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
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
2. THE MODEL AND METHODOLOGY
Our methodology, represented graphically, is as follows:
[FIGURE 1 OMITTED]
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:
1. Anthony Robert T., Hawkins David F., Merchant Kenneth A.,
Accounting, Text and Cases, 12th Edition, McGraw-Hill, International
2. Hilton Ronald W., Managerial Accounting: Creating Value in a
Dynamic Business Environment, 10th Edition, McGraw-Hill, 2009
3. Hilton Ronald W., Maher Michael W., Selto Frank H., Cost
Management. Strategies for Business Decisions, McGraw-Hill, 2003
4. Horngren C. T., Datar S. M., Foster G., Cost Accounting, A
Managerial Emphasis, 11th Edition, Pearson Education, 2003
5. 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:
1. A description of the flows of costs is given for a manufacturing
2. Schedule of Cost of Goods Manufactured (SCGM) is presented.
3. Statement of Cost of Goods Sold (SCGS) is presented.
4. The link between SCGM/SCGS and Income Statement (IS) is
5. Costs' computation is shown for each representative stage
of the costs' flows.
Step 2. We analyzed the learning objectives for the topic examined.
Textbooks represent a learning resource, so each topic's
approach has to fulfill the learning objectives presented at the
beginning of each chapter.
Step 3. Finding ways to improve the topic's approach.
We identified a few "weak points" of the approaches found
in Step 1, and tried to improve them in a helpful way for the learners.
Thus, we synthesized a more comprehensive diagram (and pedagogical
presentation) titled: "The Rules of Threes", which we have
used in classes, and have found effective in easing the learners'
Step 4. Defining a more comprehensive set of learning objectives
for the flows of costs.
Based on including "The Rule of Threes" into the learning
approach, we considered it necessary to revise the learning objectives
in order to be sure they correspond clearly to the topic.
Our findings refer to the first two steps of the research. In this
section we present the way textbooks' authors approach the flow of
costs in a manufacturing company and the learning objectives the authors
state for the flow of costs. At the end of this section our findings are
summarized in a table.
Anthony et al. in Accounting, Text and Cases, in Chapter 6,
"Cost of sales and inventories", address the flow of costs.
They describe the three types of companies: merchandising, manufacturing
and service and then describe in detail the procedures of accounting for
inventory and cost of sales in each type. For the merchandising
companies they explain the acquisition cost and the formula used in
calculating the cost of goods sold. Then, they move to manufacturing
companies where they explain the inventory accounts: materials
inventory, work in process and finished goods and illustrate the
In fact, they present in a very clear and simple way how material
inventory is calculated in the first stage of the cost calculation
process. In stage two, the conversion costs are added to material cost
to form the work in process inventory. Then, in stage three, work in
process inventory is transferred into finished goods when they are
completed, then to cost of goods sold when they are sold. Further, they
explain the terms materials used and materials inventory and explain the
cost of goods manufactured and cost of goods sold and present the way
these terms can be reflected in the accounts. Theirs impresses us as a
very good presentation. However, this textbook does not present the
learning objectives for the chapter.
In Managerial Accounting: Creating Value in a Dynamic Business
Environment, in Chapter 2, "Basic Cost Management Concepts and
Accounting for Mass Customization Operations", Hilton uses the next
approach: he describes the company's case and then he presents the
theory needed to move further: manufacturing costs, where he explains
direct material, direct labor, manufacturing overhead (indirect
material, indirect labor and other manufacturing costs) and then he
presents manufacturing cost flows.
Hilton explains the terms Cost of Goods Manufactured and Cost of
Goods Sold and presents in detail schedules for these two costs along
with the income statement. In Chapter 3 "Product Costing and Cost
Accumulation in a Batch Production Environment" and Chapter 4
"Process Costing and Hybrid Product-Costing Systems" he brings
again into discussion the flow of cost, but this time he explains the
flow through the manufacturing accounts used in production. Also, he
presents a comparison of the way costs are accumulated in job order and
process costing which help the reader to understand again how costs flow
into, between and through the production stages.
Hilton's learning objectives for this topic require being able
to give examples of the three types of manufacturing costs and to
prepare a SCGM, SCGS and an IS for a manufacturer.
