L77 CTE - BMM

Manufacturing Process

Unit: Technical Skills

Problem Area: Cost Accounting

Lesson: Manufacturing Process

Student Learning Objectives.

Instruction in this lesson should result in students

achieving the following objectives:

Explain manufacturing inventory account types.

Analyze the inventory cost flow process.

Apply predetermined overhead rate calculations.

¢ Resources.

The following resources may be useful in teaching this lesson:

E-unit(s) corresponding to this lesson plan. CAERT, Inc. http://www.mycaert.com.

Arline, Katherine. “Direct Costs vs. Indirect Costs: Understanding Each,” Business News

Daily. Accessed May 9, 2016. http://www.businessnewsdaily.com/5498-direct-costs-

indirect-costs.html.

Ingram, David. “Advantages and Disadvantages of Job Order Costing and Process Costing,”

Chron. Accessed May 9, 2016. http://smallbusiness.chron.com/advantages-

disadvantages-job-order-costing-process-costing-3082.html.

“Predetermined Overhead Rate,” Accounting for Management.org. Accessed May 9, 2016.

http://www.accountingformanagement.org/predetermined-overhead-rate/

Rogers, Karen. “Examples of Manufacturing Overhead in Cost Accounting,” azcentral.

Accessed May 9, 2016. http://yourbusiness.azcentral.com/examples-manufacturing-

overhead-cost-accounting-15403.html.

“What Is Cost Accounting?” Accounting Coach®. Accessed May 9, 2016.

http://www.accountingcoach.com/blog/what-is-cost-accounting

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Equipment, Tools, Supplies, and Facilities

Overhead or PowerPoint projector

Visual(s) from accompanying master(s)

Copies of sample test, lab sheet(s), and/or other items designed for duplication

Materials listed on duplicated items

Computers with printers and Internet access

Classroom resource and reference materials

Key Terms.

The following terms are presented in this lesson (shown in bold italics):

cost accounting

cost of goods manufactured (COGM)

cost of goods sold (COGS)

direct labor

direct materials inventory

finished goods (FG) inventory

indirect labor

indirect material

job

job order costing

manufacturing overhead

predetermined overhead rate

T-account

under- or over-applied manufacturing overhead

work-in-process inventory

¢ Interest Approach.

Use an interest approach that will prepare the students for the

lesson. Teachers often develop approaches for their unique class and student situations. A

possible approach is included here.

There are unique accounts and procedures for accounting for the manufacture

of products. (The manufacturing process is referred to as the conversion process

since materials are converted into finished products.) With manufacturing and

cost accounting, accountants and management are interested in tracking how

much it costs to make their products and how to continue to better their

manufacturing processes to save money in the long run. Accountants interested

in pursuing the Certified Management Accountant (CMA) certification set

themselves apart as experts in their field.

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CONTENT SUMMARY AND

TEACHING STRATEGIES

Objective 1: Explain manufacturing inventory account types.

Anticipated Problem: What are manufacturing inventory account types?

I. Manufacturing inventory account types

A. Costing

1. Cost accounting is a branch of accounting that determines a manufacture or

a service cost per unit of a good or service to place a value on inventory and

on the cost of goods sold. To conduct cost accounting, an accountant needs

to capture (collect, classify, record) and tally all the costs (material, labor, and

overhead) involved in producing an item for sale to arrive at the item’s selling

price. Often an auditor is relied upon to determine where savings are possible.

2. Job order costing is a system for assigning manufacturing costs to an individ-

ual product or batches of products. In job order costing, the goal is to accumu-

late and report the costs for the job. It is one method of tracking manufactur-

ing costs. In manufacturing, the batches or different types of products are a

job. A typical example of the job order costing process is similar to the follow-

ing scenario: A company receives an order to produce 5,000 T-shirts. The

manufacturer then plans to run a job to produce 5,000 T-shirts. Any future

orders are separate jobs, even if it is for the same product.

B. Five main manufacturing inventory accounts for recording costs

1. Direct materials inventory (raw materials inventory) is the traceable matter

of a product (the standard cost of the direct materials on hand) and is an

asset. This type of inventory is easily identifiable with the product. For example,

the fabric in a T-shirt or the sugar in a soda is direct materials inventory.

2. Work-in-process inventory is the partially converted materials in the produc

tion process that have not yet been completed and moved to finished goods

inventory. Work-in-process inventory is an asset.

a. It contains the costs for direct materials, direct labor, and manufacturing

overhead for the product.

b. Costs move out of work-in-process when products are completed.

