"Cost Accounting" - A new approach to your least favorite topic | Roger CPA Review

"Cost Accounting" - A new approach to your least favorite topic

"Cost Accounting" - A new approach to your least favorite topic

Cost Accounting may be dreaded by many, but it is important to all. By determining cost of goods sold, managers can make important company decisions to help cut costs and improve profitability. Less cost and more money? Sounds like something you might want to know (for the BEC Exam and beyond!).

Roger Philipp, CPA presents:

What we're going to do today is talk about a whole bunch a different areas that we need to understand because it will lead us into other areas where we talk about something called variance analysis, so it's going to be important to understand it for that. What is our goal here? Our goal, our objective is to accumulate the cost. That way we can value inventory and costs of goods sold. So, for example, you've got beginning, plus purchase is available, minus ending, is costs of goods sold, so our goal is going to be to come up with our ending inventory so we can back into things like costs of goods sold. And we will use this again and again, in job order costing, process costing, different manufacturing operations and so on, but that's what we're really looking at. Now, when we talk about cost accounting, we're looking at not just one type of inventory, but three. In financial accounting, we're mainly looking at purchases, like you have one type of item...I'm buying a calculator, I sell the calculator. What is costs of goods sold? Whatever it cost me...FIFO, LIFO, oh yeah, I remember that stuff. So it cost me 3 dollars, and then cost in, cost out. Here, we're manufacturing the calculator. So what do I have to manufacture it? I have some raw materials. I have some work in process. I have some finished goods inventory, raw materials inventory, work in process inventory, finished goods inventory and then finally costs of goods sold. So, you can see here that we have a manufacturing process, so we're going to have to look more at the actual cost as we produce the goods. It says here, the primary purpose of cost measurement is to allocate the cost of production, direct materials, direct labor, overhead to the units produced. It also provides important information for management decisions, such as product pricing decisions, so we can kind of figure out how much we should charge you for this product. Now, a formula that's going to be very important who will come back to haunt us again and again and again and again is y=a + bx. Now, what does that mean? y=a + bx or total cost equals fixed plus variable times x. Now, what does this mean? It means fixed cost. Now what are fixed costs? Fixed cost...we've talked about those in the past. Those are costs that are fixed in total but variable per unit. So let's say, for example, we're all hungry, we haven't had lunch or dinner yet, so I buy 1 pizza. Mmm hmm. How much is that? Fixed price, 10 bucks. Little pepperoni, little sausage, little vegetables, yum, yum, yum. Ten bucks. So how much is it a person? One person, 10 dollars. Hey, it still cost us 10 dollars, but now there's 2 people. Fixed cost 10 bucks, now it's 5 dollars apiece. Oh, there's 4 people. Now it's 2.50 apiece. So, notice that it's fixed in total 10 bucks, but it's variable per unit depending on how many people need to eat. We have variable costs. What are variable cost? Variable costs are fixed per unit but variable in total. For example, my electricity, it cost me what? It cost me a dollar an hour. Now, depending on how many hours I use this office, it's one hour's a dollar, 2 dollars, 2 hours is two dollars, 10 hours is 10 dollars...so notice it fixed per unit, but varies in total. Now, that's fixed, that's variable. Why do we care? Because when I say y=a + bx, that's total cost equals fixed plus variable times x. Remember in economics...wasn't that ago, BEC 1. We had something like this. That was x and that was y. So if you look at this formula...Can you see all that? Mmm hmm...here, y=a + bx. a is fixed, b is variable times x. What is x? x is some activity level. Now, remember we talked about quantity and price, so for example, if it is a fixed cost, means it's the same amount, then if you go across, boom, that would be a fixed cost because no matter what the quantity is, the price is the same. It cost me how much, for example, is my rent? 10,000 dollars, 100,000 for the year, whatever, so 100,000 for the year. It's fixed. No matter how my production is, it's fixed in total, but as I have more production, the variable cost per unit drops. Remember we talked about average variable cost and so on. What about variable cost? Let's look at it this way...boom. Here is