Nature of Manufacturing Business

Merchandising Manufacturing
includes cost of involves the conversion
merchandise purchased of raw materials into
including the finished goods through
transportation cost of the application of labor
bringing merchandise to and various factory cost
the business place. incidental to the
production of products.

Manufacturing business makes major investments in

physical facilities such as factory site, factory building
and acquisition of various machinery and equipment to
be use in the factory.
 Chart of Accounts of Manufacturing Business
Acct Acct No.
No. Assets: Liabilities:
110 Cash in Bank 310 Accounts Payable
111 Cash on Hand 320 Notes Payable – Short-term
112 Petty Cash 321 Interest Payable
120 Accounts Receivable 330 Accrued Salary Payable
130 Allowance for Uncollectible Accounts 340 Accrued Rent Payable
140 Notes Receivable – Short-term 350 Bank Loans Payable – Short-term
150 Interest Receivable 360 Income Tax Payable
160 Finished Goods 370 Withholding Tax Payable
161 Work in Process 380 SSS Contribution Payable
162 Raw Materials 390 PhilHealth Contribution Payable
165 Supplies 400 Pag-ibig Contribution Payable
170 Prepaid Rent 410 Insurance Payable
180 Prepaid Insurance 420 Unearned Service Income
190 Trading Securities 430 Notes Payable – Long-term
200 Notes Receivable – Long-term 440 Bank Loans Payable – Long-term
210 Land
220 Building Acct No.
221 Accum. Depreciation – Building Owner’s Equity:
240 Furniture & Fixtures
241 Accum. Depreciation – Fur. & Fix. 510 Owner’s, Capital
250 Office Equipment 520 Owner’s, Drawing
251 Accum. Depreciation – Office Equipment
Acct Acct
No. Cost and Expenses: No. Revenues:
810 Purchases 610 Sales
811 Purchases returns 611 Sales returns
812 Purchases allowances 612 Sales allowances
813 Purchases discounts 613 Sales discounts
814 Freight-in 620 Interest Income
815 Cost of goods sold 630 Rent Income
820 Salary Expense 640 Dividend Income
830 Rent Expense 650 Gain on sale of Land (Building,
840 Utilities Expense Furniture & Fixture or Office
850 Uncollectible Accounts Expense Equipment)
860 Advertising Expense 660 Unrealized Holding Loss – Trading Sec
870 Insurance Expense
880 Taxes and Licenses
890 Supplies Expense
900 Interest Expense
905 Freight-out
910 Depreciation Expense
920 Employees Benefits Expense
930 Loss on Sale of Land (Building, Furniture
& Fixture or Office Equipment)
940 Unrealized Holding Loss – Trading Sec
950 Loss on Sale of Trading Securities
960 Miscellaneous Expense
 Operating Cycle of Manufacturing Business

Phase 1: Phase 4:
Buy Raw Materials Collect from customers

Phase 2:
Processed raw materials to Phase 3:
finished goods Sell finished goods to
(Raw materials + direct labor customers
+ factory overhead)
 Cost Elements of
Manufacturing Business

3 Types of Production Costs:

1. Raw Materials
2. Direct Labor
3. Factory Overhead
Raw Materials
Direct Labor
 Factory Overhead
The cost of factory overhead is called as
manufacturing overhead cost. It refers to all indirect
materials, indirect labor and other miscellaneous
items used in the making of a product.

Examples are:
used factory supplies
salary of factory supervisors
factory depreciation
factory maintenance.

As a rule, if a cost could not be classified as

direct raw materials or direct labor, it is classified as
factory overhead.
 When the three elements of production cost are mixed,
the following costs can be determined until a product is
produced.
1.Manufacturing costs. This is the sum of the three (3)
cost elements: direct materials, direct labor and factory
overhead. This is sometimes referred to as production
cost or factory cost.
2.Work-in-process. The portion of the total
manufacturing costs that pertains to the goods under
process which are not yet 100% completed at the end of
the accounting period.
3.Cost of goods manufactured. The portion of the
total manufacturing costs pertaining to the work which
is 100% processed and completed, transferred to
finished goods.
 The unsold finished goods, unfinished goods-in-
process and unused raw materials at the end of the period
are inventories, which should be reported as part of the
current assets of the business.

