ACCA F2 Management Accounting - 2010 - Study text

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Chapter 7: Accounting for costs: ledger entries

Debit Credit

1) Direct materials issued from

stores to production

WIP account Raw materials account

(stores account)

2) Direct labour costs in

production

WIP account Wages and salaries

account

3) Production overheads

absorbed into production costs

WIP account Production overheads

account

Example

Raw materials costing $6,000 are transferred from the stores account into production.

Direct labour costs of $12,500 were incurred and overheads of $25,000 were absorbed

into production costs

In a cost ledger system these items would be accounted for as follows.

Work in Progress

(Debit side) $

(Credit side) $

Raw materials (stores) account 6,000

Wages account 12,500

Production overhead account 25,000

The balance on this account is now a debit balance of $43,500.

Stores account

(Debit side) $

(Credit side) $

Work in progress 6,000

Wages account

(Debit side) $

(Credit side) $

Work in Progress 12,500

Production overhead account

(Debit side) $

(Credit side) $

Work in Progress 25,000

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2.3 From raw materials to cost of sales

Materials progress through the production system, from raw materials to work in

progress, from work in progress to finished goods, and from finished goods to cost

of sales. This is recorded in the double entry system as follows:

Debit Credit

1) Direct materials issued from

stores to production (work in

progress)

WIP account Raw materials account

(stores account)

2) Completed production

transferred from WIP to

finished goods (at production

cost)

Finished goods

account

WIP account

3) Finished goods sold to

customers

Cost of sales

account

Finished goods account

(production cost of sales)

Example

Continuing the previous example, the cost of finished output is $40,000. This is

transferred to the finished goods warehouse, and finished goods costing $35,000 are

sold.

In a cost ledger system these items would be accounted for as follows.

Work in Progress

(Debit side) $

(Credit side) $

Raw materials (stores) account 6,000

Finished goods account 40,000

Wages account 12,500

Production overhead account 25,000

The balance on this account is now a debit balance of $3,500. This means that

unfinished work-in-progress has a cost of $3,500.

Finished goods account

(Debit side) $

(Credit side) $

Work in progress 40,000

Cost of sales account 35,000

The balance on this account is now a debit balance of $5,000. This means that

finished goods held in the finished goods warehouse has a cost of $5,000.

Cost of sales account

(Debit side) $

(Credit side) $

Finished goods account 35,000

Chapter 7: Accounting for costs: ledger entries

2.4 Non-production overheads

Non-production overheads are recorded initially in an administration overheads

account and a sales and distribution overheads account. They are transferred from

these accounts to the cost of sales account. The cost of sales account therefore

records the production cost of finished goods sold, administration overheads costs

and sales and distribution overheads costs.

Debit Credit

1) Administration overheads Cost of sales

account

Administration

overheads account

(administration

overheads for the period)

2) Sales and distribution

overheads

Cost of sales

account

Sales and distribution

overheads account (sales

and distribution

overheads for the period)

Example

Continuing the previous example, finished goods with a production cost of $35,000

are sold. Administration overhead costs are $15,000 and sales and distribution

overheads are $20,000.

In a cost ledger system these items would be accounted for as follows.

Cost of sales account

(Debit side) $

(Credit side) $

Finished goods account 35,000

Administration overhead 15,000

Sales and distribution overhead 20,000

The total cost of sales is $70,000.

Administration overhead account

(Debit side) $

(Credit side) $

Cost of sales 15,000

Sales and distribution overhead account

(Debit side) $

(Credit side) $

Cost of sales 20,000

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2.5 Opening and closing inventory

The raw materials account, work-in-progress account (incomplete production) and

finished goods account provide a record of the cost of opening and closing

inventory at the beginning and end of each accounting period.

The value of the inventory is the current balance on the inventory account. This is

always either 0 or a debit balance.

However, at the end of an accounting period, an account is ‘closed off’ for the

period, and the balance on the account is:

 carried forward as a closing balance for the period that has just ended, and

 an opening balance at the beginning of the new period.

