ACCOUNTING FOR

MANUFACTURING
BUSINESS

Credits:
South-Western, Thomson Learning
Warren and Reeve
Douglas Cloud
DIRECT AND INDIRECT COST
Costs are often classified in terms of how
they relate to some object or segment of
operations, called a cost object. It may be a
product, a sales territory, a department, or
some activity. Costs are identified with cost
objects as either direct costs or indirect costs.
1-2
DIRECT MATERIALS COST

The cost of any material that is an

integral part of the final product is
classified as a direct materials cost.
DIRECT LABOR COST

The wages of each employee who is

directly involved in converting
materials into the final product are
classified as direct labor cost.
FACTORY OVERHEAD COST

Costs, other than direct materials cost and

direct labor costs, that are incurred in the
manufacturing process are combined and
classified as factory overhead cost
(sometimes also called manufacturing
overhead or factory burden).
EXAMPLES OF FACTORY OVERHEAD COST

▪ Heating and lighting the factory

▪ Repairing and maintaining factory equipment
▪ Depreciation of factory plant and equipment
▪ Indirect labor such as production supervisor’s
salary
▪ Indirect materials
▪ All product costs (NOT period costs) associated
to factory or production which are NOT direct
materials and NOT direct labor
PRIME COSTS AND CONVERSION COSTS

Direct
Materials
Prime
Costs
Direct
Labor
Conversion
Costs
Factory
Overhead
PRODUCT COSTS
Product costs consist of the three
elements of manufacturing cost:
1. Direct materials
2. Direct labor
3. Factory overhead
PRODUCT COSTS
The cost of materials
Direct that are an integral
Materials part of the product.

The cost of labor

Product Direct directly involved in
Costs Labor converting material into
the product.

Manufacturing costs
Factory other than direct
Overhead materials and direct
labor.
PERIOD COSTS
Period costs are generally classified into two categories:

Selling expenses are incurred in marketing

the product and delivering the sold
product to the customer.
Administrative expenses are incurred in
the administration of the business.
(Continued)
(Concluded)
PRODUCT COSTS AND PERIOD COSTS
A MANUFACTURING FIRM’S INVENTORIES

Materials inventory:
▪ Sometimes called raw materials
inventory
▪ Consists of the costs of the direct and
indirect materials that have not yet
entered the manufacturing process
Work in process inventory:
▪ Consists of the direct materials costs,
the direct labor costs, and the factory
overhead costs that have entered the
manufacturing process but are
associated with products that have
NOT been completed.
Finished goods inventory:
▪ Consists of completed (or finished)
products that have not been sold.

Factory supplies inventory:

▪ Consists of unused indirect materials
at period end.
 Now: Statement of Financial Position
Balance Sheet Presentation
of Inventory in Manufacturing
and Merchandising Companies
FLOW OF MANUFACTURING COSTS
DETERMINING THE
COST OF GOODS MANUFACTURED
STEP 1:
Materials inventory, December 1, 2008 $ 65,000
Add: materials purchased during December 100,000
Cost of materials available for use $165,000
Less: materials inventory, Dec. 31, 2008 35,000
Cost of materials placed in production $130,000
to total manu-
facturing cost
DETERMINING THE
COST OF GOODS MANUFACTURED
STEP 2:
Cost of materials placed in production $130,000

from Step 1
 DETERMINING THE COST OF
GOODS MANUFACTURED

STEP 2:
Cost of materials placed in production $130,000
Direct labor 110,000
Factory overhead 44,000
Total manufacturing costs added $284,000

to cost of goods
manufactured
Also known as Total Manufacturing Costs section
 DETERMINING THE COST OF
GOODS MANUFACTURED

STEP 3:
Work in process inventory, Dec. 1, 2008 $ 30,000
Add: total manufacturing costs added 284,000

from Step 2

Also known as Total Manufacturing Costs

DETERMINING THE COST OF
GOODS MANUFACTURED

STEP 3:
Work in process inventory, Dec. 1, 2008 $ 30,000
Add: total manufacturing costs added 284,000
Total manufacturing costs $314,000
Less: work in process inventory 24,000
Cost of goods manufactured $290,000

