losses (net of any disposal value) should be written off
as a period cost. The following entry assumes that Impervious normally anticipates
some lost units on its custom orders and that the estimated cost of those units was
included in the development of a predetermined overhead application rate.

Assume that on Job #135, the cost of defective units was $198, but that $45
of disposal value was associated with those units. Of the remaining $153 of cost,
$120 was related to normal defects and $33 was related to abnormal defects.

Disposal Value of Defective Work 45

Manufacturing Overhead 120
Loss from Abnormal Spoilage 33
Work in Process Inventory—Job #135 198

Lesson 2: Accounting for Accretion

Accretion refers to an increase in units or volume because of the addition of

material or to factors (such as heat) that are inherent in the production process. For
example, adding soybean derivative to beef in preparing packages of hamburger
causes the pounds of product to increase just as including pasta increases the
volume of a casserole. If materials are added in a single department, the number of
equivalent units computed for that department compensates for this increase from
the beginning to the end of processing. When accretion occurs in successor
departments in a multidepartment process, the number of units transferred into the
department and the related cost per unit must be adjusted.

Example Problem:

Assume that Impervious Inc. is engaged in the production of this heavy-duty

paint. Department 1 mixes the primary paint ingredients in large vats and sends the
mixture to Department 2, which adds the scratch-resistant compound and remixes
the paint. The paint is poured into 50- gallon containers that are shipped to buyers.
Spoilage occurs in Department 2 when too much scratch-resistant compound is
added to the paint mixture. The spoilage is detected when the mixture is transferred
from the vats to the containers. Spoilage is never containerized. Spoilage is

82
considered normal as long as it does not exceed 1 percent of the gallons transferred
into Department 2 from Department 1.

December production information for Department 2 is given below. For this

product, assume that Impervious Inc. uses weighted average process costing. The
units in beginning inventory were 100 percent complete as to the compound, 0
percent complete as to the container, and 25 percent complete as to conversion
costs. Ending inventory is 100 percent complete as to the compound, 0 percent
complete as to the container, and 70 percent complete as to conversion.

Gallons in beginning inventory 1,000

Gallons transferred in 21,000
Gallons of compound added 5,000
Gallons in ending inventory 1,200
Units completed (50-gallon containers) 512

Note that the measure for completed production is containers rather than gallons.
Because each container represents 50 gallons, the actual gallons completed are
25,600 (50 x 512). To handle this change in measuring units, either the incoming
gallons must be reported as containers or the completed containers must be reported
as gallons. The cost of production report for December is prepared using gallons as
the measurement unit, and assumed cost information is supplied in the exhibit.

83
 Several items need to be noted about the given computations. First, the
number of spoiled gallons was determined by subtracting the total gallons completed
plus the gallons in ending inventory from the total gallons for which the department
was responsible. Because spoilage was less than 1 percent of the gallons transferred
into Department 2, it was all considered normal.

Second, the $197,100 cost transferred from Department 1 was related to

22,000 gallons of mixture: the gallons in beginning inventory plus those transferred
during the period. Thus, the original cost of each gallon was approximately $8.96
($197,100 / 22,000). With the addition of the compound in Department 2, the
transferred-in cost per gallon declined to $7.30.

Third, spoilage is assignable only to the completed units because the ending
inventory has not yet reached the discrete point of inspection (transference to
containers). Finally, the average cost of each 50-gallon container completed is
approximately $643.48 ($329,460 512).

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 Chapter Exercises

Problem-Solving. Give what is/are required in each of the given problem. Show
your computations in good form.

1. Journal Entries for Scrap. Munoz Metal Products accumulates metal

shavings from the shop floor and sells them periodically to a nearby scrap
dealer. Scrap sales, on account, for the period just ended total $2,300.

Required: Indicate the journal entries when:

a. The scrap sales are viewed as additional revenue.

b. The scrap sales are viewed as a reduction of the cost of goods sold
during the period.
c. The scrap sales are viewed as a reduction of factory overhead.
d. The scrap sales are traceable to individual jobs and are viewed as a
reduction in the cost of materials used on the jobs.
2. Spoilage in a Job Order Cost System. Walker Inc. manufactures custom
wood products. During the current period, an order for 2,000 workbenches
was begun on Job 1994. After the job was completed, the benches were
inspected and 100 units were determined to be defective. The customer has
agreed to accept the order with only 1,900 units instead of the quantity
originally ordered. The spoiled units can be sold as seconds for $25 each.
Spoiled goods are kept in a separate inventory account from finished goods.
Total costs charged to Job 1994 follow:

Materials $ 5,100
Labor (200 hours x $15 per hour) 3,000
Factory overhead ($9.50 per labor hour) 1,900
Total cost charged to Job 1994 $ 10,000
Custom jobs are marked up 150 percent on cost.

Required:

1) Assuming that the defective units were the result of an internal failure
(i.e., an employee error or a machine failure), prepare the appropriate
general journal entries to record the transfer of the defective units to a
separate inventory account and the completion and shipment of Job
1994 to the customer.

2) Assuming that the defective units were the result of a change in

design specified by the customer after the units were completed,
prepare the appropriate general journal entries to record the transfer

85
 of the defective units to the separate inventory account and the
completion and shipment of Job 1994 to the customer.

3. Entries for Charging Rework Costs Caused by Internal Failure and by Change
in Customer Specification. Albany Appliances manufactured 100 microwave
ovens in a recent production run and discovered that 10 ovens were defective
and required reworking as follows:

Rework cost per unit:

Materials $ 10
Labor 25
Factory overhead 25
Total $ 60
Normal production cost per unit:
Materials $ 50
Labor 75
Factory overhead 75
Total $ 200
Required:

1) Prepare the journal entries to record (a) the normal production costs,
(b) the rework costs, and (c) the transfer of the job costs to Finished
Goods assuming that rework costs were caused by an internal failure.

2) Prepare the same journal entries as in (1), assuming that rework costs
were caused by a change in customer specifications.

4. Spoilage with a Salvage Value in a Process Cost System Using an

Average Cost Flow Assumption. Carter Company manufactures a single
product in two departments, Cutting and Finishing. Units of a product are
started in the Cutting Department and then transferred to the Finishing
Department where they are completed. Units are inspected at the 80% stage
of completion in the Finishing Department. Good units are transferred to
finished goods inventory when completed and spoiled units are transferred to
a separate inventory account. Spoiled units are inventoried at their salvage
value of $3 each, and the unrecoverable cost of spoilage, which was caused
by an internal failure, should be charged to the appropriate account.

Materials are added at the beginning of the production process. At the end of
June, 2,000 units were still in process in the Finishing Department, 100%
complete as to materials and 60% complete as to conversion costs. During
July, 20,000 units were transferred from the Cutting Department to the
Finishing Department and 15,000 were transferred from the Finishing

86
 Department to finished goods inventory. At the end of July, the Finishing
Department still had 4,000 units in process, 100% complete as to materials
and 20% complete as to conversion costs. Cost data related to July
operations in the Finishing Department follow:

Beginning Added
Costs charged to the department: Inventory This Period
Cost from preceding department $6,050 $54,450
Materials 3,410 30,690
Labor 1,638 14,742
Factory overhead 2,184 19,656

Required: Complete the following cost of production report for the Finishing
Department based on the data presented for July, assuming the company
uses a process cost system with average costing to account for its
production.

5. Spoilage With a Salvage Value in a Process Cost System With a Fifo

Cost Flow Assumption. School Craft Petroleum Company uses a process
cost system with a fifo cost flow assumption to account for production, which
is manufactured in two departments. Units of product are started in the
Cracking Department and then transferred to the Refining Department where
they are completed. Units are inspected at the end of the production process
in the Refining Department. Good units are transferred to finished goods
inventory and spoiled units are transferred to a separate inventory account.
Spoiled units are inventoried at their salvage value of $8 each, and the
unrecoverable cost of spoilage resulting from an internal production failure is
charged to the appropriate account. Data related to September operations in
the Refining Department follow:

Units in beginning inventory (60% materials, 30% labor, 30% overhead) 2,800
Units received from Cracking Department this period 8,400
Units transferred to the finished goods inventory this period 7,600
Units transferred to special inventory account this period 1,100
Units in ending inventory (100% materials, 50% labor, 50% overhead) 2,500

Beginning Added
Costs charged to the department: Inventory This Period
Cost from preceding department $17,889 $68,040
Materials 2,733 11,900
Labor 7,278 30,063
Factory overhead 12,350 51,016

87
Required: Prepare a cost of production report for the Refining Department
based on the data presented for September.

88
 Module 9
OPERATION COSTING, JUST IN TIME AND BACKFLUSH ACCOUNTING

Introduction
The product costing system adopted or used by a company is often designed
to fit the particular characteristics of different production systems. When product
costing system do not fall purely into the category of job order costing or purely
process costing, the company can adopt a hybrid costing systems such as operation
costing and just-in-time system.