An example of a materials account is shown below, to illustrate how the opening

and closing inventory are recorded:

Materials account

Period 1

Opening inventory b/f 5,000

Work in progress

(direct materials)

35,000

Purchases 46,000

Production overheads

(indirect materials)

9,000

Closing inventory c/f 7,000

51,000

Period 2

Opening inventory b/f 7,000

The closing inventory at the end of a period is entered on the credit side ‘above the

line’ and the corresponding double entry is a debit entry ‘below the line’ as opening

inventory at the beginning of the next period.

‘b/f’ means ‘brought forward’. You might also see the letters ‘b/fwd’ or ‘b/d’

(meaning ‘brought down’). Similarly, ‘c/f’ means carried forward. You might also

see the letters ‘c/fwd’ or c/d (for ‘carried down’).

The opening inventory brought forward is called the ‘balance’ on the account at the

beginning of the period. In the example above, the opening balance of $7,000 at the

beginning of period 2 could be calculated as (Opening inventory + Purchases) –

Materials issued. Here this is $5,000 + 46,000 - $(35,000 + 9,000) = $7,000.

2.6 The costing system income statement

There is an income statement in the cost ledger, for recording the profit or loss in

each accounting period. This is a part of the double entry cost accounting system.

The credit side of the income statement records sales. The debit side of the income

statement records the cost of sales.

There might also be other items in this account, such as under- or over-absorbed

overheads (in an absorption costing system) or variances (in a standard costing

Chapter 7: Accounting for costs: ledger entries

system) or abnormal loss or abnormal gain (in a process costing system). The basic

rules of double entry, however, are as follows:

Debit Credit

Sales Sales account Income statement account

Cost of sales Income statement account Cost of sales account

The balance on this income statement account is:

 a credit balance when sales are higher than the cost of sales, and there is a profit.

 a debit balance when sales are less than the cost of sales, and there is a loss.

The profit or loss for the period is then transferred to a retained profits account, so

that the balance on the income statement becomes 0.

Example

Continuing the previous example, finished goods with a production cost of $35,000

are sold. Administration overhead costs are $15,000 and sales and distribution

overheads are $20,000. Sales in the period are $82,000.

In a cost ledger system these items would be accounted for as follows.

Cost of sales account

(Debit side) $

(Credit side) $

Finished goods account 35,000

Income statement 70,000

Administration overhead 15,000

Sales and distribution overhead 20,000

70,000

Cost accounting income statement

(Debit side) $

(Credit side) $

Cost of sales account 70,000 Sales account 82,000

The profit of $12,000 is shown by the credit balance on the costing income statement

account.

Debit Credit

Profit Income statement account Accumulated profit account, or

financial ledger control account

Loss Accumulated profit account, or

financial ledger control account

Income statement account

2.7 The financial ledger control account

The cost ledger includes accounts relating to costs. There are many other accounts

that are not specifically related to costs, such as the bank account, the account for

trade receivables, the account for trade payables, an account for accumulated

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profits, and so on. In the cost ledger, a special account called the financial ledger

control account (or the cost ledger control account) may be used to record one of the

double entry transactions required when the appropriate account does not exist in

the cost ledger.

Examples

 A company buys raw materials on credit from a supplier, at a cost of $2,000. It

has an addition to its materials, and owes the supplier. The double entry is:

Debit: Materials account $2,000

Credit: Financial ledger control account $2,000.

 A company pays wages of $3,000 to its work force. It has incurred labour costs,

and paid for them out of its bank account. The double entry is:

Debit: Wages and salaries cost account $3,000

Credit: Financial ledger control account $3,000.

 A company incurs production overhead expenses, such as factory rental costs,

and either pays for them out of its bank account or obtains the items on credit

from a supplier. The double entry is:

Debit: Production overheads account

Credit: Financial ledger control account.