your x, here's your y. What's it say? It says that it's 0 production, 0 cost. At this production, this cost. At this production, this cost, and so on. So that would be x and y. Notice here, again, x is your cost driver. What is a cost driver? It drives the cost. It could be direct labor dollars, direct labor hours, machine hours, some kind of quantity. That is called the cost driver. What cost driver basis will we use? Whatever base is best for your industry. So, it just depends on what you're doing, which you're manufacturing and so forth. What is y? y would be, in this case, my total costs. So as we look at this, that's called variable. So this one's fixed, this one's variable. What would total cost look like? Let's put them together...boom, boom...here's x, here's y. Here would be my fixed costs, and this angle would be my variable costs. That's total cost. What's total cost? It says that at this level of activity, boom, boom is total cost. At this level of activity, boom, boom, that's total cost. So, notice that's your total cost, that's your y, x and y. So when we come back over to this formula, total cost equals fixed plus variable times x. x is called your cost driver. x is your independent variable. Why? Because your y is total cost. That's dependent. What is that dependent upon? The x. So if you come back over here, independent, dependent. Why? Because total cost is dependent upon the x, so this is called the independent variable, this is called the dependent variable. What are we looking at? The cost driver. So let's look at the terms on page 1. It says y=a + bx, total cost equals fixed plus variable times x. The y is equal to total cost and is referred to as the what? Dependent variable since it's amount is dependent upon other factors. The x is equal to volume, which is referred to as independent variable, since it can be increased or decreased at the company's discretion. It's also called the what? Cost driver. a is called the fixed cost, b our variable cost. Note: these cost assumptions only remain valid between the...within the what? Relevant range. Now, what is the relevant range? That is defined as the range in which your cost assumptions remain valid. For example, fixed are fixed in total but variable per unit. Variable are fixed per unit but vary in total. So, for example, fixed costs are fixed in total. So the relevant range means that I assume if my factory rent's 100,000 dollars, fixed is a 100,000. What if, in my capacity, I can only manufacture 100,000 units, but I want to manufacture 105,000? Then what's going to happen to total costs? They have to go up, because now, instead of manufacturing 100,000, I want to manufacture 105, I need a new factory. So we're assuming that your costs are within the relevant range, where fixed are fixed in total, variable are also fixed per unit. So what's electricity? A dollar an hour. That is the assumption within the relevant range. Now the next thing down the page is called a mixed cost or semi-variable cost. Now, with a mixed cost, that's a cost that is both fixed and variable components, fixed and variable components. Now, when we talk about a mixed cost, basically this would be like, let's say your phone bill. Ok? In the olden days, when you had a phone and you had to pay a monthly fee. So, you pay 20 dollars a month. That's my fixed, and every minute on the phone, you're paying an extra dollar, let's say. So, that's when I pick up the phone, and I would call my girlfriend because you can't see her because you're studying, "Hi Pookie!" "No, you're Pookie." "I love you [kissing sounds]." "I love you, too [kissing sounds.]" So what happens? You've got a fixed and a variable component. So what we're trying to do is, we use this thing called the high-low method in order to break out the fixed and variable components. Because when you think about your phone bill, you've got a fixed portion and a variable portion. What is consistent between the low and the high activity? What costs are fixed? The fixed costs. So if we, for example, let's look at this graph. We're going to look at our high level of activity. We're going to look at our low level activity. Now, within both of these, what costs are the same? This fixed cost is the same. So what we do is, we're going to take the high from the low. When you take the high from the low, your fixed costs disappear. You're just left with the variable costs. Then what we're going to do is we're going to try to force the slope of the angle because the slope of the angle are what? Your variable costs. Because this is fixed, that angle is variable. This is total because it starts with the fixed and the variable. So notice that we're going to try to force the slope of the line. That'll give us an estimate