Learning Objectives:
At the end of the chapter, the student should be able to:
 Explain how operation costing is applied in a production system,
 Prepare journal entries for an operation-costing system.
 Describe a just-in-time (JIT) production system.
 State the relationship between JIT and backflushing.
 Explain how just-in-time systems simplify job costing.
 Prepare general journal entries and T accounts for backflush accounting.

Lesson 1 – Operation Costing

Operation costing is a hybrid costing system that uses job costing to assign
direct materials to costs to jobs and a departmental approach to assign conversion
costs to products or services.

Illustrative Problem:

Suppose that Starlight Glass Company manufacturers two types of glass sheet, clear
glass and colored glass. Department 1 produces clear glass sheet, some of which
are sold as finished goods. Others are transferred to Department 2, which adds
metallic oxides to clear glass sheets to form colored glass sheets, which are then
sold as finished goods. The company uses operation costing.

Starlight Glass Company finished two jobs:

Job A, 10,000 sheets of clear glass

Job B, 5,000 sheets of colored glass
Direct materials
Job A (10,000 clear glass sheets) 400,00

89
 0
Job B (5,000 colored glass sheets)
Materials for clear glass sheets in Department 1 200,000
Materials added to clear glass sheets in Department 300,00
2 100,000 0
700,00
Total direct materials 0
Conversion costs (Direct Labor and Overhead)
180,00
Department 1 0
Department 2 50,000
230,00
Total conversion costs 0
930,00
Total costs 0

Journal Entries:

The following journal entries to record Starlight Glass Company’s flow of costs.

a. Department 1 makes the first entry by recording the requisition of direct

materials when Job A entered production:

Work-in-Process Inventory: Department 1 400,000

Materials Inventory 400,000

b. Department 1 makes the following entry to record the requisition of direct

materials when Job B enters production:
Work-in-Process Inventory: Department 1 200,000
Materials Inventory 200,000

c. Conversion costs are applied in Department 1 with the following journal

entry:
Work-in-Process Inventory: Department 1 180,000
Conversion Costs Applied 180,000
d. The following entry records the transfer 0f completed clear glass sheets to
finished goods:

90
 Finished Goods Inventory 520,000
Work-in-process Inventory: Department 1 520,000
Direct Materials of P400,000 + Conversion 520,000
(12* × 10,000) = P520,000
*180,000 ÷ 15,000 = P12

e. The following entry for units of colored glass records the transfer of partially
completed colored glass sheets to Department 2:
Work-in-Process Inventory: Department 2 260,000
Work-in-process Inventory: Department 1 260,000
Direct Materials of P200,000 + Conversion
(12 × 5,000) = P260,000

f. The following entry records the requisition of the materials by Department 2

when job enters production:
Work-in-Process Inventory: Department 2 100,000
Materials Inventory 100,000

g. Conversion costs are applied in Department 2 with the following journal

entry.
Work-in-Process Inventory: Department 2 50,000
Conversion Costs Applied 50,000
h. Finally, the completed colored glass sheets are transferred to finished
goods.
Finished Goods Inventory 410,000
Work-in-Process Inventory: Department 2 410,000
Department 2 work in process P260,000 +
Materials for colored glass of P100,000 +
Conversion (P10 x 5,000) = P410,000

(Note: Illustrative problem is adopted from Cost Accounting and Control, 2018-2019 edition
by Cabrera, E. et. Al.)

Lesson 2 – Just-In-Time and Backflush Costing

91
 Just-in-Time System is a comprehensive production and inventory system
that purchases or produces materials and parts only as needed and just in time to be
used at each stage of the production process.
Just-in-time refers to a system in which materials arrive exactly as they are
needed. Demand drives the procurement of production of any needed materials, and
immediate delivery eliminates waiting time and the need for inventory.

Just-in-time (JIT) is a philosophy centered on the reduction of costs through

elimination of inventory. All materials and components should arrive at a work station
when they are needed – no earlier and no later. Products should be completed and
available to customers when the customers want them – nor earlier and no later.

JIT differs from traditional system, in which large stocks of WIP generally are
kept at many work stations. The JIT ideal is to eliminate these stocks of WIP and
produce parts only as needed. The objective of reducing inventory to zero, however,
is possible only under the following conditions:
1. Low or insignificant setup (or order) times and cost.
2. Lot sizes equal to one.
3. Minimum and almost instantaneous lead time.
4. Balanced and level workloads.
5. No interruptions due to stock outs, poor quality, unscheduled equipment
downtimes, engineering changes, or other planned changes.

JIT vs Traditional costing

JIT costing differs from traditional costing with regards to the accounts used and the
timing of cost recording. There are basically three major differences.
1. Instead of using separate accounts for Materials and Work in Process as in
traditional costing, JIT costing combines these into a Raw and in Process
account.
2. Direct labor is usually considered a minor cost item in a JIT setting so no
separate account for direct labor is created. Direct labor and factory
overhead are usually charged to a Conversion Cost account or sometimes
direct to Cost of Goods Sold account.
3. In traditional costing overhead is applied to products as they are being
produced and is recorded into the Work in Process account. In JIT costing,
overhead is not applied to production until they are completed. When
products are completed under the JIT costing, labor and overhead is added

92
 to Cost of Goods Sold, since the goods are sold soon after production is
completed.

Backflushing / Backflush Costing

Backflushing, also called backflush costing or backflush accounting, is
simplified approach to accounting for the flow of manufacturing costs. It is applicable
to mature JIT systems in which traditional costing is impractical. Under the JIT
system, where the time from the receipt of the materials to the completion of product
is reduced to a few hours, the usefulness of tracking the cost of the WIP becomes
impractical.
Under backflush costing, some or all elements of the product cost can only be
determined after the production is completed.
Illustrative Problem
Assume that Walker Company uses JIT costing for the production of goods during
the month of January. The following transactions summarize the major steps in
Walker’s production during the month of January.
1. Raw materials received from suppliers amounted to P4,000.
2. Direct labor costs of P10,400 and overhead costs of P7,800 were incurred
and applied, respectively, during the month of January.
3. The cost of work in process at January 31 was P3,600. This cost was
determined through the production report and is composed of the following
elements:
Direct materials P1,500
Direct labor 1,200
Overhead 900
In addition, assume that finished goods inventory ta January 31 was P6,500,
consisting of:
Direct materials P1,500
Direct labor 2,850
Overhead 2,150
The journal entries under the JIT costing are shown below:
Raw and in Process 4,000
Accounts Payable 4,000
To record product costs (materials)

Cost of goods sold 18,200

Wages payable 10,400

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 Factory Overhead Control 7,800
to record product cost (conversion cost)

Finished goods 2,500

Raw and in Process 2,500
To record transfer of cost of units completed

Materials received 4,000

Less: Mat. In RIP 1,500
Amount to be Backflushed 2,500

Cost of goods sold 1,000

Finished goods 1,000
To record transfer of units sold

Materials cost of units completed 2,500

Less: Materials in FG end 1,500
Amount to be backflushed 1,000

Raw and in Process 2,100

Finished goods 5,000
Cost of goods sold 7,100

For Raw and In Process:

Labor Cost - raw and in process 1,200
Overhead - raw and in process 900
Total to be adjusted 2,100

For Finished goods:

Labor cost - finished goods 2,850
Overhead - finished goods 2,150
Total to be adjusted 5,000

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 CHAPTER EXERCISES
I – Review Questions

