UNIVERSITY OF SANTO TOMAS

AMV College of Accountancy

CA 5107 – COST ACCOUNTING AND CONTROL

Introduction to Cost Accounting, Cost Concepts, Cost Behavior Analysis and Cost Accounting
Cycle

Cost defined

 Cost is cash or cash equivalent necessary to attain an objective such as acquiring goods or
services, performing a function or producing and distributing a product.

 Cost refers to the amount of resources given up in exchange for some goods or services.

Cost of Sales, Operating Expenses and Losses

 Cost of sales or costs of goods sold are those production costs incurred related to the units
sold.

 Expenses are those incurred in selling goods, distributing goods and managing a business
(operating expenses).

 Both costs and expenses give benefits to the business.

 Losses do not give any benefit to the business.

Cost Accounting

Cost accounting is an expanded phase of financial accounting which informs management

promptly with the cost of rendering a particular service, buying and selling a product, and producing a
product. It is the field of accounting that measures, records and reports information about costs.

Different Costs for different purposes (Classifications of Costs)

A. As to type

1. Product Costs

For merchandising companies, product costs are those costs incurred to acquire the merchandise
that include the purchase of the merchandise, the transportation costs, insurance, etc. For
manufacturing companies, product costs are those costs incurred to manufacture the product.
These include the materials, labor and factory overhead. Product costs of the units sold are
recognized as expense (as Cost of Goods Sold) while product costs of the unsold units become
the costs of inventory. Direct material, direct labor, and factory overhead are examples of
product costs.

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 Sold Expense (Cost of goods
DM, DL & FOH Charged to sold)
incurred during products
the period manufactured Unsold Asset (Ending
inventory)

Where:
DM = Direct materials
DL =Direct labor
FOH = Factory overhead

2. Period Costs

Period costs are non-manufacturing costs that include selling, administrative and research and
development costs. These costs are expensed in the period of incurrence and do not become part
of the cost of inventory.

B. As to function

1. Manufacturing Costs

Manufacturing costs are those costs needed to manufacture the products. These include the costs
of raw materials, labor and factory overhead.

2. Non-manufacturing Costs

These costs are not related to the manufacturing processes. These include selling expenses,
administrative expenses, finance costs, etc.

C. As to traceability

1. Direct Costs

Direct costs are costs related to a particular cost object and can economically and effectively be
traced to that object. Examples are direct materials and direct labor.

Note that a cost object can be a product or a division in an entity. If a cost object is a product, for
instance, a chair, the wood which is a direct material can be traced directly that it is used solely to
manufacture the chair and not to other products.

Question: All factory overhead items are indirect. True or False?

Answer: False. Factory overhead can be direct and indirect costs depending on the cost object. If
a cost object is a division in an entity, for instance, the production department, the salary of the
supervisor of this department which is a factory overhead can be either direct or indirect costs. If
the cost object is one of the products they produce, the salary of the supervisor is indirect. But if
the cost object is the production department, the salary is considered a direct cost of the
department because it can be effectively traced that it is incurred solely in this department.

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 2. Indirect Costs

Indirect costs are also related to a cost object, but cannot practically, economically and effectively
be traced to such cost object. Cost assignment is done by allocating the indirect cost to the related
cost objects. Examples are “some” factory overhead items that cannot be economically and
effectively traced to a cost object (indirect factory overhead).

D. For decision-making

1. Relevant Costs – future costs that will differ under alternative courses of action.

2. Differential Costs – difference in costs between any two alternative courses of action.

a. Incremental Cost – increase in cost from one alternative to another.

b. Decremental Cost – decrease in cost from one alternative to another.

3. Opportunity Costs – income or benefit given up when one alternative is selected over another.

4. Sunk, Past or Historical Costs – already incurred and cannot be changed by any decision made
now or to be made in the future.

E. As to relation to accounting period(s):

1. Capital Expenditures

Capital expenditures are those costs incurred to benefit several periods. Meaning to say, these
costs are for long-term purposes. Examples are costs to purchase non-current assets such as land,
building and equipment.

2. Revenue Expenditures

Revenue expenditures are those costs incurred to benefit only one period. Meaning to say, these
costs are for short-term purposes only. Examples are cost of goods sold and operating expenses.
These costs are called “Revenue” Expenditures because these are charged or deducted in the
revenue earned during the period to arrive at the profit or loss for the period.

F. As to behavior (Reaction to changes in Cost Driver)

 Cost Driver is anything that causes the incurrence of a cost (i.e., units of product, direct labor cost,
direct labor hours, units of materials, machine hours, etc.)

 Note that not all types of cost will automatically react/change whenever there is a change in the cost
driver. It depends whether it is a variable or a fixed cost or a combination of these two.

1. Variable Cost

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 A variable cost is one that remains constant on a per-unit basis but varies in total with changes in
activity. Examples of variable costs include direct material and direct labor.

2. Fixed Cost

A fixed cost is one that remains constant in total but varies on a per-unit basis with changes in
activity. Examples of fixed costs include straight-line depreciation, insurance, and the
supervisor's salary.

a. Committed Fixed Cost

Committed fixed cost results from an organization's ownership or use of facilities and its basic
organizational structure (e.g., property taxes, depreciation). This is called committed because an
organization cannot avoid the incurrence of this type of cost. To illustrate, if an organization
purchased machinery, the depreciation of this asset is committed to be incurred until the end of its
useful life.

b. Discretionary Fixed Cost

Discretionary fixed cost, on the other hand is a cost that can be cut back more easily in bad
economic times without doing serious harm to organizational goals and objectives. This is called
discretionary because the incurrence of this cost depends on the discretion of the management,
therefore, not committed. Examples are advertising costs and contributions to charitable
institutions.

