Cost Accounting

1
Cost Accounting

• An Overview

2
Managerial Cost Concepts

1. Direct materials raw materials physically
   associated with the final product
2. Direct labor employees physically and directly
   associated with the final product
3. Overhead costs indirectly associated with the
   final product

3
More Concepts

1. Period costs costs matched with revenue for a
   specific time period. (i.e., net income for a
   specific period (i.e., quarterly, annual).
2. Product costs costs associated with producing
   the final product. Not considered an expense
   until the product is sold.
3. Total costs equals direct materials, direct
   labor and manufacturing overhead plus indirect
   costs (selling and administrative expenses).

4
Design of the Master Budget
Sales Budget
5
Design of the Master Budget
Sales Budget
Production Budget
6
Design of the Master Budget
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Overhead Budget
7
Design of the Master Budget
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Overhead Budget
Selling and Administrative Expense Budget
8
Design of the Master Budget
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Overhead Budget
Selling and Administrative Expense Budget
Cash Budget
9
Pro Forma Financial Statements
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Overhead Budget
Selling and Administrative Expense Budget
Capital expenditures
Cash Budget
Budgeted Cash Flow Statement
10
Pro Forma Financial Statements
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Overhead Budget
Selling and Administrative Expense Budget
Capital expenditures
Cash Budget
Budgeted Income Statement
Budgeted Cash Flow Statement
11
Pro Forma Financial Statements
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Overhead Budget
Selling and Administrative Expense Budget
Capital expenditures
Cash Budget
Budgeted Income Statement
Budgeted Cash Flow Statement
Budgeted Balance Sheet
12
The Master Budget and Pro Forma Financial
Statements

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget

• Enterprise n
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Overhead Budget
13
The Master Budget and Pro Forma Financial
Statements

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget

• Enterprise n
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Overhead Budget
14
The Master Budget and Pro Forma Financial
Statements

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget

• Enterprise n
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Overhead Budget
15
The Master Budget and Pro Forma Financial
Statements

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget

• Enterprise n
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Overhead Budget
16
The Master Budget and Pro Forma Financial
Statements

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget

• Enterprise n
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Overhead Budget
17
The Master Budget and Pro Forma Financial
Statements

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget

• Enterprise n
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

Overhead Budget
18
The Master Budget and Pro Forma Financial
Statements

• Examples of direct materials
• Purchase of corn.
• Purchase of natural gas.
• Purchase of other inputs used in
• the production process.

• Enterprise 1
• Unit sales and expected price
• Unit production and inventory
• Direct materials used
• Direct labor used
• Manufacturing overhead

• Examples of manufacturing overhead
• Other expenses directly related to
• production of a specific product.
• Examples include property taxes, rent
• and depreciation

19
The Master Budget and Pro Forma Financial
Statements

• Indirect expenses are those expenses not
  associated with manufacturing a product or
  providing a service. Some examples include
• Marketing and selling expenses
• Transportation expenses outside the
• factory
• Management salaries and other
• administrative expenses

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Total Costs
Period Costs Non-manufacturing Costs
Production Costs Manufacturing Costs
Direct Materials
21
Total Costs
Period Costs Non-manufacturing Costs
Production Costs Manufacturing Costs
Direct Materials
Direct Labor
22
Total Costs
Period Costs Non-manufacturing Costs
Production Costs Manufacturing Costs
Direct Materials
Direct Labor
Manufacturing Overhead
23
Total Costs
Period Costs Non-manufacturing Costs
Production Costs Manufacturing Costs
Selling Expenses
Direct Materials
Direct Labor
Manufacturing Overhead
24
Total Costs
Period Costs Non-manufacturing Costs
Production Costs Manufacturing Costs
Selling Expenses
Direct Materials
Direct Labor
Administrative Expenses
Manufacturing Overhead
25
Total Costs
Period Costs Non-manufacturing Costs
Production Costs Manufacturing Costs
Selling Expenses
Direct Materials
Direct Labor
Administrative Expenses
Manufacturing Overhead
Other Indirect Expenses
26
Three Cost Accounting Concepts

1. Process cost accounting
2. Job order cost accounting
3. Activity based cost accounting

27
1. Process Cost Accounting

• Tracking costs associated with a specific process
• Direct materials and labor associated with the
  specific process
• Manufacturing overhead costs associated with the
  specific process
• Assigning costs to finished goods

