ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1

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Module 7
MANUFACTURING BUSINESS
Week 17

Introduction

Both merchandising and manufacturing types of business earn revenues by selling

goods. A merchandiser normally buys a product that is ready for resale when it is
received. Profit was earned for every unit sold at a mark-up to customers. A
manufacturer buys raw materials and processes them into finished goods that it sells to
customers. Therefore, the main difference between the two is the way they acquire
inventory for resale.

Illustration:

Merchandiser - athletic shoes section of PureGold Duty Free Inc. in Clark Field,
Pampanga. Cost is the price that the merchandiser paid for the shoes plus incidental
costs.

Manufacturer - entities that manufacture athletic shoes such as Nike, Reebok, Adidas,
K-Swiss, Puma, Converse and Tretorn. Entities that supply athletic shoes to
merchandisers utilize their laborers and factory assets to convert raw materials into
finished goods. Their manufacturing processes begin with materials such as cloth, rubber
and plastics. These materials are cut, glued, stitched and formed into athletic shoes. The
process of converting materials into finished products makes it more difficult to measure
the inventory cost of a manufacturer.

Note: Merchandising type of business buys ready for sale goods to which mark-up was
added to arrive at the selling price. On the other hand, manufacturing businesses
purchases raw materials, converts them into finished goods to which mark-up was added
in computing the selling price.

In your 2nd year in the program, these topic will be discussed in detail. This is considered
as one subject in our program.

Learning Objectives

After studying this module, students should be able to:

1. Compare the activities prevalent to merchandising and manufacturing entities.
2. Identify the elements of manufacturing costs.
3. List the manufacturing inventory accounts.
4. Show the pro-forma entries of the common transactions for a manufacturing entity.
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5. Prepare a statement of cost of goods manufactured.

6. Prepare a statement of cost of goods sold.
7. Pinpoint the differences in the worksheet of a manufacturing entity as compared
to a merchandising entity.

Elements of Manufacturing Costs

Manufacturing costs include all costs related to the production process. They are
classified into three categories:

Direct Materials
● become a physical part of a finished product.
● costs can be conveniently and economically traceable to the finished product.
● Example: For a pair of Nike basketball shoes as the finished product,
○ its leather uppers,
○ the rubber and plastic soles, and
○ the laces

Direct labor. I
● It is the compensation of employees or workers who physically convert raw
materials into finished [Link] efforts of these persons are directly traceable to
the finished product.
● Example: For Nike, direct labor includes
○ the wages of the machine operators and
○ the persons who assemble the shoes.

Manufacturing Overhead. This includes all manufacturing costs that cannot be classified
as direct materials or direct labor. Major classifications of this cost follow:
● Indirect materials and supplies. Glue, thread, nails, rivets, lubricants and small
tools.
● Indirect labor costs. Salaries of plant managers and engineers, wages of forklift
operators, maintenance and inspection labor, and machine helpers.

● Other indirect manufacturing costs. Includes building, machinery and tool

maintenance, real property taxes, property insurance, rent expense, utilities
expense and depreciation on property and equipment.

● These major cost elements are at times combined into prime costs or conversion
costs.
○ Prime costs consist of direct materials and direct labor.
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○ Conversion costs consist of direct labor and manufacturing overhead.

Manufacturing Inventory Accounts

Accounting for inventory differs between merchandisers and manufacturers.

Merchandisers need only one category of inventory for the finished goods they buy and
sell. In contrast, manufacturers have various inventory accounts, as follows:

Finished goods Inventory. It is the cost of completed goods that have remained unsold
at the end of the accounting period. This inventory is what the manufacturers sell to the
merchandisers.

Work in Process Inventory. This account gives the cost of the goods that are in the
manufacturing process but are not yet complete at the end of the accounting period.

Raw Materials Inventory. This account holds the cost of direct materials on hand that is
intended for use in the manufacturing process.

Factory Supplies Inventory. It is the cost of unused indirect materials at period end.

Finished goods inventory, work in process inventory, raw materials inventory and factory
supplies inventory are assets to the manufacturers and are reported as current assets in
the statement of financial posi tion.

ACCOUNTING FOR MANUFACTURING ACTIVITIES

Two accounting systems may be used in accounting for manufacturing activities – cost
and non-cost.

Cost system

● keeps perpetual records of the costs of raw material, work in process and finished
goods inventories
● provides more timely information about those inventories and changes in their
levels
● produces timely information about manufacturing costs per unit of product which
managers use in their efforts to control costs
● It is the subject of courses in higher [Link]: This will be used in your next
accounting subject in 2nd year.
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Non-cost system

● produces a manufacturing accounting system based on the periodic inventory

system.
● The costs of raw materials, work in process and finished goods inventories are
based on physical counts of the quantities on hand at the end of each period. This
information is then used to compute the amounts consumed, finished and sold
during the period.
● This system does not provide for a detailed flow of costs in the manufacturing
process.
● In the discussions to follow, the non-cost system will be used. It is also assumed
that the entity uses the voucher system. The following are the pro-forma journal
entries of the more common transactions for a manufacturing entity.