3. Mixed Cost

Mixed cost is a combination of variable and fixed costs. Meaning to say, this cost is partly
variable and partly fixed. Example of this is the electricity bills that you receive monthly. These
bills are partly fixed and partly variable.

Cost Behavior

Cost behavior refers to the way costs change with respect to a change in the activity level (sometimes
called cost driver), such as production or sales volume, labor or machine hours, etc. There are costs which
remain constant, some change directly or proportionately with the activity level, and others change in
different patterns.

Types of Cost Total amount Amount per unit

1. FIXED Constant Decreases as production increases

2. VARIABLE Increases as production increases Constant
Increases less proportionately (vs.
Decreases less proportionately (vs. fixed
3. MIXED total variable costs) as production
cost per unit) as production increases
increases

Cost Behavior Assumptions

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A. Relevant Range Assumption

The relevant range is that range of activity over which a variable cost remains constant on a per-unit basis
and a fixed cost remains constant in total. Managers can review the various ranges of activity and the
related effects on variable cost (per-unit) and fixed cost (in total) to determine how a change in the range
will affect costs and, thus, the firm's profitability. For instance, a company sets the relevant range as 5,000
units to 15,000 units. 5,000 units means the lowest level of activity and 15,000 units is the highest level of
activity. At this range, the company can expect the assumptions for total fixed cost and variable cost per
unit. Any activity level below or above the relevant range can change those assumptions (e.g., total fixed
costs or variable costs may change).

To explain further, using the relevant range 5,000 to 15,000 units, 15,000 units means the maximum
capacity or the maximum number of units the company can produce for a certain period. A company
desires to produce 20,000 units for the next period. Obviously, this will be impossible to happen using its
present machinery, facility, etc. Therefore, the company will be committed to purchase additional
machinery or rent additional facility to produce the additional 5,000 units. And if there is additional
machinery, there will be additional depreciation that results to additional fixed cost. Or if there is
additional facility to rent, there will also be additional rent expense that leads to additional fixed cost
again.

B. Time Assumption

The cost behavior patterns identified are true only over a specified period of time. Beyond this, the cost
may show a different cost behavior pattern. Meaning to say for example, prices of direct materials and
wages paid to direct labor are not expected to remain constant over a long period of time. Therefore,
variable costs per unit are not expected to remain constant over a long period of time even within the
relevant range.

C. Linearity Assumption

The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to show
otherwise over the long run.

Illustration: Variable, Fixed and Mixed Costs

Problem I:

Jason Manufacturing Company has the following information available regarding costs at various levels
of monthly production:

Production Volume
14,000 units 20,000 units
Direct materials P 70,000 P 100,000
Direct labor 56,000 80,000
Indirect materials 21,000 30,000
Supervisor’s salaries 12,000 12,000

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 Depreciation on plant assets 10,000 10,000
Maintenance 32,000 44,000
Utilities 15,000 21,000
Insurance on plant assets 1,600 1,600
Property taxes on plant assets 2,000 2,000
Totals P 219,600 P 300,600

Required:

1. Identify each cost as being variable, fixed or mixed cost.

2. Determine the variable cost per unit and the fixed cost per month.
3. Predict the total cost for a monthly production volume of 16,000 units.

Solution:

Direct materials Variable

Direct labor Variable
Indirect materials Variable
Supervisor’s salaries Fixed
Depreciation on plant assets Fixed
Maintenance Mixed
Utilities Mixed
Insurance on plant assets Fixed
Property taxes on plant assets Fixed

Discussion:

In the illustration above, two amounts are given for each type of cost for the two activity levels
(14,000 and 20,000 units). Among the three types of cost, fixed cost is the easiest one to identify. If a cost
remains constant in total even if there is a change in the cost driver (e.g., no. of units produced), it is
considered as fixed cost. For instance, the supervisor’s salaries remain constant even the number of units
produced increased from 14,000 units to 20,000 units. Hence, it is classified as fixed cost as well as the
depreciation, insurance and property taxes.

After identifying the fixed costs, the next step is to identify the variable costs. From the definition
and term used for this type of cost, this cost “varies” directly in proportion to the changes in cost driver
but its cost per unit remains constant. For instance, the cost of direct materials is classified as variable
because:

1) The change in its total cost is also the change in the cost driver. At 14,000 units, the total cost
of direct materials is P70,000 and at 20,000 units, its total cost is P100,000. The change in number of
units is an increase of 6,000 units or 42.86% (6,000/14,000) and the change in its total cost is an increase
of P30,000 or 42.86% (P30,000/P70,000). Notice that the percentage change in the number of units and
total costs are the same and it is one of the characteristics of variable costs.

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 2) Its unit cost remains constant regardless of the 6,000 units increase in the production. At
14,000 units, the cost of direct materials per unit is P5 (P70,000/14,000 units) and at 20,000 units, its cost
per unit is also P5 (P100,000/20,000 units).

Use the same procedures for direct labor and indirect materials and these costs will also be
classified as variable.

Maintenance and utilities are not classified as fixed costs because their total costs have changed
as a result of the change in the number of units. They cannot also be classified as variable costs because
their costs per unit also changed as a result of the change in the number of units.

Cost per unit

@ 14,000 units @ 20,000 units
Maintenance P2.29 P2.20
Utilities P1.07 P1.05

Problem II:

Chicago Co. manufactures and sells a single product. A partially completed schedule of the company’s
total and per unit costs over a relevant range of 60 to 100 units produced and sold each year is given
below:

Units produced and sold

60 80 100
Total costs:
Variable P120
Fixed 600
Total
Cost per unit:
Variable
Fixed

Required: Based on the above data,

1. Complete the schedule on total and unit costs (Fill in the blanks).
2. Identify two specific costs that remain constant over the relevant range.
3. Identify two specific costs that are directly related with unit production.
4. Identify the specific cost that is inversely related with unit production.
5. Express the cost formula based on the line equation for “Y = a + bX”.
6. If the company produces 90 units, then the total cost is expected to be P .

