HBC 220 – Topic 9

Accounting for Manufacturing

Learning Objectives

1. Distinguish between costs and expenses, and understand how different costs are used for different purposes

2. Define and identify the 3 manufacturing cost elements — direct materials, direct labour and factory overhead

Learning Objectives (cont’d)

3. Explain the basic nature of absorption costing and a cost allocation based on cost behaviour

• Identify the essential differences in the financial statements for retail and manufacturing entities

Learning Objectives (cont’d)

5. Describe the additional accounts and accounting procedures required for a manufacturing entity.

• Understand how a manager can use the financial reports for a manufacturing entity for control and decision making

Learning Objectives

7. Explain the nature of cost accounting

8. Describe the flow of costs in a job order cost accounting system

9. Explain the accounting procedures used in job order cost systems

Learning Objectives (cont’d)

10.Understand how costing and cost accounting are applied in service businesses

11.Understand the basic principles of a just-in-time processing system

Lecture References

• Hoggett, Edwards & Medlin, 6th edition, Chapter 8, 9

Cost Classifications LO. 1

• Cost– Economic sacrifice of resources made in

exchange for a product or service

• Expense– Consumption or loss of resources

Manufacturing Cost Elements LO. 2

• Direct materials cost• Direct labour cost• Factory overhead cost

– Allocation of common costs– Assignment of service department costs– Assignment of factory overhead costs

Absorption Costing and Cost Behaviour LO. 3

• Absorption costing– All direct manufacturing costs treated as

product costs

• Direct costing– Recognises as product costs only manufacturing

costs that vary in relation to production levels

Absorption Costing and Cost Behaviour (cont’d)

• Variable costs– Costs which vary directly, or nearly directly,

with the volume of production

• Fixed costs– Costs which remain relatively constant

regardless of the production level

Financial Statements – Retailing and Manufacturing LO. 4

Cost of SalesRetailing

Beginning + Net purchases – Ending = Cost ofInventory of inventory Inventory goods sold Beginning + Net purchases – Ending = Cost ofInventory of inventory Inventory goods sold

Manufacturing

Beg. finished + Cost of goods – End. finished = Cost ofgoods inventory manufactured goods inventory goods

sold

Beg. finished + Cost of goods – End. finished = Cost ofgoods inventory manufactured goods inventory goods

sold

A Retail EntityIncome Statement

Net Sales Revenue $1 000 000Less: Cost of salesBeginning inventory $ 150 000 Net purchases 710 000Goods available 860 000Ending inventory 160 000Cost of sales 700 000GROSS PROFIT 300 000EXPENSES Selling & distribution 90 000 Administrative 120 000 Finance & other 20 000 230 000NET PROFIT BEFORE TAX 70 000 Income tax expense 28 000PROFIT $ 42 000

A Retail EntityIncome Statement

Net Sales Revenue $1 000 000Less: Cost of salesBeginning inventory $ 150 000 Net purchases 710 000Goods available 860 000Ending inventory 160 000Cost of sales 700 000GROSS PROFIT 300 000EXPENSES Selling & distribution 90 000 Administrative 120 000 Finance & other 20 000 230 000NET PROFIT BEFORE TAX 70 000 Income tax expense 28 000PROFIT $ 42 000

A Manufacturing EntityIncome Statement

Net Sales Revenue $1 000 000Less: Cost of salesBeginning finished goods inventory $150 000 Cost of goods manufactured 710 000Goods available 860 000Ending finished goods inventory 160 000Cost of sales 700 000GROSS PROFIT 300 000EXPENSES Selling & distribution 90 000 Administrative 120 000 Finance & other 20 000 230 000NET PROFIT BEFORE TAX 70 000 Income tax expense 28 000PROFIT $42 000

A Manufacturing EntityIncome Statement

Net Sales Revenue $1 000 000Less: Cost of salesBeginning finished goods inventory $150 000 Cost of goods manufactured 710 000Goods available 860 000Ending finished goods inventory 160 000Cost of sales 700 000GROSS PROFIT 300 000EXPENSES Selling & distribution 90 000 Administrative 120 000 Finance & other 20 000 230 000NET PROFIT BEFORE TAX 70 000 Income tax expense 28 000PROFIT $42 000

