Cost system

The Cost Systems are sets of methods, rules and procedures that govern the planning, determination and analysis of the cost, as well as the process of recording the expenses of one or several productive activities in a company, in an interrelated way with the subsystems that guarantee the control of production and material, labor and financial resources.


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  • 1 Cost elements:
    • 1 Direct material costs
    • 2 Direct labor costs
    • 3 Indirect manufacturing costs
  • 2 Costing System for Work Orders
  • 3 Characteristics of the calculation of the cost in a Costing System for Work Orders
  • 4 Costing System by Process
  • 5 Costing Objectives for Processes
  • 6 Characteristics of a Process Cost System
  • 7 Methods in allocating costs by process
    • 1 Weighted Average Price Method
    • 2 FIFO Method (First in, first out)
  • 8 Sources

Cost elements:

Items that fall within an item’s manufacturing cost are direct materials, direct labor, and manufacturing overhead.

Direct material costs

They are the ones that can be identified in each product unit. In some cases, direct material costs are those that can be attributed to a specific department or process.

Direct labor costs

Refers to wages paid to workers for work performed in a given unit of product or in some cases carried out in a specific department.

Manufacturing overhead

They are non-direct expenses that cannot be attributed to specific product units or in some cases to specific departments or processes.

Costing System for Work Orders

Work order costing is a cost accumulation and distribution method used by entities that manufacture products according to customer specifications. Operations begin with the issuance of a production order in which direct materials and direct labor are accumulated for each work order. Indirect manufacturing costs are accumulated by department and then distributed to work orders. Essentially all manufacturing costs are allocated to manufactured products.

The work order cost sheet is a summary form in which the job number and other specifications and descriptive information are noted, as they appear on the production order.

Characteristics of the cost calculation in a Costing System for Work Orders

  • Direct materials and direct labor are accumulated for each work order. Indirect manufacturing costs are accumulated by department and then distributed to work orders, all manufacturing costs are allocated to manufactured products.
  • Direct materials are charged to specific work orders, indirect materials are charged to manufacturing indirect cost centers by department, and assigned to specific work orders upon completion using an indirect cost application rate of manufacturing.
  • Labor costs are accumulated through the time ticket, this is distributed to specific work orders that are in process based on time tickets that indicate the number of hours worked in each work order.

Process Costing System

Process costing is a system of accumulating production costs by department or cost center. A department is a main functional division in a factory where manufacturing processes are executed. When two or more processes are executed in a department, it may be convenient to divide the departmental unit into cost centers. Each process is shaped as a cost center, the costs are accumulated by cost centers instead of by departments. Departments or cost centers are responsible for costs incurred within their area and their supervisors must report to management for costs incurred by periodically preparing a cost of production report.

A process cost system determines how manufacturing costs incurred during each period will be assigned. The allocation of cost in a department is only an intermediate step; the objective is to determine the total unit cost in order to determine the income. During a certain period some units will be started, but not all will be finished at the end of it.

Process costing addresses the flow of units across multiple operations or departments, adding more additional costs as they go. Unit costs for each department are based on the relationship between costs incurred in a period of time and units completed in the same period.

Process Costing Objectives

The goal of a cost-per-process system is to determine how much of the direct materials, direct labor, and manufacturing overhead is applied to finished and transferred units, and how much is applied to units still in process. Each department prepares a production cost report that illustrates the allocations.

Characteristics of a Process Cost System

  • Costs are accumulated and recorded by department or cost center.
  • Each department has its own work in process inventory account in the general ledger. This account is charged with the costs of the process incurred in the department and is credited with the costs of finished units transferred to another department or finished items.
  • Equivalent units are used to determine work-in-process inventory in terms of units completed at the end of a period.
  • Unit costs are determined by department in each period.
  • The finished units and their corresponding costs are transferred to the next department or to the inventory of finished articles. By the time units leave the last department of the process, total period costs have been accumulated and can be used to determine the unit cost of finished items.
  • The total and unit costs of each department are periodically added, analyzed and calculated through the use of production reports.

Methods in allocating costs by process

Weighted Average Price Method

Under this method the initial inventory costs are added to the period costs and the total is divided by the equivalent production to obtain the average unit costs. The costs associated with the units still in process lose their identity due to the merger, and the initial inventory is considered as if it were in the current period.

FIFO method (First in, first out)

In this method the units of the initial inventory are treated differently than the units of the current period. It is assumed that the units of the initial inventory are finished before the units started in this period, in addition the costs of the units started and finished in this period are separated from the units in process of the initial inventory.


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