The ending inventories of each type of business are

compared as follows:
MERCHANDISING MANUFACTURING
1. Merchandise inventory 1. Finished goods inventory
(Unsold merchandise at (unsold)
the end of the period) 2. Work-in-process inventory
(incomplete)
3. Raw materials inventory
(unused)
4. Factory supplies inventory
(unused)
Comparative Cost Flow
The comparative cost flow of merchandising and manufacturing
business could be outlined as follows:
MANUFACTURING
MERCHANDISING Direct materials, beginning Pxxx
Merchandise beginning Pxxx
Add (Deduct) Net purchases
Add (Deduct) Net purchases
Purchases Pxxx
Purchases Pxxx
Freight-in xxx
Freight-in xxx
Purchase discount (xxx)
Purchase discount (xxx) Purchase allowances (xxx)
Purchase allowances (xxx) Purchase returns (xxx) xxx
Purchase returns (xxx) xxx Total direct materials for use Pxxx
Total goods available for sale Less: Unused raw materials at the end of the
Pxxx
period xxx
Less: Unsold merchandise at Direct materials used Pxxx
the end of the period xxx
Cost of goods sold Add: Direct labor Pxxx
Pxxx
Factory overhead xxx xxx
Total manufacturing costs Pxxx
The Cost of Sales can be described Add: work-in-process, beg. xxx
as Cost of Goods Sold for a merchandising Total work-put-in-process Pxxx
business since the items purchased are Less: work-in-process, end xxx
already the final product sold. Total costs of goods manufactured
Pxxx
Add: finished goods, beg. xxx
On the other hand, it is described as Total finished goods for sale Pxxx
the Cost of Goods Manufactured and
Less: finished goods, end xxx
Sold for manufacturing firms because the
Cost of goods manufactured and sold
items purchased are converted into Pxxx
finished products before they are sold.
 ASSETS IN THE BALANCE SHEET EXPENSE IN THE
INCOME STATEMENT
Raw Materials

WORK-IN-PROCESS
Direct Labor

FINISHED GOODS
INVENTORY

INVENTORY
Factory Overhead:
Cost of
• Indirect Materials
goods sold
• Indirect labor
• Factory depreciation
and other factory
expenses
Prime Cost and Conversion Cost
The cost elements of a manufacturing firm could be combined
and formed as (1) prime costs and (2) conversion costs.

1. Prime Costs consist of direct materials and direct labor used

to make the product . This cost is called prime cost or direct
cost because the primary materials and main labor are
combined in making the product.

2. Conversion Costs includes the costs of direct labor and

all indirect costs.

This is called conversion cost because the direct labor and

overhead costs transform the raw materials to finished goods.

Indirect manufacturing cost is also called manufacturing

overhead or factory overhead cost.
The Cost of Goods
Manufactured and Sold

The cost of goods manufactured and sold

account is generally used to describe the
merchandise sold by a manufacturing
business. The schedule of cost of goods
manufactured and sold is presented as
follows (all amounts assumed):
 VALROX Manufacturing
Schedule of Cost of Goods Manufactured and Sold
For the Year Ended December 31, 200x

Raw materials used:

Beginning raw materials inventory P 70,000
Add: Net raw materials purchases
Raw materials purchases P 200,000
Freight-in 5,000
Gross raw materials purchases 205,000
Less: Purchase discounts P2,500
Purchase returns 1,500
Purchase allowances 1,000 5,000 200,000
Total raw materials available for use P 270000
Less: Ending raw materials inventory 20,000 P250000
Direct labor 400,000
Factory overhead 150,000
Total manufacturing cost P800000
Add: Work in process, beginning 100,000
Total cost of goods in process P900000
Less: Work in process, ending 150,000
Total cost of goods manufactured P750000
Add: Finished goods, beginning 50,000
Total finished goods available for sale P800000
Less: Finished goods, ending 150,000
Cost of goods manufactured and sold P650000
Cost versus Non-Cost System
The accounting for manufacturing activities may be done using
either Cost System or Non-Cost System.

