Session 4

Manufacturing Costs

and

Inventory Costing
SECTION 1:
MANUFACTURING
COSTS
Manufacturing Accounting
Specialized accounting concepts and
techniques required to record, report, and
control the operations of a manufacturing
company
Costs
Separate Manufacturing from
Administrative
Manufacturing Costs
◦ Raw materials
◦ Direct labor
◦ Overhead
Administrative Costs
◦ Selling
◦ Administrative
Manufacturing Costs
Raw materials – material that is to be processed
into a finished product

Direct labor – wages of those person whose

efforts directly affect the quality or other
characteristics of the products manufactured
Manufacturing Costs
Overhead – all other manufacturing costs not
included in raw material or direct labor
◦ Maintenance wages/supplies
◦ Production supervision & expenses
◦ Depreciation expense of manufacturing assets
◦ Rent expense for buildings/machinery
◦ Electricity for manufacturing
◦ Insurance expense for manufacturing
◦ Indirect labor
◦ Manufacturing clerical wages
Manufacturing Inventories
Raw materials inventory – cost of items of raw
material being held for production + freight
costs
Work-in-process inventory – cost of products
being processed
Finished goods inventory – manufacturing cost
of products that have been completed and are
awaiting shipment to customers
Cost of Goods Sold
• Different from a merchandise co.
• Purpose is to properly match manufacturing costs
with sales
• Must include beginning & ending finished goods

Beginning Finished Goods Inventory

+ Cost of Goods Manufactured
= Cost of Good Available for Sale
- Ending Finished Goods Inventory
= Cost of Goods Sold
Cost of Goods Manufactured
Raw materials
used Finished
Goods
Inventory

Work-in-
Direct
Process
labor
inventory

Cost of
Factory goods sold
overhead
Cost of Goods Manufactured
Cost of Raw Materials Used:

Beginning raw materials inventory

+ Purchases of Inventory
- Ending raw material inventory
Cost of Goods Manufactured
Total manufacturing costs incurred:

Cost of raw materials used

+ Direct labor
+ Factory Overhead
Cost of Goods Manufactured
Cost of goods manufactured:

Total manufacturing costs

+ Beginning work-in-process inventory
- Ending work-in-process inventory
Example
 John Manufacturing Company, a manufacturer of soda bottles, had the following inventory
balances at the beginning and end of 2018:

 In 2018, the company purchased $1,000,000 of raw materials, and direct labor incurred a cost of
$1,600,000. Manufacturing overheads were as follows:

 Sales revenue was $4,105,000 for the year. Selling and administrative expenses for the year
amounted to $110,000.
 Prepare a cost of goods manufactured statement
 Prepare a cost of goods sold statement
Solution
CoGm to CoGS and Net Income
Income Statement
Samolis Manufacturing
Income Statement
For Month Ended March 31, 20XX

Net Sales: $ 398,000

Cost of Goods Sold
Finished Goods Inventory (Beg.) $ 40,000
Cost of Goods Manufactured 267,000
Cost of Goods Available for Sale $ 307,000
Less: Finished Goods Inventory (End.) 28,000
Cost of Goods Sold: $ 279,000
Gross Profit on Sales $ 119,000

Operating Expenses:
Selling Expense $ 15,450
Admistrative Expense 9,560
Total Operating Expenses $ 25,010
Net Income (before taxes) $ 93,990
 Reports Prepared from the Worksheet
Balance Sheet
SAMOLIS MANUFACTURING
BALANCE SHEET SAMOLIS MANUFACTURING
MARCH 31, 20XX
BALANCE SHEET
ASSETS MARCH 31, 20XX
Current Assets
Cash $ 350,000
Liabilities and Stockholders' Equity
Accounts Receivable $ 245,000
Less: Allowance for Doubtful Accounts 130,000 $ 115,000 Current Liabilities

Inventories
Notes Payable $ 145,000
Raw Materials $ 96,000
Work-in-Process 18,000 Accrued Payroll Payable 21,000 $ 166,000
Finished Goods 28,000 $ 142,000
Stockholder's Equity
Prepaid Expenses
Factory Supplies 2,500 Common Stock, $100 par 2,000 shares $ 200,000
Prepaid Factory Insurance 3,000 $ 5,500 Retained Earnings 305,000 $ 505,000
Total Current Assets $ 612,500

Plant and Equipment: Total Liab. & Stockholders' Equity $ 671,000

Factory Machinery $ 78,000
Less: Accum. Deprec., Factory Machinery 19,500 $ 58,500
Total Assets $ 671,000
  On January 1, the ledger of the Phinney Furniture Company contained, among other accounts,
the following: Cash $40,000; Finished Goods, $25,000; Work in Process, $30,000; Materials,
$15,000 (also record the total amount of these as equity).
  During January, the following transactions were completed:

 (a) Materials were purchased at a cost of [PA].

