BASIC COST ACCOUNTING

BASIC COST
ACCOUNTING

NUR ‘ABIDAH BINTI SOLIHUDDIN
SAMSINOR BINTI IBRAHIM

TABLE OF CONTENTS

Preface ii
Acknowledgment iii

BASIC COST ACCOUNTING Topic 1 1
INTRODUCTION TO COST ACCOUNTING 26
54
AND ELEMENT OF COST

Topic 2
THE COST CLASSIFICATION:
COSTING FOR MATERIALS

Topic 3
THE COST CLASSIFICATION:

COSTING FOR LABOURS

Topic 4 86
THE COST CLASSIFICATION:
COSTING FOR OVERHEAD

Topic 5 116
COSTING METHODS

Topic 6 144
BUDGETS FOR PLANNING AND CONTROL 162

Reference

PREFACE

BASIC COST ACCOUNTING provide knowledge on basic
elements, procedures and methods used in planning,

controlling and preparing the product cost which is used
in financial accounting. This knowledge will enhance
students’ ability to prepare a costing report for either
manufacturing or services sectors.

Our objective in writing this book is to prepare students
with basic cost accounting level that stimulates their
interest in the field, introducing them with the tools of
discipline, and leading them understanding cost
accounting.

Most of the materials in this book were developed to fit
into new Polytechnic syllabus which will be applied start

June 2019.

ii

ACKNOWLEDGEMENTS

I am grateful and thankful to almighty God for making
this effort possible. I would like to thanks to individual
who contributed either directly or indirectly towards

completion of this book.
Thank you also to all colleagues from Commerce
Department at Politeknik Merlimau Melaka for being
patience throughout this process all guidance, comment

and remarks are very much appreciated.
Last but not least, I would like to thank to and Head of
Department of Commerce Department, Head of DAT
Programme, Senior Librarian for their guidance and

useful suggestion.

iii

1 BASIC COST ACCOUNTING INTRODUCTION TO COST ACCOUNTING AND ELEMENT OF COST

TOPIC 1

1.1. Identify the concept, principle, methods and
techniques of cost
1.1.1. Define the cost accounting
1.1.2. Explain the importance of cost accounting to
management
1.1.3. Identify the difference between cost
accounting and financial accounting
1.1.4. Identify the basic cost concepts of costing
principles:
 Cost unit
 Cost centre
 Cost object
 Conversion costs
 Opportunity costs
 Incremental costs
 Replacement costs
 Sunk costs

1.2 Identify the cost accumulation and cost assignment
1.2.1 Explain accumulation and assignment of
costs for different functions
1.2.2 Explain cost accumulation for the purpose of
stock valuation and profit reporting
 Product cost
 Period cost
1.2.3 Describe cost accumulation for the purpose
of decision making by using high-low method
 Fixed costs
 Variable costs
 Semi-variable costs
1.2.4 Explain cost accumulation for the purpose of
planning and control
 Controllable costs
 Non-controllable costs

1.3 Prepare statement of cost

2 BASIC COST ACCOUNTING

1. TOPIC 1: INTRODUCTION TO COST ACCOUNTING AND ELEMENT OF COST

1.1. Identify the concept, principle, methods and techniques of cost

1.1.1. Define the cost accounting

CIMA, London

• Cost accounting is the establishment of budgets,
standard costs and actual costs of operations,
processes, activities or products; and the analysis of
variances, profitability or the social use of funds.

• ‘the application of accounting and costing principles,
methods and techniques in the ascertainment of costs
and analysis of savings and/or excesses as compared
with previous experience or with standards.’

Charles T. Horngen

• Cost accouonting is a quantitative method that
accumulates, classifies, summarizes and interprets
information for three major purposes:
• operational planning and controlling
• special decision
• product decision.

Institute of Cost and Works Accountants of the UK

• The application of costing and cost accounting
principles, methods and technique to the sciemce, art
and practive of cost control and ascertainment of
profitability as well as presentation of information for the
purpose of manegerial decision-making.

 Terms in Cost Accounting

COST • The amount of expenditure incurred or
attributed on a give thing - CIMA, London

COSTING • The technique and process pf ascertaining
cost - CIMA, London

3 BASIC COST ACCOUNTING

 From the definition, cost accounting is concerned with the
ascertainment of cost for each product that is made or each
service that is given.

 Cost information from cost accounting is use to aid planning and
decision-making that affects ongoing operations.

 Cost accounting involve the process of recording, classifying and
analysing all the costs involved in production, such as cost for:

Direct materials Direct labour Overhead

 It is a systematic procedure for determining the total cost and unit
cost of output.

 Cost accounting provides information that is required for
management accounting and financial accounting.

COST ACCOUNITNG DATA
Financial Accounting

Product cost for inventory Product cost for income
valuation determination

Management accounting

Predicted cost data Cost data for Cost data for
for budgeting controlling special decision

4 BASIC COST ACCOUNTING

1.1.2. Explain the importance of cost accounting to management

To determine product cost

• The cost of the product is very important in cost accounting.
• The total product cost and cost per unit of product are important

in deciding price of the product, making stock valuation and
managerial decision making.

To facilitate planning and control of regular business activities

• The cost formulation in cost accounting system is oriented to help
in planning control and decision-making.

• The accumulation, classification and analysis of cost is done in
such a way as to help management decision regarding business
activities.

To supply information for short and long run decisions

• Cost accounting system provides data for short and long run
decisions of a non-recurring nature.

• These decisions generally involve high cost commitment.

DISADVANTAGES OF NOT PREPARING COST ACCOUNTING

•Difficult for the company to achieve certain goals.
•Managerial decisions for future performance improvement are difficult to
ascertain.
•planning process will be inaccurate if the company doesn't know the cost
information.
•The budgeted product cost will be difficult to be fixed.

