COST

ACCOUNTING
AND CONTROL
What is Cost
Accounting?
A branch of accounting that deals with
the process of recording and
summarizing the amount of cost that is
spent on the company’s activities. It
includes all costs of process, product, or
service used, provided, and sold.
Organizational Strategy and Cost Information

• A company formulates a mission statement – the reason

for the company’s existence
• The development of the organization’s strategy roots
from its mission statement
• Organizational strategy is the plan of action on how the
entity will attain and realize its goals and objectives with
the use of their own resources that will be able to
contribute to the creation of VALUE both to customers
and shareholders
COST ACCOUNTING: INFORMATION FOR
DECISION MAKING
Creation of Value in Organization

One of the fundamental services of cost accounting is

measuring the effects of decisions on the value of the
organization. As providers of information (accountants) or
as the users of information (managers), we have to
understand how the information can and will be used to
increase value. Designing accounting systems that
accomplish this goal, therefore becomes an important task
of cost accounting.
COST ACCOUNTING: INFORMATION FOR
DECISION MAKING
Value Chain

The value chain is the set of activities that transforms raw

resources into the goods and services that end users
purchase and consume and the treatment or disposal of
any waste generated by them.
COST ACCOUNTING: INFORMATION FOR
DECISION MAKING
Value-Added Activities

The value-added activities that the firms in the chain perform are
those activities that customers perceive as adding utility to the
goods or services they purchase. The value chain comprises
activities from research and development through the production
process to customer service.
Business Functions in the Value Chain

1. Research and development.

This involves generating and experimenting with ideas related
to new products,
services or processes.
2. Design of products, services or processes.
This is concerned with detailed planning and engineering of
products, services or processes.
3. Production.
This involves acquiring, coordinating and assembling
resources to produce a product or deliver a service.
Business Functions in the Value Chain

4. Marketing.
This deals with promoting and selling products or services to
customers or prospective customers.
5. Distribution.
This cover delivering products or services to customers.
6. Customer service.
This involves providing after-sale support to customers.
Comparison of Financial, Managerial, and
Cost Accounting
Basis of Financial Accounting Managerial Accounting
Difference
Primary Users External users: investors, Internal users: management at
creditors, stockholders, various levels (individual,
government agencies (e.g., divisional, enterprise-wide)
SEC, BIR)
Purpose Provides information for Provides information for planning,
external reporting, controlling, and decision-making
accountability, and compliance
Focus/Scope Focuses on the enterprise as a Focuses on specific segments,
whole divisions, or activities within the
organization
Nature of Historical, quantitative, Current or future-oriented, may
Information monetary, and verifiable be quantitative or qualitative,
monetary or non-monetary
Data Basis Based on past transactions Based on forecasts, estimates,
supported by documents and analysis (may not be formally
Comparison of Financial, Managerial, and
Cost Accounting
Basis of Financial Accounting Managerial Accounting
Difference
Output/Reports Formal reports: financial Internal reports: budgets,
statements, tax returns, variance analysis, performance
regulatory reports reports, cost analysis
Frequency/ Prepared periodically Prepared as needed; emphasis
Timeliness (monthly, quarterly, on timeliness for immediate
annually) decision-making
Measurement Monetary terms (e.g., pesos) Flexible: monetary (pesos),
Units physical (units, tons, gallons), or
ratios/relationships
Regulation/ Required by law/regulations No formal requirement; format
Requirement (SEC, BIR, GAAP/IFRS and use depend on
compliance) management’s needs
Precision vs. Emphasizes precision, Emphasizes relevance and
Relevance objectivity, and verifiability timeliness, even if less precise
Interrelationship Data used may also serve as Relies partly on financial
input for managerial accounting data for analysis and
Elements of Manufacturing Costs

Direct Materials – These materials become a

physical part of a finished product. Their costs can be
conveniently and economically traceable to the
finished product.

Direct Labor – It is the compensation of employees

or workers who physically convert raw materials into
finished goods. The effort of these persons is directly
traceable to the finished product.
Manufacturing Overhead – This includes all
manufacturing costs that cannot be classified as
direct materials or direct labor. Major classifications of
this cost follow:

• Indirect Materials and supplies – Glue, thread, nails,

lubricants and small tools
• Indirect Labor costs – Salaries of plant managers
and engineers, wages of forklift operators,
maintenance, inspection labor, and machine
helpers
• Other indirect manufacturing costs – Building,
machinery, and tool maintenance, real property
taxes, property insurance, rent expense, utilities
In addition to the year-end statement of financial position and income
statement, the management of Chair-ish Furniture Company required the
controller to prepare the statement of cost of goods manufactured. During
2021, P361,920 of raw materials were purchased. Operating cost data and
inventory account balances for 2025 follow:
Direct Labor (10,430 hours at 9.50 per hour) 99,085
Plant Supervision 42,500
Indirect Labor (20,280 hours at 6.25 per hour) 126,750
Factory Insurance 8,100
Factory Utilities 29,220
Depreciation – Factory Building 46,200
Depreciation – Factory Equipment 62,800
Manufacturing Supplies 9,460
Repairs and Maintenance 14,980
Selling and Administrative Expenses 76,480
Raw Materials Inventory, Jan. 1, 2025 26,490
Work-in-Process Inventory, Jan. 1, 2025 101,640
Finished Goods Inventory, Jan 1, 2025 148,290
Raw Materials Inventory, Dec. 31, 2025 24,910
Work-in-Process Inventory, Dec. 31, 2025 100,400
Finished Goods Inventory, Dec. 31, 2025 141,100
USES OF COST ACCOUNTING DATA

Determining Product Costs

Cost accounting procedures help management in

gathering the data needed to determine product
costs and thus generate meaningful financial
statements and other reports. Cost procedures must
be designed to permit the computation of unit costs
as well as total product costs.
Situation:
In one month, a factory spent P10,000 on labor.

Info 1: The labor cost is P10,000.

Info 2: The labor produced 5,000 units, so the unit
labor cost = P2 per unit.

If you were the manager, which information would

you prefer to use? — Info 1 or Info 2?
Unit cost information is also useful in making a
variety of important marketing decisions

1. Determining the selling price of a product. A knowledge

of the cost of manufacturing a unit of product helps in setting
the selling price, which should be high enough to cover the
cost of production, pay a portion of marketing and
administrative expenses and provide a profit. It will be difficult
to set the selling price without knowing the costs incurred in
the manufacture of a product and cost incurred in rendering a
service.
[Link] competition. If a competitor is selling the
product at a low price, detailed information regarding
unit costs can be used to determine the action to be
taken by the company: The company would know if
selling price must be reduced, or manufacturing costs
must be reduced, or the product must be eliminated.

[Link] on contracts. Many manufacturing firms must

submit competitive bids in order to be awarded
manufacturing contracts by the government or private
firms. An analysis of the unit costs relating to the
manufacture of a particular product is of great
importance in determining the bid price to be submitted.
The bid price must be able to cover costs to be incurred
and at the same provide profit for the company. It must
[Link] profitability. Unit cost information enables
management to determine the amount of profit that each
product earns and possibly eliminate those that are least
profitable, thereby concentrating efforts on those items
that are most profitable.
Planning and Control

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.

Planning is the process of establishing objectives or

goals for the firm and determining the means by
which the firm will attain them. It is essential because
it coordinates all operations of the firm. Cost
accounting helps by providing historical costs as
basis for projecting data. Management can analyze
trends for estimating future costs and results, and in
making decisions on facilities, marketing strategies,
Planning and Control

Planning has three components:

1. Strategic planning – setting long range goals and
objectives to determine overall direction.
2. Tactical planning – shorter range plans to achieve
strategic goals.
3. Operations planning – day-to-day implementation
of tactical plans, coordinating materials, labor, and
facilities.