Also known as Total Manufacturing Costs

Also known as Total Costs of Goods Placed in Process

Manufacturing Company—
Income Statement with
Statement of Cost of
Goods Manufactured (cont’d)

to income
statement
Manufacturing Company—
Income Statement with
Statement of Cost of
Goods Manufactured

from
statement of
cost of goods
manufactured
Manufacturing Costs and
Inventories for Legend Guitar
Company

(Continued)
Manufacturing Costs and
Inventories for Legend Guitar
Company

(Concluded)
Cost Accounting System Overview

A job order cost system provides a separate

record for the cost of each quantity of product
that passes through the factory. A particular
quantity of product is termed job.
Manufacturers that use a job order cost system
are sometimes called job shops.
 Under a process cost system, costs are
accumulated for each of the departments or
processes within the factory. A process system is
best suited for manufacturers of units of product
that are not distinguishable from each other
during a continuous production process.
Materials

Purchased materials are first

received and inspected by
the Receiving Department.
Receiving
Report
Once inspected, a receiving
No. 196 report is prepared showing
the quantity received and its
condition.
 Receiving
Report Invoice
No. 196

The receiving report and the invoice are used

to record the receipt of the merchandise and
to control the payment for purchased items.
 Receiving
Report 750 units of Invoice
No. 196 No. 8 Maple

a. Materials 10 500 00
Accounts Payable 10 500 00
Materials purchased during
December.
 The Materials account is a
controlling account. A separate
account for each type of
material is maintained in a
subsidiary materials ledger.
 Materials Information and Cost
Flows (continued)

MATERIALS LEDGER ACCOUNT

MATERIAL: No. 8 Wood - Maple ORDER POINT: 500 ft.
RECEIVED ISSUED BALANCE

Rec. Mat.
Report Req. Unit
No. Quantity Amount No. Quantity Amount Date Quantity Amount Price
Dec. 1 600 $ 6,000 $10.00
672 200 $ 2,000 4 400 4,000 10.00
196 750 $10,500 8 400 4,000 10.00
750 10,500 14.00

Receiving
Report
No. 196
 2-2

To illustrate the issuing of materials,

assume that on December 12 Materials
Requisition Number 704 is prepared for
Job No. 72 requisitioning 400 units of
No. 8 Wood—Maple at $10 per unit,
and 500 units of No. 4 Wood—Maple
at $14 per unit.
 Materials Information and Cost
Flows (continued)

MATERIALS LEDGER ACCOUNT

MATERIAL: No. 8 Wood - Maple ORDER POINT: 500 ft.
RECEIVED ISSUED BALANCE

Rec. Mat.
Report Req. Unit
No. Quantity Amount No. Quantity Amount Date Quantity Amount Price
Dec. 1 600 $ 6,000 $10.00
672 200 $ 2,000 4 400 4,000 10.00
196 750 $10,500 8 400 4,000 10.00
750 10,500 14.00
704 900 11,000 12 250 2,500 14.00

To materials requisitions
Materials Information and Cost
Flows (continued)

from
materials
ledger
account

to job cost
sheet
Materials Information and Cost
Flows (continued)

From
materials
requisition
 Materials Information and Cost
Flows (continued)
The procedure was similar earlier when materials were
requisitioned for Job 672.
MATERIALS LEDGER ACCOUNT
MATERIAL: No. 8 Wood - Maple ORDER POINT: 500 ft.
RECEIVED ISSUED BALANCE

Rec. Mat.
Report Req. Unit
No. Quantity Amount No. Quantity Amount Date Quantity Amount Price
Dec. 1 600 $ 6,000 $10.00
672 200 $ 2,000 4 400 4,000 10.00
196 750 $10,500 8 400 4,000 10.00
750 10,500 14.00
704 400 11,000 12 250 3,500 14.00

to materials requisitions
Materials Information and Cost
Flows (continued)

from materials
ledger account
Materials Information and Cost
Flows (continued)

from
materials
requisitions
Materials Information and Cost Flows (concluded)
The flow of materials from the materials storeroom into
production ($2,000 + $11,000) is recorded by the following
entry:

b. Work in Process 13 000 00

Materials 13 000 00
Materials requisition to
jobs.
Factory Labor

The amount of time spent by an employee in

the factory is usually recorded on clock
cards or in-and-out cards. The amount of
time spent by each employee and the labor
cost incurred for each individual job are
recorded on time tickets.
 2-2

