LEARNING OBJECTIVES:

I. Introduction:
o Define manufacturing;
o Distinguish among different types and divisions of manufacturing.
II. Cost Concepts and Classifications:
o Define cost
o Discuss different classifications of cost
Apply cost classifications to different scenarios
III. Financial Statements of Manufacturing Business
o Discuss and prepare Financial Statements of Manufacturing concern
o Discuss costing System
What is Manufacturing?

Manufacturing is transforming inputs into outputs using tools and

processes. A manufacturer or a manufacturing concern would be
involved in the selling of outputs which it had processed.

PROCESS
MATERIALS
LABOR FINISHED
OVERHEAD PRODUCTS
MERCHANDISING VS MANUFACTURING

MANUFACTURING

BUY MATERIALS,
INCURRENCE OF PROCESS INTO FINISHED SELL
LABOR AND PRODUCTS
OVERHEAD

MERCHANDISING

BUY GOODS SELL

Q&A
1. Which of the following is NOT into manufacturing?
A. Furniture maker
B. Pharmacy
C. A company which prints business forms
D. Car manufacturer
TYPES OF MANUFACTURING METHODS
1. Make-to-stock (MTS): This is the traditional type of
manufacturing wherein the production strategy is based on
forecasts of customer demand and therefore company presents its
customers with the final product.

2. Make-to-order (MTO): Also known as made-to-order or build-

to-order, this is the type of manufacturing wherein the production
strategy is based on customer order.

3. Make-to-assemble (MTA): Also known as assemble-to-order

(ATO), this is the type of manufacturing wherein company makes
available the inputs while the customer decides on the final output.
Q&A
2. A sandwich shop which prepares in advance all ingredients
and allows customers to select the type of bread, vegetables, and
dressing for the sandwich is employing which of the following
strategy?
A. Make-to-order
B. Make-to-stock
C. Make-to-assemble
D. Stock-to-order
COST CONCEPTS

Cost is the monetary measure of resources given up in

order to achieve a particular objective. It is the amount of
cash or cash equivalent paid or committed to be paid in
the future for goods and services expected to bring about
current or future benefit.
COST CLASSIFICATIONS (BASIC)

AS TO DIRECT AND
TRACEABILITY
(Cost Object) INDIRECT COST

COST
CLASSIFICATIONS
AS TO PRODUCT AND
REPORTING
PERIOD COST

AS TO
BEHAVIOR
VARIABLE AND
FIXED COST
COST CLASSIFICATIONS
AS TO TRACEABILITY (Cost
Object) DIRECT VS INDIRECT COST
1. As to traceability to cost object (anything that makes you incur a cost):
a. Direct Cost - feasible to be traced to the cost object
b. Indirect Cost - not feasible to be traced to the cost object
Examples:
Materials
• Timber, for example, is a direct material in a factory that makes furniture. In a shoe-making
company, leather is a direct material, and so is silk/cotton in a factory that makes clothes.
• Cleaning chemicals, protective devices, glue, oil, and disposable tools, i.e., consumables, are
usually indirect materials. We use soap, for example, to clean the factory floor, but not to make
furniture. Therefore, soap is an indirect material.
Labor
• Labor involved in production rather than administration, maintenance, and other support services
are direct.
• For example, suppose your factory requires maintenance workers to mop the floors. You can’t really
tie a specific amount of floor cleaning to every individual product you make, so you label the
cleaning cost as indirect.
Q&A
TRUE OR FALSE
3. Bookbinder of a commercial printer/publisher is classified as indirect labor cost.
4. The salary of a foreman in an automobile company's assembly division is a direct product
cost.
5. Direct material refers to all materials used in the production of a product.
Q&A COST OBJECT: SPECIFIC PRODUCT

Listed below are cost found in various organizations:

1. Property taxes.
2. Boxes used for packaging detergent produced by the company.
3. Salesperson’s commissions.
4. Supervisor’s salary, factory.
5. Depreciation, executive autos.
6. Wages of workers assembling computers.
7. Insurance, finished goods warehouse.
8. Lubricants for production equipment.
9. Advertising costs.
10. Microchips used in producing calculators.
11. Shipping costs on merchandise sold.
12. Magazine subscription, factory lunchroom.
13. Thread in a garment factory.
14. Executive life insurance.
15. Ink used in textbook production.
16. Yarn used in sweater production.
17. Wages of receptionist, executive offices.

