MANUFACTURING COSTS

Manufacturing costs. They include three cost

categories: direct material, direct labor, and
manufacturing overhead
Direct Material. Direct material cost is the cost
of all materials and parts that are directly
traced to items produced.
Direct material cost often does not include the
cost of minor materials.
Direct Labor. Direct labor cost is the cost of
labor that is directly traced to items produced.
It does not include the cost of production
supervisors.
Manufacturing
Overhead.
Manufacturing
overhead is the cost of all manufacturing
activities other than direct material and direct
labor.

NONMANUFACTURING COSTS
Nonmanufacturing costs defined as all costs
that are not associated with the production of
goods. These costs include selling and general
and administrative costs.
Selling Costs. Selling costs include all the costs
associated with securing and filling customer
orders.
General and Administrative Costs. General and
administrative
costs
are
all
the
costs
associated
with
the
firms
general
management.
Product Costs. Product costs are those costs
assigned to goods produced. Thus, the terms
product costs and manufacturing costs are
used interchangeably.
Period Costs. Period costs are identified with
accounting periods rather than with goods
produced.

Type of Cost

When Expensed

Product Cost
Manufacturin
g Costs

Direct material
Direct labor
Manufacturing
overhead

Expensed when goods

are sold

Period Cost
Nonmanufact
uring Costs

Selling cost
General and
administrative
cost

Expensed in period in
which they are
incurred

PRODUCT COST INFORMATION IN

FINANCIAL REPORTING AND
DECISION
MAKING
GAAP requires
that inventory
on the balance
sheet and cost of goods sold on the income
statement be presented using full cost
information.

 Full cost means that product cost includes both

variable and fixed manufacturing overhead as
well as direct material and direct labor, which
are generally variable costs.
Product cost information is also needed for a
variety
of
managerial
decisions,
e.g.
incremental analysis.
In most cases, in order to perform incremental
BALANCE
SHEET
analysis,
you
need PRESENTATION
to separate fixedOF
and
Three
asset
are COSTS
related to inventory:
variable
costaccounts
components.
PRODUCT
Raw Materials, Work in Progress, and Finished
Goods.
Cost
of Goods Manufactured.
Beginning
Balance in
Work in
Progress

Current
Manufactu
ring Costs
Direct Material
Direct Labor
Manufacturing

Ending
Balance in
Work in
Process

Cost
of Goods
Manufactu
red

 Cost of Goods Sold.

BALANCE SHEET ACCOUNT
Raw
Work in Process
material
Inventory
Inventory
Direct
Material

Direct material
Direct labor

Indirect
Material

Overhead
(Indirect material,
indirect labor)

Beginning
Balance in
Finished
Goods

Cost of
Goods
Manufactu
red

Finished
Goods
Inventory

Income
Statement
Account

Cost of
Cost of goods
goods
sold
manufactur
ed

Ending
Balance in
Finished
Goods

Cost
of
Goods
Sold

TYPES OF COSTING SYSTEMS

Schedule of Cost of Goods Manufactured
For the Year Ended December 31, 2006
Beginning balance in work in process
$40,000
Plus: current manufacturing costs:
Direct material
$1,400,000
Direct Labor
600,000
Manufacturing overhead
Heat, light, and power
$10,000
Rent for production facility
40,000
Depreciation of equipment 50,000
Other
100,000
200,000 2,200,000

Income Statement
For the Year Ended December 31, 2006
Sales
$2,600,000
Less cost of goods sold:
Beginning finished goods
$80,000
Add cost of goods manufactured
2,140,000
Cost of goods available for sale
2,220,000
Less ending finished goods
60,000
2,160,000
Gross profit
440,000
Less nonmanufacturing expenses:

 Companies that produce individual products or

batches of products that are unique use a joborder costing system.
Companies that use a process costing system
generally produce large quantities of identical
items.
Total cost of
production
Unit
cost
of
items
produced
=
OVERVIEW
OF
JOB COSTS
------------------------------------------- You should also recall Total
that product
are
number costs
of units
reflected
produced in Work in Process Inventory and
Finished Goods Inventory on the balance sheet
and inn Cost of Goods Sold on the income
Work
in Process
Finished Goods Inventory
statement.
Cost
Sold Cost of jobs
Costof
of Goods
jobs
being worked
on

completed but
not yet sold

Cost of jobs sold

JOB-ORDER COSTING SYSTEM

Job cost sheet is a form, typically computer
generated, used to accumulate the cost of
producing the item or items ordered.