Solution and Discussions:

Step 1: Copy the fixed costs in the column of 100 units to 60 and 80 units because this will be the same
regardless of the number of units. Then compute for the fixed costs per unit for each level of activity by
dividing the total fixed costs to number of units.

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 Units produced and sold
60 80 100
Total costs:
Variable P120
Fixed 600 600 600
Total
Cost per unit:
Variable
Fixed 10 7.5 6

Step 2: Compute for the variable cost per unit for each level of activity. Based on the discussion on the
previous problem, variable cost per unit remains constant regardless of the changes in the activity driver.
Therefore, even if the only given total variable costs is in the column of 60 units, the resulting variable
cost per unit will just be copied to the other columns. Then finally, compute for the total variable costs of
80 units and 100 units.

Units produced and sold

60 80 100
Total costs: ÷
Variable P120 P160 P200
Fixed 600 600 600
Total x x
Cost per unit:
Variable 2 2 2
Fixed 10 7.5 6

Cost Estimation: Segregation of Mixed Costs into Fixed and Variable Elements

1. High-Low Method 4. Engineering Method

2. Least-Squares Method 5. Account Analysis Method
3. Scattergraph (Scatter Diagram) Method

Equation “Y = a + bX”

Y = total costs (dependent variable)

a = total fixed costs (y-intercept-vertical axis-intercept)
b = variable cost per unit (slope of the line)
X = activity or cost driver (independent variable)

High-Low Method

The fixed and variable elements of the mixed costs are computed from two sampled data points –
the highest and lowest points as to activity level or cost driver. For analysis purposes, the high-low
method usually produces a reasonable, not precise estimate. However, this method is criticized because it
ignores much of the available data by concentrating on only the extreme points.

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Illustration: Separation of the Fixed and Variable Components of Mixed Costs

Problem I:

Machine hours and electricity costs for Indiana Industries for 2020 were as follows:

Month Machine Hours Utility Costs

January 2,500 P 36,800
February 2,900 42,000
March 1,900 27,000
April 3,100 46,000
May 3,800 56,500
June 3,300 44,000
July 4,100 49,500
August 3,500 45,500
September 2,000 31,000
October 3,700 52,000
November 4,700 62,000
December 4,200 55,500

Required: Using the high-low method;

1. Compute for the variable cost per machine hour.

2. Compute the total variable cost at the highest and lowest level of activity.
3. Determine the fixed cost at each level of activity.
4. Develop an equation to determine the total cost at any level of activity.

Solution:

Step 1: Identify the highest and lowest points based on the number of machine hours (cost driver).

Highest point ⇨ 4,700 MH (the related utility costs amount to P62,000)

Lowest point ⇨ 1,900 MH (the related utility costs amount to P27,000)

1)
VC/MH = TCH.P. – TCL.P.
A.L.H.P. – A.L.L.P.

= P62,000 – P27,000
4,700 MH – 1,900 MH

= P35,000
2,800MH

= P12.50/MH

Where:

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 TCH.P. = Total Cost at Highest Point
TCL.P. = Total Cost at Lowest Point
A.L.H.P. = Activity Level at Highest Point
A.L.L.P. = Activity Level at Lowest Point

2)
TVC H.L. = MHH.L. x VC/MH

= 4,700 MH x P12.50/MH

= P58,750

TVC L.L. = MHL.L. x VC/MH

= 1,900 MH x P12.50/MH

= P23,750

3)
TFC H.L. = TC – TVCH.L.

= P62,000 – P58,750

= P3,250

4)
Y = a + bx

Y = P3,250 + P12.50x

Problem II:

Los Angeles Company wants to conduct an analysis of the behavior of the maintenance cost of its factory
equipment in relation to the number of units produced using such equipment. Historical cost and
production data were gathered for the past 10 months.

Month Maintenance Cost Units Produced

March P 2,750 450
April 2,250 200
May 5,000 700
June 3,500 700
July 4,000 600
August 3,250 400
September 4,500 800
October 125 25
November 2,500 350
December 3,000 300

Required: Compute for the variable maintenance cost per unit and monthly fixed cost using high-low
method.

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Least-Squares Method

Least-squares method is a statistical technique that investigates the association between

dependent and independent variables. This method determines the line of best fit for a set of observations
by minimizing the sum of the squares of the vertical deviations between actual points and the regression
line.

 If there is only one independent variable, the analysis is known as SIMPLE REGRESSION.

 If the analysis involves multiple independent variables, it is known as MULTIPLE

REGRESSION.
In the method of least squares, the deviation is the difference between the predicted and actual costs.

Formula:
∑y = na + b∑x
∑xy = a∑x + b ∑x²
Where:

∑y = Sum of total costs of all samples

n = No. of samples
a = Total fixed costs (one of the amounts to be computed)
b = Variable cost per unit (one of the amounts to be computed)
∑x = Sum of activity levels of all samples
∑xy = Sum of total costs multiplied by activity levels of all samples
∑x² = Sum of activity levels squared of all samples

Illustration: Least-Squares Method

The following activity and cost data that were provided by Kenny Corp. would help in estimating its
future maintenance costs:
Units Maintenance Cost
3 P 450
7 530
11 640
15 700

Using the least-squares regression method, the expected total cost for an activity level of 10 units would
be:

Solution:

∑y = na + b∑x
∑xy = a∑x + b ∑x²

x = No. of units
y = Total maintenance cost
n = No. of samples (4)

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 x y xy x²
3 P 450 P 1,350 9
7 530 3,710 49
11 640 7,040 121
15 700 10,500 225
36 P2,320 P22,600 404

∑y = na + b∑x
∑xy = a∑x + b ∑x²

P2,320 = 4a + 36b
P22,600 = 36a + 404b

 Eliminate either “a” or “b” in the lower equation by multiplying each of the amounts in the equation
by an amount that will lead to the elimination of either “a” or “b”.

