MANUFACTURING

COST
Introduction to Manufacturing
Concern
• Definition: A manufacturing concern is a business involved in the production of tangible goods.
◦ Characteristics:
1. Raw Material Transformation:
Manufacturing concerns undertake the conversion of raw materials into finished products. This involves a
series of steps and processes to add value to the raw materials.
Example: In the automobile industry, raw metals, plastics, and electronic components are transformed into fully
assembled vehicles through manufacturing processes.
2. Multiple Processes:
The production journey typically includes various stages and processes, each contributing to the final product.
These can include design, fabrication, assembly, and quality control.
Example: In the textile industry, raw cotton goes through processes such as spinning, weaving, and dyeing
before becoming a finished fabric.
Introduction to Manufacturing
Concern
◦ Characteristics:
3. Physical Goods Output:
The end result of manufacturing is a tangible product that can be touched, held, and used. This distinguishes
manufacturing from service-oriented businesses that provide intangible offerings.
Example: A furniture manufacturing concern produces physical items like tables and chairs, contrasting
with a consulting firm that offers advice as a service.
4. Supply Chain Integration:
Manufacturing concerns often have extensive supply chains involving the sourcing of raw materials, transportation,
and coordination of various components to ensure a smooth production flow.
Example: In the electronics industry, a manufacturing concern coordinates with suppliers for components
like microchips, ensuring a steady supply for production.
Components of Manufacturing Cost
Direct Materials:
◦ Definition: Direct materials refer to the raw substances and components directly utilized in the
manufacturing process. These materials are integral to the final product and can be traced directly to it.
Examples:
1.Raw Metals:
1. In the automotive industry, raw metals like steel and aluminum are direct materials used in the fabrication of
vehicle bodies and components.
2.Fabrics:
1. In the fashion industry, textiles such as cotton or synthetic fabrics serve as direct materials in the production of
clothing and accessories.
3.Electronic Components:
1. For electronic devices like smartphones, components such as microchips and circuit boards are direct materials.
Components of Manufacturing Cost
Direct Labor:
◦ Definition: Direct labor encompasses the cost of human effort directly involved in the manufacturing
process. It includes the wages and benefits of workers who physically contribute to the production of
goods.
Examples:
1.Assembly Line Workers:
1. In the manufacturing of consumer electronics, assembly line workers are directly involved in putting together
the various components to create the final product.
2.Machine Operators:
1. In industries like food processing, machine operators oversee the machinery that transforms raw ingredients into
packaged goods.
Components of Manufacturing Cost
Manufacturing Overhead:
◦ Definition: Manufacturing overhead consists of indirect costs associated with production but not directly
tied to specific materials or labor. These costs are essential for the overall manufacturing environment.
Examples:
1. Factory Rent:
1. The cost of renting the manufacturing facility is considered overhead, as it benefits the entire production process.
2. Utilities:
1. Electricity, water, and other utility costs that contribute to the functioning of the manufacturing facility fall under
manufacturing overhead.
3. Equipment Depreciation:
1. The decrease in value of machinery and equipment over time is an overhead cost, as it is not directly tied to the
production of a single unit but supports overall operations.
Costing System for Manufacturing
Overhead
Definition: A costing system for manufacturing overhead is a structured method used to allocate and assign
indirect costs to products during the production process. This ensures that the total cost of production is
accurately accounted for, allowing businesses to make informed decisions about pricing and resource
allocation.
◦ Methods:
1.Traditional Costing:
1. This method allocates overhead costs based on a single allocation factor, often using direct labor hours or
machine hours. It is a simpler approach but may not capture the actual usage of overhead resources.
Example:
2. If direct labor is used as the allocation factor, a product requiring more labor hours would bear a higher share of
the overhead costs.
Costing System for Manufacturing
Overhead
◦ Methods:
2. Activity-Based Costing (ABC):
• ABC is a more refined method that allocates overhead costs based on the specific activities that drive
those costs. It provides a more accurate reflection of how resources are consumed in different stages of
production.
Example:
• In a manufacturing process, ABC might allocate more overhead costs to a product that requires extensive
setup or special handling.
Costing System for Manufacturing
Overhead
Let's consider a hypothetical manufacturing scenario involving two products: Product A and Product B. We'll calculate the overhead cost
allocation using both Traditional Costing and Activity-Based Costing (ABC).
◦ Scenario Details:
• Overhead Costs: Total overhead costs for the period = 100,000 pesos.
• Allocation Factors:
• Traditional Costing: Direct Labor Hours.
• Activity-Based Costing (ABC):
• Activity 1: Setup Costs (40% of total overhead costs).
• Activity 2: Machine Utilization (60% of total overhead costs).

