Cost Accounting I

Cost & management Accounting I handout
CHAPTE ONE
COST ACCOUNTING CONCEPT, COST CONCEPT & CLASSIFCATION
Meaning of cost Accounting:
The terms costing & cost accounting are often used interchangeably. The chartered institution of
management Accounting (CIMA) London has defined costing as the techniques & process of
ascertaining cost. Weld on has defined the classifying recording & appropriate allocation of expenditure for
the determination of costs, the relation of theses cost to sales value & for the ascertainment of profitability.
Cost accounting is the process of accounting for cost from the point at which expenditure is incurred or
committed to the establishment of its ultimate relationship with cost centers & cost units.
Cost is economic scarification , measured in terms of standard monetary unit , incurred or potentially to be
incurred , as a consequence of a business decision to achieve a specific objective.
Cost Accountancy is the application of costing & cost accounting principles , methods & techniques to the
science ,art & partite of cost control & ascertainment of profitability .
It is science in the sense that it is a body of systematic Knowledge which a cost accountant should
possess for the proper discharge of his duties & responsibility.
It is an art is requires the ability & skill on the part of a cost accountant in applying the principle of cost
accountancy to various managerial problems.
It is practice refers of constant effort on the part of cost accountant in the field of cost accountant
. OBJECTIVES OF COST ACCOUNTANTING
1) Ascertainment of cost
2) Cost control :
3) Guide to business policy
4) Determination of selling prices
5) planning
6) Budgeting
7) Choice among alternative
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COMPARISION OF COST ACCOUNTING &FINANCIAL ACCOUNTING

Financial Accounting Cost Accounting
Purpose Is to provide detailed cost
Is to prepare profit & loss Account & information to management
balance sheet for reporting
Statutory These accounts have to be prepared according Maintenance of these accounts is

requirements to the legal requirement of company Act &I/Tax voluntary except in certain
industries where it has been made
obligatory to keep cost records
under the company Act
Analysis of cost
& profit Reveal the profit or loss of the business as Show the detailed cost & profit
a whole for a particular period . it does not data for each product line
show the figures of cost & profit for individual department ,process etc.
products ,department & processes.
Periodicity of Financial reports are prepared periodically, Cost reporting is a continuous

reporting usually on as annual basis process & may be daily ,weekly,
Monthly etc
Control aspect Its lays emphasis on the recording of It provides for a detailed system
financial transaction action and does not of controls with the help of
attach any importance to control aspect. certain special techniques like
standard costing & budgetary
Control.
Historical & It is concerned almost exclusively with historical It is concerned not only with
predetermined records. historical costs but also with
cost predetermined cost .
Types of Only external transaction External & internal or inter-

Transaction departmental transaction
recorded
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COST AND MANAGEMENT
Is the presentation of accounting information in such a way as to assist management in the creation of policy & in
the day-to-day operation of an undertaking or provision of information for management activities such as decision
making, planning & controlling.
Management Accounting is consist of four essential tasks
1. Cost determination:- to compute the actual cost of production a product or component which may help in
control process & planning decision
2. Cost control: to see the reasonableness of the cost incurred in relation to the tasks performed & to consider
what cost should have been incurred & what corrective action should be taken.
3. Performance evaluation: to see whether assets are used efficiently
4. Supplying information for planning & decision making
COST ACCOUNTING & MANAGEMENT ACCOUNTING –COMPARION

A. SCOPE: cost accounting provides only cost information for managerial uses whereas management accounting
provides all types of accounting information
B. Emphasis: in cost accounting, the main emphasis is on cost ascertainment & Cost control. in management
accounting the main emphasis is on decision making
C. Techniques employed : the various techniques used by cost accounting are standard costing ,budgetary control
,marginal costing & CVP analysis ,uniform costing & interim –firm comparison etc management accounting
also uses these techniques but in addition it also uses techniques like ratio analysis ,fund flow statement
,statistical analysis , operational research.
D. Purpose : cost accounting is reporting of cost of product, services jobs processes ,department etc.
Management Accounting serves the purpose of providing all accounting information relevant for use in
formulation of policies, planning controlling, decision making.
E. Evolution : Cost accounting due to the limitation of Financial accounting where as Management
accounting is due to limitation of Cost accounting .
Management Accounting, Cost Accounting, And Financial Accounting
Accounting systems take economic events and transactions that have occurred and process the data in those
transactions into information that is helpful to managers and other users,
users, such as sales representative and
production supervisors. Processing and economic transaction entails collecting, categorizing, summarizing, and
analyzing. For example, costs are collected by cost categories (materials, labor, and overhead); summarized to
determine total costs by month, quarter , or year ; and analyzed to evaluate how costs have changed relative to
revenues , say, from one period to the next. Accounting systems provide information such as financial
statements (the income statement, balance sheets, and statement of cash flows) and performance reports (such
as the cost of operating a plant or providing services).
services). Managers use accounting (a) to administer each of the
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activity or functional areas for which they are responsible and (b) to coordinate those activities or functions
within the framework of the organization as a whole.
Individual managers often require the information in an accounting system to be presented or reported
differently. Consider, for example, sales order information. A sales manager may be interested in the total dollar
amount of sales to determine the commissions to be paid. A distribution manger may be interested in the sales
order quantities by geographic region and customer-requested delivery dates to ensure timely deliveries. . A
manufacturing manager may be interested in the quantities of various products and their desired delivery dates
to schedule production. An ideal database- sometimes called a data warehouse or info barn- consists of small,
detailed bits of information that can be used for multiple purposes. For example, the sales order database will
contain detailed information about products, quantity ordered, selling price, and delivering details (place and
date) for each sales order. The data warehouse stores information in a way that allows managers to access the
information that each needs.
Management accounting and financial accounting have different goals. Management accounting measures
and reports financial and non-financial information that helps mangers make decisions to fulfill the goals of an
organization.
organization. Managers use management accounting information to choose communicates, and implement
strategy. They also use management accounting information to coordinate product design, production, and
marketing decisions. Management accounting focuses on internal reporting.
reporting.
Financial accounting focuses on reporting to external parties.

parties. It measures and records business transactions
and provides financial statement that are based on generally accepted accounting principles (GAAP).
Managers are responsible for the financial statement issued to investors, government regulators, and other
parties outside the organization.
organization. Executive compensation is often directly affected by the numbers in these
financial statements. It is not difficult to see that mangers are interested in both management accounting and
financial accounting.
Cost accounting provides information for both management accounting and financial accounting.
accounting. Cost
accounting measure and reports financial and non financial information relating to the cost of acquiring or
utilizing resources in an organization.
organization. Cost accounting includes those parts of both management accounting and
financial accounting in which cost information is collected or analyzed.
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The internal reporting-external reporting distinction just mentioned is only one of several significant
differences between management accounting and financial accounting.
accounting. Other distinctions include
managements accounting and financial accounting emphasis on the future that's budgeting and management
accounting’s emphasis on influencing the behavior of managers and employees.
employees. Another distinction is that
management accounting is not nearly as restricted by GAAP as is financial accounting.
accounting. For example, mangers
may charge interest on owners’ capital to help judge a division’s performance even though such a charge is not
allowable under GAAP. Reports such as balance sheet, income statements, and statements of cash flows are
common to both management accounting and financial accounting. Most companies adhere to, or only mildly
depart from, GAAP for the basic internal financial statements. Why? Because accrual accounting provides a
uniform way to measure an organization's financial performance for internal and external purposes. However,
management accounting is more wide-ranging than financial accounting's emphasis on financial statements.
Management accounting embraces more extensively such topics as the development and implementation of
strategies and policies,
policies, budgeting, special studies and forecasts, influence on employee behavior,
behavior, and non-
financial as well as financial information.
CHAPTER TWO
COST CLASSIFICATION AND TERMINOLOGY
2.1 Cost Vs Expense & loss
Cost should be distinguished from Expense & loss, though in practice the terms cost & expense are often used
interchangeably.
Expense is defined as an expired cost resulting from a productive usage of an asset. Thus an expense se is that
portion of the revenue producing potential of an asset which has been consumed in the generation of revenue.
Loss: reduction in firm’s equity other than from with drawls of capital for which no compensation value has been
received.
2.2 Cost center & cost unit
Cost center: a location, person, or item of equipment for which costs may be ascertained & used for the purpose of
control. Thus refers to a section of the business to which cost can be charged.
Cost unit: a unit of product, service or time in relation to which cost may be ascertained or expressed.
Profit center: the segment of an organization for which both cost as well as profit are traced .
2.3 METHODS OF COSTING
A) Job order costing: applies where work is undertaken to customer’s special requirement. Cost unit in job
Order costing is taken to be a job or work order for which costs are separately collected & accumulated.
B) Contract costing or terminal costing: The variation of job order costing is contract costing is large & job
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order costing is small

C) Batch costing: The cost of a batch or group of identical products is ascertained & therefore each batch of
products is a cost unit for which costs are ascertained .
D) Process costing: is used in mass production industries manufacturing standardized products in continuous
processes of manufacturing. Cost is accumulated for each process or department.
E) Operation costing: a refinement & a more detailed application of process costing
F) Single, output & unit costing: used for uniform production & consist of a single or two or three verities
of the same product. where the product is produced in different grades, costs are ascertain in grade wise.
G) Service costing: This method should not confuse with operation costing .it is used for undertaking which
provides services instead of manufacturing product.
H) Multiple or composite costing; it is an application of more than one techniques (method) cost
ascertainments in respect of the same product. This method is used in industries where a number of
components are separately manufactured and the assembled into a final product.
2.4 TECHNIQUES OF COSTING

Used for Special purpose of control & policy in any business irrespective of method of costing being used there.
1) Standard costing: is predetermined cost as a target of performance & actual performance is measured
against the standard.
2) Budgetary control: a techniques applied to the control of total expenditure on materials, wages &
overhead by comparing actual performance with planned performance .
3) Marginal costing: Is the regards only variable costs as the cost of the product. Fixed cost is treated as
period cost & no attempt is made to allocate or apportion this cost to individual c o s t centers of
cost unit
4) Total Absorption costing: is the traditional method of costing whereby total cost ( variable & fixed )
are charged to products.
5) Uniform costing: it simply denotes a situation in which a number of firm adopt a uniform set of
costing principle.
Costing method & techniques are tools of a cost accountant & it should not be thought that a particular method
or techniques is superior to any other. Just as skilled workman uses different tools for different task ,
similarly cost accountant should use these methods & techniques appropriately y either individually
or in combination .
2.5 CLASSIFICATION OF COST

Classification of cost is the process of grouping cost according to their common characteristic.
1) Cost assignment point of view
Direct & indirect costing:
a. Direct costing is cost which are incurred for and conveniently identified with a particular cost unit
,process or department
b. Indirect costs are general costs and are incurred for the benefit of a number of cost units, processing &
department. Direct costs of a product can be conveniently determined while the indirect costs have to be
arbitrarily apportioned to various cost units.
2) Cost behaviors point of view
a. Fixed cost: these costs remain constant in total amount over a wide range of activities for
specific period of time. Do not increased or decreased when the volume of the production change
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but fixed cost per unit increased or decreased when the volume of production change.
Characteristics of fixed cost
 Fixed total amount within a relevant output range
 Increased or decrease department on some arbitrary basis
 Such cost mostly controlled by top level management.
 Apportioned to the department on some arbitrary basis
b. Variable cost: costs tend to vary in direct proportion to the volume outp ut .when volume of
output increase, total variable cost also increased and vice versa.
It show the following characteristics
 Variability’s of total the amount in direct proportion to the volume of output.

