COST AND MANAGEMENT ACCOUNTING I
CHAPTER I:
FUNDAMENTALS OF COST ACCOUNTING
1.1 Definition of Cost accounting and Managements accounting
Accounting is a major means of
helping managers
ü To administer each of the activity or functional areas offer which they are
responsible and
ü
To coordinate those functions
within the framework of the organization as a whole.
Accounting provides information
for three major purposes:
ü Routine internal reporting for the decisions of
managers.
ü Non routine internal reporting for decisions of
managers.
ü External reporting to investors, government
authorities, and other outside parties on the organization’s financial
position, operations, and related activities.
Management Accounting
ü Measures and reports financial and non financial
information that helps managers to fulfil the goals of the organization.
ü Concerned with providing information to mangers, i.e.
people inside the organization who direct and control its operations.
ü Focuses on internal reporting.
Financial Accounting
ü
Concerned with providing
information to stockholders, creditors and other who are outside the
organization.
ü
Focuses on reporting to external
parties.
ü
It measures and records business
transactions and provides financial statements that are based on GAAPs or IFRS.
Managers are responsible for the financial statements
issued to investors, government regulators, and other outside parties.
Therefore, managers are interested in both management accounting and financial
accounting.
1.2 Management Accounting Vs Financial Accounting
ü Since planning is such an important part of the
manager’s job, managerial accounting has a strong future orientation. But
financial accounting primarily provides summaries of past financial
transaction. The difficulty with summaries of the past is that the future is
not simply a reflection of what has happened in the past. Changes are
constantly taking place in economic conditions, customer needs and so on.
ü FA data are expected to be objective and verifiable. However,
for internal uses the manger wants information that is relevant even if it is
not completely objective or verifiable. By relevant, we mean appropriate for
the problem on hand.
ü Timeliness is often more important than precision to
managers. If decision must be made, a manager would much rather has a good
estimate now than wait for a week for a more precise answer. In addition MA
places considerable weight on non monetary data. For example, information about
customer satisfaction is more important even though it is difficult to express
in monetary value.
ü FA is primarily concerned with reporting for the
company as a whole. But MA primary focuses much more on the parts, or segments
of a company. These segments maybe product lines, sales territories, divisions,
departments or ant other categorization of the company’s activities that
management finds useful.
ü FA statements prepared for external users must be
prepared in accordance with GAAPs. External users must have some assurance that
the reports have been prepared in accordance with some set of ground rules. MA
is not bound by GAAPs. Managers set
their own ground rules concerning the content and form of internal reports. The
only constraint is that the expected benefits from using the information should
outweigh the cost of collecting, analyzing, and summarizing the data.
ü FA is mandatory; that is, it must be done. But MA is
completely optional, so the important question is always, “Is the information
useful?” rather than, “Is the information required?”
ü The field of managerial accounting is less sharply
defined. That is to say that managerial accounting makes heavier use of
economics, decision sciences, and behavioural sciences. The field of financial accounting, in contrast, is more sharply
defined. This means that FA makes lighter use of related disciplines.
Features
|
Managerial Accounting
|
Financial Accounting
|
Users of Information
|
Managers at various levels within the organization.
|
Interested parties outside the organization.
|
Level of Aggregation
|
Detailed information on subunits within the
organization
|
Summarized information on the company as a whole
|
Information type
|
Economic any physical data as well as financial data
|
Financial data
|
Regulation
|
Unregulated, limited only by the value-added
principle.
|
Regulated by GAAP.
|
Information Characteristics
|
Estimates that promote relevance and enable
timeliness.
|
Factual information that is characterized by
objectivity, reliability, consistency, and accuracy.
|
Time Horizon
|
Past, present, and future
|
Past only, historically based
|
Reporting Frequency
|
Continuous reporting
|
Delayed with emphasis on annual reports
|
Sources of data
|
The organization’s basic accounting system plus
various other sources.
|
The organization’s basic accounting system.
|
Delineation of activates
|
Field is less sharply defined.
|
Field is more sharply defined
|
Report Requirement
|
Not mandatory
|
Mandatory for external reports
|
Cost Accountancy is an essential part of accountancy, which has been
developed to meet the managerial needs of business. Starting off as a branch of
financial accounting, cost accountancy has developed so fast in the last few
decades that it is difficult to give suitable definition, which fully covers
its scope.
Further cost accountancy is regarded as the
science, art and practice of s cost accountant.
