CHAPTER 3 (COST ACCOUNTING CYCLE) ▲ Elements of Manufacturing Cost
▲ Manufacturing Inventory Accounts
• Materials Inventory (Materials lnventory Control Account) – made up of
the balances of materials and supplies on hand.
- This account is maintain much the same way as the Merchandise Inventory
accóunt.
- The main difference is the way that the costs of items in inventory are
assigned.
- For the merchandising company, goods taken out of inventory are items that
have been sold.
- When a sale is made, an entry is needed to debit Cost of Goods Sold and to
credit Merchandise Inventory for the cost of the item.
- Materials, on the other hand, usually not purchased for resale but for use in
manufacturing a product.
- Therefore an item taken out of Materials Inventory and requisitioned into
production is transferred to the Work in Process Inventory account (not Cost
of Goods Sold).
• Work in Process Inventory – composed of all manufacturing costs incurred
and assigned to products being produced
- This inventory account has no counterpart in merchandise accounting.
- The issuance of materials production, begins the production process. These
materials must be cut, molded, assembled, or in some other way changed into
a finished product.
- To make this change, people, machines, and other factory resources
(buildings, electricity, supplies, and so on) must be used. All of these costs are
manufacturing cost elements (product costs), and all of them enter into
accounting for Work in Process Inventory
- Direct labor earned by factory employees are also product costs. Since these
people work on specific products, their labor costs are assigned to those
products by including the labor peso earned as part of the Work in Process
Inventory account.
- Overhead costs are product costs and must be assigned to specific products.
Thus, they, too, are included in the Work in Process Inventory account. As
discussed earlier, there are many overhead costs to account for on an
individual basis.
- To reduce the amount of work needed to assign these costs to products, they
are accumulated and accounted for under one account title: Factory Overhead
Control.
- These costs are then assigned to products by using an overhead rate. Using
this rate, called a predetermined overhead rate, costs are charged to Work in
Process Inventory account.
- As products are completed, they are put into the finished goods storage area.
- These products now have materials, direct labor, and factory overhead costs
assigned to them.
- When products are completed, their costs no longer belong to work in
process. Therefore, when the completed products are sent to the storage area,
their costs are transferred from the Work in Process Inventory account to the
Finished Goods Inventory.
- The balance remaining in the Work in Process Inventory account represents
the costs that were assigned to products partly completed and still in process
at the end of the period.
• Finished Goods Inventory
- Like Materials Inventory, has same characteristics of the Merchandise
Inventory account. At this point Finished Goods Inventory takes on the
characteristics of Merchandise inventory.
- If we compare the Merchandise Inventory account with the accounting for
Finished Goods Inventory both show that when goods or products are sold,
the costs of those goods are moved from the Finished Goods Inventory
account to the Cost of Goods Sold account.
- However, the accounting procedures affecting the debit side of the Finished
Goods Inventory account differ from those for the Merchandise Inventory.
- At this point Finished Goods Inventory takes on the account. In a
manufachuring firm salable products are produced rather than purchased.
- All costs debited to the Finished Goods Inventory account represent
transfers from the Work in Process Inventory account.
- At the end of an accounting period, the balance in the Finished Goods
Inventory account is made up of the cost of products completed but unsold as
of that date.
• Direct materials – cost of material which become part of the product being
manufactured and which can be readily identified with a certain product.
Examples: lumber used in making furniture, fabric used in the production of
clothing, crude oil used to make gasoline and leather used to make shoes and
bags.
■ Indirect materials – materials that cannot be readily identified with any
particular item manufactured are called indirect materials.
Examples: sandpaper used in sanding furniture, and lubricants used on
machinery. Classified also as indirect materials are materials that actually
become part of the finished product but whose costs are relatively
insignificant, such as thread, screws, rivets, bolts, nails, and glue.
• Direct labor – the cost of labor for those employees who work directly on
the product manufactured are classified as direct labor.
Examples: salaries of machine operators or assembly line workers.
■ Indirect labor – the wages and salaries of employees who are required for
the manufacturing process but who do not work directly on the units being
manufactured are considered indirect labor.
Examples: wages and salaries of department heads, inspectors, supervisors,
and maintenance personnel.
• Factory overhead – Includes all costs related to the manufacturing of a
product except direct materials and dire t labor.
Examples: manufacturing expenses, such as depreciation on the factory
building, machinery and equipment, supplies, heat, light, power, maintenance,
insurance, rent and taxes indirect materials, indirect labor, and other
▲ Manufacturing Cost Flow
▲ The Manufacturing Statement
- Financial statements of manufacturing companies differ little from those of
merchandising companies. Depending on the industry, the account titles found
on the balance sheet are the same in most corporation.
- Even the income statements for a merchandiser and a manufacturer are
similar. However, a closer look shows that the head Cost of Goods
Manufactured is used in place of the Purchases account. Also, the
Merchandise replaced by Finished Goods Inventory.
- The key to preparing an income statement for a manufacturing company is
to determine the cost of goods sold. The amount is the end result of a special
manufacturing statement, the statement of cost of goods manufactured, which
is prepared to support the figure on the income statement
▲ Statement of Cost of Goods Manufactured and Sold
- The statement gives the peso amount of costs for products completed and
moved to Finished Goods Inventory during the year
- The amount for cost of goods manufactured should be the same as the
amount transferred from the Work in Process Inventory account to the
Finished Goods Inventory account during the year.
- In the same way, the amount of cost of goods sold should be the same as the
amount transferred from the Finished Goods Inventory account to the Cost of
Goods Sold account during the year below.
The statement of cost of goods sold for Figure 3-1 through 3-4 is shown even
though this statement is rather complex, it can be pieced together in four
steps.
 Name of Company
Cost of Goods Sold Statement
For the year ended December 31, 2019

Direct materials used

Materials Inventory, January 1 P xxx
Add: Purchases xxx
Total available for use xxx
Less: Materials Inventory, December 31 xxx P xxx
Direct labor xxx
Factory Overhead xxx
Total manufacturing costs xxx
Add: Work in process, January1 xxx
Cost of goods put into process xxx
Less: Work in process, December 31 xxx
Cost of goods manufactured xxx
Add: Finished goods, January 1 xxx
Total goods available for sale xxx
Less: Finished goods, December 31 xxx
Cost of goods sold—normal P xxx

▲ Cost Flow – Manufacturing Firms

▲ Cost Flow – Merchandising Firms

▲ Cost Flow – Service Firms