5 BASIC COST ACCOUNTING

1.1.3. Identify the difference between cost accounting and financial

accounting

COST ACCOUNTING FINANCIAL
ACCOUNTING

Classifies, records,

Definition Classifies, records, presents and interprets in
present and interprets in terms of financial
a significant manner the
character and provides
material, labour, the figures for the
overhead costs involved preparation of the

in manufacturing and financial statements;
selling each product, Statement of

job and service. Comprehensive Income
and Statement of

Financial Position.

Objective To ascertain and control To prepare a profit and
cost and maximize loss account and
efficiency. balance sheet for
To provide cost
information to the reporting to outside
management. parties.

Primary Users The users are internal The users of financial
of Information users. statement are mainly
external to the business
They are members of
the management; enterprise.
managers. External users include
shareholder, creditors,
financial analyst and
government authorities.

6 BASIC COST ACCOUNTING

Time Focuses on present and Reports on what
Dimension future data. happened in the past to

draw up financial
statements.

Accounting Does not based on the Follow the double entry
method double entry system. system.

Segmentation Cost accounting reports Financial accounting
focus on small parts of reports and describe the
the organization, such as
whole of the business.
customers, services,

products and activities.

Unit of Applies any All information is in term
Measurement measurement unit that is of monetary unit; Ringgit

useful in a particular Malaysia.
situation; labour hours

and machine hours.

Data and statements

Report are prepared whenever Data and statement are
Frequency needed. developed for a definite

Reports may be period, usually a year.
prepared on a monthly,

weekly or even daily

basis.

7 BASIC COST ACCOUNTING

1.1.4. Identify the basic cost concepts of costing principles:

Cost Unit  A cost unit refers to the unit of quantity of
product, service or time (or combination of
these) in relation to which costs can be related.

 The unit chosen is what is most relevant for the
activities of the organization.

 Examples:
 per kilowatt hour,
 per kilogram of material,
 per passenger mile,
 per litre of paint,
 per ton of cement, etc.

Cost Centre  It can be defined as, ‘a production or service,
function, activity or item of equipment whose
costs may be attributed to cost units.

 In simple words, a cost centre is nothing but a
location, person or item of equipment for which
cost may be ascertained and used for the
purpose of cost control.

 It may include a single expensive machine, a
group of these machines and may be
extended to individual departments or even the
whole factory may be treated as a cost centre
in some cases.

 There are three types of cost centre:

Process Cost Centre:

• Process cost centre is where a specific
process or a continuous sequence of
operations is performed.

• Examples: a food processing company
would have the mixing, cooking, sterilizing
and packing departments.

8 BASIC COST ACCOUNTING

Production Cost Centre:

• Production cost centres are the cost
centres directly involved in the
manufacturing operations.

• Examples: moulding, machining, assembly,
shaping, welding, binding, cutting, etc.

Service Cost Centre:

• Service cost centres are incidental to the
production process as products or cost
units are not produced by them.

• However, these are although necessary for
it to take place.

• Examples are canteen, personnel, stores,
boiler house and maintenance, etc.

 Any cost which is incurred or charged to service

cost centres must be reapportioned

subsequently to production cost centres for

absorbing overheads in the total costs of the

product.

Cost Object  A cost object is a managerial term for a
product, process, department, or customer that
costs originate from or are associated with.

 In other words, it’s something that costs can be
identified with and traced back to.

 In the production process of any manufacturer,
accountants and managers want to be trace
costs back to the thing that creates them in
order to streamline operations and increase
efficiencies.

 These traceable costs or direct costs are
expenses that can be traced back to a single
cost object.

9 BASIC COST ACCOUNTING

Conversion  A conversion cost is the amount incurred during
Costs the transformation of raw materials inventory
into finished goods.

 In other words, this is the amount of direct
labour and overhead costs that are required to
turn raw materials into an actual product.

 Conversion costs are a manufacturer's product
or production costs other than the cost of a
product's direct materials.

 The term conversion costs often appears in the
calculation of the cost of an equivalent unit in a
process costing system.

Opportunity  An opportunity cost is the economic concept of
Costs potential benefits that a company gives up by
taking an alternative action.

 In other words, this is the potential benefit you
could have received if you had taken action A
instead of action B.

 Each business transaction and strategy has
benefits related to it, but businesses must
choose a specific action.

 By choosing one alternative, companies lose
out on the benefits of the other alternatives.

Incremental  An incremental cost or differential cost is a
Costs business planning analysis that looks at the
additional cost to the company if a particular
action is taken.

 In other words, if a company decides to take
action on a new project, what extra expenses
will the new project create?

10 BASIC COST ACCOUNTING

 Replacement cost is the amount of money

required to replace an existing asset with an

Replacement equally valued or similar asset at the current

Costs market price.

 In other words, it is the cost of purchasing a

substitute asset for the current asset being used

by a company.

Sunk Costs  A sunk cost, also known as a stranded cost, is an
expense that has already occurred and can’t
be changed or avoided.

 In other words, it’s a cost that has already been
paid and can’t be refunded or reduced.

 It’s in the past and has no bearing on any future
decision making processes.

TOTAL COST Production Prime Cost
Cost
Production Overheads
Production
Cost General & Administration
Overheads
DIRECT COST/
PRIME COST Selling & Distribution
Direct Materials Overheads

Direct Labour Financial Overheads

Direct Expenses INDIRECT COST/
PRODUCTION OVERHEADS

Indirect Materials

Indirect Labour

Indirect Expenses

11 BASIC COST ACCOUNTING

CONVESION Direct Production
COST Labour overhead

Production overhead:
- Variable production overhead

- Fixed production overhead

1.2. Identify the cost accumulation and cost assignment

1.2.1. Explain accumulation and assignment of costs for different functions

COST ACCUMULATION

Cost Accumulation is the The focus and objective are
process of collecting all costs to produce cost of product or
information about the business service by identifying various

with the help of the cost cost objects and their
accounting system. respective cost drivers.

