Accounting for Manufacturing Activities Chapter 26 Accounting for Manufacturing Activities Section 1: Accounting for Manufacturing Activities Section Objectives Chapter 25 introduced the topic of managerial accounting. Chapter 26 continues this topic with a discussion of accounting for manufacturing activities—an area that requires regular financial information for managerial decision making relating to operating efficiency. Section 1 Explains how to prepare a statement of cost of goods manufactured for a business which makes a product. In addition, the section describes the basic components of manufacturing cost and how to prepare an income statement and balance sheet for a manufacturing business. Prepare a statement of cost of goods manufactured. Explain the basic components of manufacturing cost. Prepare an income statement for a manufacturing business. Prepare a balance sheet for a manufacturing business. McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

Manufacturing Businesses Comparison Manufacturing Businesses Merchandising Businesses Merchandising businesses purchase goods to be resold in the same condition and form but at a profit. Manufacturing businesses purchase and convert raw materials into finished goods to be sold at a profit. A manufacturing business makes a product from raw materials and then sells it to retailers or merchandisers, who in turn sell the goods to consumers.

Prepare a statement of cost of goods manufactured. Objective 1 Prepare a statement of cost of goods manufactured. The biggest difference between a merchandiser’s income statement and a manufacturer’s income statement is the cost of goods sold section. Merchandisers use: “Merchandise Inventory” and the “Purchases” account to figure the cost of goods sold. Manufacturers use: “Finished Goods Inventory” and “Cost of Goods Manufactured”. In the first objective of this chapter, we will see how to prepare a Cost of Goods Manufactured Statement.

Statement of Cost of Goods Manufactured Work in Process Inventory, Jan. 1 11,900.00 Raw Materials Raw Materials Inventory, Jan. 1 27,000.00 Materials Purchases 159,700.00 Less Purchases Discounts Net Purchases 156,700.00 Total Materials Available 183,700.00 Less Raw Materials Inventory, Dec. 31 24,500.00 Raw Materials Used 159,200.00 Direct Labor 95,000.00 Manufacturing Overhead Indirect Labor 5,000.00 Payroll Taxes—Factory 9,000.00 Utilities—Factory Repairs and Maintenance—Factory 6,500.00 Indirect Materials and Supplies 7,200.00 Depreciation—Factory Building 7,500.00 Depreciation—Factory Equipment Insurance—Factory 3,900.00 Property Taxes—Factory 8,418.00 Total Manufacturing Overhead 61,518.00 Total Manufacturing Cost 315,718.00 Total Work in Process for Year 327,618.00 Less Work in Process Inventory, Dec. 31 11,500.00 Cost of Goods Manufactured 316,118.00 Parisian Manufacturing Inc. Statement of Cost of Goods Manufactured Year Ended December 31,20-- (3,000.00) The Cost of Goods Manufactured line item replaces the Purchases line item on the income statement. Accounting for the cost of raw materials used to make products and the labor and overhead required to turn raw materials into finished products are key elements of an accounting system for a manufacturing concern. The Statement Of Cost Of Goods Manufactured summarizes these costs for a company. The statement of Cost of Goods Manufactured is similar to the Cost of Goods Sold section of an income statement for a merchandiser. There are four parts of the statement: raw materials, direct labor, manufacturing overhead, and work in process. Each section reports the costs associated with its phase of the manufacturing process. The new manufacturing costs for the period are then added to beginning work in process, and the ending work in process is subtracted from total manufacturing costs. At the bottom of the statement, we see the line item, Cost of Goods Manufactured of $316,118. The Cost of Goods Manufactured line item replaces the Purchases line item on the merchandiser’s income statement.

Explain the basic components of manufacturing cost. Objective 2 Explain the basic components of manufacturing cost. Before we can really understand the manufacturing financial statement, we must become comfortable with terms like raw materials, direct labor, indirect labor, work in process, and manufacturing overhead used in manufacturing accounting. Some of these are the basic components needed to make a product.

