Introduction to Manufacturing Business PDF

BM2409 INTRODUCTION TO MANUFACTURING BUSINESS Buy-Produce-Sell Manufacturing is the most diverse of the three (3) business types in terms of activity. Aside from the buying and selling activities, a manufacturing entity's production phase is unique, which complicates things furt...

BM2409 INTRODUCTION TO MANUFACTURING BUSINESS Buy-Produce-Sell Manufacturing is the most diverse of the three (3) business types in terms of activity. Aside from the buying and selling activities, a manufacturing entity's production phase is unique, which complicates things further. First, a manufacturing concern has to buy raw materials. Second, labor is procured and applied, and other costs are incurred. Finally, the finished product is sold to customers. The accounting for raw material purchases and customer sales is similar to that of a merchandising business. Of course, there is the distinction that under a merchandising concern, purchased inventory is for sale without modification, whereas accounting for sales to customers is substantially the same. It should be mentioned that the above are just simplified descriptions of the general activities and sequencing of a manufacturing concern's activities. For deeper insight, complications may arise since making a product requires several raw materials. This means the purchasing department will have to deal with different suppliers. When orders arrive, the receiving department may have to inspect these several raw materials. Also, sufficient labor must be secured, especially when a high-skilled and technical labor force is needed. The majority of costs are incurred during the production stage. Close monitoring and proper cost accounting are critical because costing directly impacts pricing. In a competitive industry, pricing is crucial. Forecasting and budgeting are central to many of the activities listed above. All of these topics will be covered in your higher accounting classes. Elements of Manufacturing Costs In broad terms, a cost is the amount of resources spent to achieve a specific object or objective. Figure 1: Cost Classification Source: Management Guru: The Essence of Management, 2014. Retrieved from https://www.managementguru.net/cost- accounting/cost-classification/ 08 Handout 1 *Property of STI Page 1 of 9  BM2409 Product Cost and Period Cost Product cost includes all costs associated with acquiring and manufacturing a product. These are the costs associated with the product from when it is manufactured until it is ready to be sold. Product costs are initially assigned to inventory accounts (raw materials, work in process, finished goods) and then charged to expense when sold. Product costs include direct material, direct labor, and factory overhead, also called inventory costs. All costs that are not product costs are classified under period cost. All non-manufacturing costs (selling and administrative expenses) are treated as period costs and expensed as incurred. Manufacturing Cost 1. Direct material – Raw materials are incorporated into the final product and thus become integral, with their cost directly traceable to the finished product. Raw materials may be either direct or indirect. Examples of direct materials include fingerprint readers in smartphone home buttons, ink tanks in printers, and wood used for cabinets, the costs of which can be easily traced back to the finished product. Indirect materials are raw materials that are relatively inexpensive and thus difficult to trace, typically due to small amounts, such as binding glue used in books or thermal grease used in computer microprocessors. 2. Direct labor – Consists of labor costs that can be conveniently traced to the finished product. Examples are direct labor workers’ salaries in Samsung’s computer assembly lines, the labor cost of electrical wiring in construction, the salary of a shoemaker, etc. 3. Manufacturing overhead – This includes all manufacturing costs except direct materials and direct labor. It is a catch basin cost classification, which means that anything that could not be conveniently traced or classified as direct materials or direct labor falls under this category. Examples are maintenance and insurance on manufacturing facilities, heating and lighting for a building, and depreciation of factory machinery, among others. Non-Manufacturing Cost 1. Selling Costs – Include all costs incurred in selling the company’s product, including costs to secure customer orders, commissions to sales agents, recording costs for sales transactions, depreciation of selling equipment, and delivery costs. 