TYPES

JOB COSTING PROCESS COSTING HYBRID COSTING
SYSTEM: SYSTEM: SYSTEM:

is a process of takes place when is suitable when
accumulating cost there is production some production is
information about a of a huge amout large while some
specific project or of identical goods.
are small.
product.

JOB COSTING PROCESS COSTING
Used for Unique/ Custom Built Used for standard or same

products nature of products.
Production carried in small Production takes place in large

batches and quantities batches or large quantities
Record keeping is complicated Comparatively, recording

process over here keeping is simple
Further allocation to product
Useful for Direct Customer Billing level required before billing

12 BASIC COST ACCOUNTING

COST ASSIGNMENT

Cost assignment is the allocation of costs to the Cost
activities or objects that triggered the incurrence assignment is
also known as
of the costs.
cost
The concept is heavily used The cost allocation.
in activity-based costing, assignment is
where overhead costs are based on one or
traced back to the actions
more cost
causing the overhead to be drivers.
incurred.

1.2.2. Explain cost accumulation for the purpose of stock valuation and
profit reporting

 Product cost
o Product costs are costs identified with goods produced.
o Product costs are initially identified as part of the inventory, and
include all costs that are involved in manufacturing a product.

 Period cost
o Period costs are costs that are deducted as expenses during
the current period without ever having been regarded as a part
of inventory.
o Period costs are also called non-manufacturing costs, and
include all costs that are not part of product costs.

PRODUCT COSTS PERIOD COSTS
Direct Materials
Direct Labour Marketing & Selling
Production Overhead Expenses

Administrative Expenses

Interest Expenses

13 BASIC COST ACCOUNTING

1.2.3. Describe cost accumulation for the purpose of decision making by
using high-low method

FIXED COSTS A fixed cost is constant in total amount regardless of
changes in activity level.

As total fixed costs are constant, the fixed cost per
unit will vary a different level of activity.

When a business entity produces a greater number
of outputs, the fixed cost per unit decreases.

Coversely, when fewer units are produced, the fixed
cost per unit increases.

Discretionary fixed costs - fixed costs change by
management action.
Committed fixed costs - fixed costs that a manager
has no control and they must be incurred.

TOTAL FIXED COSTS FIXED COST PER UNIT

Total Cost
Costs per
Unit
Activity Level (units)
Activity Level (units)

14 BASIC COST ACCOUNTING

VARIABLE A variable cost changes in total in direct propotion to
COSTS changes in level of activity.

An increase in activity brings propotional increase in
total variable cost and vice versa.

Direct material costs usually variable cost because
they increase in propotion to increase in number of
units manufactured.

Although total variable costs change in propotion to
changes in the level of activity, per unit variable costs
remain constant across a reasonable range of
activity.

Example; Direct material, direct wages and direct
expenses.

TOTAL VARIABLE COSTS VARIABLE COST PER UNIT

Total
Costs

Cost
per
Unit

Activity Level (units) Activity Level (units)

15 BASIC COST ACCOUNTING

SEMI Semi variable costs, also known as a semi-fixed cost
VARIABLE or a mixed cost which include both fixed and
COSTS variable components.

Costs are fixed for a set level of production or
consumption, and become variable after this
production level is exceeded.

If no production occurs, a fixed cost is often still
incurred.

The fixed portion of a semi-variable cost is incurred no
matter the activity volume, while the variable portion
occurs as a function of the activity volume.

Example; electricity and telephone costs.

TOTAL SEMI VARIABLE COSTS

Total
Costs

Variable Cost

Fixed Cost

Activity Level (units)

What Is the High-Low Method?

In cost accounting, the high- The high-low method involves
low method is a way of taking the highest level of

attempting to separate out activity and the lowest level of
fixed and variable costs given activity and comparing the
total costs at each level.
a limited amount of data.

Cost Separation Using High-Low Method

FORMULA

Highest Activity Cost – Lowest Activity Cost
Variable Cost per Unit =

Highest Activity Units – Lowest Activity Units

16 BASIC COST ACCOUNTING

EXAMPLE 1.1:

High point Supplies Cost Hours of Activity
Low point
Difference RM3,970 95
RM2,170 50
RM1,800 45

Variable supplies cost rate = RM1,800/45 hours
= RM40/hours

Solution:

Total Cost = Total Fixed Cost + Total Variable Cost
RM2,170 = Total Fixed Cost + (RM40/hr x 50 hours)

RM2,170 = Total Fixed Cost + RM2,000

Total Fixed Cost = RM2,170 – RM2,000

= RM170

EXAMPLE 1.2:

The costs data for 3 volume levels are given below:

Types of Costs 2,000 units 4,000 units 6,000 units
Direct material RM4,000 RM8,000 RM12,000
RM1,200 RM1,200 RM1,200
Rent RM7,500 RM13,500 RM19,500
Salesman salary

Required:

Separate the total cost into its fixed and variable elements using
High-Low method.

Solution:

Types of VARIABLE COSTS FIXED COSTS
Costs
Direct = (RM12,000 – RM4,000) = RM4,000 – (RM2x2,000u)
6,000u – 2,000u
material =RM0
= RM 2 per unit = RM1,200 – (RM0x2,000u)
Rent = (RM1,200 – RM1,200)
=RM1,200
6,000u – 2,000u
= RM 0

17 BASIC COST ACCOUNTING

Salesman = (RM19,500 – RM7,500) = RM7,500 – (RM3x2,000u)
=RM1,500
salary 6,000u – 2,000u

= RM 3 per unit

1.2.4. Explain cost accumulation for the purpose of planning and control
CONTROLLABLE COSTS

Controllable costs are costs that can be influenced or regulated by
the manager or head responsible for it.

For example: direct materials, Another example: the sales
direct labor, and certain manager has control over the
salary and commission of sales
factory overhead costs are
controlled by the production personnel.

manager.

NON-CONTROLLABLE COSTS

Uncontrollable costs are those that are not under the control of a
specified manager. These cannot be influenced by decisions or

actions of the manager. These costs are imposed by the top
management or allocated to several departments.

