Different Accounting Metrics Involved in Manufacturing Business
Manufacturing accounting is a lot more involved than it is for retail or service businesses. It requires thoroughly using the accrual method and a system for valuing inventory.
Manufacturing accounting is an internal process determining the costs of making products. Businesses may thoroughly grasp their financial performance, make wise decisions to increase productivity and profitability, and preserve financial transparency throughout the manufacturing process by putting robust manufacturing accounting techniques from organizations like Porte Brown into practice.
The data is then used for budgeting, decision-making on cost control, constraints margin analysis, etc. The cost of labor in manufacturing is one of the most essential aspects to know, as it can significantly impact your bottom line.
Direct labor is employees’ wages directly involved in manufacturing (assembly line workers, machine operators, etc). It includes the salary cost of hourly and salaried employees, overtime pay, benefits, payroll taxes, and bonuses. Manufacturers also incur other materials and expenses inextricably linked to the finished product. For example, wood and screws are direct materials for table manufacturers.
Additionally, manufacturers may have to pay for shipping and tariffs associated with raw materials. Indirect labor is employees’ wages that support the manufacturing process but do not physically create the product. It can include security guards, janitors, plant managers, supervisors, and quality control staff. Indirect labor is typically calculated using a system called activity-based costing.
This approach aims to sort indirect labor into categories, calculate per-unit rates for each type, and then assign the costs to individual products or activities. This method is more complex than standard costing but can yield much better results.
Cost of goods sold (COGS) is a crucial manufacturing accounting metric. It is calculated by adding beginning inventory plus purchases during a period minus the ending list. It is an important metric because it ties directly to revenue and profit for the business. In addition to controlling costs, calculating COGS helps companies to set prices and manage budgets.
Manufacturers have a unique situation when determining their selling price because they must ensure they make a profit while not pricing themselves out of the market. One way to do this is by using your COGS as a guide. This metric includes all the direct costs of producing your products, including raw materials and labor.
To calculate your COGS:
- Start by adding together the value of your beginning and ending raw material inventory.
- Add the total of your face and ending finished goods inventory.
- Add your manufacturing costs during the financial period (including direct materials, labor, and factory overhead).
- Subtract the cost of any goods in a process that was not completed or sold (i.e., scrap).
Several methods for calculating your COGS include standard costing, weighted average method, FIFO, and LIFO. However, these methodologies depend on accurate inventory valuation procedures and product tracking methods.
Businesses involved in manufacturing must consider expenses related to inventory in addition to labor and raw material costs. The list can include finished goods waiting to be shipped or work still being produced. It can be a complicated accounting issue when your company uses multiple methods for valuing inventory or changing production processes that affect the value of your products over time.
These changes can result from raw material price fluctuations, market conditions, or other factors. These differences can significantly impact your cost of goods sold and the profitability of your business. You can reduce these costs through better management and implementing strategies like lean manufacturing, supplier drop shipping, and other techniques.
Some of these inventory costs are direct – such as the cost of purchasing raw materials or the cost of storing finished goods. Other indirect costs include the depreciation of your equipment, utilities (like electricity and heat/air conditioning), warehouse staff, insurance, maintenance, and other factory overhead costs that do not directly relate to producing a specific product.
These costs are aggregated into a cost pool and then allocated to each unit made during a reporting period. Ultimately, the most important aspect of inventory costing is that you understand the actual costs of your inventory.
Manufacturing accounting requires manufacturers to account for the entire cost of converting raw materials into finished goods, which makes the cost of raw materials a crucial component. It includes not only the raw material purchase price but also the costs of labor and other overhead.
A manufacturing company’s raw materials are listed in a bill of materials, which itemizes the quantity and costs of each raw material used in producing its products. The accounts of materials are recorded as current assets and expensed on the income statement within the cost of goods sold line item.
The company must take additional steps than non-manufacturing companies to register and expense long-term assets like raw materials in a separate asset account called property, plant, and equipment (PP&E). Manufacturers need to track how much of each raw material is used in production so that it can be replenished when required.
It is done by calculating the amount of raw materials consumed in a period and recording this as an inventory change, either a debit to the raw materials inventory or a credit to the work-in-process list. Once the raw materials are transformed into finished goods, they are moved to the finished goods inventory and expensed on the income statement.
The valuation method for recording the cost of the raw materials in stock depends on the manufacturing costing method employed by the business. Various ways exist, such as standard costing, weighted-average costing, activity-based costing, and cost layering.