Chapter 2

Cost Concepts and the Cost Accounting Information System

Discussion Questions
1) (a) Cost is the current monetary value of economic
resources given up or to be given up in obtaining
goods and services. Economic resources may be
given up by transferring cash or other property,
issuing capital stock, performing services, or
incurring liabilities. Costs are classified as unexpired
or expired. Unexpired costs are assets and apply to
the production of future revenues. Examples of
unexpired costs are inventories, prepaid expenses,
plant and equipment, and investments. Expired costs,
which most costs become eventually, are those that
are not applicable to the production of future
revenues and are deducted from current revenues or
charged against retained earnings. Expense in its
broadest sense includes all expired costs; i.e., costs
which do not have any potential future economic
benefit. A more precise definition limits the use of the
term expense to the expired costs arising from
using or consuming goods and services in the process
of obtaining revenues; e.g., cost of goods sold and
marketing and administrative expenses.
(b) (1) Cost of goods sold is an expired cost and may
be referred to as an expense in the broad sense of the
term. On the income statement, it is most often
identified as a cost. Inventory held for sale which is
destroyed by an abnormal casualty should be
classified as a loss. (2) Uncollectible accounts
expense is usually classified as an expense. However,
some authorities believe that it is more desirable to
classify uncollectible accounts as a direct reduction
of sales revenue (an offset to revenue). An
uncollectible account which was not provided for in
the annual adjustment, such as bankruptcy of a major
debtor, may be classified as a loss. (3) Depreciation
expense for plant machinery is a component of
factory overhead and represents the reclassification
of a portion of the machinery cost to product cost
(inventory). When the product is sold, the
depreciation becomes a part of the cost of goods sold
which is an expense.
Depreciation of plant machinery during an unplanned
and unproductive period of idleness, such as during a
strike, should be classified as a loss. The term
expense should preferably be avoided when
making reference to production costs. (4)
Organization costs are those costs that benefit the
firm for its entire period of existence and are most
appropriately classified as a noncurrent asset. When
there is initial evidence that a firms life is limited,

the organization costs should be allocated over the

firms life as an expense or should be amortized as a
loss when a going concern foresees termination. In
practice, however, organization costs are often
written off in the early years of a firms existence. (5)
Spoiled goods resulting from normal manufacturing
processing should be treated as a cost of the product
manufactured.
When the product is sold, the cost becomes an
expense. Spoiled goods resulting from an abnormal
occurrence should be classified as a loss.
2) Cost objects are units for which an arrangement is
made to accumulate and measure cost. They are
important because of the need for multiple
dimensions of data (e.g., by product, contract, or
department) to accomplish the various purposes of
cost accounting, including cost finding, planning, and
control.
3) A cost system is a combination of procedures and
records designed to provide the various types of
information required in the conduct of the enterprise;
including cost finding, planning, and control.
4) A good information system requires the
establishment of (a) long-range objectives; (b) an
organization plan showing delegated responsibilities
in detail; (c) detailed plans for future operations, both
long- and short-term; and (d) procedures for
implementing and controlling these plans.
5) A chart of accounts is necessary to classify
accounting data, so that the data may be uniformly
recorded in journals and posted to the ledger
accounts.
6) Advantages of the electronic data processing
system for record keeping are: speed, larger storage,
single entry of multiple transactions, automatic
control features, and flexibility in report formats.
7) Costs are most commonly classified based on their
relationship to (a) the product (a single batch, lot, or
unit of the good or service); (b) the volume of
activity; (c) the manufacturing departments,
processes, cost centers, or other subdivisions; (d) the
accounting period; (e) a proposed decision, action, or
evaluation.
8) Indirect materials are those materials needed for
the completion of the product but whose consumption