1. “Hybrid production system develop because there are hybrid costing

systems.” Do you agree? Explain.
2. Give examples of industries that are likely to use operation costing.
3. Explain why JIT production systems simplify job costing.
4. Describe four financial benefits of implementing a JIT system.
5. Describe the essence of backflush costing.
II – True or False. Write “T” if the statement is true and “F” if the statement is
false.
_______1. One purpose of a JIT inventory system is to have goods ready just
when the customer needs them.
_______2. Under JIT, materials are “pushed” from one workstation to another to
ensure timely completion of finished products.
_______3. A company will typically have fewer suppliers under JIT than a
conventional system.
_______4. For JIT to operate successfully, all similar pieces of equipment (such
as lathers or drill pressers) must be grouped together.
_______5. One way to reduce inventories is to reduce the setup time needed
between production runs.
_______6. The most effective way to achieve total quality control is to have an
Inspection Department that inspects all incoming raw materials, and inspects
goods as they move along the product flow line.
_______7. In a JIT environment, workers are expected to be cross-trained and
work as a team.
_______8. Under JIT, process time and queue time would both be considered
value-added activities.
_______9. The time involved in changing equipment and getting jigs and forms in
place to accommodate the production of a different item is known as the
setup time.
_______10. The workforce under JIT has less responsibility for quality
control than in a conventional production system.
III – Problems Solving

Problem 1 (Operation Costing). The Packo Company, a small manufacturer,

makes a variety of tool boxes. The company’s manufacturing operations and their
costs for November were:

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 Cutting Assembly Finishing Total

Direct Manufacturing Labor P2,600 P16,500 P4,800 P23,900

Manufacturing Overhead 3,000 22,900 3,300 29,200

5,600 39,400 P8,100 P53,100

Three styles of boxes were produced in November. The quantities and direct
materials costs were

Style Quantity Direct Materials

Standard 1,200 P18,000

Home 600 6,600

Industrial 200 5,400

P30,000

The company uses actual costing. It takes direct materials to each style of box. It
combines direct manufacturing labor and manufacturing overhead and allocates the
conversion costs on the basis of all product units passing through an operation. All
product units are assumed to receive an identical amount of time and effort in each
operation. The industrial style, however, does not go through the finishing operation.

Required:

1. Tabulate the conversion costs of each operation, the total units produced, and
the conversion costs per unit for November.

2. Calculate the total costs and the cost per unit in each style of box produced in
November. Be sure to account for all the total costs.

3. Prepare summary journal entries for each operation. For simplicity, assume
that all direct materials are introduced at the beginning of the cutting
operation. Also, assume that all units were transferred to finished goods when
completed and that there was no beginning or ending work in process.
Prepare one summary entry for all conversion costs incurred, but prepare a
separate entry for allocating conversion costs in each operation.

Problem 2 (Backflush journal entries and JIT production)

The Lim Company has a plant that manufactures transistor radios. The production
time is only a few minutes per unit. The company uses a just-in-time production
system and a backflush costing system with two trigger points for journal entries:

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  Purchase of direct (raw) materials

 Completion of good finished units of product

There are no beginning inventories. The following data pertain to April manufacturing:

Direct (raw) materials purchased P8,800,000

Direct (raw) materials used 8,500,000
Conversion costs incurred 4,220,000
Allocation of conversion 4,000,000
Costs transferred to finished goods 12,500,000
Cost of goods sold 11,900,000
Required:
1. Prepare summary journal entries for April (without disposing of under or
overallocated conversion costs). Assume no direct materials variances.

2. Post the entries in requirement 1 to T-accounts for applicable Inventory

Control, Conversion Costs Control, Conversion Costs Allocated and Cost of
Goods Sold.

3. Under an ideal JIT production system, how would the amounts in your journal
entries differ from those in requirement.

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 Module 10

ACTIVITY-BASED COST SYSTEM FOR MANAGEMENT

Introduction

One of the most difficult tasks in product costing is the determination of the
proper amount of overhead cost to assign to each job, unit of product or service
activity.

The traditional allocation of overhead is geared towards satisfying external

reporting but less often serves the needs of management and that it does not provide
realistic information for management function. Hence, activity-based costing (ABC)
has been developed in response to the manager’s need for more accurate product
costs to make the globally competitive. ABC helps managers to clearly identify the
costs involved in manufacturing a product of in providing a service and gives them a
more accurate unit cost information that is useful in pricing and other decisions.

Learning Objectives:

After finishing this module, the student should be able to:

 Define activity-based costing (ABC).

 Discuss the steps in designing and activity-based costing system.
 Apply activity-based costing to a manufacturing company.

Activity-Based Costing

ABC is a costing method that is designed to provide managers with cost

information for strategic and other decisions that potentially affect capacity and
therefore “fixed” as well as variable costs. It is ordinarily used as a supplement to,
rather than as a replacement for, the company’s usual costing system.

How ABC differs from Traditional costing

ABC differs from traditional cost accounting in three ways.

 The first is that nonmanufacturing as well as manufacturing costs may be

assigned to products, but only on a cause-and-effect basis. For example,
ABC systems can assign sales commissions, shipping costs, and warranty
repair costs to specific products.

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 The second major difference between ABC and traditional cost accounting is
that some manufacturing costs may be excluded from product costs. This is
because ABC only assigns a cost to a product if decisions concerning that
product will cause changes in the cost. ABC excludes two types of costs from
product costs:
a. Organization-sustaining costs; and
b. The costs of unused or idle capacity.

 The third major difference between ABC and traditional cost accounting is
that numerous overhead cost pools are used, each of which is allocated to
products and other cost objects using its own unique measure of activity.
ABC cost pools are created to correspond to the activities performed in an
organization that cause the consumption of overhead resources. Therefore,
the total number of ABC cost pools will definitely exceed one (as in the plant-
wide approach) and it is likely to exceed the number of departments within a
company (as in the departmental approach), since more than one activity is
often performed within each department.

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The steps or activities required in designing an ABC system are
1. Process Value Analysis (PVA)
2. Identifying activity centers
3. Assigning costs to activity centers
4. Selecting cost drivers

Activity Centers
An activity center can be defined as a part of the production process for which
management wants a separate reporting of the cost of the activity involved.
Generally, the levels of activities can be classified into four as follows:
1. Unit-level activities, which are performed each time a unit is produced.
Example: machine-related activities, such as milling, cutting, and
maintenance;
2. Batch-level activities, which are performed each time a batch of goods is
handled or processed. Example: purchase order processing, equipment
setups, material handling, and quality inspection;
3. Product-level activities, which are performed as needed to support the
production of each different type of product. Example: product testing,
product inventory management, and product design; and
4. Facility-level activities which simply sustain a facility’s general
manufacturing process. Example: general factory, plant occupancy, and
personnel administration and training.

Illustrative Problem: Manufacturing Applications of Activity-based Costing

Luzon Company manufactures 4,000 units of Product A and 20,000 units of Product
B each year. The company currently uses direct labor hours to assign overhead
costs to products. Product X requires 2.5 DLH and Product B requires 2.0 DLH to
produce.
Presently, Luzon Company uses a plantwide overhead allocation rate. Using this
method, the unit product cost is:
Product A Product B
Direct material 36.00 30.00
Direct labor 17.50 14.00
Manufacturing overhead
2.5 DLH x P18/DLH 45.00

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 2.0 DLH x P18/DLH 36.00
Total unit product cost 98.50 80.00
Management at Luzon believes that overhead costs are actually caused by the
following five activities:
Traceable
Activity Cost
Machine setups 255,000
Quality inspections 160,000
Production orders 81,000
Machine-hours worked 314,000
Material receipts 90,000
Total 900,000

The following transaction data have been compiled by the management of Luzon:
Activity Total Product A Product B
Machine setups 5,000 3,000 2,000
Quality inspections 8,000 5,000 3,000
Production orders 600 200 400
Machine-hours worked 40,000 12,000 28,000
Material receipts 750 150 600

These data can be used to develop overhead rates for each of the five activities:
Activity Costs Product A Product B
Machine setups P225,000 5,000 P 51.00 per setup
Quality inspections 160,000 8,000 20.00 per inspection
Production orders 81,000 600 135.00 per order
Machine-hours worked 314,000 40,000 7.85 per hour
Material receipts 90,000 750 120.00 per receipt
The activity based overhead rates that were just calculated can be used to assign
overhead costs to Luzon’s two products.

Product A
Activity ABC Rate Transactions Amount
Machine setups 50.00 3,000 153,000
Quality inspections 20.00 5,000 100,000
Production orders 135.00 200 27,000

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 Machine-hours worked 7.85 12,000 94,200
Material receipts 120.00 150 18,000
Total overhead assigned 392,200
Number of units produced ÷ 4,000
Overhead per unit 98.05

Product B
Activity ABC Rate Transactions Amount
Machine setups 51.00 2,000 102,000
Quality inspections 20.00 3,000 60,000
Production orders 135.00 400 54,000
Machine-hours worked 7.85 28,000 219,800
Material receipts 120.00 600 72,000
Total overhead assigned 507,800
Number of units produced ÷ 20,000
Overhead per unit 25.39

Now compare the unit product costs using the old costing system and our ABC
system.

