Now that we understand the key concepts behind managerial accounting's view of inventory, let's look at the internal cost accounting for a company.
Here you will learn how to assign cost to inventory using job order costing and understand the difference between job order costing and process costing.
Let's review the key terms from the last lesson
|Direct material costs||the costs of raw materials|
|Direct labor costs||salaries of manufacturing employees|
|Manufacturing overhead||production costs that are not direct material or labor costs|
|Indirect material costs||costs for materials that are not easily traced to individual products|
|Indirect labor costs||salaries of employees who support production, such as factory supervisors|
|Nonmanufacturing costs||selling, general, and administrative costs|
Depending on the products being manufactured, a company uses one of two methods for determining inventory costs: job order costing and process costing. Job order costing assigns costs to individual units of inventory which can include services. Each piece of inventory may vary in cost. For example, every wedding cake a baker creates will not cost the same to produce for each happy couple.
Process costing, on the other hand, averages costs over a large number of inventory units over time. Effectively, each individual item will then have a uniform, predictable cost. For example, a large soda manufacturer can accurately assign an average cost to each bottle produced.
Identify which companies will use job order costing and which will use process costing.
|Job order costing||Process costing|
|a bespoke tailor - every individual suit and smoking jacket will be unique, right down to its cost.||a cookie/cracker manufacturing and distribution company|
|a tax services professional - every person's tax situation is different with every tax professional charging a different hourly rate.||a paper mill - Trees go in, paper comes out. There's little variability making it easy to average the costs over each ream of paper.|
We learned in the last lesson that indirect labor and materials cannot be assigned to specific items of inventory and, instead, are part of manufacturing overhead.
Let's review the key concepts discussed.
|Manufacturing overhead includes indirect labor, indirect materials, and other costs associated with production.||Once products are fashioned from raw materials, raw materials inventory is credited and finished goods inventory is debited. The products have to go through work-in-process inventory before they become finished goods.|
|Raw materials inventory is debited when raw materials are purchased.||The CEO's salary is included in manufacturing overhead. This is a nonmanufacturing cost.|
|A contractor who builds custom homes will use job costing.|
Job Costing a Service
Learn how to apply job costing methods to a service company.
Summer is the controller at the law firm. A controller (or comptroller) not only supervises the accounting department, but also assists the Chief Financial Officer (CFO) in preparing financial statements. Controllers oversee internal controls, budgeting, compliance audits, and more—whatever is needed, really.
Even though law firms don't sell physical goods, they still have inventory. Every service, such as arguing a case, is a "unit of inventory." Because every case that Nougat, Praline & Associates takes is different, Summer knows that she'll be using Job order costing when assigning the firm's costs to services rendered.
The only real difference between job costing for a manufacturing company and a service firm is the names of the accounts. Match the equivalent accounts from the two industries.
|raw materials inventory||materials|
|finished goods inventory||completed services|
|cost of goods sold||cost of services|
When assigning the correct portion of overhead to a particular case (that is, the firm's inventory), Summer wants to base the assignment on some resource used by all of the law firm's cases, such as direct labor hours or direct labor costs. The resource whose use is the primary driver of overhead costs is known as the cost driver.
Lawyers work long hours. The longer they work, the more the lights are on, the more coffee they consume, the more their assistants work, etc. In other words, the more direct labor hours, the greater the firm's overhead costs. Therefore, direct labor hours is a great pick for the cost driver.