Manufacturing Operations

AL F. BERBANO

Manufacturing Business
A business engaged in manufacturing must process or create the products which it offers for
sale. It employs manpower and machines to convert raw materials into a finished product.
Examples of a manufacturing company includes furniture making, shoe making, car manufacturing
and the likes. These companies will need people to work on the products and materials to be used to
complete the product.

Merchandising Business vs. Manufacturing Business:

Merchandising Business vs Manufacturing Business

- Has only one classification of - Has three classifications of inventory
inventory - RAW MATERIALS
- GOODS IN PROCESS
- FINISHED GOODS
- Sells exactly what it purchases - Sells what it has produced from its
purchases
- Also known as “retail” - Also known as “production”

Manufacturing Costs
There are three elements of manufacturing costs, namely:
1. Direct materials or Raw materials used
2. Direct labor
3. Manufacturing or factory overhead

Direct materials are the amount of costs that are separately and traceable through the
manufacturing process to finished goods. Examples are wood, bolts and metals for furniture making.

Direct labor refers to the salaries of employees who physically convert materials to complete the
products. It represents the wages paid to factory workers who work directly on the merchandise
being manufactured.

Factory overhead involve components or activities that support the manufacturing process but are
not direct materials or direct labor. Factory overhead costs are the expenditures for factory overhead
that cannot be separately and traceable to finished goods. These costs include indirect materials and
indirect labor, costs not directly traceable to the product.

Three classifications of inventory in a manufacturing business:

1. Raw materials
– Are basic, tangible resources used as one of the inputs to manufacture a product.
– Inventories of the company which are not yet started as to productions.
2. Work in process
– are all inputs put into (and are still in the) manufacturing process. Other than raw
materials, inputs to produce a product includes labor and factory overhead.
– Inventories of the company which are started but not yet complete as to productions.
 3. Finished goods
– Are products produced from the manufacturing process and are ready to be sold to
customers.
– Inventories of the company which are started and completed as to productions, but are not
yet sold.

Prime Costs and Conversion Costs

Direct material costs and direct labor costs are also called prime costs - expenditures directly
associated with the manufacture of finished goods. Direct labor costs and factory overhead costs are
called conversion costs - expenditures incurred in the process of converting raw materials to
finished goods.

Flow of costs in a manufacturing company:

Raw materials Work in Process Finished goods
Beginning Beginning Beginning

Net purchases Materials used Total

Cost of goods Cost of goods Cost of goods
(including or manufacturing
-> manufactured -> manufactured sold
freight-in) requisitioned cost
Ending Ending Ending

Note: materials used or requisitioned to production are part of total manufacturing cost (as DM and
FOH-IM) but are not the only manufacturing costs (DL, FOH-IL, FOH-others)

Note: all costs incurred (DM, DL, and OH) are not expensed outright. They will remain part of total
assets as inventories and will only be expensed when sold (cost of goods sold) [matching principle,
matching expense (cogs) with revenue (sales)]

Other costs of a manufacturing business:

It is important to remember that a company is generally divided into three segments:
1. Factory
2. Office
3. Selling Area

All costs incurred by the factory goes to manufacturing costs (treated as inventory when incurred),
unlike costs incurred by the office or selling area (expensed when incurred). These costs are general
and administrative (for office) and selling and distribution (for selling area). Both these costs are
part of the operating expenses of the company.

Journal entries of a manufacturing business:

1. To record a purchase of raw materials (inclusive of discounts, freight-in, etc):
Raw materials xx
Accounts payable or cash xx

Note: you do not purchased work in process nor finished goods as a manufacturing company
Note: no actual production yet, production happens in entries 2-7

2. To record usage of direct materials:

Work in process xx
Raw materials xx
3. To record direct labor costs incurred:
Work in process xx
Salaries payable or cash xx

4. To record usage of indirect materials:

Factory overhead xx
Raw materials xx

5. To record indirect labor costs incurred:

Factory overhead xx
Salaries payable or cash xx

6. To record other factory overhead incurred:

Factory overhead xx
Rent payable xx
Utilities payable xx
Accumulated depreciation xx
Cash xx
Other various accounts xx

7. To apply overhead to work in process (used for higher accounting, but just means transferring of
factory overhead account to the work in process account for basic accounting):
Work in process xx
Factory overhead xx

Note: at this point, the total manufacturing cost is now complete (all inputs are put into the process
for converting into outputs or finished goods)

8. To record the transfer of finished goods out of the process:

Finished goods xx
Work in process xx

Note: the cost of goods manufactured will be transferred out of WIP since WIP is “started but not
yet complete” and manufactured means completed. The cost no longer belongs in WIP, but now
belongs to FG “started and completed”