Control is the process of monitoring operations and

determining whether objectives in planning are being
accomplished.
Planning and Control

Planning has three components:

1. Strategic planning – setting long range goals and
objectives to determine overall direction.
2. Tactical planning – shorter range plans to achieve
strategic goals.
3. Operations planning – day-to-day implementation
of tactical plans, coordinating materials, labor, and
facilities.

Control is the process of monitoring operations and

determining whether objectives in planning are being
accomplished.
RECENT DEVELOPMENTS IN COST
ACCOUNTING
Cost accounting is experiencing dramatic changes. Manual
bookkeeping has been reduced because of the use of
computers. Changes in production methods have made
traditional applications of cost accounting obsolete in some
cases. Increasing emphasis on cost control is seen now in
hospitals, in industries facing stiff foreign competition and in
many organizations that have traditionally not focused on cost
control.

The traditional role of cost accounting is to record full product

cost data for external reporting. However, the use of
accounting data for decision making and performance
evaluation has gained importance in recent years.
Extracted the following data from the company’s
accounting records for the year ended December 31,
2025
Sales 729,500
Direct Labor 142,000
Purchases of Raw Materials 240,000
Selling Expenses 50,000
Administrative Expenses 60,000
Raw Materials 64,000
Inventories at January 1, 2025 Work in Process 50,000
Finished Goods 96,000
Inventories at December 31, Raw Materials 56,000
2025 Work in Process 48,000
Finished Goods 104,000

Factory Overhead is applied at the rate of 110% direct labor

Requirement:

• Cost of Goods Manufactured

• Cost of Goods Sold
John Manufacturing Company, a manufacturer of soda bottles, had
the following inventory balances at the beginning and end of 2025
Raw Material, Beg. 240,000
Raw Material, End 280,000
Work-in-process, Beg. 480,000
Work-in-process, End 460,000
Finished Goods, Beg. 600,000
Finished Goods, End 660,000
In 2025, the company purchased 1,000,000 of raw materials, and
direct labor incurred a cost of 1,600,000. Manufacturing overheads
Indirectas
were Material
follows: 40,000
Indirect Labor 100,000
Depreciation on plant and equipment 400,000
Utilities 100,000
Other 120,000

Sales revenue was 4,105,000 for the year. Selling and

administrative expenses for the year amounted to 110,000
Requirement:

• Cost of Goods Manufactured

• Cost of Goods Sold
Lloyd Industries submits the following information on December
31, 2025:
Sales 250,000
Raw Materials inventory January 1, 2025 13,000
Finished goods inventory January 1, 2025 58,000
Purchases 102,000
Purchases return 2,000
Direct Labor cost 39,000
Power, Heat and Light 2,000
Indirect Material consumed 4,000
Depreciation on Plant 3,500
Depreciation on machinery 6,000
Tools Expenses 3,000
Indirect Labor Cost 1,000
Fire Insurance 250
Miscellaneous manufacturing costs 500
WIP inventory January 1, 2025 12,000
WIP inventory December 31, 2025 16,000
Raw Materials inventory December 31, 2025 19,000
Finished goods inventory December 31, 2025 56,500
CLASSIFICATION OF COSTS

I. Costs classified as to relation to a product

A. Manufacturing costs/product costs
1. Direct materials
2. Direct labor
3. Factory overhead
B. Non-manufacturing costs/period costs
1. Marketing or selling expense
2. General or administrative expense
II. Costs classified as to variability
1. Variable costs
2. Fixed costs
3. Mixed costs
CLASSIFICATION OF COSTS

III. Costs classified as to relation to manufacturing

departments
A. Direct departmental charges
B. Indirect departmental charges
IV. Costs classified to their nature as common or joint
A. Common costs
B. Joint cost
V. Costs classified as to relation to an accounting period
A. Capital expenditures
B. Revenue expenditures
CLASSIFICATION OF COSTS

VI. Costs for planning, control, and analytical processes

A. Standard costs
B. Opportunity costs
C. Differential cost
D. Relevant cost
E. Out-of-pocket cost
F. Sunk cost
G. Controllable cost
Marketing or selling expenses

include all costs necessary to secure customer orders and get

the finished product or service into the hands of the customer.
These expenses are often referred to as
a. order-getting
b. order-filling costs.

Examples: advertising, shipping, sales travel; sales

commissions, sales salaries, and expenses associated with
finished goods warehouses.

All organizations have marketing costs, regardless of whether

the organizations are manufacturing, merchandising, or
service in nature.
Administrative or general expenses

Administrative expenses include all executive, organizational,

and clerical expenses that cannot logically be included under
either production or marketing.

Examples: executive compensation, general accounting,

secretarial, public relations, and similar expenses having to do
with the overall, general administration of the organization as
a whole.

As with marketing expenses, all organizations have

administrative expenses
COSTS CLASSIFIED AS TO VARIABILITY

Fixed cost
Items of cost which remain constant in total, irrespective of
the volume of production. Fixed cost are not related to activity
within the relevant range.

Examples: salaries of production executives, depreciation of

equipment computed on a straight-line basis, periodic rent
payments, and insurance.
Fixed costs may be classified into two categories:

1) Committed fixed costs - costs that represent relatively

long-term commitments on the part of management as a
result of a past decision. Example - depreciation on
equipment.

2) Managed fixed costs (also known as discretionary,

programmed, or planned fixed costs) - costs that are
incurred on a short-term basis and can be more easily
modified in response to changes in management
objectives. Examples - advertising, research and
development and costs of training of employees
COSTS CLASSIFIED AS TO VARIABILITY

Variable Cost
These are the items of cost which vary directly, in total, in
relation to volume of production.

Examples are: direct materials, direct labor, royalties, and

commission of salesmen.
COSTS CLASSIFIED AS TO VARIABILITY

Mixed Cost
Items of cost with fixed and variable components. Mixed costs
vary with the level of production, though not in direct relation
to it, probably because part of the cost is fixed while the rest
is variable.

Two types of mixed costs:

a. semi variable costs
b. step costs
Semi variable cost. The fixed portion of a semi-variable cost
usually represents a minimum fee for making a particular item
or service available. The variable portion is the cost charged
for actually using the service.

Assume that a
company rents a
delivery truck at a
flat rate of P 20,000
per month plus P
1.50/km. driven.
Step costs - the fixed part of step costs changes abruptly at
various activity levels because these costs are acquired in
indivisible portions. A step cost is similar to a fixed cost within
a very small relevant range.
Assume that one
supervisor with a salary of
P 30,000 is needed for
every 10 workers, then if
15 workers are used, 2
supervisors (with salaries
of P60,000) will be needed.
If 18 workers are used, still
2 supervisors would be
needed. If the number of
workers increases to 22,
There are different methods of separating mixed costs into
fixed and variable components:
(1) scatter graph
(2) high-low point
(3) method of least square
Scatter graph method

is a visual technique used in accounting for separating the

fixed and variable elements of a semi-variable expense (also
called a mixed cost) in order to estimate and budget for future
costs.
High-Low Method
High-Low Method
Stap ET Company gathered the following information on
power costs and factory machine usage for the last six
months:
Month Power Cost Factory Machine
Hours
January 24,400 13,900
February 30,300 17,600
March 29,000 16,800
April 22,340 13,200
May 19,900 11,600
June 14,900 6,600
Using the high-low method of analyzing costs, answer the
following questions:

1. What is the estimated variable portion of power costs per

factory machine hour?
2. What is the estimated fixed power cost each month?
3. If it is estimated that 10,000 factory machine hours will be
run in July, what is the expected total power cost for July?
The management of Yoko NA Company would like to separate
the fixed and variable components of electricity as measured
against machine hours in one of its plants. Data collected over
the most recent six months follow:
Month Electricity Cost Machine
Hours
January 27,000 800
February 20,000 500
March 31,000 1,000
April 19,000 400
May 24,000 600
June 29,000 900
Using the method of least squares, compute the fixed cost
and the variable cost rate for electricity expense
QUIZ
Illustration:

