Central Luzon State University

Science City of Muñoz 3120

Nueva Ecija, Philippines

Instructional Module for the Course

ACCTG 1103 Accounting for Manufacturing Operations

Lesson 01 BASIC ACCOUNTING FOR MANUFACTURING OPERATIONS

Objectives
After studying this material, you should be able to:
1. Describe the operations of manufacturing companies.
2. Explain the nature of production, manufacturing and administrative costs of manufacturing
entities.
3. Understand the nature of inventories of a manufacturing business.
4. Explain the flow of costs in a manufacturing business.
5. Explain the elements of production costs, namely, direct materials, direct labor and factory
overhead.
6. Understand the basic accounting procedures for production costs.
7. Prepare the statement of cost of goods manufactured and cost of goods sold.
8. Prepare and explain the statement of income of a manufacturing company.

II. Learning Activities

Nature of Manufacturing Operations

A merchandising or trading concern buys its goods ready for resale. It then sells these goods above cost in
order to earn a profit. A manufacturing firm, on the other hand, buys raw materials and converts them into
finished products through formal conversion cycle operations. Finished goods are in turn sold to merchandise
or directly to consumers. This conversion cycle is not observable and formal in service and trading
establishments.

A manufacturing firm is therefore involved in three main activities:

(1) Purchase of raw materials

(2) Conversion of raw materials into a finished product and
(3) Sale of the finished product to the customers

Production, Marketing and Administrative Costs

In the course of a manufacturing firm's operation, costs are incurred. All fall into one of three general
classifications: production, marketing, and administrative. Production cost includes the direct material,
direct labor, and factory overhead incurred to produce a good or service. Product engineering and design
costs occurring before manufacturing are also, production costs.
 ACCTG 1103 | Accounting for Manufacturing

Marketing costs result from selling and delivering products and include the costs of promoting sales and
retaining customers, as well as transportation, warehousing, and other distribution costs.

Administrative costs result from directing and controlling the company and for general activities such as
personnel and legal functions. They include management and financial accounting salaries, clerical
telephone and telex costs, and rental fees. Both production and marketing functions incur administrative
costs.
Even though production costs are generally treated as product costs and included in either work in process
or finished goods inventories, marketing and administrative costs are generally treated as period costs.
Period costs are charged against revenue in each accounting period. Product costs do not become the cost
of sales charged against revenue until the sales of the product on which costs were incurred.

Inventories of a Manufacturing Company

A manufacturing company converts materials into finished goods and generally has four inventory accounts,
namely
Direct Materials Inventory
Work in Process Inventory
Finished Goods Inventory
Factory Supplies Inventory
Direct materials inventory shows the cost of raw
material on hand available for processing which will become a part of the finished product.

A work in process inventory shows the production cost of partially completed or semi-finished units. Goods
m process inventory is another name for this inventory.

Finished goods inventory shows the cost of completed goods available for sale. A finished product is sold
1) to another manufacturer, who further refuses it or uses it as a component of a product
2) to a wholesaler or retailer for resale, or
3) directly to the final consumer.
Factory supplies inventory represents the supplies to be used in production, packaging of finished product,
factory maintenance, repairs and cleaning and others.

Elements of Production Costs

Production cost includes three elements that are incurred to produce a good or service. These are
1. Direct materials,
2. Direct labor, and
3. Factory overhead or Manufacturing expense
Direct Materials
Direct materials are any raw materials that become a part of and can easily be traced to the finished products.
For example, in manufacturing men's shirts, the fabric is direct material. Accountants separately record and
trace all direct materials required in manufacturing to specific products. Companies buy direct materials in
various forms. They buy some direct material in a finished state and assemble the component parts into their
final product.

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 ACCTG 1103 | Accounting for Manufacturing

In the manufacture of television sets, companies often purchase electronic components, cabinets, and TV
tubes. Workers assemble these into finished appliances. Sugar processors, for instance, cut and cook raw
sugar cane before it becomes a finished product. There are other materials needed in the manufacturing
operations, but they either do not become a part of the product or are of such an insignificant nature that it
would be impractical to change them directly to the finished product. These are the indirect materials which
are a part of the manufacturing expenses such as sandpaper, glue, thread and nails.

Direct Labor
Direct labor costs are the wages paid to the workers who transform the material from its raw state to a finished
product. For example, the wages paid to shirt factory workers who cut fabric and sew the pieces are direct
labor costs. Only the wages earned by those workers involved in the physical manufacture of the product are
direct labor costs.