(b) Direct materials in the amount of [PB] were issued from the storeroom.
(c) Storeroom requisitions for indirect materials and supplies amounted to [PC].
(d) The total payroll for January amounted to [PD], including marketing salaries of [PE] and
administrative salaries of [PF]. Labor time tickets show that [PG] of the labor cost was direct labor.
(e) Various factory overhead costs were incurred for [PH] on account.
Transactions Example

(f) Total factory overhead is charged to the work in process account.

(g) Production in WIP completed at the amount of [PI], and also recorded in finished goods in the
shipping room.
(h) The finished WIP in (g) was shipped to customers (also record entry for cost of goods sold).
(i) The customers to whom shipments were made during the month were billed for [PJ].

AL BE CN EM OT
PA 25,000 26,000 26,000 29,000 28,000
PB 21,000 17,000 25,000 22,000 25,000
PC 3,200 3,200 3,000 3,100 3,100
PD 29,000 29,000 34,000 33,000 29,000
PE 7,400 7,400 7,200 7,200 7,900
PF 5,300 5,200 6,000 5,100 5,300
PG 14,600 15,400 16,400 15,100 15,800
PH 14,000 10,000 14,000 9,000 13,000
PI 58,000 58,000 58,000 54,000 58,000
PJ 86,000 83,000 83,000 83,000 84,000
Total A = L+E 164,300 158,400 161,800 164,700 163,800
Profit ? ? ? ? ?
SECTION 2:
INVENTORY COSTING
Inventory Costing
SpecificIdentification method
Cost Flow Assumptions
◦ FIFO- First-in, First-Out- earliest goods
purchased are the first to be sold
◦ LIFO- Last-in,First-Out- latest goods
purchased are the first to be sold
◦ Average Cost Method- costs are charged on
the basis of weighted average unit cost

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The FIFO method assumes the earliest goods
purchased are the first to be sold.
The LIFO method assumes the latest goods
purchased are the first to be sold.
The average cost method assumes
that goods available for sale are
the same.
The allocation of the cost of goods
available for sale is made on the
basis of the weighted average unit
cost incurred.
 Illustration 6-10

The average cost method

assumes
The average cost that
methodgoods available
assumes that goods
for sale
available are
for sale similar in nature.
are homogeneous.
Factors Used in Selecting an
Inventory Cost Method
 Income statement effects
 Balance sheet effects
 Tax effects

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Income Statement Effects
In periods of increasing prices
◦ FIFO reports the highest net income
◦ LIFO the lowest
◦ average cost falls in the middle.
In periods of decreasing prices
◦ FIFO will report the lowest net income
◦ LIFO the highest
◦ average cost falls in the middle.
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Balance Sheet Effects

In a period of increasing prices costs

allocated to ending inventory using:
FIFO will approximate current costs
 LIFO will be understated

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 Tax Effects

Why do companies use lifo?

 Higher cost of goods sold

 Lower net income

Lower Income Taxes

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Consistency
Whatever cost flow method a
company chooses, it must use it
consistently…
OR
Disclose the change and its effects
on net income in the financial
statement.
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The Lower of Cost or Market Basis of
Accounting for Inventories

When the value of inventory is lower

than its cost, the inventory is written
down to its market value by valuing the
inventory at the lower of cost or market
(LCM) in the period in which the price
decline occurs.
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Lower of Cost or Market (LCM)

departure from cost principle

follows conservatism concept
can be used only after one of the cost
flow methods ( Specific Identification
FIFO, LIFO, or Average Cost)

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Market Is...

CURRENT REPLACEMENT
COST

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How Much Inventory Should a Company
Have?
◦ Only enough for sales needs
◦ Excess inventory costs:
 storage costs
 interest costs
 obsolescence - technology, fashion

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Inventory Turnover
Ratio =
An indication of how quickly
a company sells its goods.

Higher is better.
Inventory Turnover
Ratio =

Cost of Goods Sold

Average Inventory
Days in Inventory =
An indication of how
quickly a company sells
its goods.
Lower is better.
Days in Inventory =

365 days
Inventory Turnover Ratio
Lifo Reserve And Its Importance For Comparing Results
Of Different Companies

Accounting standards require firms using LIFO to

report the amount by which inventory would be
increased (or on occasion decreased) if the firm had
instead been using FIFO.
This amount is referred to as the LIFO reserve.
Reporting the LIFO reserve enables analysts to
make adjustments to compare companies that use
different cost flow methods.
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