It is a science in the sense it is body of systematic knowledge having
certain principles, which a cost accountant should follow for the proper
discharge of his duties. It is an art,
as it requires the ability and skill on the part of a cost accountant in
applying the principles of cost accountancy to various managerial problems.
ü Cost Accounting primarily deals with collection, analysis of relevant
cost data for interpretation and presentation for various problems of
management.
ü Cost accounting is a management information system, which analyses
past, present, and future data to provide the basis for managerial decision
making.
ü According to Horngren, Cost
Accounting is “a Quantitative method that
accumulates, classifies, summarizes, and interprets information for three major
purposes: (i) Operational planning and control (ii) Special decisions and (iii)
product decisions.
ü In general, cost accounting is thus concerned with recording, classifying and
summarizing costs for determination of costs of products or services, planning,
controlling and reducing such costs and furnishing of information to management
for decision making.
Cost Accounting
ü
Provides
information for both management accounting and financial accounting.
ü
It
measures and reports financial and nonfinancial information that relates to the
cost of acquiring or consuming resources by an organization.
Includes
those parts of both management accounting
and financial accounting where cost
information is collected or analyzed
Thus
Cost Accounting is concerned with:
ü Accounting the costs
ü Controlling the costs
ü Reducing the cost
1.3 Matching Cost Flow with Work Flow
After identifying the different
workflows of manufacturing firm, efforts will be made to match cost incurred in
each of the respective workflows.
1. Procurement
ü
Accounts
must be provided to record the purchase of materials labor and overheads. These
costs will later be charged to production.
ü
Typical
general ledger account titles used for this purpose are raw materials, factory
payroll clearing, and manufacturing overhead control respectively.
2. Production
ü
An
account is required to gather procurement costs as they become chargeable to
manufacturing operations. This account is known as work in process.
3. Ware housing
ü
An
account must be set up to record the cost of goods that have been completely
manufactured. This account is referred as finished goods.
4. Selling
ü
The
cost of completed goods that have been sold must be recorded. An account termed
as cost of goods sold is provided in the general ledger for this purpose.
ü
Other
general ledger accounts such as Accounts receivable and sales are used for
recording the sale to the customer and the credit to income at selling price.
-
Raw Materials - Work-In-Process - Finished Goods - CGS
-
Factor Payroll Clearing
-
Manufacturing Overhead Control
1. Procurement
ü
Purchase
of materials, labor and overheads are recorded as debits to raw materials,
factory payroll clearing, and manufacturing overhead control. As
this cost are used or applies in factory operations, they are credited to these
accounts and transferred to production.
1. Production
ü
Costs
of materials, labor and overhead transferred in to production are debited to work
in process. As goods are finished and moved from the factory, their total
costs is moved from or debited to finished goods.
2. Ware housing
ü
The
cost of finished goods transferred from work in process is recorded as a debit
to finished goods. The costs of finished goods shipped from the
warehouse to customers is credited to finished goods and charged (debited) to cost
goods sold.
4. Selling
ü As finished goods are sold and
shipped from the warehouse, their cost is debited to cost of goods sold.
At the end of the accounting period, this account is closed by crediting cost
of goods sold and debiting incomes summary.
1.4 Recording the Cost Flow at Each Stage
of Work Flow
Assume that on October 1, 2015
these balances in the following accounts were available:
ü
Raw
materials 40,000 Br
ü
Work;
in process 30,000
ü
Finished
goods 24,000
- Additional
raw materials were purchased during the month of October at a cost of
60,000 Birr.
Raw materials 60,000
Vouchers payable (accounts payable) 60,000
- During
the month raw material costing 70,000
Birr were used as follows:
ü
Direct
materials charged to the work in process Br. 68, 000
ü
Indirect
materials charged to the manufacturing over head control was Br 2, 000
Work in process 68,000
Manufacturing overhead
control 2,000
Raw materials 70,000
- During
the month wages and salaries totaling 84,000 Birr were earned by the
factory employees and charged from the factory payroll register.
Factory payroll clearing 84,000
Salaries and wages payable 84,000
- An
analysis of records indicates that labor costs of 84,000 Birr is allocated
as follows:
ü
Direct
labor chargeable to the work in process 60,000
ü
Indirect
labor chargeable to man over head control
24,000
Work in process 60,000
Manufacturing over head control 24,000
Factory payroll
clearing 84,000
- In
addition to indirect materials and indirect labors other manufacturing
overhead costs totaling 14,000 Birr incurred during the month were charged
form various journals.
