Cost Accounting For Dummies. Kenneth W. Boyd
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costing combines indirect cost rate with actual production. The process gets you closer to actual total costs for your product.
Computing direct costs and indirect costs
Here are the two steps to implement normal costing:
Direct costs: Traced to the cost object by multiplying (actual prices/rates) × (actual quantity for a specific job object)
Indirect costs: Allocated to the cost object multiplying (predetermined or budgeted indirect cost rate) × (actual quantity for a specific job object)
Note that both direct and indirect costs use actual quantity in the formula. While you come up with an indirect cost rate in planning, the rate is multiplied by actual quantities. In this case, the quantity is jobs for the month.
Introducing the job cost sheet
A job cost sheet lists every cost you’ve incurred for a particular job. That includes direct material, direct labor, and all indirect costs. The job cost sheet is your basis for computing your sale price and your profit. You use this document to prepare a cost estimate for a client. Table 4-2 shows a job cost sheet using normal costing for a landscaping job.
The indirect cost calculation (vehicle and equipment costs) uses the actual quantity (miles driven) and the estimated rate per mile. The other direct costs on the job sheet use actual quantities and actual prices/rates.
TABLE 4-2 Normal Job Cost Sheet — Landscaping Job
| Type of Cost | Amount or Quantity | Price or Rate | Total Cost (Rounded) |
|---|---|---|---|
| Direct material | 100 square feet of grass seed | $12 per square foot | $1,200 |
| Direct labor | 15 hours of labor | $15 per hour | $225 |
| Mileage | 30 miles driven | $0.18 per mile | $5 |
| Indirect costs | 30 miles driven | $5.36 per mile | $161 |
| Total job costs | $1,591 |
Following the Flow of Costs through a Manufacturing System
Costs flow through a manufacturing system, from buying materials for a product all the way to the customer sale. When you envision the flow of costs, you find it easier to collect all the product costs you need to price a product. When you know all the steps, you remember all the costs related to those steps!
Control starts with control accounts
Control accounts are temporary holding places for costs. Managing costs has to start somewhere, and in accounting, that process most often starts out with control accounts.
Labor, materials, and indirect costs start off in control accounts. It may sound strange, but these accounts and their balances don’t appear in the financial statements. That’s because the balances are eventually moved to other accounts. All the checks you write for manufacturing costs are posted first to control accounts.
For many manufacturers and retailers, inventory is the biggest investment; more cash is spent on inventory than any other asset. Because of that, a big part of operating a profitable business is to control the costs of inventory.
Inventory is an asset you eventually sell to someone. (That’s a little different, of course, from buildings and equipment.) For manufacturers, inventory has three components: raw materials, work-in-process, and finished goods, whereas retailers just have finished goods. Raw materials inventory is, broadly, products not yet started; work-in-progress inventory is partially completed products; and finished goods inventory is completed products.
The three kinds of inventory are assets, because you eventually sell the goods to a customer. When you do, the inventory asset becomes an expense — cost of goods sold. Managing inventory starts in a control account.
Table 4-3 lists control account titles for each component of inventory.
TABLE 4-3 Control Accounts for Inventory
| Type of Costs | Control Account |
|---|---|
| Materials | Materials control |
| Labor | Wages payable control |
| Indirect costs | Overhead control |
Here are what those types of costs in Table 4-3 refer to:
Materials: You buy materials (such as wood for making kitchen cabinets) in advance of making your products. Materials control is the term for the control account for material costs.
Labor: Consider labor costs. Employees report the hours they work on time cards each week. Those cards list hours worked on various projects. For custom cabinets, the time cards list customer jobs that employees completed, and the hours worked. Wages payable control is the term for the control account for labor.
Indirect costs: A business (such as the kitchen cabinet business) has indirect costs (for example, machine repair and maintenance). Your firm has some method to allocate those costs to clients (see “Budgeting for indirect costs”). However, you may not get to the allocation until after you write checks for the cost. Overhead control is the term for the control account for indirect costs.
Control accounts (materials, labor and overhead), work-in-process, and finished goods are inventory accounts, which are assets. Cost of goods sold (COGS) is an expense account. When you make a sale to a customer, you “use up” the asset. The asset becomes an expense. Figure 4-1 shows the flow of manufacturing costs:
Explaining the debit and credit process
You increase and decrease account balances using debits and credits. Business owners need to know these terms because they can’t understand your accounting process without them.
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