1. Cost System maintains detailed perpetual records of the cost

of raw materials, work-in-process and finished goods
inventory. This system provides an updated information about
manufacturing costs which serves as helpful guide for price
decision-making.

2. Non-cost system determines the cost of goods manufactured

based on the periodic actual physical count of ending inventory
for materials, work-in-process, and finished goods, converting
these into value using the adapted cost method (FIFO or
weighted average).
This chapter discusses the manufacturing accounting using the
non-cost system.
Under the non-cost system, the manufacturing cost should be summarized
in manufacturing account which basically includes the following postings:
Manufacturing Summary
Direct Raw Materials
Debit Credit
Debit Credit 1. Work-in-process, 5. Work-in-process,
1. Beginning 4. Purchase return beginning end (per account)
Inventory
5. Purchase discounts 2. Direct raw
2. Purchases materials used
6. Manufacturing 6. Transferred to
3. Freight-In Summary 3. Direct Labor Finished goods
(per account)
4. Factory overhead
Direct Labor
Debit Credit
1. Actual payroll
paid 3. Manufacturing
summary Work-In-Process
2. Accrued payroll Debit Credit

Factory Overhead 1. Manufacturing

Summary
Debit Credit
1. Actual payroll, Finished Goods
indirect
Debit Credit
2. Accrued payroll,
indirect
3. Factory utilities 7. Manufacturing 1. Beginning
4. Taxes/Insurances Summary Inventory
5. Depreciation
Factory 2. Manufacturing Finished goods sold
6. Factory supplies
Summary
Notes:
1. The cost of goods manufactured and sold,
computed as follows:
Finished goods, beginning Pxxx Cost of Goods Manufactured and Sold
Add: Transferred to finished goods xxx Debit Credit
Total Pxxx
Less: Finished goods inventory,end xxx 1. Finished goods
Cost of goods manufactured and sold Pxxx sold

2. The appropriate journal entry for the finished goods inventory end would be

Finished goods, end xxx

Income summary xxx

The debit to finished goods end represents the item to be reported in the SFP,
while the credit to income summary is the finished goods end to the income
statement representing a reduction of the cost of finished goods sold during the
period.
Transactions Related to Manufacturing
Process

Business transactions of manufacturing firms are

generally similar to the merchandising firm except that
a merchandising firm doest not produce goods.

The accounting for the production of goods includes

the following pro-forma entries ( comparing periodic
non-cost accounting system from perpetual cost
accounting system):
Transactions Related to Manufacturin
Process
Business transactions of manufacturing
firms are generally similar to the merchan-
dising firm except that a merchandising firm
does not produce goods.

The accounting for the production of

goods includes the following pro-forma
entries (comparing periodic non-cost
accounting system from perpetual cost
accounting system):
 Transactions Related to Manufacturing
Process

Accounting for Materials:

1. Purchased raw materials, P105,000 & factory
supplies, P20,000.

Non-Cost System VS Cost System

Purchases 105 000 Raw Materials, Inty. 105 000

Factory Supplies 20 000 Factory Supplies 20 000

Accounts Payable 125 000 Accounts Payable 125 000

 2. Returned defective raw materials to vendor, P5,000.

Non-Cost System VS Cost System

Accounts Payable 5 000 Accounts Payable 5 000

Purchase Returns 5 000 Raw materials, inty. 5 000

3. Paid the accounts payable less P2,000 cash discount.

Non-Cost System VS Cost System

Accounts Payable 120 000 Accounts Payable 120 000

Cash 118 000 Cash 118 000

Purchase Returns 2 000 Raw materials, inty. 2 000

4. Issued raw materials, P97,000 & factory supplies,
P20,000 for factory use.
Non-Cost System VS Cost System
No entry WIP - Raw Materials 97 000

WIP - Overhead 20 000

Raw materials, Inty. 97 000

Factory Supplies 20 000

5. Returned excess raw materials to storeroom, P2,000.

Non-Cost System VS Cost System

No entry Raw materials, Inty. 2 000

WIP – Raw materials 2 000

Note : WIP means work-in-process

 6. Closed raw materials cost accounts (assume raw
materials beginning is P2,000).

Non-Cost System VS Cost System

Raw materials, Inty. - end 5 000

WIP – Raw materials 95 000

Purchase returns 5 000 No entry

Purchase discounts 2 000

Raw materials, Inty. - beg. 2 000

Purchases 105 000

 Accounting for Labor:
7. Paid payroll of factory: Direct workers, P100,000;
Supervisor, P20,000; Janitor, P3,000.