9.1 To record a sale (assuming perpetual inventory system):

Cost of goods sold xx
Finished goods xx

9.2 To record a sale:

Accounts receivable or cash xx
Sales revenue xx

10. To record operating expenses

Expenses – G&A xx
Expenses – S&D xx
Rent payable xx
Utilities payable xx
Accumulated depreciation xx
Cash xx
 Other various accounts xx

Note: if this was a merchandising company, only entries 1 and 9, and 10 would be applicable.
Note: entry 10 is the only entry here that is not related to the factory

Tips on determining whether a cost is a manufacturing cost, a G&A cost, or a S&D cost;
Find keywords such as:
- Manufacturing cost: manufacturing, production, products, factory, inventory
- G&A: Office, executive, administrative, managerial
- S&D: Sales (sales commission, sales area, etc.), marketing, endorsement, advertising,
freight-out

Formulas to remember:
- Total manufacturing cost = DM + DL + FOH

- Prime cost = DM + DL
Note: prime cost is also known as direct cost

- Conversion cost = DL + FOH

Note: conversion cost is called as such because direct materials will not turn into finished
goods by itself (it needs someone to assemble it and things to use to assemble it into FG. In
other words, DM needs DL and FOH to be converted into FG)

- Total goods put into process = Beginning WIP + TMC

Note: Beginning WIP are goods started in production last period but are yet to be
completed. TMC are goods started in production this period. But both of these will be
undergoing productions this period, regardless of when they were started.

Manufacturer's Statement of Financial Position

Manufacturers carry several unique assets and usually have three types of inventories instead of the
single inventory that merchandisers carry. These are:
1. Raw materials inventory - refers to the goods a company acquires to use in making products.
2. Goods (Work) in process inventory - consists of products in the process of being
manufactured but not yet complete.
3. Finished goods inventory - consists of completed products ready for sale.

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Manufacturer's Statement of Comprehensive Income

The main difference between the income statement of a manufacturer and that of a merchandiser
involves the items making up cost of goods sold. A merchandiser adds its cost of goods purchased
to beginning merchandise inventory and then subtracts ending merchandise inventory to get the cost
of goods sold. A manufacturer adds its cost of goods manufactured to beginning finished goods
inventory and then subtracts ending finished goods inventory to get the cost of goods sold.

A merchandiser often uses the term merchandise inventory for goods that it sells to customers; a
manufacturer meanwhile, often uses the term finished goods inventory.

MERCHANDISING BUSINESS

NET SALES XX

LESS : COGS

BEGINNING INVENTORY XX

ADD: NET PURCHASES XX

TGAS XX

LESS: ENDING INVENTORY XX XX

GROSS PROFIT XX

LESS : OPERATING EXPENSES XX

INCOME BEFORE TAX XX

MANUFACTURING BUSINESS:

NET SALES XX

LESS : COGS

FINISHED GOODS INVENTORY, BEGINNING XX

ADD: COST OF GOODS MANUFACTURED XX

TGAS XX

LESS: FINISHED GOODS INVENTORY, ENDING XX XX

GROSS PROFIT XX
LESS : OPERATING EXPENSES XX

INCOME BEFORE TAX XX

RAW MATERIALS USED

RAW MATERIALS INVENTORY, BEGINNING XX

ADD: RAW MATERIALS PURCHASES XX

RAW MATERIALS FREIGHT - IN XX

RAW MATERIALS DISCOUNT (XX)

RAW MATERIALS RETURNS & ALLOWANCES (XX) XX

RAW MATERIALS AVAILABLE FOR USE XX

LESS: RAW MATERIALS INVENTORY, ENDING XX

RAW MATERIALS USED XX

TOTAL MANUFACTURING COSTS:

RAW MATERIALS USED XX

DIRECT LABOR XX

FACTORY OVERHEAD XX

TOTAL MANUFACTURING COST XX

COST OF GOODS MANUFACTURED:

TOTAL MANUFACTURING COSTS XX

ADD: GOODS IN PROCESS, BEGINNING XX

TOTAL GOODS PLACED IN PROCESS XX

LESS: GOODS IN PROCESS, ENDING XX

COST OF GOODS MANUFACTURED XX

 CHAPTER 12 QUESTIONS

EXERCISE 1

Identify each item as:

A – Direct Materials;
B – Direct Labor;
C – Factory Overhead;
D – Operating Expense.
WRITE YOUR ANSWERS IN CAPITAL LETTERS.
1. Scents to make perfume. A
2. GI sheets used by car manufacturer. A
3. Sandpaper used in painting car assembly. C
4. Thinner used in painting finished products. C
5. Depreciation of factory building. C
6. Salary of janitor in the manufacturing plant. C
7. Depreciation of air conditioning unit in the office. D
8. Depreciation of computer equipment in the factory. C
9. Wages of a carpenter in a furniture making business. B
10. Screws and bolts used in furniture and cabinets of furniture making business. C
11. Insurance premium for employees. D
12. Ceramics used to make figurines. A
13. Glass to make window jalousies. A
14. Bottles used by a Coca Cola Bottling Company. A
15. Wages of office workers. D
EXERCISE 2
MULTIPLE CHOICE. From the given information, select the best answer.
1. Which of the following entities would most likely have raw materials, work in process, and
finished goods?
A. Mitsubishi Corporation.
B. Macy's Department Store.
C. Southwest Airlines.
E. Miriam College

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2. Which of the following inventories would a discount retailer such as Wal-Mart report as an
asset?
A. Raw materials.
B. Work in process.
C. Finished goods.
D. Merchandise inventory.
E. All of these.
3. Which of the following inventories would a company ordinarily hold for sale?
A. Raw materials.
B. Work in process.
C. Finished goods.
D. Raw materials and finished goods.
E. Work in process and finished goods.
4. Mideast Motors manufactures automobiles. Which of the following would not be classified as
direct materials by the company?
A. Wheel lubricant.
B. Tires.
C. Interior leather.
D. CD player.
E. Sheet metal used in the automobile's body.
5. Which of the following employees of a commercial printer/publisher would be classified as
direct labor?
A. Book binder.
B. Plant security guard.
C. Sales representative.
D. Plant supervisor.
E. Payroll supervisor.
6. Which of the following employees would not be classified as indirect labor?
A. Plant Custodian.
B. Salesperson.
C. Assembler of wooden furniture.
D. Plant security guard.
E. Choices "B" and "C."
7. Depreciation of factory equipment would be classified as:
A. operating cost.
B. "other" cost.
C. manufacturing overhead.
D. period cost.
E. administrative cost.
8. Which of the following costs is not a component of manufacturing overhead?
A. Indirect materials.

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 B. Factory utilities.
C. Factory equipment.
D. Indirect labor.
E. Property taxes on the manufacturing plant.
9. Which of the following statements is (are) correct?
A. Overtime premiums should be treated as a component of manufacturing overhead.
B. Overtime premiums should be treated as a component of direct labor.
C. Idle time should be treated as a component of direct labor.
D. Idle time should be accounted for as a special type of loss.
E. Both "B" and "C" are correct.
10. Conversion costs are:
A. direct material, direct labor, and manufacturing overhead.
B. direct material and direct labor.
C. direct labor and manufacturing overhead.
D. prime costs.
E. period costs.
11. Prime costs are comprised of:
A. direct materials and manufacturing overhead.
B. direct labor and manufacturing overhead.
C. direct materials, direct labor, and manufacturing overhead.
D. direct materials and direct labor.
E. direct materials and indirect materials.
12. In a manufacturing company, the cost of goods completed during the period would include
which of the following elements?
A. Raw materials used.
B. Beginning finished goods inventory.
C. Marketing costs.
D. Depreciation of delivery trucks.
E. All of the above.
13. Which of the following equations is used to calculate cost of goods sold during the period?
A. Beginning finished goods + cost of goods manufactured + ending finished goods.
B. Beginning finished goods - ending finished goods.
C. Beginning finished goods + cost of goods manufactured.
D. Beginning finished goods + cost of goods manufactured - ending finished goods.
E. Beginning finished goods + ending finished goods - cost of goods manufactured.
14. Work-in-process inventory is composed of:
A. direct material and direct labor.
B. direct labor and manufacturing overhead.
C. direct material and manufacturing overhead.
D. direct material, direct labor, and manufacturing overhead.
E. direct material only.

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 15. Many companies recognize three major categories of costs of manufacturing a product.
These are direct materials, direct labor, and overhead. Which of the following is an overhead
cost in the production of an automobile?
A. The cost of small tools used in mounting tires on each automobile.
B. The cost of the tires on each automobile.
C. The cost of the laborers who place tires on each automobile.
D. The delivery costs for the tires on each automobile.

EXERCISE 3

On December 1, Joy Company had the following inventories: materials, P240,000; work-in process,
P120,000; and finished goods, P360,000.