Bus-ted Moves Company has the following maintenance costs

and mileage data for its fleet of buses over a 6-month period.
Month Miles Driven Total Cost
January 20,000 30,000
February 40,000 48,000
March 35,000 49,000
April 50,000 63,000
May 30,000 42,000
June 43,000 61,000

Compute the total cost when the mileage is 45,000 miles

Illustration:

Sew What? Factory accumulates the following data

concerning a mixed cost, using units produced as the activity
level Month Units Produced Total Cost
March 9,800 14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460

(a.) Compute the variable and fixed cost elements using the
high-low method
(b.) Estimate the total cost if the company produces 6,000
units
Based on the following data of number of units produced and
the corresponding total cost, estimate the total cost of
producing 4,000 units. Use the least square linear regression
method
Month Units Produced Total Cost
1 1,520 36,375
2 1,250 38,000
3 1,750 41,750
4 1,600 42,360
5 2,350 55,080
6 2,100 48,100
7 3,000 59,000
8 2,750 56,800
TwinForks Manufacturing recorded the following production
and total cost data for a 6-month period:

Month Units Produced Total Cost (₱)

January 2,000 14,000
February 4,500 25,250
March 3,200 19,400
April 8,000 41,000
May 6,000 32,000
June 10,000 50,000

Required:
Using the High–Low Method, estimate the total cost when
production is 7,500 units.
Stap ET Company gathered the following information on
power costs and factory machine usage for the last six
months:
Month Power Cost Factory Machine
Hours
January 24,400 13,900
February 30,300 17,600
March 29,000 16,800
April 22,340 13,200
May 19,900 11,600
June 14,900 6,600
Using the high-low method of analyzing costs, answer the
following questions:

1. What is the estimated variable portion of power costs per

factory machine hour?
2. What is the estimated fixed power cost each month?
3. If it is estimated that 10,000 factory machine hours will be
run in July, what is the expected total power cost for July?
ChillBrew Café wants to analyze the relationship between its
monthly electricity cost (a mixed cost) and the number of
cups of coffee produced. The manager gathered the following
data for Month
the past 6 months:
Cups of Coffee Produced Electricity Cost (₱)
January 2,000 15,000
February 3,000 18,000
March 4,500 21,500
April 5,000 23,000
May 3,500 19,000
June 6,000 26,000

Required:
Using the method of least squares, develop the cost
function that expresses electricity cost as a function of cups of
coffee produced.
SteelForm Manufacturing wants to study the behavior of its
maintenance cost (mixed cost) in relation to the machine
hours used in production. The following data were collected
for six recent
Month
months: Machine Hours Maintenance Cost (₱)
January 400 52,000
February 600 59,000
March 800 66,000
April 1,000 72,000
May 900 69,000
June 700 62,000

Determine the total cost when machine hours are expected to

reach 850 hours.
Common cost vs. Joint cost

Common cost

 Costs of facilities or services employed in two or more

accounting periods, operations, commodities, or services.
Just like indirect costs, these costs are subject to allocation.

Example: if two departments are occupying the same

building, the depreciation of the building id a common cost
subject to allocation based on floor area occupied.
Common cost vs. Joint cost
Joint cost

Costs of materials, labor, and overhead incurred in the

manufacture of two or more products at the same time.
A major difficulty inherent to joint costs is that they are
indivisible and they are not specifically identifiable with
any of the products being simultaneously produced.
These costs are also subject to allocation.

Example: direct materials, direct labor, and factory

overhead cost incurred to manufacture two or more
products up to the point of split-off (or where they will
go separate ways)
Capital expenditure vs. Revenue
expenditure
Capital expenditure

Expenditure intended to benefit more than one

accounting periods and is recorded as an asset. The
allocation of the cost to the different periods is -
depreciation for fixed tangible assets, amortization for
intangible assets and depletion for wasting assets.

Revenue expenditure

Expenditure that will benefit current period only and is

recorded as an expense.
Direct vs. Indirect departmental charges
Direct departmental charges

Costs that are immediately charged to the particular

manufacturing department(s) that incurred the costs
since the costs can be conveniently identified or
associated with the department(s) that benefited from
said costs.

Indirect departmental charges

Costs that are originally charged to some other

manufacturing department(s) or account(s) but are
later allocated or transferred to other department(s)
Direct vs. Indirect departmental charges
Direct departmental charges

Costs that are immediately charged to the particular

manufacturing department(s) that incurred the costs
since the costs can be conveniently identified or
associated with the department(s) that benefited from
said costs.

Indirect departmental charges

Costs that are originally charged to some other

manufacturing department(s) or account(s) but are
later allocated or transferred to other department(s)
Costs for Planning, control and analytical
processes
Standard costs

Predetermined costs for direct materials, direct labor,

and factory overhead. They are established by using
information accumulated from past experience and data
secured from research studies. In essence, a standard
cost is a budget for the production of one unit of
product or service. It is the cost chosen by the
managerial accountant to serve as the benchmark in
the budgetary control system.
Costs for Planning, control and analytical
processes
Opportunity cost

The benefit given up when one alternative is chosen

over another. Opportunity costs are not usually
recorded in the accounting system. However,
opportunity costs should be considered when evaluating
alternatives for decision-making.

Example:
Michelle has a part-time job that pays her P1, 000 per
week. She would like to spend a week in Boracay during
summer vacation from school, but she has no vacation
time available. If she takes the trip anyway, the P1, 000
Costs for Planning, control and analytical
processes
Differential cost

Cost that is present under one alternative but is absent

in whole or in part under another alternative. An
increase in cost from one alternative to another is
known as incremental cost, while a decrease in cost is
known as decremental cost. Differential cost is a
broader term, encompassing both cost increases
(incremental cost) and cost decreases (decremental
costs) between alternatives.
Costs for Planning, control and analytical
processes
Costs for Planning, control and analytical
processes
Relevant cost

A future cost that changes across the alternatives. In

the example above, the relevant costs are cost of goods
sold, advertising, commissions, and warehouse
depreciation.
Costs for Planning, control and analytical
processes
Out-of-pocket cost

Cost that requires the payment of money (or other

assets) as a result of their incurrence.
Costs for Planning, control and analytical
processes
Sunk cost

A sunk cost is defined as a cost or payment that has

already occurred and cannot be returned.

Example: A firm has just paid P 250,000 for a special

purpose machine. Since the cost outlay has been made,
the P250,000 investment in the machine is a sunk cost.
Costs for Planning, control and analytical
processes
Controllable and Non-controllable Costs

A cost is considered to be a controllable cost at a

particular level of management if that level has power
to authorize the cost.

Example: Entertainment expense would be controllable

by a sales manager if he or she had power to authorize
the amount and type of entertainment for customers.
On the other hand, depreciation of warehouse facilities
would not be controllable by the sales manager, since
he or she would have no power to authorize warehouse
Costs for Planning, control and analytical
processes
Time dimension to controllability

Costs that are controllable over the long run may not be
controllable over the short run.

