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Principles of Cost Accounting

15th edition

Edward J. VanDerbeck
© 2011 Cengage Learning. All Rights Reserved. May
not be copied, scanned, or duplicated, in whole or in
part, except for use as permitted in a license
distributed with a certain product or service or
otherwise on a password-protected website for
classroom use.
Chapter 1

Introduction to Cost Accounting

Learning Objectives

LO1 Explain the uses of cost accounting

LO2 Describe the ethical responsibilities,
and certification requirements for
management accountants, as well as
corporate governance.
LO3 Describe the relationship of cost
accounting to financial and
management accounting. 3
Learning Objectives (cont.)

LO4 Identify the three basic elements of

manufacturing costs.
LO5 Illustrate basic cost accounting
LO6 Distinguish between the two basic
types of cost accounting systems.
LO7 Illustrate a job order cost system.

Cost Accounting
 Cost accounting provides the detailed cost data
that management needs to control current
operations and plan for the future.
 Management uses cost accounting information
to decide how to allocate resources to the most
efficient and profitable areas of the business.

Types of Businesses Entities
That Use Cost Accounting
 Manufacturers (Ford, General Motors)
 Merchandisers/Retailers (WalMart, Kmart)
 Wholesalers (Beverage Distributors)
 For-profit Service Businesses (CPAs,
 Not-for-profit Service Agencies (United
Way, Red Cross)

The Manufacturing Process

 This process involves the conversion of

direct (raw) materials, direct labor, and
factory overhead into finished goods.
 Product quality is an important competitive
weapon in manufacturing.
 Many companies require their suppliers to
be ISO 9000 certified.

ISO 9000 Certification
 The International Organization for
Standardization created a set of five
international standards for quality
management, ISO 9000-9004.
 These standards require that manufacturers
have a well-defined quality control system
and they consistently maintain a high level
of quality.

Determining Product
Costs and Pricing
 Cost accounting is used to determine
products costs and help with marketing
1. Determining the selling price of a product.
2. Meeting competition.
3. Bidding on contracts.
4. Analyzing profitability.

Planning and Control
 Planning is the process of establishing
objectives or goals for the firm and
determining the means by which they will be
met. Effective planning is facilitated by the
1. Clearly defined objectives of the
manufacturing operation.
2. A production plan that will assist and guide
the company in reaching its objectives.

Planning and Control (cont.)
 Control is the process of monitoring the
company’s operations and determining
whether the objectives identified in the
planning process are being accomplished.
Effective control is achieved through the
1. Assigning responsibility.
2. Periodically measuring and comparing results.
3. Taking necessary corrective action.

Responsibility Accounting
 Responsibility accounting is the assignment
of accountability for costs or production results
to those individuals who have the most authority
to influence them.
 A cost center is a unit of activity within the
factory to which costs may be practically and
equitably assigned. The manager of a cost
center is responsible for those costs that the
manager controls.

 Cost and production reports for a cost
center reflect its costs, in dollars, and its
production activity.
 The performance report will include only
those costs and production data that the
center’s manager can control.
 A variance is the favorable (F) or
unfavorable (U) difference between actual
costs and budgeted costs.

Performance Report Example
Leonardo’s Italian Cafe
Performance Report - Kitchen
September 30, 2011
Budgeted Actual Variance
Expense September Year-to-Date September Year-to-Date September Year-to-Date

Kitchen Wages $5,500 $47,000 $5,200 $46,100 $300 F $900 F

Food 17,700 155,300 18,300 157,600 600 U 2,300 U
Supplies 3,300 27,900 3,700 29,100 400 U 1,200 U
Utilities 1,850 15,350 1,730 16,200 120 F 850 U
Total $28,350 $245,550 $28,930 $249,000 $580 U $3,450 U

F = Favorable
U = Unfavorable

Management Accounting
 The Institute of Management Accountants
(IMA) is the largest organization of
accountants in industry. The Certified
Management Accountant (CMA) is
comparable to the Certified Public
Accountant (CPA) for public accountants.
 For more information, please visit the IMA’s
website at

Corporate Governance
 Corporate governance is the means by
which a company is directed and controlled.
 The Sarbanes-Oxley Act (SOX) of 2002 was
written to reduce abuse and improve
corporate governance.
 The Public Company Accounting Oversight
Board (PCAOB) was established to provide
oversight of the accounting profession.

Relationship of Cost Accounting to
Financial and Managerial Accounting
Cost Accounting System

Characteristics Financial Accounting Managerial Accounting

Users: •External Parties

•Managers Managers
Focus: Entire business Segments of the business
Uses of Cost Information: Product costs for •Budgeting
calculating cost of goods •Special decisions such as
sold and finished goods, make or buy a component,
work in process, and raw keep or replace a facility,
materials inventory using and sell a product at a
historical costs and GAAP. special price.
•Nonfinancial information
such as defect rates, % of
returned products, and on-
time deliveries

Relationship of Cost Accounting to
Financial and Managerial Accounting

 Cost accounting includes those

parts of both financial and
managerial accounting that collect
and analyze cost information.