2. Administrative Costs—Include all costs associated with an organization's general management and administration. Examples are administrative staff salaries, office fixtures depreciation, executive compensation, and the like. Prime Cost and Conversion Cost Two additional cost categories are frequently used in discussions of manufacturing costs: prime cost and conversion cost. The prime cost is the sum of the direct material and labor costs. Conversion cost is the sum of direct labor and manufacturing overhead costs. Conversion cost refers to the direct labor and manufacturing overhead costs incurred when converting materials into finished products. 08 Handout 1 *Property of STI Page 2 of 9  BM2409 Direct and Indirect Cost If a cost is particularly traceable to a specific activity, it is a direct cost. It is also called a separable or traceable cost. If the activity that causes its incurrence is stopped, the direct cost also ceases to be incurred. It is an indirect cost if a cost is not particularly traceable to a specific activity but rather to several activities. Cost Flow in a Manufacturing Business (Manufacturing Inventory Accounts) Product Cost Period Cost Costs Purchase of Raw Direct Labor Manufacturing Selling and Materials Overhead Aministrative Statement of Materials Work in Process Finished Goods Financial Position Inventory Inventory Inventory Statement of Profit or Loss Cost of Goods Sold Selling and Aministrative Expenses Figure 2: Cost Flow in a Manufacturing Business Distinct to a manufacturing business are the three (3) inventory categories: 1. Materials Inventory—This account shows the balance of the cost of unused materials purchased but not yet used in the production process. 2. Work in Process Inventory—This account displays the manufacturing costs incurred and allocated to partially completed product units. Therefore, it represents the costs associated with manufacturing the unfinished product. 3. Finished Goods Inventory—This account shows the costs assigned to all completed products that have not been sold. It shows the cost of the complete and ready-for-sale product. A manufacturing cost flow is the flow of direct materials, direct labor, and manufacturing overhead through these inventory accounts and into the Cost of Goods Sold account. Well-defined manufacturing cost flows are the foundation for accurate product costing, inventory valuation, and financial reporting. They supply all the information necessary to prepare the statement of cost of goods manufactured and compute the cost of goods sold. JOURNAL ENTRIES AND T-ACCOUNTS Purchase of Raw Production of Goods Product Sale of the Product Materials Completion Activity Purchase and receipt Processing and Finished products Sale and shipment of of raw materials conversion of raw are completed and finished products to moved to customers 08 Handout 1 *Property of STI Page 3 of 9  BM2409 Purchase of Raw Production of Goods Product Sale of the Product Materials Completion materials by using direct the storage area labor and overhead awaiting sale. Journal Raw materials xxx Work in process xxx Finished goods xxx Cost of goods sold xxx Accounts payable Factory overhead Control xxx Work in process Finished Goods xxx Entry xxx Raw materials xxx xxx Work in process xxx Factory overhead control xxx Salaries & Wages payable xxx Work in process xxx Applied FOH xxx T- Account Schedule of Cost of Goods Manufactured This schedule shows how much direct materials, direct labor, and manufacturing overhead remain in the Work in Process and how much of these cost elements are transferred from Work in Process to Finished Goods. To illustrate, take the following as an example: Jose Corporation has provided the following data concerning June’s manufacturing operations. Sales P375,000 Purchases of raw materials 30,000 Direct labor 58,000 Manufacturing overhead applied to work in process 87,000 Underapplied overhead 4,000 Selling expenses 45,000 Administrative expenses 35,000 Inventories Beginning Ending Raw materials P12,000 P18,000 Work in process 56,000 65,000 Finished goods 35,000 42,000 08 Handout 1 *Property of STI Page 4 of 9  BM2409 The Schedule of Cost of Goods Manufactured is a combination of three separate computations. First is determining how much direct materials have been put into the process. Observe the following equation: Raw Beginning Raw Purchases of Ending Raw materials = materials + Raw materials - materials used in inventory inventory production For Jose Corporation, the beginning raw materials inventory is P12,000, plus P30,000 in purchases of raw materials, less the ending raw materials inventory of P18,000. This equals the raw materials used in production, which is P24,000. Remember that direct and indirect materials are sourced from the same inventory account - Raw Materials Inventory. As a result, if indirect materials were used and are already included in the manufacturing overhead