Non-Cost System VS Cost System

Direct Labor 100 000 WIP, Direct Labor 100 000

Indirect Labor 23 000 WIP, Factor Overhead 23 000

Cash 123 000 Cash 123 000

 8. Closed direct labor cost account.

Non-Cost System VS Cost System

WIP – Direct Labor 100 000 No Entry

Direct Labor 100 000

 Accounting for
Factory Overhead
 9.Recorded other factory overhead expenses:
Depreciation of factory machine, P12,000; Paid
factory insurance expense, P4000 and miscellaneous
factory expense, P1,000.
Non- Cost System VS Cost System
Depreciation expense- Work-in-process, FOH 17,000

factory 12,000 Accum. Depreciation-

Insurance expense- factory machine 12,000

factory 4,000 Cash 5,000

Miscellaneous
expense-
factory 1,000
Accum. Depreciation-

factory machine 12,000

Cash 5,000
10. Summarized factory overhead accounts.
Non- Cost System VS Cost System
Manufacturing overhead
summary 60,000
factory supplies 20,000
Indirect labor 23,000 No entry
Dep’n expense - 12,000
factory
Insurance expense
- factory 4,000

Miscellaneous expense
- factory 1,000
11. Closed factory overhead

Non- Cost System Cost System

VS
Work-in-process, FOH 60,000

Manufacturing No entry
overhead
summary 60,000
Accounting for Cost of
Goods Manufactured
and Sold
12. Recorded 80% goods completed.

Non- Cost System VS Cost System

*Cost of goods Cost of goods
Manufactured 196,000 Manufactured 196,00
0

WIP – Raw 76,000 WIP – Raw 76,000

materials materials
WIP – Direct 80,000 WIP – Direct labor 80,000
labor
WIP - FOH 40,000 WIP – FOH 40,000
13. Closed cost elements of cost of sales (assuming
that finished goods - beginning, P20,000 and finished
goods – ending, P10,000)
Non- Cost System VS Cost System

Cost of goods Cost of goods

Manufactured and 206,000 Manufactured and 206,000

sold sold

*Finished goods, 10,000 Finished goods, 10,000

end end

Finished goods, 20,000 Finished 20,000

beg goods, beg

Cost of goods Cost of goods

manufactured 196,000 manufactured 196,000

 14. Closed revenue and cost of sales to
income summary (assuming that the total
sales is P400,000).

Non- Cost System VS Cost System

Sales 400,000 Sales 400,000

Cost of goods 206,000 Cost of goods 206,000

manufactured 194,000 manufactured 194,000

and sold and sold
Income Income
summary summary
Cost
Accumulation
Procedures

Process Costing
Job Order Costing
Process Costing
 Is a system applicable to continuous
process of production of the same or
similar (i.e. homogenous) goods.
There is no need to determine the
costs of the different groups of
products because the product is
uniform. Thus, each processing
department becomes a cost center.
Job Order Costing
 Is a system of allocating costs to group of
unique products. It is applicable to the
production of customer’s specified
products. Each job becomes a cost center
from which costs are accumulated. A
subsidiary record called a JOB ORDER
SHEET is needed to keep track of all
unfinished jobs (work-in-process) and
finished jobs (finished goods).
 Distinction between Process
Costing and Job Order Costing
Process Costing Job Order Costing
1. Homogenous units pass through a 1. Unique jobs are worked on a time
series of similar process. period.

2. Costs are accumulated by 2. Costs are accumulated by

processing department. individual job order.

3. Unit costs are computed by dividing 3. Unit costs are determine by dividing
the individual processing department’s the total costs on the job cost sheet by
costs by the equivalent units of the number of units on the job.
production.

