478 Accounting: Business Reporting for Decision Making
VALUE TO BUSINESS• Cost information assists entities in price setting, performance evaluation and cost management.
• A cost object is anything for which a separate measurement of cost is desired.
• The full cost of a cost object is equal to direct costs plus indirect costs.
• Direct costs can be traced in an economically feasible way to a cost object.
• Indirect costs are incurred for the benefit of multiple cost objects.
• As indirect costs cannot be traced to specific cost objects in an economically feasible way, such
costs need to be allocated.
• Cost drivers provide the link between the indirect cost and the cost objects.11.5 Inventoriable product cost
LEARNING OBJECTIVE 11.5 Calculate an inventoriable product cost.
An important cost object reported in a manufacturing entity’s financial reports is the inventory value
of manufactured products. Inventoriable product cost represents the cost of converting raw material
into a finished product. Accounting standards guide the preparation of financial statements and the
valuation of inventory. Any costs incurred to support entity activities that are non-manufacturing in
nature — such as office salaries, administration expenses, and depreciation of office equipment — are
treated as period costs (i.e. non-manufacturing costs for the current period) and expensed in the cur-
rent reporting period. Therefore, the indirect costs used to calculate the inventoriable product cost are
limited to indirect manufacturing (production) costs. Remember that the indirect manufacturing costs
are a direct cost for the manufacturing department, but indirect in relation to the individual products
being manufactured.
When products are sold, the inventoriable product cost is expensed as a cost of sales. For products
still remaining in inventory (i.e. unsold), the inventoriable product cost is carried into the next reporting
period as a current asset (either as work-in-process inventory for incomplete goods, or finished goods
inventory for completed goods) on the statement of financial position (balance sheet).
The type (structure) of the costing system selected to determine the inventoriable product cost
is influenced by an entity’s product range and processes. If an entity’s products are mass produced
(whereby all products go through similar processes and consume resources in the same way), or if
there is only one product manufactured, the entity will use a process costing system (see figure 11.8).
In the process costing system, direct costs are considered the raw materials, and the indirect costs
represent the labour and other indirect manufacturing costs (the two costs are grouped into one cost
pool and described as conversion costs). The indirect cost is allocated by averaging the indirect costs
used in the process for the period. This is done by dividing the total costs by the number of units of
output.
When an entity manufactures products to different customers’ specifications, the costing system will
need to capture the differences in resource consumption. A job costing system (see figure 11.9) is used
when the costs need to be assigned to jobs on an individual basis. Direct costs include labour, which is
used directly in the production process, and raw materials that are converted into the finished product.
Indirect manufacturing costs are all the other costs incurred in the factory.
Notice that labour is classified differently under each system. In a process costing system,
products use the same amount of labour for each product. Therefore, detailed records matching
labour hours to particular units are not required and labour can be treated as an indirect cost and
allocated to each unit. In contrast, when products do not use the same amount of labour per product
unit, separate records need to be kept that trace the labour usage to the specific jobs. The detailed
record keeping allows the labour cost to be traced to individual products, and is classified as a
direct cost.