Manufacturing overhead control 14,000
Vouchers payable (accounts payable) 14,000
- It
is estimated that over head costs totaling 38,000 Birr are applied or
charged to jobs worked on during the month
Work in process 38,000
Manufacturing overhead control 38,000
- During
the month, some jobs were completed and transferred to the finished goods
ware house. The jobs cost were Br 180,000.
Finished goods 180,000
Work in process 180,000
- During
the month, finished goods costing Br. 170, 000 were sold to various
customers.
Cost of goods sold 170,000
Finished goods 170,000
1.5 Financial Statement in a Manufacturing
Industry
Cost of Goods Manufactured
Schedule
Duncan
Manufacturing Corporation
Statement
of Cost of Goods Manufacturing
Year
ended December 31, 2004
Raw Material
|
|
|
|
Raw material inventory, Jan-1
|
|
|
Xxx
|
Material Purchase
|
|
Xxx
|
|
Less purchase return and allowance
|
xxx
|
|
|
Purchase discount
|
xxx
|
Xxx
|
|
Net Purchase
|
|
|
xxx
|
Total Material Available
|
|
|
xxx
|
Less Raw Materials Inventory Dec 31
|
|
|
xxx
|
Raw material used
|
|
|
xxx
|
Direct labor
|
|
|
xxx
|
Manufacturing Overhead
|
|
|
xxx
|
Total current manufacturing costs
|
|
|
xxx
|
Add Work in process Jan 1
|
|
|
xxx
|
Sub total
|
|
|
xxx
|
Less Work in process Dec 31
|
|
|
xxx
|
Cost of Goods Manufactured
|
|
|
xxx
|
Duncan
Manufacturing Corporation
Income
statement
Year
ended December 31, 2004
Revenue
|
|
|
|
Sales
|
|
|
xxx
|
Less Sales Return and Allowance
|
|
|
xxx
|
Net Sales
|
|
|
xxx
|
Cost of goods sold
|
|
|
|
Finished Goods inventory Jan-1
|
|
Xxx
|
|
Add Cost of goods manufactured
|
|
xxx
|
|
Total Goods
available for sale
|
|
Xxx
|
|
Less Finished Goods inventory Dec 31
|
|
Xxx
|
|
Cost of goods sold
|
|
|
xxx
|
Gross profit on sale
|
|
|
xxx
|
Less operating and admini. Expenses
|
|
|
xxx
|
Net Income from operations
|
|
|
xxx
|
Add Other Income
|
|
|
xxx
|
Subtotal
|
|
|
xxx
|
Less Other Expenses
|
|
|
xxx
|
Net Income Before Tax
|
|
|
xxx
|
Provision for Tax
|
|
|
xxx
|
Net Income After Income Tax
|
|
|
xxx
|
1.6 Identifying the Cost Accounting
System
Therefore, the primary
objectives of cost accounting system are ascertainment of cost, fixation of
price, proper recording and presentation of cost data to the management for
measuring efficiency and for cost control. In cost accounting system terms such
as cost, costing, cost accounting, expenses, losses has to be clarified
clearly.
Some of the definitions of cost
are presented below.
ü
A
cost is the value of economic resources used as a result of producing or
doing the thing. In other words, cost is the amount of expenditure
related to a specific thing or activity.
ü
A
cost is the amount of resources given up in exchange for some goods or
services. Cost is an exchange price or a sacrifice made to secure benefit.
Basically, when cost is incurred, it could be in
the form of deferred costs (asset) or expired costs (expense).Deferred costs
are unexpired costs which provide benefits in the future periods and are known
as assets. For example equipment, building, machinery and so on.
When the deferred cost (assets) are used up, to
the extent used they will become an expense. In other words, expenses
are expired costs incurred and used up in the process of generating revenue.
These expenses are then matched against the revenue that they helped to
generate. Examples of expenses include depreciation expense, selling expense,
office salaries etc.
In contrast, losses are reduction in the firm’s
equity for which no compensating value has been received. A loss is an expired
cost resulting from the decline in the service potential of an asset that
generates no benefit to the firm. Obsolescence or destruction of stock by fire
is an example of loss.
