 In this presentation, we will take a look at the flow of materials, labor and overhead within a process cost system. In other words, we're going to track the materials, labor and overhead as they flow through from the raw materials to the finished goods within a manufacturing company. Support Accounting Instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. A manufacturing company that uses a process cost system as opposed to a job cost system. In comparing the two systems from a job cost system and a process cost system, we'll see many similarities and a few differences. So we want to consider those two because every time we take a look at the process cost system, we really are contrasting it to the other type of manufacturing process, which is a job cost system, keeping in mind those differences, also keeping in mind that we might have some companies that have some component of both a job cost system or process cost system. But as we consider and learn them, we typically keep them separate in our mind so we can compare and contrast them. Both of these items will be starting with raw materials that we want to then convert to finished goods and therefore are different than a manufacturer or a merchandising type of company, which will just have the goods that will be purchased and then the goods that will be sold. There'll be no processing of the goods. It'll be a lot easier than to track in that format. Here, of course, we're going to have the raw materials, which are not finished, convert them in some way. That conversion process is going to be in the form of, in a cost form, the overhead that we're going to apply as well as the labor that will be applied to get to the finished goods. And then, of course, once we're at finished goods, we're at a similar point as a merchandising company and we will in essence just sell the finished goods, record the cost of goods sold at the point in time that we sell. The difference with tracking the flow of a process cost system and a job cost system is that we're not tracking by job, we're tracking by process. Now note, when you track by job, you still use the account of a work in process type of account, but that work in process type of account is supported by a job cost sheet. And in a process cost system, we still have work in process accounts, but we're not going to be supporting them with a job cost sheet because we're not tracking by job. We are instead tracking by process, by department. So we're going to track this information, this cost for the inventory, by the process that it's currently in. We think of a process cost system as being more of a linear type of process that we're going through typically. So if we're making something that goes through a process, such as making candy or something like that, it might go through a department one where we make the candy, department two where we put the candy into the wrapper or something like that and package the candy and then it would go to finished goods. So we can see kind of a linear type of process and that's going to be what's going to be the difference then in terms of the accounts. In other words, we might have two work in process accounts or more work in process accounts representing different departments as opposed to a job cost system where we have one work in process, which is then supported by the job cost worksheets that will support the detail of what's going into the work in process by job. Other than that, the flow in the journal entries will look similar, but we'll have to account for, of course, these two departments, these two work in processes. We'll start off in a similar fashion as we would with a job cost system. We're going to buy the materials. So we'll buy the materials, so the materials you can track kind of like you would inventory for a merchandising company. You're going to have beginning materials. You're going to have purchases and then ending materials. You can have like a similar kind of calculation for calculating what materials were used. But in essence, we're going to have beginning materials purchases for the materials. And then we're going to transfer. We're going to credit the materials. So here's our T account debit debit. Now we're crediting it. This is an inventory account and therefore it has a debit balance. If we credit it, it's going down. This is what would happen when we requisition the materials to the work in process. That would be the credit. The debit then would be to the work in process account. And we're typically considering materials. If we make something like candy with a sugar and whatnot would typically go into department A. That's where we actually make the candy typically. So we're going to go to department A and then we can imagine, of course, it's going to go to department A and then it's going to go to department B, which is the packaging department. So that would be the normal process. Most of the materials are going to go to department A and then to department B, once finished in department A, once it's been converted from sugar to candy. But also, we're going to have materials that will go to department B. So it's not all going to go to department A and then to department B. Most of it probably going to department A, then transferring to department B, once finished. But we're going to have some materials that will go directly to department B, such as the packaging kind of materials, like the wax paper or something like that, that we're going to need in department B. So we will have direct materials going both to department A and to department B. The materials going to department A are probably the bulk of the materials. The main thing we think about when we process something, because that's what we're using to convert, in this case, candy, the materials going into department B are probably not the main thing we consider, like the packaging type of materials that are going to go into department B. So if we think about that in terms of the trial balance, then, of course, we've got the materials up top. It's all inventory. We've got the materials up top. It would be decreasing the materials up here and going into department A, the working process, and here. So we would be crediting this as a debit balance account. It would be going down, and then we would debit the working process accounts, and those would be increasing. It's all in the assets. No net effect in the assets. The assets would be going up. Assets would be