Costing Method Product A Product B

Activity-based costing 151.55 69.39
Old costing system 98.50 80.00

Characteristics of Successful ABC Implementations

 There should be strong top management support.

 Top managers should ensure that ABC data are linked to how people are
evaluated and rewarded
 A cross-functional team should be created to design and implement the ABC
system.

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 CHAPTER EXERCISES

I – Review Questions

1. Why are new approaches to overhead cost application, such as activity-based

costing, needed in many companies today?
2. When designing an ABC system, why should process value analysis always be
the starting point?
3. What are the levels of activity that can be identified in a company?
4. Why is direct labor a poor base for allocating overhead in many companies?
5. What are the limitations of ABC?
II – Fill in the missing item. Listed below are several terms relating to activity-based
costing:

Process value analysis Plant-wide overhead rate

Facility level Low volume
High volume Batch level
Activity centers Two stage
Product level Unit Level
Volume Stage

Choose the term or terms above that most appropriately complete the following
statements. The terms can be used more than once. (Note that a blank can hold out
more than one word).
1. A single overhead rate used throughout an entire plant operation is known as
a _______________.
2. The major problem with direct labor-hours or machine-hours as the basis for
assigning overhead cost to products is that these bases rely on ___________
as the sole factor in overhead cost assignment.
3. Activity-based costing involves a ____________ allocation process, in which
the first ___________ assigns overhead costs to activity centers and the
second ____________ assigns overhead costs from activity centers to
products and services.

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 4. ____________, which involves a systematic analysis of the activities required
to make a product or perform a service, is the beginning point in activity-
based costing.
5. ____________ activities, such as the consumption of power, are performed
each time a unit is produced and arise as a result of the total volume of
production going through a facility.
6. ____________ activities, which are performed each time a batch of goods is
handled or processed, include tasks such as placement of a purchase order.
7. ____________ activities which are performed as needed to support the
production of a particular product, include tasks such as maintaining parts
inventories.
8. ____________ activities just sustain a facility’s general manufacturing
process and include items such as insurance or general factory management.
9. The use of activity-based costing often causes a shift in overhead costs from
____________ products to ____________ products, thereby causing the unit
cost of the ___________ products to sharply increase.
10. One of the benefits of activity-based costing is that it increases the number of
cost pools, or ____________, used to accumulate and assign overhead costs
to products and services.

III – Identification: The following activities occur at Luca Corporation, a company

that manufactures a variety of products.
a. Various individuals manage the parts inventories.
b. A clerk in the factory issues purchase order for a job.
c. The personnel department trains new production workers.
d. The factory’s general manager meets with other department heads such as
marketing to coordinate plans.
e. Direct labor workers assemble products.
f. Engineers design new products.
g. The materials storekeeper issues raw materials to be used in jobs.
h. The maintenance department performs periodic preventive maintenance on
general-use equipment.
Required:
Classify each of the activities above as either a unit-level, batch-level, product-level,
or organization-sustaining activity.

IV – Problem

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BB systems, Inc. makes paragliders for sale through specialty sporting goods stores.
The company has a standard paraglider model, but also makes custom-designed
paragliders. Management has designed an activity-based costing system with the
following activity cost pools and activity rates:
Activity Cost Pool Activity Rate
Supporting manufacturing 18 per direct labor-hour
Order processing 192 per order
Custom designing 261 per custom design
Custom service 426 per customer
Management would like an analysis of the profitability of a particular customer, Fly
High, which has ordered the following products over the last 12 months:
Standard Model Custom Design
Number of gliders 10 2
Number of orders 1 2
Number of custom designs 0 2
Direct labor-hours per glider 28.5 32.0
Selling price per glider 1,650 2,300
Direct materials cost per glider 462 576
The company’s direct labor rate is P19 per hour.
Required: Using the company’s activity-based costing system, compute the
customers margin of Fly High.

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 Module 11

ACCOUNTING FOR JOINT AND BY-PRODUCTS

Introduction:

Almost every company produces and sells more than one type of product.
Although companies may engage in multiple production processes to manufacture a
variety of products, they may also engage in a single process to simultaneously
generate various different outputs. For example, the refining of crude oil may produce
gasoline, motor oil, heating oil, and kerosene. A single process in which one product
cannot be manufactured without producing others is known as a joint process. Such
processes are common in the extractive, agricultural, food, and chemical industries.

The costs incurred for materials, labor, and overhead during a joint process
are referred to as the joint cost of the production process. This chapter discusses
joint processes, their related product outputs, and the accounting treatment of joint
cost. Outputs of a joint process are classified based on their revenue-generating
ability, and joint cost is allocated only to the primary products of a joint process, using
either a physical or monetary measure.

Learning objectives:

 Explain the concept of joint cost, joint product, and by-product.

 Discuss the concept of cost allocation in a joint production process.
 Apply the procedures in accounting for joint costs and by-products.

Lesson 1: Joint Process and Its Outputs

A joint process simultaneously produces more than one product line. The
product categories resulting from a joint process that have a sales value are referred
to as (1) joint products, (2) by-products, and (3) scrap.

 Joint products are the primary outputs of a joint process; each joint product
individually has substantial revenue-generating ability. Joint products are the
primary reason management undertakes the production process yielding
them. These products are also called primary products, main products, or co-
products. Joint products do not necessarily have to be totally different
products; the definition of joint products has been extended to include similar
products of differing quality that result from the same process.

106
 By-products and scrap are incidental outputs of a joint process. Both are
salable, but their sales values alone would not be sufficient for management
to justify undertaking the joint process. For example, donut hole cutouts are a
by-product of the donut-making process. Scrap may be generated in the
setup stage. By-products are viewed as having a higher sales value than
scrap.
 A final output from a joint process is waste, which is a residual output that
has no sales value. A normal amount of waste may create a production cost
that cannot be avoided in some industries. Alternatively, many companies
have learned either to minimize their production waste by changing their
processing techniques or to reclassify waste as a by-product or scrap through
selling it to generate some minimal amount of revenue.
 A company may change a product classification over time because of
changes in technology, consumer demand, or ecological factors. Some
products originally classified as by-products are reclassified as joint products,
whereas some joint products are reduced to the by-product category. Even
products originally viewed as scrap or waste may be upgraded to a joint
product status. Classification of joint process output is based on the judgment
of company managers, normally after considering the relative sales values of
the outputs. Classifications are unique to each company engaged in the joint
process.

The Split-off Point

The point at which joint process outputs are first identifiable as individual
products is called the split-off point. A joint process may have one or more split-
off points, depending on the number and types of output produced. Output may
be sold at the split-off point if a market exists for products in that condition.
Alternatively, some or all of the products may be processed further after exiting
the joint process.

Joint cost includes all costs incurred up to the split-off point for direct material,
direct labor, and overhead. Joint cost is allocated, at the split-off point, to only the
joint products because these products are the reason that management
undertook the production process. Allocation is necessary because of the cost
principle. Joint cost is a necessary and reasonable cost of producing the joint
products and, therefore, should be attached to them. Additional costs incurred

107
 after the split-off point that can be identified directly with individual products are
called additional processing costs or separable costs.