4. The cost of production report 4. The job cost sheet provides the
provides the detail for the work-in- detail for work-in-process account.
process account for each processing
departments.
Job Order
Costing
Job Order Costing
Assumptions: Raw materials are recorded under perpetual
inventory system. Total materials issuance for the period based on
store requisition slip, patrol costs per payroll summary, and cash
voucher and payable voucher for supplies is as follow:

JOB ORDERS
Total 001 002 003
Direct raw
materials P1,500,000 P1,300,00 P100,000 P100,000
Direct labor 950,000 800,000 100,000 50,000
Indirect labor 475,000 350,000 85,000 40,000
Factory supplies 75,000 50,000 15,000 10,000
P3,000,000 P2,500,000 P300,000 P200,000
Status at the end of
accounting period Completed In process In process
Journal entries
1. To record the costs incurred
GENERAL LEDGER
Page number 200
Date Description
Debit Credit
(a) Work-in-process - materials 1,500,000
Work-in-process - direct labor 950,000
Work-in-process - indirect labor 475,000
Work-in-process - factory supplies 75,000
Raw materials 1,500,000
Cash 1,425,000
Accounts payable 75,000
Note: individual subsidiary ledger for each job order is maintained; hence the
above entries affecting the work-in-process accounts are posted in the general
ledger and subsidiary ledger.
2. To record the completed job order 001
GENERAL LEDGER
Page number 200
Date Description
Debit Credit
(b) Cost of goods manufactured 2,500,000
Work-in-process – Job 001 2,500,000

3. Supposing that Job Order 001 was billed at P3,125,000 (using

perpetual inventory system), the journal entries would be:
GENERAL LEDGER
Page number 200
Date Description
Debit Debit
(c) Accounts receivable 3,125,000
Sales 3,125,000
To record billing for job order 001.

(d) Cost of goods manufactured and sold 2,500,000

Cost of goods manufactured 2,500,000
To record cost of goods sold

(e) Sales 3,125,000

Cost of goods manufactured and sold 3,125,000
Income summary
To close revenue and cost of goods sold
 Just-in-time is a manufacturing model based on the
philosophy that storing inventory is a non-value added
activity that a company should try to reduce or
eliminate. Hence, the best decision is to maintain zero
or minimal inventories.

This manufacturing model implies that products

should be produced when needed in the quantities
needed by customers , so there is little need for work-
in-process or finish goods inventories. In addition, raw
materials should arrive when needed, in the quantities
needed for production.
 JIT is a pull system, that is production
is determined by customer demand , and the
need for raw materials is determined by
production. Accordingly, manufacturing
firms that adopt this model use the
backflush costing system, which is
described as follows:
1. The amount of raw materials purchased , direct labor used, and
manufacturing overhead applied on the cost of goods sold
account for the period will expensed during the same period.

2. At the end of the period, if any inventory remains on hand, it is

necessary to make an entry for the adjustment of the cost of
goods sold account to reflect the cost of the remaining
inventory.

3. The cost of the ending inventory , whether it is a raw material,

work-in-process, or finished goods, is recorded in a current
asset account called raw and in-process inventory.

This accounting method eliminates the need for separate

raw materials, work-in-process and finished goods inventory
accounts, so is saves record-keeping time and cost.
Illustration:
Japan company incurs the ff. cost in connection with
the production of a product named Kamukhamo:

Raw materials purchased P 100,000

Direct labor used 150,000
Manufacturing overhead applied 50,000

At the end of the period the cost of Kamukhamo

still-in-process is P10,000 and there are 5,000 raw material
still unused.

The journal entries of the above JIT production

activities using backflush accounting would be:
 GENERAL JOURNAL The recording of raw materials,
Page Number 100 labor and overhead is eliminated
because the products are
Date Description Debit Credit
presumed to be in accordance
with the customer’s demand.
a) Cost of goods sold 100,000
Accounts payable 100,000 Accordingly, the cost of goods
To record the purchase of sold account is immediately
Inventory on acount debited upon requisition of the
basic manufacturing costs. This
b) Cost of goods sold 150,000 is accordance with the principle
Accrued wages payable 150,000 that the cost of finished goods
To record the labor used in should be expensed at the period
production.
of production.