Factory Overhead
Factory overhead also called manufacturing expenses include all production other than direct material and
direct labor. These costs benefit production as a whole and cannot be traced generally to any specific product.
The common manufacturing expense accounts include

Indirect Materials Tools Used

Indirect Labor Workmen's Compensation Insurance
Superintendence Depreciation of Factory Building
Factory Supplies Expense Depreciation of Machinery and Equipment
Patents Amortization Property Taxes on Factory, Property, Plant and
Factory Insurance Expense Equipment
Factory Repairs and Maintenance Power

In addition to indirect material and indirect labor, factory overhead includes such costs as rent, taxes,
insurance, and depreciation on manufacturing facilities. Factory overhead also includes other occupancy
costs such as light, heat, and power used in manufacturing facilities.

Basic Accounting for Production Costs

Accounting for Direct Materials

The raw materials purchased by a manufacturing concern are recorded in the same manner a merchandise
purchases of a merchandising business.

To illustrate, assume that Greco Manufacturing Company completed the following regarding raw materials.
a) Purchased raw materials from Atlas Supplies, P50,000, terms, n/30.
b) Raw materials used in actual production amounted to 30,000.
The journal entries for the above transactions follow:
Date Raw Materials Inventory or Purchases P 50,000
Cash or Accounts Payable P50,000
To record the purchase

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 ACCTG 1103 | Accounting for Manufacturing

Date Work in Process Inventory P 30,000

Raw Materials Inventory P30,000
To record the use of Raw Materials

Accounting for Direct Labor

a) The direct labor incurred is recorded as follows:
Date Direct Labor P XX
Withholding Taxes Payable PXX
Payroll Payable PXX
To record the direct labor incurred

b) To record the application of Direct Labor to production; the entry is

Date Work in Process Inventory P XX
Direct Labor PXX
To record the application of Direct Labor to production

Accounting for Factory Overhead

a) When factory overhead or manufacturing expense is incurred, the accountant makes the
following entry:
Date Factory Overhead (e.g., Indirect Materials, Rent, Insurance) P XX
Cash or Accounts Payable PXX
To record factory overhead or manufacturing expense is incurred
b) To record the application of overhead to production, the entry is
Date Work in Process Inventory P XX
Applied Factory Overhead PXX
To record the application of overhead to production

When production is completed, the accountant makes the following entry:

Date Finished Goods Inventory P XX
Work in Process Inventory PXX
To record the completion of finished goods

When finished goods are sold, the entry is

Date Cost of Sales or Cost of Goods Sold P XX
Finished Goods Inventory PXX
To record the sale of finished goods

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 ACCTG 1103 | Accounting for Manufacturing

Flow of Costs in a Manufacturing Company

The most complex cost classification systems are found in manufacturing organizations, where a special
statement must be prepared to determine the cost of goods sold.
Figure 1.0 below shows the basic flow of costs in a manufacturing company.

Case 1. Statement of Income of a Manufacturing Concern

Table 1.0 Statement of Profit or Loss

KRISTINE CELINE MANUFACTURING COMPANY

Statement of Profit or Loss
For the Year Ended December 31, 2022

Net sales ₱ 299,500.00

Less: Cost of goods sold:
Finished goods inventory, Jan. 1 ₱ 180,000.00
add: Cost of goods manufactured ₱ 130,500.00
Cost of goods available for sale ₱ 310,500.00
less: Finished goods inventory, Dec. 1 ₱ 114,000.00
Cost of goods sold ₱ 196,500.00
Gross margin ₱ 103,000.00
Marketing and administrative expense
less: Marketing expense ₱ 38,000.00
Administrative expense ₱ 35,000.00 ₱ 73,000.00
Income before Tax ₱ 30,000.00
less: Income Tax ₱ 10,000.00
Net Income ₱ 20,000.00

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Table 2.0 Cost of Goods Manufactured

KRISTINE CELINE MANUFACTURING COMPANY

Cost of Goods Manufactured
For the Year Ended December 31, 2022
Direct materials used:
Direct materials inventory, Jan 1 ₱ 16,000.00
add: Net material purchases ₱ 55,000.00
Direct materials available for use ₱ 71,000.00
less: Direct materials inventory, Dec 31 ₱ 32,000.00 ₱ 39,000.00
Direct Labor ₱ 10,000.00
Factory overhead costs:
Indirect materials used
Factory supplies, Jan 1 ₱ 4,000.00
add: Purchases ₱ 7,000.00
Factory Supplies available for use ₱ 11,000.00
less: Factory supplies, Dec 31 ₱ 6,000.00
Indirect materials used ₱ 5,000.00
Indirect labor ₱ 33,000.00
Depreciation ₱ 28,000.00
Insurance ₱ 3,000.00
Taxes ₱ 2,500.00
Miscellaneous ₱ 1,000.00 ₱ 72,500.00
Total Manufacturing Cost for the Period ₱ 121,500.00
add: Work in process inventory, Jan 1 ₱ 40,000.00
Total Cost of Goods Placed in Process ₱ 161,500.00
less: Work in process inventory, Dec 31 ₱ 31,000.00
Cost of Goods Manufactured ₱ 130,500.00