◦ Direct Labor Hours:

• Product A requires 20 hours of direct labor.
• Product B requires 30 hours of direct labor.
◦ ABC Activity Drivers:
• Product A requires 5 setups (Activity 1) and utilizes the machine for 15 hours (Activity 2).
• Product B requires 10 setups (Activity 1) and utilizes the machine for 20 hours (Activity 2).
Costing System for Manufacturing
Overhead
Traditional Costing:
Costing System for Manufacturing
Overhead
Activity-Based Costing (ABC):
Costing System for Manufacturing
Overhead
Summary:
• Traditional Costing: Product A Overhead = 40,000 pesos, Product B Overhead = 60,000 pesos.
• Activity-Based Costing: Product A Overhead = 16,525 pesos, Product B Overhead = 32,700 pesos.
◦ This simplified example illustrates how Traditional Costing and Activity-Based Costing can result in
different overhead allocations, showcasing the importance of selecting the most appropriate costing
method based on the nature of the business.
Costing System for Manufacturing
Overhead
◦ Importance: Accurate costing is crucial for several reasons:
1.Setting Product Prices:
1. Knowing the true cost of production helps businesses set competitive yet profitable prices for their products.
2.Resource Allocation:
1. Understanding where and how overhead costs are incurred allows for more effective allocation of resources,
improving efficiency.
3.Informed Business Decisions:
1. Accurate costing provides valuable insights into the financial health of the manufacturing process, aiding in
strategic decision-making for the business.
Computing Manufacturing Cost
Formula for Manufacturing Cost:
◦ The manufacturing cost is a crucial metric that encompasses the total direct and indirect expenses
incurred in the production process. It is calculated using the formula:
◦ Manufacturing Cost= Direct Materials + Direct Labor + Manufacturing Overhead
◦ This formula integrates the three fundamental components that contribute to the overall cost of producing
goods.
Computing Manufacturing Cost
Example Calculation:
◦ Let's delve into a hypothetical example to illustrate the computation of manufacturing cost. Assume we
are considering the production of a customized wooden chair.
1.Direct Materials:
1. The cost of the wood, varnish, and other materials directly used in making one chair amounts to ₱200.
2.Direct Labor:
1. The labor cost associated with crafting one chair by skilled artisans is ₱150.
3.Manufacturing Overhead:
1. Overhead costs, covering utilities, rent, and equipment depreciation, for each chair sum up to ₱80.
Computing Manufacturing Cost
Significance of the Calculation:
◦ Understanding and accurately calculating the manufacturing cost are vital for businesses as it aids in:
1.Setting Product Prices:
Determining a price that covers all production costs while remaining competitive in the market.
2.Profitability Analysis:
Assessing the profitability of specific products and identifying areas for cost optimization.
3.Resource Allocation:
Efficiently allocating resources to enhance overall operational efficiency.
4.Strategic Decision-Making:
Making informed decisions about production volumes, product lines, and pricing strategies.
Computing Cost of Sales for
Manufacturing Business
◦ Formula for Cost of Sales:
◦ The cost of sales is a critical metric that reflects the total expenses associated with producing and
delivering goods to customers. It is calculated using the formula:
◦ Cost of Sales=Opening Inventory + Manufacturing Cost− Closing Inventory
◦ This formula considers the value of products available at the beginning of a period, the manufacturing
cost incurred during the period, and the remaining value of products at the end of the period.
Computing Cost of Sales for
Manufacturing Business
◦ Example Calculation:
◦ Let's delve into a hypothetical scenario for a manufacturing business producing electronic gadgets.
1.Opening Inventory:
1. The value of gadgets in stock at the beginning of the accounting period is ₱500,000.
2.Manufacturing Cost:
1. The total manufacturing cost for the period, considering direct materials, direct labor, and overhead, is
₱2,000,000.
3.Closing Inventory:
1. The value of gadgets remaining in stock at the end of the period is ₱600,000.
Computing Cost of Sales for
Manufacturing Business
Calculation:
◦ Cost of Sales=₱500,000(Opening Inventory) + ₱2,000,000(Manufacturing Cost) −
₱600,000(Closing Inventory)
◦ Cost of Sales=₱1,900,000
◦ Therefore, the cost of sales for the electronic gadgets during this period is ₱1,900,000.
Computing Cost of Sales for
Manufacturing Business
Significance of the Calculation:
◦ Understanding the cost of sales is crucial for a manufacturing business, as it aids in:
1.Determining Profitability:
1. Assessing the actual cost incurred in selling products and deriving the gross profit.
2.Setting Prices:
1. Informing pricing strategies by ensuring that product prices cover both production costs and contribute to
overall profitability.
3.Financial Reporting:
1. Providing accurate data for financial statements, helping stakeholders assess the business's financial health.
4.Inventory Management:
1. Evaluating the efficiency of inventory management practices and identifying areas for improvement.