PALAWAN STATE UNIVERSITY

College of Business and Accountancy

Department of Accountancy
Puerto Princesa City

MODULE 2:
COST ASSIGNMENT
BA2002: COST AND MANAGEMENT ACCOUNTING
2nd Semester | SY: 2020-2021

BSBA MM 1

LARA CAMILLE C. CELESTIAL, CTT, CMA

College of Business and Accountancy
Palawan State University
 TABLE OF CONTENTS

Title Page of Module 1

Table of Contents 2

Overview 3
Course Outcome 3
Learning Outcomes 3
Summary of Topics 3
Content
Topic 1: Cost Assignment Concept 4
Topic 2: Products and Services 6
2.1: Product and Period Cost 7
Topic 3: External Financial Statements 9
3.1: Statement of Cost of Goods Manufactured 9
3.2: Statement of Cost of Goods Sold 10
3.3: Income Statement 11
Reference 12

MODULE 2 |
COST ASSIGNMENT
BA2002: Cost and Management Accounting| Module 2: Cost Assignment 2
Overview
If you can still recall on our previous module, we have
encountered the term “cost assignment”. In this module, we will
discuss cost assignment in depth so that a proper foundation is laid for
its use in studying other cost management topics. You will learn how to
assign costs to objects, how to prepare income statements and its
components which can be useful for both accountants and non-
accountants, and so much more! So, come and let’s dig deeper on our
second module! Enjoy!

Intended Learning Outcomes:

 Explain the cost assignment process
 Define tangible and intangible products
 Classify the various kinds of product or manufacturing cost
 Differentiate product cost from period cost
 Prepare income statements for manufacturing and service organizations

Topics:
1: Cost Assignment Concept
2: Products and Services
2.1: Product and Period Cost
3: External Financial Statements
3.1: Statement of Cost of Goods Manufactured
3.2: Statement of Cost of Goods Sold
3.3: Income Statement

Topic #1: Cost Assignment Concept

Assigning costs accurately to cost objects is crucial. Accuracy is not evaluated based
on knowledge of some underlying “true” cost. Rather, it is a relative concept and has to do with

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 3

the reasonableness and logic of the cost assignment methods that are being used. The
objective is to measure and assign as accurately as possible the cost of the resources used by
a cost object.
Understanding the relationship of costs to cost objects can increase the accuracy of
cost assignments. Costs are directly or indirectly associated with cost objects. As you already
know, direct cost are those cost that can be traced easily and accurately to a cost object while
indirect cost are costs that cannot be traced easily and accurately to a cost object. For costs to
be traced accurately means that the costs are assigned using a casual relationship. Thus,
traceability is the ability to assign cost directly to a cost object in an economically feasible way
by means of a casual relationship. The more costs that can be traced to the object, the greater
the accuracy of the cost assignments.

Cost management systems typically deal with many cost objects. Thus, it is possible for
a particular cost item to be classified as both a direct cost and an indirect cost. It all depends
on which cost object is the point of reference.

For example: If the plant is the cost object, then the cost of heating and cooling the plant is a
direct cost. However, if the cost objects are products produced in the plant, then this utility
cost is an indirect cost.

Tracing cost to cost objects can occur in one of two ways:

a) Direct Tracing. This is the process of identifying and assigning costs to a cost
object that are specifically or physically associated with the cost object. Direct
tracing is most often accomplished by physical observation.

For example: Assume that the power department is the cost object. The fuel used to produce
power and the salary of the power department’s supervisor are examples of costs that can be
specifically identified by physical observation with the cost object (the power department).

As a second example, consider a pair of blue jeans. The materials (denim, zipper, buttons,
and thread) and labor (to cut the denim according to the pattern and sew the pieces together)
are physically observable. Therefore, the costs of materials and labor can be directly charged
to a pair of jeans. Ideally, all costs should be charged to cost objects using direct tracing.

Unfortunately, it is often impossible to physically observe the exact amount of resources being
used by a cost object. The next best approach is to use a cause-and-effect reasoning to
identify factors – called drivers – that can be observed and which measure a cost object’s
resource consumption. Drivers are factors that cause changes in resource usage, activity
usage, costs, and revenues.

b) Driver Tracing. It is the use of drivers to assign costs to cost objects. Although less
precise than direct tracing, driver tracing can be accurate if the cause-and-effect
relationship is sound. The use of drivers to assign costs to activities will be
explained in more detail on our next modules.

For example: Consider the cost of electricity for the jeans manufacturing plant. The factory
manager might want to know how much electricity is used to run the sewing machines.