Manufacturing Costs Consist of Three Components Raw Materials Direct Labor Manufacturing Overhead The three basic components needed to manufacturer a product, whether it is a can of green beans or a Ferrari, are: Raw Materials Direct Labor and Manufacturing Overhead.

Raw Materials Raw materials consist of direct and indirect materials. Examples of direct materials are wood, glue, varnish, or hardware for a furniture maker. Indirect materials are used to work on the products, but do not become a part of the product. Raw Materials If we were making a chair, what would be the materials that would go into making it?” (material/leather, screws, metal, wood, glue, steel wool, cleaning fluid, etc.) Materials can be either: direct materials (the materials that actually become part of the product—material, screws, metal) or indirect materials (materials or supplies that are used in the manufacturing process but don’t become part of the product—steel wool, cleaning fluid). Some businesses treat insignificant direct materials, such as glue, as indirect materials as well. Indirect material is treated as manufacturing overhead.

Raw Materials and the Statement of Cost of Goods Manufactured Work in Process Inventory, Jan. 1 11,900.00 Raw Materials Raw Materials Inventory, Jan. 1 27,000.00 Materials Purchases 159,700.00 Less Purchases Discounts Net Purchases 156,700.00 Total Materials Available 183,700.00 Less Raw Materials Inventory, Dec. 31 24,500.00 Raw Materials Used 159,200.00 Parisian Manufacturing Inc. Statement of Cost of Goods Manufactured Year Ended December 31,20-- (3,000.00) On the statement of cost of goods manufactured, determining the amount of raw materials used is the first thing that needs to be calculated. Let’s examining how data about the cost of raw materials appears on the statement. The beginning inventory of raw materials, $27,000 is added to net purchases of raw materials, $156,700. Net purchases is materials purchases minus purchases discounts ($159,700 - $3,000). The result is total materials available, $183,700. The ending raw materials inventory, $24,500, is subtracted to determine the raw materials used, $159,200. Compute raw materials used. 1. Compute total materials available.

What are direct labor costs? QUESTION: What are direct labor costs? Direct labor costs are costs of the personnel who work directly on the manufactured product. ANSWER: Direct labor costs are costs of the personnel who work directly on the manufactured product.

Examples of Direct Labor Costs Salaries of workers who shape the lumber. Salaries of workers who assemble the pieces into tables. Labor costs for workers who paint the final products. Just like materials, labor can be classified as direct labor or indirect labor. The personnel who actually worked on the product to put it together are direct laborers.

Indirect Labor Costs of personnel who support production but are not directly involved in manufacturing (supervisors, janitors, maintenance staff). Indirect labor are the costs of personnel who support production but do not directly work with the product to put it together. Good examples are: supervisors, janitorial staff, repair and maintenance, etc.. Indirect labor is treated as manufacturing overhead.

Manufacturing Overhead Manufacturing overhead includes all of the costs other than direct labor and direct materials. Manufacturing overhead may include the following: Indirect labor - Costs attributable to personnel who support the production process. Utilities Depreciation Repair and maintenance Property taxes Insurance The third component of manufacturing cost is manufacturing overhead. Manufacturing overhead includes all manufacturing costs that are not direct materials or direct labor. Remember that indirect labor as well as indirect materials are included in manufacturing overhead. What would be some manufacturing overhead costs incurred in the manufacturing process to make a classroom chair? Electricity, depreciation on production equipment, property taxes on the factory, supervisory salaries, insurance on the factory and equipment, etc. are few that might be incurred.

Work in Process Products in the production process, but not yet completed. Accounted for in the cost of goods manufactured section of the income statement. As materials are requested from the raw materials inventory warehouse and labor costs arise as factory personnel work, the costs are accumulated and recorded in an account called Work in Process. Work in process refers to partially completed units in the production process. Work in process is accounted for in the cost of goods manufactured section of the income statement.