of what our variable costs are. This method is called the high hyphen low, high hyphen low method. Now, in the high hyphen low...What is a hyphen in mathematics? It's a minus. Very good. So, it's a high minus low. Hmmm....that sounds interesting. Let's look at it. It says high-low method, total cost and total hours. Here's our total cost. Here's our hours. What it says is, at the high 110 and 30,000 hours. At the low...what is it? 80,000 total cost and 20,000 hours. So if you take the high hyphen low, then that gives us 30,000 dollars and 10,000 hours. Now, if you divide the high and the low, that gives us 3 dollars per base. What's our base? Hour. 3 dollars an hour. That is an estimate of your variable costs because what happens is, back on this picture, at the high minus low, you...your fixed costs disappear, you're left with variable costs. Now, incidentally, mark this in your notes, what is this point right here called? The intercept, because that is where it crosses the y-axis. That is called the intercept. Important to understand that. So, if I wanted to then take this and set up a formula, my formula could be...oh, right here. What is it? You would say total cost, 110, equals my fixed plus variable, which we just figured as 3, times activity level is either one of these. Well, at 110, it must be 30. So, 30 times 3 is 90, 110, this must be 20. Let's try it again. Let's see if it works. Let's try the other one. 80 equals fixed plus 3 times x. What's x? 20 times 3 is 60 plus 20 is, so it works. So if I want to set up a formula, what is the formula I'm going to use? You're going to say, total cost equals fixed, 20, plus 3 times x. Now, what does x represent? Any activity level. What will this formula give me? It'll give me anything on this line. Mmmmm....so, if I were to pick a point here, go up, boom, that's going to give me total cost. What's the formula? Total cost equals 20 plus variable times x...well not variable, times 3 times x. So, whatever this is, you plug it in here. That'll tell you what this total cost should be. Remember, this is called the what? Dependent. What is this? Independent. This is independent. This is dependent upon this. Now that's an important concept. Why? Because later on, this becomes something called our flexible budget equation. It's flexible. Wooo! What does that mean? It tells you what total cost will be at different levels of activity based on your cost driver, so that is called your flexible budget equation. So, as we go through this later on, we're going to be doing something called variance analysis and all of your overhead variances are done using the flexible budget equation. So you're going to see, as we go through time, that this formula will be used again and again and again and again and again and again. Woo! Woo! Alrighty, let's turn to the next page. Cost classifications. Now, with our cost classifications, we are looking at different types of costs and we have here what we call manufacturing costs, and those are going to be called our manufacturing or our product costs. We also have what we call non-manufacturing costs. Those are called our period costs. So what I want to compare are the manufacturing costs, also called a product cost, versus our non-manufacturing costs, also called a period cost. So, we're going to look at what are the differences. Well, what is a non-manufacturing cost? A non-manufacturing cost is considered a period cost. It is considered an expense in the period whether you sell them or not. What's an example? SG & A. What is SG & A? Selling general administrative expenses. Those are considered an expense in the period. It says they're marketing costs, freight out, re-handling. Also, very important, abnormal spoilage, and I'm going to talk about that throughout the course, but abnormal versus normal spoilage. Those are all non-manufacturing. Those are all period costs and expense in the period whether you sell it or not. SG & A, selling general administrative marketing cost and abnormal spoilage versus, the other cost is called a product cost. Those are manufacturing costs. They become part of the cost of the product. The product that you are manufacturing. Now, as far as manufacturing costs, they include 3 basic elements...direct materials, direct labor, and manufacturing or factory overhead. So, I'm going to call that direct materials, DM, direct labor and factory overhead. Those are the 3 different types of manufacturing costs. For example, I'm going to build this wooden lectern I have right here. Now, if I want a build that podium or that lectern, what do I need? I need 1, 2, 3, 4, 5, 6 pieces of fake wood, alright? That's 6 pieces. That is called my direct material. What is direct materials? Those are the materials that