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Example Process Costs in Making Bread
Direct Materials Direct Labor Variable Overhead
Mixing Department
Baking Department
Packaging Department
Finished Goods
WIP
WIP
WIP
Production Cost Report
29
Example Process Costs in Making Bread
Direct Materials Direct Labor Variable Overhead
Mixing Department
Baking Department
Packaging Department
Finished Goods
WIP
WIP
WIP
Production Cost Report
Production Cost Report
30
Example Process Costs in Making Bread
Direct Materials Direct Labor Variable Overhead
Mixing Department
Baking Department
Packaging Department
Finished Goods
WIP
WIP
WIP
Production Cost Report
Production Cost Report
Production Cost Report
31
Comparison of Cost Systems
Features Process Cost System
Work in process accounts Multiple work in process accounts
Documents used Production cost reports
Determination of total manf. costs Each period
Unit-cost computations Total manf. costs/ units produced during the period
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2. Job Order Cost Accounting

• Tracking costs associated with a specific order
  or job
• Direct materials and labor associated with a
  specific order or job
• Manufacturing overhead costs associated with a
  specific order or job
• Assigning costs to finished goods

33
Comparison of Cost Systems
Features Process Cost System Job Order Cost System
Work in process accounts Multiple work in process accounts One work in process account
Documents used Production cost reports Job cost sheets
Determination of total manf. costs Each period Each job
Unit-cost computations Total manf. costs/ units produced during the period Cost of each job/ units produced for the job
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3. Activity Based Cost Accounting

• An approach for allocating overhead.
• An activity is any event, action, transaction or
  work sequence that incurs when producing a
  product or providing a service.
• An activity cost pool is a distinct type of
  activity (e.g., ordering materials).
• A cost driver is any factor or activity that has
  a direct cause-effect relationship with resources
  consumed (e.g., machine hours).

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Steps in ABC Accounting

• Identify and classify activities and allocate
  overhead to cost pools.
• Identify cost drivers correlation between
  driver and use.
• Compute overhead rates ABC rate.
• Assign overhead costs to products use of cost
  drivers.
• Comparison of unit costs across products.

36
Activity Based Cost Allocation
Overhead Costs

Activity cost pools
Ordering and Receiving Materials Cost Pool
Setting Up Machines Cost Pool
Machining Cost Pool
Assembly Cost Pool
Inspecting and Testing Cost Pool
Painting Cost Pool
Cost drivers
of Tests
of Direct hours
of Machine hours
of Parts
of Purchase orders
of Setups
Products

37
Example of ABC Accounting
ABC Overhead rate Overhead per activity Cost
driver per activity Initial status Activity Cost
Pool Process Driver
AB overhead
overhead activity
rate Setting up machines 300,000 1,500
setups 200/setup Machining 500,000
50,000 hours 10/hour Inspecting 10
0,000 2,000 inspection 50/inspection
Total 900,000 Step 1 Assigning overhead
driver activity to products Activity Cost
Pool Cost driver Driver Product 1
Product 2 activity Setting up
machines setups 1,500
500 1,000 Machining Hours
50,000 30,000 20,000 Inspecting
inspections 2,000 500 1,500

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Example of ABC Accounting
Step 1 Assigning overhead driver activity to
products Activity Cost Pool Cost driver
Driver Product 1 Product 2
activity Setting up machines setups
1,500 500 1,000 Machining
Hours 50,000 30,000
20,000 Inspecting inspections 2,000
500 1,500 Step 2 Partitioning of
process overhead
Overhead Product 1
Product 2___ Setting up machines 300,000
(33) 100,000 (67) 200,000 Machining 500,
000 (60) 300,000 (40)
200,000 Inspecting 100,000 (25)
25,000 (75) 75,000

500/1,500 x 300,000 or 500 units x 200/setup
39
Example of ABC Accounting
Step 1 Assigning overhead driver activity to
products Activity Cost Pool Cost driver
Driver Product 1 Product 2
activity Setting up machines setups
1,500 500 1,000 Machining
Hours 50,000 30,000
20,000 Inspecting inspections 2,000
500 1,500 Step 2 Partitioning of
process overhead
Overhead Product 1
Product 2___ Setting up machines 300,000
(33) 100,000 (67) 200,000 Machining 500,
000 (60) 300,000 (40)
200,000 Inspecting 100,000 (25)
25,000 (75) 75,000

