Accounting for Manufacturing Business

CHAPTER FOUR
Accounting For Manufacturing Business

4.1. Characteristics of manufacturing business

The operations of a business can be classified as service, merchandising, and manufacturing. The
accounting for service and merchandising businesses has been described and illustrated in earlier
chapters.In this chapter we will try to see the accounting for manufacturing business.Manufacturing
business are types of business that generate revenue by producing product and sale to wholeseller or
retailer.
The main characteristics of manufacturing business that differ it from other type of business is the
activity to generate revenue. Rather than serving or purchase and resale good as of service giving and
merchandising business they get revenue by producing product and sales.

4.2. Classification of manufacturing costs

A cost is a payment of cash or the commitment to pay cash in the future for the purposeof generating
revenues. For example, cash (or credit) used to purchase equipmentis the cost of the equipment.
In managerial accounting, costs are classified according to the decision-making needs of management.
For example, costs are often classified by their relationship to a segment of operations, called a cost
object.
Costs identified with cost objects are:
I. Direct costs
II. Indirect costs.

I. Direct cost

Direct costs are identified with and can be traced to a cost object. The cost which is entirly related
whith cost object that mıght be tangeble or ıntangable is direct material cost
For example the cost of purchasing wood for an enterprise that engaged in producing office furniture
II Indirect cost
Are cost that are not directly related with cost object Costs that ıncured ın the process of gettıng
dırect materıal for use ın manufacturıng process ıs ındırect cost
For example the cost we ıncured ın suprıvısıon process of unıt cot object of manufacturıng process.

Manufacturing Costs
The cost of a manufactured product includes the cost of materials used in making theproduct. In
addition, the cost of a manufactured product includes the cost of converting the materials into a
finished product. For example, office furniture uses employees andmachines to convert wood (and
other supplies) into fınıshed furnıture.Thus, the cost of a finished guitar (the cost object) includes the
following:
1. Direct materials cost
2. Direct labor cost
3. Factory overhead cost
.

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Direct Materials Cost Manufactured products begin with raw materials that are converted into
finished products. The cost of any material that is an integral part of the finished product is classified
as a direct materials cost. office furniture, direct materials cost includes the cost of the wood used in
producingeach furnicure Other examples of direct materials costs include the cost of
electroniccomponents for a television, silicon wafers for microcomputer chips, and tires for an
automobile.

To be classified as a direct materials cost, the cost must be both of the following:
1. An integral part of the finished product
2. A significant portion of the total cost of the product.

Direct Labor Cost Most manufacturing processes use employees to convert materials into finished
products. The cost of employee wages that is an integral part of the finished product is classified as
direct labor cost.For office furniture, direct labor cost includes the wages of the employees who cut
each furniture out of raw lumberand assemble it.
Other examples of direct labor costs include mechanics’ wages for repairing an automobile, machine
operators’ wages for manufacturing tools, and assemblers’ wages for assembling a laptop computer.

Like a direct materials cost, a direct labor cost must be both of the following:
1. An integral part of the finished product
2. A significant portion of the total cost of the product

Factory Overhead Cost Costs other than direct materials cost and direct labor cost that are incurred
in the manufacturing process are combined and classified as factory overhead cost. Factory overhead
is sometimes called manufacturing overheador factory burden.
All factory overhead costs are indirect costs of the product. Some factory overhead costs include the
following:
1. Heating and lighting the factory
2. Repairing and maintaining factory equipment
3. Property taxes on factory buildings and land
4. Insurance on factory buildings
5. Depreciation on factory plant and equipment
Factory overhead cost also includes materials and labor costs that do not enter directly into the
finished product. Examples include the cost of oil used to lubricate machinery and the wages of
janitorial and supervisory employees. Also, if the costs of direct materials or direct labor are not a
significant portion of the total product cost, these costs may be classified as factory overhead costs.
For office equipment, the costs of guitar strings and janitorial wages are factory overhead costs.
Additional factory overhead costs of making furniture are as follows:
1. Sandpaper 4. Power (electricity) to run the machines
2. Buffing compound 5. Depreciation of the machines and building
3. Glue 6. Salaries of production supervisors
Prime Costs and Conversion Costs
Direct materials, direct labor, and factory overhead costs may be grouped together for analysis and
reporting. Two such common groupings are as follows:
1. Prime costs, which consist of direct materials and direct labor costs
2. Conversion costs, which consist of direct labor and factory overhead costs
Conversion costs are the costs of converting the materials into a finished product. Direct labor is both
a prime cost and a conversion cost

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For example

 cost includes the cost of the wood used in producing each furnicure and wages of the
employees who cut each furniture out of raw lumber and assemble it are prime cost for
furniture.
 wages of the employees who cut each furniture out of raw lumber and assemble it and all
listed factory over head cost are conversional costs of furniture

Product Costs and Period Costs For financial reporting purposes, costs are classified as product
costs or period costs.
1. Product costs consist of manufacturing costs: direct materials, direct labor, and factory overhead.
2. Period costs consist of selling and administrative expenses. Selling expenses are incurred in
marketing the product and delivering the product to customers.
Administrative expenses are incurred in managing the company and are not directly related to the
manufacturing or selling functions.

