Cost Accounting — The Flow of Manufacturing Costs and the Schedule of Cost of Goods Manufactured

A merchandiser has one kind of inventory: merchandise. A manufacturer has inventory at three stages: raw materials not yet put into production, work in process being produced, and finished goods. Costs pass through these three inventories in turn before becoming cost of sales. This chapter uses accounts and schedules to show where the cost classifications of chapter 1 fit in that flow.

1. The flow of costs

The flow of manufacturing costs
Stage	What comes in	What goes out
Raw materials	Opening raw materials + purchases	Issued to production (direct materials), issued as indirect materials to overhead, closing raw materials
Work in process	Opening WIP + direct materials + direct labor + manufacturing overhead	Completed goods (cost of goods manufactured), closing WIP
Finished goods	Opening finished goods + cost of goods manufactured	Sold (cost of sales), closing finished goods

At each stage, what comes in is split between what goes out and what remains. Every inventory account follows the same equation.

The basic inventory equation

\text{Opening} + \text{Additions} = \text{Reductions} + \text{Closing}

This holds for the raw materials, work in process and finished goods accounts alike. If one amount is unknown, work it back from the others.

2. The schedule of cost of goods manufactured

The schedule of cost of goods manufactured sets out the work in process account as a table and shows cost of goods manufactured. The income statement takes this amount to calculate cost of sales.

Company MM’s figures for the period (unit: ₩10,000): opening raw materials 50, purchases 300, closing raw materials 40, with all raw materials used as direct materials. Direct labor is 200 and manufacturing overhead 150. Opening WIP is 80, closing WIP 90, opening finished goods 120 and closing finished goods 100.

Schedule of cost of goods manufactured and cost of sales (unit: ₩10,000)
Item	Calculation	Amount
Direct materials	50 + 300 − 40	310
Direct labor		200
Manufacturing overhead		150
Total manufacturing cost	310 + 200 + 150	660
Opening WIP		80
Closing WIP		(90)
Cost of goods manufactured	660 + 80 − 90	650
Opening finished goods		120
Closing finished goods		(100)
Cost of sales	650 + 120 − 100	670

Total manufacturing cost (660) is the cost newly put into production this period; cost of goods manufactured (650) is the cost of goods completed this period. They differ by the 10 increase in WIP over the period. The company’s prime cost is $310 + 200 = 510$ and its conversion cost $200 + 150 = 350$ (₩10,000).

3. Indirect materials and indirect labor

In practice, some raw materials, such as screws and lubricants, are used as indirect materials that are hard to trace to products. The wages of factory cleaners and maintenance staff are indirect labor. Both go into manufacturing overhead, not direct materials or direct labor. If ₩300,000 of the ₩3.1 million of raw materials issued were indirect materials, direct materials would be ₩2.8 million and manufacturing overhead ₩1.8 million, while total manufacturing cost stays at ₩6.6 million.

4. The flow in the accounts and journal entries

When raw materials are issued to production: Dr Work in process, Cr Raw materials. When products are completed: Dr Finished goods 650, Cr Work in process 650. On sale: Dr Cost of sales 670, Cr Finished goods 670. Manufacturing overhead is first collected in a manufacturing overhead account and then applied to work in process. Applying it with a predetermined rate before actual costs are known is the job costing of chapter 3.

Check your understanding

Company NN’s cost of sales for the period is ₩12 million, opening finished goods ₩1.8 million and closing finished goods ₩2.3 million. Opening WIP is ₩1 million and closing WIP ₩1.4 million; direct labor is ₩3.5 million and manufacturing overhead is 80% of direct labor. What are direct materials for the period?

From the finished goods account, cost of goods manufactured is $1{,}200 + 230 - 180 = 1{,}250$ (₩10,000). From the WIP account, total manufacturing cost is $1{,}250 + 140 - 100 = 1{,}290$ . Manufacturing overhead is $350 \times 80\% = 280$ , so direct materials are $1{,}290 - 350 - 280 = 660$ , i.e. ₩6.6 million.

References

Charles Horngren, Srikant Datar and Madhav Rajan, Cost Accounting: A Managerial Emphasis, ch. 2
Ray Garrison, Eric Noreen and Peter Brewer, Managerial Accounting, ch. 2
Korea Accounting Standards Board, K-IFRS 1002 Inventories (costs of conversion)