Closing Functional Activity Accounts

Analysis Made for the Internal Accounting Configuration

By Dr. Emanuel  Schwarz

(August 9, 1999) - In my past articles I have stressed that within the internal accounts, we should not use the terms "work in process."

It was well identified that the term "work in process" should only be designated for the amount of work, that to some degree was not finished and was left over in a direct production department at the end of the working day. On the next working day these unfinished products were terminated and transferred to the inventory of finished products.

I have also stated that the term "work in process" was established by accounting professionals long ago when they could not call this account "production cost " - as this amount of work in process had to be recorded in the assets of the company. With this identification of "work in process" as an asset account, our universities started to call this account "inventory of work in process." I feel this identification is inaccurate.

In the direct production departments, where these products in process were left overnight to be finished on the next working day, inventory control was not realized. Within these direct production departments no one was interested in counting the quantity that was unfinished because often, in the 24 hours following the closing activity, the production work was started again.

So, in my opinion, the idea of inventory as work in process is irrational. Because only financial accounting (general accounting) had been created, but not yet internal accounting. The terminology was established independently, the creators unaware of the logical fallacies.

Now, as internal accounting is established, new and correct terminology for these accounts can assigned as Class 5 and should be called: Functional Activities. All production cost accounts should be organized under this new identification. In my previous articles you have learned how we charge (debit) these accounts in Class 5 with direct and indirect cost. From Class 6 we transfer the finished. products to the corresponding Inventory account in Class 7.

At month-end, when we close these accounts, we will credit the Class 5 account with the total amount debited to this account and transfer this amount to the debit of an Other Assets account. From debit Class 6 - we transfer this amount to the same Other Assets account.

This account in the Other Assets should be identified as the Work in Process of a specific product and Job Order. On this account we are only interested in identifying the difference between the amount debited in Class 5 and the amount credited in Class 6. This difference represents the value of the work in process from one day to the next.

To illustrate this month-end transaction, I have prepared exhibit 7-01. See figure.

Let us observe, that in Class 5 we do not record any beginning balance. This is because these accounts are temporary - and only the Work in Process of the group of Other Assets is identified as a permanent account.

Now, I will clarify another important condition of the analysis of the work in process amounts of the fore-mentioned Production Cost accounts.

During the month we charge the production account 5-1-01-001 the value of the raw material transferred to this account. The Direct Labor and the Departmental Operating Cost (Indirect Cost) are also added to this Class 5 account.

During the same time period, the production department has finished some units of this product and transferred them to the Inventory of Finished Products. Class 6=1-01-001 will be credited with this amount and Class 7, Finished Goods to Inventory account, will be debited. In this example, the production is expressed in Standard Cost.

During the closing transactions to the end of this time period (month), the total amount debited in Class 5-1-01-001 will be how credited to this Class 5 account, and debited to the Work in Process account in the Other Assets of the General Accounting.

The same transactions must be recorded in the account of Class 6-1-01-001.Now it will be possible to see in this Work in Process account of Class 0: there is a difference between the amount in the debit and those in the credit. This is actually just the Work in Process that must be recorded in the group of Other Assets of the external Chart of Account.

An Analysis of Exhibit 7-02

If we start a production which we plan to be produce during several month of this year:

The first month, we charge 5-1-01-001 with raw material, direct labor and indirect cost. A total of $ 40 thousand. During the month the finished units of this product were transferred to the Finished Goods Inventory. Class 6-1-01-001 will be credited each time we transfer units to the inventory and in Class 7 the Inventory account will be debited.

But we have some work in process at the end of this first month: Class 6 will be credited with not more than $36. Not the same amount as debited in Class S.

Month end closing will show on the Work in Process account in the Other Assets an ending debit balance of $4. Next month this same amount will be the beginning balance on this account of Work in Process.

During the second month of production, the normal effectiveness is sustained, and the units in the work in process of last month are also finished. This means, that during the second month of production, the Direct Production Department would transfer as finished units a total value of $40. This amount is built up by the $4 of the work in process from last month and the normal production effectiveness of $36 per month.

An Important Point.

The Work in Process ending balance will stay at the same level of $40 if the effectiveness of production stays at the same level during all month of this production. As mentioned before, the production is expressed in Standard Cost.

If in a month, the Work in Process goes up from $4 to 6 this is an indication that the work in process amount at the end of this month increased. Why? We have to analyze the situation. Is more raw material left in the Direct Production Department? Are more finished units in process?

This Work in Process fluctuation from one month to the next must be identified to get a clear picture of what is happening in the Direct Production Department.

If the amount of Work in Process increases from month to month - this could be a sign of mismanagement of material and/or supplies. The material/supplies are still laying around in some production departments, as a consequence that they have received raw material to the department, but this material is not going out of the Direct Production department as finished product, rather as stolen goods.