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 4

Physically observing how much electricity is used would require a meter to measure the power
consumption of the sewing machines, which may not be practical. Thus, a driver such as
“machine hours” could be used to assign the cost of electricity. If the electrical cost per
machine hour is $0.10 and the sewing machine uses 200,000 machine hours in a year, then
$20,000 of the electricity cost ($0.10 x 200,000) would be assigned to the sewing activity.

COST ALLOCATION

Indirect costs cannot be traced to cost objects. Either there is no casual relationship
between the cost and the cost object or tracing is not economically feasible. Assignment of
indirect costs to cost object is called allocation. Since no casual relationship exists, allocating
indirect cost is based on convenience or some assumed linkage.

For example: Consider the cost of heating and lighting a plant that manufactures five
products. Suppose that this utility cost is to be assigned to the five products. Clearly, it is
difficult to see any casual relationship. A convenient way to allocate this cost is simply to
assign it in proportion to the direct labor hours used by each product.

Arbitrarily allocating indirect costs to cost objects reduces the overall accuracy of the cost
assignments. Accordingly, the best costing policy may be that of assigning only traceable
direct costs to cost objects. However, it must be admitted that allocations of indirect costs may
serve other purposes besides accuracy. Nonetheless, most managerial uses of cost
assignments are better served by accuracy. At the very least, direct and indirect cost
assignments should be reported separately.

Topic #2: Products and Services

One of the most important cost objects is the output of organizations. The two types of output
are tangible products and services.

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 5

 a) Tangible products are goods produced by converting raw materials into finished
products through the use of labor and capital inputs such as plant, land, and
machinery.

Televisions, hamburgers, automobiles,

computers, clothes, and furniture are
examples of tangible products.

b) Services are tasks or activities

performed for a customer or an
activity performed by a customer
using an organization’s products or
facilities. Services are also produced
using materials, labor, and capital
inputs.

Insurance coverage, medical care, dental care,

funeral care and accounting are examples of
services where the customer uses an
organization’s products or facilities.

Services differ from tangible products on three important dimensions:

 Intangibility – buyers of services cannot see, feel, hear, taste a service before it is
bought
 Perishability – services cannot be stored
 Inseparability – producers of services and buyers of services must usually be in
direct contact for an exchange to take place

Manufacturing Firm Service Firm

Organizations
that produce
tangible
products are
called

manufacturing organizations. Those that produce intangible products are called service
organizations. Managers of organizations that produce goods and services need to know
how much individual products costs for a number of reasons, including profitability analysis
and strategic decisions concerning product design, pricing, and product mix.

2.1 PRODUCT AND PERIOD COST

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 6

 An important objective of a cost management system is the calculation of product costs for
external reporting. Externally imposed conventions require costs to be classified in terms of
the special purposes or functions they serve. Costs are subdivided into two major functional
categories:

a) Production/Product Cost – these are costs associated with manufacturing goods or

providing services. These are also known as manufacturing costs. Production costs can be
further classified as:

 Direct Materials. These are materials traceable to the good or service being
produced. The cost of these materials can be directly charged to products because
physical observation can be used to measure the quantity used by each product.

For example: steel in an automobile, wood in furniture, denim in jeans.

 Direct Labor. This is labor that is traceable to the goods or services being
produced. As with direct materials, physical observation is used to measure the
quantity of labor used to produce a product or service.

For example: employees who convert raw materials, a chef in a restaurant, a pilot
for airplane.

 Overhead. All production costs other than direct materials and direct labor are
lumped into this category. In a manufacturing firm, overhead is also known as
factory burden or manufacturing overhead. The overhead cost category contains a
wide variety of items.

For example: indirect materials, indirect labor, deprecation on buildings,

maintenance, supervision, power, property taxes, landscaping of factory grounds,
and plant security.

Prime and Conversion Cost. The manufacturing and nonmanufacturing

classifications give rise to some related cost concepts. The functional distinction
between manufacturing and nonmanufacturing costs is the basis for the concepts of
non-inventoriable costs and inventoriable costs – at least for purposes of external
reporting.

Prime Cost – the sum of direct materials and direct labor

Conversion Cost – the sum of direct labor and manufacturing overhead.

