Cost flows clarified: three stages to introducing inventory accounting for manufacturing.

Author:Mutju, Alexandra

    Financial Accounting and Accounting Principles texts generally use service firms as models to introduce the accounting equation, the accounting cycle, and the four financial statements. The revenues, expenses, assets and liabilities in service firms are relatively simple, and thus easy to explain to beginning students of business or accounting. These introductory courses later introduce a merchandising model to bring in the concept of inventory as a current asset whose purchase is not necessarily an expense in the period of purchase, and to explain the schedule of cost of goods sold. A manufacturing firm's complexities may be mentioned, but rarely is the flow of costs in manufacturing fully covered in preliminary accounting courses.

    Thus, it is typically in the management accounting (or cost accounting) course that students are first introduced to the manufacturing environment. The flow of costs through a manufacturing company's three classes of inventory and three stages of operations presents an added complexity which students must grasp before tackling such basic management accounting subjects as: job order costing and process costing, budgeting, standard costing, and production variance analysis.

    This paper examines the way the flow of costs through the manufacturing process is presented in five leading management accounting and/or cost accounting texts, and considers how the related learning objectives found in those texts match with their content. We then propose a model of the flow of costs through the manufacturing process which we believe improves upon the teaching approaches that we found in those five textbooks.

    In presenting our pedagogical approach, which we call "The Rule of Threes," our intent is not to deliver a chapter explaining each step of accounting for the flow of costs. Rather, it is to present a simple diagram of that flow which we consider to be effective as a classroom tool with which to accomplish the first level of Bloom's taxonomy: knowledge, and two parts of the second level: intellectual abilities and skills. Based on the proposed diagram, we also suggest corresponding learning objectives for the flow of costs through the manufacturing process.


    Our methodology, represented graphically, is as follows:


    In the first stage of the research we identified the way the flow of costs in manufacturing process is approached in current accounting textbooks. The conclusions from this stage made us draw our attention on the learning objectives presented at the beginning of each examined chapter. Here, we analyzed if the learning objectives were linked with the text's content for the flows of costs. By analyzing comparatively the flows of costs and the learning objectives attached to them, we concluded that the way the flows of costs are presented in the textbooks could be improved. We developed a revised (and we believe improved) approach. This generated a need to restate the learning objectives for some of the textbooks analyzed.

    Further, we present the methodology we used in this research:

    We based our work on some of the world's best-known books in Managerial and Cost Accounting:

  3. Anthony Robert T., Hawkins David F., Merchant Kenneth A., Accounting, Text and Cases, 12th Edition, McGraw-Hill, International Edition, 2007

  4. Hilton Ronald W., Managerial Accounting: Creating Value in a Dynamic Business Environment, 10th Edition, McGraw-Hill, 2009

  5. Hilton Ronald W., Maher Michael W., Selto Frank H., Cost Management. Strategies for Business Decisions, McGraw-Hill, 2003

  6. Horngren C. T., Datar S. M., Foster G., Cost Accounting, A Managerial Emphasis, 11th Edition, Pearson Education, 2003

  7. Garrison Ray H., Noreen Eric W, Brewer Peter C., Managerial Accounting, 12th Edition, McGrawHill, 2008.

    Our research model comprises the following steps:

    Step 1. We analyzed the authors' approach on the flow of costs in a manufacturing company. For this, we used the following criteria:

  8. A description of the flows of costs is given for a manufacturing company.

  9. Schedule of Cost of Goods Manufactured (SCGM) is presented.

  10. Statement of Cost of Goods Sold (SCGS) is presented.

  11. The link between SCGM/SCGS and Income Statement (IS) is presented.

  12. Costs' computation is shown for each representative stage of the costs' flows.

    Step 2. We analyzed the learning objectives for the topic examined.


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