Chapter1Chapter1Chapter1Chapter1

ACCOUNTING FOR ACCOUNTING FOR MANUFACTURING MANUFACTURING

OPERATIONOPERATION

• OBJECTIVES

• Environment for Manufacturing Operation

• Manufacturing Cost Concept• Product Cost v. Period Cost

• Deal With Firms Which Are Manufacturers

• A Manufacturing A/C Is Prepared In Addition To The Trading And Income Statement Accounts

MegaLoMart

Comparing Merchandising and Manufacturing

ActivitiesMerchandisers . . .

– Buy finished goods.

– Sell finished goods.

Manufacturers . . .– Buy raw materials.– Produce and sell

finished goods.

Manufacturing Cost Concepts

Financial Accounting

Cost is a measure of resources used or

given up to achieve a stated purpose.

Managerial Accounting

Product costs are the costs a company assigns to units

produced.

Comparing Financial Accounting and Management

Accounting

MANAGERIAL COST CONCEPTS

MANAGERIAL COST CONCEPTS

• Manufacturing consists of activities and processes that convert raw materials into finished goods.

Direct Costs and Indirect Costs

Direct costs

• Costs that can beeasily and conveniently traced to a unit of product or other cost objective.

• Examples: – Direct material

– Direct labor

Indirect costs• Costs cannot be

easily and conveniently traced to a unit of product or other cost object.

• Example: Manufacturing overhead

Manufacturing costs• Manufacturing costs are

usually classified as follows: 1. Direct materials, 2. Direct labor, and 3. Manufacturing overhead.

The ProductThe Product

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

Manufacturing Costs

Direct Materials

Raw materials are the basic materials and parts that are to be used in the manufacturing process.

Raw materials that can be physically and directly associated with the finished product during the manufacturing process are called direct materials.

Example: A radio installed in an automobileExample: A radio installed in an automobile

Direct Labor

Direct labor is the work of factory employees that can be physically and directly associated with converting raw materials into finished goods.

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers

Manufacturing costs that cannot be traced directly to specific units produced.

Manufacturing/factory overhead consists of costs that are indirectly associated with the manufacture of the finished product.

Manufacturing/Factory Overheads

Examples: Indirect labor and indirect materialsExamples: Indirect labor and indirect materials

Wages paid to employees who are not directly

involved in production work.

Examples: maintenance workers, janitors and

security guards.

Materials used to support the production process.

Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Overhead

Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the

finished product.

These costs may also be manufacturing costs that cannot be classified as direct materials or direct labor.

Manufacturing overhead includes1 indirect materials;2 indirect labor;3 depreciation on factory buildings and machines4 insurance, taxes, and maintenance on

factory facilities.

• Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section.

COST OF GOODS SOLD COMPONENTS

COST OF GOODS SOLD COMPONENTS

Cost of Goods Sold

Manufacturer

Merchandiser

Beginning Merchandise

Inventory

Beginning Finished Goods

Inventory

Ending Merchandise

Inventory

Ending Finished Goods

Inventory

Cost of Goods Purchased

Cost of Goods Manufactured

+

+ -

-

=

=

ILLUSTRATION COST OF GOODS SOLD

COMPONENTS

ILLUSTRATION COST OF GOODS SOLD

COMPONENTS

COST OF GOODs SOLD STATEMENT

• Direct materials:• Beginning Materials inventory xxx• Purchases xxx• less purchases returns and allowances xxx xxx• Materials available for use xxx• less ending materials inventory xxx• direct materials consumed xxx

• Direct labor xxx

• Factory overhead• Indirect labor xxx• Salaries xxx• Payroll taxes xxx• Power xxx• Heat xxx• Light xxx

• Factory supplies xxx• Depreciation-factory building xxx • Depreciation – machinery xxx• Repairs and maintenance xxx• Patent xxx• Tools and dies used xxx• Insurance xxx• Total factory overhead cost xxx• Total manufacturing cost xxx

• Total manufacturing cost xxx• Add beginning work in process inventory xxx• xxx• less ending work in process inventory xxx • Cost of goods manufactured

xxx• Add beginning finished goods inventory xxx• Cost of goods available for sale xxx• less ending finished goods inventory xxx• Cost of goods sold xxx