Example: advertising. Once an advertising program has

been set and a contract signed, management has no
power to change the amount of spending. But the
contract expires, advertising costs can be renegotiated,
and thus management can exercise control over the
long run.
Manufacturing Inventory Accounts

1. Materials Inventory
2. Work-in-process Inventory
3. Finished Goods Inventory
Materials Inventory
 Are the materials or supplies to be consumed in
the production process to be transformed as
completed goods
Materials Inventory
Work-in-process Inventory
 Are items that are currently in the process of
production
Finished Goods Inventory
 Are items that completed the production process
and are held for sale in the ordinary course of
business
Illustration of Cost Accounting Cycle

The Noeled Products Company is a small, newly organized

company that manufactures dining tables and chairs. The
company's products are sold to jobbers or wholesale
distributors, who in turn sell them to retailers. The basic steps
in the company's manufacturing process are as follows:

1. Lumber is cut to size for table tops, legs, seats, arms, and
backs.
2. The individual pieces of cut lumber are painted in various
bright colors.
3. The pieces are assembled into tables and chairs.
The beginning Statement of Financial Position for the
company on January 1 of the current year is presented below
Noeled Products Company
To make things easy, let us assume that the company for the
month of January makes only one style of table and no chairs.
The following transactions are completed for January and
recorded, in summary form as follows:

1. Materials (lumber, paint, screws, lubricants, and solvents)

are purchased on account at a cost of P 50,000.
2. During the month, direct materials (lumber and paint)
costing P 40,000 and indirect materials (screws, lubricants
for machine, and solvents for cleaning) costing P 1,900 are
issued to the factory.
3. Total payroll for the month amounted to P36,000,
consisting of P20,000 earned by laborers working on the
product; P 7,000 for factory supervision; P 9,000 for sales
5. Depreciation expense for the building is 6% per year. The
office occupies one-tenth of the total building, and the
factory operation is in the other nine- tenths.
6. Depreciation expense for machinery and equipment is 20%
per year.
7. The cost of heat, light, and power for the month was
P3,000.
8. Miscellaneous expenses for telephone, office supplies,
travel, and rental of office furniture and equipment totaled
P1,500
9. Factory overhead is charged to production at 85% of direct
labor cost
[Link] that all goods started in process have been
finished
Assuming that 1,000 tables were produced during the month,
the unit cost is P77.00.
If management determines that a 40% gross profit percentage
is necessary to cover the product's share of selling and
administrative expenses and earn a satisfactory profit, the
selling price per unit
Assume that the following transactions take place in January
in addition to those already recorded.

[Link] of materials, utilities, and selling and administrative

expenses paid amounted to P 34,000
12.800 tables are sold to jobbers
[Link] totaling P55,000 is collected on accounts receivable
The following formulas are also of importance with regards to
the costs of goods sold statement.

1. Prime cost = direct materials used + direct labor cost

2. Conversion cost = direct labor cost + factory overhead
3. Total manufacturing cost = direct mat used + direct labor
cost+ factory OH
ILLUSTRATIVE PROBLEM FOR A SERVICE FIRM
The Magic Glass is engaged in cleaning glass walls and windows of
high-rise buildings. The company incurs service overhead of P
200,000 per month. Magic Glass has 50 workers who work 200 hours
each per month. In addition, they spend P180,000 on gasoline for
their trucks. Advertising and other marketing expenses amount to
P115,000. Administrative costs are P 150,000 per month. The workers
are paid P150 per hour. Revenues for the month amounted to P
4,450,000. All purchases, labor costs and revenues are on cash basis.

The following transactions take place during January, 2019

1. Purchased direct materials
325,000
2. Incurred and paid labor costs - direct labor costs
1,500,000
3. Supervisory labor 50,000
4. Incurred and paid other service overhead costs
200,000
5. Paid gasoline for the trucks
Job Order Costing
Job Order Costing
• Job order costing is a system where the
costs of each job, contract, or order are
tracked separately

• It’s used in industries where products or

services are made to specific orders, not
mass-produced.
Major Source Documents in Job
Order Costing
• Job-Order Cost Sheet

o Records all product costs (materials, labor,

overhead) for each specific job.
o Serves as both the costing record and a
subsidiary ledger for WIP.
o Each job has its own sheet.
Major Source Documents in Job
Order Costing
• Materials Stock Card

o Keeps track of materials on hand (quantities

and costs).
o Acts as the subsidiary ledger for the
Materials Control account.
o Each type of material has its own stock card.
Major Source Documents in Job
Order Costing
• Finished Goods Stock Card

o Keeps track of completed goods ready for

sale.
o Acts as the subsidiary ledger for Finished
Goods Control.
o Each finished product line has its own stock
card.
Major Source Documents in Job
Order Costing
• Factory Overhead Control Record

o Accumulates all manufacturing overhead

costs by department (like utilities, factory
rent, depreciation of machines).
o Serves as the subsidiary ledger for Factory
Overhead Control.
Major Source Documents in Job
Order Costing
• Materials Requisition, Time Ticket, and
Clock Card

o Serve as the source documents for assigning

costs (materials and labor) to jobs and
departments.
o Help ensure proper control and
accountability in the use of materials and
labor.
o Materials Requisition → for materials issued
to production.
Just in Time (JIT)
Manufacturing
Materials, parts, and products are delivered
exactly when needed—no earlier, no later.
or completed

Process:
• Raw materials delivered only when production starts.
• Goods move through each production stage just in time
for the next.
• Finished goods go directly to delivery vehicles, bypassing
storage.

Benefits:
• Eliminates warehouse costs.
• Reduces handling and equipment needs.
• Lowers inventory levels and production time.
Just in Time (JIT)
Manufacturing
Differences:
Accounts Used
JIT Costing vs Traditional Costing

Traditional: Separate Materials and Work in Process

accounts.
JIT: Combined into Raw and In Process account.

Treatment of Direct Labor

Traditional: Has a Direct Labor account.
JIT: Labor is minor → combined with FOH into Conversion
Cost account (or charged directly to COGS).

Timing of Overhead Application

Traditional: Overhead applied during production (goes to
WIP).
JIT: Overhead charged after completion, usually directly to
COGS (since goods are sold immediately).
Backflush Costing
The backflush costing methods accounts
the company’s inventories backward by
calculating the cost of products after they
are sold, finished or shipped to
customers rather than accounting it
before and during the production process
Accounting
for
Materials
Periodic Inventory System
• Purchases of materials recorded in “Purchases”
account
• Beginning Inventory recorded in “Materials
Inventory – Beginning”
• Materials Available for Use:
= Purchases + Beginning Inventory
• Ending Inventory determined by physical
count at period end
• Cost of Materials Issued:
= Materials Available for Use – Ending Inventory
• Cost is indirectly computed, not directly
tracked
Perpetual Inventory System
• Purchases recorded in “Materials Inventory”
(not Purchases account)
• Beginning Inventory = balance from end of
previous period
• When issued:
 Direct Materials → Debit Work in Process,
Credit Materials Inventory
 Indirect Materials → Debit Factory
Overhead Control, Credit Materials Inventory
• Cost of materials issued and Ending
Inventory can be directly determined after
each transaction
Materials Inventory Control
• Ensures minimum cost and smooth production
• Good control prevents waste and interruptions

Key Concepts:
1. Inventory = raw materials + labor + factory overhead →
finished goods
2. Inventory reduction = normal use + alternative
uses/scrapping
3. Optimum inventory investment → minimize carrying &
ordering costs
4. Efficient purchasing & management rely on accurate
sales forecasts
5. Forecasts determine when to order; scheduling aids
control
6. Control = not just records → depends on judgment &
Cost Control System

• Total cost = materials + labor + factory overhead

• Purpose: keep costs within plan, reduce waste &
inefficiency
• Focus: control people who make spending decisions
Commonly used Control Procedures

1. Order Cycling Method

• Inventory is reviewed on a fixed schedule (e.g., every
30 days).
• If materials are low at the review time, an order is
placed to restore to the desired level.
2. Min-Max Method
• Each material has a minimum level (order point) and a
maximum level (desired stock).
• When inventory reaches the minimum, order enough to
reach the maximum.
3. Two-Bin Method
• Materials are stored in two bins:
 First bin = used until empty.
 Second bin = covers usage during ordering
Commonly used Control Procedures

4. Automatic Order System

• A computerized system places an order automatically
when inventory hits a predetermined order point.
• Uses perpetual inventory records (updated
continuously).