1. To record purchase of raw materials and indirect materials on account:

Purchases - Raw Materials xx
Indirect Materials xx
Vouchers Payable xx

2. To record cost of defective raw materials returned to vendor:

Vouchers Payable xx
Purchase Returns and Allowances xx

3. To record payment of account within the discount period:

Vouchers Payable xx
Purchases Discounts xx
Cash in Bank xx

4. To record freight and handling of raw materials

Transportation In xx
Vouchers Payable xx

5. To record payroll for factory employees:

Direct Labor xx
Indirect Labor xx
SSS Contributions Payable xx
MEdicare Contributions Payable xx
Pag-IBIG Contributions Payable xx
Withholding Taxes Payable xx
Vouchers Payable xx
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6. To record employer’s payroll expenses:

Employer’s Payroll Contributions - Factory xx
SSS Contributions Payable xx
MEdicare Contributions Payable xx
EC Contributions Payable xx
Pag-IBIG Contributions Payable xx

7. To record distribution of payroll:

Vouchers Payable xx
Cash in Bank xx

8. To record accrual of factory payroll

Direct Labor xx
Indirect Labor xx
Accrued Payroll xx

9. To record depreciation of factory building

Depreciation Expense- Factory Bldg xx
Accumulated depreciation - Factory Bldg. xx

10. To record repairs on factory building:

Repairs and Maintenance - Factory Building xx
Voucher Payable xx

11. To record amortization of patents

Amortization of Patents xx
Patent xx

12. To record real property taxes on factory site

Real Property Taxes xx
Vouchers Payable xx

13. To record factory utilities incurred:

Factory Utilities xx
Vouchers Payable xx

14. To record cost of tools used:

Tools Used xx
Tools xx
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15. To record sales of finished goods:

Accounts Receivable xx
Sales xx
16. To record sales returns of customers:
Sales Returns and Allowances xx
Accounts Receivable xx

17. Closing entries peculiar to manufacturing concerns:

In order for a manufacturer to summarize all the transactions that affect the
computation of the cost of goods manufactured, a manufacturing summary
account is maintained. It is credited for the results of the physical count of raw
materials inventory and work in process inventory at the end of the accounting
period. The contra-purchases accounts are also credited to this account. This
account is debited for the beginning balances of raw materials and work in process
inventory, and the manufacturing accounts with debit balances. The balance of the
manufacturing summary account is then closed to the income summary account

a. To close manufacturing accounts with credit balances, and to record ending

inventory for materials and work in process:

Raw Materials Inventory, end xx

Work in Process Inventory, end xx
Purchases Returns and Allowances xx
Purchases Discounts xx
Manufacturing Summary xx

b. To close manufacturing accounts with debit balances

Manufacturing Summary xx
Raw Materials Inventory, beginning xx
Work in Process, Inventory, beginning xx
Purchases - Raw Materials xx
Transportation In xx
Direct Labor xx
Indirect Labor xx
Indirect Materials xx
Depreciation Expense - FactoryBldg. xx
Repairs and Maintenance - Factory Bldg. xx
Amortization of Patents xx
Real Property Taxes xx
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Factory Utilities xx
Tools Used xx
Employer’s Payroll Contribution - Factory xx
Factory Supplies Expense xx
Miscellaneous Factory Expense xx

c. To close manufacturing summary and beginning finished goods inventory

to income summary:
Income Summary xx
Manufacturing Summary xx
Finished Good Inventory, beginning xx

The debit balance in the manufacturing summary represents the cost of

goods manufactured.

d. To establish the ending finished goods inventory:

Finished Goods Inventory, beginning xx
Income Summary xx

The other closing entries after this procedure are the same as those for a
merchandising entity.

Note:

By preparing the closing entries, beginning inventory balances were removed as assets of the
company. Such was the reason why we prepare closing entry letter b wherein we credited the
beginning inventory balances of raw materials and work in process. It was replaced with the
balances from the ending inventories. Entry letter a and letter d increased the current assetswhen
we debited raw materials and work in process inventory in entry letter a and finished goods
inventory in entry letter d.

