Importance of Proper Overhead Allocation In today’s global economy, competition among manufacturing companies is greater than ever before ..If a company is to determine whether it can compete effectively in the marketplace, it must first know with some degree of precision its manufacturing costs on a per-unit basis. In highly automated factories, overhead is often the largest of the three basic categories of manufacturing costs.
Therefore, the allocation of overhead costs is one of the major challenges facing management accountants. Work in Process Inventory, Finished Goods Inventory, and the Cost of Goods Sold We have devoted much of this to discussing the three types of manufacturing costs-direct materials, direct labor, and manufacturing overhead. We will now shift our attention to the three accounts that provide the structure for the flow of these costs-the Work in Process Inventory account, the Finished Goods Inventory account, and the Cost of Goods Sold account.
The Work in Process Inventory account is used (l) to record the accumulation of manufacturing ‘costs associated with the units of product worked on during the periodand (2) to allocate these costs between those units completed during the period and those that. are only partially completed. As direct materials, direct labor, and manufacturing overhead are applied to production, their related costs are debited to the Work in Process Inventory account. The flow of costs into this Inventory account (rather than into a corresponding expense .account) is consistent with the idea that manufacturing costs are product costs, not period costs.
As specific units are completed, the cost of manufacturing them is transferred from the Work in Process Inventory account to the Finished Goods Inventory account. Thus the .balanc~ in th~ W~rk i~ ProC,l!SS~ccounteepresents only the manufacturing costs associated with units still “In process. It is important to realize that once products are classified as finished goods, 110 additional costs are allocated to them. Therefore, the costs of storing, marketing, or delivering finished goods are ‘regarded as selling exp -Ilses, not manufacturing costs. When units of finished goods are sold, their related costs must “flow” from the balance sheet through the income statement in compliance with the matching principle.
Accordingly, as products are sold, their costs are transferred from the Finished Goods Inventory account to the Cost of Goods Sold account. . The Need for Per-Unit Cost Data Transferring the cost of specific units from one account to another requires knowledge of each unit’s per-unit cost-that is, the total manufacturing costs assigned to specific units. The determination of unit cost is one of the primary goals of every cost accounting system and will be explained and illustrated more completely in Unit costs are of importance to both financial and management accountants. Financial accountants use unit costs in recording the transfer of completed goods from Work in Process to Finished Goods and from Finished Goods to Cost of Goods Sold. Management accountants use the same information to make pricing decisions, evaluate the efficiency of current operations, and plan for future operations.
Ring the Cost 01 Finished Goods Manufactured Most manufacturing companies prepare a schedule of the cost of finished goods manufactured to provide managers with an overview of manufacturing activities during the period. Using the information from our illustration on page 717, a schedule of Conquest’s cost of finished goods manufactured is shown on the following-page.Notice that ‘411,of the figures in this schedule were obtained from Conquest’s Work in .
Process Inventory account illustrated on page 717. In short, this schedule summarizes the flow.of manufacturing costs Into and out of the Work in Process Inventory account. Purpose of the Schedule A schedule of the cost of finished goods manufactured is not a Informational statement and generally does not appear in the company’s annual report.
Rather, it is intended primarily assist managers in understanding and evaluating the overall cost of manufacturing products: By comparing these schedules for succeeds periods, for example. managers can determine whether direct labor or manufacturing read is ‘rising or falling as a: percentage of total malingering costs. In addition. the schedule, is helpful in developing information about unit costs, If a company manufactures only a single product line, its cost per unit simply equals it cost fished goods divided by the of units produced.
For example. if Conquest produces only one line of mountain bike, its average cost per l.mit· would be $80 had it produced 10,000 tinished units during 2001 ($800,000 divided by 10,000 units). If Conquest produced multiple lines of mountain bikes, it would prepare a separate schedule of the cost of finished goods manufactured for each product line. Financial Statements of a Manufacturing Company Let us now illustrate how the information used in our example will be reported in the 1001 income statement and balance ‘sheet of Conquest, lite. The company’s 2001 income statement is presented below:Notice that no manufacturing costs appear among the company’s operating expenses. In fact, manufacturing costs appear in only two places in a manufacturer’s financial statements. Costs associated with units sold during the period appear in the income statement as the cost of goods sold. The $782,000 cost of goods sold figure reported in Conquest’s income statement was taken directly from the company’s perpetual inventory records.
However, this amount may be, verified as follows:All manufacturing costs associated with goods still on hand are classified as inventory and appear in the-balance sheet. The balance sheet presentation of Conquest’s three types of inventory is illustrated below:As previously mentioned, Conquest’s balance sheet includes a current liability for wages payable equal to the $8,000 credit balance in the Direct Labor account