Basic Cost Acounting

RGAB 2006

BASIC COST ACOUNTING

R. G. A. BOLAND AND J. A. FEATHERS

ACCOUNTING

STEP BY STEP

Four-hour programmes

of self-instruction in accounting

Accounting Step by Step

1. Accounting Reports

2. Debit and Credit

3. Basic Cost Accounting

4. Budgetary Control

Accounting Step by Step, Volume 3

BASIC COST ACCOUNTING

R. G. A. BOLAND

Fellow of the Institute of Chartered Accountants

J. A. FEATHERS

Fellow of the Association of Certified Accountants

Fellow of The Institute of Cost and Management Accountants

ISBN 0 340 04504 3

All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system, without permission in writing.

The figures in this book are fictitious and do not relate to any particular company or business.

HOW TO USE THIS PROGRAMME

introduction

This is an experimental programme in applying a new technique to the problems of learning accounting. The authors would appreciate comments from both teachers and others who use the programme, to improve the design of later editions.

purpose of the programme

The programme enables you to teach yourself very rapidly the language and basic concepts of cost accounting. It is a programme of instruction which leads you to an understanding of what cost of instruction which leads you to an understanding of what cost accounting reports can and cannot tell you about a business. It is not a textbook, but an aid to the understanding of existing textbooks.

The programme leads you from simple to complex ideas in a gradual fashion. If you are unfamiliar with accounting you will not be able to understand the later parts of the book until you have understood what comes before. The programme is like a ladder and the parts of the programme are like the rungs in a ladder. You cannot reach the top rung of a ladder unless you have first used all the lower rungs. If there are several rungs missing in the ladder, it is not only very difficult to reach the top, but the ladder also becomes unstable. The same things apply to your knowledge of accounting.

contents

This book is divided into five chapters. Chapter I is a brief introduction. Chapters II-V comprise the main programme which is a series of “sets”. In each set, there are ten to sixty “frames” which systematically present new knowledge and also demand from you written answers.

The main programme is followed by a quiz designed to test the knowledge you have acquired. There is also a brief glossary of cost accounting language.

technique

The following technique is used in writing the programme:

1. The number of words needed for a correct response is indicated by the number of dotted lines (...... ).

2. An acceptable answer to a frame is the correct answer, shown, or any reasonable synonym. You are the judge.

3. Answers that require an amount of money are indicated in the frame by “£...... ” and not by the normal “...... ”.

accounting step by step routine

routine

The routine for the, student to follow in using the programme is as follows:

1. Read the summary of the set. If you already understand all the words pass on to the next set. If not, do the set.

2. Read each frame and refer to the appropriate exhibit each time.

3. Write your response in the book or on a separate sheet.

4. Check your response with the correct answer which is one frame down. Do not wait until the end, check each answer separately.

5. If your answer is the same as the correct answer or is any reasonable synonym, mark it with a tick and go on to the next frame.

6. If the answer is not correct, read the frame again, write the answer to the frame correctly, and then go on to the next frame.

7. At the end of the set, read the summary of the set again. Count the number of correct answers you have made. If you have 80% correct, move to the next set. If you have less than 80% correct, do the set again.

writing the answers

Writing the answers is essential to the learning process. The answer must be written before you look at the correct solution. If you glance ahead you will lose half of the value of the programme. (However, a little intelligent cheating can be educational!)

sequence

Each frame must be answered in turn. The sequence has been carefully designed to introduce new knowledge and to reinforce old knowledge. Do not skip frames. Any apparent repetitions are there for a good reason. Avoid careless answers. If you begin to make mistakes because you are tired, and have not read the text carefully, take a rest. If you continually miss one particular point, go back to the set in which it first appeared and do that set again.

And now read quickly

through Chapter I:

“Introduction to Cost Accounting”

CONTENTS

HOW TO USE THIS PROGRAMME vii

Chapter I Introduction to Cost Accounting 9

Chapter II Meaning of Cost 13

Set 1 Calculating the cost 13

Set 2 Organization, objectives and methods 21

Set 3 Direct and indirect costs 33

Set 4 Cost estimates and selling prices 47

Chapter III Manufacturing Overhead 57

Set 5 Cost centres 57

Set 6 Cash and credit 73

Chapter IV Costing Methods 83

Set 7 Contract, job and batch costing 83

Set 8 Output costing 93

Set 9 Process costing 99

Chapter V Interpretation of Cost Data 107

Set 10 Cost statements 107

Set 11 Relevant costs 123

QUIZ A Test of Knowledge acquired from

the Programme 136

FOR THE TEACHER 151

ANSWERS TO THE QUIZ 152

GLOSSARY OF COST ACCOUNTING

LANGUAGE 153

PROGRESS WORK SHEET

chapter/set / estimated
time
(minutes) / actual
time
(minutes) / total of
frames«
in error / frame no.
of each
error
Chapter I / 20
chapter II
Set 1
Set 2
Set 3
Set 4 / 20
20
20
20
Chapter III
Set 5
Set 6 / 25
15
Chapter IV
Set 7
Set 8
Set 9 / 10
10
10
Chapter V
Set 10
Set 11 / 20
20
Quiz / 30
Total time / 240

Note: The authors would be pleased to receive the information outlined above and other comments from any serious student who is interested in research into the effectiveness of programmed learning.

«One error in a frame is treated as a frame in error.

Chapter I

INTRODUCTION TO COST ACCOUNTING

Estimated time 10 minutes (twice) (Read at beginning and end of the programme)

Read quickly through the following paragraphs. Do not study them in detail until you have completed the whole programme.