STATEMENT OF COST OF GOODS MANUFACTURED

Renante Balocating Manufacturers

Statement of Cost of Goods Manufactured
For the Year Ended Dec. 31, 2015

Direct Materials Used:

Raw Materials Inventory, beginning P xxx
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Add: Net Cost of Purchases:

Purchases - Raw Materials P xx
Less: Purchases Returns and Allowances P xx
Purchases Discounts xx xx
Net Purchases P xx
Add: Transportation In xx xxx
Raw Materials Available for Use P xxx
Less: Raw materials Inventory, end xxx
P xxx
Direct Labor xxx
Manufacturing Overhead
Indirect Labor xxx
Indirect Materials xxx
Depreciation Expense - Factory Bldg. xxx
Repairs and Maintenance - Factory Bldg. xxx
Amortization of Patents xxx
Real Property taxes xxx
Factory Utilities xxx
Tools Used xxx
Employer’s Payroll Contributions - Factory xxx
Factory Supplies Expense xxx
Miscellaneous Factory Expense xxx xxx
Total Manufacturing Costs P xxx
Add: Work in Process, beginning xxx
Total Cost of Goods Placed in Process P xxx
Less: Work in Process, End xxx
Cost of Goods Manufactured P xxx

Total manufacturing costs should not be confused with the cost of goods manufactured.

Total manufacturing costs

● the costs of direct materials used, direct labor and manufacturing overhead
incurred and charged to production during an accounting period.

Cost of goods manufactured

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● consists of the total manufacturing costs related to the products completed during
an accounting period. This statement is also called the manufacturing statement.
● Note: Meaning, not all of the manufacturing cost will become part of the cost of
goods manufactured. It is possible that the company will have work-in process
inventories which decreases the units completed/ manufactured for the period.

STATEMENT OF COST OF GOODS SOLD

The difference in the income statement of a merchandising and a manufacturing entity

lies in the cost of goods sold section. As illustrated, observe that the merchandiser
used the term merchandise inventory while the manufacturer used the term finished
goods inventory. A merchandiser’s entire inventory is finished goods; a merchandiser has
no materials inventory and work in process inventory.

A manufacturer produces its own finished goods inventory. Cost of goods manufactured
is the manufacturer’s counterpart to the merchandiser’s purchases. Net cost of
purchases is the cost of all the goods a merchandiser bought for resale during the period.
Cost of goods manufactured is the manufacturing cost of the goods completed during a
production period.

Merchandising Entity Manufacturing Entity

Merchandise Inventory, Beg. P xx Finished Goods Inventory, Beg. P xx

Add: Net Cost of Purchases xx Add: Cost of Goods Manufactured xx
Goods Available for Sale P xx Goods Available for Sale P xx
Less: Merchandise Inventory, End xx Less: Finished Goods Inventory, End xx
Cost of Goods Sold P xx Cost of Goods Sold P xx

Note: In a manufacturing entities’ cost of goods sold computation, notice that cost of
goods manufactured (which was presented in the previous page) was added to finished
goods inventory, beg. This cost of goods manufactured are the completed/finished units
during the period. Adding with the Finished Goods Inventory, Beg., we will arrive at the
total goods which will become available for sale to the consumers.

WORKSHEET FOR A MANUFACTURING ENTITY

The worksheet for a manufacturing entity is basically the same as that for a merchandising
entity except that it includes a pair of columns for cost of goods manufactured. All the
accounts that comprise the statement of cost of goods manufactured are extended to
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these columns. Beginning raw materials inventory and work in process are debited in the
manufacturing columns while the related ending inventories are credited.

The other manufacturing accounts are either debited or credited as necessary. The
difference between the total debits and total credits of these two columns is then extended
to the debit column of the income statement. Beginning finished goods inventory being a
component in the computation of cost of goods sold is extended to the debit side of the
income statement columns while the ending finished goods inventory to the credit column.

Assessments

Exercises

True or False

1. Product costs are the costs of purchasing or manufacturing inventory and

considered as assets until the goods are sold.
2. All costs and expenses incurred by a manufacturing corporation are considered
product costs rather than period costs.
3. Manufacturing costs are regarded as expenses of the current period and are
expensed when incurred.
4. A manufacturing corporation usually has three separate inventories: raw materials,
work in process and finished goods.
5. Manufacturing overhead includes all manufacturing costs except direct labor and
direct materials.
6. Prime costs consist of direct materials and direct labor. Conversion cost is
essentially direct labor.
7. Finished goods inventory is an asset, but inventories of raw materials and work in
process are not considered assets until production is completed.
8. Product costs are all deducted from revenue in the period in which they are
incurred.
9. The wages paid to supervisors are an example of indirect labor.
10. Raw materials inventory refers to the direct materials on hand and available for
use in the manufacturing process.