4.3 Product costing system

There are two types of cost accounting system those are Job order cost and process cost systems.

1) Job order costing

 costs are asignined for each job or batch

 a job may be for specific order or inventory
 A key feuture:
Each job or batch has its own distingushing characteristics
 The objective: to computebthe cost per per job
 Measures costs for each job completed – not for set time periods.
 Most of time companies that produce different products used this costing system
For example: componies advisable to use this Job order cost system are Debre Brihan textile
factory, GM furniture,

2) process cost system

 Used when a large volume of similar products are manufactured -

Cereal,authomobile, compact discs, paint
 Costs are accumulated for specific time period; a week or a month
 Costs are asigned to departments or processes for a set period of time
For example: companies advisable to use this process costing sytem are Kangaro foam,
meeta beera factory, ........ etc.
4.4Chart of accounts for a manufacturing business

Charts of account for manufacturing business is the same to that of servise giving business and
merchendising business ,the only diffence is on the following account.All the account listed below are
found only on the manufacturing business chars of account.

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Raw material inventory cost of good manufactured

Work in process inventory Finished goods inventoryetc

4.5 Recording the flow of costs through production process

The journal entries to record the cost flows and transactions for a process cost system are illustrated in this
section. As a basis for illustration, the July transactions for Nas foods plc. are used. To simplify, the entries are
shown in summary form, even though many of the transactions would be recorded daily.
A) purchased material:
İf material is purchased for production in such manner
Material...........................XXX
A/p or cash...............................XXX
For example
Nas food manufucturing plc Purchased materials, including milk, cream, sugar, packaging, and indirect materials
on account $ 88,000
Requered: record the journal entry for this transaction.
B) when the company takes some amount of material for production purpose we have the following journal
entry
WIP ......................................XXX
Material.......................................XXX
For example
Nas food manufacturing plc take an amount of $6,600 milk, sugar and cream for production purpose.
Requered: record the necessary journal entry
C) when the company incurred direct labor and factory over head cost during production process we have the
following transaction

WIP..................................XXX
Direct labour cost...................XXX
FOH cost.............................XXX
For example
Nas food manufacturing plcincurred Direct labour of 2400, machinery depriciation cost 400, supervisor sallary
expense $2000.
Requered: record the necessary journal entry
D) When the production process completed and become part of finished product we have the following
transaction
Finished goods inventory........................XXX
WIP...................................................................XXX
For example:
Nas food manufacturing plc produce $24,000 costed Nas biscutes
Requered: record the necessary journal entry
E)When finished product is sold to final customers or market brokers we have the following transaction.
When conpany used periodic inventory system
A/R or cash................................XXX
Sales.........................................XXX
When company used perpetual sytem
A/R or cash..............................XXX
Sales..........................................XXX
Cost of goods sold ......................XXX
Finished goods inventory...................XXX
For example
Nas food manufacturing plc sold $25,000 of Nas biscuts for Shamsu shop. The cost of goods sold is 20,000.
Required: record the necessary journal entry

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4.6 Financial statements for a manufacturing business

The owners equity statement and cash flow statements for a manufacturing business are similar
to those illustrated in earlier chapters for service and merchandising businesses.
However, the balance sheet and income statement for a manufacturing business are more complex.
This is because a manufacturer makes the products that it sells and, thus, must record and report
product costs. The reporting of product costs primarily affects the balance sheet and the income
statement.
Balance Sheet for a Manufacturing Business
A balance sheet is a list of all asset, liablity and owner equities accounts that used to show the
financial position of the company. The following accounts are resource of the company, so thy should
have to be included in the balance sheet of the manufacturing company.
1. Materials inventory (sometimes called raw materials inventory). This inventory consists of the
costs of the direct and indirect materials that have not entered the manufacturing process.
Examples for furniture: Wood, paint, glue, sandpaper
2. Work in process inventory. This inventory consists of the direct materials, direct labor, and
factory overhead costs for products that have entered the manufacturing process, but are not yet
completed (in process).
Example for furniture: Unfinished (partially assembled) furniture.
3. Finished goods inventory. This inventory consists of completed (or finished) products that have
not been sold.
Example: finished furniture that is not sold

