Thursday, January 31, 2013

Flow of Manufacturing Costs

A student of mine asked for help with a case study that is very common in Cost Accounting: Document the flow of costs in a manufacturing company. There's a great deal of misunderstanding in this area, so let me try and clarify:

Types of Costs: There are three categories: Material, Labor and Overhead. The costs are subcategories in Inventory. Huh? Well, until you sell a finished product, the checks you write for material, labor and overhead are in Asset accounts. Assets are defined as things you use to make money. Your incurring these costs to sell a product- and make money.

Control Accounts: A control account is a "bucket" (yea, I use buckets alot). When you write checks for a cost, you increase (debit) an Asset Account. Say you're making blue jeans. Here's your accounting entry when you buy $1,000 of denim material for blue jeans:

                                              Debit                                Credit
Material Control                   $1,000
     Cash (Or Payable)                                                      $1,000

Control accounts, as I mentioned, are subcategories in Inventory- so they're Asset accounts.

Moving Costs Into Production: Work In Process
Work in process (WIP) is defined as partially completed goods. When you open the doors of your factory on the first day of the month, it's likely that you'll have a pile of jeans that are not yet completed. For example, the denim has been cut and sewn, but not dyed a certain color (at least not yet).
WIP may be partially completed for materials and/or for labor. However, material costs usually go into production before labor (and overhead) costs. Why? Well, you need to materials (denim) into production before your staff can do anything with it (cut material, sew, etc.)

Here's the entry to move $500 of material into production:

                                             Debit                                Credit
Work In Process                   $500
     Material Control                                                        $500

I'll add onto this discussion in a future blog. In the meantime, this video might help explain the process-

Cost Accounting 4A: Flow of Manufacturing Costs:

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Author/ Cost Accounting for Dummies (John Wiley and Sons) March 2013