To correctly record the costs of production, cost accountants must be able to delineate direct and indirect costs and provide the proper accounting treatment for each one. In general, direct costs are costs that can be traced to products, and indirect costs are those that cannot be traced to products. However, the general rule is best applied separately for materials and labor.
Direct Materials
Direct materials are those used in production that can be directly traced to the product being produced. In many companies, direct materials also are precisely quantifiable during production. Direct materials costs make up a sizable portion of product costs for many products. Accountants record direct materials costs by debiting the work in process account and crediting the direct materials inventory account for the value of the materials when placed into production.
Direct Labor
Employees who directly handle or supervise those who handle products being produced are considered to be direct labor. It is important to note that the dividing line between direct and indirect labor may be different in similar companies based upon the production process, employee roles and job descriptions and even union requirements. Direct labor is assigned to products with a debit to work in process and a credit to salaries payable in the amount of the time an employee worked on the product multiplied by the employee's pay rate. Often employee fringe benefits are assigned to products in this manner as well.
Indirect Materials
Indirect materials costs represent materials used in production but are not tracked directly in production. Grease for movable parts, glue in furniture production and paint for end products are examples of costs that may be accounted for indirectly. These costs are assigned to products via an allocation of manufacturing overhead. When the costs are incurred, the company debits manufacturing overhead and credits indirect materials. When overhead is applied to products, the company debits work in process and credits manufacturing overhead.
Indirect Labor
General factory supervision, support and maintenance labor make up indirect labor. Because these employees cannot be traced directly to products, the cost related to their work is assigned to products through manufacturing overhead. Payments to these employees are recorded with a debit to manufacturing overhead and a credit to salaries payable. When overhead is assigned to products, a debit to work in process and a credit to manufacturing overhead is booked. Fringe benefits for these employees are accounted for in the same manner.
Tags: manufacturing overhead, assigned products, work process, materials costs, these employees, being produced, cannot traced