In Cost Management. Strategies for Business Decisions, Hilton et
al. present a simplified version of the production process at a
manufacturing company in Chapter 2, "Product Costing Systems:
Concepts and Design Issues". They present the production stages
using a clear and relevant exhibit. Then, they present and explain the
way Schedule of Cost of Goods Manufactured and Sold (SCGM&S) is
prepared. Separately, the Income Statement is presented in a similar way
The learning objectives for this topic require being able to
explain the role of product costs, period costs and expenses in
financial statement, to prepare an IS and a SCGM&S and to list the
components of manufacturing costs, and diagram their flow through a
In the textbook Cost Accounting, A Managerial Emphasis, Horngren et
al. tackle in Chapter 2 "An introduction in costs terminology and
their scope" the flow of production costs and the cost of goods
sold. Regarding the schedules, they show how to prepare the Income
statement and the Schedule of Cost of Goods Manufactured using a numeric
example based on a company case.
The learning objectives for this topic are explaining the
differences between the product costs and period costs and describing
the three components of manufacturing costs.
Garrison et al. present in the textbook Managerial Accounting, in
Chapter 2, "Cost Terms, Concepts, and Classifications" the
Cost Flows and Classification in a manufacturing company and the
Schedule of Cost of Goods Manufactured (SCGM)
using examples and explaining in detail the way it is prepared. The
three basic manufacturing costs are presented. They present also the
Cost of Goods Sold and the way it is prepared as a part of the IS.
The learning objectives for this topic require being able to
identify and give examples of each or the three basic manufacturing cost
categories, distinguish between product costs and period costs and give
examples of each, prepare an IS including calculation of the CGS and a
Comparison and Analysis
Regarding the learning objectives, we have structured our analysis
based on Bloom's taxonomy. The original taxonomy of educational
objectives related to cognitive domain has two levels: Knowledge, and
Intellectual abilities and skills. (Bloom, 201)
The first level: knowledge, "involves the recall of specifics
and universals, the recall of methods and processes, or the recall of a
pattern, structure, or setting."(Bloom, 201)
The second level: Intellectual abilities and skills refer "to
organized modes of operation and generalized techniques for dealing with
materials and problems" (Bloom, 201). This level refers to the
mental process of organizing and working with the materials and problems
in order to achieve a purpose. In order to be able to work with
information, this level is based on 5 sub-levels:
1. Comprehension of material and problem. Comprehension represents
the lowest level of understanding. It is related with the ability of
understanding what is being communicated and conveying the idea further
without necessarily connecting it with other ideas or materials.
2. Application. This refers to the ability and skills needed to
apply general rules, procedures, and methods called abstractions to a
specific situation. To be applied, abstractions need to be remembered
3. Analysis, which implies to break the material and problem into
parts and to analyze them separately and then in correlation with other
factors. The scope of this phase is to understand how the initial
material was build.
4. Synthesis represents the process of combining the
material's parts using a new structure, clearer than before.
5. Evaluation represents the process of judging the materials for a
given purpose. Usually, this phase requires quantitative and qualitative
judgments and very often the given purpose is not indicated by the
material ad has to be identified by the evaluator.
If we compare the structure of this taxonomy with the learning
objectives analyzed in this research, we notice that overall the
educational objectives of the flow of costs reach until the second level
of the taxonomy, most specific the application level. But some of the
textbooks define very poorly the learning objectives and some don't
do this at all. As we can see from Exhibit 2, the most well defined
learning objectives for this topic belongs to Garrison et al., followed
closely by Hilton et al.
Therefore, all the texts examined cover the flow of costs in
manufacturing, with varying degrees of detail and, in four of five
cases, in pursuit of somewhat varying learning objectives. However, we
have found in our teaching that students have had difficulty grasping
this topic. And, between the authors, we have taught using all five of
the examined texts. In our experience, the flow of costs can be made
clearer, which leads to our proposed model.
All the textbooks considered in our research presented a general
description of the flow of costs (criterion 1) and cost computation
(criterion 5) with no significant differentiation in content. On the
other hand, the differences in approaches are more obvious in respect
with the second and the third criteria: Schedule of Cost of Goods
Manufactured (SCGM) and Schedule of Cost of Goods Sold (SCGS).
Therefore, our preliminary conclusion is that the production stages
are not made crystal clear through the schedules of Cost of Goods
Manufactured, and Cost of Goods Sold. The arguments for this conclusion
rely on the different ways in which SCGM and SCGS are presented:
1--One approach presents SCGM and SCGS separately, as two different
reports. Hilton states very clearly that "manufacturers generally
prepare a Schedule of Cost of Goods Manufactured and a Schedule of Cost
of Goods Sold to summarize the flow of manufacturing costs during an
accounting period" (Hilton, 48).
2--A combined approach of these two reports in a single report,
which can be found in Hilton et al.
3--A hybrid approach where SCGM is presented separately but the
SCGS is included in IS.
Even with these differences, all the five textbooks present the
link that exists between the SCGM, SCGS and IS.