 Fixed amount in per unit in the face of change volume
 Easy and reasonable accurate allocation and apportionment to department
 Such cost can be controlled by functional manager
c. Semi-variable or semi fixed costs: The cost include both fixed and variable cost component .partly
fixed partly variable
Example : Supervision , Maintenance, repair ,compensation for accident
3 ) Committed & Discretionary costs
a. Committed costs are those that are incurred in maintaining physical facilities and managerial set up.
Such costs are committed in the sense that once the decision to incur them has been made they
are unavoidable and invariant in the short term .
b. Discretionary costs a r e those which can be avoided by management decisions such cost are not
permanent. like advertising , research & development cost salaries of low level management
4) Generally accepted accounting treatment point of view

a. Production costs and period cost: production costs are those costs which are necessary for
production & which will not be incurred if there is no production whereas period costs are those costs
which are not necessary for production and are written off as expense in the period in which these are
incurred . such costs are incurred for a time period & are charged to profit & loss account of the
period
b. Product cost for unsold goods it is recorded as an asset in the form of inventory in the balance
sheet whereas for sold goods of product cost & period cost recorded as an expense in the profit & loss
account of the current period.
4) Controllable & non-controllable cost
a. Controllable costs: these are those costs which may be directly regulated at a given level of
management authority. Variable cost general controllable by department
b. Non-controllable costs: These are those cost which cannot be influenced by the action of a
specified member of an enterprise. Both are cannot be distinguished from each other without
specifying the level & scope of management authority.
5) Historical & pre –determined costs
a. Historical costs are those cost which are ascertained after these have been incurred. It is actual cost, it
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is available after the completion of the manufacturing operation.

b. Pre-determined costs are future cost which are ascertained in advance of production on the basis of a
specification of all the factors affecting cost
6) Normal & abnormal cost
a. Normal cost may be defined as a cost which is normally incurred on expected line at a given level of
out put .
b. Abnormally cost is that which is not normally incurred at a given level of output ,
ELEMENT OF COST
1. Material cost
2. labor cost
3. Factory over head (FOH) cost
1. MATERIAL COST: The cost of commodities supplied to an undertaking
1.1 Direct material: Conveniently identified with and allocated to costs units. It is a part of finished goods .Example Clay
in bricks, Leather in shoe, steel in machine, cloth in garment, timber in furniture.
1.2 Indirect material: These are those materials which cannot be conveniently identified with individual cost unit
.Example Lubricating oil, sand paper, Nuts and bolts, coal, and small tools
2. LABOUR COST: cost of remuneration of the employees of an undertaking
2.1 Direct labour : wage paid to workers directly engaged in converting raw material into finished goods. This cost can be
conveniently identified with a particular product, job or process.
Example Machine operator, Shoe-worker, carpenter , weaver ,Tailor
2.2 Indirect labour, cannot be conveniently identified with a particular product, job or process, or not directly
engaged in the production operations but only to assist or help in production operation
Example Supervisor inspector, cleaner, clerk, peon watchman etc
3. Factory overhead cost: All manufacturing costs that are related to the cost object but that cannot be traced to that cost
object in an economically feasible way.
Example Electric power, supplies, indirect material indirect labor
3.1 productions overhead: Those overheads which are concerned with the production function. It include indirect material
and indirect Labour
3.2 office and administration overhead: Indirect expenditure incurred in general administrative function. Such overheads
are no direct connection with the production of sales of activities.
3.3 Selling and distribution overhead: selling overhead is the cost of promoting sales and retaining customers. Example
advertising
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Distribution overhead: All expenditure incurred from the time the product is completed until it reaches its destination
Example carriage outwards, insurance of goods in transit ---
Component of total cost:
 Prime cost = Direct material + direct labor

 Factory cost/work cost / =Prime cost + Factory overhead cost
 Cost of production =Work cost+ Administration cost
 Total cost or cost of sales=Cost of production +selling and distribution overhead
MANUFACTURING COSTS
Manufacturing –sector companies purchase materials and components and convert them in to different finished goods.
They typically have one or more of the following three types of inventories:
1. Direct material inventory-direct materials and in stock and awaiting use in the manufacturing process.
2. Work-in-process inventory-Goods partially worked on but not yet fully completed. They are also called Work-in-
progress.
3. Finished goods inventory- Goods fully completed but not yet sold.
Merchandising-sector companies purchases and then sell tangible products without changing their basic form.
They hold only one type of inventory, which are the products in their original purchased form. Service-sector companies
provide only services or intangible products to their customers and hence do not hold inventories of tangible products for
sale
In manufacturing company production costs are grouped in to three categories these are direct material, direct labor and
manufacturing overhead cost. See the diagram below.
Prime costs and Conversion costs-These two terms are used in manufacturing companies. Prime costs are all direct
manufacturing costs i.e. the combination of direct material and direct manufacturing labor costs. Conversion costs are all
manufacturing costs other than direct material costs. It is the combination of manufacturing labor costs and manufacturing
overhead costs. These costs are incurred to transform direct materials into finished goods.
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Total cost
Material cost LABOUR COST EXPENSE
DM IDM DL IDL Direct Indirect
Prime cost
Factory overhead
Production Administration Selling & distribution

overhead overhead overhead
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CHAPTER THREE:
JOB ORDER COSTING SYSTEM
2.1 JOB ORDER COSTING AND PROCESS COSTING
Companies frequently adopt one of the two costing systems to assign costs to products or services. These are:
1. Job order costing system: is a type of cost system that provides for a separate record of the cost of each
particular quantity of product that passes through the factory. Job order costing system is commonly used by
companies with products that are unique and divisible. In this system, costs are assigned to distinct unit, batch or
lot of product or service. Job is a task for which resources are expended in bringing a distinct product or service to
market
 No two orders are the same.
 Costs are allocated & accumulated for each job, work order separately.
 Each job will be specifically identified with a job number.
 Different jobs can vary considerably in terms of material ,labor ,& overhead cost
Examples of business that use job order costing includes
 Construction companies
 Furniture manufacturers
 Printing firms
 Repair shops
 Service giving organization
 Garages etc.
Advantages of Job order costing system
 The cost of material, labor & overhead for every job is readily available, and management is able
to control the efficiency of operations.
 It is simple as the recording of DM,DL,FOH for each job
 Spoilage & defective works can be easily identify with specific jobs so responsibility can be
fixed
 It provides basis for comparing one job cost to another or though period.
Disadvantages of Job costing System
 Very expensive as more clerical work is involved in identify each element of cost with
specific job
 With increase in clerical processes, chance of errors is enhanced.
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 In case of inflation comparison of cost of a job for one period or with that another become
meaningless.
Characteristics of Job costing system
The major objective of job order costing is to find out the profit or loss on each job. Feature of this method of
costing are given below
 The distinction b/n direct & indirect costs is more important on job order costing than in case of
process costing
 Orders are issued, and costs are kept for each lot of product manufactured.
 Direct costs are charged to the work in process account & are entered job sheet
 This method is used for estimating the amount of applied indirect cost also known as applied
manufacturing expense in respect of each job.
 This method is relatively more labor intensive.
2. Process costing system: is used for manufacturing processing which produce a single product or single mix of
products continuously for an extended period of time. In this system, the cost of a product or service is obtained
by using broad averages to assign costs to mass of similar units produced for general sale and not for any specific
customers.
Companies that use process costing system are: Megazine
 Cement factories
 Petroleum refineries
 Flour companies
 Beer factories
 Textile factories
 Beverage companies
Difference between job order costing and process costing system
Base of comparison Job order costing Process costing
Type of product Diversified heterogeneous and unique Homogeneous products produced

products continuously
Cost accumulation By job for a specified number of unit By department or cost center for a specified
period of time
Cost per unit Cost accumulated by job, divided by unit Cost accumulated by cost centers divided by
job equivalent unit of production during a
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period of time
Reporting By job By cost center or department
Most companies have costing system that are neither pure job costing nor pure process costing rather they combine
elements of both job costing and process costing. This is called hybrid costing system
2.3 SOURCE OF DOCUMENTS FOR JOB ORDER COSTING
Source documents are the original record that supports journal entries in accounting system. The key source document in
job order costing system is job cost sheet (job cost record) this document records and accumulates all the cost (direct
material, direct labor and MOH cost) assigned to a specific job. Source documents also exist for individual items in a job
Material requisition record: is used to record material used on a specific job
Material requisition record
Record No.--------------- date --------------
Job No.-------------------
Number description quantity Unit cost Total cost
1 XX1 100 $4 $400
2 ZZ4 20 $10 200
3 YY5 70 $5 350
2.4 ACCOUNTING PROCEDURES FOR JOB ORDER COSTING

Job order costing system requires a subsidiary ledger for each job order and general ledger (controlling account) for the
total amount. Entries in subsidiary ledger will be made frequently and summarized in control account in weekly or
monthly interval.
Major accounting procedures in job order costing system
 Receiving job order and purchase of raw materials

 Transferring raw material to work in process
 Recording labor to work in process
 Recording actual manufacturing over head cost incurred
 Allocating manufacturing over head cost work in process
 Transferring work in process to finished good
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 Transferring finished goods to customers.

Manufacturing over head cost is incurred for the benefit of all jobs produced during a period and cannot be related to any
particular job. As manufacturing over head costs are incurred, they are accumulated as manufacturing overhead control
account. Some manufacturing costs such as utility will not be known until the end of the period. Hence, rather than
holding a finished goods job until all costs can be attributed to it, it is necessary to develop a method of allocating
manufacturing over head cost to the job completed. This is called normal costing. In normal costing direct material and
direct labor costs are directly traced to the job completed but MOH cost is allocated to it using budgeted rate and actual
allocation base.
To determine budgeted rate:
 Estimate manufacturing overhead cost for the year.

