Cost Accounting Fundamentals

Posted on Sep 8, 2024 in Economy

Accounting Fundamentals

Accounting aims to inform and control.

  • Cash Flow Statement: Shows the sources and uses of funds.
  • Company: An agency or institution with an internal structure, a specific distribution of elements in an internal order, independent of its legal form.

Companies utilize elements like labor and manufacturing costs to produce goods and/or services. These goods or services, in turn, meet the needs of a community. Examples include furniture stores, hospitals, and educational institutions.

Branches of Accounting

In accounting, we can divide the field into two main branches:

  1. Financial Accounting
  2. Cost Accounting

Financial Accounting

Financial accounting focuses on processing financial statements.

  • Users: Primarily external, such as banks, government agencies, and individuals outside the organization.
  • Restrictions on Reporting: Subject to accounting and tax rules, including the principles of accounting, for developing accounting standards and preparing financial statements.
  • Analytical Overview: Provides a condensed view of the organization as a whole through financial statements.
  • Unit of Measure: Primarily uses monetary units, such as the country’s official currency.

Cost Accounting

Cost accounting assists management in internal decision-making through planning, controlling activities, and monitoring operations.

  • Users: Primarily internal, such as managers and employees within the company.
  • Restrictions on Reporting: Not subject to the same restrictions as financial accounting, as internal users determine the format of reports.
  • Analytical Overview: Provides a detailed overview of the entity’s activities.
  • Unit of Measure: Uses monetary units and physical units (e.g., tons, kilos, liters, gallons) and may even employ qualitative measures.

Costs

Costs represent the financial sacrifice made to obtain a good or service. It’s the investment made, measured by the reduction of assets and/or increase in liabilities.

Investment

Bank cash (credit)

Cash or bank Credit providers

Assets (-) Liabilities (+)

  • Loss: Occurs when a cost has produced a benefit.
  • Income: The selling price of products sold or services rendered.

Income Statement

The income statement summarizes a company’s financial performance over a specific period.

Operating Income
= Sales
(-) Cost of Sales
(=) Operating Margin or Contribution
(-) Selling and Administrative Expenses
(=) Income or Loss

Non-Operating Income
(-) Non-Operating Expenses
= Non-Operating Income (1)
= Result from Monetary Correction
(-) Monetary Correction
(=) Earnings Before Tax
(-) Tax
(=) Net Income

Monetary Correction of Assets
Accounting
Assets
Restatement

Passive Monetary Correction
Monetary Correction
Liabilities

Purpose of Cost Accounting

  1. Provide information for operations planning, evaluation, control, safeguarding assets, and communicating with stakeholders.
  2. Participate in strategic, tactical, and operational decision-making, coordinating effects throughout the organization.

Cost Elements

The general cost elements include:

  • Materials or Raw Materials
  • Labor
  • Manufacturing Costs and Manufacturing Overhead Costs (CIF)

Materials

Materials are the primary goods used in production, transformed into finished products with labor and manufacturing costs.

Cost of Materials Classification:

  • Indirect Material Cost
  • Direct Material Cost
  • Direct Material: Identifiable in a finished product, easily associated with it, and represents the increased material cost for that product.
  • Indirect Materials: Not directly identifiable with a specific product. Their cost is included in the manufacturing overhead (CIF).

Labor

Labor represents the physical or mental effort used in manufacturing a product.

Cost of Labor Classification:

  • Direct Labor Cost
  • Indirect Labor Cost

Direct Labor: Directly involved in manufacturing a finished product, easily associated with it, and represents the most significant labor cost for that product.

Indirect Labor: Involved in manufacturing but not considered direct labor. Costs are part of manufacturing overhead (CIF), along with indirect materials. Examples include:

  • Indirect Materials
  • Indirect Labor
  • Lease
  • Basic Consumption (Electricity, Water, Telephone, Heating, Gas)
  • Insurance
  • Depreciation
  • Other Manufacturing Expenses

Therefore, the cost of a product is determined by:

  • Direct Materials Cost
  • Direct Labor Cost
  • Manufacturing Overhead Costs (CIF)

Cost Classification

1. According to Connection with Production

  • Prime Costs: Sum of direct materials and direct labor.
  • Conversion Costs: Sum of direct labor and manufacturing overhead costs (CIF).

2. According to Relationship with Production Volume

  • Fixed Costs
  • Variable Costs
  • Mixed Costs
    • Semi-Variable Costs
    • Stepped Costs

Fixed Costs: Total fixed cost remains constant within a range of activities or production, while the unit fixed cost varies inversely with the production level. The relevant range is the activity range where total fixed costs and variable costs per unit remain constant.

Example:

Home
Rent: $500,000
5 People: $100,000 (Unit Fixed Cost)
4 People: $125,000 (Unit Fixed Cost)

Variable Costs: Total cost changes in direct proportion to changes in activity or production, while the variable cost per unit remains constant.

Total Variable Cost

1 Unit = MP = $100
2 Units = MP = $200
3 Units = MP = $300

The unit cost is always $100.

Mixed Costs: Exhibit characteristics of both fixed and variable costs. There are two types:

  • Semi-Variable Costs: The fixed portion represents a minimum charge for producing a product or service.
  • Stepped Costs: Change abruptly at different activity levels because they are acquired as indivisible units (e.g., supervisor for every 10 workers).

3. According to the Department Where Costs are Generated

Departments are major administrative divisions in a manufacturing company. There are two types:

  • Production Departments: Responsible for product development and directly related to cost elements. They transform raw materials into finished goods.
  • Service Departments: Not directly involved in product development but provide services to both production and other service departments (e.g., Human Resources, Finance, Maintenance).

