Basic Financial Accounting & Reporting Manufacturing Operations Learning Objectives: After studying this chapter, you 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. Show the pro-forma entries of the common transactions for a manufacturing entity. 5. Prepare a statement of cost of goods manufactured. 6. Prepare a statement of cost of goods sold. Pinpoint the differences in the worksheet of a manufacturing entity as compared to a merchandising entity. Making whey! Once pig feed, the dairy product is now. wonder ingredient in people food. The trailblazer Michael Otten has to scramble to stay in the high-value end of the business. For years, Otten was a laughing stock to his fellow chemists at Land O'Lakes. They ribbed him for his obsession with whey, a watery byproduct of cheesemaking best known asa scene-setter in a nursery rhyme. That was back in 1970s when the cheesemakers’ discarded whey was used as fertilizer and pig feed. Otten, 53, saw potential in whey’s high-quality protein. Problem was, it was also swimming in lactose, butterfat and cholesterol. There was no cost-effective technology to separate the good stuff from the sow sauce. That changed in the mid-1980s, when microscopic sieves—spread throughout steel tubes that are 10 meters long and 10 to 12 centimeters in diameter—were developed to filter out undesirable elements before the whey was dried to a powder for use in food manufacturing. Foodmakers then became interested in whey as a cheap alternative to ionfat dry milk. Otten s d the moment, launching Century Foods International in Sparta, Wisconsin, in 1991 with US$200,000 in savings. He built it by purchasing partly dried whey from cheesemakers for USS0.77 per kilogram. He then refined it into 34% whey protein concentrate powder and sold it for US$1.10 per kilogram. Those may seem like minuscule margins, but Century Foods grew Quickly. The whey concentrate goes into yogurt to help the bacteria grow, into bread as the ™agic ingredient to keep it moist and into sausage as a binder (if you wonder what’s going on420 |_ Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada anneal aaa ere See eee aay here, recall that Borden used to make glue from milk). Otten was attracting big buyers like Yoplait and the Holsum Bakery chain. Last year the revenues of the privately held Century Foods were US$90 million, They might have amounted to more if Otten had caught on sooner to the fastest growing and most lucrative market for whey. In 1996, bodybuilders started downing whey protein shakes of the theory that the ultrafiltered whey would replace damaged muscle tissue. The not terribly palatable stuff has a role in weights-loss diets, too. The consumer market helped boost whey sales to US$1.4 billion last year from US$1.0 billion last 1995. A lot of entities are gunning for a cut. Early this year, Philip Morris’ Kraft Foods bought the whey-packed Balanced Bar, and its rival Nestle USA snapped up PowerBar. Other entities are upgrading their facilities to make the 95% whey protein isolate for protein pills and bars. Eighteen months ago, Otten decided that he did not want to miss out on whey’s heyday. He spent US$30.0 million on four new plants, including ‘one that makes capsules and tablets. He also built two new facilities to make it possible for Century Foods to process larger volumes of whey. Upgrades have cost him. Century's revenue declined by US$10 million last year, as Otten moved away from his traditional business. Already, however, he has new clients. He recently started selling high-protein drinks and tablets to Prolab Nutrition and MuscleTech. Otten now buys high- protein whey concentrate from cheesemakers, refines it in his plants and extracts different proteins for various customers. He hopes the higher-end whey will ultimately make up 75% of his business, up from the current 50%. Now he’s the one who is laughing. Adapted from: Making Whey By Nathan Vardi of Forbes Globol, Oct. 2, 2000. : COMPARING MERCHANDISING AND MANUFACTURING ACTIVITIES Merchandising and manufacturing entities earn revenues by selling goods. A merchandiser normally buys 2 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 Gifficult to measure the inventory cost of a manufacturer.PE Manufacturing Operations | 421 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 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. 