Cost Accounting vs. Financial and
Managerial Accounting (cont.)

Cost Management
Accounting Accounting
Cost of Goods Sold
Merchandiser Manufacturer
Beginning Beginning
merchandise inventory finished goods inventory
Plus: Plus:
Purchases (merchandise) cost of goods manufactured
Merchandise Finished goods
available for sale available for sale
Less: Less:
ending merchandise inventory ending finished goods inventory
Cost of good sold Cost of good sold

Merchandiser Manufacturer
Current assets: Current assets:
Cash Cash
Accounts receivable Accounts receivable
Inventories: Inventories:
Merchandise Finished goods
inventory Work in process
Inventories (cont.)
 Most manufacturers maintain a perpetual
inventory system that provides a continuous
record of purchases, issues, and balances of all
goods in stock.
 A periodic inventory system does not provide
a continuous record.
 An inventory ledger is a subsidiary ledger
maintained to provide support for the control
Elements of Manufacturing
 Direct materials
 Materials that become part of the finished good and
can be readily identified.
 Direct labor
 Labor of employees who work directly on the product
 Factory overhead
 Includes all costs related to production other than
direct materials and direct labor.

Prime Cost and Conversion Cost

Direct Materials
Elements Prime Cost
of Cost
Direct Labor
Factory Overhead Cost

Flow of Manufacturing Costs

Direct Materials
Work in Process Finished Goods Cost of Goods Sold
Direct Labor
(Assets) (Assets) (Expenses)
Factory Overhead

Illustration of Accounting for
Manufacturing Costs
 Materials xx  Work in Process
 Accounts Payable xx (Direct Labor) xx
 Factory Overhead
 Work in Process (Indirect Labor) xx
(Direct Materials) xx  Selling & Admin Exp
 Factory Overhead (Salaries) xx
(Indirect Materials) xx  Payroll xx
 Materials xx
 Factory Overhead
 Payroll xx (Depr. Bldg) xx
 Wages Payable xx  Selling & Admin Exp
(Depr. Bldg) xx
 Wages Payable xx  Accum. Depr. – Bldg xx
 Cash xx

Illustration of Accounting for
Manufacturing Costs (cont.)
 Factory Overhead  Finished Goods xx
(Depr. Mach & Eq) xx  Work in Process xx
 Accum. Depr. –
Mach & Eq xx  Accounts Payable xx
 Cash xx
 Factory Overhead
(Utilities) xx  Accounts Receivable xx
 Selling & Admin Exp  Sales xx
(Utilities) xx  Cost of Goods Sold xx
 Accounts Payable xx  Finished Goods xx

 Selling & Admin Exp xx  Cash xx

 Accounts Payable xx  Accounts Receivable xx

 Work in Process xx
 Factory Overhead xx

Cost Accounting Systems
 Job Order Cost System
 Output consists of special or custom-made
 Provides a separate record for the cost of
each quantity of these special or custom-
made products.
 Process Cost System
 Accumulates costs for each department or
process in the factory.

Job Order Cost System

Direct Materials Work in Process Finished Goods

Direct Labor Account Account
Factory Overhead

Job Cost Sheets

Process Cost System

Work in Process
Work in Process
Dept. 2 Finished Goods
Dept. 1

Direct Direct Direct Direct

Materials Labor Materials Labor

Factory Factory
Overhead Overhead

Standard Cost System
 May be used with either a job order or a
process cost system.
 Uses predetermined standard costs to furnish a
measurement that helps management make
decisions regarding the efficiency of operation.
 Standard costs are costs that would be incurred
under efficient operating conditions and are
forecast before the manufacturing process begins.

IMA Statement of Ethical Professional Practice

 Members of the IMA shall behave ethically.

They have an obligation to the public, their
profession, the organizations they serve,
and themselves to maintain the highest
standards of ethical conduct.
1. Competence
2. Confidentiality
3. Integrity
4. Credibility

Appendix (cont.)

 Resolution of Ethical Conflict

 When applying the standards of ethical conduct,
IMA members may encounter problems in
identifying unethical behavior or in resolving an
ethical conflict.
1. Discuss issues with your immediate supervisor except when it
appears that the supervisor is involved.
2. Clarify relevant ethical issues by initiating a confidential
discussion with an IMA Ethics Counselor or other impartial advisor
to obtain a better understanding of possible courses of action.
3. Consult your own attorney as to legal obligations and rights
concerning the ethical conflict.


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