Introduction & Cost Flows

Updated 8/20/2013

Cost ?

Monetary measure of resources given up to attain an objective (such as acquiring a good or delivering a service)

The Conversion Process

Input
Purchase raw materials or supplies

Output
Product or Service

CONVERSION

Degrees of Conversion
Low

Moderate Moderate

High

Low

High

Department stores Gas stations ??? ??? Florists Meat markets Oil-change businesses

Moderate

Manufacturing Construction Agriculture Architecture Auditing Mining Printing

???

Service Company
Input
Purchase supplies

Significant amount of labor Tangible or intangible output

Use supplies, labor, overhead to provide service

Output
Sell to customer

Retail Company
Input
Purchase products for resale

Output
Warehouse and/or display

Purchase finished goods Resell to customers

Sell to customer

Manufacturer
Significant amount of labor & machinery Tangible output

Input
Purchase raw materials and supplies Production Center
add labor and overhead

Output
Finished product

Sell to customer

Basics of Cost Flows - Part 1

Beginning Balance Inputs Outputs

Ending Balance

Inventory

$10,000

$457,500

$458,800

$8,700

In other words...
We started the accounting period with $10,000 worth of stuff and purchased another $457,500 worth. This means that during the period we had $467,500 worth of this inventory to use, abuse, lose, or sell. At the end of the period, however, a physical inventory was taken & we discovered that $8,700 worth was still on hand. Therefore, we know the difference between $467,500 & $8,700 (which is $458,800) is now no longer in inventory. Presumably the inventory was used for its intended purpose.

LSW Sales Corporation (Retail) Income Statement for the period ending December 31, 20XX

Revenues.. $1,500,000 Less:Cost of Goods Sold: Beg.Mdse.Inventory..$ 50,000 Net Purchases of Inventory. 875,000 Cost of Goods Available for Sale 925,000 Less:End.Mdse.Inventory. (40,000) Cost of Goods Sold(885,000) Gross Margin. 615,000 Operating Expenses: Selling Expenses..150,000 Administrative Expenses...350,000 Total Operating Expenses (500,000) Net Income. $115,000

LSW Manufacturing Corporation Income Statement for the period ending December 31, 20XX

Revenues.. $1,500,000 Less:Cost of Goods Sold Beg.F. Goods Inventory.....$ 50,000 Cost of Goods Mfg.... 875,000 Cost of Goods Available for Sale 925,000 Less:End.F. Goods Inventory... (40,000) Cost of Goods Sold(885,000) Gross Margin. 615,000 Operating Expenses: Selling Expenses..150,000 Administrative Expenses...350,000 Total Operating Expenses (500,000) Net Income. $115,000

Cost Accumulation in a Manufacturing Company

Materials Inventory Work in Process Inventory Finished Goods Inventory Balance Sheet Cost of Goods Sold Income Statement

Inventory Accounts for a Manufacturing Firm

1. 2. Direct Materials Inventory - sometimes called Raw Materials Inventory. Work-in-Process Inventory - where costs are accumulated as products are being made.

3.

Finished Goods Inventory - where costs of products that are ready for sale are kept. This is exactly the same thing as the Merchandise Inventory account for a merchandising firm (retail).

Cost Flows - Part 2 Now lets see what happened during the period; it is what happened during the period that we are really concerned about.
Direct Materials Inv. Work-in-Process Inv. Finished Goods Inv.

$ 5,000 $97,200 $6,500

$8,000

$10,000

$12,000

$11,000

$97,200 worth of direct materials were purchased. This means that $102,200 of materials could have been used in the manufacturing process.

Cost Flows - Part 2 Of this $102,200 of materials, some was requisitioned by production during the period; what wasnt used during the period remained in ending inventory.
Direct Materials Inv. Work-in-Process Inv. Finished Goods Inv.

$ 5,000 $97,200 $6,500 $95,700

$8,000

$10,000

$12,000

$11,000

Since $102,200 could have been used, & $6,500 wasnt used, then the difference, $95,700, must be the value of materials taken out of DM Inv. & used in the production process.

Cost Flows - Part 2 This $95,700 of materials was requisitioned by production during the period; as the material is transferred to production, the costs are also transferred to Work-in-Process Inventory.
Direct Materials Inv. Work-in-Process Inv. Finished Goods Inv.