For example, a company-wide Other examples include
advertising cost that is allocated depreciation, insurance,
by the central office to different
share in rent, share in
departments is not under the organization-wide security
control of the department heads.
costs, etc.

1.3. Prepare statement of cost
 The Cost Statement is prepared usually to present the detailed costs of
total output during certain period.
 It provides information relating to cost per units at different stages of the
total cost of production or at a different stages of completion of the
product.

18 BASIC COST ACCOUNTING

Format of Cost Statement

XYZ SDN BHD

COST STATEMENT FOR THE MONTH/YEAR ENDED …

RM RM

DIRECT MATERIAL: XX
XXX
Opening Stock of raw material XX XXX
XXX
Add: Purchase of raw material XX
Less: XX
Carriage inward XX XX
XXX
Closing Stock of raw material (XX)
XX
Cost of raw material used
XX
DIRECT LABOUR XX
(XX)
DIRECT EXPENSES: XXX

Royalty XX

PRIME COST

Add: PRODUCTION/MANUFACTURING OVERHEAD XX
Less: Indirect material XX
Indirect wages XX
Add: Depreciation of machine XX
Less: Depreciation of factory’s building XX
Rent and rates of the factory XX
Opening Work in Progress (XX)
Closing Work in Progress
PRODUCTION COST /MANUFACTURING COST XX
/FACTORY COST XX
ADMINISTRATIVE OVERHEAD: XX
Manager’s salary XX
Clerk’s salary XX
Stationery
Depreciation of office building XX
Depreciation of photocopy machine XX
SELLING AND DISTRIBUTION OVERHEAD: XX
Sales expenses
Promotion
Depreciation of finished goods delivery van
Opening Finished Goods
Closing Finished Goods
TOTAL COST

19 BASIC COST ACCOUNTING

PRACTICE QUESTIONS

QUESTION 1

Define the term cost accounting.
Explain briefly what is “cost centre” and “cost unit”. Give an example for each of
them.

QUESTION 2

Outline SIX major difference between cost accounting and financial accounting.

QUESTION 3

List down two (2) main objectives of cost accounting and explain how it is differ
from financial accounting.

QUESTION 4

Identify the following cost as either:

PRIME COST PRODUCTION ADMINISTRATION SELLING & DISTRIBUTION
OVERHEAD
OVERHEAD OVERHEAD

a. Production manager’s salary
b. Depreciation of machinery
c. Assembler’s wages
d. Office salaries
e. Advertising
f. Delivery expenses
g. Raw material used
h. Salesman’s salaries and expenses

QUESTION 5

A company manufactures and retails clothing and incurs the following costs:

 Lubricant for sewing machine
 Pen drive for general office computer
 Maintenance fees for general office photocopying machine
 Telephone rental plus metered calls
 Interest on bank overdraft

20 BASIC COST ACCOUNTING

 Family day and annual dinner expenses
 Market survey undertaken prior to a new product launch
 Wages of security guards for factory
 Carriage on purchase of basic raw material
 Royalty payable on number of units of clothing produced
 Cost of advertising products on television
 Chief accountant’s salary
 Wages of storekeepers in warehouse
 Wages of forklift truck drivers who handle raw materials
 Developing a new product in the laboratory

Required:

Classify the cost above into the following cost classifications:

a. Direct material
b. Direct labour
c. Direct expenses
d. Indirect production overhead
e. Research and development costs
f. Selling and distribution costs
g. Administration costs
h. Finance costs.

Note: each cost is intended to belong to only one classification.

QUESTION 6

EZYCORP Manufacturing Co. produces 1000 sets of table and chair. The
information are as follows:

Advertising RM
Machine maintenance 10 000
Factory Insurance 3 000
Direct Material 6 000
Depreciation of factory equipment 135 000
Depreciation of office equipment 300 000
Office supplies 6 000
2 500

21 BASIC COST ACCOUNTING 15 000
60 000
Factory utilities 240 000
Director’s remuneration 48 000
Direct wages 20 000
Supervisor (factory)
Administrative salary

QUESTION 7

The following data have been extracted from Ekia Wood Furniture as at 31
December 2020:

Carpenter's wages RM
Supervisor's salary
Wood : Opening stock 21,000
13,500
Closing stock 9,800
Purchase (wood) 6,850
Factory overhead 83,000
Clerk's salary 14,000
Lorry driver's salary 16,200
Manager's salary 6,700
Carriage inwards 20,000
Rental of special machine 2,500
Rental of machine 1,800
Depreciation : Machinery 9,000
2,800
Equipment at showroom 1,100
Lorry (use for delivery) 6,000
Carriage outwards 4,700
Electricity 8,700
Canteen maintenance 1,500

Additional information:

i. Electricity cost is divided between factory, administration and showroom
according to the floor area occupied (sq. metres):
factory 2000 m2, office 500 m2 and showroom 1000 m2.

ii. Canteen is used by 5 clerks, 10 carpenters and 5 sales officers.

You are required to prepare statement of cost on 31 December 2020.

22 BASIC COST ACCOUNTING

QUESTION 8

The following information given by Syarikat MIZAN Electric Trading for the month of
January 2021:

Direct material RM
Factory worker’s salary 105,000
Office worker's salary 55,250
Lorry driver's salary
Salesman's salary 4,250
Canteen manage's expenses: 1,250
4,000
(3/4 of canteen users are factory workers)
(1/4 of canteen uscrs arc officc workers) 4,000
Salesman's commission
Depreciation of factory machine 600
Depreciation of office furniture 3,000
Depreciation of 250
Depreciation of exhibition room's furniture 750
Factory supervisor's salary
Plant rent (special job) 50
6,000
1,000

You are required to prepare cost statement to find prime cost, production/factory
cost and total cost.