Legend Guitars incurred

850 direct labor hours on
Jobs 71 and 72 during
December. The total direct
labor costs were $11,000,
divided into $3,500 for Job
71 and $7,500 for Job 72.
 Labor Information and Cost
Flows (continued)

Only Job 72
is illustrated TIME TICKET
in Slides 29 No. 6311
and 30. Employee Name S. Andrews
Date Dec. 26, 2008
December Job Work Description Assembling
Job No. 72
72 (500 total
Start Finish Hours Hourly
hours) for a total Time Time Worked Rate Cost
cost of $7,500 9:00 12:00 3 $15.00 $45.00
1:00 6:00 5 15.00 75.00

to Job Cost Sheet

Total Cost $120.00 18
A. M.
Approved by _____________________________
 Labor Information and Cost
Flows (continued)

Job Cost Sheet

Job 72
60 units of America Series Guitars

Direct materials $11,000 from

Direct labor 7,500 Time
Factory overhead
Sheets

The same procedure is followed for Job 71.

Labor Information and Cost Flows (concluded)

Both jobs
are
shown
here.
The labor costs that flow into production are recorded by the
following summary entry to the Work in Process controlling
account.

c. Work in Process 11 000 00

Wages Payable 11 000 00
Factory labor used in
production of jobs.
Factory Overhead Cost

Factory overhead includes all manufacturing

costs except direct materials and direct labor.
Factory overhead includes such items as
indirect materials, indirect labor, factory
power, and factory depreciation.
The factory overhead of $4,600 incurred in December
for Legend Guitars would be recorded as follows:

d. Factory Overhead 4 600 00

Materials 500 00
Wages Payable 2 000 00
Utilities Payable 900 00
Accumulated Depreciation 1 200 00
Factory overhead incurred.
Allocating Factory Overhead

Factory overhead costs are assigned to the

jobs on the basis of some known measure
about each job. The measure used to allocate
factory overhead is frequently called an
activity base, allocation base, or activity
driver.
Predetermined Factory Overhead Rate

To provide current job costs, factory

overhead may be allocated or applied to
production using a predetermined
factory overhead rate. This rate is
calculated using the following formula:
Estimated Total
Predetermined Factory Overhead Costs
factory overhead rate = Estimated Activity Base
 2-2

An activity base is chosen for the denominator of the

formula that is relevant to overhead and can be
realistically measured. There are several possibilities
for Legend Guitars.

Activity base possibilities

1. Direct labor hours
2. Direct labor dollars
3. Machine hours
4. Direct materials
Management estimates factory overhead costs to be $50,000
and the activity base to be 10,000 direct labor hours. The
predetermined overhead rate is calculated below.
Predetermined Estimated Total Factory Overhead Costs
Factory =
Estimated Direct Labor Hours
Overhead Rate
Predetermined $50,000
Factory =
10,000 direct labor hours
Overhead Rate
Predetermined
Factory = $5 per direct labor hour
Overhead Rate
 Assigning Factory Overhead
to Jobs

TIME TICKET
Recall that Job 72 No. 6311
required 500 Employee Name B. Andrews
direct labor hours. Date Dec. 26, 2008
Because the Work Description Assembling
number of direct Job No. 72
labor hours is the Start Finish Hours Hourly
cost driver, we Time Time Worked Rate Cost
use 500 as the 9:00 12:00 3 $15.00 $45.00
basis for 1:00 6:00 5 15.00 75.00
determining
overhead.
18
Total Cost $120.00
A. M.
Approved by _____________________________
 Assigning Factory Overhead
to Jobs (continued)