[P2,320 = 4a + 36b] -9 ⇨ “a” is preferred to be eliminated first because this is lower than “b”

P22,600 = 36a + 404b

As a result;

-P20,880 = -36a - 324b

P22,600 = 36a + 404b
P1,720 = 80b
b = P1,720/80
b = P21.50

 At this point, “b” is already determined as P21.50. Next step is to determine the value of “a” by
substituting P21.50 to b at any of the two equations above.

P2,320 = 4a + 36b ⇨ This equation is preferable since it is the equation that has lower values.

As a result;

P2,320 = 4a + 36(P21.50)

P2,320 = 4a + P774

By process of interpolation;

P2,320 – P774 = 4a
P1,546 = 4a
a = P1,546/4
a = P386.50

Y = a + bx
= P386.50 + P21.50(10)
= P386.50 + P215

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 = P601.50

Illustration: High-Low vs. Least-Squares Method

Green Company’s total overhead costs at various levels of activity are presented below:

Month Machine Hours Total Overhead Costs

March 500 P 970
April 400 851
May 600 1,089
June 700 1,208

The breakdown of the overhead costs in April at 400 machine hour level of activity is as follows:

Supplies (variable) P 260

Salaries (fixed) 300
Utilities (mixed) 291
Total P 851

Required:

1. Determine how much of June’s overhead cost of P1,208 consisted of utilities cost.
2. Using high-low method, determine the cost function for utilities cost.
3. Using high-low method, determine the cost function for total overhead cost.
4. Using least squares method, determine the cost function for total overhead costs.
5. What would be the total overhead costs if operating level is at 450 machine hours?

Solution and Discussions:

1) Expected to remain constant

VC/MH = P0.65 (P260/400MH)
Supplies (Variable) P 260 Expected to remain constant @ 400 MH (lowest
1) P851 Salaries (Fixed) 300 point) Utilities
(Mixed) 291

P0.65 x 700 MH
Supplies (Variable) P 455 @ 700 MH
P1,208 Salaries (Fixed) 300 Copied from 400 MH (highest
Utilities (Mixed) 453 Balancing figure (P1,208-P455-P300) point)

2) Highest point = 700 MH (P453 total utilities)

Lowest point = 400 MH (P291 total utilities)

VC/MH = P453 – P291

700 - 400

= P162
300

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 = P0.54

Total fixed cost (using the lowest point);

Total Fixed Cost = Total Cost – Total Variable Cost

= P453 – (P0.54 x 700)
= P75

Therefore, the cost function will be:

Y = P75 + P0.54x

3) Let us classify again all the costs.

Classification Total Cost Cost/MH

Supplies Variable Not necessary* P0.65
Salaries Fixed P300 Not necessary*
Utilities Fixed portion P75 Not necessary*
Variable portion Not necessary* P0.54
P375 P1.19

* The cost function “Y = a +bx” means “Total Cost = Total Fixed Cost x (VC/MH x No. of MH**).
Therefore, Total Variable Cost and Fixed Cost/unit is irrelevant to determine in order to have a cost
function.

** MH is the cost driver

Or, simply;

Highest point = 700 units

Lowest point = 400 units
Highest total overhead cost = P1,208
Lowest total overhead cost = P851

VC/MH = P1,208 – P851

700 – 400

= P357
300

= P1.19

TFC = TC – TVC

= P851 – (P1.19 x 400)

= P851 – P476
= P375

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Therefore, the cost function for total overhead cost is:

Y = P375 + P1.19x

4) ∑y = na + b∑x
∑xy = a∑x + b ∑x²

x y xy x²
March 500 P 970 P 485,000 250,000
April 400 851 340,400 160,000
May 600 1,089 653,400 360,000
June 700 1,208 845,600 490,000
Ʃ 2,200 P4,118 P 2,324,400 1,260,000

P4,118 = 4a + 2,200b
P2,324,400 = 2,200a + 1,260,000b

[P4,118 = 4a + 2,200b] -550

P2,324,400 = 2,200a + 1,260,000b

-P2,264,900 = -2,200a – 1,210,000b

2,324,400 = 2,200a + 1,260,000b
P 59,500 = 50,000b
b = P59,500/50,000
= P1.19

P4,118 = 4a + 2,200(P1.19)
P4,118 = 4a + P2,618
P1,500 = 4a
a = P1,500/4
a = P375

Cost function:

Y = P375 + P1.19x

Total overhead costs at 450 machine hours:

Y = P375 + P1.19(450)
= P375 + P535.50
= P910.50

Scattergraph (Scatter Diagram) Method

All observed costs at various activity levels are plotted on a graph. Based on sound judgment, a regression
line is then fitted to the plotted points to represent the line function. Its principal advantage over the high-
low method is that it considers more than two points. The major objective of this method is to develop an
equation to predict future costs.

Engineering Method

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 This method is best used for estimating costs for totally new activities. It can detail each step
required to perform an operation and sometimes can be quite expensive to use.

Account Analysis Method

Each account is classified as either fixed or variable based on experience and judgment of
accounting and other qualified personnel in the organization.

Conference Method

Costs are classified based on opinions from various company departments such as purchasing,
process engineering, manufacturing, employee relations and so on.