Classify the following costs as (D) direct costs or (ID) indirect costs in relation to a specific product.
Q&A
COST OBJECT: A DEPARTMENT
Classify the following costs as (D) direct costs or (ID) indirect costs in relation to a
manufacturing company with three production departments and assuming Finishing
Department is the cost object.
1. Salary of Finishing Department’s supervisor
2. Depreciation on Finishing Department’s equipment
3. Salary of company’s research/development staff
4. Salary of production departments’ security personnel
5. Salary of production manager
6. Factory supplies used in Finishing Department
7. Salary of production departments’ maintenance personnel
8. Wages of Finishing Department’s workers
9. Salary of production departments’ clerk
10.Depreciation on office computer
Source: Dela Cruz, A.L.C., Rabo, J.S., & Tugas, F.C. (2019). Basic financial accounting and reporting.
COST CLASSIFICATIONS
AS TO REPORTING
PURPOSES PRODUCT VS PERIOD COST
2. As to reporting purposes:
a. Product cost: This refers to cost that forms part of the product, thus the cost of unit unsold is
presented under inventory section in the statement of financial position while the cost of unit sold is
presented under cost of sales section in the income statement.
b. Period cost: This refers to cost that is expensed immediately in the period it is incurred, thus the
entire cost is presented under operating expenses section in the income statement.
COST CLASSIFICATIONS
AS TO REPORTING
PURPOSES PRODUCT VS PERIOD COST
1. PRODUCT COSTS (Inventoriable or manufacturing costs) are costs associated with the production
of products that are recognized for financial reporting when they are sold.
a. DIRECT MATERIALS – represents the reasonable cost of materials that can be identified directly
with the product.
b. DIRECT LABOR - cost of the labor time spent on that product (directly working on the product)
c. MANUFACTURING OVERHEAD - all production costs other than direct labor and direct
materials (indirect manufacturing costs)

2. PERIOD COSTS (nonmanufacturing costs) are costs associated with marketing and administrative
expenses, not related to production of products.
a. DISTRIBUTION COSTS (SELLING EXPENSES)
b. GENERAL ADMINISTRATIVE EXPENSES
Q&A
TRUE OR FALSE
6. Direct material refers to all materials used in the production of a product.
7. Product costs are those that can be traced back to a specific product and are included in inventory
values.
8. A factory's insurance can be classified as a period cost.
9. Product costs affect only the income statement.
10. Manufacturing overhead usually subdivided into three categories: indirect materials, indirect
labor, and other manufacturing overhead.
Q&A Tell whether the following items are Product or Period cost.

1. Hamburger buns in a Wendy’s outlet.

2. Advertising by a dental office.
3. Apples processed and canned by Del Monte.
4. Shipping canned apples from a Del Monte plant to customers.
5. Insurance on Adidas factory producing shoes.
6. Insurance on IBM’s corporate headquarters.
7. Salary of a supervisor overseeing production of printers at Canon.
8. Commissions paid to Encyclopedia Britannica salespersons.
9. Depreciation of factory lunchroom facilities at a General Electric plant.
10. Steering wheels installed in BMW’s
COST CLASSIFICATIONS
AS TO COST BEHAVIOR
VARIABLE VS FIXED COST
Cost behavior refers to how cost changes given changes in activity
level.
A. Fixed cost: This refers to cost which when expressed as a total
amount, does not change with changes in activity level.
B. Variable cost: This refers to cost which when expressed as a
total amount, changes in direct proportion to changes in activity
level. This means that total costs increase as activity levels
increase or that total costs decrease as activity levels decrease.
COST CLASSIFICATIONS
AS TO COST BEHAVIOR
VARIABLE VS FIXED COST