is either so small or so complex that their treatment

as direct materials would not be feasible. For
example, nails used to make the product are indirect
materials.
9) Indirect labor, in contrast to direct labor, is labor
expended that does not affect the construction or the
composition of the finished product. For example, the
labor of custodians is indirect labor.
10) (a) A service department is one that is not directly
engaged in production, but renders a particular type
of service for the benefit of other departments.
Examples of service departments are receiving,
storerooms, maintenance, timekeeping, payroll, and
cafeteria. (b) Producing departments classify their
share of service department expenses as indirect
overhead expenses.
11) (a) Capital expenditures are intended to benefit
more than one accounting period.
The expenditures should therefore be recorded by a
charge to an asset account for allocation to the
periods benefited. Revenue expenditures benefit the
operations of the current period only.
They should be recorded by charges to the
appropriate expense accounts. (b) If a capital
expenditure is improperly classified as an expense,
assets, retained earnings, and income for the period
will be understated. In future periods, income will be
overstated by any amount that would have been
amortized had the expenditure been properly
capitalized. Assets and retained earnings will be
understated on future balance sheets by successively
smaller amounts until the error has been fully
counterbalanced. If revenue expenditure is
improperly capitalized, assets, retained earnings, and
income for the period will be overstated. Income will
be understated in subsequent periods as the
improperly capitalized item is charged to the
operations of those periods. Assets and retained
earnings will continue to be overstated in subsequent
balance sheets by successively smaller amounts until
the improperly capitalized item has been completely
written off. (c) The basic criterion for classifying
outlays as revenue or capital expenditures is the
period of benefit. The amount of detail necessary to
maintain subsidiary records, the materiality of the
expenditures, and the consistency with which various
expenditures recur from period to period are other
criteria generally considered in establishing a
capitalization policy. Firms frequently establish an
arbitrary amount below which all expenditures are
expensed, irrespective of their period of benefit. The

level at which this amount is set is determined by its

materiality in relation to the size of the firm. The
objective of such a policy is to avoid the expense of
maintaining excessively detailed subsidiary records.
Expenditures for items that fall below the set amount
but are material in the aggregate should be
capitalized, if total expenditures for these items vary
significantly from period to period. A capitalization
policy that reasonably applies these criteria, although
it disregards the period of benefit and is therefore
lacking in theoretical justification, will not
significantly misstate periodic income.
12) The five parts are:
Direct material
Direct labor
Factory overhead
Work in process inventories
Finished goods inventories
13) The balance sheet is a statement of financial
position, whereas income stamen is a stamen of
activities. The income statement is a complementary
to the balance sheet, accounting in particular for the
change in the equity as a result of operations during
the year. In that respect, the income statement s
essentially nothing more than a major section of the
retained earnings account, therefore the revenue and
expenses account in the income statement have been
termed explanatory accounts, explaining the ebb
and flow of revenues and expenses that lead to the
new income (loss) and to the new retained earnings
balance in the balance sheet.
14) The ordinary balance sheet and income statement
are intended to provide information as to financial
position and results of operations of a business in
accordance with several assumptions which are made
in preparing the statements. From the standpoint of
the criticism made, the most important of these
assumptions are that cost less appropriate
amortization of cost measures unexpired cost, and
that a business may be assumed may be going to
continue operations indefinitely into the future.
Accounting statements are usually prepared on the
theory that a sale or some other definite event is
essential before revenue is recognized. Basically the
asset side of balance sheet contains a presentation of
the amount of cost incurred which can be presumed
to benefit future periods. An income statement
presents the amount of revenue recognized as having
been realized during the period, less the portion of all
costs incurred which does not appear to be fairly
deferrable to future periods.

Exercises
E-1
1- Identify the conversion cost per unit
Conversion cost = Direct labor + factory Over head
= 20 + (15+6) = 41 /- units
2- Identify the prime cost
Prime cost= direct material + Direct labor
= 32 + 20 = 52 /-units
3- Determine the estimated total variable cost per unit
= 32+20+15+3 = $70
4- Total cost for production 12,000 units and sale 8,000 units:
(($32 + $20 +$15 + $6 + $4) 12,000) + ($3 8,000)
= $924,000 + $24,000
= $948000
E-2
Determine Mercado Companys expected operating income or loss
for 19B.
Sale decease to 15%

Rs

19950,000 15%
1950,000 2992500

16957500

Less: cost of goods sold

Fixed cost

7623000

Variable cost (W)

9835350

1745835

Net loss

(500850)

(w) Variable cost varies with sales

VC

Sales

19A

11571000

1950,000

19B

16957500

1950,000 x = (1157100) (1695750)

x = 9835350
E- 3:

Crockett Company
Cost of Goods Sold Statement
For The Year Ended On Dec, 31B
Rs.

