Accounting Systems for Manufacturing Businesses

Chapter 10

Cost Classifications for Manufacturers Direct materials

Cost of materials that become part of the finished product

Direct labor Cost of labor that is directly involved with

converting materials into finished products

Cost Classifications for Manufacturers Overhead

All other costs involved in converting materials into finished products Indirectly related to the product

Indirect materials, indirect labor, utilities, depreciation, property taxes, plant manager’s salary, maintenance, etc.

Conversion costs Direct labor plus overhead

Cost Classifications for Manufacturers Product costs

Direct materials, direct labor and overhead Closely related to the manufacturing of the

product Asset (inventory) until the product is sold

Period costs More closely related to time periods than to the

product Expense when incurred

Inventories in a Manufacturing environment Raw materials inventory

Materials or components which have not yet been placed into production

Work in process inventory Partially completed goods Includes material, labor and overhead cost

Finished goods inventory Completed goods ready for sale Similar to the merchandise inventory of a retailer

Types of Accounting Systems for Manufacturing Operations Job order system

Costs are accumulated for each job Used for custom goods for specific customers or

when a variety of goods are produced for stock Process cost system

Costs are accumulated for each time period, then allocated to the units produced during the time period

Used for continuous production process of identical goods

The Flow of Goods and Costs Through a Manufacturing System

Materials are Raw Materials placed Work in Goods are Finished Goods Cost ofpurchased materials in production process completed goods are sold goods sold

inventory inventory inventory (expense)

Labor

Overhead

The Flow of Goods and Costs Through a Manufacturing System Purchases of materials

Raw material inventory is increased

Materials are placed into production Raw materials inventory is decreased

Work in process inventory is increased

Labor and overhead costs are incurred Work in process inventory is increased

The Flow of Goods and Costs Through a Manufacturing System Goods are completed

Work in process inventory is decreased

Finished goods inventory is increased

Goods are sold Finished goods inventory is decreased

Cost of goods sold is increased

Cost of Goods Manufactured Statement Matches the flow of costs

Determine the total manufacturing costs for the period (inputs) Cost of materials used in production

Cost of labor

Cost of overhead

Determine the cost of goods manufactured (outputs) Beginning work in process + total manufacturing costs –

ending work in process

Cost of Goods Manufactured Statement

Beginning raw materials inventory 10,000$ Purchases of raw materials 182,000 Raw materials available for use 192,000$ Ending raw materials inventory 15,000 Raw materials used in production 177,000$

Direct labor 48,000 Overhead 116,000

Total manufacturing costs for the period 341,000$

Beginning work in process inventory 27,000 368,000$

Ending work in process inventory 25,000 Cost of goods manufactured 343,000$

Applying Overhead to Production Overhead is an indirect cost and cannot be

accurately related to individual jobs

Overhead is applied to jobs using a predetermined overhead rate

Total estimated overhead = rate per unitTotal estimated activity of activity

Amount of overhead applied is determined by the amount of activity consumed

Applying Overhead to Production The amount applied is an estimate

Any difference between the actual overhead cost and the amount applied is transferred to cost of goods sold If overhead is overapplied (too much was charged

to jobs), reduce cost of goods sold

If overhead is underapplied (not enough was charged to jobs), increase cost of goods sold

Applications to Service Industries The same concepts apply to service

industries except Probably no raw materials, although supplies may

be used

No finished goods inventory Services are performed on demand, and cannot be

stored for later sale

Costs move directly from work in process to cost of services provided (similar to cost of goods sold)

Activity-Based Costing

More refined method of applying overhead to production

Uses multiple application rates for more accurate charging of costs to products based on the demand those products place on the company’s resources Products and services consume activities, and

activities consume resources

Activity-Based Costing

Costs are accumulated in cost pools related to the major activities

A separate application rate is determined for each cost pool For example, cost per hour of inspection time,

cost per test performed, cost per pound of material moved, etc.

Costs are charged to products based on how much of the activity the product consumes