5. ABC Plan
• Materials are grouped based on value and importance:
 A items → High-value, critical items → need strict
control.
 B items → Moderate value → medium control.
 C items → Low-value, non-critical → simple control
methods.
Material Control

There are two basic aspects of materials

control

1. Physical control or safeguarding of

materials
2. Control of the investment in materials
Physical Control of Materials

1. Limited Access - Only authorized personnel should

have access to materials storage area. All issuance of
materials for use in production and release of finished
goods for shipment should be properly documented and
approved.
2. Segregation of Duties - The following functions
should be segregated to minimize opportunities for
misappropriation of inventories - purchasing, receiving,
storage, use, and recording.
3. Accuracy in Recording - Inventory records should
permit the determination of inventory quantities on hand
upon request, and cost records should provide the data
for the valuation of inventories for the preparation of
financial statements.
Controlling the Investment in Materials

One of the most important objectives of material control is

maintaining the proper balance of materials on hand. An
inventory of sufficient size and diversity for efficient
operations must be maintained, but the size should not be
excessive in relation to scheduled production needs. The
planning and control of the materials inventory investment
requires careful study of the following factors: usage of funds,
costs of materials handling, storage, and insurance against
fire, theft, or other casualty, loss from damage, deterioration,
and obsolescence. These factors should be considered in
determining:

(1) when orders should be placed

(2) how many units should be ordered.
Order Point
A subsidiary ledger must be kept for each individual item of
raw material used in the manufacturing process. This ledger
will indicate the inventory on hand for each item.

The point at which an item should be ordered, called the

order point occurs when the predetermined minimum level
of inventory on hand is reached. Calculation of the order point
is based on the following data:

1. Usage - the anticipated rate at which the materials will

be used.
2. Lead time - the estimated time interval between the
placement of an order and receipt of the material.
3. Safety stock - the estimated minimum level of
inventory needed to protect against running out of
Assume that the expected daily usage of
an item of material is 100 units, the
anticipated lead time is 4 days, and it is
estimated that a safety stock of 800
units is needed.

Order Point is?

Economic Order Quantity - the purchase order which
results in the minimum total inventory cost. In determining
the quantity to be ordered, the cost of placing an order
and the cost of carrying inventory must be considered.

Factors to be considered in determining ordering costs:

1. Salaries and wages of employees engaged in purchasing,
receiving, and inspecting materials.
2. Communication costs associated with ordering, such as
telephone, postage, and forms of stationery.
3. Materials accounting and record keeping.

Factors to be considered in determining carrying costs

1. Materials storage and handling costs.
2. Interest, insurance, and property taxes.
3. Loss due to theft, deterioration, or obsolescence.
4. Records and supplies associated with the carrying of inventories.
 Total ordering costs and total carrying costs
vary inversely. The greater the inventory on
hand, the greater the total carrying costs but the
lower the ordering costs. If a small inventory is on
hand, total carrying costs will be lower but more
orders will be placed, thus increasing the total
ordering costs.

It is the responsibility of management to find

the proper inventory policy that keeps the total
inventory costs (total carrying costs + total
ordering costs) to a minimum
First – in, First – out (FIFO)

The inventory on August 31 shows 600 units on hand

Moving average
Discounts
1. Trade Discounts – generally given in terms of percentage (15%, 10%, 5%)
and are used to convert single price list into a series of price lists for different
types of middleman. Trade discounts are not recorded on the books because
purchases are recorded on the books net of discount
2. Quantity discount – represent cost savings for volume purchases. Like
trade discounts, quantity discounts are not given explicit accounting
recognition in the books.
3. Cash discounts – granted to customers to motivate them to pay promptly.
a. When taken method - purchases and liabilities are recorded at gross
amounts at the time of purchase. The discount is only recognized when
the account is paid within the discount period.
b. When not taken method - purchases and liabilities are recorded at net
at the time of purchase; when payment is made after the lapse of the
discount period, the discount not availed of is charged to a "Purchase
Discount Lost" account. It is called when not taken method because even if
the account is paid within the discount period, no "Purchase Discount" is
recorded and therefore readers of the financial statements would not know
that the company has availed of the discount.
c. When offered method - purchases are recorded at net and the liability is
recorded at gross, the difference is charged to an "Allowance for Purchase
Discount" account. When payment is made after the lapse of the discount
Freight-In
1. Direct charging- the freight incurred on the purchase of raw
materials is added to the invoice price. The account debited for the
freight is Materials. The effect is an increase in the unit cost. If two
or more materials are purchased and delivered at the same time,
the freight must be allocated using the following methods:
a. Relative peso value method - freight is allocated on the basis of
the peso value of the items purchased. This is used for materials
purchased and expressed in different terms of measurement.
b. Relative weight method - freight is allocated on the basis of the
weight of the items purchased.

2. Indirect charging - the freight incurred on the purchase of raw

materials is charged to Factory Overhead Control account.
Accounting for
Labor
Labor
• Labor refers to the physical or mental effort used in
manufacturing, while labor cost is the payment for
using human resources.
• The main labor cost is wages paid to production
workers (hourly, daily, or per output), while salaries
are regular fixed payments for managerial or clerical
work.

Types of Factory Labor:

 Direct Labor – payroll costs that can be traced
directly to the product; charged to Work in Process
(WIP).
 Indirect Labor – costs related to production but
not directly traceable; charged to Factory Overhead,
Procedures in Recording Payroll Costs:

1. Record total and job-specific hours worked.

2. Record quantity of output.
3. Analyze how employees’ time should be charged.
4. Allocate payroll costs to jobs and factory overhead.
5. Prepare payroll: compute and record gross pay,
deductions, and net earnings.
Wage Plans are systems used by companies to compensate
employees, subject to union approval and government
regulations. The main types are:

• Hourly-Rate Plan – Employees are paid a fixed rate per

hour worked.
Advantage: Simple to use.
Disadvantage: No incentive for higher productivity.

• Piece-Rate Plan – Employees are paid based on units

produced (rate per piece × output).
Advantage: Encourages productivity.
Disadvantage: May reduce product quality.

• Modified Wage Plan – Combines both hourly and piece-

rate systems.
Employees receive a minimum hourly wage, plus
Controlling Labor Cost
Labor costs are monitored through the Time-Keeping and
Payroll

Departments:
 Time-Keeping Department – Tracks employees’ working
hours using:
• Clock cards
• Time tickets
• Production reports

 Payroll Department – Calculates employees’ gross pay,

deductions, and net pay, using:
• Payroll records
• Employee earnings records
• Payroll summaries
Recording Labor Costs:

• Hourly workers record time through time tickets,

while piece-rate workers use individual
production reports.
• These records show hours worked, rate, and earnings,
and are sent daily to the payroll department for
computation.

The accounting department uses a labor cost

summary to distribute payroll to:
 Work in Process (WIP) – for direct labor
 Factory Overhead (FOH) – for indirect labor or
overtime premium
Treatment of Overtime:

• Regular hours → charged to Work in Process (WIP).

• Overtime pay (same hourly rate) → may go to WIP or
FOH, depending on reason.
• Overtime premium (extra pay rate) → usually charged
to Factory Overhead, unless the overtime was due to a
rush job, in which case it’s charged to WIP.

Example:
Regular: ₱30/hr × 8 hrs = ₱240
Overtime: ₱30/hr × 4 hrs = ₱120
Overtime premium (50% rate): ₱15/hr × 4 hrs = ₱60
Total = ₱420 (₱360 to WIP, ₱60 to FOH)
Employer’s Payroll Taxes:
Employers must pay and report statutory contributions such as:
• Social Security (SSS)
• Pag-IBIG Fund
• PhilHealth
Failure to file reports or remit these taxes can lead to civil or
criminal penalties.

