Manufacturing Operations finished, and unsold during the period.

This
system does not provide for a detailed flow of
costs in the manufacturing process.
Comparing Merchandising and Manufacturing
Activities
The following are the pro-forma journal entries of the
- Merchandising and manufacturing entities earn more common transactions for a manufacturing entity.
revenues by selling goods. A merchandiser
normally buys a product that is ready for resale 1. To record purchase of raw materials and indirect
when it is received. A manufacturer buys raw materials on account:
materials and processes them into finished goods
Purchases – Raw Materials xx
that it sells to customers.
Indirect Materials xx
Merchandising Companies
Vouchers Payable xx
 Buy Products
 Sell Products Instead of Accounts Payable, Vouchers Payable is used
for manufacturing which means it is recorded on account.
Manufacturing Companies It is a liability.
 Buy materials
 Use labor and other economic resources to 2. To record cost of defective raw materials
produce products returned to vendor:
 Sell products
Elements of Manufacturing Costs Vouchers Payable xx

Manufacturing costs include all costs relates to the Purchases Rets & Allow xx
production process. They are classified into three
categories: 3. To record payment of account within the discount
period:
 Direct Materials – these materials become a
physical part of a finished product. Their costs
can be conveniently and economically traceable Vouchers Payable xx
to the finished product. Purchase Discounts xx
 Direct Labor – it is the compensation of
employees or workers who physically convert Cash in Bank xx
raw materials into finished goods.
 Manufacturing Overhead – this includes all 4. To record freight and handling of raw materials:
manufacturing costs that cannot be classified as
direct materials or direct labor.
Transportation In xx
Manufacturing Inventory Accounts
Vouchers Payable xx
Manufacturers have various inventory accounts, as
follows; 5. To record payroll for factory employees:
 Finished Goods Inventory – it is the cost of
completed goods that have remained unsold at the Direct Labor xx
end of the accounting period. This inventory is
Indirect Labor xx
what the manufacturers sell to the merchandisers.
 Work in Process Inventory – this account gives SSS Contribution Payable xx
the cost of the goods that are in the manufacturing
process but are not yet complete at the end of the Medicare Contributions Payable xx
accounting period. Pag-IBIG Contributions Payable xx
 Raw Materials Inventory – this account holds
the cost of direct materials on hand that is Withholding Taxes Payable xx
intended for use in the manufacturing process.
Vouchers Payable xx
 Factory Supplies Inventory – it is the cost of
unused indirect materials at period end. Before giving the employee's salary, the company first
reduces the payroll. The company serves only as a
Accounting for Manufacturing Activities
collecting agent. They deduct it from the employee's
Two accounting systems may be used in accounting for payroll, then give it to the corresponding agencies. While
manufacturing activities – cost and non-cost. they have not yet given it to the agencies, they record it as
liability. And it is recorded in the voucher payable until
 The cost system keeps perpetual records of the they have not given the wages.
costs of raw material, work in process, and
finished goods inventories. This system provides
6. To record employer’s payroll expenses:
more timely information about those inventories
and changes in their levels.
 The non-cost system produces a manufacturing Employer’s Payroll Contributions – Factory
accounting system based on the periodic
SSS Contribution Payable xx
inventory system. The costs of raw materials,
work in process, and finished goods inventories Medicare Contributions Payable xx
are based on physical counts of the quantities on
hand at the end of each period. This information EC Contributions Payable xx
is then used to compute the amounts consumed, Pag-IBIG Contributions Payable xx
When the company deducts the employee's payroll, the 13. To record factory utilities incurred:
employer has a corresponding share.
Factory Utilities xx
7. To record distribution of payroll:
Vouchers Payable xx
Vouchers Payable xx
14. To record cost of tools used:
Cash in Bank xx
Tools Used xx
8. To record accrual of factory payroll:
Tools xx
Direct Labor xx It is a composite record for small tools combined.
Indirect Labor xx
15. To record sales of unfinished goods
Accrued Payroll xx
Accrued Payroll means payroll liabilities. Accounts Receivables xx
Sales xx
9. To record depreciation of factory building:
Assuming that it is on account, use accounts receivables.
If not, use cash account.
D.E. – Factory Bldg. xx
A.D. – Factory Bldg. xx 16. To record sales returns of customers:
Any amount of cost associated in the manufacturing of the
product should be charged as part of the cost of the Sales Rets. & Allow. xx
product. This depreciation pertaining to factory building Accounts Receivables xx
will be charged as the cost of the product as one of the
factory overhead.
17. Closing entries peculiar to manufacturing
concerns:
10. To record repairs on factory building:
In order for a manufacturer to summarize all the
Repairs and Maint. – Factory Bldg. xx transactions that affect the computation of cost of
goods manufacture, a manufacturing summary
Vouchers Payable xx account is maintained. It is credited the results of the
physical count of raw materials inventory and work in
The factory building is specified because there are process inventory at the end of the accounting period.
buildings used by sales, administrations, and other The contra-purchases accounts are also credited to
support services. The building being occupied by those this account. This account is debited for the beginning
departments will not be charged as part of the cost of the balances of raw materials and work in process
product. Their depreciation will be charged in the inventory, and the manufacturing accounts with debit
operating expenses. balances. The balance of the manufacturing summary
account is then closed to the income summary
11. To record amortization of patents: account.