Exercise 1

A company incurs the following costs:

(a) Purchases of raw materials $20,000

(b) Costs of wages and salaries $25,000

(d) Cost of other overhead expenses (administration overheads and selling and

distribution overheads) $7,000

(e) The opening inventory in the materials account is a balance of $1,000 and in

the work-in-progress account the opening balance is $4,000. The opening

balance on the financial ledger control account is $5,000.

(f) The company also had sales of $90,000.

Required

Record these transactions in the following cost accounts:

 Materials account

 Wages and salaries account

 Production overheads account

 Other overheads account

 Sales account

Chapter 7: Accounting for costs: ledger entries

 Financial ledger control account.

(You are not required to show the WIP account, although you can do so if you want

to see that all the debit entries and all the credit entries add up to the same total

amount.)

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Double entry accounting for costs: overheads

 Accounting for direct and indirect materials and labour costs

 Absorbed production overheads

3 Double entry accounting for costs: overheads

3.1 Accounting for direct and indirect materials and labour costs

Direct materials costs and direct labour costs are direct costs of production and are

charged to the work-in-progress account.

Indirect materials costs and indirect labour costs are overhead costs of production

and are charged to the production overhead account, administration overhead

account or selling and distribution overheads account, as appropriate.

Debit Credit

Direct materials issued

from stores to production

WIP account

Raw materials account

(inventory account)

Direct labour costs in

production

WIP account

Wages and salaries

account

Indirect materials

Indirect materials issued

from stores to production

cost centres

Production overheads

account

Raw materials account

(inventory account)

Indirect materials issued

from stores to

administration cost centres

Administration

overheads account

Raw materials account

(inventory account)

Indirect materials issued

from stores to sales and

distribution cost centres

Sales and distribution

overheads account

Raw materials account

(inventory account)

Indirect labour

Indirect labour production

cost

Production overheads

account

Wages and salaries

account

Administration costs of

labour

Administration

overheads account

Wages and salaries

account

Sales and distribution

labour costs

Sales and distribution

overheads account

Wages and salaries

account

Chapter 7: Accounting for costs: ledger entries

3.2 Absorbed production overheads

Production overheads are absorbed into the cost of production. This is accounted for

as follows:

Debit Credit

Production overheads

absorbed

WIP account

(Absorbed overheads

are added to the cost

of production)

Production overheads

account

The balance on the production overhead account is the under-absorbed overhead or

over-absorbed overhead. At the end of each accounting period, this balance is

transferred to an under- or over-absorbed overhead account.

Example

During an accounting period, a company recorded the following transactions:

(a) Opening inventory: raw materials $5,000; WIP $3,000

(b) Purchased raw materials costing $23,000

production materials.

(d) Incurred total labour costs of $25,000. Of this total, $12,000 were direct labour

costs, $6,000 were indirect production labour costs and $7,000 were other

overhead labour costs.

(e) Production overhead expenses were $18,000.

(f) Absorbed $27,000 of production overheads into the cost of production.

These transactions are accounted for as follows. Work through the accounting

entries carefully, and make sure that you can see how each item is accounted for.

‘Balance’ in some of the accounts here means ‘balancing item’: this is the entry

required to complete the account, which is calculated from the other figures in the

account.

Raw materials

Opening inventory b/f 5,000

Work-in-progress 14,000

Purchases (financial ledger

control account)

23,000

Production overheads 5,000

Closing inventory c/f

(balance)

9,000

28,000

Opening inventory b/f 9,000

Paper F2: Management Accounting

Wages and salaries

Costs incurred 25,000

Work-in-progress 12,000

(financial ledger control

account)

Production overheads 6,000

Other overhead 7,000

25,000

Production overheads

Expenses (fin. ledger control) 18,000

Work-in-progress

(absorbed)

27,000

Raw materials 5,000

Under-absorbed o’head

(balance)

2,000

Wages and salaries 6,000

29,000

Work-in-progress

Opening inventory b/f 3,000

Materials 14,000

Wages and salaries 12,000

Production overhead 27,000

Other overheads

Wages and salaries 7,000

Under-absorbed overhead account

Production overhead 2,000

ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing

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