EXERCISES

TRUE OR FALSE

1. The portion of an asset’s value on the Statement of Financial Position is referred to as an expired cost. F

2. The portion of an asset that was consumed during a period is referred to an expired cost. T

3. A variable cost remains constant on a per-unit basis as production increases T

4. A fixed cost remains constant on a per-unit basis as production changes. F

5. The relevant range is valid for all levels of activity F

6. An indirect cost can be easily traced to a cost object. F

7. Both accountants and economists view variable costs as linear in nature. F

8. Fixed cost per unit varies directly with production. F

9. Variable cost per unit remains constant within the relevant range. T

10. A cost that shifts upward or downward when activity changes by a certain interval is referred to as a
mixed cost. F

11. A cost that shifts upward or downward when activity changes by a certain interval is referred to as a step
cost. T

12. If the cost of an additive is P5,000 + P0.50 for every unit of solvent produced, the cost is classified as a
mixed cost. T

13. If the cost of an additive is P5,000 + P0.50 for every unit of solvent produced, the cost is classified as a
step cost. F

14. A predictor which has an absolute cause and effect relationship to a cost is referred to a cost driver. T

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 15. A mixed cost will be an effective cost driver. F

16. A variable cost will be an effective cost driver. T

17. Unexpired costs are reflected on the balance sheet. T

18. Expired costs are reflected on the balance sheet. F

19. Distribution costs are an example of product costs. F

20. Distribution costs are an example of period costs. T

FILL-IN THE BLANKS

1. Costs that can be conveniently traced to a cost object are referred to as ____________ costs.
direct
2. Anything for which management wants to accumulate or collect costs is known as a
______________________.
cost object
3. Costs that cannot be conveniently traced to a cost object are known as __________________ costs.

indirect
4. A cost that remains unchanged in total within the relevant range is known as a _____________ cost.

fixed
5. A cost that varies in total in direct proportion to changes in activity is known as a _______________ cost
variable
6. The assumed range of activity that reflects the company’s normal operating range is referred to as the
_____________________________.
relevant range
7. A cost that remains constant on a per unit basis within the relevant range is a
________________________ cost.
variable
8. A cost that varies inversely with the level of production is known as a _______________ cost.
fixed
9. A cost that has both fixed and variable components is known as a __________________ cost.
mixed
10. Another name for inventoriable costs is ______________ costs.
product
11. Consider the regression equation y = a + bX. The portion of the equation that represents fixed costs is
________
ANS: a
12. Consider the regression equation y = a + bX. The portion of the equation that represents the variable rate
is ________.
ANS: b
13. Consider the regression equation y = a + bX. The portion of the equation that represents the activity base
is ________.
ANS: X
14. An observation that is found outside the relevant range is referred to as a(n) ______________.

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 ANS: outlier
15. When a relationship between several independent variables and one dependent variable is analyzed, the
regression is referred to as _____________.
ANS: multiple

16. When a relationship between one independent variable and one dependent variable is analyzed, the
regression is referred to as _____________.
ANS: simple

PROBLEM-SOLVING

Problem 1

Franklin Corporation has the following data relating to its power usage for the first six months of the
current year.

Month Usage (Kw)Cost

January 500 P450
February 550 455
March 475 395
April 425 310
May 450 380
June 725 484

Assume usage is within the relevant range of activity.

Required:

1. Using the high-low method, compute the cost formula.

2. Franklin Corporation estimates its power usage for July at 660 watts. Compute the total power
cost for July.

Problem 2

Charlwin Company provides a personalized training program that is popular with many companies. The
number of programs offered over the last five months, and the costs of offering these programs are as
follows:

Programs Offered Costs Incurred

January 55 P 15,400
February 45 14,050
March 60 18,000
April 50 14,700
May 75 19,000

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Required:

1. Using the high-low method, compute the variable cost per program and the total fixed
cost per month.

2. Using the least squares regression method, compute the variable cost per program and
the total fixed cost per month.

Problem 3

The Rodelio Co. has the following information available regarding costs and revenues for two recent
months. Selling price is P20.

March April
Sales revenue P60,000 P100,000
Cost of goods sold -36,000 - 60,000
Gross profit P24,000 P 40,000
Other expenses:
Advertising P   600 P    600
Utilities 4,200 5,600
Salaries and commissions 3,200 4,000
Supplies (bags, cleaning supplies etc.) 320 400
Depreciation 2,300 2,300
Administrative costs   1,900   1,900
Total -12,520 -14,800
Net income P11,480 P25,200

Required:

1. Identify each of the company's expenses (including cost of goods sold) as being variable, fixed, or
mixed.

2. By use of the high-low method, separate each mixed expense into variable and fixed elements. State
the cost formula for each mixed expense.

3. What is the total cost equation?

4. Estimate the total cost, if sales amount to P75,000.

Problem 4

Apolinario Company owns two luxury automobiles that are used by employees on company business.
Mileage and expenses, excluding depreciation, by quarters for the most recent year are presented below:

Quarter Mileage Expenses

First 3,000 P  550
Second 3,500 560

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 Third 2,000 450
Fourth 3,500 600
12,000 P2,160

Required: Determine the variable cost per mile (nearest tenth of a cent) and the fixed costs per quarter,
using the method of least squares.

Cost Accounting Cycle

Types of Manufacturing Costs:

1) Direct Materials

These refer to materials used in the manufacturing process that become a significant part of the
finished goods. Examples are wood to manufacture a table, flour to bake cakes, glass to produce
windows. Not all materials used to produce a product are considered direct because it depends on
the significance of the materials for the production of a product. Materials which are not
considered direct materials are classified as indirect materials which are part of another
manufacturing cost, factory overhead.

2) Direct Labor

These are salaries paid to employees who work directly with the raw materials in converting them
to finished goods. Examples are those who are paid to manufacture the table, to bake the cakes
and to make the windows. Therefore, salaries of those employees who are not working directly to
the products are not direct labor.