Accounting for Work in Process on the Income Statement Work in Process Inventory, Jan. 1 11,900.00 Raw Materials Raw Materials Inventory, Jan. 1 27,000.00 Materials Purchases 159,700.00 Less Purchases Discounts Net Purchases 156,700.00 Total Materials Available 183,700.00 Less Raw Materials Inventory, Dec. 31 24,500.00 Raw Materials Used 159,200.00 Direct Labor 95,000.00 Manufacturing Overhead Indirect Labor 3,600.00 Payroll Taxes—Factory 9,917.75 Utilities—Factory 9,000.00 Repairs and Maintenance—Factory 6,500.25 Indirect Materials and Supplies 7,200.00 Depreciation—Factory Building 8,000.00 Depreciation—Factory Equipment 5,000.00 Insurance—Factory 4,300.00 Property Taxes—Factory Total Manufacturing Overhead 61,518.00 Total Manufacturing Cost 315,718.00 Total Work in Process for Year 327,618.00 Less Work in Process Inventory, Dec. 31 11,500.00 Cost of Goods Manufactured 316,118.00 Parisian Manufacturing Inc. Statement of Cost of Goods Manufactured Year Ended December 31,20-- (3,000.00) At the end of each period, an estimate is made of the costs of raw materials, direct labor, and manufacturing overhead for the work in process. For Parisian Manufacturing Company, the beginning inventory of work in process was $11,900, and the ending inventory of work in process was $11,500. On the statement of cost of goods manufactured, the beginning work in process amount of $11,900 is added to $315,718 of total manufacturing cost. The result is total work in process for the year of $327,618. The ending work in process of $11,500 is subtracted from the total work in process for the year to arrive at the cost of goods manufactured of $316,118. An estimate is made of the costs of raw materials, direct labor, and manufacturing overhead that apply to work in process at the end of the period.

Prepare an income statement for a manufacturing business. Objective 3 Prepare an income statement for a manufacturing business. The objective of this section will be to prepare and income statement for a manufacturing business.

Income Statement for a Manufacturing Concern Revenue Sales 625,000.00 Less Sales Returns & Allowances 5,000.00 Net Sales 620,000.00 Cost of Goods Sold Finished Goods Inventory, Jan. 1 32,500.00 Cost of Goods Manufactured 316,118.00 Total Goods available for Sale 348,618.00 Less Finished Goods Inventory, Dec. 31 29,000.00 319,618.00 Gross Profit on Sales 300,382.00 Operating Expenses Selling Expenses (Control) 83,500.00 Administrative Expenses (Control) 95,090.00 Total Operating Expenses 178,590.00 Income Tax Expense 30,448.00 Parisian Manufacturing Inc. Income Statement Year Ended December 31,20-- Net Income Before Income Taxes 121,792.00 91,344.00 Figure taken from the cost of goods manufactured statement The Cost of Goods Manufactured line is similar to the Purchases line in a merchandising income statement. The difference is that a merchandising firm purchases finished goods to resell, while a manufacturer purchases raw material and turns it into finished products. Recall, that the cost of goods manufactured amount of $316,118, was taken from the cost of goods manufactured statement. It is important to understand that when a good is completed, it is transferred out of the work-in-process inventory account and into the finished goods inventory account. The actual cost of goods sold is calculated in the same way as for a merchandising business.

Prepare a balance sheet for a manufacturing business. Objective 4 Prepare a balance sheet for a manufacturing business. A manufacturing business’s balance sheet is the next statement we will look at.

Inventories and the Balance Sheet for a Manufacturing Business Raw Materials 24,500.00 Work in Process 11,500.00 Finished Goods 29,000.00 65,000.00 PARISIAN MANUFACTURING INC. Partial Balance Sheet December 31, 20-- One big difference in the balance sheets for a manufacturing business vs. a merchandising business is the current asset section. A merchandiser has one account for inventory— Merchandise Inventory. A manufacturer has three inventory accounts—Raw Materials, Work in Process and Finished Goods The balance sheet for a manufacturing business contains three inventory categories.