Costing simply means ascertainment of
costs. It includes the techniques and process of ascertaining and determining
costs. The technique consists of principles and rules which are applied
for ascertaining costs of products manufactured and services rendered.
The process includes the day to day routine
activity of determining costs with in the method of costing adopted by a
business enterprise. Generally, costing refers to the technique and
process of determining costs of product manufactured or services rendered.
CHAPTER 2:
BASIC COST TERMS AND CONCEPTS
2.1. Definition
The term cost has
been defined as "the cash or cash equivalent value required
to attain an objective such as acquiring the goods and services used,
completing with a contract, performing a function, or producing and
distributing a product." This definition indicates that there is a
current monetary deprivation or sacrifice that is related to the current or
total consequence or benefit of every event.
As used in accounting, cost refers to an out lay or expenditure of
money to acquire goods and services that assist in performing business
operations.
Costs, Expenses and Losses
ü Cost is defined as the monetary value of goods and services
expended to obtain current or future benefits.
ü Expenses are expired costs for which benefits have already
been received in the current fiscal period. Expenses are deductible from
revenue.
ü Losses sacrifices without any benefit. Loss can be defined as
the excess of all expenses over revenues for a period.
·
Accountants define cost
as a resource sacrificed or forgone to achieve a specific objective. It is
usually measured as the monetary amount that must be paid to acquire goods or
services.
·
An actual cost is the cost
incurred (a historical cost) as distinguished from budgeted or forecasted
costs.
2.2. Cost Classifications
2.2.1 General Cost Classifications
A. Manufacturing Costs
Ø Direct Materials
Raw materials refer to any materials that are used in the final
product; and finished product of one company can become the raw materials of
another company.
Direct materials are those materials that become an integral part of
the finished product and that can be physically and conveniently traced to it.
This would include for example the seats Boeing purchases from subcontractors
to install in its commercial aircrafts.
Those that can not be traceable to the final
product are called indirect materials. This can be glue used to assemble a chair.
Ø Direct Labor
The term direct labor is reserved
for those labor costs that can be easily i.e. physically and conveniently
traced to individual units of product. Direct labor is sometimes called touch
labor, since direct labor workers typically touch the product while it
is being made.
Labor costs that cannot be
physically traced to the creation of products, or that can be traced only at
great costs and inconvenience, are termed as indirect labor and treated as part
of manufacturing overhead. It includes the labor costs of janitors,
supervisors, material handlers, and night security guards.
Ø Manufacturing Overhead
Includes all costs of
manufacturing except direct materials and direct labor.
Manufacturing overhead includes
items such as
ü indirect materials;
ü indirect labor
ü maintenance and repairs on production equipment
ü heat and light
ü property taxes
ü depreciation and insurance on manufacturing facilities.
A company also incurs costs for
heat and light, property taxes, insurance, depreciation, and so forth
associated with its selling and adminstatrative functions but these cots are
not included as part of manufacturing overhead. Only those costs associated
with operating the factory is included the manufacturing overhead category.
Manufacturing overhead is also
called indirect manufacturing cost, factory overhead and factory burden
Direct Material + Direct Labor = Prime Cost
Direct Labor + Manufacturing Overhead = Conversion Cost
|
Ex. 2.1: Classify the following as direct materials,
direct labor, or factory overhead:
a.
Glue used in the manufacture of desks
b.
Labor of a janitor
c.
Factory utilities
d.
Wood used in the manufacture of a table
e.
Labor of a machinist
B. Non-manufacturing Costs
Generally,
non-manufacturing costs are sub classified into two categories:
ü Marketing or selling costs: include all
cost categories to secure customer orders and get the finished product or
service into the hands of the customer. These costs are often called
order-getting and order filling costs. Like advertising, shipping, sales
travel, sales commissions, sales salaries, and costs of finished goods
warehouses.
ü Administrative Costs: include all executive, organizational associated with
the general management of an organization rather than with manufacturing,
marketing or selling. Like executive compensation, general accounting,
secretarial, public relations, and similar costs involved in the overall,
general administration of the organization as a whole.
2.2.2. Product
Costs versus Period Costs
Ø Product Costs
ü Product costs include all cots that are involved in
acquiring or making product- direct materials, direct labour, and manufacturing
overhead.
ü Initially product costs are assigned to an inventory
account on the balance sheet. When goods are sold, the costs are released from
inventory as expenses (cost of goods sold) and matched against revenue. For
this reason they are also known as inventoriable costs.