3) Factory Overhead

All costs incurred in the factory that cannot be considered as direct materials or direct labor are
considered factory overhead. Sometimes called manufacturing overhead, manufacturing
expenses, or factory burden. Manufacturing overhead is usually subdivided into three categories:

a. Indirect Materials – Materials that are used in small amounts in the manufacturing process or
that cannot easily be traced to specific products. Examples are nails and sandpapers used to
produce furniture.

b. Indirect Labor – Wages of factory personnel who do not work directly on raw materials. An
example is the salary of factory supervisor.

c. Other Manufacturing Overhead – Includes payroll taxes on factory wages, rent on factory
building, depreciation of factory building, insurance on factory building and machinery, heat,
light and power; repairs and maintenance of machinery and equipment, etc. Many of these
relate to physical plant (building, machinery, and equipment).

Prime Cost

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 Prime cost reflects the primary sources of costs for units in production. It is the sum of direct
materials and direct labor.

Conversion Cost

Conversion cost indicates the costs required to convert the raw materials into finished products. It
is the sum of direct labor and factory overhead.

Inventories for a Manufacturing Company

1. Raw Materials Inventory

This inventory represents the materials still unused at the end of a period.

2. Work in Process Inventory

This inventory represents the cost of goods placed in the production but not yet finished at the
end of the period. Cost of goods means the costs of raw materials, labor and overhead incurred in
the production of goods. This is also called as Goods in Process Inventory.

3. Finished Goods Inventory

This inventory represents the cost of goods already manufactured during a period but not yet sold
at the end of the period.

Systems of Cost Accumulation

1. Actual Cost System

This system uses the “actual” costs of materials, labor and factory overhead in determining the
total cost of a product.

2. Standard Cost System

This system uses the “standard” or predetermined costs of materials, labor and factory overhead
in determining the total cost of a product.

3. Normal Cost System

This system uses actual cost of materials, actual cost of labor and applied factory overhead in
determining the total cost of a product.

Question:

What is the difference between actual and applied overhead?

Answer:

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Actual factory overhead is the factory overhead “actually” incurred during a period while applied factory
overhead is measured using a pre-determined or application rate multiplied by the actual activity level or
cost driver for a period.

Predetermined/ = Budgeted annual factory overhead

application rate Budgeted annual activity level

The commonly used activity levels in computing predetermined overhead rate are:

1. Units produced
2. Direct labor hours
3. Direct labor costs
4. Machine hours
5. Material costs

Recording Transactions of a Manufacturing Company

Transactions Pro-forma Entry

1 Acquisition/purchase of raw materials Raw materials xx
Cash/Accounts payable xx

2 Return of materials to supplier Cash/Accounts payable xx

Raw materials xx

3 Issuance of raw materials to production

a. Direct materials Work in process xx
FOH-control xx
b. Indirect materials Raw materials xx

4 Return of excess materials from Raw materials xx

production department Work in process xx
FOH-control xx

5 Payroll for a specified period

Payroll xx
xx
Withholding tax payable
SSS contributions payable
xx
PHILHEALTH cont.
payable
xx
PAG-IBIG cont. payable
xx
Accrued payroll
xx

6 Employer’s share for contributions FOH-control xx

Selling expense xx
Administrative expense xx
SSS contributions payable xx
PHILHEALTH cont. xx
payable xx

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 PAG-IBIG cont. payable

7 Distribution of payroll Work in process xx

Factory overhead-control xx
Selling expense xx
Administrative expense xx
Payroll xx

8 Payment of payroll
Accrued payroll xx
Cash xx

9 Remittance of payroll deductions Withholding tax payable xx

SSS contributions payable xx
PHILHEALTH cont. payable xx
PAG-IBIG cont. payable xx
Cash xx

10 Incurrence of various overhead, other Factory overhead-control xx

than indirect labor and indirect materials Accumulated depreciation xx
- Depreciation of factory plant & equipment Prepaid insurance xx
- Maintenance of factory plant & equipment Various accounts xx
- Insurance of factory plant & equipment
- Power, light and water

11 Overhead is applied to production Work in process xx

Factory overhead-control xx

12 Completion of goods put into process Finished goods xx

Work in process xx

13 Sale of goods on account Accounts receivable xx

Sales xx

Cost of goods sold xx

Finished goods xx

Discussions:

1) Manufacturing companies usually use the perpetual inventory system. Under perpetual inventory
system, every physical flow of inventories, inflow or outflow must be recorded using the appropriate
inventory account. Therefore, at the time the materials are purchased, the Raw Materials account is
debited instead of Purchases account which is used in the other system, periodic inventory system.

2) In case of returns of materials purchases, the entry is simply to reverse the entry made in the materials
purchases.

3) If the raw materials are issued to production, this means that these are no longer raw materials and the
Raw Materials account should be credited and debited to Work in Process account if the materials
issued are direct materials and Factory Overhead-Control account if the materials are indirect.

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 4) Issuing of materials to production does not necessarily mean that these will be immediately used.
Therefore, there are some instances that after the issuance, some materials are returned to materials
stockroom and the entry to record this transaction is simply reverse the entry made in the issuance.

5) A payroll serves as a list of employees of a company that will be given salaries for a period. This
includes the gross salary, payroll deductions such as withholding taxes, contributions to SSS,
PHILHEALTH and PAG-IBIG and the net salary. It also includes the employer’s share for SSS,
PHILHEALTH and PAG-IBIG. Payroll account is debited for an amount representing the total gross
pay of all employees, whether they are related to manufacturing, sales or administrative functions.
Withholding tax, SSS, PHILHEALTH and PAG-IBIG Contributions payable accounts are credited at
amounts equal to the “employee” share. Note that the Accrued Payroll account credited represents the
net pay.

6) Employer’s share for the salaries’ deductions is expense on the part of the company. Therefore,
expense accounts such as are debited to record this transaction depending on the nature of the expense.
If the employer’s share relates to the salaries of factory employees, Factory Overhead-Control account
is debited. If this relates to the salaries of employees related to sales functions, Selling Expense is used
and if this relates to the salaries of employees related to administrative functions, Administrative
Expense is debited.