Rs.

Direct Material
Material Opening
Add: purchases (Net)
Add: Freight in
2432000
Material available for use
2608000
Less: Material Ending
196000
Direct Material used
2412000
Add: Direct Labor
3204000
Add: Factory Overhead
188560O
Total current manufacturing cost
7501600
Add: Work - in process opening
129800
Cost of goods available for manufacturing
7631400
Less: Work - in process ending
136800
Cost of goods manufactured
7494600
Add: Finished goods opening
620,000

176000
2400,000
32000

Cost of goods available for sale

8114600
Less: Finished goods ending
567400
Cost of goods sold
7547200

E- 4 Prepare journal entries for above transactions.

JOURNAL

Dr. Rs.

Cr.

Rs.
1- Work - in process
24500
Factory overhead
4500
Material
_____________________________
2- Payroll
44000
Accrued payroll
Income tax withheld
FICA tax at 7.5%
Accrued payroll
33700
Cash
___________________________
3- Work- in process
30,000
Factory Overhead
6000
Marketing expenses
8000
Payroll
Factory overhead
4932
Marketing expenses
1096
Unemployment Insurance
Federal unemployment
FICA Tax payable
Working
Total cost =2376+352+3500 = 6028
FOH (direct & indirect labour)
=6028+36000/44000 = 4932
Marketing expenses
=60288000/44000= 1096

29000
33700
7000
33000
33700

44000

2376
352
3500

4- Factory overhead
7500
Voucher payable
7500
____________________________________
5- Work - in process
22932
Factory overhead applied
22932
____________________________________
6- Finished goods
60,000
Work - in process
60,000
____________________________________
7- Material
50,000
Voucher P/A
50,000
____________________________________
8- Cost of goods sold
20,000
Finished goods
20,000
Account Receivable

26000

Sales
_____________________________________

26000

E-5

Dr

Date
(a)

Particulars
Material

Cr
Rs.

120,000
Account payable

(b)

Payroll

120,000
90,000

FICA Tax payable

6750

Income Tax payable

15750

Accrued payroll

675000

Work in process

45,000

Factory overhead

9,000

Marketing expenses

15,000

Administrative expenses

21,000

Payroll
(c)

Material

90,000
26250

Account payable
(d)

Rs.

26250

Factory overhead

6156

Marketing expenses

1710

Administrative expenses

2394

State unemployment

2790

Federal unemployment

720

FIACA Tax

6750

(working)
Total cost = 10260
W.I.P = 10260(54000)/90,000
=6156
Mark. Exp = 10260(15000)/90,000
=1710
Admin exp = 1026(21000)/90,000
=2394
(e)

Work in process

60,000

Factory overhead

15,000

Marketing expenses

4,500

79500

Material
(f)

Account payable

900

Material
(g)

900

Account payable

75000

Accrued payroll

67500
142500

Cash
(h)

Factory overhead

1000
Accumulated Depreciation

1000

-Machinery
(i)

Factory overhead

9600
Account payable

(j)

Finished goods

9600
126000

Work in process

126000

(k)

Cost of goods sold

96000
Finished goods

96000

Account receivable

150,000
Sales

(l)

150,000

Factory over head

38056
Account payable

E-6

Dr

Date
(a)

38056

Particulars

Rs.

Work in process

18500

Factory overhead

2800

Material
(b)

Finished goods

51000

Material

51000
32000

Account payable
(d)

Rs.

21300

Work- in- process

(c)

Cr

Payroll

32000
50,000

FICA Tax payable

3750

Federal Income Tax payable

8750

State Income Tax payable

2500

Accrued payroll

35000

(working)
Let total payroll = 100
Accrued payroll = 100- 7.5- 17.5-5
=70%
Accrued payroll

35,000
Cash

(e)

35000

Work- in- process

27500

Factory over head

9000

Marketing expenses

8500

Administrative expenses

5,000

Payroll
(f)

50,000

Factory over head

5000

Marketing expenses

1165

Administrative expenses

685

FICA tax payable

3750

Federal unemployment tax

400

p/a

2700
State unemployment tax

p/a

(working)
Total = 6850
F-O-H = 685036500/50,000
=5,000
Marketing exp = 68508500/50,000
= 1165
Admin exp = 68505,000/50,000
= 685
(g)