become an integral part of the product. Those are called my direct materials. So, they become an integral part of the product. The direct labor is, my friend Jesse here is going to hammer, glue and screw it together, and I go, "Hey, how long is it going to take you?" He goes, "Dos horas, Senor amigo. Two hours!" I go, "Hey, muchas gracias. Si por supuesto." I say, "Cuanto t..." No, I'll say it in German. "Jawohl. Wieviel teich brauchen Sie." And he says, 'Ich will zwei stunden brauchen auch ja ehrlich das vouche du ergen." Whatever. So, what is he saying? "It's going to take me two hours." I go, "Okay. I pay you 15 bucks an hour for 2 hours, that's 30 bucks. So that's direct materials, direct labor. What about factory overhead? What is that? That all the other time in the factory except which two? Direct materials, direct labor. So, I go, "Oh, okay." That's indirect materials, indirect labor, all of those are the costs in the factory. What else? Insurance, rent, depreciation, heat, electricity, right? All of those costs also indirect labor, such as what? He works right on the product. That's direct. But what about the factory foreman? He doesn't work on the product directly. What about the timekeeper? He doesn't work...so all of those are people in the factory, but not working directly. So when we talk about manufacturing costs, it says product cost, direct materials, direct labor, manufacturer overhead, all costs in the factory except which two? Direct materials, direct labor. So it includes indirect materials, indirect labor, things like that. Now, there's another term you need to know. These two together are called the prime costs of the product. Because what is the main cost of the product? The materials and labor. The overheads and all the others are not, but the materials and labor. What about these two together? These are called conversion costs. Those are the costs of converting a raw material to a finished good. What does it take, to take this wood and make it a podium? Labor and overhead. So we're going to talk about materials, labor, overhead. Remember the words prime cost, conversion cost, prime direct materials, direct labor, conversion, labor overhead. Question on the exam a long time ago: which cost is included in both prime and conversion? Direct labor. Hmm...ok. So, notice indirect materials is a what? It is a factory overhead. It is a conversion cost. It is a manufacturing cost. It is a product cost. Those are all correct answers. One more time...indirect labor is an overhead, conversion, manufacturing, product. Now, what does it mean to be a product cost? What it means is, you don't expense it till it's sold. Cost of goods sold. So, as I spend the money, I don't debit expense, credit asset, I debit asset...I'm sorry...I don't...I don't debit expense, credit asset like cash. I don't debit expense credit cash. I debit asset inventory, work in process inventory, finished goods inventory, work in process inventory. Then, when I sell it, boom, now it becomes costs of goods sold, and get rid of the inventory, because now we're selling it. So notice, you capitalize it, it becomes a product cost versus a period cost. Now another expense in there are called your spoilage. Now, what is spoilage? Let's say, for example, I'm going to manufacture this beautiful Roger CPA Review shirt that I'm wearing, gorgeous shirt, gorgeous shirt. Now, how do you manufacture a shirt? You take a piece a material, like this, and you have to cut it out, and you can see I'm not an artist, okay, it's a little irregular. I'll sell it to Marshall's. Okay, so here's my shirt, let's get rid of the head. Here's my shirt, so I cut around here, and all of this material around here is called normal spoilage. Why? Because that's a normal part of the production process. Now, what do you do with normal spoilage? Normal spoilage is over here. Normal spoilage. Because normal spoilage should be part of the cost of the good units you produce. Why? Because that's part of the...if this whole piece of material cost me a dollar, even though I'm cutting around it, that should still be part of the cost of the dollar of creating the shirt. Now, obviously a nice shirt, it's only one piece I'll have to tie a string around it to wear it. It's a backless shirt. So that's that. Now, that is called the product cost. What if the shirts are done and they're on the loading dock and the truck is coming back to pick them up? Beep, beep. C'mon. Beep, beep. C'mon. Beep, beep..whoops. They run over them, oil, grease all over. We have to throw them way. That's called abnormal spoilage. That's an expense. So, abnormal is an expense in the period, normal usually becomes part of the good units produced. So that's what we mean by normal versus abnormal