A Manufacturing EntityCost of Goods Manufactured Statement

Direct materials:Beginning raw materials $48 000Net purchases of raw materials 141 000

189 000Ending raw materials 47 000

Direct materials used $142 000Direct labour 355 000Factory overhead:

Indirect labour 56 000Supplies 5 000Electricity 42 000Rent 22 600Insurance 18 000Rates & taxes 28 400Depreciation 32 000Miscellaneous 4 000Total factory overhead 208 000

Manufacturing costs for the period 705 000Beginning work in progress 35 000Total work in progress 740 000Ending work in progress 30 000COST OF GOODS MANUFACTURED $710 000

A Manufacturing EntityCost of Goods Manufactured Statement

Direct materials:Beginning raw materials $48 000Net purchases of raw materials 141 000

189 000Ending raw materials 47 000

Direct materials used $142 000Direct labour 355 000Factory overhead:

Indirect labour 56 000Supplies 5 000Electricity 42 000Rent 22 600Insurance 18 000Rates & taxes 28 400Depreciation 32 000Miscellaneous 4 000Total factory overhead 208 000

Manufacturing costs for the period 705 000Beginning work in progress 35 000Total work in progress 740 000Ending work in progress 30 000COST OF GOODS MANUFACTURED $710 000

Balance Sheetas at 30 June 2006

A Retail Entity

CURRENT ASSETSCash at bank $50 000A/C’s receivable 100 000Inventories* 237 000Other 50 000TOTAL CURRENT ASSETS $437 000

* All finished goods

A Retail Entity

CURRENT ASSETSCash at bank $50 000A/C’s receivable 100 000Inventories* 237 000Other 50 000TOTAL CURRENT ASSETS $437 000

* All finished goods

A Manufacturing Entity

CURRENT ASSETSCash at bank $50 000A/C;s receivable 100 000Inventories: Finished goods 160 000 Work in progress 30 000 Raw materials 47 000Other 50 000TOTAL CURRENT ASSETS $437 000

A Manufacturing Entity

CURRENT ASSETSCash at bank $50 000A/C;s receivable 100 000Inventories: Finished goods 160 000 Work in progress 30 000 Raw materials 47 000Other 50 000TOTAL CURRENT ASSETS $437 000

Accounting Systems Considerations LO. 5

• Periodic inventory system – Additional accounts required

• Raw materials inventory• Raw materials purchases• WIP inventory• Finished goods inventory• Manufacturing plant and equipment

Accounting Systems Considerations (cont’d)

• Periodic inventory system – Additional accounts required

• Factory payroll

• Factory overhead

• Manufacturing summary

– Worksheets• Additional two columns required to record

manufacturing data

Accounting Systems Considerations (cont’d)

• Closing entries– Account balance used to determine cost of goods

manufactured closed to ‘Manufacturing Summary’ account

– Manufacturing summary closed to Profit and Loss Summary account

Accounting Systems Considerations (cont’d)

• Valuation of inventories– All three types of inventory valued at the end of

the accounting period– Raw materials and finished goods

• Inventory counted and costed

– Work in process• Judgement required, usually an educated guess.

Management Analysis LO. 6

Inventories

Raw materials turnover ratio = Cost of raw materials used Average raw materials inventory

Raw materials turnover ratio = Cost of raw materials used Average raw materials inventory

Control of costs

Cost of raw materials ratio = Direct materials cost Cost of goods manufactured Cost of raw materials ratio = Direct materials cost Cost of goods manufactured

Cost Accounting LO. 7

• Cost information recorded in separate ledger accounts– Product costs used to value WIP and finished

goods– Facilitates management decisions

• Non-manufacturing entities– Used to determine cost of services

Cost Accounting (cont’d)

• Two types of cost accounting systems• Job order costing

– Used when items produced can be separately identified

• Process costing– Products manufactured on a continuous basis

• Cost accounting in non-manufacturing entities

Job Order Costing LO. 8

• Costs assigned to each job• Requires well defined beginning and

completion time• Can be used for a single product• Needs a perpetual inventory system

