HBC 220 – Topic 9 Accounting for Manufacturing

Learning Objectives 1.Distinguish between costs and expenses, and understand how different costs are used for different purposes 2.Define and identify the 3 manufacturing cost elements — direct materials, direct labour and factory overhead

Learning Objectives (cont’d) 3.Explain the basic nature of absorption costing and a cost allocation based on cost behaviour Identify the essential differences in the financial statements for retail and manufacturing entities

Learning Objectives (cont’d) 5.Describe the additional accounts and accounting procedures required for a manufacturing entity. Understand how a manager can use the financial reports for a manufacturing entity for control and decision making

Learning Objectives 7.Explain the nature of cost accounting 8.Describe the flow of costs in a job order cost accounting system 9.Explain the accounting procedures used in job order cost systems

Learning Objectives (cont’d) 10.Understand how costing and cost accounting are applied in service businesses 11.Understand the basic principles of a just-in- time processing system

Lecture References Hoggett, Edwards & Medlin, 6th edition, Chapter 8, 9

Cost Classifications LO. 1 Cost –Economic sacrifice of resources made in exchange for a product or service Expense –Consumption or loss of resources

Manufacturing Cost Elements LO. 2 Direct materials cost Direct labour cost Factory overhead cost –Allocation of common costs –Assignment of service department costs –Assignment of factory overhead costs

Absorption Costing and Cost Behaviour LO. 3 Absorption costing –All direct manufacturing costs treated as product costs Direct costing –Recognises as product costs only manufacturing costs that vary in relation to production levels

Absorption Costing and Cost Behaviour (cont’d) Variable costs –Costs which vary directly, or nearly directly, with the volume of production Fixed costs –Costs which remain relatively constant regardless of the production level

Financial Statements – Retailing and Manufacturing LO. 4 Cost of Sales Retailing Beginning + Net purchases – Ending = Cost of Inventory of inventory Inventory goods sold Beginning + Net purchases – Ending = Cost of Inventory of inventory Inventory goods sold Manufacturing Beg. finished + Cost of goods – End. finished = Cost of goods inventory manufactured goods inventory goods sold Beg. finished + Cost of goods – End. finished = Cost of goods inventory manufactured goods inventory goods sold

A Retail Entity Income Statement Net Sales Revenue$ Less: Cost of sales Beginning inventory$ Net purchases Goods available Ending inventory Cost of sales GROSS PROFIT EXPENSES Selling & distribution Administrative Finance & other NET PROFIT BEFORE TAX Income tax expense PROFIT $ A Retail Entity Income Statement Net Sales Revenue$ Less: Cost of sales Beginning inventory$ Net purchases Goods available Ending inventory Cost of sales GROSS PROFIT EXPENSES Selling & distribution Administrative Finance & other NET PROFIT BEFORE TAX Income tax expense PROFIT $

A Manufacturing Entity Income Statement Net Sales Revenue$ Less: Cost of sales Beginning finished goods inventory$ Cost of goods manufactured Goods available Ending finished goods inventory Cost of sales GROSS PROFIT EXPENSES Selling & distribution Administrative Finance & other NET PROFIT BEFORE TAX Income tax expense PROFIT $ A Manufacturing Entity Income Statement Net Sales Revenue$ Less: Cost of sales Beginning finished goods inventory$ Cost of goods manufactured Goods available Ending finished goods inventory Cost of sales GROSS PROFIT EXPENSES Selling & distribution Administrative Finance & other NET PROFIT BEFORE TAX Income tax expense PROFIT $42 000

A Manufacturing Entity Cost of Goods Manufactured Statement Direct materials: Beginning raw materials$ Net purchases of raw materials Ending raw materials Direct materials used$ Direct labour Factory overhead: Indirect labour Supplies5 000 Electricity Rent Insurance Rates & taxes Depreciation Miscellaneous4 000 Total factory overhead Manufacturing costs for the period Beginning work in progress Total work in progress Ending work in progress COST OF GOODS MANUFACTURED$ A Manufacturing Entity Cost of Goods Manufactured Statement Direct materials: Beginning raw materials$ Net purchases of raw materials Ending raw materials Direct materials used$ Direct labour Factory overhead: Indirect labour Supplies5 000 Electricity Rent Insurance Rates & taxes Depreciation Miscellaneous4 000 Total factory overhead Manufacturing costs for the period Beginning work in progress Total work in progress Ending work in progress COST OF GOODS MANUFACTURED$

Balance Sheet as at 30 June 2006 A Retail Entity CURRENT ASSETS Cash at bank$ A/C’s receivable Inventories* Other TOTAL CURRENT ASSETS$ * All finished goods A Retail Entity CURRENT ASSETS Cash at bank$ A/C’s receivable Inventories* Other TOTAL CURRENT ASSETS$ * All finished goods A Manufacturing Entity CURRENT ASSETS Cash at bank$ A/C;s receivable Inventories: Finished goods Work in progress Raw materials Other TOTAL CURRENT ASSETS$ A Manufacturing Entity CURRENT ASSETS Cash at bank$ A/C;s receivable Inventories: Finished goods Work in progress Raw materials Other TOTAL CURRENT ASSETS$

Accounting Systems Considerations LO. 5 Periodic inventory system –Additional accounts required Raw materials inventory Raw materials purchases WIP inventory Finished goods inventory Manufacturing plant and equipment

Accounting Systems Considerations (cont’d) Periodic inventory system –Additional accounts required Factory payroll Factory overhead Manufacturing summary – Worksheets Additional two columns required to record manufacturing data

Accounting Systems Considerations (cont’d) Closing entries –Account balance used to determine cost of goods manufactured closed to ‘Manufacturing Summary’ account –Manufacturing summary closed to Profit and Loss Summary account

Accounting Systems Considerations (cont’d) Valuation of inventories –All three types of inventory valued at the end of the accounting period –Raw materials and finished goods Inventory counted and costed –Work in process Judgement required, usually an educated guess.