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 7

 b) Non-production costs – these are costs associated with the functions of selling and
administration. These are also known as period costs. Period costs are expensed in the
period in which they are incurred. Thus, period costs are not inventoried and are not
assigned to products. Period costs appear on the income statement – not the balance
sheet.
 Selling Costs (Marketing Costs)
Those costs necessary to market and distribute a product or service.
Examples of these costs include: advertising, salaries and commission of sales,
personnel, warehousing, shipping, and customer service.
 Administrative Costs
These are all costs that cannot be reasonably assigned to either marketing or
production. Administration is responsible for ensuring that the various activities of
the organization are properly integrated in accordance with the overall mission of
the firm.
The president of the firm, for example, is concerned with the efficiency of both
marketing and production as they carry out their respective roles. Example of
administrative costs include: legal fees, research and development, top executive
salaries, printing and distributing the annual report, and general accounting.

For service organizations, the relative importance of selling and administrative costs depends
on the nature of the service being produced. Physicians and dentists, for example, generally
do very little marketing and thus have very low selling costs. An airline, on the other hand, may
incur substantial marketing costs.

Physicians and dentists, for example, generally do very little marketing and thus have very low
selling costs. An airline, on the other hand, may incur substantial marketing costs.

Topic #3: External Financial Statements

The functional classification of cost classification require for external reporting. In

preparing an income statement, production and nonproduction costs are separated. The
reason for the separation is that production costs are product costs and the nonproduction

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 8

 costs of marketing and administration are view as period costs. Thus, production costs
attached to the units sold are recognized as an expense (cost of goods sold) on the
income statement. Marketing and administrative expenses re viewed as costs of the period
and must be deducted each and every period as expenses on the income statement.
Nonproduction costs never appear on the balance sheet.

INCOME STATEMENT: SERVICE FIRM

The income statement for a service organization looks very similar to the one shown in
Lesson 3.3 illustration for a manufacturing organization. However, the cost of goods sold does
differ in some key ways. For one thing, the service firm has no finished goods inventories
since services cannot be stored, although it is possible to have work in process for services.
For example, an architect may have drawings in process and an orthodontist may have
numerous patients in various stages of processing for braces.

INCOME STATEMENT: MANUFACTURING FIRM

The income statement prepared for external parties follows the standard format taught in an
introductory financial accounting introductory course. This income statement is frequently
referred to as Absorption Costing Income or Full Costing Income because all manufacturing
costs are fully assigned to the product.

Under the absorption-costing approach, expenses are separated according to function and
then deducted from revenues to arrive at operating income. The two major functional
categories of expense are cost of goods sold and operating expenses. These categories
correspond to a firm’s manufacturing and non-manufacturing expenses.

3.1 STATEMENT OF COST OF GOODS MNUFACTURED

To compute the cost of goods sold, it is first necessary to determine the cost of goods
manufactured. The cost of goods manufactured represents the total manufacturing cost of
goods completed during the current period. The only costs assigned to goods completed are
the manufacturing costs of direct materials, direct labor, and overhead. The details of this cost
assignment are given in a supporting schedule, called the statement of cost of goods
manufactured.

Work-in-process consists of all partially completed units found in production at a given

point in time. Beginning work in process consists of the partially completed units on hand at
the beginning of a period. Ending work in process consists of the incomplete units on hand
at the
period’s
end.
X Company
Statement of Cost of Goods Manufactured
For the Coming Year

Direct Materials
Beginning Inventory xxx
Add: Purchases xxx
Materials Available xxx
BA2002: Cost and Management Accounting| Module 2: Cost Assignment 9
Less: Ending Inventory (xxx)
Direct Materials used in production xxx
3.2 STATEMENT OF COST OF GOODS SOLD

Once the cost of goods manufactured statement is prepared, the cost of goods
sold can be computed. The cost of goods sold is the manufacturing cost of the units
that were sold during the period. It is important to remember that the cost of goods
sold may or may not equal the cost of goods manufactured. In addition, we must
remember that the cost of goods sold is an expense, and it belongs on the income
statement.

X Company
Statement of Cost of Goods Sold
For the Coming Year

Cost of Goods Manufactured xxx

Add: Beginning finished goods xxx
Cost of Goods Available for Sale xxx
Less: Ending finished goods (xxx)
Cost of Goods Sold xxx

3.3 INCOME STATEMENT

Finally, we are ready to prepare an income statement for a manufacturing firm.

Gross margin (also called gross profit) is the difference between sales and cost of
goods sold. This is an important number on the income statement.

X Company
Income Statement
For the Coming Year
BA2002: Cost and Management Accounting| Module 2: Cost Assignment 10
Sales Revenue
 xxx
(xxx)
xxx

xxx
xxx (xxx)
xxx

REFERENCES|
Leonardo E. Aliling, CPA, MBA and Ma. Flordeliza L. Anastacio, CPA, PhD, Management Accounting
1 (2015) Rex Publishing

BA2002: Cost and Management Accounting| Module 2: Cost Assignment 11