You are on page 1of 20

Manufacturing company have to convert raw materials to finished goods and then sale them to customers

Unlike the merchandising company where the company have only to purchase the finished products from the supplier and then resale them to the customer.

There are four financial statements of a manufacturing business: 1. Balance sheet 2. Income statement 3. Cost of goods manufactured statement 4. Statement of cash flow

Net Income Statement

Net income = sales - cost of goods sold - operating expenses The difference between sales and cost of goods sold is often reported as gross profit.

Balance Sheet

Assets = liabilities + stockholders equity Assets = current assets + fixed assets + other assets Liabilities = current liabilities + long-term liabilities Stockholders equity = common stock + premium/discount on common stock + retained earnings

Statement of Cash Flow

Change in cash = sources and uses from operations + sources and uses from financing activities + sources and uses from investing activities.

Income Statement

The income statement consists of four different sections, the heading, sales, cost of goods sold and general & administrative expense. Regardless which type of arts and crafts business you own(service , merchandise, or manufacture), your income statement shows sales, manufacturing and merchandising businesses will have a cost of goods sold and all three types will have general and administrative expenses. Manufacturing and merchandising businesses differ in the part of inventory. Merchandise and manufacture difference in inventory 1-Merchandisers purchase inventory that they then sell without any changes. In the cost of goods sold calculation, merchandisers only deal with one inventory, merchandise inventory.

2-On the other hand, manufacturers have three inventories. The three inventories are1) raw materials, 2) work in process/progress, and 3) finished goods.

Additional costs are to be determined due to the manufacturing process are labor and overhead costs Insurance factory Indirect labor Machine rental Utilities factory Supplies Depreciation, factory Property taxes, factory These three inventory accounts capture the costs that are associated with production and are what make the Cost of Goods Manufactured Schedule necessary.

Raw materials consist of all the items you buy to make your arts and crafts Work in process are all your items that you are in the middle of making at

products. For example, a clothing designer will have fabric, notions and patterns. the end of the financial period. For example, if the clothing designer has five dresses in various stages of completion, work in process is the value of those five dresses. Following along in that same line of logic, the value of all completed dresses that are not yet sold to merchandisers are included in your finished goods inventory.

Income Statement for a manufacturing Business


Income Statement For the 4th quarter, Year 1 Sales $17,123,428 Cost of goods sold 7,878,470 Gross profit 9,244,958 Expenses Selling 8,733,425 General and Admin. 924,313 Fixed mfg. overhead 1,889,574 Total expenses 11,547,312 Net operating income (2,302,354) Other income & expenses (112,500) Income taxes (965,941) Net loss ($1,448,912)

Cost of goods sold = finished goods (beginning) + cost of goods manufactured - finished goods (ending) Finished goods (beginning) plus cost of goods manufactured is often called goods available for sale. Net income = sales cost of goods sold operating expenses The difference between sales and cost of goods sold is often reported as gross Profit.

Cost of Goods Manufactured Statement For the 4th Quarter, Year 1 Materials Inventory (B) $1,940,160 Material Purchases 4,892,160 _________ 6,832,320 Materials Inventory (E) 2,065,114 _________ Material used 4,767,206 Factory labor 2,787,840 Manufacturing Overhead (V) 323,424 _________ $7,878,470 _________ _________ Units manufactured 57,027 Cost per unit 138.16 _________

Cost of Good Manufactured

Material used = materials (beginning) + material purchases materials inventory(ending) Cost of goods manufactured = materials used + factory labor + manufacturing overhead + work in process (beginning) work in process (ending)

The five basic elements of cost of goods manufactured are:


1. Materials used 2. Factory labor 3. Manufacturing overhead Manufac . costs this period 4. Work in process inventory (B) Total manufacturing costs 5. Work in process inventory (E) $ 20,000 35,000 25,000 80000 20,000 1ooooo 25,000

$75000

1. Materials inventory (B) 2. Material purchases Materials available 3. Materials inventory (E)

Materials Used

$ 5,000 25,000 30,000 10,000 $20,000

Merchandising Business
1. Assets Current assets Cash Accounts receivable Merchandise inventory Fixed assets 2. Liabilities Current liabilities Long-term liabilities 3. Stockholders Equity Paid-in capital Retained earnings $ 50,000 30,000 65,000 $ 55,000 $200,000

Manufacturing Business
Assets Current assets Cash Accounts receivable Inventory Work in process Materials Finished goods Fixed assets 2. Liabilities Current liabilities Long-term liabilities 3. Stockholders Equity Paid-in capital Retained earnings $ 50,000 30,000 25,000 10,000 30,000 55,000 $200,000

$ 20,000 30,000 30,000 120,000 $200,000

$ 20,000 30,000 30,000 120,000 $200,000

In the merchandize we use only the inventory.

The manufacturing business has a number of unique transactions not found in a merchandising business. These transactions as a whole all fall into the manufacturing costs category. Basically, there are three types of manufacturing transactions: 1. Material 2. Factory labor 3. Manufacturing overhead

Examples of manufacturing overhead incurred include: 1. Indirect factory labor and indirect material 2. Factory utilities 3. Repairs and maintenance on factory equipment 4. Factory insurance 5. Depreciation on factory equipment

Cash flow statement

The cash flow statement is divided into three sections: o Cash flow from operating activities o Cash flow from investing activities o Cash flow from financing activities

Exceptions due cash flow statement

Short-term marketable securities are treated as long-term investments and appear in cash flow from investing activities

Short-term debt is treated as longterm debt and appears in cash flow from financing activities

Although dividends are handled as a cash outflow in the cash flow from financing activities section, interest payments are considered an operating outflow, despite the fact that both are payments to outsiders for using their money.

