Before a business can calculate work in process, it must understand manufacturing costs incurred during the period. To calculate manufacturing costs, apply manufacturing overhead based on the company's predetermined allocation rate and add it to direct labor and direct material costs.
About Manufacturing Overhead
Work in process represents inventory a company has started to manufacture but hasn't finished at the end of an accounting period. Work in process costs are comprised of direct labor, direct materials and manufacturing overhead. Manufacturing overhead refers to all costs incurred to create a product that don't qualify as direct labor or direct materials. Examples of manufacturing overhead costs are:
- Factory utilities
- Depreciation on machinery
- Factory supplies
- Rent or property taxes on the factory
- Wages for factory supervisors, maintenence personnel and quality control staff
Allocating Manufacturing Overhead
Unlike direct labor and direct materials, manufacturing overhead is an indirect cost. Because of this, manufacturing costs are applied to inventory using predetermined allocation rate that reflects how much overhead is generally spent on each type of inventory.
To allocate overhead, managers choose a cost driver that they think best reflects how overhead costs are incurred. If production relies heavily on manual labor, the company might allocate overhead expense based on how many labor hours are worked. If machines are used to create the product, the company might base the overhead rate on machine hours. At the end of the year, accounting staff adjust for any differences between this applied overhead and actual overhead.
Calculating Ending Work in Process
Labor, materials and overhead are all part of inventory costs, so to calculate ending work in process for a month you first must find both manufacturing overhead and total overhead costs.
Calculate Manufacturing Overhead
- Identify the company's manufacturing overhead allocation rate. For example, the manufacturing overhead rate could be $50 of overhead for every direct labor hour worked.
- Multiply the amount of activity during the period by the allocation rate to apply manufacturing overhead costs. For example, say that factory workers logged 1,000 hours during the month. If the overhead rate is $50 per labor hour, manufacturing overhead applied during the period would be $50 multiplied by 1,000, or $50,000 worth of overhead.
Calculate Total Manufacturing Costs
Add manufacturing overhead applied to direct labor and direct materials cost incurred to find total manufacturing costs for the period. For example, if the company incurred $40,000 in direct labor costs and $10,000 in direct materials cost during the month, manufacturing costs incurred would be $100,000 ($50,000 in overhead plus $40,000 in direct labor and $10,000 in materials).
Find Work in Process
Add the beginning balance of work in process to manufacturing costs and subtract the cost of goods manufactured to calculate the ending work in process balance.
The beginning balance of work in process is the ending balance from the previous period. The cost of goods manufactured is the cost of goods that have been completed and transferred out of the work in process department.
For example, say that beginning work in process is $30,000 and the cost of goods manufactured is $40,000. Work in process would be the beginning balance of $30,000, plus $100,000 in new manufacturing costs, less $40,000 cost of goods manufactured for an ending balance of $90,000.