This is part five in our Management Accountability series on manufacturing
company costs. We're going to take up where we left off in part four with our
three inventory accounts for a manufacturing company and how the costs
flow through those t accounts. So just a quick overview remember when we used
materials the direct materials went into work in process along with direct labor
and overhead those three costs made up product costs. Once a product was
completed it moved out of work in process into finished goods as our cost
of goods manufactured and it remained in finished goods until the product was
sold and we expensed it as cost of goods sold. So just a little bit more
terminology here. Your beginning materials plus purchases is called your
cost of materials available for use. Your beginning work in process plus your
product costs: materials, labor, and overhead is called your costs to account
for. Your beginning finished goods plus your cost of goods manufactured is
called your cost of goods available for sale and again your direct materials
plus your direct labor plus your overhead make up what is called product
cost. Remember you can also hear that called inventoriable costs or
manufacturing costs. Another term I'd like for you to be familiar with is
prime costs. Prime costs are made up of your direct materials plus your direct
labor. These are called prime costs because they're direct cost, they are
directly associated with the product and they are the prime cost of that product.
Conversion costs are your direct labor plus your overhead.
They're called conversion costs because it takes direct labor and overhead to
convert direct materials into a finished good. Let's look at an example here of
computing materials used. So you're a new accounting intern at the warehouse. Your
boss gives you the following information and asks you to compute direct materials
used. So we're given purchases of direct materials, we're given Freight in, we're
given property taxes, ending and beginning materials. So for me the
easiest way to compute our materials used is to draw that materials t-account.
So we'll start with the t-account and remember this is an inventory account so
it's an asset so any beginning and ending inventories will appear on the
debit side. We're just going to fill in the information that we know. We know
we start with beginning materials, we know that purchases make materials go up,
and we've also learned that Freight in is not an expense but it's considered
part of the cost of our inventory in this case our materials and also we have
our ending materials. When materials move out of our materials inventory account
into work in process that's called materials used and that is what we're
looking to calculate here. So let's just fill in information that we know. We know
beginning inventory is 4200, we know our purchases of materials was 6700, and we
know our Freight in is 100 and our ending inventory is 1600. So if we take
all of our debits add them up and then subtract our ending, we will get
materials used to be $9,400.
Overhead- there are three types of costs that are included as part of overhead:
indirect materials, indirect labor, and other overhead. So for example let's say
we're producing wooden chairs. The wood to produce the chair would be a major
part of the cost of the product. That would be considered a direct material.
An indirect material might be glue a little bit of glue that is used on the
chair to glue things together or to make things more stable. That would be
considered an indirect material. Labor- well the people that put the chair
together actually hands on putting the chair together would be called direct
labor. An example of indirect labor may be the custodian in the plant. The word
plant is your key word there and other overhead would be things like utilities
for the plant or depreciation on plant equipment. Let's look at an example
and we're going to add up here our total overhead costs from these selected
accounts given. Moon Dust manufactures sunglasses. Suppose the company's August
records include the following items. Calculate Moon Dust's total manufacturing
overhead cost in August. So we're looking for overhead here. Let's start with
glue for the frames. Let's just quickly scan the dollar amounts of all these
items here. So they're pretty small except for the company president's salary
and lenses. We know the company president's salary is not part of the
product, but lenses that is actually part of the sunglasses and look how much it
is. So we can tell by looking at the amount and thinking
about lenses and knowing it's part of the product that that is actually a
direct material. It's a prime cost of that product. So let's go back to glue
for the frames. Now comparing the glue with the lenses, $400 to
$48,000 we can assume that glue is an indirect cost, an
indirect material. It's going to be part of the product, but it's not really cost
advantageous for us to trace that cost back to the product. So we just call it
an indirect material and it's included as part of overhead. How about
depreciation expense on company cars used by the sales force? Well the
the word sales that clues us in this is a selling expense, so it's not a product
cost, it's an operating cost. How about plant depreciation expense?
There's that keyword that I told you about "plant." Plant depreciation- any time
you see the word plant or factory or manufacturing that's a pretty good clue
that that is going to be overhead. So in this case plant depreciation would be
that third category of overhead called other overhead. So the keyword plant
there so this is overhead. Interest expense- interest expense is an operating
expense. Actually it's an other expense underneath operating. So it is not my
product cost. Company president's salary- well the company president is not
working in the plant he's working in the administrative building. He's an admin
person, so that is an administrative expense another operating expense. How
about the plant foreman's salary? Again that keyword
"plant." So that is overhead. Plant janitors' wages- again that keyword
"plant," that is overhead. It's indirect labor. Oil for the manufacturing equipment-
there's the keyword "manufacturing" that is other overhead so that is included as
part of overhead and we distinguished earlier that lenses is a direct material.
It is not part of overhead. It's a product cost, but it's not part of
overhead. So if we add up all the ones indicated here you will find that your
overhead costs equal $11,150.
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