Lesson 2 – Methods of Allocating Joint Costs to Joint Products

Joint cost is only assigned to joint products. However, before allocation, joint cost
may be reduced by the value of the by-products and scrap. The most commonly
used methods to allocate joint costs to joint products are:

1. The Physical Measure

2. The Sales Value (Sales Value at Split-off, and
3. The Net Realizable Value method

A. The Physical Measure Method

An easy, objective way to prorate joint cost at the split-off point is
through the use of a physical measure. Physical measurement allocation
treats each unit of output as equally desirable and assigns the same per-unit
cost to each. Physical measures are useful in allocating joint cost to products
that have extremely unstable selling prices.
However, a major disadvantage of allocating joint cost based on a
physical measure is that the method ignores the revenue-generating ability of
individual joint products. Products that weigh the most or that are produced in
the largest quantity will receive the highest proportion of joint cost allocation—
regardless of their ability to bear that cost when they are sold.
Illustration:

Assume the following data for a manufacturing company:

Allocation of the joint cost based on physical measure is as follows:

Cost per Ton = Total Joint Cost / Total number of Tons

$5,400,000 / 9,000 tons

Joint Cost per Total per Allocated

Product Ton Ton Cost
Steaks 3800 $600 $2,280,000
Roasts 2400 600 1,440,000
Ground 2800 600 1,680,000
9000 $5,400,000

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 B. The Sales Value at Split-Off Method
The sales value at split-off allocation assigns joint cost to joint
products based solely on the relative sales values of the products at the split-
off point. Thus, to use this method, all joint products must be marketable at
split-off.
Under this method, the low selling price per ton of ground, relative to
the other joint products, results in a lower allocated cost per ton than resulted
from the physical measure allocation technique. This process uses a
weighting technique based on both quantities produced and selling price of
production.
The allocation of the joint cost based on sales value at split-off is shown
below:

Total
Approximated Appoximated
Joint Net Realizable Net Realizable Decimal Amount Cost per
Products Tons Value per Ton Value Fraction Joint Cost Allocated Ton

Steaks 3,800 2,800 10,640,000 0.58 5,400,000 3,132,000 824.21

Roasts 2,400 1,800 4,320,000 0.24 5,400,000 1,296,000 540.00
Ground 2,800 1,200 3,360,000 0.18 5,400,000 972,000 347.14
Total 9,000 18,320,000 1.00 5,400,000

C. The Net Realizable Value Method

The net realizable value at split-off allocation method assigns joint
cost based on the joint products’ proportional net realizable values at the
point of split-off. Net realizable value (NRV) is equal to product sales revenue
at split-off minus any costs necessary to prepare and dispose of the product.
This method requires that all joint products be marketable at the split-off point,
and it considers the additional costs that must be incurred at split-off to realize
the estimated sales revenue.

The allocation of joint costs using the net realizable value method is as
follows:

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 Lesson 3 – Accounting for By-Products

The objective in accounting for by-products is to reflect the economic

relationship between the by-products and the main products. The two common
methods used are:

Method 1 – The net realizable value from sale of the by-products is deducted
from the cost of the main product.

Method 2 – The net realizable value from sale of the by-product is treated as
other income.

To illustrate, assume that GS Company has a production process that yields product
ABC as the main product and product X as the by-product. Data related to these
products follow:

ABC X
Sales Value 2,000,000 11,000
Processing costs up to split-off point, chargeable
To product ABC 800,000
Additional processing costs of product X 3,000

Method 1 Method 2
Sales revenue from ABC P2,000,000 P2,000,000
Other Income (11,000 – 3,000) 0 8,000
Total revenue 2,000,000 2,008,000
Cost of Sales:
Total production costs 800,000 800,000
Less by-product:
Net Realizable Value of X 8,000 0

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 Adjusted cost of sales 792,000 800,000
Gross margin P1,208,000 P1,208,000

Journal Entries Under each method

Method 1 – The net realizable value of the by-product is deducted from the cost of
the main product.

Work in Process Inventory 800,000

Direct materials inventory
Direct labor 800,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Separable By-product costs 3,000

Direct labor 3,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Accounts Receivable or Cash 11,000

By-product revenue 11,000
*Debit assumed

By-product revenue 11,000

Separable By-product costs 3,000
Work in process inventory 8,000
To deduct the net realizable value of the by-product from
the cost of the main product

Finished Goods Inventory 792,000

Work in process 792,000

Cost of goods sold 792,000

Finished goods inventory 792,000

2,000,00
Accounts Receivable 0
Sales revenue (Main Product) 2,000,00

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 0
*Debit assumed
Method 2 – The net realizable value of the by-product is shown as other income in
the Income Statement.

Work in Process Inventory 800,000

Direct materials inventory
Direct labor 800,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Separable By-product costs 3,000

Direct labor 3,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Accounts Receivable or Cash 11,000

By-product revenue 11,000
*Debit assumed

Finished Goods Inventory 800,000

Work in process 800,000

Cost of goods sold 800,000

Finished goods inventory 800,000

2,000,00
Accounts Receivable 0
2,000,00
Sales revenue (Main Product) 0
*Debit assumed

CHAPTER EXRCISES

I – Review Questions:

1. What is joint process? Joint costs?

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 2. What are the outputs of a joint process?
3. Distinguish between joint product and by-product.
4. What is the objective of joint cost allocation?
5. Explain the basic difference between the method of accounting for joint
products and that for by-products.

II – Problems

1. A company processes Chemical XD-1 through a pressure treatment

operation. After the process is complete, there are two outputs: R and S. The
monthly cost of processing XD-1 are P45,000 for materials and P160,000 for
conversion costs. This processing results in outputs that sell for a total of
P455,000. The sales revenue from R amounts to P273,000 of the total.
Required:
Compute the costs to be assigned to R and S in a typical month, using the net
realizable value method.
2. BL Company produces only two products and incurs joint processing costs
that total $3,750. Products Aba and Ibi are produced in the following
quantities during each month: 4,500 and 6,000 gallons, respectively. BL also
runs one ad each month that advertises both products at a cost of $1,500.
The selling price per gallon for the two products are $20 and $17.50,
respectively.
Required:
a. What amount of joint processing costs is allocated to each product
based on gallons produced?
b. What amount of advertising cost is allocated to each product based on
sales value?

3. GAB Company produces three products from the same process and incurs
joint processing costs of $3,000.
Disposal
Sales price cost per Further Final sales
per gallon gallon at processing price per
Gallons at split-off split-off costs gallon
Mat 2,300 $ 4.50 $1.25 $1.00 $ 7.00
Nat 1,100 6.00 3.00 2.00 10.00
Qat 500 10.00 8.00 2.00 15.00

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 Disposal costs for the products if they are processed further are:
Mat, $3.00; Nat, $5.50; Qat, $1.00.
Required:
a. What amount of joint processing cost is allocated to the three products
using sales value at split-off?
b. What amount of joint processing cost is allocated to the three products
using net realizable value at split-off?

4. A company engages in a manufacturing process that uses one input product

(Q) to produce three outputs (X, P, and Z). outputs X and P are considered
main products and output Z is by-product. During the recent month, the
following events occurred:
1) Produced and sold 200 units of X and 100 units of P. produced 25
units of Z.
2) Recorded sales revenue of P35,000 from sales of X and P. The cost
of sales before accounting for the by-product was P18,000.
3) Incurred P125 to process the 25 units of Z to completion. These costs
are charged as they are incurred against any by products’ sales.
(None of these by-product costs are kept in inventory at the end of the
period.)
4) Received P570 in revenue from the sale of 10 units of Z.
Required:
1) Prepare a statement showing, in parallel columns, the sales revenue,
other income, costs of goods sold, separate costs to process by-
products, and gross margin that would be reported for each of the two
methods.
2) Prepare journal entries under the two methods of accounting for by-
products.

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 Module 12

STANDARD COSTING AND ANALYSIS OF VARIANCE

Introduction

Organizations develop and use standards for almost all tasks. Because of the
variety of organizational activities and information objectives, no single performance
measurement system is appropriate for all situations. Some systems use standards
for prices, but not for quantities; other systems (especially in service businesses) use
labor, but not material, standards. This chapter discusses a traditional standard cost
system that provides price and quantity standards for each cost component: direct
material (DM), direct labor (DL), and factory overhead (OH). Discussion is provided
on how standards are developed, how variances are calculated, and what
information can be gained from detailed variance analysis. Journal entries used in a
standard cost system are also presented.

Learning Objectives:

After finishing this module, the student should be able to:

 State the nature and rationale of standard costs.

 Discuss the benefits and limitations of standard costs.
 Describe how standards are set for direct material, direct labor and overhead.
 Identify the possible causes of variances and responsibility for them.
 Compute and analyze the variances between actual costs and standard
costs.

Lesson 1 – Standard Costs

Standards

 Standards are expected level of performance.

 Standards are established to institute order, discipline, expectations, and
normalcy.
 Standards are oftentimes quantitative for objectivity of measurement.
 Standards are used in almost all functions of management – planning,
organizing, directing, and controlling.