ü Product costs are not necessarily treated as expenses
in the period in which they are incurred. Rather they are treated as expenses
in the period in which the related products are sold. This means that a product
cost such as direct materials or direct labor might be incurred during one
period but not treated as an expense until a following period when the
completed product is sold.
Ø Period Costs
ü Period costs are all the costs that are not included
in product costs. These costs are expensed on the income statement in the
period, in which they are incurred, the rules of accrual accounting.
ü Period costs are not included as part of the cost of
either purchased or manufactured goods like sales commissions and office rent
and all selling and administrative expenses are considered to be period costs.
2.2.3. Cost Classification for Predicting Cost
Behaviour
Cost
behaviour mans how a cost will react or respond to changes in the level of
business activity. As the activity level rises and falls, a particular cost may
rises and fall as well or it may remain constant.
Ø Variable Cost
ü A variable cost is a cost that varies, in total, in
direct proportion to change in the level of activity. The activity can be
expressed in many ways such as units produced, units sold, miles driven, beds
occupied, hours worked and so on.
ü A good example of a variable cost is direct materials.
The cost of direct materials used during a period will vary, in total, in
direct proportion to the number of units that are produced.
ü In variable cost, the total cost rises and falls as the activity level rises and falls.
One interesting aspect of variable cost behaviour is that a variable cost is
constant if expressed on a per unit basis.
Let’s assume that we manufacture autos, each auto
requires a battery that costs Br. 24 each. If only 1 auto is manufactured the
total variable cost for batteries is Br. 24.
No. of
Autos Produced Cost
for Battery Total VC-Batteries
1 Br.
24 Br. 24
500 24 12,000 1,000 24 24,000
Ø Fixed Cost
ü A fixed cost is a cost that remains constant in total
regardless of changes in the level of activity. Unlike variable costs, fixed
costs are not affected by changes in activity.
ü Consequently, as the activity level rises and falls,
the fixed costs remain constant in total amount unless influenced by some
outside force, such as price changes. E.g.: Rent Expense
ü When we say a cost is fixed, we mean it is fixed
within some relevant range. The relevant range is the range of activity within
which the assumptions about variable and fixed costs are valid.
ü Fixed costs can create difficulties if it becomes
necessary to express the costs on per unit basis. This is because if fixed
costs are expressed on a per unit basis, they will react inversely with changes in activity.
Monthly Rental Cost No.
of Tests Performed Average Cost per Test
Br. 8,000
10 Br.
800
8,000 500 16
8,000 2000 4
Behaviour of the Cost (within the relevant
range)
|
Cost
|
In Total
|
Per Unit
|
Variable Cost
|
Total variable cost increases
and decreases in proportion to changes in the activity level.
|
Variable cost remains constant
per unit.
|
Fixed Cost
|
Total fixed cost is not
affected by changes in the activity level within the relevant range.
|
Fixed costs decrease per unit
as the activity level rises and increase per unit as the activity level
falls.
|
Ex. 2.2: Classify
the following as variable cost or fixed cost
a.
President’s salary
b.
Direct labor
c.
Straight-line depreciation on
factory building
d.
Commissions paid to sales
persons.
e.
Direct material
f.
Advertising
Ex. 2.3: Guild Company
manufactures and sells one product. The production can vary from 20,000 to
60,000 units. A partially schedule of the company’s total and per unit costs
for the coming year follows:
Units produced and sold
Total costs:
Variable
costs $ 80,000 ?
?
Fixed
costs 100,000 ? ?
Total
costs $180,000 ?
?
Cost per unit:
Variable
cost ? ?
?
Fixed
cost ? ? ?
Total
cost per unit
? ? ?
Required:
1. Compute the schedule for Guild
Company’s total and per unit costs.
2. Determine the cost formula in
the format of Y=a + bx
2.2.4. Cost Classification for Assigning Costs to Cost
Object
ü A cost object is anything for which
cost data are desired- including products, product lines, customers, jobs, and
organizational subunits or which is anything for which a separate measurement
of costs is desired. For the purpose of assigning costs to cost objects, costs
are classified as either direct or indirect.
ü A costing system typically accounts for costs in two
basic stages- accumulation and then assignment.
ü Cost accumulation is the allocation of cost data in some organized way
by means of an accounting system.
ü Coat assignment is a general term that includes both (1) tracing accumulated costs to a cost
object, and (2) allocating accumulated cost to cost object
ü A key question in cost assignment is whether costs
have direct or an indirect relationship to a particular cost object.