At the end of the production

c) Cost of goods sold 50,000
period, the raw material unused
Factory overhead 50,000 and the work-in-process are
To record the overhead applied adjusted in the raw and in-
to production process inventory account.

d) Raw and in-process inventory
Cost of goods sold
To record raw materials and
work-in-process inventory
15,000 The cost of goods sold, net of
15,000 raw and in-process inventory at
the end of the period is actually
the amount of the total cost of
goods manufactured and sold.
 Cost of Goods Sold Account
No.16

Debit Credit
Direct Materials 100,000 Raw and in-process 15,000
Direct Labor 150,000
Factory Overhead 50,000

300,000

285,000 Raw and In-Process Inventory Account

No. 18

Debit Credit
Cost of goods sold 15,000
Activity-Based
Costing System

(ABC SYSTEM)
Activity-Based Costing (ABC) System
Activity-based costing uses more than one predetermined
overhead rate to assign overhead costs for each activity utilized
in production. Accordingly, this method ensures that the amount
of overhead assigned represents the resources consumed.
When companies use an activity-based costing(ABC)
system, they first assign estimated manufacturing overhead
costs to activity level called cost pools. A cost pool is a group of
costs that change in response to the same cost driver. Cost
Drivers measure activity in the conversion cycle and are
assumed to cause the change of conversion cycle cost. A good
example of cost driver is the number of hours used for a
particular type of activity.
The following activity-based costing overview facilitates an understanding of the
concept:
ACTIVITY-BASED COSTING OVERVIEW

Activity Level Types of Activities Types of Costs Example of Cost Drivers

Facility Owning buildings Depreciation Number of square feet

sustaining Occupying buildings Property taxes Number of square feet
Using buildings Utilities BTUs of heat produced
Maintaining buildings Insurance Number of square feet

Product Testing products Testing costs* Number of tests required

sustaining Designing products Design costs* Number of hours of design time
Maintaining products inventory Carrying costs* Number of parts required
Using specialized machinery Depreciation No. of specialized processes required

Batch related Ordering parts Ordering costs* Number of orders placed

Setting up machines Setup costs* Number of setups required
Handling materials Moving costs* Number of moves required
Requisitioning parts Requisition cost Number of requisition made

Unit related Cutting/drilling units Power costs Number of machine hours

Assembling units Indirect labor Number of labor hours
Painting units Indirect material Direct materials cost
Inspecting units Rework costs* Number of units reworked
*Includes the salaries and wages of those individuals involved in the acitivity.
Illustration
Assume the following costs and cost drivers of the cost
pools of New Products Manufacturing Company:

Predetermined overhead rates:

Cost drivers Costs assigned Total cost driver Cost driver per unit

Building costs P400,000 100,000 sq. ft. P4 per square foot

P10 per development
Development costs P200,000 20,000 hours
hour
Product testing costs P 30,000 30 quality test P1,000 per test
P1,000 per production
Setup and inspection P150,000 150 production runs
run
10,000 machine
Machine usage costs P 50,000 P5 per machine hour
hours
 Assuming that during the period, the production of New
Products Manufacturing Company actually required the
following resources to produce Kamukhamo products:
•3,000 square feet of building space
•2,000 hours of development time
•10 quality tests
•150 production runs
•1,000 machine runs
Using the predetermined overhead rates, the manufacturing overhead
is applied to the production, as follows:

Building costs: (P 4x 3,000 sq.feet) = P 12,000

Development costs: (P10x 2,000 devt.hours) = 20,000
Product testing costs: (P1,0000x10 quality tests) = 10,000
Setup and inspection costs: (P1,000x150 production runs) = 150,000
Machine usage costs: (P5x1000) = 5,000
Total Manufacturing overhead applied in the period = P 197,000
The appropriate journal entry to reflect the applied
manufacturing overhead costs for the period would be:

GENERAL JOURNAL
Page
100
Number
Date Descriptions Debit Credit
a) Work-in-process inventory – Kamukhamo 197,000
Factory overhead – Building 12,000
Factory overhead – Development 20,000
Factory overhead – Testing 10,000
Factory overhead – Setup and inspection 150,00
0
Factory overhead – Machining 5,000
To record applied manufacturing overhead for
The period