Wednesday, April 13, 2016




In manufacturing, raw material is transformed with the help of labor and machinery. In a merchandising firm, only one type of inventory is maintained, and only few costs are added to the purchase price of goods to arrive at cost of goods sold. In a manufacturing firm, many and different types of costs are incurred:
1- direct material,
2- direct labor, and
3- factory or manufacturing overhead.
These costs are accumulated in three inventories:
1- materials,
2- work in process, and
3- finished goods.

INVENTORY ACCOUNTS The three inventory accounts used in manufacturing operations are
1- materials inventory: these are raw materials which have not yet entered the processing phase;
2- work in process: this accounts for all goods in the process of manufacturing;
3- finished goods: these are completed goods ready to be sold. Combined, they represent the inventory in the balance sheet.

To control costs, the different types of costs are identified: 1- direct materials: these make up the major component of and are easily traceable to a given finished product;
2- direct labor: that portion of labor which is assignable to a specific product;
3- factory overhead: all costs other than direct materials and direct labor; this includes fixed costs such as rent and depreciation, but also indirect materials and indirect labor.
Direct materials and direct labor are the prime costs. Direct labor and factory overhead are conversion costs. All the above costs are product costs, as opposed to period cost which are not part of the cost of products and are classified as expenses.

The cost of goods manufactured statement combines all the direct materials, direct labor and factory with beginning work in process inventory, minus the ending work in process inventory, to report the total cost of the goods which have been manufactured during the period. In order to prepare the statement, a manufacturing summary is debited for all the costs during the year, and credited for the cost of goods manufactured and ending inventories. The cost of goods manufactured is added to finished goods inventory to sum to the goods available for sale, which gives the cost of goods sold when ending finished inventory is deducted.

The cost accounting system provides a much more effective means of controlling costs than a general accounting system, and offers information on unit costs useful for product pricing and promotion. The cost accounting system uses perpetual inventories. There are two types of cost accounting systems:
1- job order cost systems used when one-of-a-kind products or batches of products are manufactured,
2- process cost systems applicable when uniform and identical products are manufactured on a continuous basis.

A purchase requisition triggers a purchase order to a supplier from the purchasing department, and when the goods are delivered, a receiving report showing the quantity and condition of the goods. After verification, the material inventory account is debited. A materials requisition causes goods to be transferred from the storeroom or warehouse to the manufacturing department, and thereupon the materials inventory account is credited. A separate account is often maintained for each type of material.

Time tickets are used to record the labor cost for each individual job. Hours worked are verified by comparing time tickets and clock cards. Labor costs are recorded by debiting work in process and/or factory overhead (depending on whether it is direct or indirect labor), and crediting wages payable.

Factory overhead consists of all manufacturing costs other than direct materials and direct labor. Factory overhead costs are both fixed and variable. The factory overhead controlling account is debited when costs are incurred and credited when factory overhead is "applied" (i.e. allocated) to various job orders. The overhead application rate can be based on either direct labor hours, direct labor cost or machine hours. Total credits rarely equal debits. A remaining credit indicates the overhead was underapplied (or underabsorbed), a debit indicates the overhead was overapplied. If this difference is small, it is closed to cost of goods sold. If it is large, it is allocated to the various inventory accounts.

The work in process account receives debits for direct materials, direct labor and factory overhead costs. The work in process account is a controlling account. Cost ledgers maintain details on the costs of each individual job. A individual cost ledger account is called a job cost sheet. It provides extensive information on each job direct materials, direct labor, and factory overhead costs. When a job is completed, total costs are added up and divided by the number of units finished to determine cost per unit.

The finished goods account is a controlling account, with a subsidiary ledger called the stock ledger or the finished goods ledger. The finished goods ledger provides detailed information on goods manufactured and shipped on quantity, price, date, and unit cost. When finished goods are sold, the cost of goods sold is debited and finished goods credited. In the event goods are returned by buyers, the finished goods account is debited and the cost of goods sold credited.

Three inventory accounts are used by manufacturing enterprises: 1) materials, 2) work in process, and 3) finished goods. These inventory accounts record the costs of manufacturing goods. The materials account records the costs of materials purchased for production purposes. When materials are used in production, the work in process account is debited. The work in process inventory records materials, labor, and factory overhead costs. When goods are completed the finished goods account is debited. When goods are sold the cost of goods sold accounts is debited. Each of these accounts are controlling accounts, and the detailed information is present is subsidiary ledgers.