 Choose allocation base such as labor hour, direct labor cost or machine hour.
 Estimate the allocation base for the year
 Calculate the budgeted rate using the formula
Manufacturing-Overhead costs-It is relatively simple to trace direct-material and direct labor costs to production jobs,
but manufacturing overhead is not easily traced to jobs. By definition, manufacturing overhead is a heterogeneous pool of
indirect production costs, which bears no obvious relationship to individual jobs or units of products, but must be incurred
for production to take place. Therefore, it is necessary to assign manufacturing-overhead costs to jobs in order to have a
complete picture of product costs. This process of assigning manufacturing overhead costs to production jobs is called
overhead application /or overhead allocation / or sometimes overhead absorption.
Exhibit 2-1: Summary of overhead concepts
Estimated overhead cost: The amount of overhead cost that management estimate to be incurred. This estimate is made
before the period or at the beginning of the period in order to compute predetermined overhead rate.
Actual overhead cost: The amount of overhead cost that is actual incurred during a period (as shown by payment for
utilities, rents, and so on.)
Applied overhead: The amount of overhead cost represents that is added (applied)to work in process. This amount is
over applied computed by applying actual activity during the period by the predetermined overhead rate. The deference
b/n the amount over or under applied.
Actual costing- Allocate direct material and direct labor costs to cost objects on the bases of actual direct-cost rate(s) and
actual quantity of direct-cost input(s). Overhead costs are allocated to cost object on the basis of actual overhead rate
computed at the end of the period and actual amount of cost deriver used
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Normal costing- allocate direct material and direct labor cost on the bases of actual direct cost rate(s) and actual quantity
of direct-cost input(s). Overhead costs are allocated to cost object on the basis of predetermined /budgeted/ overhead rate
computed at the beginning of the period and actual quantity of cost-allocation base(s).The summary is given as follows.
Actual costing Normal costing
Direct costs - Actual direct-cost rate(s) × - Actual direct-cost rate(s) ×
Actual quantity of direct-cost Actual quantity of direct-cost
Input(s) input(s)
Indirect costs -Actual indirect-cost rate(s) × - Budgeted indirect-cost rate(s) ×
Actual quantity of cost-allocation Actual quantity of cost-allocation
base(s). base(s)
Allocation of overhead costs- for product costing to be useful, information must be provided to managers on a timely
basis. Suppose the cost-accounting department waited until the end of an accounting period so that the actual costs of
manufacturing overhead could be determined before applying overhead costs to the firm’s products. The result would be
very accurate overhead application and decision based in such information could be better i.e. better pricing and control
decisions may result from more accurate product costs. However, the information might be useless because it was not
available to managers for planning, control, and decision making at the appropriate time. Do to this fact many
opportunities may be missed and late responses may be given to events. Thus, managers and management accountants
must weigh the costs and benefits of this information.
It might be tempting to solve the overhead rate problem by using an actual rate and recomputed the rate frequently to
provide more timely information. This is generally because of the numerator and denominator factors such as the
following.
Numerator factors (indirect cost pools)
The shorter the period, the greater the influence of seasonal patterns e.g. Cost of heating is higher in the winter than it is
in the summer. Cost of ventilator is higher in the summer than in winter. Non seasonal erratic costs such as cost incurred
in a particular month that benefit operation during future month’s e.g. Repair and maintenance of equipment, vacation
and holiday pay.
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The denominator reason (quantity of the allocation base)
Some indirect costs such as costs of supplies may be variable with respect to the cost- allocation base, whereas other
indirect costs are fixed (for example, property taxes and rent) Thus, it is possible to smooth out fluctuation in the overhead
rate and the numerator and denominator related variations by computing the rate over a long time such as one year period
and so.
Actual overhead rate Predetermined overhead rate
- More accurate, but - Less accurate, but more
untimely information timely information
Each entails costs and benefits
that must be considered
Predetermined overhead rate-As most management accountants recommend, and as most organizations do, apply
overhead to products on the basis of estimates made at the beginning of the accounting period. The accounting department
chooses some measure of productive activity to use as the basis for overhead application. In the case of traditional
approaches, this could be volume based cost drive (or activity base) such direct labor hours, direct-labor cost, machine
hours, number of miles traveled and the like
As estimate is made of (1) the amount of manufacturing overhead costs that will be incurred during a specified period of
time and (2) the amount of the cost driver that will be used or incurred during the same time period, then a
predetermined overhead rate is computed as follows:
Predetermined = Budgeted total manufacturing overhead cost for the period
Overhead rate Budgeted total amount of cost driver (activity base)
For example, suppose that R-printing co. has chosen machine hours as its cost driver (activity- base), and estimated that
its total overhead cost to work on two distinct jobs, job-1,and job-2 for the next year will amount to $90,000 and that the
total machine hours required for the two jobs will be 10,000 hours. Then, its predetermined overhead rate is computed as
follows:
Predetermined overhead rate = $90,000 = $9.00 per machine hours.
10,000 hours
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Applying overhead costs- The predetermined overhead rate is used to apply manufacturing overhead costs to production
jobs/ normal costing/. The actual quantity of the cost driver (or activity base) required by a particular job is multiplied by
the predetermined overhead rate to determine the amount of overhead cost applied to the job. For example, suppose that
R-printing co. job number one (Job-1), consists of 1,000 brochures that requires a total of three machine hours. The
overhead applied to the job is computed as follows:
Predetermined overhead rate---------------------------------$9
Machine hours required by job-1------------------- --------×3
Overhead applied to job-1-----------------------------------$27
The $27 of applied overhead will be added to Work-in-Process Inventory and recorded on the job-cost sheet for job-1.
The accounting entry made to add manufacturing overhead to Work-in-Process Inventory may be made daily, weekly,
monthly and so, depending on the time required to process production jobs. Before the end of the accounting period,
entries should be made to record all manufacturing costs incurred to date in Work-in-Process Inventory. This is necessary
to properly value work in process on the balance sheet.
Work-in-process control-is the account used to record direct material and direct labor cost used / put/ in to production.
As direct materials are used, they are charged to individual job records, which are subsidiary ledger accounts for the
Work-in Process control account in the general ledger account. Its balance increases when indirect costs are applied to
production.
Manufacturing overhead control- is the account used to record the actual costs incurred during the period in all the
individual overhead categories such as indirect material, indirect labor, and other indirect costs. It has a normal debit
balance i.e. it increases when actual indirect costs are incurred and decreases when indirect costs are applied to production
process on the basis of the predetermined overhead rate.
Manufacturing overhead applied-is the account used to record the manufacturing overhead allocated during the period
to individual jobs on the bases of the budgeted rate multiplied by actual amount /number/unit/ allocation base such as
direct manufacturing labor-hours. It is a contra-account to manufacturing overhead account.
Disposing of factory overhead balances-If the actual overhead had been less than or more than the applied overhead,
then, there will be overhead balances that should be disposed as of the end of the accounting period.
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If actual overhead is less than applied overhead, the difference would have been called over applied overhead or over
allocated overhead.
If the actual overhead is more than applied overhead, then, the difference is called under applied
2.5 ACCOUNTING PROCEDURES FOR JOB ORDER COSTING

In any ways, companies have three alternatives to dispose the overhead balances at the end of the period. These are:
(1) Adjusted allocation rate approach- this approach restate all entries in the general and subsidiary
ledgers by using actual cost rates than budgeted cost rates. First the indirect cost rate is computed at
the end of the year. Then, every job to which indirect costs were allocated during the year has its
amounts recomputed using the actual indirect-cost rate rather than the budgeted indirect cost rate.
This will give the best accuracy, and decisions based on accurate information could be sound and
more important. But unless computer system is applied, it will be complicated and costly.
(2) Write-off to cost of Goods sold Approach-as in the case of most companies, the over or under
applied overhead costs may be closed into cost of goods sold.
a) For under applied overhead balance, by debiting Cost of Goods sold accounts and crediting
Manufacturing overhead account by the amount of the difference or by debiting cost of goods sold by
the amount of the difference and debiting Manufacturing overhead applied account by its balance and
crediting Manufacturing overhead control account by the total amount of its balance i.e.
Cost of goods sold----------------------------------x
Manufacturing overhead applied-----------------xx
Manufacturing overhead control--------------xxx
b)For over applied overhead balance, by crediting Cost of Goods sold account and debiting to
manufacturing overhead applied account by the amount of the difference or by crediting cost goods sold
by the amount of the difference, crediting manufacturing overhead control account by its balance and
debit manufacturing overhead applied account by its balance.
i.e. Manufacturing over head applied-------------------------xxx
Cost of goods sold------------------------------------------------x
Manufacturing overhead control-------------------------------xx
19
(3) Proration Approach-is the distribution of overhead balances among ending work in process,
finished goods, and cost of goods sold accounts. Materials inventories are not allocated any
manufacturing overhead costs, so they are not included in this spreading of under-or over allocated
overhead among proration. To this effect, companies may use the amount of the current period’s
applied overhead remaining in each account as the base for the proration procedure.
Suppose that AB-Manufacturing company produces two products X and Y. Assume that the total actual overhead costs
incurred by the company and the total overhead costs applied by the company during the year 2002 were $18,600 and
$18,000 respectively. The current period before adjustment overhead balance allocated to Work-in-Process, Finished
Goods Inventory and Cost of Goods sold accounts are $9,000,$3,000 and $6,000 respectively.
The under applied overhead balance = $18,600- $18,000 = $600
The company can prostate the balance of $600 among the three accounts as follows.
Total year end overhead balances of the three accounts (before adjustment) = $9,000 + $3,000 + $6,000 = $18,000
Thus, the amount allocated to each account should be:
Work-in process = $9,000 × $600 = $300
$18,000
Finished goods inventory = $3,000 × $600 = $100
$18,000
Cost of goods sold = $6,000 × $600 = $200
$18,000
The entry for this case should be:
Work-in process inventory--------------------300
Finished goods inventory-----------------100
Cost of goods sold-------------------------200
Manufacturing overhead control--------------600
This approach gives us a more accurate figure of work in process, finished goods, and cost of goods sold, but it is still not
as simple as write off to cost of goods sold methods.
20
NB-In all of the above cases /approaches/, the balances of manufacturing Overhead control and Manufacturing Overhead
applied accounts should be reduced to zero after the factory overhead balances are removed through adjustment and
ready to accumulate the overhead costs of the next accounting period.
 In choosing among the three approaches, managers should be guided by how the resulting information will be used.
-If managers desire to develop the most accurate records of individual job costs for profitability analysis purposes, the
adjustment allocation-rate approach is preferred.
- If the purpose is confined to reporting the most accurate inventory and cost of goods sold figures, proration approach on
the manufacturing overhead-allocated component in the ending balances should be used.
-If the amount of under or over allocated balances is small-in comparison to total operating income, or some other
measure of materiality, the write off to cost of goods sold method(the simples method) could be used. This approach can
be reliable in today’s business environment where the concept of JIT is applicable.
To illustrate the procedures used in job-order costing, we will examine the accounting entries made by Alpha-
manufacturing co. during November 2003. The company uses machine hours to allocate overhead costs to the individual
jobs. It has worked on two production jobs during the month.
Job-1: 80 deluxe wooden canoes
Job-2: 80 deluxe aluminum fishing boats
The company undertaken the following activities/transaction during the month of November
Transaction-1: Acquisition of direct materials
4000-square feet of rolled aluminum sheet metal were purchased on account for $10,000. The purchase is recorded with
the following journal entry.
Raw-material Inventory----------------------10,000
Accounts payable------------------------------10,000
Transaction-2: Use of direct material
On November -1, the following material requisitions were filed.
Requisition number-001 (for job-1) ---------8,000 board feet of lumber, at $2 per

