Cost Accounting For Dummies. Kenneth W. Boyd
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FIGURE 4-1: The flow of manufacturing costs.
Don’t be frustrated if you need to read this section a few times. I’ve taught the concept for years, and it requires some review before you fully understand it. Here are rules that never change:
Debits: Always posted on the left side of an account
Credits: Always posted on the right side of an account
All accounts are formatted like this:
| Material Control | |
| Debit | Credit |
In accounting, debit and credit don’t mean the same things they do in common talk. Debit can refer to an increase or a decrease. It depends on what type of account you’re working with. The same is true of a credit. Here are the rules for the purposes of this book:
Asset accounts:
Debits: Always increase the account balance. A big debit in the Cash account (an asset) is a good thing
Credits: Always decrease the account balance
Control accounts, work-in-process, and finished goods are all inventory accounts, making them asset accounts. Cost of goods sold is an expense account. Debiting increases all these accounts. The balance for any of these accounts is equal to debit balance less credit balance.
Liability accounts:
Debits: Always decrease the account balance
Credits: Always increase the account balance
Income accounts:
Debits: Always decrease the account balance
Credits: Always increase the account balance
Expense accounts:
Debits: Always increase the account balance.
Credits: Always decrease the account balance
Walking through a manufacturing cost example
Say you’re the manager of Karl’s Kustom Kitchen Kabinets. You order $20,000 in lumber. You then take $5,000 of the lumber and start making cabinets for a customer.
When you bought the lumber, cash (an asset) went down, but the material control account (as asset) went up. The material control account was increased (debited) when you bought the lumber.
The material control account balance decreases (credit) when you take $5,000 in lumber to start using the material for a customer. Now how would your material control account look?
Material control account
| Debit | Credit | |
|---|---|---|
| $20,000 | ||
| $5,000 |
If the month ends with no other activity, the ending material control balance is $15,000 (20,000 – $5,000).
But the $5,000 didn’t just vanish. When you put materials into production, you reduce (credit) the material control account and increase (debit) the work-in-process control account.
Work-in-process control account
| Debit | Credit |
|---|---|
| $5,000 |
You reduce one asset (material control account) and increase another asset (work-in-process control account).
Now assume that the people on the shop floor finish some cabinets and move $2,000 of the $5,000 work-in-process to finished goods.
Work-in-process control account
| Debit | Credit |
|---|---|
| $5,000 | |
| $2,000 |
You reduce one asset (work-in-process control account) and increase another asset (finished good control account). If the month ends with no other activity, the ending balance is $3,000 ($5,000 – $2,000).
Again, there’s no disappearing money. The “other side” of the transaction hits the finished goods control account.
Finished goods control account
| Debit | Credit |
|---|---|
| $2,000 |
So one more time, you reduce one asset (work-in-process control account) and increase another asset (finished goods control account).
At some point, you sell what you made. You’ve got $2,000 in finished goods. Because you make custom cabinets, there’s one customer. The finished goods control account shows this:
Finished Goods
| Debit | Credit |
|---|---|
| $2,000 | |
| $2,000 |
You are almost home. When goods are sold, you reduce (credit) the finished goods account and increase (debit) cost of goods sold. And that’s an expense account. At last!
Cost of Goods Sold
| Debit | Credit |
|---|---|
| $2,000 |
The difference between your sale price and the cost of goods sold is your profit.
Why do you go with the flow? The reason