Evaluating annual results to orient the outsiders

• Current ratio• Acid – test ratio• Income before income tax as a %

os sales• Net income as a % of sales• Gross profit as a % of sales• Rate of return on capital

employed

Evaluating annual results to orient the insider

• Cost of goods manufactured/units manufactured

• Cost of beginning finished goods inventory/units in beginning finished goods inventory

• Cost of ending finished goods inventory/units in ending finished goods inventory

• Cost of goods sold/units sold

Nonmanufacturing Costs

a) Administration / Operating costs

a) Marketing and selling costs

ADMINISTRATION EXPENSES

All executive, organizational,

and clerical costs. Examples:

- managers’ salaries

- legal and accountancy

charges

- depreciation of accounting

machinery & secretarial

salaries

SELLING AND DISTRIBUTION EXPENSES

Costs necessary to get the order and deliver the

product. Examples: - Sales staff’s - Salaries & commission - Carriage outwards - Depreciation of delivery vans - Advertising expenses

PRODUCT COSTSPRODUCT COSTS

Costs that are a necessary and integral part of

producing the finished product.include each of the manufacturing cost elements

(direct materials, direct labor, and

manufacturing overhead)These costs are not expensed to cost of goods

sold under the matching principle until the

finished goods inventory is sold.

PRODUCT COSTS (Cont…)

Direct materials and direct labor are often referred to as prime costs due to their direct association with the manufacturing of the finished product.

Direct labor and manufacturing overhead are often referred to as conversion costs since they are incurred in converting raw materials into

finished goods.

Classifications of Costs

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

PrimeCost

ConversionCost

Manufacturing costs are oftencombined as follows:

PERIOD COSTS

a) are identifiable with a specific time period,

b) relates to nonmanufacturing

non-inventoriable costs, and

c) include selling and administrative expenses.

ILLUSTRATION: PRODUCT VERSUS PERIOD COSTS

ILLUSTRATION: PRODUCT VERSUS PERIOD COSTS

Prime Costs

Conversion Costs

Product Costs

Direct Materials

Direct Labor

Manufacturing Overhead

Period Costs

Selling Expenses

Administrative Expenses

{{{Manufacturing

Costs

{Nonmanufacturing Costs

VARIABLE FACTORY OVERHEADS• Supplies• Fuel• Power• Small tools• Spoilage, salvage and reclamation

expenses• Receiving costs• Hauling within plant• Royalties• Communication costs• Overtime premium

FIXED FACTORY OVERHEADS

• Salaries of production executives• Depreciation• Property tax• Patent amortization• Wages of security guards and fire

fighters• Maintenance and repairs of

building and grounds• Insurance- property and liability

SEMI VARIABLE FACTORY OVERHEADS

• Supervision• Inspection• Payroll department services• Personnel department services• Factory office services• Materials and inventory services• Cost department services• Maintenance and repairs of machinery and

equipment• Compensation insurance• Health and accident insurance• Payroll taxes• Industrial relations and employees’ welfare expenses• Heat, light and power

Controllable and Uncontrollable costs

• Controllable costs:• Costs that can be controlled or heavily

influenced by the manager.

• Uncontrollable costs:• Costs that a manager cannot influence

significantly.

Manufacturing operations and Manufacturing Costs

• Job Shop:• Low production volume; little standardization; one

of a kind product.

• Batch: • Multiple products; low volume

• Assembly line: • A few major products; higher volume.• Mass customization:• Higher production volume; many standardized

components ; customized components of components.

• Continuous flow:• Higher production volume; highly standardized

commodity products.

More cost classifications

• Opportunity costs:• Is defined as a benefit that is sacrificed when the choice

of one action preludes taking an alternative course of action.

• Out of pocket costs:• Costs that require payment of cash or other assets as a

result of their incurrence.

• Sunk costs:• Costs that have been incurred in the past. • They do not affect future costs and cannot be changed

by any current or future action.• Irrelevant to all future decisions.

More cost classifications

• Differential costs:• It is the amount by which the cost differs under two

alternative actions.

• Incremental costs:• The increase in cost from one alternative to another.

• Marginal costs:• Additional costs incurred when an additional unit is

produced.

• Average costs:• It is the total cost for whatever quantity is

manufactured, divided by the number of units manufactured.

• Standard costs:• Pre determined costs for direct materials, direct

labor and factory overhead. • They are established by using information

accumulated from past experience and data secured from research studies.