Inventory Managers need frequent and reliable information on inventory. Perpetual inventory systems are used to update all additions to and deletions from inventory as they occur. A physical inventory is taken annually to verify the perpetual inventory records. Has anyone ever started to cook or bake something at home and discovered that you were out of butter or eggs or flour, etc.? What did you do? (Go to the store, borrow from neighbor, substitute something else, etc.) When a business manufacturers a product, they need to keep careful track of the inventory they have: Raw materials need to be readily on hand for the manufacturing process. Work-in-process needs to be monitored to insure that inventory is completed on schedule and to control costs. Finished goods on hand needs to be adequate to be able to meet sales demands but not too excessive as to incur excess costs. Some companies keep perpetual records of their inventory so that reliable information is available on a daily basis.

Accounting for Manufacturing Activities Chapter 26 Accounting for Manufacturing Activities Section 2: Completing the Accounting Cycle Section Objectives In section 2 of chapter 26, we will complete the accounting cycle for a manufacturer-- Prepare a worksheet for a manufacturing business. Record the end-of-period adjusting entries for a manufacturing business. Record closing entries for a manufacturing business. Record reversing entries for a manufacturing business. McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

Prepare a worksheet for a manufacturing business. Objective 5 Prepare a worksheet for a manufacturing business. The fifth objective of this chapter is to prepare a worksheet for a manufacturing business.

The Accounting Cycle for a Manufacturing Business The steps in the accounting cycle do not change for a manufacturing business. The worksheet must be constructed to facilitate preparation of the cost of goods manufactured statement. The worksheet has two new columns: Cost of Goods Manufactured Debit column Cost of Goods Manufactured Credit column The steps in the accounting cycle do not change for a manufacturing business. However, in the worksheet, two new columns are added. We add a cost of goods manufactured debt and credit column.

The worksheet of a manufacturing business contains several new accounts: Raw Materials Inventory Work in Process Inventory Finished Goods Inventory Direct Labor Various Manufacturing Overhead Accounts Manufacturing Summary The worksheet of a manufacturing business contains several new accounts. Those new accounts include: Raw materials inventory Work in process inventory Finished goods inventory Direct labor Various manufacturing overhead accounts; and Manufacturing summary

It is similar to the Income Summary account. QUESTION: What is the Manufacturing Summary account? The Manufacturing Summary account is the account to which all items on the statement of cost of goods manufactured are closed. ANSWER: What is the manufacturing summary account? The manufacturing summary account is the account to which all items on the statement of cost of goods manufactured are closed. It is very similar to the income summary account used in sole proprietorship accounting. It is similar to the Income Summary account.

Adjusting Inventory Accounts Raw Materials Work in Process Finished Goods DR Manufacturing Summary CR Raw Materials Inventory for beginning inventory amount DR Manufacturing Summary CR Work in Process Inventory for beginning inventory amount 5. DR Income Summary CR Finished Goods Inventory for beginning inventory amount DR Raw Materials Inventory CR Manufacturing Summary for ending inventory amount DR Work in Process Inventory CR Manufacturing Summary for ending inventory amount 6. DR Finished Goods Inventory CR Income Summary for ending inventory amount In this slide, we examine the various adjusting journal entries made for the raw materials, work in process and finished goods inventory accounts for both beginning and ending inventory.

Adjusting Entries on the Worksheet Inventory Uncollectible accounts Expired insurance Supplies on hand Depreciation Accrued salaries Payroll taxes on accrued payroll Income tax payable As with sole proprietorship accounting, we also make adjusting journal entries on the manufacturing worksheet for: Uncollectible accounts Expired insurance Supplies on hand Depreciation Accrued salaries Payroll taxes, and Income taxes

Preparing Financial Statements From the Worksheet Three sets of columns exist for the financial statements: Cost of Goods Manufactured Balance Sheet Income Statement When preparing the financial statement for a manufacturing business from a worksheet, we use three sets of columns. Those columns are the Cost of Goods Manufactured, the Balance Sheet and the Income Statement.

