Flow of Manufacturing Costs: Part Two

This continues our discussion of the Flow of Manufacturing Costs (a prior blog). I left off with the journal entry to move Material into Work in Process. Well, what about Labor and Overhead costs? They're handled in nearly the same way.

Two Step Process

For all three types of costs (Material, Labor and Overhead), use this two step process:
Step 1: When you spend money, debt to increase a Control Account.
Step 2: When you move costs into production, debit Work in Process and credit (reduce) the Control Account. Overhead is slightly different, but close to this same process.

Labor Costs
You pay employees $1,500 in labor costs:
                                                       Debit                                    Credit
Labor Control                                $1,500
  Cash (Or Wages Payable)                                                          $1,500

You move $1,000 of labor into production. In other words, you determine that $1,000 in costs are incurred for a specific product or service:

                                                        Debit                                    Credit
Work in Process                             $1,000
  Labor Control                                                                             $1,000

Ending Balances in Control Accounts:
Now, I made the amount transferred into Work in Process different (less) than the labor costs incurred. That's because you may have an ending balance in the Labor Control accounts at the end of a period (month or year). In fact any control account might have an ending balance. No problem- the ending balances are part of Inventory until they are transferred into production.

Using an Inventory Account:
Eventually, you will move these costs into a product and sell it. So, you'll use this spending to eventually make money from a sale. That's why the spending is part of an Asset account (Inventory).

Overhead Costs: 
Activity related to overhead is posted to two accounts:
Overhead Control: When you write checks for an overhead cost (Say, utility costs for your factory), you increase (debit) Overhead Control. Here's an example:


                                                       Debit                                    Credit
Overhead Control                          $700
  Cash (Or Wages Payable)                                                          $700

Overhead Applied: When to apply overhead to production, you debit Work in Process. OK- you saw that same type of entry for labor costs (above). However, you don't credit overhead control. Instead, you credit a different account- Overhead Applied.


                                                      Debit                                    Credit
Work in Process                             $500
  Overhead Applied                                                                       $500

At this point, you may have two questions:
Question #1: Why not credit Overhead Control? That way, the debit and credit are in the same T-Account. That would make things easier to track.

Question #2: In these two entries, the amount applied to overhead ($500) is different from the spending on overhead control ($700). What does that mean?

We'll answer those questions- and finish the Flow of Manufacturing Costs discussion- in Part 3 of this blog. This video will also help you understand the process:

Cost Accounting 4A: Flow of Manufacturing Costs:

http://www.youtube.com/watch?v=WCrb3MIK3jY

Your comments are welcome! For live chats on some of the toughest accounting topics, go to my website listed below.

Thanks!

Ken Boyd

St. Louis Test Preparation

(cell) (314) 913-6529

(email) ken@stltest.net

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(twitter) @StLouisTestPrep                         

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