BEHAVIOR TOTAL PER UNIT

COST
VARIABLE CHANGE CONSTANT
FIXED CONSTANT CHANGE
COST CLASSIFICATIONS
BEHAVIOR TOTAL COST PER UNIT
VARIABLE CHANGE CONSTANT
FIXED CONSTANT CHANGE

Example: BFAR Tire Manufacturing currently produces 2,000 tires per month. The
following per unit data apply for sales to regular customers (based on 2,000 tires):
Direct materials 20
Direct manufacturing labor 3 1. Compute the total variable cost of
Variable manufacturing overhead 6 producing 3,000 tires.
Fixed manufacturing overhead 10 2. Compute the total fixed cost of
Total manufacturing costs 39 producing 3,000 tires.
Q&A
11. When 10,000 units are produced, variable costs are P 6 per
unit. Therefore, when 20,000 units are produced:
A. Variable costs will total P 120,000
B. Variable costs will total P 60,000
C. Unit variable costs will increase to P 12 per unit
D. Unit variable costs will decrease to P 3 per unit
Q&A Tell whether the following items are Variable or Fixed cost.

1. Hamburger buns in a Wendy’s outlet.

2. Advertising by a dental office.
3. Apples processed and canned by Del Monte.
4. Shipping canned apples from a Del Monte plant to customers.
5. Insurance on Adidas factory producing shoes.
6. Insurance on IBM’s corporate headquarters.
7. Salary of a supervisor overseeing production of printers at Canon.
8. Commissions paid to Encyclopedia Britannica salespersons.
9. Depreciation of factory lunchroom facilities at a General Electric plant.
10. Steering wheels installed in BMW’s
COST CLASSIFICATIONS DIAGRAM
Direct Materials &
Direct Labor
DIRECT
AS TO
TRACEABILITY Manufacturing Overhead
and other costs (Indirect
(Cost Object) INDIRECT costs)

Direct Materials, Direct

COST PRODUCT Labor and Manufacturing
CLASSIFICATIONS Overhead
AS TO
REPORTING Distribution costs and
PERIOD General Administrative
Expenses

AS TO VARIABLE
BEHAVIOR
FIXED
FINANCIAL STATEMENTS OF A
MANUFACTURING BUSINESS
Financial statements represent the output of financial reporting.

The objective of financial statements is to provide financial

information about the reporting entity’s assets, liabilities, equity,
income, and expenses that is useful to users of financial statements in
assessing the prospects for future net cash inflows to the reporting
entity and in assessing management’s stewardship of the entity’s
economic resources
Financial Statements

A complete set of financial statements includes the following:

(1) Statement of financial position,
(2) Statement of comprehensive income,
(3) Statement of changes in equity,
(4) Statement of cash flows, and
(5) Notes comprising significant accounting policies and other
explanatory information.
Financial Statements

A complete set of financial statements includes the following:

(1) Statement of Financial Position,
(2) Statement of Comprehensive Income,
(3) Statement of Changes in Equity,
(4) Statement of Cash Flows, and
(5) Notes comprising significant accounting policies and other
explanatory information.
STATEMENT OF FINANCIAL POSITION
For Merchandising – Inventory for Merchandise For Manufacturing: As of reporting date, it is
are the unsold items of the purchase merchandise possible for a manufacturing concern to still have
also known as “Merchandise Inventory”. unused materials, unfinished products, and unsold
products. Thus, its statement of financial position
normally includes a separate line item for
inventories.