Factory overhead

11300
Accumulated Depreciation-

9450

Equip

600
Prepaid insurance

1250

Account payable
(h)

Work in process

28100.50
Factory overhead applied

(i)

Account receivable

28100.50
92120

Sales
(j)

Cost of goods sold

92120
65800

(92120100/140)Finished goods
Cash A/C

65800
76000

Account receivable

76000

E-7
Tuornton Company
Cost of goods manufactured statement
For the month of October, 19A
Direct Material

Rs.

Opening Inventory

16200

Add: purchases

29,000

Cost of material available

36200

Less: closing Inventory

17000

Cost of material used

Add: Direct labour
Prime cost
Add: Factory overhead
Current manufacturing cost
Add: Work in- process Opening
Cost of goods to be manufactured

Rs.

19200
16500
35700
8580
44280
3600
47880

Less: Work-in-process closing

7120

Cost of goods manufactured

40760

E-8
Pensacola Corporation
Cost goods sold statement
For the year ended.
Direct material

Rs.

Opening inventory

88,000

Add: Net purchases

366,000

Add: Direct expenses

6,600

Cost of material available

460,600

Add: closing inventory

64,000

Rs.

Cost of material used

396600

Add: Direct labour

523600

Prime cost

920200

Add: Factory overhead (468,400+104,400)

572800

Current Manufacturing cost

149300

Work in process
Add: Opening inventory

29800

Cost of goods to be manufactured

1522800

Less: closing inventory

38800

Cost of goods manufactured

1484000

Finished goods
Add: opening inventory

54200

Cost of goods available for sale

1538200

Less: closing inventory

66000

Cost of goods sold

1472200

Problems
P-1
Mat. Company
Cost of goods manufactured statement
For the month of March,
Direct Material

Rs.

Opening inventory

20,000

Add: purchases

110,000

Cost of material available for use

130,000

Less: closing inventory

26,000

Direct material used

Rs.

104,000

Direct Labour:
Add: Direct Labour cost
Prime cost

160,000
264,000

Factory overhead:
Add: Factory Overhead

80,000

Current manufacturing cost

344,000

Work in process:
Add: Opening inventory

40,000

Cost of goods to be manufactured

384,000

Less: closing inventory

36,000

Cost of goods manufactured

348,000

Finished good:
Add: Opening inventory

102,000

Cost of goods available for sale

450,000

Less: closing inventory

105,000

Cost of goods sold

345000

(Working)
F-O-H = 50% of direct labour
= direct labour50/100
Current manufacturing cost = Direct material + direct labor +
factory Overhead
344,000 = 104,000+ x +(x 50/1000)
344,000 104,000 = x + 50x/100
240,000 = 100x + 50x/100
240,000 100/150 = x
160,000 = x
(a)
(b)
(c)

cost of goods manufactured = 348,000

prime cost = 264,000
conversion cost = direct labour + F-O-H
= 160,000 + 80,000
= 240,000

P-2
Company - A
Rs.
Cost of goods manufactured

380000

Finished goods:
Add: opening inventory

600,000

Cost of goods available for sale

4400,000

Less: closing inventory

1200,000

Cost of goods sold

3200,000

(Working)
Cost of goods sold = sale -- G.P
= $ 4000,000 -- (40, 00,000 20/100)
= $ 320,000
Company-B
Rs.
Cost of goods available for sale
1490,000
Less: Finished goods closing
190,000
Cost of goods sold
00,000

13,

P 2 (cont.)
Company-C
Rs.
Sales
Less: cost of goods sold
Gross profit
(Working)
$
Cost of goods manufactured
340,000
Add: Finished goods opening
45,000
Cost of goods available for sale
385,000
Less: Finished goods closing
52,000
Cost of goods sold
333,000

