Chapter 1 ACCOUNTING FOR MANUFACTURING OPERATION OBJECTIVES Environment

Chapter 1 ACCOUNTING FOR MANUFACTURING OPERATION

• OBJECTIVES • Environment for Manufacturing Operation • Manufacturing Cost Concept • Product Cost v. Period Cost

• Deal With Firms Which Are Manufacturers • A Manufacturing A/C Is Prepared In Addition To The Trading And Income Statement Accounts

Comparing Merchandising and Manufacturing Activities Merchandisers. . . – Buy finished goods. – Sell finished goods. Mega. Lo. Mart Manufacturers. . . – Buy raw materials. – Produce and sell finished goods.

Manufacturing Cost Concepts Financial Accounting Cost is a measure of resources used or given up to achieve a stated purpose. Managerial Accounting Product costs are the costs a company assigns to units produced.

Comparing Financial Accounting and Management Accounting

MANAGERIAL COST CONCEPTS • Manufacturing consists of activities and processes that convert raw materials into finished goods.

Direct Costs and Indirect Costs Direct costs Indirect costs • Costs that can be easily and conveniently traced to a unit of product or other cost objective. • Costs cannot be easily and conveniently traced to a unit of product or other cost object. • Examples: – Direct material – Direct labor • Example: Manufacturing overhead

Manufacturing costs • Manufacturing costs are usually classified as follows: 1. Direct materials, 2. Direct labor, and 3. Manufacturing overhead.

Manufacturing Costs Direct Materials Direct Labor The Product Manufacturing Overhead

Direct Materials ¤ Raw materials are the basic materials and parts that are to be used in the manufacturing process. ¤ Raw materials that can be physically and directly associated with the finished product during the manufacturing process are called direct materials. Example: A radio installed in an automobile

Direct Labor ¤ Direct labor is the work of factory employees that can be physically and directly associated with converting raw materials into finished goods. ¤ Those labor costs that can be easily traced to individual units of product. Example: Wages paid to automobile assembly workers

Manufacturing/Factory Overheads Ø Manufacturing costs that cannot be traced directly to specific units produced. Ø Manufacturing/factory overhead consists of costs that are indirectly associated with the manufacture of the finished product. Examples: Indirect labor and indirect materials Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards. Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Overhead Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the finished product. These costs may also be manufacturing costs that cannot be classified as direct materials or direct labor. Manufacturing overhead includes 1 indirect materials; 2 indirect labor; 3 depreciation on factory buildings and machines 4 insurance, taxes, and maintenance on factory facilities.

COST OF GOODS SOLD COMPONENTS • Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section.

ILLUSTRATION COST OF GOODS SOLD COMPONENTS Merchandiser Beginning Merchandise Inventory + Cost of Goods Purchased - Ending Merchandise Inventory = Cost of Goods Sold Manufacturer Beginning Finished Goods Inventory + Cost of Goods Manufactured - Ending Finished Goods Inventory =

COST OF GOODs SOLD STATEMENT • • Direct materials: Beginning Materials inventory Purchases xxx less purchases returns and allowances xxx Materials available for use less ending materials inventory direct materials consumed • • • • • Direct labor Factory overhead Indirect labor Salaries Payroll taxes Power Heat Light Factory supplies Depreciation-factory building Depreciation – machinery Repairs and maintenance Patent Tools and dies used Insurance Total factory overhead cost Total manufacturing cost xxx xxx xxx xxx xxx xxx

• • • Total manufacturing cost Add beginning work in process inventory xxx xxx less ending work in process inventory Cost of goods manufactured Add beginning finished goods inventory Cost of goods available for sale less ending finished goods inventory Cost of goods sold xxx xxx xxx

Evaluating annual results to orient the outsiders • Current ratio • Acid – test ratio • Income before income tax as a % os sales • Net income as a % of sales • Gross profit as a % of sales • Rate of return on capital employed

