{"id":4459,"date":"2023-11-28T18:34:13","date_gmt":"2023-11-28T18:34:13","guid":{"rendered":"https:\/\/fx5.com\/en-au\/?p=4459"},"modified":"2023-11-30T18:42:45","modified_gmt":"2023-11-30T18:42:45","slug":"cogs-part-ii-overhead-allocation-under-gaap","status":"publish","type":"post","link":"https:\/\/fx5.com\/en-au\/cogs-part-ii-overhead-allocation-under-gaap\/","title":{"rendered":"COGS Part II \u2013 Overhead Allocation under GAAP\u00a0"},"content":{"rendered":"\n<p>For some important background, make sure you\u2019ve read the first blog post in this series, <a href=\"https:\/\/fx5.com\/en-au\/cogs-why-you-should-care-and-how-to-track-it\/\" target=\"_blank\" rel=\"noreferrer noopener\">COGS \u2013 Why You Should Care and How to Track It<\/a>.\u00a0<\/p>\n\n\n\n<p>This post\u2019s intended audience is distillery management and accountants\/CFOs\/controllers.&nbsp;&nbsp;<\/p>\n\n\n\n<p>First and foremost, we should define the goal of this exercise. What we\u2019re aiming for is GAAP-compliant books that can be presented to external stakeholders. GAAP-compliant books are not only a good idea, but they are also a regulatory requirement for DSPs (<a href=\"https:\/\/www.law.cornell.edu\/cfr\/text\/27\/19.73\" target=\"_blank\" rel=\"noreferrer noopener\">27 CFR 19.73 (11)<\/a>). An important fact is that <strong>GAAP-compliant books do not necessarily provide inventory costs that are accurate down to the product level<\/strong>. Instead, overhead expenses attributed to WIP and Finished Goods inventory need only be accurate <strong>in aggregate<\/strong> and <strong>in the right period <\/strong>to meet your GAAP requirements for external reporting. In simple terms, GAAP requires overhead costs to be matched to the correct <strong>period<\/strong> (vs. the correct <strong>inventory unit<\/strong>).&nbsp;<\/p>\n\n\n\n<p>It is a natural desire for management to see accurate, per-SKU costs, including all overhead. These costs (used for business decisions like pricing) should be computed entirely outside of your accounting software and distillery management software. This is referred to as \u201cactivity-based costing\u201d (ABC) and it attempts to compute a true cost of production (direct &amp; indirect) for <strong>internal<\/strong> decision-making and reporting. For a complete financial picture that serves both external and internal stakeholders, most distilleries will need to compute both GAAP costing and ABC \u2013 separately.&nbsp;<\/p>\n\n\n\n<p>As covered in the previous blog post, <strong>Material COGS<\/strong> are tracked in your distillery management software. But what about all your other expenses? Some of them are considered <strong>non-manufacturing expenses<\/strong>, like <strong>Selling, General and Administrative Costs (SG&amp;A)<\/strong> \u2013 this includes office salaries, salesperson commission and compensation, advertising, trade shows, accountants and IT, legal and consulting fees and more. SG&amp;A expenses are not considered manufacturing overhead; you simply account for them in your accounting system under SG&amp;A.&nbsp;<\/p>\n\n\n\n<p>In contrast, <strong>manufacturing expenses<\/strong> include manufacturing labor, costs of input materials, depreciation of equipment, excise tax, product-related insurance, waste\/scrap, subscriptions, repairs\/maintenance including consumables and parts, and items like pallets or slip sheets. Some of these costs (e.g. input materials) are direct costs, tracked in your distillery management system as <strong>Material COGS <\/strong>and <strong>Excise Tax COGS<\/strong>. The remainder are indirect (overhead) costs.&nbsp;<\/p>\n\n\n\n<p>If you are using Whiskey Systems\u2019 labor cost tracking feature, then you can separate out Direct Labor (which is rolled into Material COGS) and Indirect Labor (which is not, and must be accounted for as overhead). If you are not using the labor cost tracking feature, simply account for all your manufacturing labor as indirect labor.&nbsp;&nbsp;<\/p>\n\n\n\n<p>The reality of small to medium distilleries is that individuals typically perform many different tasks across many business functions. Plus, distilleries are usually equipment-, utility- and rent-intensive operations. Given these facts, it is appropriate to avoid the \u201cdirect labor\u201d allocation method and use the \u201cmachine hours\u201d method, instead.