Standards Setting

 Standard setting is strategic in nature. Standard could be set by top

management, outsourced from independent entity, developed by industrial

115
 engineering department, or established with the participation and involvement
of lower level managers and personnel.
 Standards set in organizations could either motivate or demotivate
employees, give relevance or irrelevance to their work, or produce excellent
performance or mediocre performance.
 A standard is a benchmark or “norm” for measuring performance. In
managerial accounting, two types of standards are commonly used by
manufacturing, service, food and not-for-profit organizations:
 Quantity standards specify how much of an input should be used to
make a product or provide a service. For example: Auto service
centers like Firestone and Sears set labor time standards for the
completion of work tasks. Fast-food outlets such as McDonald’s have
exacting standards for the quantity of meat going into a sandwich.

 Price standards specify how much should be paid for each unit of the
input. For example: Hospitals have standard costs for food, laundry,
and other items.
 Capacity levels in standard setting include:
1. Theoretical capacity – Standards are set at the highest possible capacity
where there are no allowance for waste, spoilage, inefficiencies, machine
breakdowns and other downtimes, and other interruptions in the
production line.
2. Practical capacity - Standards attain the most reasonable production
level, with allowances for machine breakdowns, downtimes, inefficiencies,
waste and spoilage, and other normal production disturbances.
3. Budgeted Capacity – This is the estimated level of performance that the
company plans to achieve in the next 12 months.
4. Standard capacity – This is the estimated capacity that should have been
used in actual capacity. It is determined by multiplying actual production in
units by the standard rate per unit produced.
5. Normal capacity – This is the average production level over a long period
of time. It is the middle point where variations in production levels over a
longer span of time would finally settle down.

Sample Problem on Capacity Levels

Myrcella Company acquired a machine with a 200,000 units level of capacity five
years ago. Using this machine, the standard labor time is 2 hours per unit.

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Engineering estimates based on attainable performance is 170,000 units.
Management has planned to produce only 160,000 units in the coming year using the
same machine. Total production in the last five years is 828,000 with annual
production recorded as follows:

first year 180,000 units

second year 140,000 units
third year 170,000 units
fourth year 182,000 units
fifth year 156,000 units
The capacity levels are as follows:

Hours
(units x 2
Units hours)
Maximum Capacity 200,000 400,000
Practical Capacity 170,000 340,000
Budgeted Capacity 160,000 320,000
Normal Capacity (828,000/5 years 165,600 331,200
Standard capacity first year (180,000 x 2 hours 360,000

Setting Direct Material Standards

 The standard price per unit for direct materials should reflect the final,
delivered cost of the materials, net of any discounts taken.
 The standard quantity per unit for direct materials should reflect the amount of
material required for each unit of finished product, as well as an allowance for
unavoidable waste, spoilage, and other normal inefficiencies.
 A bill of materials is a list that shows the quantity of each type of material in a
unit of finished product.

Setting Direct Labor Standards

 The standard rate per hour for direct labor includes not only wages earned
but also fringe benefits and other labor costs. Many companies prepare a
single rate for all employees within a department that reflects the “mix” of
wage rates earned.
 The standard hours per unit reflects the labor hours required to complete one
unit of product. Standards can be determined by using available references

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 that estimate the time needed to perform a given task, or by relying on time
and motion studies.

Setting Variable Manufacturing Overhead Standards

 The price standard for variable manufacturing overhead comes from the
variable portion of the predetermined overhead rate.
 The quantity standard for variable manufacturing overhead is expressed in
either direct labor hours or machine hours depending on which is used as the
allocation base in the predetermined overhead rate.

Price and quantity standards are determined separately for two reasons:

 Different managers are usually responsible for buying and for using inputs.
For example: The purchasing manager is responsible for raw material
purchase prices and the production manager is responsible for the quantity of
raw material used.
 The buying and using activities occur at different points in time. For example:
Raw material purchases may be held in inventory for a period of time before
being used in production.

Sample Problems on Setting Standards for Materials and Labor

1. Southern Corporation produces product Durito weighing 3.2 lbs., net of 20%
processing loss. It buys materials from a supplier at an invoice price of P40
per pound with a normal trade discount of 2/10, n/30. Freight for the delivery
of materials costs P5 per lb. What is the standard materials quantity, price
and cost per unit?
Solution:
Standard materials input = Standard materials output / (100 – loss rate)
= 3.2 lbs. / 80% = 4 lbs.

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 Standard price per lb.:
Purchase price P40 x 98% P39.20
Freight-in 5.00
Standard price per lb. P44.20
Standard materials cost = Standard materials input x Standard net price
= 4 lbs. x P44.20 = P176.80
2. Northern Company produces product Durito after 45 minutes of direct labor
time. The company pays its production personnel for eight (8) hours a day
and gives a paid break time of 30 minutes a day. It normally starts its process
with 5,000 units and completes at 4,500 good units. It pays its personnel at an
hourly rate of P70 plus social welfare benefits of approximately 10% on the
basic rate. What is the standard direct labor hours, rate and cost per unit?
Solution:
The production rate is 90% (4,500/5,000). The standards are determined a
follows:
Standard direct labor hours = Standard output time / (100 – Loss rate)
= 45 minutes / 90%
= 53.33333 minutes or 0.888889 hour
Standard direct labor rate per hour:
Basic wage rate per hour P70.00
Fringe benefits (10%) 6.00
Standard rate per hour P76.00
Standard direct labor costs = standard direct labor time x Standard labor rate
= 0.888889 hrs x P76.00
= P67.5556

Lesson 2: Production Costs Variance Analysis

 Differences between standard prices and actual prices and standard

quantities and actual quantities are called variances. The act of computing
and interpreting variances is called variance analysis.
 A variance should be investigated, analyzed, studied, and avoided in the
future.
 A variance may be unfavorable or favorable. If actual cost is more than the
standard costs, the variance is unfavorable. If actual cost is less than
standard costs, the variance is favorable.

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  A variance may be normal or exceptional.

A General Model for Variance Analysis

Price and quantity variances can be

computed for all three variable cost
elements – direct materials, direct
labor, and variable manufacturing
overhead – even though the
variances have different names as
shown.

 Although price and quantity variances are known by different names, they are
computed exactly the same way (as shown on this slide) for direct materials,
direct labor, and variable manufacturing overhead.
 The actual quantity represents the amount of direct materials, direct labor,
and variable manufacturing overhead actually used.
 The standard quantity represents the standard quantity allowed for the actual
output of the period.
 The actual price represents the actual amount paid for the input used.
 The standard price represents the amount that should have been paid for the
input used.
 In equation form, price and quantity variances are calculated as shown below:

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Responsibility for Variances:

 Material Cost Variances:

The purchasing manager and production manager are usually held
responsible for the materials price variance and materials quantity variance,
respectively. The standard price is used to compute the quantity variance so
that the production manager is not held responsible for the performance of
the purchasing manager.
 Labor Variances:
Labor variances are partially controllable by employees within the Production
Department. For example, production managers/supervisors can influence:
- The deployment of highly skilled workers and less skilled workers on
tasks consistent with their skill levels.
- The level of employee motivation within the department.
- The quality of production supervision.
- The quality of the training provided to the employees.

Advantages of Standard Costs

Research has shown that a substantial portion of companies in the United Kingdom,
Canada, Japan, and the United States use standard cost systems. This is because
standard cost systems offer many advantages including:

 Standard costs are a key element of the management by exception approach

which helps managers focus their attention on the most important issues.

 Standards that are viewed as reasonable by employees can serve as

benchmarks that promote economy and efficiency.

 Standard costs can greatly simplify bookkeeping.

 Standard costs fit naturally into a responsibility accounting system

Potential Problems with Standard Costs

The use of standard costs can also present a number of problems. For example:

 Standard cost variance reports are usually prepared on a monthly basis and
are often released days or weeks after the end of the month; hence, the
information can be outdated.

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  If variances are misused as a club to negatively reinforce employees, morale
may suffer and employees may make dysfunctional decisions.

 Labor variances make two important assumptions. First, they assume that
the production process is labor-paced; if labor works faster, output will go up.
Second, the computations assume that labor is a variable cost. These
assumptions are often invalid in today’s automated manufacturing
environment where employees are essentially a fixed cost.

 In some cases, a “favorable” variance can be as bad or worse than an

unfavorable variance.

 Excessive emphasis on meeting the standards may overshadow other

important objectives such as maintaining and improving quality, on-time
delivery, and customer satisfaction.