SSS (Social Security System)

Employers and employees share the contribution, with the
employer paying about 68% and the employee 32%.
Example: For a ₱10,000 salary → Total contribution ₱925 (₱506.70
employer + ₱333.30 employee).
Benefits:
Retirement pension or lump-sum benefit
Salary, educational, and housing loans
Maternity and calamity benefits
PhilHealth
Employer and employee contribute equally.
Example: ₱10,000 salary → ₱125 deducted from employee and ₱125
from employer (₱250 total).
Maximum contribution: ₱375 each for salaries ₱30,000 and above.
Benefits:
Hospitalization coverage
Reimbursement for room, medicines, and professional fees (paid
directly to hospitals)

Pag-IBIG Fund
Employee contributes 3% of basic salary or ₱100, whichever is
lower, and the employer matches the same amount.
Benefits:
Salary, educational, and housing loans
Upon retirement: Employee receives total contributions
(employee + employer share) plus dividends earned.
Classification of Labor

• Direct Labor – Labor that can be specifically

identified and measured for a particular product or
job; directly charged to the production order cost
sheet.

• Indirect Labor – Labor that cannot be feasibly

measured or traced to a specific product.

It includes:
a. Labor related to specific products but not practical
to measure individually.
b. Labor performed for the benefit of overall
production, not tied to any single product. (Charged
• Labor Overhead
Labor overhead refers to indirect labor costs or additional
payroll-related expenses that cannot be directly charged to
a specific job but are necessary for factory operations.

 Waiting Time / Idle Time

Cost of non-productive hours due to unavoidable delays
(e.g., machine breakdown, lack of materials).

Normal idle time → charged to Factory Overhead

Control.
Example:
Work in Process – Job 101 (36 hrs × ₱50) = ₱1,800
Factory Overhead Control – Idle Time (4 hrs × ₱50) =
₱200
Accrued Payroll = ₱2,000
 Make-up Pay
For employees under piece-rate system with a
guaranteed minimum
wage.

If output pay < guaranteed wage → difference charged

to Factory Overhead Control.

Example:
Guaranteed pay ₱1,500; actual output ₱1,200 → ₱300 to
FOH.
WIP – ₱1,200; FOH – ₱300; Accrued Payroll – ₱1,500.
If output pay > guaranteed wage → charge total to WIP
only.
 Overtime Premium
Extra pay beyond regular rate for working overtime,
holidays, or rest days.
Regular pay → Work in Process
Overtime premium → Factory Overhead (unless
caused by a specific rush job, then charge to WIP).

Example:
WIP (45 hrs × ₱50) = ₱2,250
FOH (5 hrs × ₱25) = ₱125
Accrued Payroll = ₱2,375
 Shift Premium
Additional pay for working less desirable shifts
(evening or night).
Always charged to Factory Overhead Control.

Example:
WIP (40 hrs × ₱50) = ₱2,000
FOH (40 hrs × ₱20) = ₱800
Accrued Payroll = ₱2,800
Problem 1:

Kera Teen Company’s compensation scheme for its factory

workers provides a combined maximum guaranteed wage and a piece
rate. Each worker is paid P50 per piece with a maximum guaranteed
wage of P 3,000 a week (5 work days). During the first week of May
the production department submitted the following output:

Employee Units Produced

Jan-Jan 58
Ching-Ching 45
Kwini 40
Anabel 54
Pepito 50
Elsa 36

Determine the following:

(a)The amount of labor charged to work in process
(b)The amount of labor charged to manufacturing overhead
Accounting for
Factory
Overhead
Factory Overhead
• Factory overhead includes all indirect manufacturing
costs incurred in the factory that are not direct
materials or direct labor.
• If a cost cannot be directly traced to either, it is
classified as factory overhead.

Examples:
 Indirect materials and labor
 Factory utilities (heat, light, power)
 Rent and depreciation of factory
building/equipment
 Maintenance of factory facilities
Factory overhead costs are classified based on
their behavior relative to production:

• Variable Overhead – changes directly with

production volume; total cost varies, but per-unit
cost stays constant.
• Fixed Overhead – remains constant in total
regardless of production level; per-unit cost
decreases as production increases.
• Mixed Overhead – has both fixed and variable
components; must be separated for planning
and control purposes.
Factors to Consider in Computing the Overhead Rate

• Base to be Used – The basis for applying overhead, which

may be:
a. Physical output
b. Direct materials cost
c. Direct labor cost
d. Direct labor hours
e. Machine hours

• Activity Level to Use – The level of production activity to

be used in computing the rate:
a. Normal capacity
b. Expected actual capacity
• Inclusion or Exclusion of Fixed Factory Overhead –
Depends on the costing method:
a. Absorption costing – includes fixed factory overhead
(used for cost accounting).
b. Direct costing – excludes fixed factory overhead (used
for internal or management reporting).

• Use of Single or Several Rates – Refers to how many

overhead rates are applied:
a. Plant-wide or blanket rate – one rate for the entire
factory.
b. Departmentalized rate – a separate rate for each
producing department.
Base to be Used in Computing Factory Overhead Rate

1. Direct Labor Hours

- Most commonly used base.
- Suitable if factory overhead varies with labor hours.
- Used when labor time has a strong link to overhead and wage
rates differ significantly.

2. Direct Labor Cost

- Used when overhead is closely related to total labor cost.
- Reliable since labor rates are relatively stable.
- Not suitable when overhead is mostly machine-related (e.g.,
depreciation).

3. Machine Hours
- Best for highly automated factories where overhead (like
depreciation) depends on machine use.
- Requires tracking of machine time for each job.
4. Direct Material Cost
- Used when overhead varies with material cost (e.g.,
material-intensive industries).
- Not ideal for companies producing multiple products
with different materials.

5. Units of Production
- Simplest method; suitable when only one type of
product is manufactured.
Steps in Computing Departmentalized Overhead Rate

1. Divide the Company into Departments or Cost

Centers
Identify segments where costs will be accumulated.
2. Estimate Factory Overhead for Each Department
Include both direct departmental charges and indirect
departmental charges.
3. Select and Estimate the Base for Each Department
Choose an appropriate base (e.g., labor hours, machine
hours) that reflects cost behavior.
4. Allocate Service Department Costs to Producing
Departments
Distribute costs of service departments (e.g., maintenance,
personnel, utilities) to departments that directly produce
goods.
5. Compute the Factory Overhead Rate
Apply the same formula used in the blanket rate
Typical Allocation Bases for Common Costs

Common costs are grouped into four categories, each with suitable allocation
bases depending on the nature of the cost:
METHODS OF ALLOCATING SERVICE DEPARTMENT COST TO PRODUCING
DEPARTMENTS

1. Direct method - the most widely used method. This method ignores any
service rendered by one service department to another; it allocates each
service department's total cost directly to the producing departments.
METHODS OF ALLOCATING SERVICE DEPARTMENT COST TO PRODUCING
DEPARTMENTS

2. Step method - sometimes called sequential method of allocation. This

method recognizes services rendered by service departments to other service
departments and is more complicated because it requires a sequence of
allocation. The sequence typically starts with the department that renders
service to the greatest number of other service departments and ends with the
department that renders service to the least number of other departments.
Once a service department's costs are allocated, no subsequent service
department costs are allocated to it.
METHODS OF ALLOCATING SERVICE DEPARTMENT COST TO PRODUCING
DEPARTMENTS

3. Algebraic method - sometimes called reciprocal method. This method

allocates costs by explicitly including the mutual services rendered among all
departments.
Capacity Production

In estimating manufacturing overhead and the allocation base, it is essential to

determine the appropriate production capacity level to use. The main capacity
levels are:

a. Theoretical / Maximum / Ideal Capacity – Assumes production at full,

uninterrupted speed (24/7, all year).No allowance for maintenance, rest, or
production stoppages. Represents the highest possible output but is
unrealistic in practice.

b. Practical Capacity – Allows for normal interruptions such as maintenance,

rest, and minor delays. Reflects a more attainable level of production than
theoretical capacity.

c. Expected Actual Capacity – Based on short-term forecasts considering

seasonal or market fluctuations. Suitable for firms with seasonal demand or
changing market conditions.

d. Normal Capacity – Reflects average long-term utilization of the plant,

considering seasonal and cyclical variations. Most commonly used in
computing factory overhead rates because it provides a balanced and
Method of Accumulation of Factory Overhead Costs

Non-Controlling Account System

o Separate ledger accounts are maintained for each type
of overhead expense.
o Each expense is recorded directly upon incurrence.
o Provides detailed classification but less overall control.

