Accounting Systems for
Manufacturing Businesses
Chapter 10
Cost Classifications for Manufacturers

Direct materials


Cost of materials that become part of the finished
product
Direct labor

Cost of labor that is directly involved with
converting materials into finished products
Cost Classifications for Manufacturers

Overhead


All other costs involved in converting materials
into finished products

Indirectly related to the product

Indirect materials, indirect labor, utilities, depreciation,
property taxes, plant manager’s salary, maintenance,
etc.
Conversion costs

Direct labor plus overhead
Cost Classifications for Manufacturers


Product costs

Direct materials, direct labor and overhead

Closely related to the manufacturing of the
product

Asset (inventory) until the product is sold
Period costs

More closely related to time periods than to the
product

Expense when incurred
Inventories in a Manufacturing environment

Raw materials inventory



Materials or components which have not yet been
placed into production
Work in process inventory

Partially completed goods

Includes material, labor and overhead cost
Finished goods inventory

Completed goods ready for sale

Similar to the merchandise inventory of a retailer
Types of Accounting Systems for
Manufacturing Operations

Job order system



Costs are accumulated for each job
Used for custom goods for specific customers or
when a variety of goods are produced for stock
Process cost system


Costs are accumulated for each time period, then
allocated to the units produced during the time
period
Used for continuous production process of
identical goods
The Flow of Goods and Costs
Through a Manufacturing System
Materials are
purchased
Raw
materials
inventory
Materials placed
in production
Labor
Overhead
Work in
process
inventory
Goods are
completed
Finished
goods
inventory
Goods
are sold
Cost of
goods sold
(expense)
The Flow of Goods and Costs
Through a Manufacturing System

Purchases of materials



Raw material inventory is increased
Materials are placed into production

Raw materials inventory is decreased

Work in process inventory is increased
Labor and overhead costs are incurred

Work in process inventory is increased
The Flow of Goods and Costs
Through a Manufacturing System


Goods are completed

Work in process inventory is decreased

Finished goods inventory is increased
Goods are sold

Finished goods inventory is decreased

Cost of goods sold is increased
Cost of Goods Manufactured Statement

Matches the flow of costs


Determine the total manufacturing costs for the
period (inputs)

Cost of materials used in production

Cost of labor

Cost of overhead
Determine the cost of goods manufactured
(outputs)

Beginning work in process + total manufacturing costs –
ending work in process
Cost of Goods Manufactured Statement
Beginning raw materials inventory
Purchases of raw materials
Raw materials available for use
Ending raw materials inventory
Raw materials used in production
$
$
$
Direct labor
Overhead
Total manufacturing costs for the period
48,000
116,000
$
Beginning work in process inventory
$
Ending work in process inventory
Cost of goods manufactured
10,000
182,000
192,000
15,000
177,000
$
341,000
27,000
368,000
25,000
343,000
Applying Overhead to Production

Overhead is an indirect cost and cannot be
accurately related to individual jobs

Overhead is applied to jobs using a
predetermined overhead rate
Total estimated overhead = rate per unit
Total estimated activity
of activity

Amount of overhead applied is determined by
the amount of activity consumed
Applying Overhead to Production

The amount applied is an estimate

Any difference between the actual overhead
cost and the amount applied is transferred to
cost of goods sold

If overhead is overapplied (too much was charged
to jobs), reduce cost of goods sold

If overhead is underapplied (not enough was
charged to jobs), increase cost of goods sold
Applications to Service Industries

The same concepts apply to service
industries except

Probably no raw materials, although supplies may
be used

No finished goods inventory


Services are performed on demand, and cannot be
stored for later sale
Costs move directly from work in process to cost
of services provided (similar to cost of goods sold)
Activity-Based Costing

More refined method of applying overhead to
production

Uses multiple application rates for more
accurate charging of costs to products based
on the demand those products place on the
company’s resources

Products and services consume activities, and
activities consume resources
Activity-Based Costing

Costs are accumulated in cost pools related
to the major activities

A separate application rate is determined for
each cost pool


For example, cost per hour of inspection time,
cost per test performed, cost per pound of
material moved, etc.
Costs are charged to products based on how
much of the activity the product consumes