QUESTION 9

Calculate prime cost, factory cost, cost of production and cost of sales from the
following particulars:

Direct materials RM

Direct wages 40 000
Direct expenses
Wages of foreman 10 000
Storekeeper's wages 2 000
Electric power 1 000
Lighting — factory 500
200
— office 500
Rent — factory 200
2 000
— office 1 000

23 BASIC COST ACCOUNTING 500
1 000
Repairs and renewal: 200
Factory plan 500
Machinery 200
Office premises 2 000
Depreciation — office premises
200
— plant and machinery
Manager's salary 50
Office printing and stationery
Telephone charge 100
Postage and telegram
Salesman's commission and salary 500
Advertising
Carriage outward 500

150

QUESTION 10

Below is the balance of the accounts of Rangkaian Mesra Sdn Bhd for the year
ended 31st December 2020.

Sales RM

Direct labour 200,000

Carriage inward 15,500
1,000
Purchase of raw material 77,500

Opening stock: Raw material 7,500
Work-in-progress 2,800
Finished goods (1,500 units) 5,500
6,000
Closing stock: Raw material 1,500
Work-in-progress 5,800
Finished goods (2,100 units) 16,000
5,000
Rental
900
Utilities 500
1,700
Salesman commission 12,000

Depreciation of van (used for sales activities)

Office clerk salary

Royalty

Additional information:

i. Rental is divided between factory and office (60:40)
ii. Utilities is divided between factory and office (50:50)

24 BASIC COST ACCOUNTING

iii. Total production units are 25,000 units during the period. Advertising costs is
calculated as RM0.60 per unit sold during the period.

iv. Royalty is based on units sold.
You are required to prepare a statement of cost based on the information given.

QUESTION 11

The following information was taken from Ikatan Manufacturing Com wood based
furniture:

Stock of raw material on 1 January 2020 RM
Stock of raw material on 31 December 2020
Direct wages 3,200
Carriage inward of raw material 2,400
Stationary 64,000
Depreciation 800
Advertising 350
Purchase of raw material 8,500
Office staff salary 1,200
Insurance of factory 40,000
Lubricant for machine 20,500
Electricity and water bill 2,400
Royalty (based on production units) 500
Sales 1,000
4,500
300,000

Additional information:

i. 4/5 of the electricity and water bill is for factory use and 1/5 is for office use.
ii. 60% of the depreciation is for production use and the balance is allocated

for office use.
iii. Commission for sales will be given at 5% from sales

You are required to;

a. Define direct material and direct labour.
b. Prepare the Statement of Cost for the company for the Year Ended 31

December 2020.

25 BASIC COST ACCOUNTING

QUESTION 12

A. Identify the behaviour of the following costs:

COST FIXED OR VARIABLE

Advertising cost

Sugar used in producing soft drinks

Store keeper salary

Salesman commission

Royalty paid to author of the book
'Cost and Management Accounting'
Wages for production workers

Road tax paid for the company vehicles

Production manager salary

B. Delima Sdn Bhd is a company that produces children's wear. The information
below is related to the production of children t-shirt for the first quarter of 2020.

Cost RM

Advertisement in newspaper 500
Factory rental 6,000
Direct labour wages 10,000
General manager salary 7,500
Production manager salary 7,500
Depreciation on photostat machine 1,500
Cotton 15,000
Royalty for 'Angry Bird' character 3,000
Depreciation on sewing machine 3,000
Thread and button 1,500

Required:
Summarize the above costs in a form of cost statement by showing the Prime
Cost, Production Overhead, Production Cost, Administrative Cost and Selling
Cost.

THE COST CLASSIFICATION:26 BASIC COST ACCOUNTING
COSTING FOR MATERIALS
TOPIC 2

2.1. Describe the material control

2.2. Explain purchasing department’s function,
purchasing procedure, storing control and raw
material issuing procedure

2.3. Determine stores control procedures for material
using Economic Order Quantities (EOQ),
inventory control levels and inventory turnover
ratio.

2.4. Record inventory using perpetual and periodic
inventory system

27 BASIC COST ACCOUNTING

1. TOPIC 2: THE COST CLASSIFICATION: COSTING FOR MATERIALS

2.1. Describe the material control

A. MATERIALS
o The term 'materials' is generally used in manufacturing and its refers to
raw materials used for production.
o The terms 'materials' and 'store' are sometimes used interchangeably,
while 'store' is wider in meaning than materials.
o Material cost constitute a prime part of the total cost of product of
manufacturing firms.
o Control over material purchases, consumptions & stocks are important
for effective management of a firm.
DIFFERENT TYPES OF MATERIALS

Supplies Raw Parts Sub- Component
Material assemblies s

DIRECT MATERIALS

Raw materials which Can be easily Example:
are directly traceable identified in the Denim used to
as an integral part of produce jeans,
product. plywood used to
the product produce furniture.
manufactured.
Example:
INDIRECT MATERIALS Nails used in the

Raw material that Those miscellaneous production of
cannot be traced items which are furniture, baking
impossible powder used to
as part of the uneconomical to produce bread.
product.
trace to the products.

28 BASIC COST ACCOUNTING

B. MATERIAL CONTROL
o Needs for Material Controls:
 Materials form a large part of the total cost.
 One of the most important assets in a business management.
o Objectives of a good system of Material Control
 Materials of the desired quality will be available when needed for
efficient production.
 Material will be purchased only when a need exist & in economic
quantities.
 The investment in materials will be maintained at the lowest level
consistent with operating requirements.
 Purchase of materials will be made at the most favourable prices
under the best possible terms.
 Materials are protected against loss or damage by fire, theft &
handling with the help of proper physical controls.
 Materials should be stored in such a way that they can provide
minimum of handling cost & time.

C. STAGES IN MATERIAL CONTROL CYCLE
o The materials are purchased from an outside supplier or vendor.
o When the material arrived, it will be received and the stored in the
storeroom.
o This is followed by the issue of materials to production.
o These stages are repetitive and continuous.