Amortization of Patents xx a. To close manufacturing accounts with credit

balances, and to record ending inventory
Patent xx materials and work in process:
No matter how much the cost of the patent is, it will be
amortized during the light of that patent. If it is 20 years, Raw Materials Inventory, End xx
you have to amortize it for 20 years.
Work in Process Inventory, End xx
Note:
Purchases Rets. & Allow. xx
Depreciation – physical assets
Purchases Discounts xx
Amortization – intangible assets (logo, brand)
Manufacturing Summary xx
12. To record real property taxes on factory site:
b. To close manufacturing accounts with debit
balances:
Real Property Taxes xx
Vouchers Payable xx Manufacturing Summary xx
Real property taxes are taxes paid yearly for the real Raw Materials Inventory, beg. xx
property. Be specific on recording real property taxes. If
it is for product or manufacturing cost, then it should be Work in Process Inventory, beg. xx
taxes on factory site. It is to clear that the property taxes Purchases – Raw Materials xx
are not for the administrative account.
Transportation In xx
Direct Labor xx
 Indirect Labor xx Tools Used
Depreciation Exp – Factory Bldg. xx Employer’s Payroll Contribution – Factory
Repairs and Ment – Factory Bldg. xx Factory Supplies Expense
Amortization of Patents xx Miscellaneous Factory Expense
Real Property Taxes xx Total Manufacturing Costs
Factory Utilities xx Add: Work in Process, beginning
Tools Used xx Total Cost of Goods Placed in Process
Employer’s Payroll Contri. – Factory xx Less: Work in Process, end
Factory Supplies Expense xx Cost of Goods Manufactured
Miscellaneous Factory Expense xx
Statement of Cost of Goods Sold
c. To close manufacturing summary and beginning
finished goods inventory to income summary: The difference in the income statement or a
merchandising and a manufacturing entity lies in the cost
of goods sold section. As illustrated, observe that the
Income Summary xx
merchandiser used the term merchandise inventory while
Manufacturing Summary xx the manufacturer used the term finished goods inventory.
A merchandiser’s entire inventory is finished goods: a
Finished Goods Inventory, beg xx merchandiser has no materials inventory and work in
process inventory.
d. To establish the ending finished goods inventory:
A manufacturer produces its own finished goods
inventory. Cost of goods manufactured is the
Finished Goods Inventory, beg xx manufacturer’s counterpart to the merchandiser’s
Income Summary xx purchases. Net cost of purchases is the cost of all the
goods a merchandiser bough for resale during the period.
Cost of goods manufactured is the manufacturing cost of
the goods completed during a production period.
Statement of Cost of Goods Manufactured
Merchandising Entity

Renante Balocating Manufacturers Merchandise Inventory, Beg. xx

Statement of Cost of Goods Manufactured Add: Net Cost of Purchase xx
For the Year Ended Dec. 31, 2019 Goods Available for Sale xx
Less: Merchandise Inventory, End xx
Direct Materials Used: Cost of Goods Sold xx
Raw Materials Inventory, beg. Manufacturing Entity
Add: Net Purchases
Finished Goods Inventory, Beg. xx
Purchases – Raw Materials
Add: Cost of Goods Manufactured xx
Less: Purchases Rets & Allow.
Goods Available for Sale xx
Purchases Discounts
Less: Finished Goods Inventory, End xx
Net Purchases
Cost of Goods Sold xx
Add: Transportation In
Worksheet for a Manufacturing Entity
Raw Materials Available for Use
The worksheet for a manufacturing entity is basically the
Less: Raw Materials Inventory, end same as that for a merchandising entity except that it
Direct Labor includes a pair of columns for cost of goods
manufactured. All the accounts that comprise the
Manufacturing Overhead statement of cost of goods manufactured are extended to
these columns. Beginning raw materials inventory and
Indirect Labor work in process are debited in the manufacturing columns
Indirect Materials while the related ending inventories are credited.