board foot, for a total of $16,000
21
Requisition number-002 (for job-2) ---------7,200 square feet of aluminum sheet metal,
at $2.50 per square foot, for a total of $18,000
The following journal entry records the release of these raw materials to production.
Work-in-process Job 1---------------Dr 16,000
WIP job 2--------------------------- Dr 18,000
Raw-material inventory-------------------Cr 34,000
Transaction-3: Use of indirect material
On November 15, the following material requisition was filed.
Requisition-003: 5-gallons of bonding glue, at $10 per gallon, for a total cost of $50
Manufacturing overhead control------------------Dr 50
Manufacturing supplies inventory------------------Cr 50
Since only small amounts of bonding glue are used in the production of all classes of boats manufactured by the company,
the costs incurred is small, and no attempt is made to trace the cost of glue to specific jobs. Instead, glue is considered an
indirect material, and its cost is included in manufacturing overhead. The company accumulates all manufacturing-
overhead cost in Manufacturing Overhead account. All actual overhead cost are recorded by debiting the account when
indirect materials are requisitioned, when indirect-labor costs are incurred , when utility bills are paid, when depreciation
is recorded on manufacturing equipment, and so on.
Transaction-4:Use of direct labor
At the end of November, the cost-accounting department used the labor time tickets filed during the month to determine
the following direct-labor costs of each job.
Direct labor: Job-1----------------$9,000
Direct labor: Job-2--------------12,000
Total direct labor------------------$21,000
The journal entry used to record these costs should be
Work-in-process Inventory Job 1---------------Dr 9,000
WIP inventory Job 2--------------------------- Dr 12,000
Wages payable-------------------------------- Cr 21,000
Transaction-5: Use of indirect labor
22
The analysis of large time card undertaken on November-30 also revealed the following use of indirect labor that is not
charged to either of the products specifically, amounts to $14,000.
This cost is comprised of the production supervisor’s salary and the wages of various employees who spent some of their
time on maintenance, general cleanup duties and salary of guards and store keepers during November.
Manufacturing overhead Control --------------------Dr 14,000
Wages Payable------------------------------------ Cr 14,000
No entry is made on any job cost sheet, since indirect-labor costs are not traceable to any particular job. In practice,
journal entries (4) and (5) are usually combined into one compound entry as follows:
Work in process inventory------------------21,000
Manufacturing overhead---------------------14,000
Wages payable------------------------------------35,000
Transaction-6:Other manufacturing over head costs
During November, the company incurred the following other manufacturing overhead cost besides the indirect materials
and indirect labors costs.
Rent on factory building (expired prepaid rent) ------------$3,000
Depreciation on equipment-------------------------------------5,000
Utilities (electricity, water, telephone) -----------------------4,000
Property taxes-----------------------------------------------------2,000
Insurance (amount expire during the month) -----------------1,000
Total --------------------------------------------------------------$15,000
The following compound entry is made on November-30, to record these costs.
Manufacturing overhead control ------------------------15,000
Prepaid Rent----------------------------------------------3,000
Accumulated depreciation-Equipment---------------- 5,000
Accounts Payable (utilities and property tax) --------6,000
Prepaid Insurance-----------------------------------------1,000
2.6 APPLICATION OF MANUFACTURING OVERHEAD

23
Various manufacturing-overhead costs were incurred during November, and these costs were accumulated by debiting the
Manufacturing-Overhead accounts. However, no manufacturing-overhead cost have yet been added to Work- in-Process
Inventory or recorded on the job-cost sheets. The application of overhead to the firm’s products is based on a
predetermined overhead rate. This rate computed by the accounting department at the beginning of the period. (Refer to
page-14 to 15)
Transaction-7:Allocation of overhead costs
Factory machine-usage records indicate the following usage of machine hours during November.
Machine hour used: Job-1 -----------------------------1, 200 hours
Machine hour used: Job-2-------------------------------2,000 hours
Total machine hours-----------------------------------3,200 hours
The total manufacturing overhead applied to Work-in-Process Inventory during November is calculated as follows
(refer page 5 for predetermined rate)
Machine hour x Predetermined Manufacturing
Overhead rate overhead applied
Job-1 1,200 × $9.00 = $10,800
Job-2 2,000 × $9.00 = $18,000
Total manufacturing overhead applied $28,800
The following journal entry is made to apply manufacturing overhead to Work-in-Process Inventory.
Work-in-Process Inventory ----------------------28,800
Manufacturing overhead applied---------------------------------28,800
NB. As the following time line shows, three concepts are used in accounting for overhead. Overhead is budgeted at the
beginning of the accounting period, it is applied during the period, and actual overhead is measured at the end of the
period.
Beginning of End of
Accounting period accounting period
24
TIME
Budgeted overhead
(and calculation of Applied Actual
Predetermined overhead overhead
Overhead rate)
Transaction-8: Selling and administrative costs
During November, Alpha-manufacturing co. incurred the following selling and administrative costs.
Rental of sales and administrative offices--------------------------$1,500
Salaries of sales personnel---------------------------------------------4,500
Salaries of management------------------------------------------------8,000
Advertising---------------------------------------------------------------1,000
Office supplies used------------------------------------------------------ 300
Total---------------------------------------------------------------------$14,800
Since these are not manufacturing costs, they are not added to Work-in-Process Inventory. Selling and administrative
costs are period costs, not product costs. They are treated as expenses of the accounting period. The following journal
entry is made
Selling and Administrative Expenses---------------------14,800
Wages Payable---------------------------------------------------12,000
Accounts payable-------------------------------------------------1,000
Prepaid Rent-------------------------------------------------------1,500
Office Supplies inventory------------------------------------------300
Transaction-9: Completion of production job
Job-2 was completed during November, whereas job-1 remained in process. The job sheet indicates that the total cost of
job-2 was $48,000. The following journal entry records the transfer of these job costs from Work-in-Process Inventory to
finished goods inventory.
25
Finished goods inventory--------------------48,000
Work-in- Process inventory-------------------48,000
Transaction-10: Sales of goods
Sixty deluxe aluminum fishing boats manufactured in job-2 were sold for $900 each during November. The cost of each
unit sold was $600 as shown on the job cost sheet. The following journal entries were made
a) Accounts Receivable------------------54,000
Sales Revenue-----------------------------54,000
b) Cost of goods sold-----------------------36,000
Finished goods inventory-----------------36,000
The reminder of the manufacturing cost of job-2 remains in Finished –goods inventory until some subsequent accounting
period when the units are sold. Therefore the cost balance for job-2 remaining in inventory is $12,000 (20 units remaining
times $600 per unit.)
Transaction-11: Disposition of overhead balances
During November, Alpha-Manufacturing co. incurred total actual manufacturing-overhead costs of $29,050, but only
$28,800 of overhead was applied to Work-in-Process Inventory. The amount by which the company’s actual overhead
exceeds applied overhead, called under applied overhead, and is calculated below.
Actual manufacturing overhead*----------------------------------$29,050
Applied manufacturing overhead+-------------------------------- 28,800
Under applied overhead---------------------------------------------$ 250
The company disposes its overhead balances at the end of the year by directly writing the amount to cost of goods sold
during the period. Accordingly, the following journal entry is made by the company. This entry reduces the balance of
Manufacturing Overhead accounts to zero and increase the balance of cost of goods sold account by $250.
Cost of goods sold------------------------------250
Manufacturing Overhead control--------------250
26
Schedule of cost of goods sold
Schedule of cost of goods sold for Alpha-manufacturing Company is displayed in exhibit 3-9 .This schedule shows the
November cost of goods sold and detailed the changes in Finished-Goods Inventory during the month.
Exhibit 3-9: Schedule of cost of goods manufactured
Alpha-Manufacturing company
Schedule of cost of Goods Manufactured
For the month of November, 2003
Direct material:
Raw-material inventory, November-1-----------------------$30,000
Add: November purchase of raw material-------------------10,000
Raw material available for use-------------------------------$40,000
Deduct: Raw-material inventory, November-30--------------6000
Raw material used--------------------------------------------------------------$34,000
Direct labor---------------------------------------------------------------------------------21,000
Manufacturing overhead:
Indirect material---------------------------------------------- $50
Indirect labor----------------------------------------------------14,000
Rent on factory building--------------------------------------- 3,000
Depreciation on equipment-------------------------------------5,000
Utilities------------------------------------------------------------4,000
Property taxes----------------------------------------------------2,000
Insurance----------------------------------------------------------1,000
Total actual manufacturing overhead--------------------$29,050
Deduct: Under applied overhead------------------------- 250 *
Overhead applied to work in process-------------------------------------------- 28,800
27
Total manufacturing costs-------------------------------------------------------- $83,800
Add: Work in process inventory, November-1-------------------------------- 4,000
Subtotal-------------------------------------------------------------------------------$87,800
Deduct: Work in process, November-30, -------------------------------------- 39,800
Cost of goods manufactured---------------------------------------------------- $48,000
The schedule of cost of goods manufactured lists the manufacturing costs applied to Work in Process. Therefore, the
under applied overhead of $250 must be deducted from total actual overhead to arrive at the amount of overhead applied
to work in process during November. If there had been over applied overhead, the balance would have been added to total
actual manufacturing overhead.
Exhibit 3-10: Schedule of cost of goods sold
Schedule of cost of goods sold
For the Month of November, 2003
Finished goods inventory, November-1------------------------------------$12,000
Add: Cost of goods manufactured*-------------------------------------------48,000
Cost of goods available for sale--------------------------------------------- $60,000
Deduct: Finished-goods inventory, November-30------------------------ 24,000
Cost of goods sold (before adjustment) ------------------------------------$36,000
Add: Under applied overhead +--------------------------------------------- 250
Cost of goods sold (adjusted for under applied overhead) ------------- $36,250
* The cost of goods manufactured is obtained from the schedule of cost goods manufactured in exhibit 3-9.
+ The company closes overhead balances to cost of goods sold account. Hence the $250 balance in under applied
overhead is added to cost of goods sold for the month.
Exhibit 3-11: Income statements
28
Income statement
For the Month of November, 2003
Sales revenue----------------------------------------------------------------------$54,000
Less: Cost of goods sold*------------------------------------------------------- 36,250
Gross margin----------------------------------------------------------------------$17,750
Selling and administrative expenses---------------------------------------------14,800
Income before taxes---------------------------------------------------------------$ 2,950
Income tax expenses------------------------------------------------------------ 1,420
Net Income----------------------------------------------------------------------- $1,530
*The cost of goods sold is obtained from the schedule of cost of goods sold
in exhibit 3-10.
2.7 POSTING JOURNAL ENTRIES TO THE LEDGER

All of the journal entries in the Alpha-Manufacturing illustration are posted to the ledger in exhibit 3-12 as follows. An
examination of these T-accounts provides a summary of the cost flows discussed throughout the illustration
Exhibit 3-12: Ledger accounts for Alpha-Manufacturing Company’s illustration.
Accounts Receivable Raw material Inventory Wages Payable
10,000 Bal.
Bal. 11,000 Bal. 30,000 34,000 (2) 21,000 (4)
(10a) 54,000 (1) 10,000 14,000 (5)
12,000 (8)
Prepaid Insurance Work-in-Process Inventory Office Supplies inventory
Bal. 4,000 48,000 (9) Bal. 900 300 (8)
Bal. 2,000 1,000 (6) (2) 34,000
(4) 21,000
(7) 28,800
29
Prepaid Rent Accumulated Depreciation-equipment
Finished Goods inventory
Bal. 5,000 Bal. 12,000 36,000 (10b) 105,000 Bal.
3,000 (6) (9) 48,000 5,000 (6)
1,500 (8)
Accounts payable Manufacturing Overhead
Manufacturing supplies 3,000 Bal. (3) 50 28,000 (7)
Inventory 6,000 (6) (5) 14,000
10,000 (1) (6) 15,000
Bal. 750 50 (3) 1000 (8)
250 (11)
Selling and administrative
Cost of Goods sold Expenses Sales Revenues
(10b) 36,000 54,000 (10a)
(11) 250 (8) 14,800
* The number in parentheses relates T-account entries to the associated journal entries. The given balances are the
November-1 account balances.
2.6 FINANCIAL STSTEMENT FOR MANUFACTURING COMPANY