 Just meeting standards may not be sufficient; continual improvement using

techniques such as Six Sigma may be necessary to survive in a competitive
environment

Sample Problems on Variance Analysis (Materials and labor costs variances)

The standard unit cost of Tomen Company is given below:

Direct materials : 4 lbs. @ P4.00 P16.00

Direct labor : 3 hrs. @ P8.00 24.00

Variable Overhead : 3 hrs. @ P2.00 P6.00

Fixed Overhead : 3 hrs. @ P3.00 P9.00 P15.00

Total standard unit cost P55.00

The company has a normal capacity of 135,000 units and a budgeted capacity of
132,000 units. Actual data taken from the production records in the month of
September 2018 are:

Actual production 130,000 units

Materials purchases (580,000 lbs. @ P3.90) P2,262,000

Materials used 525,000 lbs.

Payroll incurred (380,000 lbs. @ P8.15) P3,097,000

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 Factory overhead: Variable P 800,000

Fixed P1,250,000

Required: Materials and labor cost variances using 2-way analyses.

Solution/Discussion:

Direct Materials Costs Variances

Material variances are classified as price variance and quantity variance as tabulated
below:

Quantity Unit Price Amount

Actual 525,000 lbs P3.90 P2,047,500
Less: Standard 520,000 4.00 2,080,000
Variance - UF (F) 5,000 UF P (0.10) F P (32,500) F

The total peso value of these materials variances are computed as follows:

Materials Price Variance = (Actual price – Standard price) x Actual Quantity

Materials Quantity Variance = (Actual Quantity – Standard Quantity) x Standard Price

MPV = (AP – SP) x AQ = (P3.90 – P4.00) x 525,000 lbs. = (P52,500) F

MQV = (AQ – SQ) x SP = (525,000 – 520,000) x P4.00 = 20,000 UF

Net direct materials costs variance P (32,500) F

Direct Labor Costs Variances

Except for terminologies, the manner in which the direct labor costs variances are
analyzed is similar to that of the direct materials. Direct labor is also basically
affected by two factors – hours and rate per hour. The variances are presented
below:

Hours Rate /Hr Amount

Actual 380,000 P8.15 P3,097,000
Less: Standard 390,000 8.00 3,120,000
Variance - UF (F) (10,000) F P 0.15 UF P(23,000) F
Labor Rate Variance = (Actual Rate – Standard Rate) x Actual Rate

Labor Efficiency Variance = (Actual Hours – Standard Hours) x Standard Rate

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LRV = (AR – SR) x AH = (P8.15 – P8.00) x 380,000 lbs = P57,000 UF

LEV = (AH – SH) x SR = (380,000 – 390,000) x P8.00 = (80,000) F

Net Direct Labor Costs Variance P(23,000) F

Factory Overhead Variance Analysis

Sample Problem

In analyzing the factory overhead variances, the following relevant data are taken
from the original information:

Normal Capacity 135,000 units or 405,000 hours

Standard hours 390,000 hours
Actual hours 380,000 hours
Standard overhead rates:
Fixed overhead rate P3.00 per hour
Variable overhead rate 2.00 per hour
Total overhead rate P5.00 per hour
Actual Overhead costs
Variable P800,000 and Fixed, P1,250,000

Required: Analyze the factory overhead variances using the:

1. 2-way analysis (ConVo)

2. 3-way analysis (SEV)
3. 4-way analysis
4. 5-way analysis

Solution/Discussions:

 First, let us analyze the total factory overhead variance, then analyze it into ist
components. The total factory overhead variance is calculated below:

OVERHEAD
Fixed Variable Total
Actual factory overhead 1,250,000 800,000 2,050,000
Less: Standard factory overhead 1,170,000 780,000 1,950,000
Variances-UF (F) 80,000 20,000 100,000

2-way analysis (Con Vo)

The 2-way variance analysis classifies the variances in relation to amount of money
spent (controllable variance) or level of production (volume variance). The 2-way
overhead variance analysis is presented below:

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 Controllable Variance
Actual Factory Overhead 2,050,000
Less: Budgeted Allowance on Standard Hours
Fixed (405,000 hours x P3.00) 1,215,000
Variable (390,000 hours x P2.00) 780,000 1,995,000 P55,000 UF
Volume Variance
Budgeted Allowance on Standard Hours 1,995,000
Less: Standard Factory Overhead
(390,000 hrs. x P5) 1,950,000 45,000 UF
Total Overhead Variance P100,000 UF

 The budgeted fixed overhead is based on normal capacity.

 In computed the budget allowance in standard hours, the fixed overhead is
the budgeted fixed overhead while, the variable overhead is standard hour
times standard variable overhead rate.
 Controllable variance represents the change in the amount of money spent
based on absolute peso amount and on the number of hours used. It is
composed of the spending variance and the variable efficiency variance
which are both controllable in the level of the supervisors.
 Volume variance measures the deviation in hours between the standard
capacity from normal capacity. Volume variance is strictly fixed overhead
variance.

3-way analysis

The controllable variance could still be divided into two, the spending (or budget)
variance and the variable efficiency variance. As such, we will have three overhead
variances computed as follows:

Controllable Variance
Actual Factory Overhead 2,050,000
Less: Budgeted Allowance on Actual Hours
1,215,00
Fixed (405,000 hours x P3.00) 0
Variable (380,000 hours x P2.00) 760,000 1,975,000 P75,000 UF
Variable Efficiency Variance
Budgeted Allowance on Actual Hours 1,975,000
Less: Budgeted Allowance on Standard Hours 1,995,000 (20,000) F
Volume Variance

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 Budgeted Allowance on Standard Hours 1,995,000
Less: Standard Factory OH 1,950,000 45,000 UF
P100,000
Total Overhead Variance UF

 In determining budgeted overhead amounts, the budgeted fixed overhead

does not change regardless of level of activity or level of hours used.
 Spending variance is the rate variance. It indicates the difference in the
amount of money spent per unit produced or per hour used.
 The variable efficiency variance refers to the amount of money spent on the
difference in hours used relative to variable overhead.

4-way analysis

The spending variance in the 3-way analysis above could still be divided as to fixed
spending and variable spending variance. This makes our overhead analysis into a
4-way analysis, as follows:

Fixed Spending Variance

Actual Factory Overhead 1,250,000
Less: Budgetd Fixed Overhead 1,215,000 P35,000 UF
Variable Spending Variance
Actual Variable Overhead 800,000
Less: Actual Hours x Variable OH rate
(380,000 hrs x P2.00) 760,000 40,000 UF
Variable Efficiency Variance
Budgeted Allowance on Actual Hours 1,975,000
Less: Budgeted Allowance on Standard Hours 1,995,000 (20,000) F
Volume Variance
Budgeted Allowance on Standard Hours 1,995,000
Less: Standard Factory OH 1,950,000 45,000 UF
Total Overhead Variance P100,000 UF

Materials price, mix and yield variances

Almost all products need different materials to complete. In this case, materials
mixing and yield variances are to be isolated, analyzed, studied, and given proper
managerial action. The materials mix and yield variances represent the quantity

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variance. The computation of the materials price, mix, and yield variances are
illustrated using the following information:

Sample Problem

The standard materials costs in producing 400 units of product “Covid” are as
follows:

Materials Qty. in lbs. Price per lb. Total Costs

A 400 P10.00 P4,000
B 500 5.00 2,500
C 100 8.00 800
1,000 P7,300
Actual production data in October 2019 are as follows:

 Production, 16,000 units

 Materials used:

Materials Qty. in lbs. Price per lb. Total Costs

A 18,000 P10.20 P183,600
B 19,000 4.90 93,100
C 5,000 8.05 40,250
42,000 P316,950
Determine the materials price, mix and yield variances.

Solutions/Discussions:

 First, let us determine the Standard Output Cost (SOC) and the Standard
Input Cost (SIC). SOC is the average standard materials cost per output
(completed units), while SIC is the average standard materials cost per unit
(materials input).