Ø Direct Cost
A direct cost is a cost that can
be easily and conveniently traced to the particular cost object under
consideration. The concept of direct cost extends beyond just direct material
and direct labor.
Ø Indirect Cost
An indirect cost is a cost that
cannot be easily and conveniently traced to the particular cost object under
consideration. To be traced to a cost object such as a particular product, the
cost must be caused by the cost object.
The term cost allocation is used
to describe the assignment of indirect costs to a particular cost abject.
A common cost is a cost
that is common to a number of costing objects but cannot be traced to them
individually. A common cost is a particular type of indirect cost.
2.2.5. Cost Classification for Decision Making
Ø Decision Significance
A decision involves making
choices among alternative courses of action the decision maker generally
collects cost information to assist in making the decision.
I) Relevant costs are future
costs that differ with the various decision alternatives. They are costs that
make a difference in a decision making process.
II) Irrelevant costs do not
relate to any of the decision alternatives, are historical in nature, or are
the same under all decision alternatives
Irrelevant costs are generally
excluded from the cost analysis
Costs are an important feature
of many business decisions. In making decisions, it is essential to have a firm
grasp of the concepts of differential
cost, opportunity cost, and sunk costs.
Ø Commitment to Cost Expenditure
Commitment to a cost expenditure
focuses on fixed costs as opposed to variable costs and on budgeted costs as
opposed to historical costs.
Budgeted fixed costs can be
broadly classified as committed costs and discretionary costs.
i. A committed costs: is one that is an inevitable consequence of
a previous commitment. Property tax budgeted for the coming year is an example
of a committed cost.
ii. A discretionary costs; also called a programmed costs or a Managed
cost, is one for which the amount or the time of incurrence is a matter of
choice. There are some non- recurring costs for which a final commitment has
not yet been made and that can be postponed until a future period or canceled
entirely. Replacing the carpet in the administrative offices and repainting the
walls of the factory are examples of discretionary costs where the right timing
is a matter of judgment
Ø Differential Cost and Revenue
ü A difference in cost between any two alternatives is
known as a differential cost. A difference in revenue between ant two
alternatives is known as differential revenue.
ü A differential cost is also known as an incremental cost, although technically
an incremental cost should refer only to an increase in cost from one
alternative to another; decrease in cost should be referred to as decremental costs. Differential cost is
a broader term, encompassing both cost increases (incremental cost) and cost
decreases (decremental cost) between alternatives.
ü The accountant’s differential cost concept can be
compared to the economist’s marginal cost concept. The revenue that can be
obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit
of product is called marginal cost.
ü Differential cost can be either fixed or variable.
Ø Opportunity Cost
ü Opportunity cost is the potential benefit that is
given up when one alternative is selected over another.
ü Opportunity cost is not usually entered in the
accounting records of an organization, but it is a cost that must be explicitly
considered in every decision a manager makes.
Example: - Vicki has a part-time job that pays $100 per week
while attending college. She would like to spend a week at the beach during
spring break, and her employer has agreed to give her the time off, but without
pay. The $100 in lost wages would be an opportunity cost of taking the week off
to be at the beach.
Ø Sunk Cost
A sunk cost is a cost that has
already been incurred and that cannot be changed by any decision made now or in
the future. Since sunk costs cannot be changed by any decision, they are not
differential costs. Therefore, they can and should be ignored when making a
decision.
Summary of Cost Classification and Terminology
Cost Classification Sub-
classifications
2.3. Costs on Financial Statements
Financial
statements of a Manufacturing company are more complex as compared to financial
statements of Merchandising and Service companies. Particularly, the Balance
sheet, and Income statement of a Manufacturing Enterprise are somewhat
different from their Merchandising and Service counterpart. All costs mentioned
above should be properly accounted for and reported in the financial statements
of a manufacturing firm, which is more complex than that of the Merchandising
and Service complements.
The Balance Sheet
The
balance sheet or statement of financial position, of a manufacturing company is
similar to that of a merchandising company. However there are differences in
the inventory accounts.
A
merchandising company has only one class of inventory- goods purchased from
suppliers that are awaiting resale to customers. By contrast, manufacturing
companies have three classes of inventories:
ü Raw materials: shows the cost of raw materials on hand and intended
for use in the manufacturing process.