PURCHASE

ISSUE RECEIPT

STORAGE

29 BASIC COST ACCOUNTING

D. ORGANIZING MATERIAL CONTROL
I. Control should be exercised through the 3 main functions related to
materials:

Control through Control through Control through issuance
purchase of store
materials
STORE PRODUCTION
PURCHASING DEPARTMENT DEPARTMENT &
DEPARTMENT STORE DEPARTMENT
Good record
Purchase at system of - Actual usage of
the correct stock materials in
time, price, production
quality and movement,
and proper compared to
quantity. standard, and
store
arrangement. variance
investigated.

- Authorized
issuance through

forms.

2.2. Explain purchasing department’s function, purchasing procedure, storing
control and raw material issuing procedure

2.3. Determine stores control procedures for material using Economic Order
Quantities (EOQ), inventory control levels and inventory turnover ratio.

A. CONTROL THROUGH PURCHASE

I. FUNCTION OF PURCHASING DEPARTMENT
• Purchasing is responsible for the procurement process. This means it
ensures the supply of goods, production materials and equipment
so that a smooth production and sales process can take place.

This department will determines:

what materials are how much is when they are
required required and required.

30 BASIC COST ACCOUNTING

 The quantities should be bought in economic size so that there may
not be over stocking.

 It also responsible for the price, quality and delivery of materials
ordered/purchased.

 Late or non-delivery, poor & substandard materials, incorrect
specifications; are likely to have at least as great impact on
profitability as paying an unnecessarily high price.

II. PURCHASING AND RECEIVING PROCEDURE
 Purchasing procedures vary with different business firms. The
important steps are as follows:

Purchase • Purchase requisition is commonly used as formal
Requisition request to the purchasing department to order
goods or services.

• The storekeeper prepares the purchase
requisition.

Purchasing • After the requisition is received and approved, the
Order purchasing department places an order with
supplier.

• The purchasing department may ask for bids for
quotation before placing the order.

• The objective is to secure the highest quality
materials at the lowest price.

• Copies of the purchase order are sent to the
department concerned, the sender of the
purchase requisition and the store department.

• Copies of the purchase requisition and purchase
order are sent to the accounting department for
the purpose of payment and voucher.

Receiving • The receiving department perform the function of
material unpacking materials which are received by an
organization.

• This department will count, check/inspect the
good received and compare the goods received
with the description on the purchase order and
make a record.

• The receiving report or material received report is
prepared.

31 BASIC COST ACCOUNTING

Approval of • Invoice approval is important in material control
Invoice programme.

• It indicates that goods according to the purchase
order have been received and payment should
be make.

Making • After the purchase invoice total is approved, the
Payment process of making payment begins.

• A cheque is drawn for the amount and sent to
supplier.

B. CONTROL THROUGH STORE

I. FUNCTION OF STORE DEPARTMENT
 Storekeeper is the person responsible in handling the store & ensures
optimal stock level is maintained for each item in the stock.

Function of the store:

Keeping the material Keeping the record – stock
movement

Objectives of store keeping:

To ensure that too much stock is To ensure that too little stock is not
not held – too much capital is tied held as this will result in production

up unnecessarily. (increase hold-ups due to stock shortage.
storage cost)

To ensure materials can be To ensure materials can be
protected against pilferage or received, located & issue
deterioration as this will lead to
speedily.
losses.

32 BASIC COST ACCOUNTING

PRODUCTION DEPT
Required material for production - send

Material Requisition Form to store.

STORE
Storekeeper will check stock availability.

STOCK AVAILABLE STOCK NOT AVAILABLE

Storekeeper will issue material Storekeeper will issue Purchase
to production department. Requisition Note to purchasing

department.

PRODUCTION DEPARTMENT PURCHASING DEPARTMENT
Receive the material ordered. Selection of supplier. Contact supplier

 INSPECTION DEPARTMENT by issuing Purchase Order.

 Quality of the material will be SUPPLIER
 checked. Send the material together with copy
Issue Inspection report if
material quality is good. of invoice & Delivery Note.
Reject the material if quality
not within standard. GOOD RECEIVING DEPARTMENT
Checked quantity send by supplier
against invoice & delivery note. Goods
Receiving Note will be prepared if

quantity tally.

II. MAINTAINING STORE RECORDS

Store Ledger • A stock record shows the receipts, consumption &
Card balance both in quantities & values.

Bin Cards • A quantitative record of receipts, issue & closing
balance of all items in the store. For each type of
material, a separate record is kept on a bin card;
it also stated the maximum & minimum quantities
to be carried.

33 BASIC COST ACCOUNTING

STORE LEDGER CARD BIN CARD
Maintain by store account Maintain by storekeeper
Record of quantity only
Record both quantity &
values Transaction are posted individually

Sometimes transactions may Does contain the detailed
be posted periodically & in information of materials. Only
record actual movement of
total
materials.
Normally maintains detailed
information of materials
reserved & ordered.

STOCK To ensure the minimum amount of capital is tied-up
CONTROL
To maintain sufficient materials in stock in order to
meet production demands.
To anticipate period of short supply(season fluctuation)

To anticipate price changes

To ensure that slow moving items are kept to a
minimum
Up-to-date records are kept.