$ 5,000

$97,200
$6,500

$8,000 $95,700 DM $95,700 $12,000

$10,000

$11,000

Everybody intuitively understands that direct (or raw) materials (DM) are a cost related to the production of a product.

Cost Flows - Part 2

Direct material & direct labor are referred to as direct costs because we can usually directly attribute these costs to the product we are making
Direct Materials Inv. Work-in-Process Inv. Finished Goods Inv.

$ 5,000 $97,200 $6,500

$8,000 DM $ 95,700 $95,700 DL $165,400 $12,000

$10,000

$11,000

In this example, we say we have $261,100 in direct costs. These are sometimes called prime costs.

Factory Overhead
Indirect manufacturing costs Manufacturing overhead Total overhead Fixed or variable overhead

Examples of Factory Overhead Costs

1. 2. 3. 4. 5. 6. 7. 8. Factory Supervisors Salaries Plant Maintenance & Repairs Expense Factory Utilities Indirect Labor Property Taxes - Factory Plant Insurance Indirect Materials Depreciation on Plant Assets

This is not an exhaustive list. The common theme of all of them is that they are necessary costs incurred to support the production process & they are not directly traceable to any specific product made. Also, it is the problem in cost accounting.

Examples of Costs that are not Factory Overhead Costs

1. 2. 3. 4. 5. 6. 7. General Administrative Expenses Selling Expenses Depreciation on Sales Office Equipment Other Operating Expenses Income Tax Expense Freight-In Sales Salaries & Wages

This is also not an exhaustive list. The common theme of all of them is that they are not costs incurred to support the production process. In other words, the production process could continue without incurring these costs. So, back to the cost flows.

Accounting for Factory Overhead

As actual overhead costs are incurred, they are debited to the Factory Overhead Control Account. Factory Overhead Work-in-Process Inv. $8,000 DM $ 95,700 DL $165,400 FOH $423,125 Fact.Ins. $ 5,000 Fact.Util. 9,500 Sup.Slry. 38,000 . . . . . . Fact.Dep.155,000 $423,125 $423,125

$12,000

Computing Cost of Goods Manufactured

Work-in-Process Inv. $8,000 DM $ 95,700 DL $165,400 FOH $423,125 $680,225 Beginning balance plus inputs less ending balance will tell us the costs that were credited during the period. In this example, that is $680,225($8,000+$95,700+$165,400 +$423,125-$12,000=$680,225). This is the cost of goods manufactured (COGM).

$12,000

Terminology
Work-in-Process Inv. $8,000 Direct or Prime Costs = DM + DL DM $ 95,700 DL $165,400 FOH $423,125 $12,000

$680,225

Terminology
Work-in-Process Inv. $8,000 DM $ 95,700
Conversion Costs = DL + FOH

$680,225

DL $165,400 FOH $423,125 $12,000

Terminology
Work-in-Process Inv. $8,000
Tot. Mfg. Costs or Product Cost= DM +DL + FOH

DM $ 95,700 DL $165,400 FOH $423,125 $12,000

$680,225

Terminology
Work-in-Process Inv. $8,000
Tot. Costs to Account for = Beg. Inv. + DM +DL + FOH Cost of Goods Manufactured (COGM)

DM $ 95,700 DL $165,400 FOH $423,125 $12,000

$680,225

More Terminology
Work-in-Process Inv. $8,000 DM $ 95,700 DL $165,400 FOH $423,125 $680,225 Finished Goods Inv. $ 10,000 $680,225

$679,225 COGS

$12,000

$ 11,000

Overview of Inventories & Cost Flows

Direct Materials $ 5,000 $97,200 $6,500 $95,700

Work-in-Process $8,000 $ 95,700 $165,400 $680,225

Finished Goods $10,000 $680,225 $679,225 $11,000

$423,125
$12,000

Cost Flows Summary

DM Used:
Beg. DM + Purchased DM Available - End. DM DM Used xxx xxx xxx xxx xxx

COGS: Beg. FG xxx + COGM xxx Cost avail. For sale xxx - End. FG xxx COGS xxx

COGM: Beg. WIP + DM Used + DL + OH Cost to acc. For - End. WIP COGM

Net Income:
Revenue + COGS Gross Margin xxx - Other Expenses NI

xxx xxx xxx xxx xxx xxx xxx

xxx xxx xxx xxx