10.1 Integrating Cost and Financial Accounts: Control Accounts and the Manufacturing Account
Key Takeaways
An integrated system uses one ledger for both cost and financial accounting, while an interlocking system keeps a separate cost ledger linked through a cost ledger control account.
Direct materials and direct wages are debited to work-in-progress, while indirect materials and indirect wages are debited to the production overhead control account.
Production overhead is charged to work-in-progress at the predetermined absorption rate, and any balance left on the overhead control account is under- or over-absorbed overhead.
Completed production is transferred from work-in-progress to finished goods, and goods sold are transferred from finished goods to cost of sales.
A manufacturing account builds from materials used to prime cost, production cost, cost of goods completed and finally cost of sales.
Why this topic is examined
Syllabus area C4(a) asks you to explain the integration of the cost accounts with the financial accounting system, including "manufacturing accounts including raw material, work-in-progress, finished goods and manufacturing overhead control accounts". Questions typically ask for the correct double entry for a transaction (for example, issuing indirect materials), or for a missing balance on a control account. Section 10.2 extends this to overhead under- or over-absorption and standard cost variances.
Integrated and interlocking systems
| System | How it works | Main feature |
|---|---|---|
| Integrated | A single set of ledger accounts records transactions for both financial reporting and costing | No duplication; cost and financial profits agree automatically |
| Interlocking | The cost accounts are kept in a separate cost ledger; items from the financial ledger are posted through a cost ledger control account | Cost and financial profits can differ and must be reconciled |
Most modern organisations use integrated systems, typically within an enterprise resource planning (ERP) system. The rest of this section assumes an integrated system.
The control accounts and the flow of costs
Manufacturing costs flow through a chain of control accounts, mirroring the physical flow of goods from stores, through production, into the finished goods warehouse and out to customers.
| Transaction | Debit | Credit |
|---|---|---|
| Buy materials on credit | Raw materials control | Trade payables |
| Issue direct materials to production | Work-in-progress (WIP) control | Raw materials control |
| Issue indirect materials (for example, lubricants) | Production overhead control | Raw materials control |
| Pay gross wages | Wages control | Bank (and payroll liabilities) |
| Analyse direct wages | WIP control | Wages control |
| Analyse indirect wages (supervisors, idle time, overtime premium not charged to specific jobs) | Production overhead control | Wages control |
| Incur other production overheads | Production overhead control | Bank or payables |
| Depreciation of factory machinery | Production overhead control | Accumulated depreciation |
| Absorb production overhead at the predetermined rate | WIP control | Production overhead control |
| Complete production | Finished goods control | WIP control |
| Sell goods (at production cost) | Cost of sales | Finished goods control |
| Record the sale | Trade receivables | Sales |
Important
Direct costs go straight to WIP. Indirect production costs go to production overhead control first and reach WIP only through the absorption entry. This is why the overhead control account can finish with a balance: the amount absorbed at the predetermined rate rarely equals the overhead actually incurred.
Worked example: Kestrel Ltd, March
Opening balances: raw materials $18,000; WIP $12,000; finished goods $25,000.
Transactions in March:
- Materials bought on credit: $60,000.
- Materials issued: direct $52,000; indirect $4,000.
- Gross wages paid: $45,000, of which direct $36,000 and indirect $9,000.
- Other production overheads paid: $21,000. Depreciation of factory machinery: $6,000.
- Production overhead absorbed: 2,050 machine hours at $20 per hour = $41,000.
- Cost of production completed: $125,000.
- Production cost of goods sold: $130,000. Sales on credit: $190,000.
Raw materials control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Opening balance | 18,000 | WIP (direct materials) | 52,000 |
| Trade payables (purchases) | 60,000 | Production overhead (indirect) | 4,000 |
| Closing balance | 22,000 | ||
| Total | 78,000 | Total | 78,000 |
Wages control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Bank (gross wages) | 45,000 | WIP (direct wages) | 36,000 |
| Production overhead (indirect wages) | 9,000 | ||
| Total | 45,000 | Total | 45,000 |
Production overhead control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Raw materials (indirect) | 4,000 | WIP (absorbed) | 41,000 |
| Wages (indirect) | 9,000 | ||
| Bank (other overheads) | 21,000 | ||
| Accumulated depreciation | 6,000 | ||
| Statement of profit or loss (over-absorbed) | 1,000 | ||
| Total | 41,000 | Total | 41,000 |
Actual overhead was $40,000 but $41,000 was absorbed, so overhead is over-absorbed by $1,000. The balancing debit transfers this to the statement of profit or loss as a credit (a reduction in cost). Section 10.2 explains this entry in more detail.
Work-in-progress control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Opening balance | 12,000 | Finished goods (completed) | 125,000 |
| Raw materials (direct) | 52,000 | Closing balance | 16,000 |
| Wages (direct) | 36,000 | ||
| Production overhead (absorbed) | 41,000 | ||
| Total | 141,000 | Total | 141,000 |
Finished goods control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Opening balance | 25,000 | Cost of sales | 130,000 |
| WIP (completed) | 125,000 | Closing balance | 20,000 |
| Total | 150,000 | Total | 150,000 |
The manufacturing account
The same information can be presented as a manufacturing account (a statement of the cost of goods manufactured), which management accountants use to report production costs:
| Manufacturing account, March | $ | $ |
|---|---|---|
| Opening raw materials | 18,000 | |
| Purchases | 60,000 | |
| Less closing raw materials | (22,000) | |
| Materials used | 56,000 | |
| Less indirect materials (to overheads) | (4,000) | |
| Direct materials | 52,000 | |
| Direct labour | 36,000 | |
| Prime cost | 88,000 | |
| Production overhead absorbed | 41,000 | |
| Production cost incurred | 129,000 | |
| Add opening WIP | 12,000 | |
| Less closing WIP | (16,000) | |
| Cost of goods completed | 125,000 | |
| Add opening finished goods | 25,000 | |
| Less closing finished goods | (20,000) | |
| Cost of sales (before over-absorption adjustment) | 130,000 |
Kestrel's gross profit is then sales $190,000 − cost of sales $130,000 + over-absorbed overhead $1,000 = $61,000, before administration and selling costs.
Tip
If a question gives you most of a control account and asks for one missing figure (such as the cost of goods completed), write the account out with both sides and let the balancing figure fall out. Remember that inventories appear on the debit side as opening balances and the credit side as closing balances.
Why integration matters
- One version of the truth: cost and financial profits agree, so no reconciliation is needed.
- Timely information: managers see production costs as transactions are recorded rather than at year-end.
- Inventory valuation: the WIP and finished goods balances support the inventory figures in the financial statements.
- Control: balances on the overhead control account and, in a standard costing system, the variance accounts highlight where performance differed from plan.
In an integrated cost accounting system, what is the double entry to record the issue of indirect materials from stores?
Debit work-in-progress control; credit raw materials control
Debit raw materials control; credit production overhead control
Debit production overhead control; credit raw materials control
Debit cost of sales; credit raw materials control
A company's work-in-progress control account shows opening WIP of $8,000, direct materials $40,000, direct wages $30,000 and production overhead absorbed $24,000. Closing WIP is $11,000. What is the cost of production transferred to finished goods?
$102,000
$91,000
$94,000
$113,000
Which feature distinguishes an interlocking accounting system from an integrated system?
An interlocking system records costs in a separate cost ledger linked to the financial ledger through a cost ledger control account
An interlocking system does not record production overheads
An interlocking system can only be used with marginal costing
An interlocking system values inventory at selling price
Sections you finish are checked off in the contents.