DIRECT MATERIAL COST

A material requisition form is used to request

the release of materials from a companys
storage area.
Removal of materials from storage for use on a
specific job decreases Raw Materials and
increases Work in Process Inventory.
Dr
Cr
(dat Work in Process
e)
Inventory
Raw Materials

60,000.0
0
60,000.0
0

DIRECT LABOR COST

Workers in a company that uses a job-order
costing system fill out time tickets to keep
track of the amount of time spent on each job.
Removal of materials from storage for use on a
specific job decreases Raw Materials and
increases Work in Process Inventory.

Journal Entry to Record Direct Labor

(dat Work in Process
e)
Inventory
Wages Payable

10,000.0
0

10,000.0
MANUFACTURING OVERHEAD
0
An overhead allocation rate is calculated by
dividing estimated overhead costs by the
estimated quantity of the allocation base.
The amount of overhead assigned to jobs is

(dat Manufacturing Overhead 66,000.

e)
Accumulated
00
Depreciation
Utilities Payable
Various other accounts
(dat Work in Process Inventory
e)
Manufacturing overhead

10,000.
00

1,000.0
0
55,000.
60,000.
00
00
60,000.

To record overhead costs

incurred.
To
record overhead costs
applied to jobs.

00

USING JOB COST INFORMATION

Analysis of estimated and actual cost.
Actual costs are higher than estimated.
Work to improve the estimation process.

THE OVERHEAD ALLOCATION BASE

In selecting the allocation base, consider
whether the production process is labor
intensive or machine intensive. If an operation
is labor intensive (i.e., large quantities of labor
are used to produce most jobs), then direct
labor hours or direct labor cost is likely to be a
reasonable allocation base. If an operation is
highly mechanized, then machine hours is likely
to be a reasonable allocation base.
You get what you measure, may be applied on
selecting allocation base.

ACTIVITY-BASED COSTING (ABC)

Activity-based costing (ABC) is a method of

assigning overhead costs to products using a
number of different allocation bases.

PREDETERMINED OVERHEAD RATES

Overhead rates are based on estimates of
overhead cost and estimates of the level of the
allocation base rather than on actual costs and
quantities.
The estimated or budgeted overhead cost and
the estimated level of the allocation base are
generally estimated for a year so that the
overhead allocation rate stays the same from
month to month.
When expected levels of the allocation base
decrease, the expected amount of variable
overhead
also
decreases.
However,
Dr
Cr the
expected
amount
of fixed overhead
does not
(dat
Cost of Goods
Sold
2,000.0
Thus, the
overhead rate
is likely
to
e) decrease.
Manufacturing
overhead
0
2,000.0
be higher in slow months.
0
To close manufacturing

 The amount of under- or overapplied overhead

should be apportioned among Work in Process,
Finished Goods, and Cost of Goods Sold.
If the amount is immaterial (i.e., relatively
small) it is sufficient for practical purposes to
simply debit (for underapplied overhead) or
credit (for overapplied overhead) the amount
to Cost of Goods Sold. If the amount is material
(i.e., relatively large), it should be apportioned
among Work in Process, Finished Goods, and
JOB-ORDER
COSTING FOR SERVICE
Cost
of Goods Sold.
Shops do not assign
overhead to jobs. Rather,
COMPANIES
they mark up the charges for labor and parts to
cover overhead and generate profit.

MODERN MANUFACTURING
Here we brieflyPRACTICES
discuss three of the

major
changes: just-in-time production, computercontrolled manufacturing, and total quality

JUST-IN-TIME (JIT) PRODUCTION

Also referred to as lean production systems.
The goals of a JIT system are to develop a
balanced production system that is flexible and
allows for smooth, rapid flow of materials.

TOTAL QUALITY MANAGEMENT

Listening to the needs of customers,

Making products right the first time,
Reducing defective products
Encouraging workers continuously
their production processes.

improve

SUMMARY OF LEARNING OBJECTIVES

Discuss the types of product costing systems.

There are two types of product costing
systems: job-order systems and process
costing systems. Companies using job-order
systems generally produce individual products
or batches of products that are unique.
Companies using process costing systems
generally produce large quantities of identical
items in a continuous production operation.
Discuss modern manufacturing practices and
how they affect product costing. U.S.
companies are facing stiff competition from
companies abroad. In response, many have
adopted manufacturing systems that minimize
inventories of raw materials and work in
process. In addition, many companies have
become highly automated and have instituted