as far as the spoilage. Now, when we get down the road, we're going to talk about another fun and exciting area called what? Variance analysis. What is that? Variance, well variance analysis says what could go wrong with these costs. Direct materials, direct labor, overhead. First of all, with materials, what could go wrong? You could pay too much per pound or you could use too many pounds. So we're going to learn about direct material price variance, direct materials usage variance. Labor...what can go wrong? You either pay too much direct labor rate variance, or you use too many hours because people wasted time, they were less efficient, causing direct labor efficiency variance. Then you've got overhead. Now these are the hard ones. These are the ones from school that most of you hated, never understood. But what could go wrong in this huge, big factory? What could go wrong is we either spend too much on fixed or variable, fixed rent, variable electricity, or we are less efficient with our electricity or our production volume, our production capacity is down...In other words, this factory, I could have produced 100,000 podiums, but we only produce 90,000. What does that mean? That we were underutilized. Our production volume was down, so that's what we mean by spending efficiency volume. That's called overhead variances, we'll do in another section, but again, just some of the excitement that's coming our way. Now, as far as cost of systems, it says their actual cost system standard cost system, normal cost system. What's the difference? In an actual cost system, that's where we're going to go through and use direct materials, direct labor and factory overhead based on what? Actual. We have a standard cost system. That's where we're going to use materials labor and overhead based on what? Standards. And then we have a normal cost system, that's what we're going to be using. What does a normal cost system say? It says, if he's going to build this podium or lectern, isn't it pretty easy to keep track as I hand him a piece of wood, of how much that wood cost me? Mmm hmm. And, every day he works, he goes, "How much did you work?" "I worked 8 hours today." 8 hours at 15 bucks, 80, answer 120 bucks. Let's keep track of that. What about, okay, I just worked today. How much should I add for electricity, insurance, rent, depreciation? I don't know, so what I'll do is that's where I'll say, "You know what? Let's come up with what we call a pre-determined overhead rate. It'll be an application rate. It's going to be based on estimates at the beginning of the month, beginning of the year, and I will apply that into production as he works on this podium." So, that way, every hour he works, I'll add some money for electricity rent, insurance, depreciation, glue, screws, the factory foreman salary, the timekeeper salary, the guy who cleans and sweeps the floor...all these factory costs that are not direct material, direct labor. Because I don't know till the end of the month. At the end of the month, I get a bill, and I go, "Oh, that's how much it really was." Then I can compare it to what I...what we call applied in to work in process. So, under a normal cost system, I'm going use materials and labor based on actual because I can figure those out pretty easily, but the overhead is the one that I'm going to use what we call a pre-determined overhead application rate. That is going to be overhead based on what? On a standard called a pre-determined overhead rate. That's what we're going be doing in most of this section, which is dealing with normal costing. So, normal costing says what? Direct materials, actual. Direct labor, actual. Overhead based on a pre-determined overhead rate. Alrighty, you'll see here in the notes it says pre-determined overhead rate. So, let's talk about that pre-determined overhead rate, and the pre-determined overhead rate just basically says, how am I going to go about applying my overhead into production. So what we're really looking at here is, how should I apply my overhead into production? Alright, now with a pre-determined overhead rate, what we're going to do at the beginning of the month is figure out what my costs are expected to be. Estimated cost for...over some estimated base. Then I'm going to come up with a basic overhead rate, so this is my pre-determined overhead rate. I will then multiply that times actual production, actual units, actual hours, actual pounds, actual dollars. If I'm using direct labor, dollars is a base. That'll give me how much overhead I need to apply. Where? Into WIP. What's WIP? Work in process. So, what I'm trying to figure out is, how much to apply into my work in process. So the way this works is, let's look at a couple of journal entries, and