going back down when we do that transfer. This is what the journal entry would look like. This is the T account up top. This is the journal entry. The journal entry would generally be triggered with a materials requisition form. So that's the form that would generally say, hey, we know we need materials from the warehouse. We're imagining the materials are in some type of warehouse. It's going to be moved then to the working process department. We can imagine all the sugar being dumped into a big bucket or something, and that's now we're in the working process department. The journal entry then would be a debit to a department A working process, debit to department B working process for whatever is needed in department A and department B. Department A needing in our case sugar and whatnot. B is going to be needing the wax paper, and then we would credit the raw materials, decreasing the raw materials. Of course, again, that would mean materials is going down, and then the working process would be going up. These two accounts would be going up. We're all talking about assets. The assets here would be increasing with a debit. The asset here would be decreasing with a credit. The next step we're going to have is to be adding things into the working process. We consider working process now. We've got direct materials in there. There's three things that are going to be involved in inventory all the time. Direct materials, we have direct labor, and then we've got the overhead, all the other kind of stuff that we have. We already have the materials in there. The next thing is the factory payroll or the payable or the labor that's going to go in there. When you think of labor, you've got to think of kind of payroll. Payroll is happening, and it's a little bit confusing to think of payroll because payroll we usually consider, we debit payroll expense or something like that, and we credit payroll payable or cash. I'm not dealing with payroll taxes. We're just getting into the generals of payroll here for the process of the inventory. Here we're going to say, no, we're not going to debit the expense because we're putting these workers are working on inventory. We're basically going to capitalize their work as an asset as opposed to expensing it in what they're working on, which is inventory that is not yet completed, and therefore in the process of work and process. We're going to credit factory payroll payable. When you see a book problem, they'll typically credit a payable account when you're working with these process cost systems because you could think of it as crediting cash, or paying cash, or taking it out of the checking account, but that doesn't indicate what we're paying and the debit's going to go into work and process. So if we say it's a payable, we're taking it out of the payable, that gives us some indication without having to write a description with the journal entry that we're talking about some type of payroll item that's happening. So we're going to credit the liability as if we haven't yet paid the payroll yet instead of cash, and then we're going to debit the work and process instead of an expense for wages expense or payroll expense because these people are working on the inventory that's not yet completed, therefore work and process. Again, most of it will probably be in department A because that's where most of the work is done. Also note that the labor, the conversion with labor usually is fairly small possibly for a process cost system because everything is the same, we might automate the entire process. So there might not be a lot of labor involved in the work and process in a process type system that is more automated type of system. And then we're also going to have the direct labor that's going to go into department B, however. So remember, you're usually thinking it's going to go into department A and then roll into department B once it's done in department A. But of course we are going to have some direct labor that could be in department B as well. So the majority of it probably in A because that's where most of the conversion happens and B might be less labor, but again, we're going to have to apply out the labor to A from A to B, A and B. And once A is done, of course then we'll convert or transfer the process or the inventory from A to B as well. The journal entry will look like this. We're going to debit the work and process for department A, the work and process department B, and we're going to credit the factory payroll payable. Now note, again, this is kind of like, this is basically a payroll journal entry. We're not dealing with any withholdings here, however. So you could consider if this was cash, we're paying people cash and then we're debiting the work and process instead of payroll expense because we're capitalizing it here. And note, we're not dealing with anything with regard to payroll taxes or withholdings at this point. We're just making a simplified journal entry so that we can see the process or how it would look in terms of the capitalization of these items within the work and process. So work and process here would be going up, here and then the payable would be going up because we haven't yet paid the employees. Also note that we're always talking about payroll on the factory because we're talking about those workers that work in the factory. If you're talking about a book problem and it says the factory, well, then it has to do with inventory. If it says something admin, then it has not to do with inventory and you're not talking about something that would be in part of the inventory but something that would be a period cost typically. And then, of course, we have the third thing that's going to happen, which is going to be the manufacturing overhead. So in our work and process, we have the direct materials, we have the direct labor, now we have the manufacturing overhead. Now the actual costs with the manufacturing overhead is anything on the factory. So anything that's included in the factory is going to be a debit to the manufacturing overhead, the actual cost, depreciation on the factory or if there's rent on the factory or rent on the equipment or maintenance on the equipment in the factory. All these things that we can't apply to a specific department possibly then would go into the manufacturing overhead and then we're going to use some type of estimate to take the money out of the manufacturing overhead and apply it to