Current assets: Current assets:

Cash and cash equivalents (Note __) XX Cash and cash equivalents (Note __) XX
Trade and other receivables (Note__) XX Trade and other receivables (Note__) XX
Financial Assets through Profit or Loss (Note __) XX Financial Assets through Profit or Loss (Note __) XX
Merchandise Inventory (Note __) XX Inventories (Note __) XX
Prepaid expenses (Note __) XX Prepaid expenses (Note __) XX
Total Current Assets XX Total Current Assets XX
STATEMENT OF FINANCIAL POSITION
Current assets:
Cash and cash equivalents (Note __) XX
Trade and other receivables (Note__) XX
Financial Assets through Profit or Loss (Note __) XX
Inventories (Note __) XX
Prepaid expenses (Note __) XX
Total Current Assets XX

Inventories (Manufacturing)
a. Raw materials inventory: This refers to cost of materials, whether direct or indirect, which
remain unused as of reporting date. Raw materials refer to resources used as inputs in the
production process for conversion into finished goods.
b. Work-in-process inventory: This refers to cost of partially-completed goods which
remain on-hand as of reporting date.
c. Finished goods inventory: This refers to cost of completed goods which remain unsold
as of reporting date.
STATEMENT OF CHANGES IN EQUITY

Baguio Trading Co.

Statement of Changes in Equity
For the year ended December 31,2022

Baguio, Capital 1/1/2022 3,256,000

Additional Investments -

Profit for the year 3,634,500

Drawings (50,000)
Baguio, Capital 12/31/2022 6,840,500
STATEMENT OF CASH FLOWS

• Cash flows from Operating activities vary between industries,

depending on their core business. For manufacturers, the production and
sale of goods are core activities such payment of raw materials, payment
of factory payroll etc.

• Cash flows from Investing activities activities include acquisition and

disposition of factory plant and equipment.

• Cash flows from Financing activities describes the money your

business generates from financing activities and how much you’ve repaid
(Capital and loans).
STATEMENT OF PROFIT OR LOSS
A manufacturing concern, like a merchandising concern, follows a traditional multi-step format for
external reporting purposes. The difference between the two Statement of Profit or Loss lies in the Cost
of Sales computation.

Functional form (See Sample below)

Note
Net Sales 1 XX
Cost of Sales 2 (XX)
Gross Profit XX
Other Income XX
Total Income XX
Operating Expenses
Distribution Cost 3 (XX)
General and Administrative Expenses 4 (XX)
Finance Cost (XX)
Net Income (Net Loss) XX
STATEMENT OF PROFIT OR LOSS (Cost of Sales)
MERCHANDISING MANUFACTURING

Direct Materials used XX

Merchandise Inventory, beginning XX Direct Labor XX
Add: Net Purchases* XX Manufacturing Overhead XX
Total Goods Available for sale XX
Total Manufacturing Cost XX
Less: Merchandise Inventory, ending (XX)
Cost of Sales XX Add: Work-in Process, beginning XX
Cost of Work put into process XX
Less: Work-in Process, ending (XX)
Where Net Purchases is equal to Purchases + Freight
In – Purchase returns and allowances – Purchase Cost of Goods Manufactured XX
Discounts Add: Finished Goods, beginning XX
Cost of Goods Available for Sale XX
A merchandising business resells goods purchased Less: Finished Goods, ending (XX)
from its suppliers. A manufacturing company Cost of Sales XX
produces goods from raw materials that are then
sold as finished goods.
Cost of Sales

Direct Materials used XX Direct Materials are the traceable matter used in
manufacturing a product. It is the cost of the raw
Direct Labor XX materials and components used to create a product.
Manufacturing Overhead XX The formula in getting the direct materials is below:

Total Manufacturing Cost XX

Raw Materials Inventory, beginning XX
Add: Work-in Process, beginning XX
Add: Raw materials purchases XX
Cost of Work put into process XX Less: Raw Materials Inventory, end (XX)
Less: Work-in Process, ending (XX) Indirect materials (XX)
Direct Materials Used XX
Cost of Goods Manufactured XX
Add: Finished Goods, beginning XX OR
Cost of Goods Available for Sale XX
Direct Materials Inventory, beginning XX
Less: Finished Goods, ending (XX) Add: Direct materials purchases XX
Cost of Sales XX Less: Direct Materials Inventory, end (XX)
Direct Materials Used XX
Q&A
Compute the amount of direct materials used during November if P20,000 in raw materials were
purchased during the month and if the inventories were as follows:

Balance
1-Nov 30-Nov
Raw materials 4,000 3,000
Work in process 12,000 15,000
Finished goods 24,000 27,000
Q&A
BFAR Company is a manufacturing concern using the perpetual inventory system. The following data
is provided:
• Beginning balance, P275,000
• Purchased materials, P860,000
• Indirect materials issued to production, P5,000.
• Excess of ending inventory over beginning inventory, 55,000
How much is the cost of materials issued (used) to production?
Cost of Sales
Total manufacturing costs is the sum of costs of all resources consumed in the process of making a
product. The manufacturing cost is classified into three categories: direct materials cost, direct labor
cost and manufacturing overhead.

Direct Materials are the traceable matter used in manufacturing a product. It is the cost of the raw materials
and components used to create a product.

Direct labor costs are the wages or salaries paid to employees who physically produce products. In other
words, these expenses are the costs paid to workers who make the products that manufactures sell.

Manufacturing overhead comprises of indirect materials, indirect employee cost and indirect expenses
which are not directly identifiable or allocable to a cost object. Overheads may defined as the aggregate of
the cost of indirect material, indirect labor and such other expenses including services as cannot
conveniently be charged directly to specific cost units. Other term: Factory Overhead

Examples of Manufacturing Overhead: Indirect Materials, Indirect Labor, Factory utilities, Factory
Depreciation, Factory Supervisor Salaries, Factory insurance or any cost related to factory except direct
materials and direct labor.
Cost of Sales
Total manufacturing costs is the sum of costs of all resources consumed in the process of making a
product. The manufacturing cost is classified into three categories: direct materials cost, direct labor
cost and manufacturing overhead.
Cost of Sales
PRIME AND CONVERSION COSTS
In cost accounting, the term for the sum of the direct materials and direct labor is prime cost.

• Prime cost reflects the primary source of costs of units in production. The total of direct labor and
manufacturing overhead is often called conversion costs.

• Conversion cost indicates the costs required to convert the raw materials into finished products.

Direct Materials + Direct Labor = Prime Cost

Direct Labor + Manufacturing Overhead = Conversion Cost
Q&A
The accounting records of BFAR Company revealed the following costs:
Factory utilities 156,000
Wages of assembly-line personnel 170,000
Customer entertainment 45,000
Indirect materials used 119,000
Depreciation on salespersons' cars 51,000
Production equipment rental costs 110,000

Compute the manufacturing overhead.

Q&A
The following miscellaneous data has been collected for a manufacturing company for the most
recent year-end:

Inventories: Beginning Ending

Raw material P50,000 P55,000
Work in process 40,000 45,000
Finished goods 60,000 50,000

Costs recorded during the year:

Purchases of raw material P195,000
Direct labor 150,000
Cost of goods sold 595,000
Compute the prime and conversion costs.
COST ACCULUMATION SYSTEM
The basic objectives of cost accounting is the determination or accumulation of a product’s
cost for inventory valuation.

The following systems maybe used in accumulating a product’s cost (input Measurement
Basis)

1. Actual Cost system (Historical) - Assigns actual costs to direct materials, direct labor, and
manufacturing overhead

2. Normal Cost System - Commonly used, computes total manufacturing costs based on
actual costs of direct materials and direct labor, and applied manufacturing overhead cost.