let's take a mental picture of all this. Alright, that's your lens, very good. We'll recreate it later when we do some problems on this because we're going to do some problems. We're going to have some fun. Woo. We're going to do some problems. We're going to have some fun with everyone. Alright, how ya' doin'? Good? Let's have a little bit more Fresca...oh no, Mountain Dew. Do the Dew. Mmmm. Alright. Now, with our pre-determined overhead rate, what we're going to do is, we're going to come up with a basic rate, and we're doing this at the beginning of the month, beginning of the year. We're going to have our estimated, and this is going to be estimated overhead costs divided by our estimated base, and the base could be direct labor dollars, direct labor hours, that equals our pre-determined overhead rate. We will multiply that times our actual production. That equals our applied overhead. One more time. We take estimated...overestimated...why? Because it's the beginning of the month. You take your estimated overhead costs. Let's say, for example, I think I'm going to spend 100,000 dollars in overhead. What is overhead? Indirect materials, indirect labor, and so on, divided by an estimated base. Now, your base could be whatever. Now, in the exam, it's usually either direct labor dollars, direct labor hours, machine hours, could be, you know, materials, could be size meters, inches, yards, whatever. Usually, it's direct labor dollars, direct labor hours. So, let's say for example, it's direct labor hours, and I figure we're going to work 20 hours, 20,000 hours. So, I think we're going to spend 100,000 dollars on overhead and we're going to spend 20,000 hours. That gives me about 5 dollars per direct labor hour. So, that means my pre-determined rate is 5 dollars per what? Per hour. So, I'm going to multiply that times actual hours. That means for every hour that Jesse works on this lectern, this podium, I'm going to add materials, what I actually put in, labor 15 bucks an hour times the number of hours and overhead would be 5 dollars per hour. So, for every hour he works, I'm going to add 5 dollars for overhead. Hmmm...okay. And that's going to give me what I apply. Now, where do you apply this? To work in process, to WIP. Whip it! Whip it good, right? Who sings doo doo doo doo doo doo doo? Woo! Whip it! Devo. '80s. Look it up on YouTube. Alright, you should know that by now. So, that's what's going on. Hey, what's another base we could use? We can use direct labor dollars. So let's say direct labor dollars was our base. We'd say 100,000 dollars over, let's say 50 direct labor dollars, 50,000 direct labor dollars. What does that mean? It means we think overhead is going to be 100,000 dollars. We expect to have 50,000 dollars in direct labor. That's how much our cost is going to be. Notice, that equals, in this case, 2. What is 2? 200%. Now, what is 200% mean? It means it's 200% of the base, 200% of direct labor dollars. What does that mean? It means for every hour he works, I'm going to add double. So, whatever his dollars are...if I pay him 15 dollars, I'm going to add 30 dollars for overhead, and that's 200%. Now, a lot of times it might be 200%, it might be 80%, 60%. What does that mean? For every hour, I'm going to add 80% or 60%. So if I'm paying 10 dollars in labor, I'll add 8 dollars or 6 dollars. So, notice, it could be your base, could be direct labor hours, direct labor dollars. If its direct labor hours...and what does that mean? It means that per hour. If it's direct labor dollars, it's that per dollar. So, notice, here's something I want to teach you now because I'm going to teach you break even analysis. I want you to remember this. Dollars over hours equals dollars per hour. So, dollars over non-dollars is dollars. Dollars over dollars is non-dollars. One more time, dollars over non-dollars is dollars. Dollars over dollars is non-dollars. What is the non-dollars? A percent. Hmmm...okay. So, that's good to know. So, that's our pre-determined overhead rate. Now this is how you apply it. Where you apply it into? Work in process, WIP. So, let's look at our journal entry in our notes, and I'll put it up here. I've got applied act...applied overhead. As you apply overhead into production, what's your journal entry going to be? You're going to debit work in process control, credit factory overhead applied. That's for your applied overhead. Then, at the end of the month, you get your bill for your actual overhead. What is your journal entry? Debit factory overhead control for what it really cost you, credit whatever...cash, payables and so on. Now, what is this all mean? Here's what it means. Apply it. How am I applying it? Let's look back over here. I'm setting up some pre-determined overhead