Management Analysis LO. 6 Inventories Raw materials turnover ratio = Cost of raw materials used Average raw materials inventory Raw materials turnover ratio = Cost of raw materials used Average raw materials inventory Control of costs Cost of raw materials ratio = Direct materials cost Cost of goods manufactured Cost of raw materials ratio = Direct materials cost Cost of goods manufactured

Cost Accounting LO. 7 Cost information recorded in separate ledger accounts –Product costs used to value WIP and finished goods –Facilitates management decisions Non-manufacturing entities –Used to determine cost of services

Cost Accounting (cont’d) Two types of cost accounting systems Job order costing –Used when items produced can be separately identified Process costing –Products manufactured on a continuous basis Cost accounting in non-manufacturing entities

Job Order Costing LO. 8 Costs assigned to each job Requires well defined beginning and completion time Can be used for a single product Needs a perpetual inventory system

Job Order Costing (cont’d) Cost flows in a job order system –Inventory controlled via general ledger control accounts and subsidiary ledgers –Productions costs: Recorded Assigned to production (WIP) Assigned to finished goods when job completed

Job Order Costing (cont’d) Job cost order Control account –Itemised listing of production costs: materials labour overhead –Serves as a subsidiary ledger –Control number assigned to each job started

Job Order Costing Procedures LO. 9 Accounting for materials –materials requisition DateRaw Material Inventory GST Outlays4 250 Accounts Payable to record raw materials purchased DateRaw Material Inventory GST Outlays4 250 Accounts Payable to record raw materials purchased DateWIP Inventory Factory Overhead1 680 Raw Material Inventory to record raw materials requisitioned DateWIP Inventory Factory Overhead1 680 Raw Material Inventory to record raw materials requisitioned

Job Order Costing Procedures (cont’d) Accounting for labour DateGeneral Wages & Salaries Factory Wages & Salaries Deductions (various) Wages Payable to record payroll for January DateGeneral Wages & Salaries Factory Wages & Salaries Deductions (various) Wages Payable to record payroll for January DateWIP Inventory Factory Overhead6 200 Factory Wages & Salaries to assign direct and indirect labour DateWIP Inventory Factory Overhead6 200 Factory Wages & Salaries to assign direct and indirect labour

Job Order Costing Procedures (cont’d) Accounting for factory overhead –predetermined overhead rate Predetermined = Estimated annual factory overhead cost overhead rate Estimated annual level of production activity Predetermined = Estimated annual factory overhead cost overhead rate Estimated annual level of production activity DateWIP InventoryXX Factory Overhead AppliedXX to record factory overhead applied DateWIP InventoryXX Factory Overhead AppliedXX to record factory overhead applied

Job Order Costing Procedures (cont’d) Over/under-applied overhead DateFactory Overhead AppliedXX Factory OverheadXX to transfer overhead applied to overhead a/c DateFactory Overhead AppliedXX Factory OverheadXX to transfer overhead applied to overhead a/c DateFactory OverheadXX Factory Overhead Under/Over-appliedXX to transfer over-applied overhead DateFactory OverheadXX Factory Overhead Under/Over-appliedXX to transfer over-applied overhead DateCost of Goods SoldXX Factory Overhead Under/Over-appliedXX to transfer under-applied overhead to COGS DateCost of Goods SoldXX Factory Overhead Under/Over-appliedXX to transfer under-applied overhead to COGS

Job Order Costing Procedures (cont’d) Limitation of direct labour as a cost driver Accounting for the completion of the job DateFinished Goods InventoryXX WIP InventoryXX to record the completion of job XYZ and transfer to finished goods DateFinished Goods InventoryXX WIP InventoryXX to record the completion of job XYZ and transfer to finished goods

Job Order Costing Procedures (cont’d) Accounting for the sale of a job DateAccounts ReceivableXX SalesXX GST CollectionsX to record the sale of job XYZ DateAccounts ReceivableXX SalesXX GST CollectionsX to record the sale of job XYZ DateCost of Goods SoldXX Finished Goods InventoryXX to record the cost of sale of job XYZ DateCost of Goods SoldXX Finished Goods InventoryXX to record the cost of sale of job XYZ

Cost Accounting in Service Entities LO. 10 Cost information needed to prepare budgets, determine fees and analyse profitability Developing cost application rules –Direct labour costs –General overheads Assigning costs to jobs and setting a price

Just-in-time Processing LO. 11 Eliminates holding excess inventory Materials arrive just as needed and go straight into production Finished goods shipped straight to customers on completion Highly automated Little margin for error