Accounting Language

Accounting has been called the language of business and, like any language, it can never express our thoughts with absolute precision and clarity. Our task of learning this language is complicated by the fact that many of the words used in accounting mean almost, but not quite, the same as they mean in every-day life. You must learn not to think of the words in their popular meaning. In this programme we have used a standard set of accounting terms, although certain other terms are also commonly used in practice. However, frequent repetition and writing of the standard accounting terms reinforces your basic grasp of the accounting language.

Rules and principles

In any language there are some rules of principles that are definite and some others that are not definite. The latter are a matter of opinion or style. Accountants have different opinions just as grammarians have different opinions. As language changes to meet the needs of communication in a society, so accounting changes to meet the needs of business.

Uncertainty

Accounting encompasses the facts about a business that can be expressed in money. However, many important business facts, i.e. the health of management, the morale of the workers, the state of the market, etc., cannot be expressed in money. Accounting must necessarily therefore provide only a limited picture of a business.

accounting step by step routine

Consistency and Comparability

Accounting figures became significant, not in themselves, but when they are compared with other figures for a similar previous period, with a budget estimate, or even with figures for another business.

The accountant, therefore, despite the problems of uncertainty, tries to be consistent in his judgment so that the figures he produces are comparable.

Financial Accounting

Financial accounting generally relates to the records, and to the concepts necessary to prepare balance sheets and income statements (profit and loss accounts) showing a true and fair overall position of a business.

Cost Accounting

Cost accounting is concerned not with the overall results of the business but with the efficiency of the various sections of the business and with the cost of a unit of production. The cost is not in not a scientific fact but depends upon the judgment of the cost accountant. This book shows how the cost of a unit of production may be calculated and the key assumptions underlying this calculation. You should therefore appreciate not only the advantages of cost accounting but also some of its limitations

Actual and Standard Costs

The programme deals with historical or actual cost accounting. A separate programme will deal with the technique of standard cost accounting. The latter involves the setting of standards as measures of performance against which to measure actual cost and efficiency of operations in terms of variances of price, quantity and volume.

Language

In the programme we have used a simple set of standard words in place of highly technical terms. The glossary at the end of the book defines each word used in the book and other words used in practice.

Now start the detailed programme

at chapter II Set 1.

Chapter ii

MEANING OF COST

Set 1 CALCULATING THE COST

Estimated time 20 minutes

SUMMARY

In financial accounting we compute for an accounting period the sales, cost and profit for the whole business. However, in cost accounting we analyse costs and compute the cost of each unit of production.

Cost depends upon the judgment of the cost accountant in each situation.

The cost of a product purchased for resale, is the price we pay. But if we buy material to make a product for resale, then the cost of the product includes the material, labour and overhead.

The cost of those units of a product sold is not the same as the total cost of materials, labour and overhead, since some of those costs may relate to unsold units.

If we buy goods for £4 and sell half of them for £6, our profit to date is £4 (provided the goods left over are still worth £2).

Chapter ii

MEANING OF COST

Set 1 CALCULATING THE COST

Exhibit 1 Financial Accounting Report

INCOME STATEMENT

Year ended December 31, Year 1

£
Sales / 120
Less Costs / 100*
Profit / 20

* Relates to four different products produced and sold during the year.

frame detail / correct answers
1 In financial accounting we compute the sales, costs, and profit for all products. However, in cost ...... we compute the cost for each ...... separately. / Now check your answer with the correct answer in the frame below. Tick it if correct
2 Now read Exhibit 1 which is an income statement or profit and loss account for an accounting period of ...... year. / accounting
product
3 It shows total sales and costs during the year, and a figure of total ...... for the year of £20. / one
4 The statement that indicates the total sales, costs and profit for an accounting period is called a ...... and ...... account or ...... statement. / profit
5 In Exhibit 1 the income statement shows the sales, cost, and profit for ...... (how many?) different products produced and sold during the period. Does it show the cost of each product? For this we need not financial accounting but ...... accounting / profit
loss
income
6 If we only make 4 identical units of the same product for £100, the cost of one unit may easily be calculated by dividing the total cost by ...... Thus the cost per unit is £...... / four
no
cost
7 However, if we make four different products we ...... (can, cannot) divide the total cost by the total quantity of the output to get the cost of one product. What do we need? / 4
£25
8 If we purchase goods for resale the cost is the purchase ...... that we pay for the goods. / cannot
cost accounting

Chapter ii Set 1

CALCULATING THE COST

Exhibit 2 Cost of one product: Product X

£
Material 3 tons @ £5 per ton / 15
Labour 5 hours @ £1 per hour / 5
20
Overhead 5 hours @ £2 per hour / 10
Total cost / 30
frame detail / correct answers
9 However, if we buy raw material and manufacture a product, then to the cost of raw material, we must add the cost of manufacture to get the total ...... of the product. / price
10 Read Exhibit 2 relating to ...... (how many) product. It shows the computation of the total cost of product X as £...... / cost
11 To manufacture the product we used ...... tons of raw material at £5 per ton for a total material cost of £...... ; similarly we used 5 hours of labour at £...... per hour for a total labour cost of £ ...... / one
£30
12 Is the cost of labour and material the total cost of product X? / 3 tons
£15
£1
£5
13 To arrive at total cost we must add £10 for ...... This overhead cost is an estimate based upon ...... hours at £2 per hour. / no
14 The overhead cost appropriate to a particular product is always an estimate. Therefore the total product cost must also always be an ...... It must depend upon the judgment of the ...... accountant. / overhead
5