Table 1.0 illustrates a statement of income for a manufacturer. The income statement picks up the cost of
goods manufactured shown in Table 2.0 and adds the cost to the beginning balance in finished goods
inventory to arrive at the cost of goods available for sale. Some units remain unsold, since there is an ending
balance in the finished goods inventory. The Finished Goods Inventory ending balance on December 31,
2022, is deducted from the cost of goods available for sale to determine the Cost of Goods Sold. Subtracting
Cost of Goods Sold from Sales yields gross margin. Accountants deduct marketing and administrative
expenses from gross margin to arrive at income before taxes. Net income results from then deducting income
taxes. The manufacturer's statement of income and cost of goods manufactured can be combined into one
statement, but such a statement may be long and somewhat difficult to read. In practice, accountants often
report only the cost of goods sold and not the cost of goods manufactured on the statement of income.

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Case 2. Statement of Cost of Goods Manufactured and Sold

Lily & Chloe Manufacturing Company's net sales for the year ended October 31, 2022 was P345,000 with a
gross margin of P 19,000. Ending inventory for work in process was 60 percent of beginning work in process
inventory. Factory overhead applied was 25 percent of direct labor cost. Total current manufacturing cost
was P300,000.
A count at year-end showed the following balances in ending inventory on October 31, 2022:

Direct Materials ₱ 18,000.00

Work in Process ?
Finished Goods ₱ 70,000.00

An analysis of the records showed the following data:

Net direct material purchases ₱ 50,000.00

Beginning inventories on November 1, 2021:

Direct Materials ₱ 15,000.00
Work in Process ?
Finished Goods ₱ 90,000.00

Required:
Prepare a combined statement of cost of goods manufactured and partial income statement for the year
ended October 31, 2022.

Lily & Chloe Manufacturing Company

Statement of Cost of Goods Manufactured and Partial Income Statement
For the Year Ended October 31, 2022

Net Sales ₱ 345,000.00

Cost of Goods Sold
Direct materials inventory, Nov. 1 2021 ₱ 15,000.00
add: Purchases of direct material ₱ 50,000.00
Direct materials available for use ₱ 65,000.00
less: Direct materials inventory, Oct. 31 2022 ₱ 18,000.00
Direct materials used ₱ 47,000.00
Direct Labor ₱ 202,400.00
Factory overhead ₱ 50,600.00
Total Manufacturing Cost ₱ 300,000.00

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 ACCTG 1103 | Accounting for Manufacturing

add: Work in process inventory, Nov 1 2021 ₱ 15,000.00

Total Cost of Goods Placed in Process ₱ 315,000.00

less: Work in process inventory, Oct 31 2022 ₱ 9,000.00
Cost of Goods Manufactured ₱ 306,000.00
add: Finished goods inventory, Nov. 1 2021 ₱ 90,000.00
Cost of goods available for sale ₱ 396,000.00
less: Finished goods inventory, Oct. 31 2022 ₱ 70,000.00
Cost of goods sold ₱ 326,000.00
Gross Margin ₱ 19,000.00

Manufacturing companies should establish a cost accounting system to make the accounting reports more
useful and responsive to the needs of management particularly for planning, control and decision-making
purposes. This is explained fully in cost accounting courses.

Review Questions
1. Compare the financial statements of a merchandising company with those of a manufacturing
concern.
2. What are the three elements of manufacturing costs? Briefly explain each.
3. Describe the four inventory accounts which are found in the balance sheet of a manufacturing
concern.
4. How is the cost of goods sold of a manufacturing company determined?
5. How would the following errors in the financial statements of a manufacturing firm affect the cost of
goods manufactured and the net income for the period?
a. overstatement of finished goods inventory at the end of the period
b. understatement of goods in process inventory at the beginning of the period
c. overstatement of factory overhead
d. understatement of raw materials inventory at the end
e. understatement of depreciation of machinery
f. overstatement of commission expense
g. understatement of advertising expense
6. Which of the following expenditures would be classified as factory overhead?
a. Freight or raw materials purchased
b. Factory rent
c. Direct labor

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References

Aliling, L. E., & Anastacio, M. L. (2015). Management Accounting 1. Manila: Rex Books
Store.
Drury, C. (2014). Management and Cost Accounting. Cengage Learning Asia Pte Ltd.

Flores, M. O. (2016). Integrated Cost Accounting - Principles and Applications. Quezon

City: Rex Printing Company Inc.

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