Objective 6 Record the end-of-period adjusting entries for a manufacturing business. The sixth objective of this chapter is to record the end-of-period adjusting entries for a manufacturing business.

Adjusting Entries for a Manufacturing Business 2010 Dec. 31 Manufacturing Summary 27,000.00 Raw Materials Inventory 27,000.00 (Adjustment a) Raw Materials Inventory 24,500.00 Manufacturing Summary 24,500.00 (Adjustment b) Manufacturing Summary 11,900.00 Work in Process Inventory 11,900.00 (Adjustment c) Work in Process Inventory 11,500.00 Manufacturing Summary 11,500.00 (Adjustment d) Income Summary 32,500.00 Finished Goods Inventory 32,500.00 (Adjustment e) Finished Goods Inventory 29,000.00 Income Summary 29,000.00 (Adjustment f) 31 In this slide we make the adjusting entries for raw materials, work in process, and finished goods inventory for a manufacturing business. Notice the inventory accounts are credited for the beginning inventory, and debited for the ending inventory. Inventory accounts are credited for beginning inventory and debited for ending inventory.

Adjusting Entries for a Manufacturing Business Record uncollectible accounts expense 2010 Dec. 31 Administrative Expense (Control) 1,240.00 Allowance for Doubtful Accounts 1,240.00 (Adjustment g) Insurance—Factory 3,900.00 Administrative Expense (Control) 100.00 (Adjustment h) Supplies on Hand 800.00 Indirect Materials and Supplies 800.00 (Adjustment i) Depreciation—Factory Building 7,500.00 Depreciation—Factory Equipment 5,000.00 (Adjustment j) Administrative Expense (Control) 1,000.00 Accumulated Depr.—Factory Building 7,500.00 31 Prepaid Insurance 4,000.00 Accumulated Depr.—Factory Equipment 5,000.00 Accumulated Depr.—Office Equipment 1,000.00 Record expired insurance amount Record supplies on hand In this slide, entries are shown to record uncollectible accounts expense, expired insurance, supplies expense and depreciation. These entries are similar to what are recorded in sole proprietorship accounting. Record depreciation expense

Adjusting Entries for a Manufacturing Business 2010 Dec. 31 Direct Labor 3,000.00 Salaries and Wages Payable 3,500.00 (Adjustment k) Payroll Taxes—Factory 257.75 Social Security Tax Payable 217.00 (Adjustment l) Income Tax Expense 2,025.00 Income Tax Payable 2,025.00 (Adjustment m) 31 Indirect Labor 500.00 Medicare Tax Payable 50.75 Record accrued wages Record payroll taxes on accrued wages In this slide adjusting journal entries are made for accrued wages, payroll taxes on accrued wages, and estimated income tax expense. Record estimated income tax

Record closing entries for a manufacturing business. Objective 7 Record closing entries for a manufacturing business. The seventh objective of this chapter is to record closing entries for a manufacturing business.

Closing Entries Close accounts to Manufacturing Summary. Close revenue and expense accounts to Income Summary. Close Manufacturing Summary to Income Summary. Close Income Summary to Retained Earnings. There are four closing entries need for a manufacturing business. First, accounts are closed to the manufacturing summary. Second, revenue and expense accounts are closed to income summary. Third, the manufacturing summary account is closed to income summary. Finally, the income summary is closed to retained earnings.

Record reversing entries for a manufacturing business. Objective 8 Record reversing entries for a manufacturing business. The eight objective of this chapter is to record reversing entries for a manufacturing business.

Reversing Entries Reversing entries may be made for adjustments for accruals. Reversing entries are also made for expenditures which were initially debited to expense accounts. Reversing entries are optional. Reversing entries for a manufacturing business are very similar to sole proprietorship accounting. First, reversing entries are optional. Second, reversing entries may be made of accruals and for expenditures which were initially debited to an expense account.

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