Cash Flow from Operating Activities Net Income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Changes in other accounts affecting operations: (Increase)/decrease in accounts receivable (Increase)/decrease in inventories (Increase)/decrease in prepaid expenses Increase/(decrease) in accounts payable Increase/(decrease) in taxes payable Net cash provided by operating activities Cash Flow from Investing Activities Capital expenditures Proceeds from sales of equipment Proceeds from sales of investments Investments in subsidiary Net cash provided by investing activities Cash Flow from Financing Activities Payments of long-term debt Proceeds from issuance of long-term debt Proceeds from issuance of common stock Dividends paid Purchase of treasury stock Net cash provided by financing activities Increase (Decrease) in cash

Statement of Cash Flows


XXX,XXX XX,XXX

X,XXX X,XXX X,XXX X,XXX X,XXX XXX,XXX


(XXX,XXX) XX,XXX XX,XXX (XXX,XXX) (XXX,XXX) (XX,XXX) XX,XXX XXX,XXX (XX,XXX) (XX,XXX) (XX,XXX) XXXXX

o The cash flow from operating activities section of a cash flow statement can be presented using the direct format or the indirect format.

Cash flow from operating activities Two formats


Cash received from customers Cash paid to suppliers Cash paid to employees Other cash operating Net cash provided b y operating Activities

Direct

$400000 -260000 -70000 - 30000 $40000

Net Income

Indirect

$30,000

Depreciation 25,000 Changes in other accounts affecting operations: (Increase) in receivables -12,000 Decrease in inventory 5,000 (Decrease) in payables -8,000 Net cash provided by operating 40,000 activities

Notes important to know


The treatment of fixed manufactured overhead ,there are consequences that makes the two methods : Absorption Costing can be diagramed in T-accounts as follows:
Material

Work in process
Factory Labor

Finished Goods

Cost of Good Sold Income summary

Variable Overhead

Fixed Overhead

Absorption costing: includes all manufacturing costs --- including direct materials, direct labor, and BOTH variable and fixed manufacturing overhead. Absorption Costing = Full Costing

Material

Direct Costing can be diagramed in T-accounts as follow Variable costing: includes only variable manufacturing costs --- direct materials, direct labor, and variable manufacturing overhead.

Factory Labor

The entire amount of fixed costs are expenses in the year incurred.

Work in Process

Finished Goods

Cost of Good Sold

Income Summary

Variable Overhead

Fixed Overhead

Direct Labor definition: Work involved directly in making the product is classified as 'Direct Labor', sometime referred to as "touch labor". For example, Assembly Operator, Fabrication Operator, Testing Operator, etc. Dictionary of small business defines Direct Labor as 'Personnel assigned to production process whose payroll expenses are traced to the units of output and are included in cost of goods sold.'

Distinguish between terminologies

Indirect Labor definition: Indirect Labor consists of support activities that do not contribute directly in making the product. For example, Material Handling Operator, Support Technician, Engineers, etc. Dictionary of small business defines Indirect Labor as 'Personnel assigned to tasks other than producing products. It is included as a part of operating expenses.

Work in Process

Material that has entered the production process but is not yet a finished product. Work in progress (WIP) therefore refers to all materials and partly finished products that are at various stages of the production process. WIP excludes inventory of raw materials at the start of the production cycle and finished products inventory at the end of the production cycle.

While
Finished Goods
Completely manufactured products which ready for sale and delivery to the marketplace.

Definition of 'Variable Overhead or Indirect Costs The indirect costs of operating a business that fluctuate somewhat with the level of business activity. Example Overhead costs that increase with higher business activity and decrease with lower business activity are termed as variable overhead. These usually consist of indirect material, indirect labor and other costs that cannot be directly allocated to a specific product, such as expenses for utilities and supplies and equipment repair and maintenance , power , fuel, and lubricant.

Definition of Fixed Overhead or Direct Costs Are costs that stay the same whether sales or production go up or down. Example Are those costs like rent, utilities, basic telephone, loan payments , insurance ,office expense, etc.

Effect of Variations in Production Units and Sales Units

In order to fully understand the difference consequences of using absorption costing as opposed to using direct costing, the effect of production being more or less than units sold needs to be clearly understood. Some important relationships are the following:

1. When production units equals sales units, there is no difference in net income between absorption costing and direct costing. If inventories do not change, then there is no change in the fixed manufacturing overhead costs in inventories under absorption costing. Therefore, under both costing methods all of the current fixed manufacturing overhead will flow through to the income statement as an expense. In the case of absorption costing it will be part of cost of goods sold. In the case of variable costing, it will be a period expense. 2. When production (units) is greater than units sold, absorption costing will show greater net income than direct costing. When production exceeds sales, inventories grow. If inventories grow, then some of the current fixed manufacturing overhead costs will be deferred or absorbed in inventories under absorption costing. Since all of the current fixed manufacturing overhead costs are expensed under variable costing, the net operating income reported under absorption costing will be greater than the net operating income reported

3. When production is less than units sold, absorption costing will show less net income than direct costing. When sales exceed production, inventories shrink. If inventories decrease, then some of the fixed manufacturing overhead costs that had been deferred in inventories in previous periods will be released to the income statement as part of cost of goods sold as well as all of the current fixed manufacturing overhead costs. Since only the current fixed manufacturing overhead costs are expensed under variable costing, the net operating income reported under absorption costing will be less than the net operating income reported under variable costing.

4. Changes in production volume. Variable costing net operating income is not affected by changes in production volume. On the other hand, absorption costing net operating income is affected by changes in production volume. For any given level of sales, net operating income under absorption costing will increase as the level of output increases and hence inventories increase.