7) Distribution of payroll means proper classifying the Payroll account. At the time the salaries/wages are
incurred, the Payroll account is debited that represents the total salaries of all employees of the
company at gross amounts. But it must be subsequently classified if these are related to the salaries of
manufacturing, sales or administrative personnel. Salaries of manufacturing personnel, if directly
working on the product (direct labor) must be debited to Work in Process account. Salaries of
manufacturing personnel, if not directly working on the product (indirect labor) must be debited to
Factory Overhead-Control account. Salaries of sales personnel are debited to Selling Expense and the
salaries of personnel related to administrative functions are debited to Administrative Expense.

8) Once the salaries of employees are paid, the Accrued Payroll account must be debited by the amount
equivalent to the payment.

9) The payroll process includes withholding of payroll deductions and incurrence of employer’s
contributions. These deductions are withheld from the salaries of employees but these should
subsequently be remitted to corresponding government agencies such as BIR, SSS, PHILHEALTH
and PAG-IBIG. At the time these were withheld/incurred, the entry was a credit to each of the
appropriate liability accounts. Therefore, at the time of their remittance, the entry must be a debit in
order to close those liabilities and credit cash to represent the payment.

10) All factory overhead items actually incurred during a period shall be debited to factory overhead-control
account. The accounts credited depend on the specific account incurred. For instance, the pro-forma
entry includes a credit to Accumulated Depreciation account because the factory overhead item is
related to depreciation and the entry to record depreciation is debit Depreciation Expense and credit
Accumulated Depreciation. In short, the account debited is the only account that should be substituted
by factory overhead-control account and the credit should be the same.

11) The pro-forma entry shows that the company uses actual costing because the account credited is factory
overhead-control account. The amount that is credited to this account is equivalent to the sum of all
factory overhead actually incurred during a period. Alternatively, if a company uses normal costing,
factory overhead-applied is credited.

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12) Once the goods placed in production are already completed, the entry is to credit WIP and to debit FG
to reclassify the inventory from “in process” to “finished”.

13) Accounts Receivable is debited and Sales account is credited by an amount equivalent to the sales price
of the goods sold. Finished Goods account is credited by an amount equal to the cost of goods sold
because the goods are already sold and are no longer in the possession of the company.

Illustration:

Given the following information for Tiffany Corporation, prepare the necessary journal entries, assuming
that the Raw Material Inventory account contains both direct and indirect material.

a. Purchased raw materials on account, P28,500.

b. Issued materials to production: P15,000 of direct materials and P3,000 of indirect materials.
c. Accrued payroll of P90,000, of which 70 percent was direct and the remainder was indirect.
d. Incurred and paid other overhead items, P36,000.
e. Completed goods costing P86,500.
f. Sold goods costing P71,300 on account for P124,700.

Solution:

a. Raw Materials 28,500

Accounts Payable 28,500

b. Work in Process 15,000

Factory Overhead-Control 3,000
Raw Materials 18,000

c. Work in Process 63,000

Factory Overhead-Control 27,000
Salaries/Wages Payable 90,000

d. Factory Overhead-Control 36,000

Cash 36,000

e. Finished Goods 86,500

Work in Process 86,500

f. Accounts Receivable 124,700

Sales 124,700

Cost of Goods Sold 71,300

Finished Goods 71,300

Pro-forma Cost of Goods Sold Statement for Manufacturing Companies:

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 Raw materials, beginning xxx
Raw materials net purchases xxx
Raw materials available for use xxx
Raw materials, end ( xxx )
Raw materials used xxx
Direct labor xxx
Factory overhead xxx
Total manufacturing cost xxx
Work in process, beginning xxx
Total work placed in process xxx
Work in process, end ( xxx )
Cost of goods manufactured xxx
Finished goods, beginning xxx
Total goods available for sale xxx
Finished goods, end ( xxx )
Cost of goods sold xxx

Illustration:

Prepare a Schedule of Cost of Goods Statement (in good form) for the Graves Company from the
following information for June 2020:

Inventories Beginning Ending

Raw Material P 6,700 P 8,900
Work in Process 17,700 22,650
Finished Goods 29,730 19,990

Additional information: purchases of raw materials were P46,700; 19,700 direct labor hours were worked
at P11.30 per hour; overhead costs were P33,300.

Solution:

Raw materials, beginning P 6,700

Raw materials purchases 46,700
Raw materials available for use P 53,400
Raw materials, end ( 8,900 )
Raw materials used P 44,500
Direct labor (19,700 hrs x P11.30/hr) 222,610
Factory overhead 33,300
Total manufacturing cost P 300,410

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 Work in process, beginning 17,700
Total work placed in process P 318,110
Work in process, end ( 22,650 )
Cost of goods manufactured P 295,460
Finished goods, beginning 29,730
Total goods available for sale P 325,190
Finished goods, end ( 19,990 )
Cost of goods sold P 305,200

Over and Under-applied Factory Overhead

Over or under-applied factory overhead is the difference between the actual and applied factory overhead.
If the factory overhead applied during a period is higher than the actual, it is said to be over-applied and
under-applied if applied is lower than the actual. This account is just a temporary account and will
eventually be closed at the end of a period. This over or under-applied factory overhead can be material
(significant) or immaterial (insignificant) in relation to cost of goods sold and the inventory accounts. If
immaterial, the over or under-applied factory overhead is closed to cost of goods sold only. But if the
over or under-applied overhead is material, it is closed to cost of goods sold and appropriate inventory
accounts.

Question: What are these appropriate inventory accounts?

Answer: Work in Process and Finished Goods Inventory only. Materials Inventory account is not
included because the application process of factory overhead comes first through Work in Process
Inventory account. Raw Materials Inventory has nothing to do with the applied FOH.