Income Statement for a Manufacturing Company

The income statements for merchandising and manufacturing businesses differ primarily in the
reporting of the cost of merchandise (goods) available for sale and sold during the period.
A merchandising business purchases merchandise ready for resale to customers. The total cost of the
merchandise available for sale during the period is determined by adding the beginning merchandise
inventory to the net purchases. The cost ofmerchandise sold is determined by subtracting the ending
merchandise inventory from the cost of merchandise available for sale.
A manufacturer makes the products it sells, using direct materials, direct labor, and factory overhead.
The total cost of making products that are available for sale during the period is called the cost of
goods manufactured. The cost of finished goods availablefor sale is determined by adding the
beginning finished goods inventory to the cost of goods manufactured during the period. The cost of
goods sold is determined by subtracting the ending finished goods inventory from the cost of finished
goods available for sale.
Cost of goods manufactured is required to determine the cost of goods sold, and thus to prepare the
income statement. The cost of goods manufactured is often determined by preparing a statement of
cost of goods manufactured. This statement summarizes the cost of goods manufactured during the
period as shown below.

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Statement of Cost of Goods Manufactured

Begining work in process inventory ............................................................XXX

Direct material

Begining direct material ............................................XX

Purchase ....................................................................XX

Cost of materials available for use.............................XXX

Cost of ending material...............................................XX

Cost of material used.......................................................................XX

Direct labor cost .............................................................................XX

Factory over head cost ...................................................................XX

Total manufacturing cost incurred .....................................................................XX

Total manufacturing cost.................................................................................XXX

Ending work in process.............................................................................................XX

Cost of goods manufactured........................................................................................................XXX

To illustrate, the following data for Adot furniture are used:

Jan. 1, 2010 Dec. 31, 2010

Inventories:
Materials . . . . . . . . . . . . . . . . . . . . . . . . . birr 65,000 birr 35,000
Work in process . . . . . . . . . . . . . . . . . . . . . . 30,000 24,000
Finished goods . . . . . . . . . . . . . . . . . . . . . . ..60,000 62,500
Total inventories . . . . . . . . . . . . . . . . . . . . .birr 155,000 birr 121,500
Manufacturing costs incurred during 2010:
Materials purchased . . . . . . . . . . . . . . . . . . ........................................$100,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . .........................................110,000
Factory overhead:
Indirect labor . . . . . . . . . . . . . . . . . . . . . .birr 24,000
Depreciation on factory equipment . . . . . . ...10,000
Factory supplies and utility costs . . . . . . .birr 10,000 44,000
Total birr 254,000
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . birr 366,000
Selling expenses . . . . . . . . . . . . . . . . . . . . . . .20,000
Administrative expenses . . . . . . . . . . . . . . . .15,000

Exercise

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Cost data for Zabidar beer Manufacturing Company for the month ending December 31, 2013, are as
follows:
Inventories January 1 December 31
Materials birr 175,000 birr 154,000
Work in process 119,000 133,000
Finished goods 91,000 105,000
Direct labor birr 315,000
Materials purchased during April 336,000
Factory overhead incurred during April:
Indirect labor 33,600
Machinery depreciation 20,000
Heat, light, and power 7,000
Supplies 5,600
Property taxes 4,900
Miscellaneous cost 9,100
a. Prepare a cost of goods manufactured statement for the year ending on December 2013.
b. Determine the cost of goods sold for the year ending on December 2013.

Adjusting and closing entries for a merchandising business

The adjusting entry of manufacturing business is the same to that merchandising business. But in
manufucturing business the entries those need adjustment are material inventory and WIP.
At the end of the period amount of material inventory and work in process on the begining of the
period are cleared by debiting income summery and crediting them. On contrast the amount of WIP
and material inventory that is found on our hand at the end of the period is become part of our
inventory for the comming accounting period.
Entry to show adjusment for begining material inventory and WIP
İncome summery........................................XXX
Material inventory..........................................................XXX
İncome summery...............................................XXX
WIP.................................................................................XXX
Entry to show adjustment for ending material and WIP
Material inventory...................................................XXX
Income summery...............................................................XXX
WIP................................... ..................................XXX
İncome summary..................................................XXX
The closing entry of manufucturing business is the same to that of merchandising enterprises. So any
account that is not permanent is closed at the end of the period.

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