In order to prepare financial statement for manufacturing company, the following schedules are necessary
Schedule 1 Direct Material cost used
Direct Material beginning XX
Direct material purchase XX
30
Direct material available for use XX
Direct material ending (XX)
Direct material cost used XX
Schedule 2 Cost of goods manufacture
Direct material cost used XX
Direct labor cost XX
Manufacturing overhead cost XX
Cost incurred in current period XX
Work in process beginning XX
Total cost incurred to date XX
Work in process ending (XX)
Cost of goods manufactured XX
Schedule 3 Cost of good sold
Finished goods inventory XX
Cost of goods manufactured XX
Cost of goods available for sale XX
Finished goods ending (XX)
Cost of goods sold XX
Schedule 4 Income statement for manufacturing company
Revenue XX
Cost of goods sold XX
Gross profit XX
Operating expense (XX)
Operating income
Example 1: consider the following account balance for ABC manufacturing company in the year 2004
Beginning balance End balance
Direct material inventory-----------22,000 -----------------------------------------26,000
31
WIP inventory------------------------21,000 -----------------------------------------20,000
Finished goods inventory-----------18,000------------------------------------------23,000
Purchase of direct material-------------------------------------------------- --------75,000
Direct labor cost -------------------------------------------------------------------- 25,000
Indirect labor cost1----------------------------------------------------------------------5,000
Plant insurance --------------------------------------------------------------------------9,000
Depreciation plant building and equipment -----------------------------------------11,000
Repair and maintenance ---------------------------------------------------------------- 4,000
Marketing, distribution and customer service cost ---------------------------------93,000
General and administrative cost -------------------------------------------------------29,000
Required:
a) Calculate cost of direct material used

b) Calculate cost of goods manufactured
c) Calculate cost of goods sold
d) If revenue for the year is $ 300,000, prepare income statement for the company.
Example 2: a fire destroyed XYZ manufacturing company completely on January 29,2004. Fortunately certain accounting
records were kept in another building. It revealed the following for the period from January 1, 2004 to January 29, 2004.
Direct material purchased -----------------------------160,000
WIP January1-------------------------------------------34,000
Direct material January1, 2004 ------------------------16,000
Finished goods January 1, 2004------------------------30,000
MOH cost -----------------------------------------------40%of conversion cost
Revenue --------------------------------------------------500,000
Direct labor cost-------------------------------------------180,000
Prime cost -------------------------------------------------294,000
Gross profit based on sales--------------------------------20%
32
Cost of goods available-------------------------------------450,000
Requirement:
a) Direct material destroyed

b) Cost of goods manufacturing
c) Finished goods destroyed
d) WIP destroyed
CHAPTER FOUR
Process costing
The objectives of either job order or process costing is to match costs of a period with units produced in
the same period. The types of manufacturing operations performed determines the cost procedures
that must be used .for job order costing sheet used cost sheet for accumulates M,L,FOH cost . In
contrast, the chemical company cannot identify material, Labor & FOH with each order, which is part of
a batch or a continuous process. The individual order identify is lost, and the cost of a completed unit
must be computed by dividing the total cost incurred during a period by total units completed.
Process costing is used when products are manufactured under conditions of continuous processing or
under mass production methods .this conditions is exist in industries that produced such commodities as
plastic, petroleum, textile, steel flour & sugar.
The characteristics of process costing

1) Costs are charged to the departmental WIP account
2) A cost of production report is used to collect, summarized and computed total and unit costs. Unit’s
costs are determined by dividing the total cost charged to a department by the total production of
the department for a specific period.
3) Production in process at end of a period is restated interns of equivalent units.
4) Costs of completed unit of a department are transferred to the next processing department in order
to arrive eventually at the total cost of the finished products during a period ,and cost are assigned
to units still in process.
Product flow
A) Parallel product flow. certain portions of work are done simultaneously and then brought together
in a final process or processes for completion and transfer to finished goods
WIP Cutting Dep’t → WIP planing & sending dep}

WIP Asembly dep’t → WIP painting Dep”t → FG
WIP Melting dep’t → WIP casting Departmet }
Under the first dep’t of each parallel the cost incurred is material ,Labor & factor overhead ,the 2 nd
parallel department added on labor & FOH but on the 3 rd department(Assembly dep’t )& painting
department all cost material ,Labor & factor overhead
33
B) Sequential product flow.

Ina sequential flow each product is processed in the same series of steps.
The processing of materials begins in the blending Department ,and labor & factory overhead costs are
added When the work is finished in this Department, it moves to the testing department .Any
succeeding processes may add more material or simply work on the partially completed input from the
preceding process, adding only labor and FOH
C) Selective product flow

The product moves to different department within the plant ,depending upon the desired final
product
} WIP packing dep’t
The importance of process costing

Costing is an important process that many companies engage in to keep track of where their money is being
spent in the production and distribution processes. Understanding these costs is the first step in being able to
control them. It is very important that a company chooses the appropriate type of costing system for their
product type and industry. One type of costing system that is used in certain industries is process costing that
varies from other types of costing (such as job costing) in some ways. In process costing unit costs are more like
averages, the process-costing system requires less bookkeeping than does a job-order costing system. Thus,
some companies often prefer to use the process-costing system.
When process costing is applied?

Process costing is appropriate for companies that produce a continuous mass of like units through series of
operations or process. Also, when one order does not affect the production process and a standardization of
the process and product exists. However, if there are significant differences among the costs of
34
various products, a process costing system would not provide adequate product-cost information. Costing is
generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, and
food.
Reasons for use

Companies need to allocate total product costs to units of product for the following reasons:
 A company may manufacture thousands or millions of units of product in a given period of time.
 Products are manufactured in large quantities, but products may be sold in small quantities, sometimes one at a
time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies), etc.
 Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct
and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales
revenue.
 Managers need to maintain cost control over the manufacturing process. Process costing provides managers with
feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with
projected manufacturing budgets.
 A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when selling millions of
units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process,
while at the same time dealing with materials and output in huge quantities.
 Materials part way through a process (e.g. chemicals) might need to be given a value, process costing allows for this. By
determining what cost the part processed material has incurred such as labor or overhead an "equivalent unit" relative to
the value of a finished process can be calculated.
Types of Process Costing
There are three types of process costing, which are:
Weighted average costs. This version assumes that all costs, whether from a preceding period or the current one, are
lumped together and assigned to produce units. It is the simplest version to calculate.
Standard costs. This version is based on standard costs. Its calculation is similar to weighted average costing, but
standard costs are assigned to production units, rather than actual costs; after total costs are accumulated based on
standard costs, these totals are compared to actual accumulated costs, and the difference is charged to a variance
account.
First-in first-out costing (FIFO). FIFO is a more complex calculation that creates layers of costs, one for any units of
production that were started in the previous production period but not completed, and another layer for any production
that is started in the current period.
There is no last in, first out (LIFO) costing method used in process costing, since the underlying assumption of process
costing is that the first unit produced is, in fact, the first unit used, which is the FIFO concept.
Why have three different cost calculation methods for process costing, and why use one version instead of another?
The different calculations are required for different cost accounting needs. The weighted average method is used in
situations where there is no standard costing system, or where the fluctuations in costs from period to period are so
35
slight that the management team has no need for the slight improvement in costing accuracy that can be obtained with
the FIFO costing method. Alternatively, process costing that is based on standard costs is required for costing systems
that use standard costs. It is also useful in situations where companies manufacture such a broad mix of products that
they have difficulty accurately assigning actual costs to each type of product; under the other process costing
methodologies, which both use actual costs, there is a strong chance that costs for different products will become mixed
together. Finally, FIFO costing is used when there are ongoing and significant changes in product costs from period to
period – to such an extent that the management team needs to know the new costing levels so that it can re-price
products appropriately, determine if there are internal costing problems requiring resolution, or perhaps to change
manager performance-based compensation. In general, the simplest costing approach is the weighted average method,
with FIFO costing being the most difficult.
Procedures for materials, Labor & factory overhead costs

Material costs. In job order costing material requisition is the basis for charging direct material to specific Jobs.
If requisitions are used in process costing, the details are considerably reduced because materials are charged to
department rather than to job and the number of jobs which a firm handles at a given time. The material
requisition forms may be useful for material control purpose. If the requisition are not priced individually , the
cost of material used may be determined at the end of the production period through inventory difference
procedures .Consumption reports which state the cost or quantities of material put into process by various
departments may also be used . The cost or quantities charged to department is determined may be based on
the formulas or proportion.
Atypical Journal entry to record the direct material used during a period is as follows
WIP –blending dep’t -----------------------------------------------Br 24,500

Material ---------------------------------------------------------------------------24,500
Labor costs. The detailed clerical work of accumulating labor costs by jobs is eliminated in process costing
because labor costs are identified by charged to departments. Daily time ticket or weekly card s are used instead
of jib time tickets.
WIP Blending Dep’t---------------------------------------------------Br 29,140.00
WIP Testing Dep’t---------------------------------------------------------37,310.00
WIP Terminal Dep’t-------------------------------------------------------32,400.00
Payroll -------------------------------------------------------------------------------98,850.00
FOH costs. In both job order and process costing, FOH should be accumulated in a factory overhead subsidiary
ledger for producing and service departments. This procedure is consistent with requirement for responsibility
accounting and reporting. As expense are incurred ,they are recorded in factory overhead control account and
posted to department expense analysis sheets, which constitute the subsidiary ledger .
FOH control ----------------------------------------------------------------------Br 81,500.00
A/p ------ --------------------------------------------------------------------------------24,500.00
Accumulation depreciation – machinery ---------------------------------------------42,500.00
Prepaid insurance ----------------------------------------------------------------------- 8,000.00
Indirect material ------------------------------------------------------------------------- 4,500.00
Indirect labor -----------------------------------------------------------------------------2,000.00
36
At the end of each period, either actual FOH or applied FOH is charged to the producing department.
When overhead applied in process costing, the rates are multiplied by the respective actual activities based (e.g
Labor cost).
WIP Blending Dep’t---------------------------------------------------------28,200.00
WIP Testing Dep’t-----------------------------------------------------------32,800.00
WIP Terminal Dep’t---------------------------------------------------------19,800.00
Applied FOH -------------------------------------------------------------------------80,800.00
The cost of production report

