Accounting Systems for Manufacturing Businesses

1. Accounting Systems for Manufacturing Businesses Chapter 10

2. 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

3. 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

4. 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

5. 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

6. 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

7. The Flow of Goods and Costs Through a Manufacturing System

8. 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

9. 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

10. 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

11. Cost of Goods Manufactured Statement

12. 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 unit Total estimated activity of activity • Amount of overhead applied is determined by the amount of activity consumed

13. 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

14. 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)

15. 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

16. 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