Controlling Account System

o A Factory Overhead Control Account is maintained in
the general ledger.
o Subsidiary ledgers show detailed breakdowns of each
overhead expense.
o Allows better control and monitoring of factory
overhead by grouping related accounts and showing
department-wise details.
Recording and Application of Overhead:

o Actual overhead costs are incurred daily and recorded

periodically in both general and subsidiary ledgers.
o After the predetermined overhead rate is computed, it
is used to apply overhead to production based on the
selected base (e.g., direct labor cost, machine hours, or
units produced).

o Applied Overhead Formula:

Applied Factory Overhead = Actual Base × Predetermined

Overhead Rate

Journal Entry to Apply Overhead:

Work in Process – Overhead XXX
Factory Overhead Applied XXX
Classification of Manufacturing Overhead Variance

1. Types of Overhead Variance

a. Underapplied Overhead – Occurs when actual
overhead > applied overhead.
b. Overapplied Overhead – Occurs when actual overhead
< applied overhead.

2. Causes of Overhead Variance

a. Spending Variance – Caused by differences in actual
expenses versus the budgeted amount (expense-
related factors).
b. Idle Capacity or Volume Variance – Caused by
differences in production volume or activity level
compared to expectations.
Computation of Manufacturing Overhead Variance

a. Spending Variance

Actual Factory Overhead Incurred xxx

Less: Budget Allowed Based on Capacity Used:
Fixed Factory Overhead xxx
Variable Factory Overhead xxx
Spending Variance xxx
b. Idle Capacity (Volume) Variance

Budget Allowed Based on Capacity Used xxx

Less: Factory Overhead Applied (xxx)
Idle Capacity Variance xxx
Accounting for Overhead Variance

a. During the Period (Before Closing Books)

o The overhead variance is not yet recognized.
o The Actual Factory Overhead and Applied Factory
Overhead accounts remain open.
o If the variance is expected to be corrected (absorbed) before
year-end, it should be deferred, not immediately disposed of.

b. At the End of the Accounting Period

o If variance is immaterial or due to inefficiency → Close to
Cost of Goods Sold (COGS).
o If variance is material and caused by error in
predetermined overhead rate → Allocate it among:
 Cost of Goods Sold
 Finished Goods Inventory
 Work in Process Inventory
Activity-Based Costing (ABC)

Concept and Purpose

• Activity-Based Costing (ABC) arose due to

automation and increased overhead in modern
manufacturing.
• Traditional methods (e.g., based on direct labor) are no
longer accurate because direct labor’s role has
decreased while overhead costs have increased.
• ABC identifies activities that consume overhead
resources and assigns costs to products based on their
actual use of those activities.
• It provides more accurate product costing by
establishing a cause-and-effect relationship between
activities and overhead.
Comparison with Traditional Costing

• Traditional Costing: Uses volume-based bases

(DLH, machine hours, etc.) which may distort costs—
low-volume or complex products may be under
costed, while high-volume products may be over
costed.
• ABC: Uses activity-based drivers (e.g., setup
hours, material moves, number of parts) that reflect
how products actually consume overhead activities.

Basic Principle

Products that use more activities (resources)

should be assigned higher overhead costs—similar
to a user’s fee system (“the more you use, the more
Five Basic Steps in Applying ABC

1. Assemble Similar Actions into Activity Centers

Group related actions to simplify cost tracing.
Activities are classified into four levels:
Unit-Level Activities: Performed per unit (e.g., assembly, machining).
Batch-Level Activities: Performed per batch (e.g., machine setup, order
processing).
Product-Level Activities: Support each product type (e.g., product
design, testing).
Facility-Level Activities: Support the overall factory (e.g., supervision,
utilities).
2. Classify Costs by Activity Center and Type of Expense
Trace direct costs to specific activity centers.
Allocate shared costs using suitable cost drivers (e.g., floor space, machine
hours).
3. Select Cost Drivers
Cost drivers are factors that cause costs to change.
They serve as the link between activity costs and products (e.g., setup
hours, material moves).
4. Compute a Cost Function
Determine the rate per cost driver unit.
Example: ₱25,000 setup cost ÷ 500 setup hours = ₱50 per setup hour.
Fish Tea Company has three products namely: C, D, and E and three related
overhead activities: product-line steps, number of handles and number of
parts. The number of setups refer to the number of times each product line is
readied for production. The number of handles refers to the number of times
each product is moved from one work station to another. The number of parts
refers to the number of parts that is used in making each product. The
production, overhead activities and their corresponding costs are shown on the
table below:
Process
Costing
Process Costing
• Process costing is used when a company produces
continuous, identical, homogeneous units rather
than custom or separate jobs. Because production
has no clear start or end, individual job costing
cannot be used. Instead, all manufacturing costs are
first collected by department or process, and then
assigned to units as they are completed.
• Each department has its own Work in Process
(WIP) account where direct materials, direct labor,
and factory overhead are recorded. At the end of the
period, departmental costs are divided between:
1. Units still in process, and
2. Units completed and transferred out (or
transferred to Finished Goods if it is the final
department).
Process Costing
• To measure production fairly when some units are not
fully complete, process costing uses equivalent
units, which convert partially completed units into a
smaller number of fully completed ones. Unit costs
and total costs for each department are summarized
in a Cost of Production Report.

• Process costing is used in industries with mass,

continuous, or standardized production, such as
chemicals, petroleum, cement, pharmaceuticals,
flour, plastics, steel, assembly lines, and utilities like
water and gas.
Characteristics of a Process Cost
System
 Costs are accumulated by department or cost
center.
 Each department has its own WIP account (debited
for costs, credited for completed units).
 Equivalent units are used to measure partial
completion.
 Costs of completed units are transferred to the next
department or to Finished Goods.
 Department Cost of Production Reports are
prepared to compute and analyze total and unit
costs.
Job Order Costing vs. Process
 Job Order Costing:
Costing
•Used for customized, unique, or small-batch jobs.
• Costs are traced to specific jobs using job cost
sheets.
• Unit cost is computed when the job is finished.
• Finished job cost is transferred from WIP to
Finished Goods.

 Process Costing:
• Used for continuous, homogeneous, mass
production.
• Costs are accumulated by department, not by job.
• Unit cost is computed at the end of each month
using equivalent units.
Production by Department
In a process cost system, products pass through several
departments.

When a department finishes its work on the units, it transfers the

units together with their accumulated costs to the next department.
• The output of Department 1 becomes the input of Department 2.
• Department 2 receives both the units and the costs added by
Dept. 1, then adds its own costs before transferring them to
Dept. 3.
• This continues until the units reach Finished Goods.

As the units move from one department to the next, their total cost
increases because each department adds more cost.
Production by Department
Example: A chair is produced in three departments:

Dept. 1: cutting/cleaning – P45

Dept. 2: assembly – P15
Dept. 3: painting – P25

The cost builds up through each stage, resulting in a total cost per
finished chair of P85.

