Introduction to Cost Accounting

Introduction to Cost Accounting

September 23, 2019 by admin0


There are two major areas of accounting – financial accounting and managerial accounting.

Financial accounting

Is the use of accounting information for reporting to external parties, including investors and creditors? Financial accounting is primarily concerned with financial statements for external use by those who supply funds to the entity and other persons who may have vested interest in the financial operations of the firm. The supplier of funds include stockholders, partners and sole proprietors. Creditors who provide debts are also interested on the financial statements of the entity. The financial statements are the output from an accounting system. The reports prepared under financial accounting focus on the enterprise as a whole. Financial accounting is based on historical transaction data. The information may be historical, quantitative, monetary and verifiable. The date are historical and are supported by documents/evidence. The information provided by financial accounting is usually presented in the form of financial statements, tax returns, and other formal reports distributed to various external users. The same information may also be used internally to provide a basis for financial analysis by management.

Financial accounting is required for many firms organized as corporations because of the requirements of the Securities and Exchange Commission.

The Bureau of Internal Revenue also requires financial accounting information for compliance with the country’s tax laws. Information based on accounting data is required for all firms without regard for their size.

Managerial Accounting

Focuses on the need of parties within the organization, rather than interested parties outside the organization. Managerial accounting information commonly address individual or divisional concerns rather than those of the enterprise as a whole. The information may be current or forecasted, quantitative or qualitative, monetary or non-monetary and most of all timely data are futuristic and some of the costs are not recorded on the accounting books of the organization.

Managerial accounting is not separate and distinct form financial accounting. Financial accounting data are used in the managerial accounting system. Management decisions made today will affect the financial statements of future periods. There are no requirements or legislation that mandates the format or use of managerial accounting. Managerial accounting methods are tools that are available for use to the management.

Financial accounting attempt to present some degree of precision in reporting historical information while at the same time emphasizing verifiability and freedom from bias in the information, relevance to the general user and some degree of timeliness in reporting which is not as critical in managerial accounting. The timing of information and its relevance to the decision on hand has greater significant of the information so management cannot wait until tomorrow for information that is required for today’s decision.

The measuring based in managerial accounting does not necessarily have to be restricted to pesos. Various bases may be appropriate to report managerial information. Examples include: 1. an economic measure such as pesos; 2. A physical measure such as pounds, gallons, tons, or units; and 3. A relationship such as ratios.

Cost Accounting

Is the intersection between financial and managerial accounting. Cost accounting information is needed and used by both financial and managerial accounting. Cost accounting provides product cost information to external parties, such as stockholders, creditors and various regulatory boards for credit and investment decisions. Cost accounting provides product cost information also to internal parties such as managers for planning and controlling.


The information produced by a cost accounting system provides a basis for determining product cost and aids management in planning and controlling operations.

Determining Product Costs

Cost accounting procedures help management in gathering the data needed to determine product costs and thus generate meaningful financial statements and other reports. Cost procedures must be designed to permit the computation of units cost as well as total product costs. For example, if manufacturer spent 10,000 pesos for labor in a certain month, the information is insignificant; but if this labor produced 5,000 finished units, the fact that the cost of labor was 2 per unit is significant, because this figure can be compared to the unit labor cost of other periods and trends analyzed. Units cost information is also useful in making a variety of important marketing decisions.

1. Determine the selling price of a product. A knowledge of the cost of manufacturing a unit of product helps in setting the selling price, which should be high enough to cover the cost of production, pay a portion of marketing and administrative expenses and provide a profit. It will be difficult to set the selling price without knowing the costs incurred in the manufacture of a product and cost incurred in rendering a service.

2. Meeting competition. If a competitor is selling the product at a low price, detailed information regarding unit costs can be used to determine the action to be taken by the company. The company would know if selling price must be reduced, or manufacturing cost must be reduced, or the product must be eliminated.

3. Bidding on contracts. Many manufacturer firms must submit competitive bids in order to be awarded manufacturing contracts by the government or private firms. An analysis of the unit cost relating to the manufacture of a particular product is of great importance in determining the bid price to be submitted. The bid price must be able to cover costs to be incurred and at the same provide profit for the company. It must not be set so high so as to be able to compete with other bidders.

4. Analyzing profitability. Unit cost information enables management to determine the amount of profit that each product earns and possible eliminate those that are least profitable, thereby concentrating efforts on those items that are most profitable.

Costs are said to be useful for managerial accounting purposes when costs are used inside the organization by managers or evaluate the performance of operations or personnel, or as a basis for decision making. When costs are used by outsiders, such as stockholders or creditors, or evaluate the performance of top management and make decisions about the organization, we say costs are used for financial accounting purposes.

Planning and Control

One of the most important functions of cost accounting is the development of information which can be used by management in planning and controlling operations. Planning is the process of establishing objectives or goals for the firm and determining the means by which the firm will attain. Planning is essential to good management because it provides a means of coordinating all of the operations of the firm. Cost accounting helps in the development of plans by providing historical cost that serves as the basis for projecting data for planning. Management can analyze trends and relationships among such data as an aid in estimating future and cost operating results and in making decisions regarding acquisition of additional facilities, changes in marketing strategies, and obtaining additional capital.

