Flow of Costs

What Is Flow of Costs?

Flow of costs alludes to the way or path wherein costs travel through a firm. Ordinarily, the flow of costs is applicable with manufacturing companies by which accountants must measure what costs are in raw materials, work in process, completed goods inventory, and cost of goods sold.

Flow of costs applies not exclusively to inventory yet additionally to factors in different processes to which a cost is joined, like labor and overhead.

Figuring out Flow of Costs

The course of the flow of costs starts with esteeming the raw materials utilized in manufacturing. The flow of costs then, at that point, moves to the work-in-process inventory. The cost of the machinery and labor engaged with production are added as well as any overhead costs. The flow of costs next moves to the inventory stage where the completed goods are stored until they're sold. Following the sale of the goods, the flow of costs at last moves to cost of goods sold.

There are several methods for accounting for the flow of costs. These incorporate LIFO (last in, first out), FIFO (first in, first out), specific identification, and weighted-normal cost. For instance, the costs of raw materials could differ over the long haul, by which some are higher in price than others. After the goods are sold, the company must account for the cost of goods sold by eliminating the things from inventory to COGS.

Under the FIFO method, the main raw material purchased would be moved from inventory and charged to COGS as an expense. Alternately, in the event that the company utilized the LIFO method, the last unit of raw materials purchased would be moved from inventory and charged to COGS as an expense.

At the end of the day, with the LIFO method, the most established raw materials are kept or kept in inventory longer while FIFO leaves the as of late purchased materials in inventory. Companies must utilize similar cost flow computations and presumptions.

U.S. GAAP (generally accepted accounting principles) financial reporting standards expect that companies that utilization the LIFO method report the difference between that method and FIFO in a detail called LIFO reserve. This permits analysts to promptly compare firms utilizing different cost flow suspicions.

Illustration of Flow of Costs

For instance, Ford Motor Company produces cars and trucks. The company needs to purchase raw goods to make the cars it sells, which denotes the beginning of the cost of auto production. Next, there are the costs to pay employees to run the assembly line, which adds on to the cost of the raw materials. The cost to operate the machines and the costs associated with the building where the machines are found are likewise accounted for in the flow of costs.