In process costing ,all costs chargeable to a department are summarized in a departmental cost of production
report .This report is advice for presenting the amount of costs accumulated and disposed of during a month. It
is also the source of information for preparing summary journal entries which record activity in the cost
accounts.
The cost of production report for the department shows (1) Total & unit cost transfer from preceding
department (2) Material, Labor & FOH added for the department 3) unit cost added by the department (4) Total
& unit cost accumulated at the end of operations in the department (5) the cost of the beginning and ending
WIP inventories, which are in various stages of completion (6) cost transfer to the succeed department or to
finished goods store room. The cost section of the department divided in to two part
1) Total cost for which the department is accountable 2) showing the disposition of this cost.
It indicates the cost elements for each department because theses detailed data are needed for cost control
and for determining the cost of the ending WIP inventories.
The cost of production report also includes a quantity schedule which shows the total number of units for
which a department is accountable and the disposition of these units. Information in this schedule, adjusted for
equivalent production, is used to determine the unit cost added by the department, the cost of ending WIP
inventory, and the cost to be transferred out of the department.
Illustration
The cost of production report of the blending Department ,the originating department of ABC corporation .the
quantity schedule of this report shows that the Belding Dep’t put 50,000u in process
Of these units for which the department was responsible, 45,000u were transferred to next testing department,
4000u are still in process, and 1,000u were loss in processing.
ABC
Blending Department
Cost of production report
For jan,20xx
Quantity schedule
Units started in process-------------------------------------------------------------------------------------50,000
Unit transferred to next department ---------------------------------------------------45,000.
Units still in Process(all M-1/2 labor & FOH)--------------------------------------------4,000
Units lost in process----------------------------------------------------------------------------1,000
50,000
Cost charged to the department
Cost added by the department Total cost Unit cost
Material-------------------------------------------------------------------------------------------24,500 0.50
Labor ----------------------------------------------------------------------------------------------29,140 0.60
FOH ----------------------------------------------------------------------------------------------28,200 0.60
Total cost to be accounted for ----------------------------------------------------------Br81,840 1.72
Cost Accounted for as follows

37
Transferred to next department (45,000x1.72)-----------------------------------------------------------77,400

WIP –ending inventory
Material (4,000x0.05)--------------------------------------------------------------------------2,000
Labor (4,000x1/2X0.6)------------------------------------------------------------------------- 1,240
FOH (4,000x1/2x0.06)--------------------------------------------------------------------------- 1,200 4,440.
Total cost accounted for 81,840.
Additional computation
Equivalent production : Material=45,000+4,000=49,000
Labor & FOH =4500+4,000x1/2=47,000
Unit cost = 24,500/49,000=0.50 per unit
Unit cost =29140/47000=0.60
Unit cost =28200/47000=0.60
Journal entry for transfer WIP
WIP_ testing Department-------------------------------------------------77,400

WIP –Blending Dep’t-------------------------------------------------------------77,400
Testing department
BY adding labor and FOH to process the transferred unit from Blending department ,then the unit of 40,000
transfer to Terminal department but the unit of 3,000 is remain in the ending inventory of WIP whereas 2,000u
is lost during the process
ABC
Testing Department
For jan,20xx
Quantity schedule
Units still in Process(1/3 labor & FOH)-----------------------------------------------------3,000
50,000
Cost from preceding Department Total cost Unit cost
Transferred in during the month 77,400 1.72
Cost added by the department
Labor ----------------------------------------------------------------------------------------------37,310 0.91
FOH ----------------------------------------------------------------------------------------------32,800 0.80
Total cost to be added ---------- ----------------------------------------------------------Br70,110. 1.71
Adjusted for loss unit --------------------------------------------------------------------------------------------- .08
Total cost to be account for ----------------------------------------------------------------147,510. 3.51
Transferred to next department (40,000x3.51)-----------------------------------------------------------140,400.
Adjusted cost from preceding department 3,000x(1.72+0.08)-----------------------5,400
Labor (3,000x1/3x0.91) ------------------------------------------------------------------------- 910
FOH (3,000x1/3x0.80)------------------------------------------------------------------------------800 7110.
Equivalent production :
Labor & FOH =40000+3,000x1/3=41,000
Unit cost = 37310/41,000=0.91 per unit
Unit cost =32,800/41,000=0.80
Adjustment for lost units =40,000+3000=43,000
Method 1 =77400/43000=1.80
38
1.80-1.72=0.08
Method 2 = 2000ux1.72=3,440=3,440/43,000=0.08per unit
Journal entry for transfer WIP
WIP_ terminal Department-------------------------------------------------140,400

WIP –testing Dep’t-------------------------------------------------------------140,400
Terminal Department
BY adding labor and FOH to process the transferred unit from Testing department ,then 35,000 transfer to
warehouse after finished processing but the unit of 4,000 is remain in the ending inventory of WIP whereas
1,000u is lost based on WIP the unit of labor & FOH is 1/4
ABC
Terminal Department
For jan,20xx
Quantity schedule
50,000
Labor ----------------------------------------------------------------------------------------------32,400 0.90
FOH ----------------------------------------------------------------------------------------------19,800 0.55
Total cost to be added ---------- ----------------------------------------------------------Br 52200. 1.55
Adjusted for loss unit --------------------------------------------------------------------------------------------- .09

Transferred to next department (35,000x5.05)-----------------------------------------------------------176750.
Adjusted cost from preceding department 4,000x(3.51+0.09)----------------------14,400
Labor (4,000x1/4x0.90) ------------------------------------------------------------------------- 900
FOH (4,000x1/4x0.55)------------------------------------------------------------------------------550 15,850.
Labor & FOH =35000+4,000x1/4=36,000
Unit cost = 32,400/36,000=0.90 per unit
Unit cost =19,800/36,000=0.55
Method 1 =140,400/39000=3.60
39
3.6-3.51=0.09
Method 2 = 1000ux3.51=3510=3510/39,000=0.09per unit
Journal entry for transfer fG
FG inventory -------------------------------------------------176,750
WIP –terminal Dep’t-------------------------------------------------------------176,750
OTHER FACTOR IN ACCOUNTING FOR LOST UNITS
In the testing Department as well as in the blending & terminal Dep’t ,it was assumed that the loss of units
applied to all good units and was within normal tolerance limits .Thus, the loss of units resulted in an increase in
the unit cost of the remaining good units, i.e the units completed and the units still in process.
Timing of loss units
Situations may arise in which the cost of loss units does not pertain to the ending WIP, because the loss is
charged to units identification of loss units occurs at a point beyond the stage of completion of the units still in
process . Thus, any measured loss pertain only to units completed .No part of the loss is charged to units still in
process.
Since the loss units were discovered after completion of the department processed is completed, unit cost are
based on the equivalent production for goods units plus lost units. Therefore no adjustment of the preceding
department units cost is required, and none of the cost of the spoiled units is included in the cost assigned to
the ending WIP inventory.
Assume that the 2,000u lost by the testing department of ABC Corporation above were result of spoilage which
was discovered by quality control Department at its final inspection.
ABC
Testing Department
For jan,20xx
Quantity schedule
50,000
Labor ----------------------------------------------------------------------------------------------37,310 0.87
FOH ----------------------------------------------------------------------------------------------32,800 0.76
Total cost to be added ---------- ----------------------------------------------------------Br70,110. 1.63

Transferred to next department (40,000x3.35+0.1675)------------------------------------------------140,720.00
From preceding Department(3,000x1.72)--------------------------------------------------- 5,160
Labor (3,000x1/3x0.87) ------------------------------------------------------------------------- 870
FOH (3,000x1/3x0.76)---------------------------------------------------------------------------------760 6,790.
40

Labor & FOH =40,00+3,000x1/3+2000=43,000
Unit cost = 37310/43,000=0.87 per unit
Unit cost =32,800/43,000=0.76
Method 2 = 2000ux3.35=6700=6700/40,000=0.1675 per unit
Normal VS Abnormal Loss of units
Units are lost through evaporation ,shrinkage ,substandard yields ,spoiled work ,poor workmanship ,or
inefficient equipment. In many instances, the nature of operations makes certain losses normal; or abnormal.
When such losses are determined to be within normal tolerance limits for human and machine errors, the cost
of the units does not appear as a separate item of cost but is spread over the remaining good units.
A different situation is created by abnormal or avoidable losses that are not expected to arise under normal,
efficient operation conditions. Again ,the procedure involves computing units costs based on equivalent
production for goods units plus loss unit . The lost units are multiplied by the resulting units costs to determine
the cost applicable to the abnormal loss. this cost is Charge to FOH or to current –period expense account which
is reported as a separate item in the CGS statement . if The cost of the abnormal loss is charged to FOH as shown
in the following entry
FOH control-------------------------------------6,700
Abnormal lost units WIP---------------------------------6700
41
Cost & management Accou nti I handout
Accounting
Unit 5: spoilage, rework and scrap

5.1 Introduction
Improving quality and minimizing defects are the major aim of management. To attain this
objective, management needs to get accurate information about the costs of these defects on time,
which will help it to make cost related informed decisions such as cost control; product costing
valuing Inventory valuing (cost of good sold).
In the previous units on product costing systems, the whole discussion was in the absence of
defects, but in any manufacturing process having a defects is obvious. In this unit we will discuss
about the three types of defects and the procedures to account for them spoilage defective and
scrap.
5.2 TERMINOLOGIES
Spoilage: - Are completed or semi-completed products that do not meet the standard or
specification and that are discarded or are sold for a disposal value.
Net spoilage cost is the total of the costs accumulated to the point of inspection less any disposal
value if any.
Reworks (defective) are completed units that do not meet the standard or the specification but while
can subsequently repaired and sold as acceptable finished goods with incurrence of additional costs
which are called Rectifying or rework costs. These units are salable as seconds of firsts
depending on the market condition. The accounting issue related to rework is how to accumulate
and record the rework costs.
Scrap is material residue from the manufacturing operations that has measurable but relatively
minor recovery value. For example, out lined metal from a stamping operation, shavings, filings,
turning, baring, sawdust, and short lengths from wood working etc. scrap is unavoidable but can
be kept, to a minimum. Scrap may be either reused or discarded
5.3 different types of spoilage
The accounting for spoilage is assumed at determining the size of the spoilage and differentiating
between normal and abnormal spoilage.
42
The costs of spoilage should be identified as normal and abnormal and the costs of normal spoilage
should include as part of the costs of goods or units manufactured so that management can use
this information to determine the costs of products and to control and reduce costs by spoilage
taking measures to minimize spoilage.
5.3.1 Normal Spoilage
Normal spoilage is a spoilage that arises under efficient operating conditions; it is an inherent result
of the particular process and is thus uncontrollable in the short run. Management must establish
the rate of spoilage that is to be regarded as normal within its selected set of production conditions.
The costs of normal spoilage are typically viewed as part of the costs of goods units (products)
because the production of good units necessitates the simultaneous presence of spoiled units. In
other words normal spoilage is planned spoilage, in the sense that the choice of a given
combination of factors of production entails a spoilage rate that management is willing to accept.
Normal spoilage is computed by using total good units as a base, not total units started in
production, since these units include any abnormal spoilage in addition to the normal spoilage.
5.3.2 Abnormal Spoilage
Abnormal spoilage is a spoilage that is not expected to arise under efficient operating conditions. It is
not an inherent part of the manufacturing process. Most of this spoilage is usually regarded as
controllable in the sense that the first line supervision can exert influence over inefficiency such
causes as machine breakdowns, accidents, and inferior materials are typically regarded as being
subject to some management’s influence costs of abnormal spoilage are the cost of inferior
products that should be written off directly as losses for the period using a separate account known
as loss from abnormal spoilage.
5.4 PROCESS COSTING AND SPOILAGE