III. STOCK LEVEL
 To ensure that there is no risk of overstocking or under stocking.
 A system to determine the reorder level and the maximum or
minimum quantity to store
 Control can be exercised by using the following stock levels:

Re-order Level Min Stock Max Stock Re-order
Level Level quantity @

EOQ

Average Stock Average Stock Stock Turnover No. of order
Level per year

RE-ORDER LEVEL
- This is the level to which stock is allowed to fall before an order for further

supplies is placed:
• The rate of consumption of materials

34 BASIC COST ACCOUNTING

• The time required to obtain new supplies (Re-order period)

FORMULA

Re-Order Level = Maximum Usage X Maximum Re-Order Period

MINIMUM STOCK LEVEL
- The minimum stock level is the level below which stock should not

normally be allowed to fall.
- Also known as buffer stock or safety stock
- This is the lowest quantity to which the stock should fall
- It is determined by:

• The rate of consumption of materials
• Re-order period

FORMULA

Minimum Stock Level =
Re-Order Level - (Normal @ Average Usage X Normal @ Average

Re-Order Period)

MAXIMUM STOCK LEVEL
- Maximum stock level is the level which stocks should normally be allowed

to rise.
- It is determined by:

• The rate of consumption of materials
• The re-order period
• Amount of capital available
• Cost of storage
• Price fluctuation

FORMULA

Maximum Stock Level =
Re-Order Level + EOQ - (Minimum Usage X Minimum Re-order

Period)

35 BASIC COST ACCOUNTING

EXAMPLE 2.1:

Re-order quantity (EOQ) 2,000 units
Re-order period 3 to 5 weeks
Maximum consumption of materials 500 units per week
Minimum consumption of materials 300 units per week
Normal consumption of materials 400 units per week

Solution:

Re-order level = Max Usage X Max Re-Order Period

= 500 x 5

= 2,500 units

Minimum stock level = Re-Order Level - (Normal @ Average

Usage X Normal @ Average Re-Order

Period)

= 2,500 – (400 x 4)

= 900 units

Maximum stock level = Re-Order Level + EOQ - (Minimum Usage X

Minimum Re-order Period)

= 2,500 + 2,000 – (300 x 3)

= 3,600 units

The relationship between all the stock levels is shown in the diagram
below:

36 BASIC COST ACCOUNTING

Stock Level
Max Stock

Level

Re-order
Level

Min Stock
Level

Safety
Stock

Time

Lead time
(Re-order Period)

-

RE-ORDER QUANTITY @ ECONOMIC ORDER QUANTITY (EOQ)
 EOQ is the quantity which is most economic to order.
 It is the size of the purchase order, which minimizes the total cost of stock

that is, ordering cost and holding cost.
 You need to know:

 Carrying/ storage / holding cost

CARRYING/ STORAGE/ HOLDING COST

Costs incurred on holding inventory in hand.

Oppotunity costs of money held up in inventories, storage
costs, spoilage costs and insurance cost.

e.g: rent, warehouse, guard, storekeeper, rent of forklift.

 Ordering cost

ORDERING COST

Costs that are incurred on obtaining additional inventories.
Costs incurred on communicating the order, transportation

cost and clerical costs.
e.g: telephone bill, fax, courier, carriage, loading etc.

37 BASIC COST ACCOUNTING

 Demand
 Number of orders
 Purchase price
 Calculating EOQ Assumption:
 Constant stockholding cost
 Constant ordering cost
 The rate of demand is known
 Constant price per unit
 Replenishment is made instantaneously, i.e.: the whole batch is

delivered at once.

FORMULA

EOQ = 2D Co D = Demand per annum
P Cs Co = Cost of ordering
P = Price
Cs = Cost of storage

FORMULA
Total Cost = Storage/Carrying Cost + Ordering Cost

Storage Cost = Average Stock X % of carrying cost X Cost per unit

Ordering Cost = No. of order per year X Cost per order

EXAMPLE 2.2:

The following information was supplied to the accountant to help the
management decide on the optimal level of stock to be ordered.

Quantity per annum 12 000 units
Cost of storage 24%
Cost per order RM 2
Price RM5

Solution:

EOQ = 2D Co
P Cs

38 BASIC COST ACCOUNTING

= 2 x 12,000 x RM2
RM5 x 0.24

= 48,000
1.2

= 200 units
-

AVERAGE STOCK
 Average value of stock during Financial Year.

FORMULA

Average Stock = EOQ
2

AVERAGE STOCK LEVEL
 The amount of stock management should maintain at any time of

operation.

FORMULA

Average Stock level = Minimum Level + EOQ
2

STOCK TURNOVER
 The stock turnover rate measures the number of times the average stock

is used up during a certain period. It is a good technique to be used in
the control of materials cost.

FORMULA

Annual Usage
Stock Turnover = Average Stock

39 BASIC COST ACCOUNTING

EXAMPLE 2.3: RM 200 000
RM 50 000
Cost of material XYZ used in the year RM 30 000
Opening stock of material XYZ
Closing stock of material XYZ

Calculate:
a. Average stock
b. Stock turnover rate

Solution:

Average Stock = Opening Stock + Closing Stock
2

= 50,000 + 30,000
2

= 40,000 units

Stock Turnover Rate = Annual Usage
Average Stock
200,000

= 40,000

= 5 times per year

This means that the stock is turned over 5 times a year or once in every
73 days (365 days/5)

NO. OF ORDER PER YEAR

FORMULA

Annual Usage
Stock Turnover =

EOQ

40 BASIC COST ACCOUNTING

ENRICHMENT EXERCISE 2.1

Maximum usage : 200kg
Minimum usage : 100kg
Reorder period (ROP) : 2 to 4 weeks
Reorder quantity (ROQ) : 400kg

Calculate:
a. The reorder level
b. The maximum stock level
c. The minimum stock level
d. The average stock level

Solution:

Re-order = Max Usage X Max Re-Order Period
level =
=

Maximum = Re-Order Level + EOQ - (Min Usage X Min Re-order
stock level Period)
=
=

Minimum = Re-Order Level - (Normal @ Average Usage X
stock level Normal @ Average Re-Order Period)
=
=

Average = Min Stock Level + [EOQ/2]

stock level =

=

-

41 BASIC COST ACCOUNTING

C. THE ISSUING OF MATERIALS
 A systematic and efficient procedure for issuing and supplies the
materials is equally important.
 No materials can be issued from storeroom except on properly
prepared and approved of material requisitions.

The process when material kept
in the storeroom issued to

production dept when required
for manufacturing of finished
good.

Any transfer of material from Production dept. will issue the
one job to another job it will Material Requisition Form
when they request for
be recorder in Material material from store.
Transfer Note.