3. Finished goods (FG) inventory is the completed product of a manufacturer

waiting to be sold. It is the cost of the products in the FG warehouse. FG

inventory is an asset.

4. Cost of goods sold (COGS) is the cost attributable to the production of goods

sold by a company. It is the cost of the goods sold to customers, not all the

production costs. Cost of goods sold is an expense. It is calculated as: Cost of

Beginning Inventory + Cost of Goods Purchased + Freight-in – Cost of Ending

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Inventory. COGS is often the largest expense on a company’s income state

ment (a company that sells products or goods).

5. Manufacturing overhead (factory overhead) is the indirect costs incurred

(obligated) when manufacturing a product; they are costs other than direct

materials and direct labor. Manufacturing overhead includes indirect materials,

indirect costs, and indirect labor, such as:

a. Glue and grease (indirect materials)

b. Supervisor salaries and maintenance (indirect labor)

c. Depreciation and taxes on the manufacturing facility (indirect overhead

costs)

d. Estimated costs (e.g., electricity) to run the job at the plant (indirect

overhead costs)

Teaching Strategy:

Many techniques can be used to help students master this

objective. Project VM–A through VM–E to review. [NOTE: Presenting the manufacturing

inventory accounts in order helps prepare the students for Objective 2.]

Objective 2: Analyze the inventory cost flow process.

Anticipated Problem: What is the inventory cost flow process?

II. Inventory cost flow process

A. Sequential process

1. Manufacturers convert raw materials into finished goods through the use of

labor and plant facilities. Inventory moves through the manufacturing process

in the following order: materials, work-in process, and finished goods. NOTE:

The Cost of Goods Sold and manufacturing overhead accounts are used in

conjunction with the first three inventory accounts:

a. Direct materials inventory

b. Work-in-process inventory

c. Finished goods (FG) inventory

2. It is easier to understand inventory cost flow by visually seeing the costs and

reconciling each account in T-accounts. A T-account is a visual aid that illus

trates the effect of debits and credits on accounts. A T-account visual is an

informal method of recording transactions as well as an informal type of dou

ble-entry bookkeeping. The following manufacturing events make up the cost

flow.

B. Cost flow events

1. It is necessary to purchase direct and indirect materials.

a. The purchase of direct materials requires a debit to Direct Materials

Inventory and a credit to Cash or Accounts Receivable.

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b. An indirect material is a supply not easily “traceable” (noticeable) in a

product. It is not cost-effective for an accountant to track these supplies

per unit. Indirect material costs are applied to the job via manufacturing

overhead (addressed in another objective). For instance, glue to assemble

a wooden chair is an indirect material. The purchase of indirect materials

requires a debit to Manufacturing Supplies and a credit to Cash or

Accounts Receivable.

2. It is important to transfer direct materials into production.

a. Materials are requisitioned from inventory when scheduled for a job.

b. The transfer of materials into production requires a debit to Work-in-

Process Inventory and a credit to Direct Materials Inventory.

3. Indirect materials must be transferred into production.

a. Materials are requisitioned from inventory when scheduled for a job.

b. The transfer of materials into production requires a debit to Manufacturing

Overhead and a credit to Manufacturing Supplies.

4. Direct labor must be used for the job.

a. Direct labor is the cost of the actual employee hours worked on the job

directly related to product production.

b. The recording of direct labor into production requires a debit to Work-in-

Process Inventory and a credit to Salary and Wages Payable.

5. Application of indirect labor

a. Indirect labor is the cost of work that supports the production process

(but does not involve transforming raw materials into a finished product).

b. Production supervisors, accounting, marketing, quality control, and

maintenance staff hours are examples.

6. Job completion

a. When a product is complete (direct materials, direct labor, and

manufacturing overhead applied), the finished product cost is moved out of

Work-in-Process Inventory and into Finished Goods Inventory.

b. The entry is recorded as a debit to Finished Goods Inventory and a credit to

Work-in-Process Inventory; the dollar amount is referred to as the cost of

goods manufactured. Cost of goods manufactured (COGM) is the total

cost of goods completed during the period. The COGM formula is: COGM =

Direct Materials Used + Direct Labor Used + Factory Overhead + Work-in-

Process Opening Inventory – Work-in-Process Closing Inventory

7. Product sales

a. When a product is sold, the finished goods are removed from inventory (as

they are no longer available), and the cost is assigned to Cost of Goods

Sold.

b. The entry is recorded as a debit to COGS and a credit to Finished Goods

Inventory.