3. Standard cost system - Assigns standard or budgeted costs to all manufacturing costs.

The Standard cost system will be discussed in advanced cost accounting courses.
Normal Cost System
APPLIED MANUFACTURING OVERHEAD = PREDETERMINED OVERHEAD RATE X
ACTUAL SPECIFIED ACTIVITY

Predetermined Manufacturing Overhead

The primary purpose of overhead rate is to charge a fair share of overhead cost to each costs. The common bases
are as follows:
• Direct Labor costs
• Direct Labor hours
• Direct material costs
• Machine hours
• Units of Production

Inputs to get Predetermined MOH

• Estimated Manufacturing overhead (beg of the year)
• Common bases (activity drivers) – see above
Predetermined Overhead rate

Illustrative Example: ABC Company charges manufacturing overhead to products by using

a predetermined application rate, computed on the basis of machine hours. The
following data pertain to the current year:
Budgeted manufacturing overhead: P480,000
Actual manufacturing overhead: P440,000
Budgeted machine hours: 20,000
Actual machine hours: 16,000
1. Calculate Predetermined Overhead rate
2. Determine the overhead cost applied to production:

Solution:
1. The predetermined rate is P480,000/P20,000 = P24 per machine hour.

2. Under normal cost system, the overhead applied to production is

APPLIED MANUFACTURING OVERHEAD = PREDETERMINED OVERHEAD RATE X ACTUAL
SPECIFIED ACTIVITY
24 per hour X 16,000 hours = P384,000.
Q&A
1. BFAR Company has the following estimated costs for next year:
Direct materials .................... P15,000
Direct labor ........................ 55,000
Sales commissions ................... 75,000
Salary of production supervisor ..... 35,000
Indirect materials .................. 5,000
Advertising expense ................. 11,000
Rent on factory equipment ........... 16,000
BFAR estimates that 10,000 direct labor and 16,000 machine hours will be worked during the year. If
overhead is applied based on machine hours, the overhead rate per hour will be:

2. BFAR Company used a predetermined overhead rate last year of P2 per direct labor hour, based
on an estimate of 25,000 direct labor hours to be worked during the year. Actual costs and activity
during the year were:
Actual manufacturing overhead cost incurred P47,000
Actual direct labor hours worked .......... 24,000
Compute the applied manufacturing overhead.
• Aren’t we supposed to account the actual costs since
applied is only based on estimates?
• What happens to the actual costs if the normal cost system
is used?
• What happens to the difference between actual and
applied costs?
Normal Cost System

• Actual costs > Applied Costs – The overhead appears to be

underapplied. Meaning under normal system, applied costs is
below than the actual costs. Underapplied is reported as
Prepaid Expense at the end of interim reporting of SFP.
• Actual costs < Applied Costs - The overhead appears to be
overapplied. Meaning under normal system, applied costs is
higher than the actual costs. Overapplied is reported as Other
Liabilities at the end of interim reporting of SFP.

At the end of the year, any balance of under or overapplied manufacturing overhead is closed
to COGS (write off approach). Thus, the balance will not appear at the end-of-year statement of
Financial Position. This will be discussed in the advanced cost accounting courses.
Normal Cost System

Illustrative Example: MJE, Inc., applies manufacturing overhead at the rate of

P60 per machine hour. Budgeted machine hours for the current period were
anticipated to be 80,000; however, a lengthy strike resulted in actual machine
hours being worked of only 65,000. Budgeted and actual manufacturing
overhead figures for the year were P4,800,000 and P4,180,000, respectively.
Overhead is ______.

Actual 4,180,000
Applied (60 X 65,000) 3,900,000
Underapplied overhead 280,000
Q&A
1. BFAR Company has the following estimated costs for next year:
Direct materials .................... P15,000
Direct labor ........................ 55,000
Sales commissions ................... 75,000
Salary of production supervisor ..... 35,000
Indirect materials .................. 5,000
Advertising expense ................. 11,000
Rent on factory equipment ........... 16,000
BFAR estimates that 10,000 direct labor and 16,000 machine hours will be worked during the year. If
overhead is applied based on machine hours. Compute the over or under applied overhead.
2. BFAR Company used a predetermined overhead rate last year of P2 per direct labor hour, based
on an estimate of 25,000 direct labor hours to be worked during the year. Actual costs and activity
during the year were:
Actual manufacturing overhead cost incurred P47,000
Actual direct labor hours worked .......... 24,000
Compute the over or under applied overhead.
QUESTIONS?