When there is any return of Upon accepted this form
material to store from storekeeper will issue the material
to production provided the form is
production the Material
Return Note will be used. properly authorized.

42 BASIC COST ACCOUNTING

2.4. Record inventory using perpetual and periodic inventory system

A. STOCKTAKING
 It involves physically going to the store with the objective to verify the
stock record.
 It can be conducted on a continues or periodic basis.
 The process of verifying the stock balance is important to ensure that
the perpetual inventory system is functioning efficiently and any
minor stock discrepancies will be corrected.
 Difference continuous and periodic stocktaking.

CONTINUOS STOCKTAKING PERIODIC STOCKTAKING

Count sample stock only Complete stock count

Done regularly All store items are
e.g daily counted at one point in

Less disruptive time

Can disrupt production

B. STOCK LEVEL

Perpetual Definition – Is a record of all receipt, issues & balances for
Inventory each stock to facilitate regular checking (day to day
System stock movement).

The records are constantly kept up to date, as a result
management will be able to control store & ascertain
stock at any moment of time.

Continuous Definition – The continuous taking of stock, quantity
Stocktaking counted being checked against the appropriate
System perpetual inventory balance.

This process is important to ensure that the perpetual
inventory system is functioning efficiently & any minor
stock discrepancies will be corrected.

43 BASIC COST ACCOUNTING

C. STOCK VALUATION
 When store department issued material to production department
the issues must be valued or priced because it will affect the cost of
the products produced by production department.
 This may be difficult to do so because the same type of material may
have been purchased at several different prices.
 The basic problem in valuing material issues to production
department is to decide which price to be used.
 Objectives of valuing material:

To charge a realistic figure for To enable the store
material consumed & value department to charge a
consistent, reasonably simple
of stock on hand. method of valuing stock to
production department.

D. STOCK VALUING METHODS

FIFO The earliest materials purchased are used first until
[FIRST IN exhausted.
FIRST OUT]
Materials are issued in chronological order.

Price of the first batch received will be used for all
issues until all units from this batch have been used
before price of the next batch receive become the
issue price to production.

FIFO ensures materials are issued at actual cost.

The older items are the first to leave and the closing
stock will represent the most recent purchases.

Under FIFO method closing stock valuation is higher
because its consist of material which is recently
purchased at higher cost.

WEIGHTED The average price used.
AVERAGE
METHOD Price is calculated by dividing the total cost of
material in stock by the total quantity of material in
stock.

A new price needs to be calculated each time new
material are received.

The actual price paid for the material may not be
used because the average price used.

44 BASIC COST ACCOUNTING

FIRST IN FIRST OUT (FIFO)

ADVANTAGES DISADVANTAGES
The inventories consist of the The objective of matching current
latest batch (purchases). cost with current revenue is not
achieved under this method.
Mgt has little control over the
selection of units in order to FIFO costing is improper if many
influence recorded profits. lots are purchased during the
Valuation of inventories & cost period at different prices.
of goods manufactured are
consistent & realistic. This method overstates profits
Easy to understand & operate. especially with high inflation.

WEIGHTED AVERAGE METHOD (WAC)

ADVANTAGES DISADVANTAGES
Logical & consistent as it absorbs Simplicity & convenience are lost
while determining the average for when there is too much change in
pricing material issues. the prices of materials.
Changes in the prices of materials An average price is not based on
do not affect much the materials actual price incurred; therefore, is
issues & stock. not realistic.
Follows the concept of total stock
& total valuation.

EXAMPLE 2.4

Beauty Manufacturing Co. Ltd. makes the following purchases of material
‘X’ in the month of January. Find the value of stock using FIFO and WAC.

Date Purchases Issues
01/01 100kg @ RM1 per kg
05/01 100kg @ RM1.50 per kg 10/01 80kg
15/01 130kg @ RM2.31 per kg
29/01 150kg @ RM2.50 per kg 20/01 50kg

25/01 100kg

30/01 125kg

45 BASIC COST ACCOUNTING

STORE LEDGER ACCOUNT – FIFO METHOD

RECEIPTS ISSUES STOCK BALANCE

Date Qty Price Amount Qty Price Amount Qty Price Amount
Jan 1
(kg) (RM) (RM) (kg) (RM) (RM) (kg) (RM) (RM)

100 1.00 100 100 1.00 100

Jan 5 100 1.50 150 100 1.00 100
100 1.50 150

Jan 10 80 1.00 80 20 1.00 20

100 1.50 150

Jan 15 130 2.31 300 20 1.00 20
100 1.50 150
130 2.31 300

Jan 20 20 1.00 20

30 1.50 45 70 1.50 105

130 2.31 300

Jan 25 70 1.50 105
30 2.31 69 100 2.31 231

Jan 29 150 2.50 375 100 2.31 231
150 2.50 375

Jan 30 100 2.31 231
25 2.50 62.50
125 2.50 312.50

CLOSING STOCK 125 2.50 312.50

46 BASIC COST ACCOUNTING

STORES LEDGER ACCOUNT – WEIGHTED AVERAGE

RECEIPTS ISSUES STOCK BALANCE

Date Qty Price Amount Qty Price Amount Qty Price Amount

(kg) (RM) (RM) (kg) (RM) (RM) (kg) (RM) (RM)

Jan 1 100 1.00 100 100 1.00 100

Jan 5 100 1.50 150 100 1.50 150
200 1.25 250

Jan 10 80 1.25 100 (80) 1.25 (100)
120 1.25 150

Jan 15 130 2.31 300 130 2.31 300
250 1.80 450

Jan 20 50 1.80 90 (50) 1.80 (90)
Jan 25 100 1.80 200 1.80 360

180 (100) 1.80 (180)
100 1.80 180

Jan 29 150 2.50 375 150 2.50 375
250 2.22 555

Jan 30 125 2.22 277.50 (125) 2.22 (277.50)
125 2.22 277.50

CLOSING STOCK 125 2.22 277.50

-