429,000
333,000
96,000

P-3
(1)
Material A/C
Bal. b/d
20,000
A/P
65,000

85,000

W-I-P(Bal)
70,000

Bal. c/d
15,000
85,000

Material issue to production = 70,000

(2)
Payroll A/C
Accrued payroll
6000

W-I-P
6000

6000

6000

Direct labour cost = 6000

(3)
F-O-H A/C
Supplies exp
20000
Ind lab exp
55000
Acc: Dep
10000
Prep Ins
2000

W-I-P (Bal)
100,000

Misc: exp
13000

100,000

100,000
Total F-O-H = 100,000

(4)
W-I-P A/C
Bal. b/d
7000

Fin goods
172,000

Material
70000
Payroll(lab)
6000
F-O-H
100,000

Bal. c/d
11000
183000

183000
Cost of goods manufactured = 172000
(5)
Finished goods A/C
Bal. b/d
34000
W-I-P
172000

206,000

C.GS
176000

Bal. c/d
30,000
206,000

Cost of goods sold = 176000

(6)
A/P A/C
Cash
77000

Bal. b/d
18000

Bal. c/d
6000

Material
65000

83000

83000

Payment of A/P = 77000

(7)
A/R A/C
Bal. b/d
54000
Sales
500,000

554000

Cash
532000

Bal. c/d
22000
554000

Amount collected from account receivable = 548000

(8)
Accrued payroll A/C

Cash
10,000

Bal. b/d
13000

Bal. c/d
9000

Payment A/C
6000

19000

19000

Payment to A/P = 10,000

P-4
Water Lux Company
1- For Purchase Of Material
Dr. Rs
Cr. Rs
Material
91,000
Account payable
91,000
______________________________________
2- For Use Of Material
Work- in- process
84,000
Material
84,000
___________________________________
3- For Direct Labour
Work in process
50,000
Payroll
50,000
________________________________
4- For Factory Overhead
Factory overhead
25,000
Account payable
25,000
________________________________
5- For Finished Goods
Finished goods
157,000
Work in process
157,000
_____________________________
6- For Cost Of Goods Sold
Cost of goods sold
140,000
Finished Goods
140,000
_____________________________

P 4 (Working)
Calculation of purchase, use of material, direct labour, FOH,
Finished goods, cost of goods sold.
Direct Material
Rs.
Opening inventory
17000
Add: purchases
91,000
Cost of material available
108,000
Less: Closing inventory

24,000

Cost of material used

84,000

Direct Labour
+Direct labour cost
Prime cost
Factory overhead
+F-O-H
Current Material cost
W-I-P
+ Opening inventory
Cost of goods to be manufactured
-- Closing inventory
Cost of goods manufactured
Finished Goods
+opening inventory
Cost of goods available for sale
-- Closing inventory
Cost of goods sold
140,000
____________________________________________________

50,000
134000
25000
150,000
12000
1, 71,000
141000
1, 57,000
29,000
185,000
45,000

P-5
Prepare T accounts with January 1 Balance.
1Cash
Bal b/d
20,000
A/P A/C

199379

Accrued payroll
74820
179379 A/P A/C
104000
Bal c/d
20559
199379

2Account Receivable
Bal b/d
25000
Sales A/C
228800

Cash A/C
179379
Discount A/C
Bal c/d
70760

253800

253800

3Finished Goods
Bal b/d
9500
W/P
188000

CGS
176000

197500

197500

Bal c/d
21500

3661

4W-I-P
Bal b/d
4500
Payroll
60500
Material
82500
FOH applied
47330

F. goods
188000
Bal. c/d

6830

194830

194830
5A/P
Cash
104000

Bal c/d
160000
264000

Bal b/d
15500
Material
92000
FOH A/C
18500
Mark exp
18000
Admin exp
120000
264000