This preliminary conclusion is accompanied by our opinion that for
clarity, the flow of costs in manufacturing might best be presented
first as the focus of a single chapter.
As a contribution to the teaching of the flow of costs, we offer
what we consider a comprehensive approach. Our formulation is built on
Anthony et al.'s idea which we consider to be the clearest of all
presented. They underline explicitly the three stages of the production
process. We also acknowledge that Hilton et al. state clearly their
opinion regarding the necessity of presenting the "the stages of
production from the receipt of raw material through manufacturing to the
storage of finished goods" (Hilton et al., 44).
Our proposed presentation of Manufacturing Cost Flows is as
The Rule of Threes
In a manufacturing company the manufacturing cost accounts relate
to the three stages of the process by which raw materials are converted
into salable, and then sold, products. The accounts written in italics
are the inputs to each stage. The direction of product flow is shown by
After presenting the Rule of Threes (often the old fashioned way,
with chalk on a blackboard), we have found it helpful to show Exhibit 4,
which explains how the three stages are presented in the Schedule of
Cost of Goods Manufactured, and in the Statement of Cost of Goods Sold.
We also use Exhibit 4 to show the Prime Costs (cost of material
used in production plus direct labor cost) and the Conversion Costs
(direct labor cost plus manufacturing overhead) by circling them on the
diagram, which emphasizes that these cost concepts both include direct
labor cost, and thus should never be added together.
We hereby offer the Rule of Threes model to all teachers of
accounting and/or of management accounting, and encourage you to use it
in class without compunction. However, if you use it in a book or in an
article, we ask that this article be cited.
Therefore, the proposed Learning Objectives for a chapter on the
Manufacturing Cost Flows are:
1. To diagram the three basic stages of manufacturing.
2. To relate the three classes of manufacturing inventory to their
3. To identify the inputs and outputs to each stage.
4. To prepare a Schedule of Cost of Goods Manufactured
5. To prepare a Statement of Cost of Goods Sold for a manufacturing
6. To prepare an Income Statement for a manufacturing company.
This work was supported by CNCSIS-UEFISCSU, project number
PNII--IDEI 2476/2008, "Study regarding the development process of
the Romanian educational accounting system toward a global economic
Anthony R. T., Hawkins D. F., Merchant K. A., Accounting, text and
cases, 12th Edition, McGraw-Hill, International Edition, 2007
Bloom B.S., Taxonomy of Educational Objectives, Handbook 1.
Cognitive domain, Longman Green and Co LTD, London, 1956
Hilton W., Maher M. W., Selto F. H., Cost management. Strategies
for Business Decisions, McGraw-Hill, 2003
Hilton R. W., Managerial Accounting: Creating Value in a Dynamic
Business Environment, 10th Edition, McGraw-Hill, 2009
Horngreen C. T., Datar S. M., Foster G., Cost accounting, a
managerial emphasis, 11th Edition, Pearson Education, 2003
Garrison Ray H., Noreen Eric W, Brewer Peter C., Managerial
Accounting, 12th Edition, McGraw-Hill, 2008
Alexandra Mutju, Babes-Bolyai University, Cluj-Napoca, Romania
Duncan C. McDougall, Plymouth State University, New Hampshire, USA
Dr. Alexandra Muliu earned her PhD. at the Babes Bolyai University,
Cluj-Napoca in 2003. Currently she teaches managerial accounting and
controlling at Faculty of Economics and Business Administration, Babes
Dr. Duncan C. McDougall earned his master's and doctoral
degrees in business administration from Harvard Business School. He
currently teaches operations management and managerial accounting at
Plymouth State University, New Hampshire, USA.
TABLE 1. COMBINED RESULTS OF STEP 1 AND 2
1 2 3 4 5
Author / Descrip- SCG SCG SCGM/ Cost Learning
Textbook tion M S SCGS compu- objectives
of the and IS tation of the topic
Anthony 1 1 1 1 1 N/A
Hilton 1 1 1 1 1 1. Give examples
Managerial of three types
Accounting of manufacturing
2. Prepare a
SCGM, SCGS and
an IS for a
Hilton et 1 1 1 1 1. Explain the
al. role of product
Cost costs, period
management costs and
2. Prepare an IS
and a SCGM&S
3. List the
flow through a
Horngreen 1 1 1 * 1 1 1. Explaining
et al. the differences
Cost between the
accounting product costs
and period costs
Garrison 1 1 1 * 1 1 1. Identify and
et al give examples of
Managerial each or the
Accounting three basic
costs and period
costs and give
examples of each
3. Prepare an IS
4. Prepare a
schedule of cost
1 = positive, 0 = negative, * it is included in the IS