ü Work in process: shows the cost of goods in the manufacturing
process, but not completed at the end of the accounting period.
ü Finished goods: shows the cost of the goods completed and ready for
sale.
Inventory
of Direct Material represents the
costs of materials that are not yet entered into a manufacturing process. Such
materials may be purely raw materials that have not received any processing
before, such as agricultural outputs, or they may be semi processed or fully
processed products of another firm like wheat flour directly going into Biscuit
in Food Complex Industries.
Inventories
of Work-In-Process represent all
goods that are undergoing some manufacturing process but yet not finished to be
dispatched for use by customers. The
costs of work in process inventory include all the manufacturing costs incurred
so far in the manufacturing process; the cost of direct materials, the costs of
labour, and applied manufacturing overhead.
The Finished Good Inventory embodies the
final product that is not yet sold. The cost of finished good inventory
includes all manufacturing costs, direct material, direct labour, and
manufacturing overhead incurred to produce that product.
The Income Statement
Income
statement of a manufacturing firm differs from income statement of a
merchandising firm by the Cost of Goods Manufactured
caption. A merchandising firm sells
goods after buying it from a manufacturing firm. But a manufacturing firm sells
goods that are internally produced. Hence, the costs of goods sold caption
contains cost of goods manufactured instead of purchase. The amount of purchase
can easily be found from the ledger, but cost of goods manufactured cannot.
Cost of goods manufactured must first be computed before the income statement
is prepared.
Merchandising Company
Sales xxx
Cost of goods sold:
Beginning merchandise
inventory xxx
Add Purchases xxx
Goods available for sale xxx
Deduct: Ending
merchandise inventory xxx
Cost of
Goods Sold xxx
Gross Margin xxx
Less: Operating Expenses:
Selling
Expenses xxx
Administrative
Expenses xxx xxx
Net Income xxx
Manufacturing Company
Sales xxx
Cost of goods sold:
Beginning finished goods
inventory xxx
Add: Cost of goods manufactured xxx
Goods available for sale xxx
Deduct: Ending finished
goods inventory xxx
Cost of
Goods Sold xxx
Gross Margin xxx
Less operating expenses:
Selling Expenses xxx
Administrative Expenses xxx xxx
Net income xxx
Schedule of
Cost of Goods Manufactured
Direct Materials
Beginning
raw materials inventory xxx
Add:
Purchases of raw materials xxx
Raw
materials available for use xxx
Deduct:
Ending raw materials inventory xxx
Raw
materials used in production xxx
Direct Labor xxx
Manufacturing overhead:
Insurance,
factory xxx
Indirect
labor xxx
Machine
rental xxx
Utilities,
factory xxx
Supplies xxx
Depreciation,
factory xxx
Property
taxes, factory xxx
Total
manufacturing costs xxx
Add: Beginning work in process inventory xxx
Total goods in production xxx
Deduct: Ending work in process
inventory xxx
Cost of goods manufactured xxx
Cost of goods manufactured = beginning work in process
inventory + (direct material used + direct labor incurred + manufacturing
overhead) – ending work in process inventory
Ex. 2.4: The following cost data relate to Taylor Products Company for
the year ended June 30, 2005.
Direct Materials $ 55,600
Direct Labor 72,400
Factory Overhead 36,500
Work in process inventory, July
1, 2004 38,200
Work in process inventory, June
30, 2005 34,800
Required:
1.
Calculate the manufacturing
costs for the year.
2.
Calculate the cost of goods
manufactured for the year.
Ex. 2.5: Iowa
Products Company accumulated the following data for 2005.
Jan 1, 2005 Dec 31, 2005
Inventories:
Finished
Goods $ 52,000 $ 54,000
Work
in Process 29,600 27,800
Raw
materials 14,200
15,000
Direct labor 95,000
Raw material purchases 138,000
Indirect labor 15,300
Indirect materials and supplies 10,800
Factory utilities 18,600
Depreciation expense- Factory 14,000
Factory rent 18,000
Payroll taxes- Factory wages 8,100
Repairs and maintenance 6,000
Insurance expense- Factory 6,800
Miscellaneous factory expenses 5,200
Sales 710,000
Sales discount 12,000
Selling expenses 95,600
General expenses 75,300
Interest expenses 7,000
Required:
1. Prepare a statement of cost of goods manufactured.
2. Prepare an income statement
(assume an income tax rate of 25%)