6Material

Bal b/d
10,000 A/P A/C
92000

102000

W/P
82500
FOH
8300
Bal c/d
11200
102000

7Accrued payroll
Cash
74820

Bal b/d
2250

Bal c/d
2250

Payroll
74820

77070

77070

8Machinery
Bal b/d
40,000

40,000

Bal c/d
40,000
40,000

9Depreciation

Bal c/d
10,000
10,000

Bal b/d
10,000

10,000

10Common stock

Bal c/d
60,000
60,000

Bal b/d
60,000

60,000

11Retained Earnings

Bal c/d
21250
21250

Bal b/d
21250

21250

12With Holding

Bal c/d
8170
8170

Payroll A/C
8170

8170

13State unemployment

Bal c/d
2322
2322

Payroll
2322

2322

14F-O-H
A/P A/C
18500
Payroll
12500
FIAC Tax
5475
Material
8300

Bal c/d
44775
44775

44775

15Marketing expense
Payroll
8000
FIAC tax
600
A/P A/C
18000
26600

Bal c/d
26600
26600

16Admin expense
Payroll
5000
FIAC Tax
375
A/P A/C
120,000
125375

Bal c/d
125375
125375

17FIAC Tax
FOH
5475
Bal c/d
6450

Mark exp

600

Admin exp
375

6450
6450

18F-O-H Applied

Bal c/d
47330
47330

W/P
47330

47330

19C.G.S
FG
176000

176000

Bal c/d
176000
176000

20Sales

Bal c/d
228800
228800

Account receivable
228800

228800

21Discount
A/R A/C
3661

3661

Bal c/d
3661
3661

22Payroll
W.H.Tax
8170

W/P
60500

State unemp tax

2322

FOH
12500

Federal unemp tax

688

Mark exp
8000

Accrued payroll
74820

Admin exp
5000

86000

86000

P 5 (cont.)
TRAIL BALANCE
SR
#

A/C

TITLE

Dr

Cr

1-

Cash

20559

2-

A/R A/C

70760

3-

F G A/C

21500

4-

W/P A/C

6830

5-

A/P A/C

6-

Material A/C

7-

Accrued payroll A/C

8-

Machinery A/C

9-

A/C Depreciation A/C

10,000

10
-

Common stock

60,000

R.E A/C

21250

W.E Tax A/C

8170

State unemp tax

2322

Fedral unemp tax

688

11
12
13
14
-

160,000
11200
2250
40,000

15
16
17
-

Marketing exp

26600

Admin exp

125375

FICA Tax

6450

FOH Applied A/C

47330

C.G.S

18
-

Sales A/C

19
-

Payroll A/C

20
-

Discount A/C

FOH A/C

176000
28800
3661
_

44775

21
22
23
547260

547260

P- 5 (cont.)
JOURNAL ENTRIES
Rs
A. Material
A/P

B. F-O-H

Rs

93,000
93,000
18500

A/P

C. Payroll

18500

86000
Withholding tax

8170

State un employment tax

2322

Federal un employment tax

688

Accrued payroll

74820

Accrued payroll
Cash

74820

W-I-P

60500

F-O-H

12500

Marketing expenses
Payroll

8000

F-O-H

5475

Marketing expenses
FICA Tax

600

74820

86000

6450

D. Work -in -process

82500
8300

F-O-H
Material
E. W-I-P

90800
47330

F-O-H Applied
F. Finished goods

47330
188000

W-I-P
G. Cost of goods sold

188000
176000
176000

Finished goods
A/R

228800
228800

Sales A/C
H. Cash A/C

179379

Discount (1830402%)
A/R (22880080%)

I. Marketing expenses
Admin expenses
A/P
J. A/P

3661
183040
18000
120,000
300,000
104000

Cash

104000

P-6
MANDMENEYER COMPANY
COST OF GOODS SOLD STATEMENT
FOR THE YEARB ENDED ON 30-11-19B
Direct Material
Opening inventory
+purchases
Cost of material available
-- Closing inventory
Direct material used
17750
Direct Labour
+Direct labour
7500
Prime cost
225250
F-O-H
+F-O-H Applied
5000
Current manufacturing cost
30250
W-I-P
+Opening inventory
4000
Cost of goods to be manufactured
34250
-- Closing inventory
7500

$
4000
1, 80,000
22,000
4250

Cost of goods manufactured

26750
Finished Goods
+Opening inventory
3500
Cost of goods available for sale
30250
-- Closing inventory
5700
Cost of goods sold
25150
________________________________________
P -6 (cont.)
MANDMEYER COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED 30-11-19B
Rs
Rs
Net sales
56000
Less: cost of goods sold
(25150)
Gross Profit
30850
Less: Opening expenses
Marketing expenses

2800

560002%
Administration expenses
(3920)

1120

560002%
Operating Income
26,930
Less: Other expenses
(560)
56000 1%
NET INCOME
26,370