Job Order Costing (cont’d)

• Cost flows in a job order system– Inventory controlled via general ledger control

accounts and subsidiary ledgers– Productions costs:

• Recorded• Assigned to production (WIP)• Assigned to finished goods when job completed

Job Order Costing (cont’d)

• Job cost order• Control account

– Itemised listing of production costs:• materials• labour• overhead

– Serves as a subsidiary ledger– Control number assigned to each job started

Job Order Costing Procedures LO. 9

• Accounting for materials– materials requisition

Date Raw Material Inventory 42 500GST Outlays 4 250Accounts Payable 46 750

to record raw materials purchased

Date Raw Material Inventory 42 500GST Outlays 4 250Accounts Payable 46 750

to record raw materials purchased

Date WIP Inventory 36 550Factory Overhead 1 680

Raw Material Inventory 38 230to record raw materials requisitioned

Date WIP Inventory 36 550Factory Overhead 1 680

Raw Material Inventory 38 230to record raw materials requisitioned

Job Order Costing Procedures (cont’d)

• Accounting for labour

Date General Wages & Salaries 51 800Factory Wages & Salaries 42 200

Deductions (various) 30 000Wages Payable 70 000

to record payroll for January

Date General Wages & Salaries 51 800Factory Wages & Salaries 42 200

Deductions (various) 30 000Wages Payable 70 000

to record payroll for January

Date WIP Inventory 42 000Factory Overhead 6 200

Factory Wages & Salaries 48 200to assign direct and indirect labour

Date WIP Inventory 42 000Factory Overhead 6 200

Factory Wages & Salaries 48 200to assign direct and indirect labour

Job Order Costing Procedures (cont’d)

• Accounting for factory overhead– predetermined overhead rate

Predetermined = Estimated annual factory overhead costoverhead rate Estimated annual level of production activity

Predetermined = Estimated annual factory overhead costoverhead rate Estimated annual level of production activity

Date WIP Inventory XXFactory Overhead Applied XX

to record factory overhead applied

Date WIP Inventory XXFactory Overhead Applied XX

to record factory overhead applied

Job Order Costing Procedures (cont’d)

• Over/under-applied overhead

Date Factory Overhead Applied XXFactory Overhead XX

to transfer overhead applied to overhead a/c

Date Factory Overhead Applied XXFactory Overhead XX

to transfer overhead applied to overhead a/c

Date Factory Overhead XX Factory Overhead Under/Over-applied XX

to transfer over-applied overhead

Date Factory Overhead XX Factory Overhead Under/Over-applied XX

to transfer over-applied overhead

Date Cost of Goods Sold XXFactory Overhead Under/Over-applied XX

to transfer under-applied overhead to COGS

Date Cost of Goods Sold XXFactory Overhead Under/Over-applied XX

to transfer under-applied overhead to COGS

Job Order Costing Procedures (cont’d)

• Limitation of direct labour as a cost driver• Accounting for the completion of the job

Date Finished Goods Inventory XXWIP Inventory XX

to record the completion of job XYZ and transfer to finished goods

Date Finished Goods Inventory XXWIP Inventory XX

to record the completion of job XYZ and transfer to finished goods

Job Order Costing Procedures (cont’d)

• Accounting for the sale of a job

Date Accounts Receivable XXSales XXGST Collections X

to record the sale of job XYZ

Date Accounts Receivable XXSales XXGST Collections X

to record the sale of job XYZ

Date Cost of Goods Sold XXFinished Goods Inventory XX

to record the cost of sale of job XYZ

Date Cost of Goods Sold XXFinished Goods Inventory XX

to record the cost of sale of job XYZ

Cost Accounting in Service Entities LO. 10

• Cost information needed to prepare budgets, determine fees and analyse profitability

• Developing cost application rules– Direct labour costs– General overheads

• Assigning costs to jobs and setting a price

Just-in-time Processing LO. 11

• Eliminates holding excess inventory• Materials arrive just as needed and go

straight into production• Finished goods shipped straight to

customers on completion• Highly automated• Little margin for error