In the accounting treatment for spoilage in process costing is first to know the spoiled units and
then to identify them into normal and abnormal spoilage.
The units of normal spoilage can be determined by either counting or without counting. To
determine the equivalent units the 1st approach, i.e., counting the normal spoiled units results with
accurate data because it spreads spoiled units to good units only. If the other approach is used it
will spread the normal spoilage not only to good units but also to all units produced as well as to
43
those units not completed. The problem with this approach is it results in spreading spoilage to the
incomplete goods twice, first in the current period and second in the following period when these
units are completed.
There is a five steps procedure for process costing with spoilage. The steps were discussed in the
previous unit, but with some modifications it is stated below to show the effect of spoilage.
Step 1. Summarize the flow of physical units of out put
The normal and abnormal spoilage should be separately identified in this step using the following
formula.
Units Units Good Units

Spoiled =
- At the + currently __ Units + at the end
Unit
Beginning Started
After determining the spoiled units, the normal spoilage is determined by multiplying the accepted
rate by the cost good units. Then the abnormal spoilage is equal to the total spoilage less the
normal spoilage as shown below:
Normal spoilage = Accepted rate X Cost of good Units.
Total
Abnormal spoilage = Spoiled – Normal spoilage
Step 2computeoutput in terms of equivalent units
Spoilage is identified at the inspection point which can be made only once or more times during a
period.
The equivalent unit for both spoiled and good units is determined at the inspection point. The work
done for good and spoiled units is the same to that point of inspection. The spoiled and good units
are 100% completed for both direct material and conversion cost at the point of inspection.
44
Step 3compute equivalent unit costs.
To compute the equivalent unit cost for each cost element, divide the total costs of each cost
element by the equivalent units of each cost element.
Step 4 summarize total costs to account for
The total costs to account for represents the direct material and conversion costs which is debited
to work in process inventory account of the related department or process at the end of a given
period.
Step 5. Assign total costs to units completed to spoiled units and to units in the ending work in
process inventory.
To assign costs the assignment should be made to good units, normal spoilage, abnormal spoilage
and ending work in process inventory separately.
To go through the last three steps, we should know the inventory costing method used: weighted
average or First-In, First-Out.
5.4.1 Weighted-Average Method
The equivalent unit cost is computed by dividing the total cost to date (beg. WiP Inventory + Costs
incurred currently) by the equivalent units of each cost element as shown below:
The computation of physical units (step 2) and equivalent units (step 2) are the same except that
normal and abnormal spoilage are include
1.Equivalent Total Direct materials Cost to date (B.eg + current period cost
unit cost of DM = Equivalentunits forDirect material
EquivalentUC of Total conversion cost to date (Beg.+current cost )
CC = Equivalent unit cost for conversion cost
Based on the equivalent unit costs computed as shown above, the total direct material costs and
conversion costs are assigned to good units, normal spoilage abnormal spoilage and units in the
ending inventory.
45
Costs Beg. Unit cost
Assigned = good X Direct.M + good X equ.
To good units units unit
Units cost
of cc.
+ Normal the total
Spoiled X Equivalents
Units units cost of Direct
material and
conversion costs
Costs Assigned
to abnormal = Abnormal X The total
spoilage spoiled Equivalent unit
units costs of direct
material and
conversion costs
costs assigned to units in the ending inventory is done as usual.
WIP Ending
D.m costs = units X Equivalent
at the unit
end cost of Dm
46
Conv. costs = units X equivalent
at the end unit cost of
Conversion costs
To understand the accounting treatment process costing and spoilage under weighted Average
Method, see the following illustration:
Consider the following data for November 2002 For Hiwot Manufacturing company, which makes
chemical products and operates a process costing system – All direct materials are added at the
beginning of the process and conversion costs are added evenly during the process. Spoilage is
detected upon inspection at the completion of the process. Spoiled units are disposed at zero net
disposal prices. Hiwot manufacturing Co. uses the weighted average method for inventory
valuation.
Physical Direct Conv.
Flow of production . Units Material Costs
Work-in process, Nov. 1. 1000 1423 1110
Started in Nov. 2002 ?
Good units Cam. &trans
Out during Nov. 2002 9000
Normal spoilage 100
Abnormal spoilage 50
Work-in process, Nov. 30 2000
Costs added during Nov. 12,180 27,750
Note: - Degree of completion:

47
Beg. Work –in process
Direct materials ------ 100%
Conversion Costs ----- 50%
Ending work-in process:
Direct materials 100%
Conversion costs 30%
Required:
(1) Compute equivalent units for direct materials and conversion costs.
(2) Summarize total costs to account for
(3) Compute the cost per equivalent unit for direct materials and conversion costs
(4) Assign the costs in (2) to
(a) Units completed and transferred and (including normal spoilage)
(b) Abnormal spoilage
(c) Units in ending work-in process
Answers
Equivalent units
Physical Direct Conversion
Flow of Production units Materials Costs
Work-in process, beginning 1000
Started during current period 10150
To account for 11150
Good unit completed
and transferred out 9000 9000 9000
Normal spoilage 100 100 100
48
Abnormal spoilage 50 50 50
Work-in process, ending 2000 2000 600
Total accounted for 11150
Work done to date 11150 9750
Total
Prodn. Direct Conversion
Costs Materials Costs
Work-in process, beginning Br. 2533 Br. 1423 Br. 1110
Costs added current period 39930 12180 27750
Total costs to account for Br. 42463 Br. 13603 Br. 28860
Divide by equivalent units 11150 9750
Equivalent unit costs Br. 1.22 Br. 2.96
Assignment of costs
Good units completed and
Transferred out (9000 units)
Costs before adding normal spoiled Br. 37620 9000 x Br. 1.22 + 9000 x Br. 2.96
Normal spoilage (100 units) 418 100 x Br. 1.22 + 100 x Br. 2.96
Total costs of good units
Completed and transferred out 38038
Abnormal spoilage (50 units) 209 50 x Br. 1.22 + 50 x Br. 2.96
Work-in process, ending (2000 units):
Direct materials Br. 2440 2000 x Br. 1.22
49
Conversion costs 1776 600 x Br. 2.96
Total work-in process, ending Br. 4216
Total costs accounted for Br. 42463
FIFO method and spoilage
The FIFO method that focuses on equivalent units of work done in the current period is the same
as before except that here it includes spoiled units. The spoiled units are identified after the
inspection point and these spoiled units are related only to the current work done and are included
in determining equivalent units and equivalent unit cost .the same data used for Weighted Average
Method will be used again here: Let’s see the answer for each of the requirements below:
(1)
Equivalent units
Physical Direct Conversion
Flow of production units Materials Costs
Work-in process, beginning 1000
Started during current period 10150
To account for 11150
Good units completed & transferred
Out during current period:
From beginning work-in process 1000 500
Started and completed 8000 8000 8000
Normal spoilage 100 100 100
Abnormal spoilage 50 50 50
Work-in process, ending 2000 2000 600

