Every business shares roughly the same goals, to provide for consumers, solve niche issues, generate income and spur local economies. In the same token, every business also establishes the same foundations for success, two of which are good financial planning and decision-making, which hinge on good and proper accounting practices. Since each business across different industries provides different products and services, there are certain nuances to the accounting practice best prescribed to certain businesses.
Accounting for a manufacturing business is unique to the nature of the industry. They hold raw materials as inventory and involve expenses for product developments, quality testing, etc. Moreover, the ultimate goal of lean manufacturing is the ability to maximize resources while lessening waste. Good bookkeeping and accounting of records as a manufacturing firm will help you improve your business. Here’s what you need to know about accounting for a manufacturing business to optimize operations and maintain clean financial records.
Cost Terms Used
There are certain terms unique to manufacturing. This business entails transforming raw materials into selling goods, unlike wholesale or retail which sell finished goods.
- Direct Materials
Direct materials, also known as raw materials, are used in production to come up with finished products. These are often listed on a bill of materials, stating the costs and quantities of each material used in production. In the process of manufacturing, this bill of materials is also referred to as a production recipe, especially in the cases of factories that produce food and beverage.
- Direct Labor Costs
The direct labor cost is the value given to the labor used to produce the finished goods, like assembly line operators or machine workers, as their labor is directly involved in production. This would include regular hourly wages, overtime pay, and other relevant payroll taxes.
Apart from direct costs manufacturing companies also need to account for overhead costs. These must be accounted for to aid you in proper pricing. Failure to include overhead costs might result pricing your products at a loss.
Manufacturing costs include utility costs, wages for personnel not directly involved in the production, like facility guards, office supply costs not related to production, storage costs of inventory, etc.
Goods are broken down into two:
Work-in-process goods generally refer to items in production that are not yet completed. This would include money spent on direct materials, direct labor costs, and overheads on all work-in-process goods that are in inventory.
- Finished goods
Finished goods, as the name suggests, are completed and ready for selling. The costs of storing these goods must also be accounted for.
Production Costing Methods
The right costing methods will help you maximize profitability. Here are the most common ones:
- Standard costing
Standard costing includes the establishment of standard rates for labor or materials used. In doing so, you will find out the total costs to produce a single unit of your product. This is the best kind of costing when producing large quantities of products. It allows you to see how much you spend on manufacturing while spotting inefficiencies in your production system.
- Variable costing
Also known as job costing, variable costing is preferred for manufacturers who order or focus on delivering a small number of units. This is often the case for companies that manufactures small units that are unique or made to order. This system would enable you to find the manufacturing cost for a certain product and price it accordingly.
- Activity-based costing
Activity-based costing includes indirect costs, like resource consumption. This type of accounting assigns overhead and indirect costs to products and services. Resources costs are calculated for each product made and assigned such costs only to said product. For example, if in a bakery Oven 1 bakes 12 cookies in 30 minutes, and Oven 2 produces 2 cakes for 30 minutes, the total resources spent baking the goods will not be allocated to all products. Instead, the cost for 30 minutes of energy spent in baking the cookies is what will be included in costing for the cookies, while the 30 minutes of energy spent baking the cake would be charged to the cost of the cakes alone. The same is true even if the products are the same to properly account for overhead.
Inventory is an asset and needs proper accounting. Here are the common ways to manage inventory for a manufacturing business.
- First in, first out
Products are sold in the same order they are added to the inventory. This is often the case for products with a shelf life, like food items.
- Average cost
This method uses a weighted average of all products to track inventory. This is used when it is hard to assign costs to specific products.
- Specific identification
Opposite to the average cost method, specific identification tracks each item through serial numbers.
If you need assistance tracking the numbers for your manufacturing firm, give our team of CPAs a call. We’re a one-stop shop so we can help you with accounting, auditing, bookkeeping, payroll services and even tax compliance.