In cost accounting, control accounts are temporary holding places for costs. Managing costs has to start somewhere, and in accounting, that process most often starts out with control accounts.
Labor, materials, and indirect costs start off in control accounts. It may sound strange, but these accounts and their balances don’t appear in the financial statements. That’s because the balances are eventually moved to other accounts. All the checks you write for manufacturing costs are posted first to control accounts.
For many manufacturers and retailers, inventory is the biggest investment; more cash is spent on inventory than any other asset. Because of that, a big part of operating a profitable business is to control the costs of inventory.
Inventory is an asset you eventually sell to someone. (That’s a little different, of course, from buildings and equipment.) For manufacturers, inventory has three components: raw materials, work-in-process, and finished goods, whereas retailers just have finished goods. Raw materials inventory is, broadly, products not yet started; work-in-progress inventory is partially completed products; and finished goods inventory is completed products.
The three kinds of inventory are assets, because you eventually sell the goods to a customer. When you do, the inventory asset becomes an expense — cost of goods sold. Managing inventory starts in a control account.
Here are control account titles for each component of inventory.
| Type of Costs | Control Account |
|---|---|
| Materials | Materials control |
| Labor | Wages payable control |
| Indirect costs | Overhead control |
Materials: You buy materials (such as wood for making kitchen cabinets) in advance of making your products. Materials control is the term for the control account for material costs.
Labor: Consider labor costs. Employees report the hours they work on time cards each week. Those cards list hours worked on various projects. For custom cabinets, the time cards list customer jobs that employees completed, and the hours worked. Wages payable control is the term for the control account for labor.
Indirect costs: A business has indirect costs (for example, machine repair and maintenance). Your firm has some method to allocate those costs to clients. However, you may not get to the allocation until after you write checks for the cost. Overhead control is the term for the control account for indirect costs.
Control accounts (materials, labor and overhead, work-in-process, and finished goods) are inventory accounts, which are assets. Cost of goods sold (COGS) is an expense account. When you make a sale to a customer, you “use up” the asset. The asset becomes an expense.