4. According to the Company’s Functional Areas

Manufacturing Firm

  • Production Area: Manufacturing Costs
  • Management Area: Management Costs
  • Marketing Area: Marketing or Commercialization Costs
  • Finance Area: Financial Costs
  • Manufacturing Costs: Generated from the production process, including materials, labor, and manufacturing overhead.
  • Administrative Costs: Incurred during administration, control, and/or operation of a business, including salaries of administrative personnel.
  • Marketing or Commercialization Costs: Generated by selling a product or service, such as sales commissions and lease of sales premises.
  • Borrowing Costs: Incurred when obtaining loans or credits, including interest, fees, and bank charges.

5. According to the Company’s Ability to Associate Costs

  • Direct Costs: Management can identify them with specific items or areas (e.g., direct materials, direct labor).
  • Indirect Costs: Common to many items or services and not identifiable with any specific item or area.

6. According to their Relationship with Planning, Control, and Decision-Making

  • Pre-calculated or Predetermined Costs: Estimated costs and standard costs. The difference lies in the degree of preparation. Standard costs are scientifically calculated based on engineering studies and represent a model of what costs should be under efficient operations. Predetermined costs lack this level of detail.
  • Controllable Costs and Uncontrollable Costs:
    • Controllable Costs: Management has authority over them.
    • Uncontrollable Costs: Management has no authority over them (e.g., depreciation).
  • Authorized Fixed Costs and Discretionary Fixed Costs:
    • Authorized Fixed Costs: Arise from the basic organizational structure (e.g., location, equipment, staff).
    • Discretionary Fixed Costs: Incurred as the company operates (e.g., machinery repairs, staff training, advertising).
  • Opportunity Costs: Benefits lost by choosing one alternative over another.
  • Shutdown Costs: Costs incurred even when there is no production (e.g., leases, basic consumption, insurance payments, salaries). These typically occur during seasonal periods.

Terms

  • MD: Direct Material
  • MOD: Direct Labor
  • CIF or GF: Manufacturing Overhead Costs
  • AD: Administrative Costs
  • FIN: Financial Costs
  • COM: Marketing or Commercialization Costs
  • Prime Costs: MD + MOD
  • Conversion Costs: MOD + CIF
  • Product Cost: MD + MOD + CIF
  • Period Costs: AD + COM + FIN
  • Materials: Direct Material + Indirect Material

Nature of Cost Accounting System

The primary objective of a cost accounting system is to determine the unit costs of manufacturing products or providing services. Management uses this information for decision-making to maintain or increase profits.

A cost accounting system comprises forms, models, daily administrative reports, and procedures to obtain cost information quickly. Common forms include:

  1. Production Orders: Instruct the factory on what to manufacture.
  2. Material Requisitions: Specify the quantity, characteristics, and cost of materials used in production.
  3. Time Sheets: Record employee hours and costs for specific tasks.
  4. Cost Sheets: Accumulate direct materials, direct labor, and manufacturing overhead costs for specific orders, departments, or processes.

The cost accounting system also includes books such as:

  • Journal of Manufacture: Similar to the general journal, it summarizes cost-related transactions.
  • General Ledger and Subsidiary Ledgers: Track materials, labor, manufacturing overhead, and finished product costs.

Cost System Classification

  • Under the Cost Approach:
    • Absorption Costing System: Considers fixed and variable costs (MD, MOD, CIF) in product cost.
    • Variable Costing System: Considers only variable costs (MD, MOD, CIF) in product cost.
  • According to the Period of Cost Generation:
    • Historical Cost System: Uses actual costs incurred after a period.
    • Standard Cost System: Uses pre-calculated costs before a period begins.
  • Depending on the Type of Production:
    • Job Order Cost System: Used for specific orders or work orders.
    • Process Cost System: Used for continuous production processes.

Accounting for Acquisitions

Purchases Journal

Purchases are recorded in a daily journal that accumulates the values of all supplier invoices received during a month. Totals are then transferred to the general ledger.

DateInvoice No.Provider NameProviderNet WorthVATTotal
Total

Accounting Entry

Materials
VAT Credit
Accounts Payable
(To record purchases from the purchases journal)

Material Requisition

A material requisition form is used to request materials from the warehouse.

Posting of Orders to Warehouse

An order register is maintained to track all materials issued from the warehouse during a period. Totals are then transferred to the general ledger.

Accounting Entry

Work in Process – Direct Materials
Manufacturing Overhead (Indirect Materials, CIF)
Materials
(To record materials issued from the warehouse)

Accounting for Labor

The accounts of the workforce has two specific purposes.

  1. Collecting remuneration earned by staff to attend monthly payments involved.
  2. Charge such fees to the various functions that are developed.

Elements to control the time worked

To control the time worked in the production process also requires knowing the specific activity which was devoted to work during the day with the aim of making assignments and corresponding cost for this ballot is used and time cards that can be the time card or per worker per task.

Manufacturing costs: implementation of the processing costs

Methods: Cost-based

  • Direct material cost share
  • Direct labor share
  • Prime cost share

Based on the hours

  • Number of hours Fee MOD
  • No share of machine hours

1 .- direct material cost share of manufacturing expenditure
Direct material cost

2 .- fee direct labor cost manufacturing expenditure
Cost of direct labor

3 .- expenditure share manufacturing prime cost
Prime cost (MD + MOD)

4 .- No hours Fee MOD manufacturing costs
MOD No. of hours

5 .- fee number of hours machine manufacturing costs
Number of machine hours