Job Cost Sheet

Job 72
60 units of American Series Guitars

Direct materials $11,000

Direct Labor 7,500
2,500
500 hours
Factory Overhead
Total job cost $21,000 x $5
 Assigning Factory Overhead
to Jobs

(Concluded)
 This illustration has primarily
focused on Job 72. The textbook
shows two jobs that were worked
on in December. So, when
overhead is applied to both jobs,
the entry is for $4,250.
The summary entry to apply the $4,250 of factory
overhead ($1,750 + $2,500) is as follows:

e. Work in Process 4 250 00

Factory Overhead 4 250 00
Factory overhead applied
to jobs according to the
predetermined overhead
rate.
Overapplied and Underapplied

ACCOUNT Factory Overhead ACCOUNT NO.

Post. Balance
Date Item Ref. Debit Credit Debit Credit
Dec. 1 Balance 200
31 FO cost incurred 4,600 4,400
31 FO cost applied 4,250 150

Overapplied
At the beginning of December, (overabsorbed)
Factory Overhead was overapplied
(overabsorbed).
Overapplied and Underapplied

ACCOUNT Factory Overhead ACCOUNT NO.

Post. Balance
Date Item Ref. Debit Credit Debit Credit
Dec. 1 Balance 200
31 FO cost incurred 4,600 4,400
31 FO cost applied 4,250 150

At the end of December, Factory

Overhead was overapplied Underapplied
(overabsorbed). (underabsorbed)
Disposal of Factory Overhead Balance

The journal entry to eliminate Legend Guitars’

underapplied overhead balance of $150 at the end of
the calendar year would be:

f. Cost of Goods Sold 150 00

Factory Overhead 150 00
Closed underapplied factory
overhead to cost of goods
sold.
Job Cost Sheets and the Work
in Process Controlling
Account
At the end of the accounting period (December) the total
costs for all completed jobs during the period are determined
and the following entry is made:

g. Finished Goods 10 250 00

Work in Process 10 250 00
Job 71 completed in
December.
Finished Goods and Cost of
Goods Sold

The Finished Goods account

is a controlling account. Its
related subsidiary ledger,
which has an account for
each product, is called the
finished goods ledger or
stock ledger.
Finished Goods Ledger
Account
Using the first-in, first-out method to determine cost
data, a summary entry is made to record the cost of
the units shipped.

h. Cost of Goods Sold 20 000 00

Finished Goods 20 000 00
Cost of 40 Jazz Series
guitars sold.
Sales

Legend Guitars sold the 40 Jazz Series guitars during

December for $850 per unit. The entry would be:

i. Accounts Receivable 34 000 00

Sales 34 000 00
Revenue received from
guitars sold.
Period Costs

Period costs are expenses that are used

in generating revenue during the current
period and are not involved in the
manufacturing process. Period costs are
generally classified into two categories:
selling and administrative.
▪ Selling expenses are incurred
in marketing the product and
delivering the sold product to
the customer.
▪ Administrative expenses are
incurred in the administration
of the business.
 The Legend Guitars, the following period
expenses for December:

j. Sales Salaries Expense 2 000 00

Office Salaries Expense 1 500 00
Salaries Payable 3 500 00
Recorded December period
costs.
Summary of Cost Flows for Legend Guitars
Costs & Expenses
Product Costs Balance Sheet

Materials Materials
Purchases Inventory

Direct
Work in Cost of goods
Labor
Process manufactured
Inventory
Factory
Overhead
Finished
Goods
Inventory
Summary of Cost Flows for Legend Guitars
Costs & Expenses
Product Costs Balance Sheet

Materials Materials
Purchases Inventory
Period costs flow
Direct directly to the
Work in
Labor
Process income statement
Inventory
Factory
Overhead
Income Statement
Finished
Goods Cost of
Inventory Goods Sold
Period Costs
Selling and Selling and
Administrative Administrative
66
Flow of Manufacturing Costs
for Legend Guitars

(Continued)
Flow of Manufacturing Costs
for Legend Guitars

(Continued)
 Flow of Manufacturing Costs
for Legend Guitars (concluded)

The full
exhibit

(Concluded) 69
Income Statement of
Legend Guitars