            Planning can be divided into three components:

1.    Strategic Planning – concerned with setting long range goals and objectives to determine the overall direction of the company.

2.    Tactical Planning – concerned with plans for a shorter range (or time period) and emphasizes plans to achieve the strategic goals.

3.    Operations Planning – relates to the day to day implementation of tactical plans. It emphasizes the coordination of the major factors of production (materials, labor and facilities)

Control is the process of monitoring the company’s operations and determining whether the objectives identified in the planning process are being accomplished.


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

The traditional role of cost accounting is to record full product cost data for external reporting. However, the use of accounting data for decision making and performance evaluation had gained importance in recent years.


The recording of the cost of a product or a service is part of financial accounting. The cost for valuation inventory and cost of goods sold for external reporting is also financial accounting. The use of data in choosing between two or more alternatives is part of managerial accounting. Differential cost analysis is considered by others as a form of applied microeconomics. Cost accounting provides date for use in decision models for finance, operations management, and marketing. Cost accounting is also related to motivation and behavior because it is used in planning and performance evaluation. Finally, tools from statistics, mathematics, and computer science are used to perform cost analysis.


Job order costing

A system for allocation cost to group of unique products. It is applicable to production of customer specific products such as the manufacture of special machines. Each job becomes a cost center for which costs are accumulated.

Process costing

A system applicable to a continuous process of production of the same or similar goods. Since there is no need to determine the cost of different groups of products because the product is uniform, each processing department becomes a cost center.


Job order costing and process costing are the two traditional basis approaches to product cost accounting systems. Actual cost accounting system may differ widely. However, all are based on one of these two product costing concepts. Once the type of system is selected, it is then adjusted to fit a particular industry, company, or operating department. The objective of the two systems is the same. They both provide product unit cost information for pricing, cost control, inventory valuation, and income statement preparation. End-of-period values for Cost of Goods Sold, Work in Process Inventory, Finished Goods Inventory accounts are computed using product unit cost data.


 A job order cost accounting system is a product costing system used by companies making one-of-kind or special-order products. In such a system, direct materials, direct labor, and factory overhead cost are assigned to specific job orders or batches of production. In computing unit costs, the total manufacturing cost for each job order are divided by the number of goods units produced for that order. Industries that use job order cost accounting system include those that make ships, airplanes, large machines, and special orders. Job order costing may also be used when producing a set of a product for inventory replenishment, such as a production run of 500 identical lawn mowers. Procedures similar to those used in job-order costing are used in many service industry firms, even if these firms have no work in process for finished goods inventories. In a public accounting firms, for example, cost are assigned to audit engagements. For consulting and architectural firms, cost is assigned to contracts, while for universities it maybe be for every research projects.

The primary characteristic of a job order cost system are as follows:

  1. It collects all manufacturing cost and assigns them to specific job or batches of product.
  2. It measures cost for each completed job, rather than for set time periods.
  3. It uses just one Work in Process Inventory Control account in the general ledger. This account is supported by a subsidiary ledger of job order cost cards or sheets for each job process at any point of time.

Many manufacturing firms have production system which are not suited for strictly job-order costing or process costing, bust instead require a costing system which incorporates ideas from both. This blending of ideas is known as hybrid costing.

The costing system an organization selects will mainly depend on its underlying production system. Operating Costing is a hybrid costing system often used in repetitive manufacturing where finished products have common, as well as distinguished characteristics. For example, in the manufacture of clothing, basic suits can be assembled in one operation. These suits can them move on to the next operation and have a deluxe lining added. Based on the variations, the products and the related cost are identified by batches or production runs. A television assembly plant, which produces a basic chassis and component system, but which varies options such as remote and cabinetry would be a logical user of operation costing.

Some companies process large orders of identical units as a group through the same production sequence. Each of these orders is called a batch. In batch production, costs are allocated to each batch. Whenever a change in the production line is required to continue production, a new batch is created. A furniture manufacturer may produce a batch of chairs, then a batch of tables, then a batch of drawers, and so forth. Generally, job costing concepts are used to account for batch production and each batch is treated as a job for costing purposes.


Homogenous units pass through a series of similar process. Unique jobs are worked on during a time period.
Cost are accumulated by processing department Cost are accumulated by individual job.
Unit costs are computed by dividing the individual departments’ cost by the equivalent production. Unit cost are determined by dividing the total costs on the job cost sheet by the number of units on the job.
The cost of the production report provides the detail for the Work in Process account for each department. The job cost sheet provides the detail for the work in Process account.  

In job order costing, accounts are accumulated for each job or batch produced. In process coting, cost are accumulated by department for an accounting period (for example, a month) Process costing has less detailed recordkeeping, hence, if a company was choosing between job and process costing, it would generally find that recordkeeping cost are lower under process costing. Process costing does not provide as much information as job costing because record of the cost of each unit produce are not kept using process costing. The choice of process costing versus job costing system involves a comparison of the cost and benefits of each system.

As a general rule job systems are usually more costly than process systems. So if managers and accountants must decide whether to use job costing or process costing, recordkeeping cost must be compared with additional benefits that will be derived from knowing the actual cost of each unit. If recordkeeping cost were equal under job and process systems, for the units in a product line, then the job costing systems are better because they provide all of the date that process systems do.

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@Philippine Accountancy Guide