How to Hunt Down the Total Costs of Production in Cost Accounting
When cost accounting, you need to add costs to complete production on the units. Material costs are generally easy, but a department will add conversion costs. For example, you pay labor costs to an employee, so the worker will operate a sewing machine. That’s labor, and there’s overhead as well.
The goal is to isolate the costs added during the period. After you do that, separate the cost total between direct material and conversion costs. As a manager, you need to estimate the percentage of work completed on each unit.
Derive direct material costs in cost accounting
Estimating direct material costs is easier than estimating labor and overhead costs. In fact, it may be an exact figure, because you probably know how much material you moved into production. Say you make men’s cotton dress shirts. Your records indicate that you’ve moved 125 linear yards of cotton fabric into production. You know how much fabric you use in each shirt, and you also know the number of shirts in production.
With that info, you can compute the percentage of completion for units in production. Assume that 100 shirts are in production, but the cotton fabric moved into production will make only 50 shirts. At that point, you’re 50 percent complete (50 shirts ÷ 100 shirts) in terms of direct materials.
Figure out labor and overhead costs in cost accounting
Labor and overhead percentage completion estimates are harder. That’s because there is less hard data to grab and analyze. Also, the labor estimate typically drives the overhead allocation.
You can estimate labor completion based on the percentage of total tasks complete. If you’re making blue jeans, you have production departments to dye, cut cloth, sew, finish, and package.
You can judge your percentage completion by adding your estimates for each department in the production process. If dyeing is 10 percent and cutting is 20 percent, the product is 30 percent complete when it arrives in the sewing department. If work in the sewing department is 40 percent of the process, the product is 70 percent complete before it goes to finishing.
A level of activity usually drives overhead allocations. Those levels of activity are usually based on labor hours or machine hours. If sewing the jeans amounts to 40 percent of the labor, you can usually use the same percentage for overhead costs.
Estimating by percentage completion requires your experience, as well as math. It’s both an art and a science.