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8. Reconciliation of manufacturing overhead

a. In addition to direct material and direct labor, manufacturing overhead

must be allocated to each unit produced for Finished Goods Inventory and

Cost of Goods Sold to be valued correctly.

b. The debit side of manufacturing overhead is the actual cost of indirect

materials and labor. The credit side is the applied (allocated) portion of

indirect materials and labor. It is an estimate.

(1) To record applied manufacturing overhead (the estimated piece),

Work-in-Process is debited, and Manufacturing Overhead is credited.

(2) Actual overhead costs are debited to Manufacturing Overhead, and

Cash or a Liability account is credited for each transaction.

(3) The difference between the debit and credit balance in Manufacturing

Overhead is closed out to Cost of Goods Sold.

Teaching Strategy:

Many techniques can be used to help students master this

objective. Project VM–F to review. Assign LS–A.

Objective 3: Apply predetermined overhead rate calculations.

Anticipated Problem: What is a predetermined overhead rate calculation?

III. Predetermined overhead rates

A. Calculating predetermined overhead rates

1. The pre-determined overhead rate is an allocation (a share) rate used to

apply the estimated cost of manufacturing overhead to jobs—typically applied

for a specific reporting period. To record applied manufacturing overhead, esti-

mates of costs and activity are established. Once these estimates are deter-

mined, the predetermined overhead rate is calculated by dividing the esti

mated total overhead costs by the estimated amount of activity that drives the

cost (e.g., machine hours cost).

2. The predetermined overhead rate formula is: Estimated Costs ÷ Estimated

Activity. For example: A business expects to incur $40,000.00 in overhead

costs with 10,000 machine hours. The predetermined overhead rate is calcu

lated as:

$40,000.00 ÷ 10,000 machine hours = $4.00 rate

3. To record the actual applied manufacturing overhead (in the above example):

Assuming 9,500 machine hours are logged, the applied manufacturing over

head is calculated as:

9,500 machine hours × $4.00 = $38,000.00

4. Actual manufacturing overhead is updated as indirect employees are paid and

invoices for utilities and manufacturing supplies are received and recorded.

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B. Under- or over-applied manufacturing overhead

1. According to accountants, under- or over-applied manufacturing overhead

is the difference between the applied manufacturing overhead and the actual

manufacturing overhead.

a. If the actual costs are greater than the applied overhead (debit side

exceeds the credit side), manufacturing overhead is said to be “under-

applied,” or not enough cost was dedicated to the job (via Work-in-

Process).

b. If the applied overhead is greater than the actual costs (credit side exceeds

the debit side), manufacturing overhead is said to be “over-applied,” or too

much cost was dedicated to the job (via Work-in-Process).

2. This difference is closed out to Cost of Goods Sold.

a. If Manufacturing Overhead has a debit balance, it is necessary to credit

Manufacturing Overhead and debit Cost of Goods Sold.

b. If Manufacturing Overhead has a credit balance, it is necessary to debit

Manufacturing Overhead and credit Cost of Goods Sold.

c. This entry process eliminates the under- or over-applied manufacturing

overhead and adjusts Cost of Goods Sold to reflect the correct cost

amount.

Teaching Strategy:

Many techniques can be used to help students master this

objective. Project VM–G and VM–H for discussion. Assign LS–B for student practice.

¢ Review/Summary.

Use the student learning objectives to summarize the lesson.

Have students explain the content associated with each objective. Student responses can

be used in determining which objectives need to be reviewed or taught from a different

angle. If a textbook is being used, questions at the ends of chapters may be included in

the Review/Summary.

Application.

Use the included visual master(s) and lab sheet(s) to apply the

information presented in the lesson.

Evaluation.

Evaluation should focus on student achievement of the objectives for the

lesson. Various techniques can be used, such as student performance on the application

activities. A sample written test is provided.

Answers to Sample Test:

Part One: Completion

1. indirect materials

2. finished goods

3. direct materials

4. job order costing

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5. work-in-process

6. estimated production costs (or estimated costs)

Part Two: True/False

1. T

2. F

3. F

4. F

5. T

6. F

Part Three: Short Answer

1. Answers will vary slightly although the cost flow process is quite specific and would

be similar to the following explanation. The typical sequence is:

a. When direct materials are purchased, Direct Materials Inventory is debited and

Accounts Payable is credited.

b. When direct materials are requisitioned for use in production, Work-in-Process

Inventory is debited and Direct Materials Inventory is credited.

c. Any labor used for the job is debited to Work-in-Process Inventory and the pay-

ment due the employees is credited to a Wages Payable account.

d. Applied manufacturing overhead (indirect labor and material) is debited to Work-

in-Process Inventory and credited to Manufacturing Overhead.

e. Completed product is moved out of Work-in-Process Inventory with a credit and

is debited to Finished Goods Inventory.

f. Any product sold is debited to Cost of Goods Sold and credited to Finished

Goods Inventory.

g. Finally, any difference between the balance of actual manufacturing overhead

and applied manufacturing overhead is closed out to Cost of Goods Sold.

