Introduction to Accumulating and Assigning Costs

What you will learn to do: Assign costs to jobs

Financial and managerial accountants record costs of production in an account called Work in Process. The total of these direct materials, direct labor, and factory overhead costs equal the cost of producing the item.

In order to understand the accounting process, here is a quick review of how financial accountants record transactions:

Let’s take as simple an example as possible. Jackie Ma has decided to make high-end custom skateboards. She starts her business on July 1 by filing the proper forms with the state and then opening a checking account in the name of her new business, MaBoards. She transfers $150,000 from her retirement account into the business account and records it in a journal as follows:

Date Account/Explanation Debit Credit
Jul 01 Checking Account     150,000
      Owner’s Capital       150,000
Owner investment – initial deposit to business bank account

 

For purposes of this ongoing example, we’ll ignore pennies and dollar signs, and we’ll also ignore selling, general, and administrative costs.

After Jackie writes the journal entry, she posts it to a ledger that currently has only two accounts: Checking Account, and Owner’s Capital.

A journal entry dated July 01 shows a debit of $150,000 to Checking Account and a credit of $150,000 to Owner’s Capital with the note “Owner’s investment - initial deposit to business bank account”. Each line item in the journal entry points to the corresponding debit or credit on its respective t-account.
In both the journal and the ledger, debits equal credits. The journal is a sequential listing of every financial transaction, while the ledger is the same information organized by account. Each account represents a category Jackie wants to track, such as the Checking Account.

A t-account for Checking Account shows a debit of $150,000 dated July 01 beginning balance, and a debit of $150,000 ending balance. A t-account for Owner's Capital shows a credit of $150,000 dated July 01 beginning balance and a credit of $150,000 ending balance.

Debits are entries on the left side of the account, and credits are entries on the right side.

Here is a quick review of debits and credits:

You can view the transcript for “Colin Dodds – Debit Credit Theory (Accounting Rap Song)” here (opens in new window).

Also, this system of debits and credits is based on the following accounting equation:

Assets = Liabilities + Equity.

  • Assets are resources that the company owns
  • Liabilities are debts
  • Equity is the amount of assets left over after all debts are paid

Let’s look at one more initial transaction before we dive into recording and accumulating direct costs such as materials and labor.

Jackie finds the perfect building for her new business; an old woodworking shop that has most of the equipment she will need. She writes a check from her new business account in the amount of $2,500 for July rent. Because she took managerial accounting in college, she determines this to be an indirect product expense and so she records it as Factory Overhead, following a three-step process:

  1. Analyze transaction

Because her entire facility is devoted to production, she determines that the rent expense is factory overhead.

2. Journalize transaction using debits and credits

If she is using Quickbooks(™) or other accounting software, when she enters the transaction into the system, the software will create the journal entry. In any case, whether she does it by hand or computer, the entry will look much like this:

 

Date Account/Explanation Debit Credit
Jul 03 Factory Overhead         2,500
      Checking Account           2,500
Rent on manufacturing facility

 

3. Post to the ledger

Again, her computer software will post the journal entry to the ledger, but we will follow this example using a visual system accountants call T-accounts. The T-account is an abbreviated ledger. Click here to view a more detailed example of a ledger.

Jackie posts her journal entry to the ledger (T-accounts here).

A journal entry dated July 03 shows a debit of $2,500 to Factory Overhead and a credit of $2,500 to Checking Account with the note “Rent on manufacturing facility”. Each line item in the journal entry points to the corresponding debit or credit on its respective t-account.

She now has three accounts: Checking Account, Owner’s Capital, and Factory Overhead, and the company ledger looks like this:

A t-account for Checking Account shows a debit of $150,000 beginning balance, a credit of $2,500 dated July 03, and $147,500 ending debit balance. A t-account for Owner's Capital shows a credit of $150,000 beginning and ending balance. A t-account for Factory Overhead shows a debit of $2,500 dated July 03 beginning balance and a debit of $2,500 ending balance.

In a retail business, rent, salaries, insurance, and other operating costs are categorized into accounts classified as expenses. In a manufacturing business, some costs are classified as product costs while others are classified as period costs (selling, general, and administrative).

We’ll treat factory overhead as an expense for now, which is ultimately a sub-category of Owner’s Equity, so our accounting equation now looks like this:

Assets = Liabilities + Owner’s Equity

147,500 = 150,000 – 2,500

Notice that debits offset credits, and vice versa. The balance in the checking account is the original deposit of 150,000 less the check written of 2,500. Once the check clears, if Jackie checks her account online, she’ll see that her ledger balance and the balance the bank reports will be the same.

Here is a summary of the rules of debits and credits:

Assets = increased by a debit, decreased by a credit

Liabilities = increased by a credit, decreased by a debit

Owner’s Equity = increased by a credit, decreased by a debit

Revenues increase owner’s equity, therefore an individual revenue account is

increased by a credit, decreased by a debit

Expenses decrease owner’s equity, therefore an individual expense account is

increased by a debit, decreased by a credit

Here’s Colin Dodds Accounting Rap Song again to help you remember the rules of debits and credits:

You can view the transcript for “Colin Dodds – Debit Credit Theory (Accounting Rap Song)” here (opens in new window).

Let’s continue to explore job costing now by using this accounting system to assign and accumulate direct and indirect costs for each project.

When you are done with this section, you will be able to:

  • Record direct materials and direct labor for a job
  • Record allocated manufacturing overhead
  • Prepare a job cost record

Learning Activities

The learning activities for this section include the following:

  • Reading: Direct Costs
  • Self Check: Direct Costs
  • Reading: Allocated Overhead
  • Self Check: Allocated Overhead
  • Reading: Subsidiary Ledgers and Records
  • Self Check: Subsidiary Ledgers and Records