Depreciation Exp – Factory Bldg. The other manufacturing accounts are either debited or
credited as necessary. The difference between the total
Repairs and Ment. – Factory Bldg. debits and total credits of these two columns is then
extended to the debit column of the income statement.
Amortization of Patents
Beginning finished goods inventory being a component in
Real Property Taxes the computation of cost of goods sold is extended to the
debit side of the income statement columns while the
Factory Utilities ending finished goods inventory to the credit column.
 Manufacturing Business A. As to Function

1. Production Costs (sometimes called

Operations of a Manufacturing Business
Manufacturing Costs or Factory Costs) - these
A manufacturing business is one engaged in the are the costs incurred to produce the product. Any
conversion of raw materials into finished product which cost associated with the manufacturing operations
will be sold at a price higher than the production costs. will fall into this classification. Examples are the
Examples are manufacturers of drugs, cars, calculators, raw materials, wages of the factory workers,
computers, radios, televisions, toys, tables and chairs, depreciation of the machinery, factory rent,
pencils, ball pens, etc. factory supplies, etc. All the production costs are
called Inventoriable Costs because they are
included in the cost of the inventory.
Stages in the Manufacturing Operations and the
Inventories 2. Selling Costs (sometimes called Marketing
Costs) - these are the costs incurred to sell the
Whatever product is to be manufactured, there are products. Any cost which can be identified with
always three stages in the manufacturing process. The the selling activity will fall into this classification.
manufacturing operations begin from the time the raw Examples are advertising expense, delivery
materials are purchased (first stage) which will then be expense, commission expense, salary of the sales
processed (second stage) and converted into a finished manager, depreciation of the delivery truck,
product (third stage). The three stages therefore in the impairment loss on accounts receivable (bad
manufacturing operations are the: debts), etc.

1. Raw materials stage 3. Administrative Costs - these are the costs

2. Goods in process stage incurred to run the business other than the
3. Finished goods stage production and selling costs. Examples are office
rent, salary of general manager, insurance
Materials purchased which are not yet processed are expense, office supplies, depreciation of office
still in the raw materials stage (first stage). Once these raw equipment, light and water expense, etc. Any
materials are processed, they are called goods in process other cost of operation which cannot be classified
or more popularly called work in process (second stage) as production or selling cost will fall into this
and after completion, they become finished goods (third classification.
and last stage) and will be available for sale.
4. Financing Costs - these are the costs incurred as
a result of borrowing money. Examples are the
In a manufacturing business, there are three types of
interest expense, documentary stamps, legal fees,
inventories represented by the three stages. They are the
bank charges, etc.
Raw Materials Inventory referring to the materials on
hand not yet processed, the Work in Process Inventory Note: The selling costs, administrative costs and
referring to the raw materials already processed but not financing costs are all considered as expenses and are
yet completed, and the Finished Goods Inventory called period costs (costs that are subtracted from the
referring to the work in process which has been income of the period). In the case of the production costs
completed. In a merchandising business, there is only one (inventoriable costs), once the units produced are sold,
inventory called Merchandise Inventory referring to the they will become period costs because they will partake
goods purchased but not yet sold. the nature of expenses (to be subtracted from the income
of the period).
When the raw materials are processed, leftovers or
incidental output may be produced. These leftovers of
materials resulting from the manufacturing process are B. As to Nature
called scrap materials if they can still be sold or used for
other purposes. However, if the leftovers have no more 1. Actual or Historical Costs - these are costs
value or cannot be used for any other purpose and will just already incurred. Either they are already paid or a
be thrown away, they are called waste materials. liability has been incurred if not yet paid.

In the case of mass production of a product, not all 2. Estimated Costs - these are budgeted or
finished goods will turn out to be good units. If the units projected costs and no cash outlay is involved.
do not meet the required specification, they are called the
spoiled goods. They will just be sold as seconds or at a C. As to Traceability to the Product
much lower price than the good units. If the units can still
be reworked to meet the required specification, they are 1. Direct Costs - these are costs traceable or can be
called the defective goods. conveniently identified to a product. These costs
are directly charged to the product. The raw
material used, the wages of the factory workers
Cost Classifications are examples of direct costs.
The costs of a manufacturing business can be
2. Indirect Costs - these are costs which are
classified into several ways depending on the purpose for
applicable to all the products manufactured hence
which they are being measured. The classifications are as
cannot be conveniently identified with a specific
follows:
product and as such, are merely allocated to the
different products. Examples are factory rent
expense, depreciation of factory building, salary
of the foreman, factory supplies, etc.
 D. As to Behavior Methods of Costing
When computing the cost of the product, these questions
1. Variable Cost - a cost which fluctuates or varies need to be answered:
with the change in volume. Examples are raw
materials used, commission expense, light and
water expense, etc.
1. What kind of production costs will be used?
2. Fixed Cost - a cost which remains constant or
a. Actual Costing – all actual costs
does not change regardless of a change in volume.
Examples are rent, advertising, insurance, Actual Direct Materials xx
salaries, depreciation, etc.
Actual Direct Labor xx