the proper department based on some type of estimate. We'll talk more about that later but we're going to apply it out. So now we're going to be reducing the manufacturing overhead and again the manufacturing overhead would be increasing by what all the stuff we couldn't apply to the department. So anything in a book problem that says factory this, factory that and we can't apply it to department A or department B we're just going to dump into manufacturing overhead then use some type of estimate to apply it out. In terms of the journal entries then everything that we dumped into manufacturing overhead would typically be a debit, debiting these items for things like the utility on the factory crediting whatever we paid for utilities or utilities payable debiting anything that would be supervisor, salary or something for both departments that we couldn't apply to the department and crediting payroll for the indirect items and they're debiting this item for any possibly small materials that are going to both A and B and crediting the materials for that item. So these are the types of things that would be going into the manufacturing overhead because we know they're on the factory, they're part of inventory but they haven't been, we can't apply them to a particular department. Then we're going to apply them out. How do we do that? We do some type of estimate. So we're going to use some type of estimate and apply them out to department A or department B. So once that is done then we're going to have the applied overhead. Again most of it we might think would go to department A depending on how our estimate works but then the rest of it is going to go to department B and again once we're done with department A these items are going to roll over to department B because it's in that process but as we go through this note that we had part of the materials the direct labor and applied overhead that goes to department A and department B. The journal entry then factory overhead decreasing and it's going to be a debit to work in process department A, work in process department B here's work in process department A work in process department B and the overhead. Next item that's going to happen is now we're going to finish items in the work in process department A so it includes direct materials labor and applied overhead the three components of inventory now in department A we're going to transfer it now when it's completed from department A so the candy's made it's not now in the wrapper so now we're going to transfer it out of department A and we're going to put it into department B so we're going to credit department A to decrease it because it's an asset account we're going to debit department B because now we've transferred the actual candy into department B which will then go into the wrapping department now we have a work in process for department B increasing with a debit and work in process for department A decreasing with a credit so remember we're talking about assets here so the department A is going down the opposite thing to it which is a credit department B is going up so we're going to do the same thing to it as it's normal balance a debit next item at some point we're going to finish the work in process for department B and notice that includes now the direct materials for department B like the wrapper and stuff and then we've got the direct labor for department B the overhead for department B and then the stuff that was transferred of course from department A to department B once the wrapping is on the candy for department B in our example we're going to credit department B and we're going to move it then to finished goods so we're going to credit the work in process move it to finished goods and that's going to be the calculation of the cost of goods manufactured and that's going to be what we'll use to know the amount that we need to take out of the work in process for department B in our example and take it into the finished goods cost of goods manufactured journal entry then is going to be a debit so now we've got the debit to finished goods inventory that's going to increase with the debit it's going to decrease the work in process inventory account now it's in finished goods and we're in kind of a similar type of situation that we would be if we were just buying and selling inventory because we're ready to sell the inventory then we're going to take the information from finished goods we're actually going to sell it so when we sell it then we're going to take it out of the finished goods we're going to credit finished goods for the cost of goods sold now this is a little bit confusing because at this point in time we spent all this time tracking the cost and usually when we consider accounting we're spending a lot of time focusing in on the sale and so when we consider this transaction this last transaction it's hard to decouple it from the goal of the business which is revenue generation so the two things that happen at the same time is that this happens when we make a sale and the sale we can think of as a separate kind of journal entry that happens at the same time which is revenue increases and then accounts payable increases or cash increases at the same time the inventory finished goods inventory decreases and the cost of goods sold the expense increases so if we look at the journal entry then there's two things that really happen here we're concentrating on this item the cost of goods sold the type the part of the journal entry that usually gets less attention to it so when we make a sale we're going to increase the accounts receivable increase sales so this item and this item the other thing that happens of course is the inventory goes down finished goods inventory and a process cost system goes down with a credit and the debit is the cost of goods sold so note sales went up with a credit with the top journal entry and then it's going to go down or net income goes up with a credit because the income goes up with a credit the net income goes up with a credit or an increase to income and then the cost of goods sold increases the expense of cost of goods sold and bringing the net income back down so the net income would go up by the sales and then down by the cost of goods sold which of course would make sense because we're selling the item for what we can sell it for minus what it costs for us to produce it the cost of goods sold that's the effect on net income