Production Cost Accounting Workflow for Small- and Medium-Scale Manufacturers

Manufacturing Accounting and Bill of Materials are terms often associated with manufacturing of goods. But they can equally apply to provision of services, such as design, software development, project management etc. Some people are less familiar with these words than the hypes and dread associated with them. This dread has given rise to the notion that accounting for manufacturing costs is something complicated, tedious and expensive, and meant only for big manufacturing companies. Thus, the small-scale manufacturers have always chosen to carry on without even trying to comply with standard accounting procedure.

Manufacturing accounting involves accounting for the cost of all the materials and resources you employ and deploy in the production of goods or provision of services, to accurately determine the true cost of the finished products. These materials and resources include:

  • Raw Material
  • Labour
  • Depreciation on Property, Plant and Equipment
  • Overhead Cost

A Bill of Materials is a document listing all the materials and resources, along with their respective quantities and unit costs, required to build or manufacture a given quantity of a particular product. In its simplest form, a Bill of Materials contains all the components, parts and materials which serve as a recipe for building the product. However, some Bill of Materials could be very technical and complex, detailing not only the components and their technical specifications, but also instructions for building the product.

Proper accounting for manufacturing cost is not optional; it is vital for the survival of any business that engages in any form of manufacturing—irrespective of its size or type of goods or services it produces. Failure to accurately measure manufacturing cost could also means failure to determine profit accurately. This has been the bane of many small-scale manufacturers who rely on manual method of accounting and costing. Apart from the costing, there are various accounting entries required at each stage of the manufacturing process (see chart).

It does not matter whether you are manufacturing at industrial scale or from your kitchen—the result is the same: If you cannot accurately determine what it costs you to produce a product, you will, certainly, not be in a position to know how much profit or loss you are making until, perhaps, things get out of hands.

COMPONENTS OF A BILL OF MATERIALS

Some of the important components of a Bill of Materials include:

Raw Material Cost

These are raw materials procured and stored for the manufacturing project. They are drawn from inventory and used at cost for manufacturing.

Direct Labour Cost

This is the labour cost (for both permanent and casual employees) deployed directly in the manufacturing project. 100% of salary and wages of such employees are charged to the project. Direct labour cost is computed and allocated to each production batch on the basis of Rate/Hour for each employee.

Both the Raw Materials and Drect Labour Costs are classified as Direct Manufacturing Cost.

Other Labour Cost (Employees Burden)

These are indirect labour costs arising from payroll liabilities which forms part of employees’ gross earning. They include the allowances, taxes, pension, medical insurance, bonuses, etc. A certain percentage of gross salary is charged to the manufacturing project as Burden (some organisation allocate as much as 60% of the gross salary).

Other Direct Costs (ODC)

These are costs arising from resources and services deployed directly in the manufacturing process, but are neither raw material or direct labour. They include items, such as (among others):

  • Computer Services
  • Consultancy Services
  • Special Equipment
  • Royalties
  • Packaging and Reproduction
  • Taxes and Duties

You will have to work out the percentage of each cost to allocate to each production batch.

Overhead Costs

These are costs arising from factory overhead, such as depreciation on Property, Plant and Equipment, cost of electricity, rents, consumable items, etc. used in running the factory. These costs are also called Factory or Production Overhead. A certain percentage of these costs is apportioned to manufacturing jobs. It is the duty of the account department to work out the portion of overhead to allocate to each production batch.

There may be other categories of costs for certain manufacturing projects, but these are the obvious ones. Also, there are formal methods and formulae for computing some of these costs, but their treatment is beyond the scope of this article.

WORK-IN-PROGRESS (WIP)

After preparing the Bill of Materials, the next step is to execute it by committing the items in the list to production. At this stage, you will have to account for all the items involved in the production process by making appropriate accounting entries in the book.