SOC = Total Standard Materials Cost / Standard Production

SIC = Total Standard Materials Cost / Standard Materials Input

SOC = P7,300 / 400 units = P18.25 per unit

SIC = P7,300 / 1,000 lbs. = P7.30 per pound

Actual Direct materials costs P316,950

Less: Actual output @ Standard Output Cost

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 (16,000 units x P18.25) 292,000
Total materials costs variance P24,950 UF
 The materials price, mix and yield variances are as follows:

Materials Price Variance:

Actual direct materials costs P316,950
Less: Actual Materials input @ Standard Price
A (18,000 lbs x P10.00) P180,000
B (19,000 lbs x P5.00) 95,000
C (5,000 lbs x P8.00) 40,000 315,000 P1,950 UF

Materials Mix Variance

Actual Materials Input @ Standard Price 315,000
Less: Actual Materials Input @ Standard Input cost
(42,000 lbs x P7.30 per lb) 306,600 8,400 UF

Yield Variance
Actual Materials Input @ Standard Input Cost 306,600
Less: Actual Output @ Standard Output Cost
(16,000 units x P18.25) 292,000 14,600 UF

P24,950
Total Materials Cost Variance UF

 Materials price variance is the difference in price multiplied by the actual

quantity purchased (or quantity used if quantity purchased is not available).
 The materials mix variance is the difference between the actual quantity used
in a material and the standard quantity that should have been used for that
material based on the standard materials mix and out of the total materials
used.
 The materials yield variance represents the difference in actual output and the
expected output given a particular number of materials used in production.
The standard materials yield is equal to the ratio of output over the input.

Disposition of Variances

A variance may be normal or exceptional. Normal variances are those within the
range of expectations while exceptional variances are those outside the range of
normal expectations. These variances are disposed of as follows:

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  Normal variance – adjusted to cost of goods sold, ie, immediately treated as
period costs.
 Exceptional Variance – Traditionally, exceptional material variances are
allocated among the materials inventory, work-in-process inventory, finished
goods inventory, and cost of goods sold accounts. Exceptional variances of
direct labor and overhead are allocated among work in process inventory,
finished goods inventory and cost of goods sold accounts. Modern business
philosophies treat exceptional variances as an expense.

Chapter Exercises

I – True/False. Identify each of the following statements as either true or false.

On your working paper, write T if the statement is true and F if the statement is
false.

1. Specifications for materials are compiled on a bill of materials.

2. Specifications for materials are compiled on a purchase requisition.
3. An operations flow document shows all processes necessary to manufacture
one unit of a product.
4. A standard cost card is prepared after manufacturing standards have been
developed for direct materials, direct labor, and factory overhead.
5. The total variance can provide useful information about the source of cost
differences.
6. The total variance does not provide useful information about the source of
cost differences.
7. The formula for price/rate variance is (AP - SP) x AQ
8. The formula for price/rate variance is (AP - SP) x SQ
9. Specifications for materials are compiled on a bill of materials.
10. Specifications for materials are compiled on a purchase requisition.
11. An operations flow document shows all processes necessary to manufacture
one unit of a product.
12. A standard cost card is prepared after manufacturing standards have been
developed for direct materials, direct labor, and factory overhead.
13. The total variance can provide useful information about the source of cost
differences.
14. The price variance reflects the difference between the quantity of inputs used
and the standard quantity allowed for the output of a period.

129
 15. The usage variance reflects the difference between the quantity of inputs
used and the standard quantity allowed for the output of a period.
16. The difference between the actual wages paid to employees and the standard
wages for all hours worked is the labor rate variance.
17. The difference between the actual wages paid to employees and the standard
wages for all hours worked is the labor efficiency variance.
18. The difference between the standard hours worked for a specific level of
production and the actual hours worked is the labor efficiency variance.
19. The difference between the standard hours worked for a specific level of
production and the actual hours worked is the labor rate variance
20. The difference between actual variable overhead and budgeted variable
overhead based upon actual hours is referred to as the variable overhead
spending variance.
21. The difference between budgeted and applied fixed factory overhead is
referred to as a fixed overhead volume variance.
22. A fixed overhead volume variance is a controllable variance.
23. An overhead efficiency variance is related entirely to variable overhead
24. Managers have no ability to control the budget variance,
25. Unfavorable variances are represented by debit balances in the overhead
account.

II – Problem Solving. Give what is/are required in each of the given problem
below. Write your solution in good form.
1. Fitzhugh Company has the following information available for the current
year:
Standard:
Material 3.5 feet per unit @ $2.60 per foot
Labor 5 direct labor hours @ $8.50 per unit

Actual:
Material 95,625 feet used (100,000 feet purchased @ $2.50 per foot)
Labor 122,400 direct labor hours incurred per unit @ $8.35 per hour
25,500 units were produced
Required:
a. Refer to Fitzhugh Company. Compute the material purchase price and
quantity variances.

130
 b. Refer to Fitzhugh Company. Compute the labor rate and efficiency
variances.

2. Taylor Company applies overhead based on direct labor hours and has the
following available for November:
Standard:
Direct labor hours per unit 5
Variable overhead per DLH $.75
Fixed overhead per DLH
(based on 8,900 DLHs) $1.90
Actual:
Units produced 1,800
Direct labor hours 8,900
Variable overhead $6,400
Fixed overhead $17,500
Required:
a. Compute all the appropriate variances using the two-variance
approach.
b. Compute all the appropriate variances using the four-variance
approach.
c. Compute all the appropriate variances using the three-variance
approach.

3. The Michigan Company has made the following information available for its
production facility for the month of June. Fixed overhead was estimated at
19,000 machine hours for the production cycle. Actual machine hours for the
period were 18,900, which generated 3,900 units.

Material purchased (80,000 pieces) $314,000

Material quantity variance $6,400 U
Machine hours used (18,900 hours)
VOH spending variance $50 U
Actual fixed overhead $60,000

Actual labor cost $40,120

Actual labor hours 5,900

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 Michigan’s standard costs are as follows:

Direct material 20 pieces @ $4 per piece

Direct labor 1.5 hours @ $6 per hour
Variable overhead
(applied on a machine hour basis) 4.8 hours @ $2.50 per hour
Fixed overhead
(applied on a machine hour basis) 4.8 hours @ $3 per hour

Required:
a. material purchase price variance
b. standard quantity allowed for material
c. total standard cost of material allowed
d. actual quantity of material used
e. labor rate variance
f. standard hours allowed for labor
g. total standard cost of labor allowed
h. labor efficiency variance
i. actual variable overhead incurred
j. standard machine hours allowed
k. variable overhead efficiency variance
l. budgeted fixed overhead
m. applied fixed overhead
n. fixed overhead spending variance
o. volume variance
p. total overhead variance

4. The following information is available for Whitestone Company for the current
year:
Standard:
Material X: 3.0 pounds per unit @ $4.20 per pound
Material Y: 4.5 pounds per unit @ $3.30 per pound
Class S labor: 3 hours per unit @ $10.50 per hour
Class US labor: 7 hours per unit @ $8.00 per hour
Actual:
Material X: 3.6 pounds per unit @ $4.00 per pound (purchased and used)
Material Y: 4.4 pounds per unit @ $3.25 per pound (purchased and used)
Class S labor: 3.8 hours per unit @ $10.60 per hour

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Class US labor: 5.7 hours per unit @ $7.80 per hour
Whitestone Company produced a total of 45,750 units.
Required:
a. Compute the material price, mix, and yield variances (round to the
nearest dollar).
b. Compute the labor rate, mix, and yield variances (round to the nearest
dollar).

133
References: (To be revised)

1. Cabrera, Ma. Elinita B., 2018. Cost Accounting and Control. GIC Enterprises
& Co,.Inc. Recto, Manila
2. Cabrera, Ma. Elinita B., 2015. CPA Examination Reviewer and Quizzer in
Management Advisory Services. GIC Enterprises & Co,.Inc. Recto, Manila
3. Carter, Wiiliam K. 2012. Cost Accounting, International Edition. Thomson
Learning Asia, Singapore
4. De Leon, Norma D., De Leon, Ellery D., De Leon Jr. Guillermo M. 2016. Cost
Accounting. GIC Enterprises & Co,.Inc. Recto, Manila
5. Cost Accounting Traditions and Innovations by Barfield (3e), PDF
6. Kinney, Michael R. Raiborn, Cecily A. 2012. Cost Accounting.
McGraw-Hill/Irwin, USA
7. Garrison, Ray H., Noreen, Eric W., 2015. Managerial Accounting, 10th
Edition, McGraw-Hill/Irwin, USA
8. Mejorada, Nenita D. 2016. Cost Accounting. Goodwill Bookstore, Makati City
9. Raiborn, Cecily A., Kinney, Micheal R., Prather-Kinsey, Janice. 2016.
Accounting using Cost Management Approach. R.I. Irwin, USA
10. Ricketts, Don. Gray, Jack,. 2016. Managerial Accounting 3rd edition.
Houghton Mifflin Co., USA
11. Willson, James D., Colford, James P., Controllership, 2015. The Work of the
Managerial Accountant. John Wiley & Sons, Inc., USA

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