Costs are recorded in the accounting records in various ways according to company policies, but in essence, each cost related to a product is accumulated in work-in-process until the goods are finished. When the product is sold, the cost of the product is moved from Finished Goods Inventory to Cost of Goods Sold.

Let’s trace some representative transactions through Dad’s Perfect Pies accounting system.

First, for the sake of simplicity, let’s assume that as of the start of business on January 1, there were only two general ledger accounts with balances: the checking account and the owner’s capital account. All journal entries and ledger accounts are expressed in dollars, but the dollar signs in this example have been omitted, which is customary in accounting records.

On January 2nd, the company paid rent on the facility and machines. For purposes of this example, we’ll limit the transactions to factory overhead. Normally, all kinds of expenses would be posted to this account, and there would also be general, selling, and administrative expenses that would be posted to other expense accounts not related to the manufacturing process.

 

This would then be posted on the appropriate ledger pages:

That same day the company bought two tons of flour @ $0.60/lb, one ton of butter at $1.20/lb, and 3200 pie tins @.25 each. The supplier extended the company credit terms of 30 days.

 

Then the company bought sugar, salt, and other indirect raw materials:

 

And on January 3rd, the Mixing Department production manager submitted a raw materials requisition order to the inventory manager for 500 pounds of flour and 375 pounds of butter—enough raw materials to mix up a batch of 750 pie crusts. This results in a journal entry that moves the cost of the materials from raw materials to work in process. Five hundred pounds of flour that cost $0.60 per pound = $300, and 375 pounds of butter at $1.20 per pound = $450, which is $750 total, which comes to $1 in raw materials per pie shell (each shell takes ⅔ pound of flour and half a pound of butter). These would then be the equivalent of standard costs and standard quantities.

By crediting the asset account Raw Materials – direct and debiting the asset account Work in Process – Mixing, the cost of the raw materials are “reassigned” from the inventory pool to the process.

You can review the rules of debit and credit by watching this video:

You can view the transcript for “Debits and Credits MADE EASY with ADEx LER” here (opens in new window).

The company started another batch on January 15th:

 

A third batch on the 21st:

 

And a fourth batch on the 28th:

 

Resulting in the following ledger balances:

At the end of the month, a physical count of the indirect raw materials (sugar, salt, etc.) revealed that there was $200 (at original cost) of supplies left in those bins, so the accountants made the following entry to factory overhead:

 

Which, when posted, moved the cost of indirect raw materials to factory overhead:

Meanwhile, the baking/packaging department used 2,400 pie tins that cost $0.25 each. They add them at the end of the process as they are packaging because the pie shells are cooked upside-down on a baking mold. The tins are part of final preparation for freezing and shipping. Although the tins were used as each batch was completed, we’ll just make one journal entry at the end of the period.

 

Also on the 31st, the payroll department calculated the wages owed to workers. Based on the time cards, wages were split as follows:

 

The company allocated Manufacturing Overhead to the Mixing Department based on Direct Machine Hours at a rate of $0.50 per hour. Machine hours for January were 3,600, resulting in an allocation of $1,800 of factory overhead to the mixing department.

 

We can now create the production cost report for the mixing department to determine the cost of product transferred out to baking/packaging:

 

And then journalize and post the transfer:

Next, we allocate factory overhead to the baking/packaging department. In this example, we’ll use a rate of $30/machine-hour against 100 machine hours for a total allocation of $3,000. Using standard costs like this usually leaves some under or over-allocated factory overhead that we would eventually have to account for, but in this example, we will be allocating all of the factory overhead with no leftover.

 

And now we can complete the production cost report for the baking/packaging department:

 

Notice that the total costs to be accounted for are taken from the general ledger account and that we are transferring out 2,000 completed units at a total cost of $9,000, which is $4.50 per unit.

 

To finish off the cycle, let’s say we sold 1,600 pie shells at $6 per shell, to a wholesaler/distributor on the last day of the month.

Obviously, there would be many more transactions in a real business, even a small one like this, and there would be selling, general, and administrative costs as well. But we’ll end this example here, with the posting of the sale that records the revenue earned but not yet collected and the cost of the 1,600 shells sold being transferred from Finished Goods to Cost of Goods Sold.

 

Here are the final account tallies from the general ledger showing that debits equal credits:

 

And a reconciliation of the direct raw materials purchased, used, and remaining:

 

Notice that the $1,290 of ending work-in-process for the mixing department ties to the production cost report, as does the ending work in process of $650 for the baking/packaging department.

By reconciling and proving each account, financial and managerial accountants verify that the information fairly represents the actual costs and results of operations.

You can view the transcript for “Process Costing Journal Entries” here (opens in new window).

Before we take a final look at the production cost report from an analysis standpoint, check your understanding of the recording process that gives us the accurate information we need to track costs.