2. Answers may vary but should mention that not all the costs are known at the time of

job production. Costs are estimated and applied to the job via Manufacturing

Overhead. Once actual costs are known (all invoices received), any difference

between the estimate and actual cost is reconciled (settled) in Cost of Goods Sold.

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Sample Test

Name ________________________________________

Manufacturing Process

Part One: Completion

Instructions: Provide the word or words to complete the following statements.

1. Supplies not easily traceable in a product are _________________________.

2. The completed manufactured goods waiting to be sold are _________________________.

3. The traceable matter of a product is recorded as _________________________.

4. A system for assigning manufacturing costs to an individual product or batches of products is

called _________________________.

5. Those partially converted materials still in the production process are recorded as

_________________________.

6. The predetermined overhead rate is calculated by dividing _________________________ by

estimated production activity.

u Part Two: True/False

Instructions: Write T for true or F for false.

_____1. The correct sequence of manufacturing cost flow is direct materials, work-in-process,

and finished goods.

_____2. An accountant credits Work-in-Process when direct materials are placed into

production.

_____3. The purchase of indirect materials is recorded as a debit to Direct Materials and a

credit to Cash.

_____4. Work-in-Process Inventory is an expense account.

_____5. The predetermined overhead rate is calculated using estimated figures.

_____6. Cost of Goods Manufactured is an asset account.

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Part Three: Short Answer

Instructions: Answer the following.

1. Explain how cost travels through each of the inventory accounts. Use debit and credit terms

in your explanation.

2. Explain the reason an entry for applied manufacturing overhead is recorded in the Work-in-

Process Inventory.

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VM–A

DIRECT MATERIALS INVENTORY

Direct materials inventory

(or raw materials

inventory) is the traceable

matter of a product and

is an asset. These wood

lengths and textiles yarn

spools are examples of

direct materials inventory.

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VM–B

WORK-IN-PROCESS INVENTORY

Work-in-process inventory is the partially converted

materials in the production process that have not yet been

completed and moved to finished goods inventory. This

production line worker is completing a portion of a

manufacturing process.

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VM–C

FINISHED GOODS (FG)

INVENTORY

Finished goods (FG) inventory is the finished product of a

manufacturer waiting to be sold. It is the cost of the

products in the FG warehouse. FG inventory is an asset.

This warehouse manager is checking stock counts.

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VM–D

COST OF GOODS SOLD

Cost of goods sold (COGS) is the cost attributable

(assigned) to the production of goods sold by a company.

It is the cost of the goods sold to customers, not all the

costs of production. The cost of goods sold is an expense.

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VM–E

MANUFACTURING OVERHEAD

Manufacturing overhead

(factory overhead) is the

indirect costs incurred

(obligated) when

manufacturing a product.

They are costs other than

direct materials and

direct labor.

Manufacturing overhead

includes indirect

materials, indirect costs,

and indirect labor.

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VM–F

INVENTORY CASH FLOW WITH

T-ACCOUNT VISUALS

Follow the balances and transactions through the inventory

T-accounts below. Transactions are labeled. Calculations

are shown in bold.

Beginning and Ending balances of:

t Direct materials: $15,000.00 and $8,000.00

t Work-in-process: $46,000.00 and $26,000.00

t Finished goods inventory: $30,000.00 and

$19,000.00

1) Purchase of direct materials: $400,000.00

2) Direct materials are put into production: $15,000 + $400,000 –

$8,000 = $407,000.00

3) Incur direct labor costs of $150,000.00

4) Applied manufacturing overhead is $250,000.00

5) Completed product: $46,000 + $407,000 + $150,000 +

$250,000 – $26,000 = $827,000.00 (or COGM)

6) Product sold: $30,000 + $827,000 – $19,000 = $838,000.00

7) Actual manufacturing overhead is $247,000.00

8) Close out manufacturing overhead

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Direct Materials Inventory Work-in-Process Inventory Finished Goods Inventory

15,000 46,000 30,000

1) 400,000 2) 407,000

2) 407,000 3) 150,000 5) 827,000

4) 250,000 6) 838,000

5) 827,000

8,000 26,000 19,000

Cost of Goods Sold Manufacturing Overhead Payable Accounts

6) 827,000 4) 250,000 1) 400,000

7) 247,000 3) 150,000

7) 247,000

3,000

8) 3,000 8) 3,000

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VM–G

PREDETERMINED OVERHEAD

RATE CALCULATION

You work for a plastic bottle

manufacturer. You are asked

to evaluate production costs

and determine an appropriate

predetermined overhead rate.