Multiple Choice

1. Which of the following costs may be included when arriving at the cost of finished
goods inventory for inclusion in the financial statements of a manufacturing
corporation?
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1. Transportation in
2. Transportation out
3. Depreciation of factory building
4. Finished goods storage costs
5. Factory supervisors’ salaries
a. 1 and 5 only
b. 2, 4 and 5 only
c. 1, 3 and 5 only
d. 1, 2, 3 and 4 only

2. According to IAS 2 Inventories, which of the following costs should be included in

valuing the inventories of a manufacturing corporation?
1. Transportation in
2. Transportation out
3. Depreciation of factory building
4. General administrative expenses
a. 1, 2 and 4 only
b. 2 and 3 only
c. 1 and 3 only

3. Which of the following is not likely to be treated as a product cost?

a. Deprecation on the factory.
b. Interest paid on notes payable.
c. Wages paid to factory workers.
d. Portion of the cost of running the quality control department.

4. The direct labor account is debited

a. When a new factory employee begins work
b. When the goods manufactured are completed.
c. At the end of the payroll period, when employees are paid.
d. When related labor costs are transferred into the Work in Process Inventory
account

5. Manufacturing costs would not include

a. Deprecation on factory equipment
b. Indirect materials used.
c. Sales salaries expense.
d. Indirect labor costs.
6. The purchases – raw materials account is debited when
a. Indirect materials are placed into production.
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b. Direct materials are placed into production.

c. Indirect materials are purchased.
d. Direct materials are purchased.

7. Each of the following is true with respect to product costs, except

a. Product costs are deducted from revenue when the manufacturing process
is completed.
b. Product costs are not regarded as expenses of the current period.
c. Product costs represent inventoriable costs.
d. Direct labor is an example of a product cost.

Problem 1
Cost of Goods Manufactured

In addition to the year-end statement of financial position and statement of

comprehensive income, the management of Del Mundo Corporation required the
controller to prepare the statement of cost of goods manufactured. During 2019, P
361,920 of raw materials were

Direct Labor (10,430 hours at P 9.50 per hour) P 99,085

Plant Supervision 42,500

Indirect Labor (20,280 hours at P 6.25 per hour) 126,750

Factory Insurance 8,100

Factory Utilities 29,220

Depreciation – Factory Building 46,200

Depreciation – Factory Equipment 62,800

Manufacturing Supplies 9,460

Repairs and Maintenance 14,980

Selling and Administrative Expenses 76,480

Raw Materials Inventory, Jan. 1, 2019 26,490

Work in Process Inventory, Jan. 1, 2019 101,640

Finished Goods Inventory, Jan. 1, 2019 148,290

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Raw Materials Inventory, Dec. 31, 2019 24,910

Work in Process Inventory, Dec. 31, 2019 100,400

Finished Goods Inventory, Dec. 1, 2019 141,100

purchased. Operating cost data and inventory account balances for 2019 follow:
Required:
1. Compute the cost of direct materials used during the year.
2. Compute the total manufacturing costs for the year.
3. Compute the cost of goods manufactured during the year.

Problem 2
Manufacturing Overhead, Statement of Cost of Goods Manufactured and Statement
of Comprehensive Income

The following account balances and other information were taken from the accounting
records of Langga Corporation for the year ended, Dec. 31, 2019. Use the information to
prepare a schedule of manufacturing overhead costs, a manufacturing statement (show
only the total overhead cost), and a statement of comprehensive income.

Advertising Expense P 85,000

Amortization of Patents 16,000

Uncollectible Accounts Expense 28,000

Depreciation Expense – Office Equipment 37,000

Depreciation Expense – Factory Building 133,000

Depreciation Expense – Factory 78,000

Equipment
Direct Labor 250,000

Factory Insurance Expense 62,000

Factory Supervision 74,000

Factory Supplies Expense 21,000

Factory Utilities 115,000

Finished Goods Inventory, Dec. 31, 2018 15,000

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Finished Goods Inventory, Dec. 31, 2019 12,500

Work in Process Inventory, Dec. 31, 2018 8,000

Work in Process Inventory, Dec. 31, 2019 9,000

Indirect Labor 26,000

Interest Expense 25,000

Miscellaneous Expenses 55,000

Property Taxes – Factory Site 14,000

Raw Materials Inventory – Dec. 31, 2018 60,000

Raw Materials Inventory – Dec. 31, 2019 78,000

Purchases – Raw Materials 313,000

Repairs and Maintenance – Factory 31,000

Equipment
Salaries Expense 150,000

Sales 1,630,000

Required:
1. Analyze the list of the costs and select those items that are manufacturing overhead.
2. Arrange these costs in a schedule of manufacturing overhead costs for 2019.
3. Prepare the cost of goods manufactured statement for 2019.
4. Prepare the statement of comprehensive income for 2019.

Reference:

Ballada, Win and Ballada, Susan (2020). Basic Accounting Financial Accounting and
Reporting. Domdane Publishers & Made Easy Books. Sampaloc, Manila.