Like any other kind of company, a manufacturing company is in business to make money. It wants to generate revenues and in order to do that it will incur costs. What makes a MANUFACTURING company different from a MERCHANDISING company is HOW it views and records the costs that it incurs.
A MERCHANDISING company buys inventory for the purpose of re-selling it at a profit - A MANUFACTURING company on the other hand, MAKES the product it intends to sell. This distinction is at the root of the challenge a manufacturing company has as it records the costs it incurs. Costs incurred to make the product are considered maufacturing costs.
So - what is important to take away from a discussion of manufacturing costs......
The SIMILARITIES to a MERCHANDISING company
- Costs incurred are for the most part very similar to the costs a merchandising company incurs - salaries, wages, utilities, rent, depreciation, insurance, etc.
- Costs are recorded in the journal and posted to the ledger.
- Costs are recorded with DEBITs and CREDITs.
- If payment is with cash - Credit is to CASH
- If purchase is on account - Credit is to Accounts Payable
The DIFFERENCES......
- Inventory for a manufacturing company is not purchased - it is MADE
- Costs incurred for wages, salaries, depreciation etc. which are incurred as part of the production process (i.e. manufacturing costs) are NOT recorded as EXPENSES
- So, before recording a cost, a determination has to be made regarding the REASON the cost was incurred. If the cost was incurred as part of the process to manufacture the product then the cost is not an expense - instead it is included in account treated as part of INVENTORY cost (an asset).
- This means that the Chart of Accounts for a Manufacturing company is quite a bit expanded when compared to a merchandising company- for example, there may be multiple accounts for 'depreciation' - one depreciation account in the Chart of Accounts may be classified as expense, another may be part of inventory. Either account is subject to be DEBIT-ed when a depreciation charge is incurred - which account gets Debit-ed depends on why the cost was incurred.
- If the depreciation is related to the Factory where the product is made - then the charge is related to the manufacturing process and is debit-ed to the depreciation account in Inventory.
- If, however, the charge is related to the headquarters office building then the charge is not part of the manufacturing process - it is therefore treated as an expense and is debit-ed to depreciation expense.
Manufacturing Cost Categories
Manufacturing Costs can be categorized as Labor, Materials or Overhead costs. All manufacturing costs incurred can be slotted into one of these three categories.
Direct Labor - Costs incurred for the employees directly involved with creating the product
Direct Materials - Costs of materials used directly in each unit created in the production process
Overhead - Costs incurred in the manufacturing process which cannot be directly assocuated with or attributed to specific units of production. Overhead costs include costs such as depreciation, insurance, utilities - as long as these costs were incurred for a production-related facility.
Also included in Overhead are Indirect Labor and Indirect Materials
- Indirect Labor - Costs incurred for the employees who are part of the manufacturing process but who are not directly making the product (e.g. Factory supervisor)
- Indirect Materials - Materials used out of inventory which were were used in the production process, but cannot be associated with a specific unit of production.