Work in Process xx
Factory Overhead-Applied xx

Note that actual factory overhead is the sum of all factory overhead-control debited during a period and
the normal balance of factory overhead-applied is credit.

Pro-forma entries for closing over or under-applied factory overhead:

1) Immaterial under-applied factory overhead

Factory overhead-applied xx
Cost of goods sold xx
Factory overhead-control xx

2) Immaterial over-applied factory overhead

Factory overhead-applied xx
Cost of goods sold xx
Factory overhead-control xx

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3) Material under-applied factory overhead

Factory overhead-applied xx
Cost of goods sold xx
Work in process xx
Finished goods xx
Factory overhead-control xx

4) Material over-applied factory overhead

Factory overhead-applied xx
Cost of goods sold xx
Work in process xx
Finished goods xx
Factory overhead-control xx

If the over or under-applied factory overhead is material, this amount is closed not only to Cost of Goods
Sold but also to Work in Process and Finished Goods allocated based on the amounts of factory overhead
applied to each of COGS, WIP and FG if still possible to determine. But if this is not determinable, the
allocation should be based on the balances of COGS, WIP and FG.

Illustration:

Venus Corporation has the following data for the current year:

Direct Labor P 220,000

Direct Material 137,800
Actual Overhead 320,000
Applied Overhead 395,000
Raw Material 51,394
Work in Process 101,926
Finished Goods 111,192
Cost of Goods Sold 250,182

Required:

1. Compute the amount of under- or overapplied overhead.

2. Prepare the necessary journal entry to dispose of under- or overapplied overhead.

Solution:

Applied Overhead P395,000

Actual Overhead 320,000
P 75,000 overapplied

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Since, the amounts of factory overhead applied to COGS, WIP and FG are not determinable, the
allocation is based on the balances of those accounts.

WIP P101,926/P463,300 x P75,000 = P16,500

FG P111,192/P463,300 x P75,000 = P18,000
COGS P250,182/P463,300 x P75,000 = P40,500
P463,300 P75,000

Factory Overhead-Applied P75,000

Work in Process P16,500
Finished Goods 18,000
Cost of Goods Sold 40,500

EXERCISES

PROBLEM-SOLVING

Problem 1

Instruction: Determine whether each of the following costs should be classified as direct materials (DM),
direct labor (DL), or factory overhead (FOH).

1. Depreciation on factory equipment

2. Wages paid to assembly line workers
3. Factory rent
4. Depreciation of pencil painting machinery
5. Lead inserted into pencils
6. Wages of assembly line worker
7. Factory machinery maintenance
8. Wood used to manufacture furniture
9. Eraser compound
10. Steel used in manufacturing product.
11. Insurance on factory building.
12. Rivets and screws used in production.
13. Tires used in manufacturing vehicles.
14. Nails and glue used in production
15. Cabinet maker's wages
16. Factory supervisors’ salaries
17. Depreciation on factory machines
18. Factory utilities
19. Property taxes on the factory building
20. Insurance on factory equipment

Problem 2

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Manny Manufacturing Company has the following data at June 30, 2020:

Raw materials inventory, June 1 P 13,800

Work in process inventory, June 1 18,100
Finished goods inventory, June 1 43,500
Total manufacturing costs 510,000
Sales 590,000
Work in process inventory, June 30 30,400
Finished goods inventory, June 30 50,200
Raw materials inventory, June 30 18,000

Required: Prepare an income statement through gross profit for the month of June.

Problem 3

The following information is for the Rayne Manufacturing Company for November.

Inventories Beginning Ending

Raw Material P 17,400 P 13,200
Work in Process 31,150 28,975
Finished Goods 19,200 25,500

Direct Labor (21,000 DLH @ P13)

Raw Material Purchases P 120,000
Indirect Labor 11,200
Factory Supplies Used 350
Other Expenses:
Depreciation – Factory Equipment 17,300
Insurance – Office Building 2,570
Office Supplies Expense 900
Insurance – Factory Building 1,770
Depreciation – Office Equipment 3,500
Repair & Maintenance – Factory Equipment 7,400

Required: Prepare a Statement of Cost of Goods Sold.

Problem 4

Selected data concerning the past fiscal year’s operations (000 omitted) of the Clark Manufacturing
Company are presented below:
Inventories
Beginning Ending
Raw materials P75 P 85
Work in process 80 30
Finished goods 90 110

Other data:

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 Raw materials used P 326
Total manufacturing costs incurred (FOH is applied at
a rate of 60% of DL) 686
Cost of goods available for sale 826
Selling and general expenses 25

Required: Compute for the following:

1. Cost of raw materials purchased during the year. P336

2. Direct labor costs charged to production during the year. P225
3. Cost of goods manufactured. P736
4. Cost of goods sold. P716

Problem 6

The following events took place at the Dreams Company for the current year:

 Purchased P120,000 in direct materials

 Incurred labor costs as follow:
a. Direct labor, P72,000
b. Supervisor labor, P26,000 (part of FOH)
 Purchased manufacturing equipment for P94,000
 Other manufacturing overhead excluding supervisor labor, was P88,000
 Transferred 80% of the materials to the manufacturing assembly line
 Completed work on 70% of the goods in process. Costs are assigned equally across all work in
process
 Sold 60% of the completed goods

There were no beginning balances in the inventory accounts. All costs incurred were debited to the
appropriate account and credited to accounts payable.

Required: Compute for the following:

1. Ending balance of direct materials inventory. P24,000

2. The amount of cost of goods sold. P118,440

Problem 7

In June 2020, the Graves Company has Cost of Goods Manufactured of P296,000; beginning Finished
Goods Inventory of P29,730; and ending Finished Goods Inventory of P19,990. The following additional
information is available:

Selling Expenses P 40,500

Administrative Expenses 19,700
Sales 475,600

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Required: Prepare an income statement in good form.

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