account, they must be deducted from the P24,000 to calculate the direct materials used in production. Second, the total manufacturing cost would be computed. Total Applied manufacturing = Direct materials + Direct labor + Manufacturing cost overhead For Jose Corporation, direct materials used in production is P24,000, add the direct labor cost of P58,000, and add the applied manufacturing overhead of P87,000. The total manufacturing cost, in this case, is P169,000. Third, the cost of goods manufactured itself would be computed. Cost of Goods Total Beginning WIP Ending WIP Manufactured = Manufacturing + Inventory - Inventory Cost For Jose Corporation, the total manufacturing cost of P169,000, added to the beginning work in process of P56,000 and deducted from the ending work in process of P65,000, would give us the cost of goods manufactured of P160,000. Schedule of Cost of Goods Sold The Cost of Goods Sold is an expense account. It is recognized in the period incurred. It is commonly the largest expense account of most firms. The Schedule of Cost of Goods Sold displays how much direct materials, direct labor, and manufacturing overhead remain in the Finished Goods inventory and how much of these cost elements are transferred from the Finished Goods to the Cost of Goods Sold account. Unadjusted Beginning FG Cost of Goods Ending FG Cost of = Inventory + Manufactured - Inventory Goods Sold 08 Handout 1 *Property of STI Page 5 of 9  BM2409 Continuing our illustration for Jose Corporation, beginning finished goods of P35,000, added to the P160,000 cost of goods manufactured, less ending finished goods of P42,000, results in an unadjusted cost of goods sold of P153,000. Such cost of goods sold is said to be unadjusted since it is before the closing of any under or overapplication of manufacturing overhead. Closing the P4,000 underapplied overhead will finally bring us to the adjusted cost of sales/cost of goods sold of P157,000. Jose Corporation Statement of Cost of Goods Manufactured For the month ended June 30, 2023 Beginning raw materials P12,000 Add: Purchases of raw materials 30,000 Raw materials available for use 42,000 Deduct: Ending raw materials 18,000 Raw materials used in production 24,000 Direct labor 58,000 Applied manufacturing overhead 87,000 Total manufacturing cost 169,000 Add: Beginning work in process 56,000 Total work in process 225,000 Deduct: Ending work in process 65,000 Cost of goods manufactured P160,000 Josue Corporation Statement of Cost of Goods Sold For the month ended June 30, 2023 Beginning finished goods P35,000 Add: Cost of goods manufactured 160,000 Cost of goods available for sale 195,000 Deduct: Ending finished goods 42,000 Unadjusted cost of goods sold 153,000 Add: Underapplied overhead 4,000 Adjusted cost of goods sold P157,000 Comparison of Statements of Profit or Loss and Statement of Financial Position Service Business Merchandising Business Manufacturing Business Statement of Profit or Service Revenue PXXX Sales PXXX Sales PXXX Less: Cost of Services XXX Less: Cost of Sales* XXX Less: Cost of Sales* XXX Loss Gross Income XXX Gross Income XXX Gross Income XXX Less: Operating Expenses XXX Less: Operating Expenses XXX Less: Operating Expenses XXX Operating Income PXXX Operating Income PXXX Operating Income PXXX # # Beginning Inventory PXXX Beginning FG Inventory PXXX Add: Net Purchases XXX Add: Cost of goods manufa. XXX Cost of GAFS PXXX Cost of GAFS PXXX 08 Handout 1 *Property of STI Page 6 of 9  BM2409 Comparison of Statements of Profit or Loss and Statement of Financial Position Service Business Merchandising Business Manufacturing Business Less: Ending inventory XXX Less: Ending FG Inventory XXX Cost of Sales* PXXX Cost of Sales* PXXX Statement of Financial No inventory account One inventory accounts: Three inventory accounts: Merchandise inventory Raw Materials Inventory Position (Inventory (bought ready for sale) Work in Process Inventory Accounts) Finished Goods Inventory Also, a statement of profit or loss can be prepared for Jose Corporation as follows: Jose Corporation Statement of Profit or Loss For the month ended June 30, 2023 Sales P375,000 Less: Cost of goods sold 157,000 Gross income/Gross profit P218,000 Less: Operating expenses: Selling expenses 45,000 Administrative expenses 35,000 80,000 Net income P138,000 Comprehensive Illustration Bien Company of Alcala, Pangasinan, is a family-owned enterprise that makes bamboo crafts for the North Luzon market. The company sells its bamboo crafts through an extensive network of commission agents who receive a percentage of their sales. The company usually transacts with customers, employees, and suppliers on account. The company uses a job-order costing system in which overhead is applied to jobs based on direct labor