During the manufacturing phase, the cost of all materials and resources used in the production project are debited to Work-in-Progress account, while the credit parts go to either Raw Material Inventory (for raw materials) or Manufacturing Cost account (a liability account for non-raw materials). On completion of the project, all the entries in the Manufacturing Cost account are transferred to Profit or Loss account as the finished products are transferred to inventory.

The chart below summarizes all the accounting entries that take place for each category of production cost:

Raw Materials

  • Dr. Work-in-Progress
  • Cr. Inventory—Raw Materials

Direct Labour Cost

  • Dr. Work-in-Progress
  • Cr. Manufacturing Costs—Direct Labour Costs

Other Direct Cost (ODC)

  • Dr. Work-in-Progress
  • Cr. Manufacturing Costs—ODC

Other Labour Cost

  • Dr. Work-in-Progress
  • Cr. Manufacturing Costs—Other Labour Costs

Overhead Cost

  • Dr. Work-in-Progress
  • Cr. Manufacturing Overhead Cost

TRANSFER TO INVENTORY

On completion of the manufacturing project, the next phase is to transfer the finished product from Work-in-Progress to Finished Goods Inventory at production cost. This will result in the following accounting entries:

  • Dr.    Inventory—Finished Goods
  • Cr.    Work-in-Progress

All the direct and overhead costs associated with the product that were credited to Manufacturing Cost during the Work-in-Progress stage are moved to the Profit or Loss account:

  • Dr.    Manufacturing Cost
  • Cr.    Manufacturing Overhead and Sundry Costs (Profit or Loss)

Manufacturing Accounting Workflow

Actual costs for labour, ODC and overhead are recognized independent of the manufacturing project when due, and are debited to their respective expense accounts. Costs of goods are recognized when goods are sold.

BILL OF MATERIALS PROCESSING AND CONTROL (BOMPAC) UTILITY

We do understand that the process of accurate costing and accounting for production of goods can be too tedious and expensive for Small and Medium Enterprises (SMEs). That is why we have developed a special utility called, Bill of Materials Processing and Control (BOMPAC), and packaged it as an optional module in our ABC Toolkit financial and business solution for Small and Medium Enterprises (SMEs). This tool is designed to collate and automatically account for all costs associated with the production or manufacturing of any goods—from Bill of Materials through Work-in-Progress to Inventory. It also allows you to determine your selling price based on a percentage markup.

Apart from this general offering, we have also built a customized version for production costing and accounting for the Bakeries. ABC BakerMITS is bespoke application that allows Bakers to design Bill of Materials templates for different categories of bread and confectioneries they produce. These templates can be used and re-used simply by specifying the quantity of flour required for a given production run, and all associated raw materials cost will update automatically. BakerMITS is available in Basic, Standard and Professional Editions, and can be deployed either as a single-user or multi-users application.

Sample Bread Production Cost Report from BakerMITS

Production Schedule showing Cost and Profit Margin, among others…

About Uso Etim

Etim Uso is a systems analyst and a programmer with over 20 years of experience in the design and implementation of financial and business solutions. He is an IFRS/IPSAS systems specialist, and holds a Bachelor of Technology degree in mathemetics and computer Science from the Federal Univeristy of Technology, Owerri, Nigeria. He also holds a Certificate in Entrepreneurial Management from Enterprise Development Centre (EDC) of Pan-Atlantic University, Lagos. He has contributed to a number of discourses on important national and international issues, including the Nigeria Leadership Initiative's (NLI) White Paper (Volume 2) on Nigeria tax system. He was a guest columnist for the Nigeria's Businessday Newspaper throughout 2012, writing weekly on International Financial Reporting Standards (IFRS) and International Public Sector Accounting Standards (IPSAS). Mr. Uso has written a number of books and eBooks on accounting, including the following, all of which are available in the Amazon Kindle store: 1. IFRS Accounting Manual for Small Businesses 2. IFRS Accounting Manual for the Real Estate 3. How to Master IFRS Accounting for Hotels with 3 Easy Steps. www.accountingbychoice.com is his blogging and marketing platform on financial and business solutions.

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