Evaluating annual results to orient the insider • Cost of goods manufactured/units manufactured • Cost of beginning finished goods inventory/units in beginning finished goods inventory • Cost of ending finished goods inventory/units in ending finished goods inventory • Cost of goods sold/units sold

Nonmanufacturing Costs a) Administration / Operating costs a) Marketing and selling costs

ADMINISTRATION EXPENSES l All executive, organizational, and clerical costs. l Examples: - managers’ salaries - legal and accountancy charges - depreciation of accounting machinery & secretarial salaries

SELLING AND DISTRIBUTION EXPENSES Costs necessary to get the order and deliver the product. Examples: - Sales staff’s - Salaries & commission - Carriage outwards - Depreciation of delivery vans - Advertising expenses

PRODUCT COSTS ¤Costs that are a necessary and integral part of producing the finished product. ¤include each of the manufacturing cost elements (direct materials, direct labor, and manufacturing overhead) ¤These costs are not expensed to cost of goods sold under the matching principle until the finished goods inventory is sold.

PRODUCT COSTS (Cont…) ¤Direct materials and direct labor are often referred to as prime costs due to their direct association with the manufacturing of the finished product. ¤ Direct labor and manufacturing overhead are often referred to as conversion costs since they are incurred in converting raw materials into finished goods.

Classifications of Costs Manufacturing costs are often combined as follows: Direct Materials Direct Labor Prime Cost Manufacturing Overhead Conversion Cost

PERIOD COSTS a) are identifiable with a specific time period, b) relates to nonmanufacturing non-inventoriable costs, and c) include selling and administrative expenses.

ILLUSTRATION: PRODUCT VERSUS PERIOD COSTS Product Costs { Direct Labor Manufacturing Overhead Period Costs Nonmanufacturing Costs { Selling Expenses Administrative Expenses { { Manufacturing Costs Direct Materials Prime Costs Conversion Costs

VARIABLE FACTORY OVERHEADS • • • Supplies Fuel Power Small tools Spoilage, salvage and reclamation expenses Receiving costs Hauling within plant Royalties Communication costs Overtime premium

FIXED FACTORY OVERHEADS • • • Salaries of production executives Depreciation Property tax Patent amortization Wages of security guards and fire fighters • Maintenance and repairs of building and grounds • Insurance- property and liability

SEMI VARIABLE FACTORY OVERHEADS • • • • Supervision Inspection Payroll department services Personnel department services Factory office services Materials and inventory services Cost department services Maintenance and repairs of machinery and equipment Compensation insurance Health and accident insurance Payroll taxes Industrial relations and employees’ welfare expenses Heat, light and power

Controllable and Uncontrollable costs • Controllable costs: • Costs that can be controlled or heavily influenced by the manager. • Uncontrollable costs: • Costs that a manager cannot influence significantly.

Manufacturing operations and Manufacturing Costs • Job Shop: • Low production volume; little standardization; one of a kind product. • Batch: • Multiple products; low volume • Assembly line: • A few major products; higher volume. • Mass customization: • Higher production volume; many standardized components ; customized components of components. • Continuous flow: • Higher production volume; highly standardized commodity products.

More cost classifications • Opportunity costs: • Is defined as a benefit that is sacrificed when the choice of one action preludes taking an alternative course of action. • Out of pocket costs: • Costs that require payment of cash or other assets as a result of their incurrence. • Sunk costs: • Costs that have been incurred in the past. • They do not affect future costs and cannot be changed by any current or future action. • Irrelevant to all future decisions.

More cost classifications • Differential costs: • It is the amount by which the cost differs under two alternative actions. • Incremental costs: • The increase in cost from one alternative to another. • Marginal costs: • Additional costs incurred when an additional unit is produced. • Average costs: • It is the total cost for whatever quantity is manufactured, divided by the number of units manufactured.

• Standard costs: • Pre determined costs for direct materials, direct labor and factory overhead. • They are established by using information accumulated from past experience and data secured from research studies.