During the month, materials purchases total P560,000. Direct labor for December was P400,000 at a
uniform wage of P64.00 per hour. Marketing and administrative expenses for the month amounted to
10% of net sales.

Inventories on December 31 were as follows: materials, P200,000; work-in process, P80,000; and
finished goods, P400,000. Net sales for December totaled, P2,000,000. Factory overhead is applied
on the basis of P80 per direct labor hour.
Required: Compute for:
1. Prime costs 1,000,000
2. Conversion costs 900,000
3. Manufacturing costs. 1,500,000

Raw materials inventory, December 1 240,000

Raw materials purchases 560,000
Raw materials inventory, December 31 (200,000)
Raw materials used 600,000
Direct labor 400,000
Factory overhead ( 400,000/64= 6,250 hours x 80) 500,000
Manufacturing costs 1,500,000

EXERCISE 4

The accounts of JPIA Company selected from the December 31, 2019 year-end trial balance
are as follows:
Raw materials purchases P 360,000
Raw materials discount 10,000
Raw materials returns & allowances 45,000
Raw materials - freight-in 8,000
Raw materials inventory, Jan 1 105,000
Raw materials inventory, Dec 31 236,000
Goods in process, Jan 1 150,000
Cost of goods manufactured 85,000
Finished goods inventory, Jan 1 225,000
Finished goods inventory, Dec 31 289,000
Direct labor 200,000
Indirect labor 34,000
Indirect materials 24,000
Depreciation- plant machinery 12,000
Utilities - plant 23,000
Rent - plant 16,000
Supplies - plant 3,000

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Required:
1. Compute for the amount of raw materials used.
2. Compute for the amount of total manufacturing costs.
3. Compute for the amount of total goods placed in process.
4. Compute for the amount of goods in process, December 31.
5. Compute for the amount of Cost of
goods sold.

Raw materials inventory, January 1 105,000

Raw materials purchases 360,000
Raw materials - freight-in 8,000
Raw materials discount (10,000)
Raw materials RETURNS AND ALLOWANCES (45,000) 313,000
Raw materials available for use 418,000
Less: Raw materials inventory, December 31 236,000
Raw materials used 182,000
Direct labor 200,000
Indirect labor 34,000
Indirect materials 24,000
Depreciation- plant machinery 12,000
Utilities - plant 23,000
Rent - plant 16,000
Supplies - plant 3,000 112,000
Total Manufacturing Costs 494,000
Add: Goods in process, January 1 150,000
Total Goods placed in process 644,000
Less: Goods in process, December 31 559,000
Cost of goods manufactured 85,000
Finished goods inventory, January 1 225,000
Total Goods Available for Sale 310,000
Finished goods inventory, December 31 289,000
COST OF GOODS SOLD 21,000

FACTORY OVERHEAD = indirect materials/labor +

PLANT/FACTORY

OPERATING COSTS = SELLING AND

ADMINISTRATIVE

EXERCISE 5
The accounts of LUXENT Company selected from the December 31, 2019 year-end
trial balance are as follows:
Advertising expense P 150,000
Freight out 260,000
Depreciation expense-Office equipment 110,000
Depreciation expense-Store equipment 140,000
Doubtful accounts 20,000
 Interest expense 35,000
Finished goods inventory - 1/1 1,160,000
Finished goods inventory - 12/31 1,040,000
Cost of goods manufactured 1,500,000
Miscellaneous selling expenses 90,000
Office supplies expense 430,000
Rent expense (40% Store) 70,000
Salaries and wages- Selling 960,000
Salaries and wages- administrative 1,130,000
Sales 9,810,000
Sales returns and allowances 260,000
Sales discounts 140,000
Selling supplies expense 70,000

Required:
Prepare a formal Statement of Comprehensive Income for LUXENT Company for the
year ended December 31, 2019.
Sales 9,810,000
Less: Sales discounts 140,000
Sales returns and allowances 260,000 400,000
Net sales 9,410,000
Less: Cost of Goods Sold
Finished goods inventory - 1/1 1,160,000
Add: Cost of goods manufactured 1,500,000
TGAS 2,660,00
0
Less: Finished goods inventory – 12/31 1,040,000 1,620,000
Gross profit 7,790,000
Less: Operating Expenses
Selling Expenses
Advertising expense 150,000
Freight out 260,000
Depreciation expense-Store equipment 140,000
Salaries and wages- Selling 960,000
Selling supplies expense 70,000
Rent expense – Selling (60%) 28,000
Miscellaneous selling expenses 90,000 1,698,00
0
General and administrative expense
Depreciation expense-Office equipment 110,000
Doubtful accounts 20,000
Office supplies expense 430,000
Salaries and wages- administrative 1,130,00
0
Rent expense - General (60%) 42,000 1,732,00 3,430,000
0
Income from operation 4,360,000
Less: Interest expense 35,000
NET INCOME BEFORE TAX 4,325,000