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 po:ARCOUNTING FOR MANUFACTURING ACTIVITIES ng HARES may be used in accounting fi The coat system Uneg work in process and fimamed goods © mation abort those imuentonies and changes namncbacturing © sis of raw materid, Stem providet MOre timesy their levels. Mt alto produces timety of ptogurt which managers use in thei wiactuting activities using CON systems ip leon treatise” atte torts the subject ¢ The nen-cest system produces 4 manufacturing accounting system based on the periadic ievertary system, The coots of tam materials, work in process and finithed gods imeentories are based on pirysical counts of the quantities on hand at the end of cach perad This information is then used te compute the amounts consumed, finished and sold during the period, Thin system does mot provide for 3 detailed flow of costs in putacturing process. In the discussions to follow, the non-cost system will be ssa. It is alse assumed that the entity uses the vourher system, The following are the peo-fcema journal entries of the mare common transactions for 3 manufacturing entity: tthe om L Te rweerd purchase of raw materials and inditect materials on account: xx xx Purchases Maw Materials iretirect Materials Voucters Payable 2 Te record cost af defective caw materials returmed to vendor: Wouchers Payable oo Purctases Returns and Allowances 3. To recaed payment of account within the discount period: vouchers Payable Purchaves Onicounts Caen im Bane 4 Te record freagnt and handling of raw materials: Tramsporation tn Wouthers Payable x To recerd payroll for factory employees: Owect Labor inetwect Later S85 Contnbunions Payable Medicare Contritauons Payable Fag “OG Contributions Payable = aoe& Ta record employer's payroll expenses: Employer's Payrait Contributions Factory SSS Contributions Payable Medicare Cantritutions Papatie EC Contributians Payabie Pag IBIG Contributions Payabie 7. Torecotd distribution of payralt Vouchers Payabie Cash in Bank 8. To record accrual of factory payroll Direct Labor Indirect Labor Accrued Payrol 9. To record depreciation of factory building: Depreciation Expense—Factory Bicty, Accumulated Depreciation—Factony Bigg. 10. To record repairs on factory building: Repairs and Mlaintenance—Factary Building Vouchers Payable 11. To record amortization of patents: Amortization of Patents Patent 12. To record real property taxes on factory sit Real Property Taxes Vouchers Payable 13. To record factory utilities incurred: Factory Utilities Vouchers Payable 14, To record cost of tools used: Tools Used Tools Marutecureg Oneretor xe xx » a a m | 423424 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada 15. Torecord sales of finished goods: Accounts Receivable xx. Sales xx 16. To record sales returns of customers: Sales Returns and Allowances xx, XK Accounts Receivable 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 x Purchases Discounts x Manufacturing Summary x b. To close manufacturing accounts with debit balances: Manufacturing Summary Mx | Raw Materials Inventory, beginning . xx Work in Process Inventory, beginning Oe Purchases—Raw Materials. xx Transportation In xx Direct Labor xx Indirect Labor 1x Indirect Materials xx | Depreciation Expense—Factory Bldg. xx Repairs and Maintenance—Factory Bldg. xx Amortization of Patents xx Real Property Taxes Om Factory Utilities xx Tools Used * Employer's Payroll Contributions—Factory Xx, Factory Supplies Expense x» x | Miscellaneous Factory ExpenseEe Manufacturing Operations | 425 To close manufacturing summary and beginning finished goods inventory to income summary: Income Summary ‘Manufacturing Summary a Finished Goods inventory, beginning x 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 x» Income Summary x The other closing entries after this procedure are the same as those for a i merchandising entity. X STATEMENT OF COST OF GOODS MANUFACTURED Renante Balocating Manufacturers Statement of Cost of Goods Manufactured For the Year Ended Dec. 31, 2020 Direct Materials Used: Raw Materials Inventory, beginning, Pan Add: Net Cost of Purchases: Purchases—Raw Materials Po : Less: Purchases Returns and Allowances Pak Purchases Discounts em - Net Purchases Pa ‘Add: Transportation In a | Raw Materials Available for Use : Pee. | Less: Raw Materials inventory, end vo Pe Direct Labor ad ‘Manufacturing Overhead Indirect Labor ; mt Indirect Materials : - . Depreciation Expense—Factory Bldg 1 \ Repairs and Maintenance—Factory Bide ~ ‘Amortization of Patents hi Real Property Taxes eee Factory Utilities : ee Tools Used eee Employer's Payroll Contibutions—Factory bas Factory Supplies Expense = Miscellaneous Factory Expense +e Total Manufacturing Costs = : ‘Add: Workin Process, beginning = otal Cost of Goods Paced in Process = Less: Work in Process, end Tata cost of Goods Manufactured tes426 | Basic Financial Accounting and Reporting 2021 Edition by Prof. WIN Ballada Total manufacturing costs should not be confused with the cost of goods manufactured, Total manufacturing costs are the costs of direct materials used, direct labor and ” manufacturing overhead incurred and charged to’ production during’ an accounting period. The 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. 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 i Merchandise inventory, Beg. Pxx Finished Goods'Inventory, Beg. Pax ‘Add: Net Cost of Purchases xx__ Add: Cost of Goods Manufactured x Goods Available for Sale Px Goods Available for Sale Pre Less: Merchandise Inventory, End xx ___Less: Finished Goods Inventory, End ee Cost of Goods Sold Pxx_ Cost of Goods Sold Prox ‘WORKSHEET FOR A MANUFACTURING ENTITY The worksheet for a manufacturing entity is basically the same as that for a merchandising entity except that jt 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 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. :