rate, times actual production is what gets applied into WIP. So, in this example I came up with some base times the production equals what gets applied into WIP. This is only for overhead, not for materials and labor, just for overhead. So, you have WIP, credit factor...What is WIP? I'll show you in a minute...work in process. It's an inventory account. What is this? It is a temporary holding account, like purchases. Then when I actually spend money, debit factory overhead control, credit cash, balance sheet. What is this? This is a temporary account. At the end of the month, end of the year, let's flip these out. What do I do? This is to close it out. I debit factory overhead applied for 300, credit factory overhead control for 500. The difference is 200 dollars. What does it mean? I only applied 300 dollars for electricity, rent and insurance, but it really cost me 5, so we're going to call that over- or underapplied...in this case I applied 3, but it really cost 5, I'm underapplied. By what? By 200 bucks...mmm...so what does that mean? My costs really are higher, so therefore costs of goods sold is generally increased for the extra 200 bucks because I didn't apply what was called underapplied robe reply. Now, this is going to be important when I teach you variances because what we're going to do in variances, is we're going to figure out what happened here. Why did I apply 3 but really spent 5? What was the problem? That's where we're going to have those 3 different variances, and if you look down this way, you'll see here materials, labor, oh, here, overhead. What are the 3 variances? Spending, efficiency, volume. I'm off by 200 bucks. Why? Because I spent too much on fixed or variable or I was less efficient so I wasted electricity or my production volume capacity was down. So, those are going to be my spending efficiency volume variances. So, when I come back to looking at overhead and saying, why am I underapplied, this difference could be spending efficiency or volume because spending could be fixed or variable, efficiency, you're going to learn, is all variable, volume, you'll learn, is all fixed. So, these are the problems. This is why I am underapplied or overapplied, so that's how I'm getting it. Now, what I want us to see is the flow of the cost system. What does that mean? It means, how do I get the money into work in process? How do I do that? So let's come on down this way, before I erase all this, let's take a little mental picture of this again. Ready? [clicking sound] Again, what we're looking at is materials, labor and overhead. We're talking about how do I get these into work in process materials, actual labor, actual overhead, applied...Applied what? [whistling] Based on a pre-determined overhead rate, estimated cost, estimated base, comes up with a pre-determined rate times actual gives you applied. Where does it go? Into WIP. How do I get it into WIP? Thatís what we're going to do now. Look at the journal entries in your notes where it says the flow of a cost system. So let's set this up and see how the cost system will actually flow. Now, as far as the flow of a cost system, we're going to have what we call raw materials inventory, work in process inventory, finished goods inventory and then costs of goods sold. I was just thinking, we haven't had an earthquake in a little while. I think we're due. Hmmm? Uh-oh, here we go. I'm just kidding. Yeah, the things start shaking. Alright, flow of a cost system. We've got raw materials, work in process, finished goods and then, finally, costs of goods sold. Are we good? Okay, so we'll skip that for now. Let's come back over here. So, raw materials. What is that? We have some beginning raw materials plus purchases equals raw materials available for sale minus ending raw materials equals raw materials either used or requisitioned into production. Okay? So, that's called requisition. Now, where does it go? Raw materials goes where? It goes into WIP. WIP. Whip it good. Alright, so, work in process. I've got some beginning work in process, plus normally this raw materials, that becomes your DM, direct materials. Then I'm going to add to that direct labor. Now remember, if I'm using what we call a normal cost system, as Jesse works on this podium or lectern, what am I saying? I'm saying, ìHey, here's some materials, direct materials. Okay we'll add the cost to that. Here's some direct labor. Ok, we'll add the cost to that.