EXERCISE 6
Classify the following costs as Product or Period. Further classify them as direct
materials, direct labor, or overhead if product cost, and as general & administrative or
selling & distribution if period cost.
Product or Period DM/DL/OH/G&A/S&D
1. Wood that is used to manufacture PRODUCT DM
tables, which is the product of the
company.
2. Office supervisor paid a salary of PERIOD G&A
P15,000 semi-monthly.
3. Factory supervisor paid a salary of PRODUCT OH
P10,000 per month.
4. Electricity drawn by the computers PERIOD G&A
used by the accounting staff.
5. Depreciation of factory equipment PRODUCT OH
using the straight line method.
6. Workers that are paid P100 per PRODUCT DL
hour to assemble the tables.
7. Commissions paid to sales PERIOD S&D
personnel.
8. Depreciation of office equipment PERIOD G&A
using the double declining method.
9. Electricity drawn by the machinery PRODUCT OH
used to produce the products.
10. Salary of the company president. PERIOD G&A
11. Wages of personal drivers of top PERIOD G&A
executives.
12. P150,000 spent by the company for PERIOD S&D
advertising.
13. Depreciation of furniture on the PERIOD S&D
showcase floor using the sum of
the years digits method.
14. Factory rent. PRODUCT OH
15. Office rent. PERIOD G&A

EXERCISE 7
Journal Entries
OHB Manufacturing Company had the following transactions during the month of April
2020:
a. Purchased P150,000 worth of raw materials with a required down payment of
P50,000
b. Issued to productions P100,000 worth of raw materials, 10% of which were
considered insignificant to the finished product
c. Salaries and wages incurred for the whole company totaled P450,000 broken
down as follows:
P200,000 for assembly line workers
P50,000 for factory supervisor
P120,000 for administrative personnel
P80,000 for sales representatives
d. Electricity bill of the whole company totaled P90,000, half of which was
traceable to the factory and the remaining half to the executive office.
e. Factory equipment depreciation expense amounted to P10,000
Office equipment depreciation expense amounted to P15,000
Sales equipment depreciation expense amounted to P5,000
f. Factory overhead account is closed to the work in process account
g. Goods costing P300,000 were completed as to production
h. Goods costing P280,000 were sold on account for a mark-up of 25% based on
 cost

Required: Provide the journal entries, assuming the company uses a perpetual inventory
system.
EXERCISE 8
Long Problem:
CVD Manufacturing Company had the following statement of financial position as of
December 31, 2019:
Cash P500,000 Accounts payable P590,000
Accounts receivable 100,000 Capital 2,000,000
Raw materials 230,000
Work in process 400,000
Finished goods 360,000
PPE, net 1,000,000
Total P2,590,000 Total P2,590,000

The following information were gathered from the transactions during the calendar year
2020:
a. Total gross purchases amounted to P390,000, exclusive of P4,000 purchase
returns and P6,000 purchase discount. Freight-in amounted to P20,000.
b. A total of P300,000 worth of materials were requisitioned and used in production.
Of this amount, P30,000 are indirect materials.
c. Factory labor totaled P200,000, 60% of which were for direct labor.
d. Rent for the factory space amounted to P50,000, while rent for the office space
amounted to P60,000.
e. Salaries of office staff amounted to P30,000
f. Sales commission to sales personnel amounted to P40,000
g. Utilities incurred by the company equaled P140,000 (50% for the factory, 50% of
the remaining for the office, and the rest is traceable to the selling area)
h. P450,000 worth of goods were completed in production during the year.
i. P700,000 worth of goods were sold on account. The gross profit rate of the
company is 20%.

Required:
1. How much is the total manufacturing cost?
2. How much is the total manufacturing overhead cost?
3. How much is the prime cost?
4. How much is the conversion cost?
5. How much is the total goods put into process?
6. How much is the cost of goods manufactured?
7. How much is the total goods available for sale?
8. How much is the cost of goods sold?
9. How much is the ending balance of raw materials?
10. How much is the ending balance of work in process?
11. How much is the ending balance of finished goods?
12. How much is the sales revenue?
13. How much is the gross profit?
14. How much is the general and administrative expenses?
15. How much is the selling and distribution expenses?
16. How much is the net income or net loss?