Elements of Production Cost Actual Factory Overhead xx

The three elements of production costs are the following: Actual Manufacturing Costs xx

b. Normal Costing – actual and estimated costs

Actual Direct Materials xx
Actual Direct Labor xx
Applied (estimated) Factory Overhead xx
Normal Manufacturing Costs xx

Direct Materials – materials which can be identified or c. Standard Costing – all estimated costs
conveniently charged to a specific product. These are
materials which form part of the finished product. Standard (estimated) Direct Materials xx
Examples are the cloth in the manufacture of dresses and
Standard (estimated) Direct Labor xx
the lumber used in manufacture of tables.
Standard (estimated) Factory Overhead xx
Indirect Materials – materials necessary in the Standard Manufacturing Costs xx
manufacturing process but cannot be conveniently
identified with a specific product. The amount is usually
insignificant. Examples are thread used in the
manufacture of hats and the sand paper used in the 2. Which elements of production costs must be
manufacture of tables. included in the cost of the product?

a. Absorption Costing – all the production costs

Direct Labor – refers to the wages of the factory workers. are included in the cost of the product regardless
of whether the item is a variable or a fixed cost.
Indirect Labor – refers to the compensation of the other This method id used for external reporting
employees in the production department other than the purposes (reporting to outsiders).
factory workers which include the salaries of the foreman,
supervisor, stock clerk, warehouseman, etc. Direct Materials (variable) xx
Direct Labor (variable) xx
Factory Overhead (also called factory burden,
Factory Overhead (variable & fixed) xx
manufacturing expenses) – these are the expenses
incurred by the production department other than direct Total Manufacturing Costs xx
materials and direct labor costs. Included in the factory
overhead costs are the indirect materials costs, indirect
labor costs, and all other costs associated with production. Note: the direct materials and direct labor are
All factory overhead costs are assumed to be indirect costs assumed to be purely variable costs while the factory
for recording purposes. overhead has a variable and fixed component.

For product costing purposes, the direct and indirect b. Variable Costing – only the variable production
production costs must be segregated. The three elements costs are included in the cost of the product. This
of production costs can thus be restated as follows: method is used for internal reporting purposes
Direct Materials xx (reporting to management) only.

Direct Labor xx Variable Direct Materials xx

Factory Overhead xx Variable Direct Labor xx

Manufacturing Costs xx Variable Factory Overhead xx

Variable Manufacturing Costs xx

The sum of direct materials and direct labor is called

Prime Cost. The sum of direct labor and factory overhead
is called Conversion or Processing Cost.
 3. How are the 3 elements of production costs
accumulated?

a. Job Order Costing - Under this method of

costing the 3 elements of production costs will be
accumulated by jobs. This means that each job
will have its own direct materials, direct labor and
factory overhead. This method generally uses
Normal Costing. The costs incurred by each job
are recorded and summarized in the job cost sheet
This method is employed if the company is
producing heterogeneous (dissimilar) products.

b. Process Costing - Under this method of costing,

the 3 elements of production costs will be
accumulated by processing departments. This
means that each producing department will have
its own direct materials, direct labor and factory
overhead. This method can use Actual Costing,
Normal Costing or Standard Costing. The costs
incurred by each department are summarized in
the monthly report called Cost of Production
Report. This method is employed if the company
is producing homogeneous (similar) products.

Financial Statements of a Manufacturing Business

After getting familiar with the different cost concepts and
terminologies peculiar to a manufacturing business, the
financial statements of this type of business, with
emphasis on the Statement of Cost of Goods Sold, (the
end product of cost accounting) will be illustrated to
distinguish from the financial statements of a servicing or
trading business. Familiarity with the statements of a
manufacturing business will be a good starting point in
introducing and learning Cost Accounting.

What is Cost Accounting?

- The branch of accounting that deals with the
determination of the cost of goods manufactured
and sold. Cost Accounting emerged as a result of
the proliferation of the different manufacturing
businesses.

There are two methods of recording the manufacturing

transactions or activities. They are the non-cost system
(the periodic inventory method) and the cost system (the
perpetual inventory method). Recording of these
manufacturing activities will be taken up in detail in the
Cost Accounting subject. In this chapter only the financial
statements of a manufacturing business owned and
operated by a sole proprietor will be illustrated using the
non-cost system and the actual costing method.

Note: The Statement of Comprehensive Income is

prepared using the functional format. In the Statement of
Cost of Goods Sold Statement, the three elements of
production costs (direct materials, direct labor, and
factory overhead) as well as the three inventories (raw
materials, work in process, and finished goods inventory)
are shown or presented. The beginning inventories will
increase the cost of sales while the ending inventories will
decrease the cost of sales. The different period costs
(selling and administrative expenses) are usually
supported by a schedule.