50
Accounted for 11150
Work done in current period only 10150 9250
Of view Total
Production Direct Conversion
Costs MaterialsCosts
Work - in process, beginning Br. 2533
Costs added current period 39930Br.12180 Br. 27750
(2) Total cost to account for Br. 42463
Divide by equivalent units. ÷ 10150÷ 9250
(3) Equivalent unit costs. Br. 1.20 Br. 3.
(4) Assignment of costs:
Good units completed & transferred out (9000 units)
Work – in process, beginning (1000 units): Br 2533
Direct materials added current period 0 0 X Br. 1.20
Conversion costs added current period 1500500 X Br. 3
Total From beginning work – in process Br.4033
Started & completed before normal
Spoilage (8000 units) 33600 8000 X 4.20
Abnormal spoilage (100units) 420 100 X Br. 1.20 100 X Br.3
Total cost of goods units transferred out 38053
Abnormal spoilage (50 units) 210 50 X Br. 1.20 50 X Br. 3
Work – in process ending (2000 units):
51
Direct materials 2400 2000 X Br. 1.20
Conversion costs 1800600X Br.3
Total work – in process, ending 4200
Total Costs accounted for Br.42463
Inspection points and Allocating
Costs of normal spoilage
Inspection for quality of the units can be made at one or more specific points usually; inspection is
made at the point of completion. If this is true all spoiled units are part of the goods completed and
transferred out, no spoilage is assigned to the units in process /ending work in process inventory)
The unit cost of normal and abnormal spoilage is general if both are detected at the same point of
inspection. But if they are identified at different stages in the manufacturing process, each will
have different unit cost.
Costs of normal spoilage are included to the costs of good units net of their salvage value of any
where as the costs of abnormal spoilage is reported as loss of the period in which it is detected.
5.5 Job costing and spoilage
There are normal and abnormal spoilages in job order costing as in process costing the main
concepts discussed in process costing to these units’ remains the some except that the accounting
treatment differs. Costs of normal spoilage are inventor able where as abnormal spoilage is not
inventor able and are written off as losses of the period in which they are identified. In Job order
costing system abnormal spoilage are regarded as controllable by the first stage supervisor.
Normal spoilage in Job order costing are two types – attributable to specific job and common to all
jobs. Normal spoilage attributable to all Jobs. Normal spoilage attributable to a specific Job is
assigned to that specific job this step is not related to process costing because in process costing all
products are identical normal spoiler common to all jobs is allocated to jobs with the other indirect
manufacturing costs at the end of the month.
5.5.1 Normal spoilage attributable to a specific Job(nahom)
52
When the spoilage is caused due to the specification related to a particular Job, that job should
absorb this cost of the spoilage by net of the salvage value of the spoiled units, if soluble. To
recognize the estimated selling price (disposal value) if the spoilage, J. entry should be recorded
Materials control------------------------------Disposal
Work in process --------------------- Value.
After posting the above entry the work in process inventory account balance represents the costs of
good units (including normal spoilage)
Example:
In fasica machine shop, 10machine parts of a job lot of 100 machine parts are spoiled. Costs
assigned period to the inspection point are Br. 4000 per part. The company calculates these costs
on the basis of its inventory costing assumptions weighted average or FIFO. But the Co-does not
consider the cost how assumptions. The current disposal price of the spoiled parts is estimated to
be Br. 1200 per past
Required: Prepare the necessary J. entry at the time the spoiled parts are identified and given
That they are related to the particular job.
Materials control-------------------------------- 12000
Work –in process --------------------- 12000
The cost of the spoiled units = (10 parts X Br 4000)- Br 12000)
= Br. 40,000 – Br. 12,000
= 28,000
The cost of good units =
= (90 units X Br.4000) - Br 28,000
= Br. 360,000 – Br. 28,000
= Br. 33200
53
1.5.1 Normal spoilage common to all jobs
Normal spoilage may coincidentally occur due to the inherent problem in the manufacturing.
Process where a gover job is being worked on. Under this condition, the costs of the spoilage
cannot be assigned to that particular job but to all jobs manufacturing overhead the j. entry based
on the above examples is recorded as follows:
Materials Control ------------------------------ 12,000
Manufacturing over head control ------------ 28,000
Work in process ------------------------------------- 40,000
When normal spoilage is common to all jobs, the budgeted manufacturing over head application
rate spoilage cost. Therefore, the normal spoilage is allocated, to all jobs based on the application
rate under this condition;
The costs of goods units = 90 parts X Br 4000 = Br. 36000
Plus the allocated share of the Br. 28000
Overhead costs of the normal spoilage.
5.5.2 Abnormal spoilage
If the spoilage is abnormal, the cost of the abnormal spoilage het of any disposal value is debited to
an account titled loss from abnormal spoilage. Abnormal spoilage is not part of the cost of good
units. If the spoilage in the above example was abnormal, the J. entry would be:
Material control ------------------------- 12,000
Loss form abnormal spoilage --------- 28,000
Work – in process -----------------------40,000
Abnormal spoilage is reported as the loss of the period in which it is identified.
54
5.6 JOB COSTING AND REWORK
As it has been defined before is the cost of unacceptable units of production that are subsequently
repaired and sold as normal finished goods. Rework is distinguished
As (1) Normal rework attributable to specific jog
(2) Normal rework common to all jobs
(3) Abnormal rework
Assume the 10 spoiled machine parts in our previous illustration are reworked at a total costs of Br
40,000 details of costs assumed) assigned to the 10 spoiled parts before considering rework costs
are as follows.
Work in process ----------------------------------- 40,000
Material control -------------------------------------- 15000
Wages payable --------------------------------------- 15000
Manufacturing overhead control ------------------- 10000
Assume that rework costs equal Br. 7600 (direct materials Br. 1600. direct labor 4000;
manufacturing overhead, Br 2000
5.6.1 Normal rework attributable to a specific job
If the rework is normal and if it is related to the specification of a particular job, the costs of the
rework should be assigned to that particular job.
Work – in process----------------------- 7600
Materials control --------------- -------1600
Wages payable ------------------------ 4000
Manufacturing overhead control---- 2000
5.6.2 Normal rework common to all jobs
55
When rework is normal and is caused to the inherent problem of the manufacturing process the
costs of the rework are charged to manufacturing process the costs of the rework are charged to
manufacturing overhead control account and allocated to all jobs like the other overhead costs and
the journal entry recorded the rework costs is as follows – assume the rework costs in the previous
example.
Manufacturing overhead control ---------------------------------- 7600
Materials control ------------------------------------------- -------1600
Wages payable ---------------------------------------------------- 4000
Manufacturing overhead control-------------------------------- 2000
Or
Manufacturing overhead ------------------------------------------5600
Materials control -----------------------------------------------------1600
Wages payable ------------------------------------------------------ 4000
5.6.3 Abnormal Rework
If the rework is abnormal, it is charged to loss form abnormal rework account. The accounting
treatment for abnormal rework is the same in both job costing and process costing if the rework
cost in the previous example is abnormal; the J. entry is recorded as follows:
Loss from abnormal rework -----------------------------------7600
Materials control -------------------------------------- ----------1600
Wages payable --------------------------------------------------- 4000
Manufacturing overhead control ------------------------------ 2000
5.7 Accounting for scraps
56
A scrap as has been defined before represents remains of materials left over from the
manufacturing process. They have low soles value as compared with the soles value of the
products.
The accounting issue related to scrap is (1) when should the value of screp be recognized in the
accounting records- at the time scrap is produced or at the line scrap is sold?
(2) how should revenue from scrap be accounted for?
5.7.1 Recognizing scrap at the time of sole
Scrap is recognized at the time of sole when its dollar amount is immaterial. The accounting
treatment is to make a memo of the quantity of the scrap returned to the store room and to
recorded the following J. entry the the time of well
Assume the selling price of a given quantity of material is Br. 500
Cash (A/R) ------------------
Sales of scrap ----- 500
The soles of scrap are an account that represents the revenue generated from the selling of the
scrap. It is reported the income statement as other income.
When the dollar amount of scrap is material and the scrap is sold gnockly after it is known, the
accounting treatment depend in whether the scrap is attributable to a specific job or is common to
all jobs.
5.7.1.1 Scrap attributable to a specific job
If a scrap is feasible with the making of a specific job the selling price of the scrap reduces the cost
of the particular job. In the above example is attributable to a specific job, the J. entry will be
recorded as follows:
Unlike spoilage and rework, there is no cost attached to the scrap, and hence no distinction is
made between normal and abnormal scrap.
57
5.7.1.2 Scrap common to all jobs
When it is not possible to identify scrap with a specific job, the selling price of the scrap will be
prorated and deducted from the costs of all jobs. If the in the previous example is assumed to be
common to all jobs the J. entry is:
Cash (A/R) -----------------------------------
Manufacturing overhead control ----- 500
The expected disposal price of the scrap should be considered in setting the manufacturing
overhead application rate. Thus, the budgeted overhead application rate is lower than it would be
if the overhead budget had not been reduced by the expected sales of scrap. The accounting for
scrap is as common to both job costing and process costing.
5.7.1.3 Recognizing scrap at the time of its production
In the discussion of 2.7.1itwas assumed that the scrap is sold immediately as if is produced
(identified) and there may be a time interval between its production and it’s selling or remising it.
In this case, separate scrap inventory account is maintained or the scrap is recorded in the
materials control account like the other materials. At its expected net realizable value so that
production cost and related scrap recovery ate recognized in the same accounting period. The
scrap is than stirred until sold or reused.
The scrap may be attributable to specific job or many be common to all jobs.
5.7.2. Scrap attributable to a specific job
When a scrap is identifiable with a specific job its expected net realizable value should be deducted
from the cost of that particular job’s and the scrap inventory should increase the balance of the
materials control account. let us assume that the estimate selling price of a given scrap is Br. 1000
and its related costs of selling (disposal, is estimated to be Br. 200, the net realizable value of the
scrap is Br. 800 (Br 1000 – Br 200) and, the storage of the scrap is recorded as follows:
Cash (A/R) ------------------
Work - in process ----- 800
58
5.7.2 Scrap common to all jobs
When scrap is not identified with a specific job but caused due to the inherent problem associated
in the prorated amount of manufacturing process, the expected net realizable value of the scrap
reduces the cost of all jobs. Let us use the previous example to recurred the J. entry the time the
scrape is resulted
Cash (A/R) -----------------------------------
Manufacturing overhead control ----- 800
Later, when the scrap is sold, the actual selling price of the scrap may be different from its
expected net realizable value, the situation could be one of the following .
1. the selling price = net realizable value
i) the selling price < net realizable value

ii) the selling price > net realizable value
Because of the difference in the selling price and net realizable value of the scrap the J. entry that
is recorded at the time of the sales also different. Lt’s see the J. entry assuming the above example
the selling price is Br. 800 Br.700 and Br. 900 is respectively
If (i) the selling price = Net realizable value
Cash (A/R) -----------------------------------
Material control ----- 800
(ii) The selling price < Net realizable value
Cash (A/R) ----------------------------------- 700
Work – in process (Manu OHD) ---------- 100
Material control -------------------- 800
(iii) The selling price > Net realizable value
59
Cash ----------------------------------- 900
Material control -------------------- 800
Work – in process (Manu OHD) -------100
*Manufacturing overhead control.
Instead of selling some time the scrap is reused as direct materials. In this case, it should be
debited to materials control as other purchases of materials and recorded at its expected net
realizable value. The scrap may be attributable to a specific job or common to all jobs. The
accounting procedure to record the scrap returned to the storeroom will remain the same.
 Materials control----------------------------------800
Work in process---------------------------------800
(if attributable to a specific Job)
 Materials control -------------------------------- 800

Manufacturing overhead control-----------800
(If common to all Jobs)
 This J. entry is similar to those entries that are recorded the issuance of materials to
production.
The accounting for scrap under process costing is like the accounting under job costing when scrap
is common to all jobs-because process costing appears to the manufacture of masses of identical or
similar units.
High cost of scrap is an indicator of inefficiency attracts manager’s attenuation. Even though scrap
is an inherent part of every manufacturing process and unavoidable, mechanisms should be
implemented to keep it to the possible minimum.
60

Cost Accounting I

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Cost & management Accounting I handout

. OBJECTIVES OF COST ACCOUNTANTING

COMPARISION OF COST ACCOUNTING &FINANCIAL ACCOUNTING

Statutory These accounts have to be prepared according Maintenance of these accounts is

Periodicity of Financial reports are prepared periodically, Cost reporting is a continuous

Types of Only external transaction External & internal or inter-

COST AND MANAGEMENT

Management Accounting is consist of four essential tasks

COST ACCOUNTING & MANAGEMENT ACCOUNTING –COMPARION

Management Accounting, Cost Accounting, And Financial Accounting

Financial accounting focuses on reporting to external parties.

2.2 Cost center & cost unit

2.3 METHODS OF COSTING

order costing is small

2.4 TECHNIQUES OF COSTING

2.5 CLASSIFICATION OF COST

It show the following characteristics

 Variability’s of total the amount in direct proportion to the volume of output.

3 ) Committed & Discretionary costs

4) Generally accepted accounting treatment point of view

is available after the completion of the manufacturing operation.

1. MATERIAL COST: The cost of commodities supplied to an undertaking

2. LABOUR COST: cost of remuneration of the employees of an undertaking

Example Machine operator, Shoe-worker, carpenter , weaver ,Tailor

Example Supervisor inspector, cleaner, clerk, peon watchman etc

Example Electric power, supplies, indirect material indirect labor

Component of total cost:

 Prime cost = Direct material + direct labor

Material cost LABOUR COST EXPENSE

DM IDM DL IDL Direct Indirect

Production Administration Selling & distribution

Base of comparison Job order costing Process costing

Type of product Diversified heterogeneous and unique Homogeneous products produced

Reporting By job By cost center or department

2.3 SOURCE OF DOCUMENTS FOR JOB ORDER COSTING

Material requisition record: is used to record material used on a specific job

Material requisition record

Record No.--------------- date --------------

Number description quantity Unit cost Total cost

1 XX1 100 $4 $400

2 ZZ4 20 $10 200

2.4 ACCOUNTING PROCEDURES FOR JOB ORDER COSTING

Major accounting procedures in job order costing system

 Receiving job order and purchase of raw materials

 Transferring finished goods to customers.

To determine budgeted rate:

 Estimate manufacturing overhead cost for the year.

Exhibit 2-1: Summary of overhead concepts

Actual costing Normal costing

Direct costs - Actual direct-cost rate(s) × - Actual direct-cost rate(s) ×

Actual quantity of direct-cost Actual quantity of direct-cost

Indirect costs -Actual indirect-cost rate(s) × - Budgeted indirect-cost rate(s) ×

Actual quantity of cost-allocation Actual quantity of cost-allocation

Numerator factors (indirect cost pools)

The denominator reason (quantity of the allocation base)

Actual overhead rate Predetermined overhead rate

- More accurate, but - Less accurate, but more

untimely information timely information

Each entails costs and benefits