Generally, the cost per unit increases as units flow through each
department. The unit cost can decrease when units pass through a
department if volume is added to the product.
SYSTEM FLOW
• In a process cost system, the units and their costs move
together from one department to the next.
• To keep track of all the units, we use a physical flow of
units equation.
• This equation shows where the units came from and
where they went.
Sequential Product Flow
• Raw materials enter the first department
and move through all departments in a
fixed sequence.
• Additional materials may be added in later
departments.
• All products follow the same path from
start to finish.
Parallel Product Flow
• Certain parts of the work are done
simultaneously in different departments.
• Outputs are combined in the final process.
• Completed products are then moved to
finished goods inventory.
Selective Product Flow
• Product moves to different departments
based on the desired final product.
• Multiple products can be made from the
same initial raw materials.
Procedures – Direct Materials,
Direct Labor, and Factory
Overhead
Direct Materials

• Always added in the first processing

department; may also be added in later
departments.
• Journal entries are simpler and fewer than
in a job order cost system.
• Fewer departments typically use direct
materials compared to the number of jobs
in job order costing.
Procedures – Direct Materials,
Direct Labor, and Factory
Overhead
Direct Labor

• Labor costs are charged to the department

where the employee works.
• Example: Maxine works in Department C,
so her entire gross salary goes to
Department C’s WIP.
• Less paperwork because costs are grouped
by department.
Procedures – Direct Materials, Direct
Labor, and Factory Overhead
Factory Overhead
• Purpose: Assign indirect manufacturing costs (utilities,
depreciation, etc.) to departmental WIP.
• Two Methods of Applying FOH:
a. Predetermined Overhead Rate:
 FOH applied to WIP at a predetermined rate. Based
on normal capacity.
 Useful when production volume or FOH costs
fluctuate monthly.
b. Actual FOH Method:
 Charges actual FOH costs incurred to WIP.
 Suitable when production and FOH costs are stable
month-to-month.
THE COST OF PRODUCTION REPORT
(COPR)
A Cost of Production Report summarizes all the costs and unit
movements in a department for a given period. It shows:

• How many units were processed

• How complete those units are
• How much cost each unit should receive
• Where the costs and units are transferred

Each department prepares its own report.

Cost of Production Report Steps:

1. Quantity Schedule - Shows the physical flow of units:

beginning WIP, units started, units completed, and ending
WIP.
2. Equivalent Units & Unit Cost - Equivalent units convert
partially completed units into their full-unit equivalent.
3. Total Costs to Account For - Includes beginning WIP
costs + current period costs (DM, DL, FOH).
4. Cost Assignment - Distributes total costs into:
a. Units Transferred Out (Completed)
b. Ending Work in Process (EWIP)

Costing Methods:
• FIFO: Current costs only; beginning WIP treated
separately
• Weighted Average: Beginning + Current costs combined
Computation of Equivalent Production

1. Units received from preceding department

10,000
Units completed and transferred
8,000
Units in process, end (60% completed)
2,000

Materials are added 100% at the beginning of the process

2. Same data as in No. 1 except this time materials are

added 100% at the end of the process in the department

3. Same data as in No.1 except this time, materials are

added 50% at the beginning of the process and the
remaining 50% when the units are 40% completed
4. Same data as in No.1 except this time materials are added
as follows:
50% at the beginning of the process
30% when the units are 20% complete
20% at the end of the process
Scrap, Defective Units, and Losses in Process Costing

General Treatment

• Treatment of scrap and defective units in process costing

is similar to job order costing.
• Rework costs in a process cost system are charged to
Factory Overhead Control, not WIP, because defects arise
from internal failures.
• Units classified as lost in process costing are equivalent
to spoiled units in job order costing.
NORMAL vs. ABNORMAL LOSSES

Normal Loss
• Expected and unavoidable.
• Cost is treated as product cost (absorbed by good
units).
• Cost is charged to:
 Completed units + Ending WIP, when normal loss
is:
1. Discovered at the beginning of the process
2. Discovered during the process (no inspection
point)
3. Discovered after substantial processing (WIP-end
has passed inspection)
 Completed units only, when normal loss is
discovered at the end of the process.
Abnormal Loss

• Unexpected and excessive.

• Treated as period cost.
• Cost is charged to Factory Overhead
Control (or a separate loss account).
• Applicable whether abnormal loss is
discovered:
1. At the beginning
2. During the process (inspection point
stated)
3. At the end
Joint Products
and By-
Products
Standard Costing
Joint and by-
product
Cost – Volume –
Profit Analysis
(CVP)
CVP Analysis
• CVP analysis shows how changes in cost
(fixed/variable), sales volume, and selling
price affect profit.
• It is used for planning (predicting conditions)
and controlling (evaluating results).

• The Break-Even Point (BEP) is the sales

level where:

Total Revenue = Total Cost

Managers use CVP to answer:

a. How many units must be sold to break

even?
b. What happens if fixed costs change—how
will BEP shift?
c. What happens if selling price per unit
changes—how will BEP shift?
Cost Classifications in CVP
Instead of functional (manufacturing, selling, admin),
CVP uses behavioral classification:

A. Variable Costs
• Direct materials
• Direct labor
• Variable overhead
• Variable selling
• Variable administrative
B. Fixed Costs
• Fixed overhead
• Fixed selling
• Fixed administrative
CVP Assumptions

a. Relevant Range – Within a normal operating range,

variable cost per unit and total fixed costs remain
constant.
b. Revenue – Selling price per unit remains constant; total
revenue is proportional to sales volume.
c. Variable Cost – Per unit variable cost is constant; total
variable cost changes with volume.
d. Fixed Cost – Total fixed costs remain constant; per unit
fixed cost decreases when volume increases (and vice
versa).
e. Mixed Cost – Needs separation before analysis.
Illustrative problem 1

Nicolas Company produces a product that sells for P800.00. The

variable cost is P350 for direct materials, P200 for labor, P50 for
variable overhead and P 30,000 for fixed overhead. The units
sold for the month is 500 units

Required:
a. Compute for total variable cost
b. Compute the total fixed cost
c. Compute for the BEP (units)
d. Compute for the contribution margin
e. Compute for the contribution margin ratio
f. Compute for the BEP (pesos)
If a statement is prepared for the break-even sales, it will
appear as

Sales P 120,000
Variable cost (150 x P600) 90,000
Contribution margin 30,000
Fixed cost 30000
Net income 0
The contribution margin statement for the Nicolas Company
assuming sales of 500 units will appear as

Sales (500 x P800) P 400,000

Variable cost (500 x 600) 300,000
Contribution margin 100,000
Fixed cost 30,000
Net income P 70,000
MARGIN OF SAFETY

Margin of safety is the units sold or revenue earned

above the BEP volume. In simple words, it
represents the number of units or amount of sales
revenue that the company can absorb before
incurring a loss.
CVP ANALYSIS IN A MULTIPRODUCT

Illustrative Problem 2

Selina Company produces three products A, B, and

C with the following characteristics

Total fixed costs are P 1,800,000. Assume that sales

mix will be the same at all sales levels.
CVP ANALYSIS IN A MULTIPRODUCT

Required:

1. Compute for the break-even point in total units

2. Compute for the units A, B, and C must sell at
break-even point
3. Compute for the total contribution margin if the
company expects profit of P350,000.
SALES AND UNITS WITH DESIRED PROFIT

Illustrative Problem 3
The Gilas Company is trying to do CVP analysis with
the following information for the month of August.

Sales P 550,000
Total fixed cost 140,000
Selling Price 20
Variable cost per unit 12

Required:
1. Sales (units and amount) to break even.
2. Sales if the company desires a profit of P 120,000
Operating Leverage

Operating leverage measures how sensitive a

company’s profit is to changes in sales.