MANUFACTURING OPERATIONS

COMPARING MERCHANDISING AND MANUFACTURING OPERATIONS

Merchandising and manufacturing entities earn revenues by selling goods. A merchandiser normally
buys a product that is ready for resale when it is received. 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. To illustrate, consider the distinction between the
athletic shoes section of PureGold Duty Free Inc. in Clark Field, Pampanga – the merchandiser and the
entities that manufacture athletic shoes such as Nike, Reebok, Adidas, K-Swiss, Puma, Converse and
Tretorn – the manufacturers.
Like other merchandisers, PureGold buys ready-made inventory for resale to customers. Determining
PureGold’s cost of the shoes is relatively easy. Cost is the price that the merchandiser paid for the shoes
plus incidental costs. 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.
ELEMENTS OF MANUFACTURING COSTS
Manufacturing costs include all costs related to the production process. They are classified into three
categories:
Direct materials. These materials become a physical part of a finished product. Their costs can be
conveniently and economically traceable to the finished product. Consider a pair of Nike basketball shoes
as the finished product; its leather uppers, the rubber and plastic soles, and the laces are among its direct
materials.
Direct labor. It is the compensation of employees or workers who physically convert raw materials into
finished goods. For Nike, direct labor includes the wages of the machine operators and the persons who
assemble the shoes. The efforts of these persons are directly traceable to the finished product.
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, 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 time combined into prime costs or conversion costs. Prime
costs consist of direct materials and direct labor. Conversion costs consist of direct labor and
manufacturing overhead.
Note: When we added these three costs, we will arrived at the total manufacturing costs.
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
position.
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 accounting. Note: This will be used in your next accounting
subject in 2nd year.
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
Purchases 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

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
Vouchers 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

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
Purchase 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 – Factory Bldg. xx
Repairs and Maintenance – Factory Bldg. xx
Amortization of Patents xx
Real Property Taxes xx
Factory Utilities xx
Tools Used xx
Employer’s Payroll Contributions – 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 Goods 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, ending 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 assets when 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
Kareen Leon Manufacturing Corporation
Statement of Cost of Goods Manufactured
For the Year Ended, Dec. 31, 2019

Direct Materials Used

Raw Materials Inventory, beginning P xxx
Add: Net Purchases:
Purchases – Raw Materials P xx
Less: Purchase Returns and Allowances P xx
Purchase Discounts xx xx
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 P 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

 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 statement of comprehensive income 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 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 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 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 statement of
comprehensive income. Beginning finished goods inventory being a component in the computation of
cost of goods sold is extended to the debit side of the statement of comprehensive income columns while
the ending finished goods inventory to the credit column.

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.

Key Answers:

1. T 6. F
2. F 7. F
3. F 8. F
4. T 9. T
5. T 10. T

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?
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.
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.

Key Answers
1. C 5. C
2. C 6. D
3. B 7. A
4. C

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
purchased. Operating cost data and inventory account balances for 2019 follow:

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
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

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.

Key Answers
1.
Raw Materials Inventory, Jan. 1, 2019 P 26,490
Add: Raw Materials Purchases (net) 361,920
Cost of Raw Materials Available for Use P 388,410
Less: Raw Materials Inventory, Dec. 31 24,910
Cost of Direct Materials Used P 363,500

2.
Cost of Direct Materials Used P 363,500
Direct Labor (10,430 hours at P 9.50 per hour) P 99,085
Total Factory Overhead Costs
Plant Supervision 42,500
Indirect Labor (20,280 hours at P 6.25 per 126,750
hour)
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
Total Manufacturing Costs P 802,595
3.
Total Manufacturing Costs P 802,595
Add: Work in Process Inventory, Jan. 1 101,640
Total Cost of Work in Process During the Year P 904,235
Less: Work in Process Inventory, Dec. 31 100,400
Cost of Goods Manufactured P 803,835
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 Equipment 78,000
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
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.

Key Answers

1 & 2.

Langga Corporation
Schedule of Manufacturing Overhead Costs
For the Year Ended Dec. 31,2019

Amortization of Patents 16,000

Depreciation Expense – Factory Building 133,000
Depreciation Expense – Factory Equipment 78,0h00
Factory Insurance Expense 62,000
Factory Supervision 74,000
Factory Supplies Expense 21,000
Factory Utilities 115,000
Indirect Labor 26,000
Property Taxes – Factory Site 14,000
Repairs and Maintenance – Factory 31,000
Equipment
Total Manufacturing Overhead P 570,000

3.
Langga Corporation
Cost of Goods Manufactured Statement
For the Year Ended, Dec. 31, 2019

Direct Materials
Raw Materials Inventory, Dec. 31, 2018 P 60,000
Add: Raw Materials Purchases 313,000
Raw Materials Available for Use P 373,000
 Less: Raw Materials Inventory, Dec. 31. 2019 78,000
Direct Materials Used P 295,000
Direct Labor 250,000
Manufacturing Overhead Costs 1,115,00
Total Manufacturing Costs P 1,115,000
Add: Work in Process Inventory, Dec. 31, 2018 8,000
Total Cost of Work in Process During the Year P 1,123,000
Less: Work in Process Inventory, Dec. 31 9,000
Cost of Goods Manufactured P 1,114,000

Langga Corporation
Statement of Comprehensive Income
For the Year Ended, Dec. 31, 2019

Sales P 1,630,000
Less: Cost of Goods Sold
Finished Goods Inventory, Dec. 31, 2018 P 15,000
Add: Cost of Goods Manufactured 1,114,000
Goods Available for Sale P 1,129,000
Less: Finished Goods Inventory, Dec. 31. 2019 12,500
Cost of Goods Sold 1,116,500
Gross Profit P 513,500
Less: Operating Expenses
Advertising Expense P 85,000
Uncollectible Accounts Expense 28,000
Depreciation Expense – Office Equipment 37,000
Interest Expense 25,000
Miscellaneous Expenses 55,000
Salaries Expense 150,000
Total Operating Expenses 380,000
Profit before Taxes P 133,500
Less: Income Taxes Expense (35%) 46,725
Profit P 86,775