&nbsp;<\/p>\n\n\n\n<p>Here\u2019s a simple example of a distillery using the \u201cmachine hours\u201d overhead allocation method:&nbsp;<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"309\" height=\"181\" src=\"https:\/\/fx5.com\/en-au\/wp-content\/uploads\/2023\/11\/image-1.png\" alt=\"\" class=\"wp-image-4461\"\/><\/figure>\n\n\n\n<p>With this method, you define a distillery-wide \u201cmachine hour\u201d capacity (instead of direct labor hours) and then assign machine hours to each finished product. This allows you to assign overhead costs to your finished product inventory as needed. The upside here is simplicity; the downside is that you have only a single rate for machine hours which may not reflect the diversity of actual costs (e.g. an hour of distillation may have significantly higher overhead costs than an hour of bottling).&nbsp;<\/p>\n\n\n\n<p>One way to address that is by splitting overhead on a departmental basis. Here\u2019s an example distillery using the \u201cdepartmental machine hours\u201d overhead allocation method. In this example, we have broken out different manufacturing departments (Distillation &amp; Bottling), as well as a \u201cservice\u201d department called Quality Control whose O\/H costs are spread across Distillation and Bottling:&nbsp;<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"574\" height=\"245\" src=\"https:\/\/fx5.com\/en-au\/wp-content\/uploads\/2023\/11\/image.png\" alt=\"\" class=\"wp-image-4460\"\/><\/figure>\n\n\n\n<p>Note: For simplicity\u2019s sake, these examples do not include \u201cWIP\u201d inventory, which must also have periodic O\/H costs assigned to it under GAAP.&nbsp;<\/p>\n\n\n\n<p>Once you have computed a GAAP-accepted measure of overhead costs, you can proceed to assign those costs to your WIP and Finished Good inventory, at the cadence of your choosing (typically, monthly or quarterly).&nbsp;<\/p>\n\n\n\n<p>Need help navigating these waters?&nbsp; We\u2019re here to cut through the noise and give you actionable, reliable advice. <a href=\"mailto:support@fx5solutions.com\" target=\"_blank\" rel=\"noreferrer noopener\">Reach out to our Customer Success team<\/a>, or\u202f<a href=\"mailto:https:\/\/calendly.com\/fx5-consulting\/intro-call\" target=\"_blank\" rel=\"noreferrer noopener\">book a free Consulting Intro Call<\/a>.&nbsp;&nbsp;<\/p>\n","protected":false},"excerpt":{"rendered":"<p>For some important background, make sure you\u2019ve read the first blog post in this series, COGS \u2013 Why You Should Care and How to Track It.\u00a0 This post\u2019s intended audience is distillery management and accountants\/CFOs\/controllers.&nbsp;&nbsp; First and foremost, we should define the goal of this exercise. What we\u2019re aiming for is GAAP-compliant books that can [&hellip;]<\/p>\n","protected":false},"author":6,"featured_media":3458,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_gallop_menu_shadow":false,"content-type":"","inline_featured_image":false,"_genesis_hide_title":false,"_genesis_hide_breadcrumbs":false,"_genesis_hide_singular_image":false,"_genesis_hide_footer_widgets":false,"_genesis_custom_body_class":"","_genesis_custom_post_class":"","_genesis_layout":"","footnotes":""},"categories":[1],"tags":[],"class_list":{"0":"post-4459","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-uncategorized","8":"entry"},"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v24.4 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>COGS Part II \u2013 Overhead Allocation under GAAP\u00a0 - FIVE x 5\u00ae<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/fx5.com\/en-au\/cogs-part-ii-overhead-allocation-under-gaap\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"COGS Part II \u2013 Overhead Allocation under GAAP\u00a0 - FIVE x 5\u00ae\" \/>\n<meta property=\"og:description\" content=\"For some important background, make sure you\u2019ve read the first blog post in this series, COGS \u2013 Why You Should Care and How to Track It.\u00a0 This post\u2019s intended audience is distillery management and accountants\/CFOs\/controllers.&nbsp;&nbsp; First and foremost, we should define the goal of this exercise. 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