costs. Its predetermined overhead rate is based on a cost formula that estimated P330,000 manufacturing overhead for an estimated P200,000 direct labor pesos activity level. At the beginning of 2023, the inventory balances were as follows: Raw materials P25,000 Work in process 10,000 Finished goods 40,000 During the year, the following transactions were completed: a. Raw materials purchased on account, P275,000. b. Raw materials requisitioned for use in production, P280,000 (materials costing P220,000 were charged directly to jobs; the remaining materials were indirect). c. Cost for employee services were incurred as follows: 08 Handout 1 *Property of STI Page 7 of 9  BM2409 Direct labor P180,000 Indirect labor 72,000 *Sales commissions 63,000 Administrative salaries 90,000 *paid in cash d. Paid rent for the year was P18,000 (P13,000 of this amount related to factory operations, and the remainder related to administrative activities) e. Utility costs incurred in the factory, P57,000 f. Paid advertising expenses, P140,000 g. Depreciation recorded on equipment, P100,000. (P88,000 of this amount was on equipment used in factory operations; the remaining P12,000 was on equipment used for administrative activities) h. Manufacturing overhead cost was applied to jobs. i. Goods that had cost P675,000 to manufacture according to their job cost sheets were completed. j. Sales on account for the year totaled P1,250,000. The total cost to manufacture these goods, according to their job cost sheets, was P700,000. Requirements: 1. Prepare journal entries to record the transactions for the year. 2. Prepare T-accounts for the three (3) inventory categories: Factory Overhead Control and Applied Factory Overhead. Post relevant data from your journal entries to these T-accounts. Do not forget to enter the beginning balances in your inventory accounts. Compute an ending balance in each account. 3. Is Manufacturing Overhead underapplied or overapplied for the year? Prepare a journal entry to close any under or overapplied overhead to the Cost of Goods Sold. 4. Calculate net income by preparing a Statement of Profit or Loss for the year. A Raw materials 275,000 Accounts payable 275,000 B Work in process 220,000 Factory overhead control 60,000 Raw materials 280,000 C Work in process 180,000 Factory overhead control 72,000 Commission expense 63,000 Salaries expense 90,000 Cash 63,000 Salaries and wages payable 342,000 D Factory overhead control 13,000 Rent expense 5,000 Cash 18,000 E Factory overhead control 57,000 Accrued utilities payable 57,000 08 Handout 1 *Property of STI Page 8 of 9  BM2409 F Advertising expense 140,000 Cash 140,000 G Factory overhead control 88,000 Depreciation expense 12,000 Accumulated depreciation 100,000 H Work in process 297,000 Applied factory overhead 297,000 (P330,000/200,000=1.65 X P180,000) I Finished goods 675,000 Work in process 675,000 J Accounts receivable 1,250,000 Sales 1,250,000 Cost of goods sold 700,000 Finished Goods 700,000 Notes on the foregoing journal entries: A. The usual entry is used to record purchases of raw materials on the account. B. Out of the P280,000 requested materials, P220,000 is direct materials and, therefore, enters the Work in Process account. The remaining P60,000 is actual factory overhead incurred and, therefore, debited to the Factory Overhead Control account. C. Direct labor is debited to Work in Process; indirect labor is the actual overhead incurred and, therefore, debited to Factory Overhead Control. Sales commission and administrative salaries are period costs and are expensed as incurred. D. P13,000 is the actual factory overhead, and the balance is operating expenses. E. Factory-related utility costs are factory overhead. Enter the Factory Overhead Control account. F. The usual recording of advertising expense is a period cost. G. The portion relating to factory overhead is debited to Factory Overhead Control, and the portion pertaining to operating expense is depreciation expense. H. As mentioned in earlier discussions, the applied overhead enters the product cost. The application rate is computed by dividing a budgeted cost (P300,000) by a budgeted activity (in this case, the activity is in direct labor pesos of P200,000). The rate is then applied (multiplied) to the actual level of activity (P180,000 direct labor pesos). I. This entry transfers the cost of the completed units from the work-in-process inventory to the finished goods inventory. J. The first entry records sales on the account. The second entry transfers the cost of the units sold from the finished goods inventory to the cost of goods sold. References Reyno, F., & Reyno, D. (2021). Financial Accounting and Reporting (Part One). Reyno Publishing House. 08 Handout 1 *Property of STI Page 9 of 9