You review a history of your

company’s manufacturing

costs and hours logged.

Based on your review, you

estimate that in the next six

months, your company will

spend $792,000.00 in

manufacturing costs. Also, each of the four machines in the

facility would run for 480 hours each month. Calculate the pre-

determined overhead rate for each machine hour logged.

Predetermined Overhead Rate = Estimated Cost ÷ Estimated

Activity

Estimated Cost = $792,000.00

Estimated Activity = 480 hours × 4 machines × 6 months =

11,520 hours

Rate = $792,000 cost ÷ 11,520 hours = $68.75

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VM–H

CLOSING MANUFACTURING

OVERHEAD WITH

T-ACCOUNTS VISUALS

In the plastic bottling

example, the

predetermined overhead

rate was $68.75 based on

an estimate of $792,000

of production costs, with

11,520 hours worked. In

the first month of using

this rate, the total hours

logged were 1,880. Actual

production costs were

$135,000.00.

A. Calculate and record the entry for Manufacturing

Overhead applied.

Actual hours = 1,880

Predetermined overhead rate = $68.75

1,880 hours × $68.75 = $129,250

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B. Record the actual manufacturing overhead.

The credit component sits in a combination of

Cash and Payables entries.

C. Record the closing of manufacturing overhead.

The balance in Manufacturing Overhead is a debit

balance of $5,750. This means that too little cost

was dedicated to the jobs. (It should have been

$135,000.)

It’s too late to record cost in Work-in-Process

Inventory; the cost is recorded in Cost of Goods

Sold.

Work-in-Process Inventory Manufacturing Overhead Cost of Goods Sold

a) 129,250 a) 129,250

b) 135,000

5,750

c) 5,750 c) 5,750

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LS–A

Name ________________________________________

Manufacturing Cost Flow

Transactions with T-Account Visuals

Purpose

The purpose of this activity is to record the manufacturing costs as they flow through the

various inventory accounts.

Objectives

1. Calculate manufacturing costs.

2. Record the manufacturing costs in the respective inventory accounts.

3. Create T-account visuals to represent each inventory account.

Materials

lab sheet

t class notes

writing utensil

calculator (optional)

Procedure

1. Review your class notes about manufacturing process cost accounting.

2. Work independently or with a partner to complete this lab sheet activity.

3. Analyze the transactions given.

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4. Record the balances and transactions in the appropriate inventory T-accounts shown

below. Label each transaction.

a. Beginning and Ending balances of:

Direct Materials: $60,000.00 and $80,000.00 respectively

Work-in-Process: $100,000.00 and $110,000.00

Finished Goods Inventory: $110,000.00 and $140,000.00

b. Purchase of direct materials: $450,000.00

c. Amount of direct materials put into production = _________________________

d. Incur direct labor costs of $150,000.00

e. Applied manufacturing overhead is $363,000.00.

f. Cost of goods manufactured = _________________________

g. Amount of product sold = _________________________

h. Actual manufacturing overhead is $370,000.00.

i. Close out manufacturing overhead.

Direct Materials Inventory Work-in-Process Inventory Finished Goods Inventory

Cost of Goods Sold Manufacturing Overhead Payable Accounts

5. Turn in your completed lab sheet to your instructor.

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LS–B

Name ________________________________________

Predetermined Overhead Rate

Calculation

Purpose

The purpose of this activity is to calculate a predetermined overhead rate.

Objective

Calculate a pre-determined overhead rate.

Materials

lab sheet

class notes

paper

writing utensil

calculator (optional)

Procedure

1. Review your class notes about calculating predetermined overhead rates. Review the

formula to calculate a predetermined overhead rate.

2. Work independently to complete this lab activity.

3. Select the information needed to calculate the predetermined overhead rate.

4. Perform the calculation.

SCENARIO: ABC Company applies manufacturing overhead on the basis of machine

hours. The staff accountant collected the following overhead data. Determine the pre-

determined overhead rate.

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Estimated Actual

Machine hours 350,000 375,000

Overhead costs $700,000 $735,000

a. Show your calculations on your paper.

b. The predetermined overhead rate = _________________________

5. Turn in your completed lab sheet to your instructor.

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