î And then what about all the overhead? What kind of overhead am I going to add in here? It's called applied overhead. Notice, it's not actual, it's applied. How did I figure out this amount? Because I said estimated dollars, over estimated base, equals some rate times actual something equals applied. How did I do that? I debited WIP control, that's that, work in process, factory overhead applied. That's for this amount. Later I'm going to find out that it really cost me 500, but right now, we just did this. We debited WIP. What is WIP? Work in process. What is work in process? It is called an inventory account. That gives me my WIP available minus ending WIP, work in process, equals costs of goods, careful, not costs of goods sold, called cost of goods completed or manufactured. Now, cost of goods completed or manufactured. Where do those go? Those go into finished goods. So, I have some beginning finished goods plus, woooop, cost of goods manufactured or completed equals finished goods available minus ending finished good equals costs of goods sold. Now, I'll bring that over here to cost of goods sold, plus, this is where I'm going to adjust over/under applied. So now what's happening? Now, I've got my costs of goods sold number, but now what we're going to say is, if I didn't apply enough, then my expense is too low, plus underapplied or minus overapplied equals your real costs of goods sold. So, in this case, I was underapplied by 200 bucks. That's why I'm adding it here in costs of goods sold. So, let's look back here. You're going to hear that beep beep beep beep. That's me backing up. Because Iíve got a big booty. Big booty backing up. Beeeeep beep. Watch out! Here we go. Remember here? Debit WIP credit factory overhead applied. Then factory over...cash. What happened? We were underapplied by 200, boom. Hit it for what? Throw it into costs of goods sold. Ohhh...the lights are going on. So what do we do? We just throw it into costs of goods sold, unless it's material. If it's material, you could throw it into wherever there is ending inventory and there's overhead in it. Does raw materials have overhead? No. Work in process? Yes. Finished goods? Yes. Cost of goods sold? Yeah. The stuff you sold has electricity in it. Yes. So, you could allocate it either all to costs of goods sold, which is what's usually tested, or you could put it into WIP, finished goods and costs of goods sold. So, like, they'll say, base it on ending. So what is ending? Ending, ending, ending. Add them up. Divide them. 1/3rd, 2/3rds, you know, whatever it is. So you just do a proportionate share. Usually it's just immaterial, throw it out to costs of goods sold. So, again, why did we increase costs of goods sold? Because we were underapplied. In other words, we were underapplied by 200. This amount here...we only applied 300, it should have been 500, but we didn't know till the end of the month, so we added the 200 in here. Mmm kay, that makes sense. Now, what does this mean? Raw materials, boom, this is what we use, becomes direct materials, WIP, direct materials, direct labor, overhead, boom, that's the cost of goods completed, transferred, beginning costs of goods completed, finished goods available minus ending, costs of goods sold, then, boom, I adjust over/under here. Notice, when I say different types of ending inventory on your balance sheet, if I am buying calculators, that's my calculator now, If I buy this calculator, what is it? Just the cost. FIFO. First in, first out, you know. That's how I figure it out. FIFO LIFO weighted average, moving average, dollar value, blah blah blah. Here, I'm manufacturing it, so what kind of inventory? Raw materials inventory, work in process inventory, finished goods inventory, those are all the types of inventory I could have on my balance sheet. So, on your balance sheet under inventory, you're not going to just have purchases, but you can have all these different types. You look in your notes, you'll see the flow of the cost system, and, again, it's important to understand the flow and how it goes. Now, you'll see here in your notes, it says to determine direct materials used the calculation is, beginning plus purchases minus ending is direct materials used. What is that? That's over here as just this. Raw materials used, direct materials used, cost of goods manufactured...this. Finished goods, this. So, I kind of give it to you in a formula format, but it's really just my T account that we're using again and again and again. Alright, if you look on the next page, it says in boldface, direct labor hours, direct labor dollars, machine hours...the paragraph that says the most common base. What is the most common base up here for figuring this out? As I said, it could be direct labor hours, could be direct labor dollars, could be machine hours...it's whatever works best for your industry. So, that's what we have to look at as far as the different types that we're going to do. Ok? Alright. Very good. Let's turn to the back, and in a minute, let's do a couple questions on all this fun stuff.