1,000/1,500 x 300,000 or 1,000 x 200/setup
40
Example of ABC Accounting
Step 1 Assigning overhead driver activity to
products Activity Cost Pool Cost driver
Driver Product 1 Product 2
activity Setting up machines setups
1,500 500 1,000 Machining
Hours 50,000 30,000
20,000 Inspecting inspections 2,000
500 1,500 Step 2 Partitioning of
process overhead
Overhead Product 1
Product 2___ Setting up machines 300,000
(33) 100,000 (67) 200,000 Machining 500,
000 (60) 300,000 (40)
200,000 Inspecting 100,000 (25)
25,000 (75) 75,000

30,000/50,000 x 500,000 or 30,000 x 10/hour
41
Example of ABC Accounting
Step 1 Assigning overhead driver activity to
products Activity Cost Pool Cost driver
Driver Product 1 Product 2
activity Setting up machines setups
1,500 500 1,000 Machining
Hours 50,000 30,000
20,000 Inspecting inspections 2,000
500 1,500 Step 2 Partitioning of
process overhead
Overhead Product 1
Product 2___ Setting up machines 300,000
(33) 100,000 (67) 200,000 Machining 500,
000 (60) 300,000 (40)
200,000 Inspecting 100,000 (25)
25,000 (75) 75,000

20,000/50,000 x 500,000 or 20,000 x 10/hour
42
Example of ABC Accounting
Step 1 Assigning overhead driver activity to
products Activity Cost Pool Cost driver
Driver Product 1 Product 2
activity Setting up machines setups
1,500 500 1,000 Machining
Hours 50,000 30,000
20,000 Inspecting inspections 2,000
500 1,500 Step 2 Partitioning of
process overhead
Overhead Product 1
Product 2___ Setting up machines 300,000
(33) 100,000 (67) 200,000 Machining 500,
000 (60) 300,000 (40)
200,000 Inspecting 100,000 (25)
25,000 (75) 75,000

500/2,000 x 100,000 or 500 x 50/inspection
43
Example of ABC Accounting
Step 1 Assigning overhead driver activity to
products Activity Cost Pool Cost driver
Driver Product 1 Product 2
activity Setting up machines setups
1,500 500 1,000 Machining
Hours 50,000 30,000
20,000 Inspecting inspections 2,000
500 1,500 Step 2 Partitioning of
process overhead
Overhead Product 1
Product 2___ Setting up machines 300,000
(33) 100,000 (67) 200,000 Machining 500,
000 (60) 300,000 (40)
200,000 Inspecting 100,000 (25)
25,000 (75) 75,000

1,500/2,000 x 100,000 or 1,500 x 50/inspection
44
Example of ABC Accounting
Step 2 Partitioning of process overhead
Overhead
Product 1 Product 2 Setting up
machines 300,000 100,000 200,000 Machi
ning 500,000 300,000 200,000 Inspecti
ng 100,000 25,000 75,000
Total 900,000 425,000
475,000 Step 3 Process overhead costs per
unit Units produced 25,000 5,000
Process overhead cost per unit 17
95 Traditional process overhead cost per unit
30 30 900,000 divided by 30,000
units

Avoids overstating profitability of some
enterprises and understating profitability of
others
45
Example of ABC Accounting
Product 1 Product 2 COP unit costs
with ABC costing Direct materials
40 30 Direct labor
12 12 ABC overhead
17 95 Total unit costs
69 137 COP unit costs with
traditional costing Direct materials
40 30 Direct labor
12 12 Traditional overhead
30 30 Total unit costs
82 72 900,000 divided
by 30,000 units
Traditional overhead costing suggests that
Product 2 is cheaper to produce than Product 1,
which is not true!
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LOC and the Master Budget

• Identifying monthly cash flow surpluses and
  deficits.
• Determining the required LOC peak value of
  monthly draws less monthly repayments.
• Role of the Master Budget LOC a component of the
  cash budget.

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Cash Management

• Acceleration of cash receipts
• Pre-addressed stamped envelopes
• Obtain deposits on large orders
• Charge interest on overdue receivables
• Delay cash payments
• Pay with check (float)
• Delay frequency of paying employees
• Just in time inventories