Unlike a business that provides a service (meaning product only goes one way), bookkeeping in the manufacturing industry can be seen as more complicated and more work. This is because you not only have product going out, but you have product coming in as well.
This means that you are not only keeping track of your transactions, assets, liabilities, and cash flow, you will likely have inventory that you need to take into consideration and keep track of. Simply put, you have more products to track in manufacturing.
You will need to keep track of your expenses as well as your inventory and material costs so that you can accurately price your product to ensure that you are attaining the profit margin that you want to attain.
Inventory & Production Costs
The products that you need to keep track of include your raw materials or the direct material inventory. These are the products that you use to make your product. For example, if your industry is building computers, this could include sand, metals, motherboards, and so on. It is any material being directly used to produce the computer. These costs as well as the inventory of these materials need to be tracked and accounted for.
You will also need to keep track of your direct labor costs. This cost is the labor that goes into producing your product, whether it be on an assembly line or operating machinery. These wages are separated out from other employees’ wages such as administration, security and inspectors, which are considered fixed overhead costs.
In addition to these wages, a manufacturing business has other fixed overhead expenses which can include depreciation of the building or equipment, as well as occupancy costs such as utilities.
Last, a manufacturing business will have variable overhead, which is the production costs that are associated with the increase or decrease in goods being produced. For example, the electricity used specifically to operate the machinery on the production line.
Inventory can be a large part of manufacturing, and it includes the raw materials, any work-in-process, and finished goods. Inventory constantly needs to be monitored and tracked at all stages of manufacturing and production to be able to accurately reflect inbound and outbound costs. This includes materials coming in, work-in-progress materials and products, and outbound products.
The materials that are coming into the manufacturer are called raw materials. This means that if you are manufacturing vehicles, your raw materials could include steering wheels, tires, cloth or leather for seats, and so on.
Work in process (WIP) inventory needs to be taken into account when discussing inventory. There are costs associated to the product while it is still on the assembly line. Since they have used material and labor to date, these costs, and the product, need to be accounted for even if they are not in the finished goods inventory.
Finished goods inventory is the inventory that is completed and ready to be sold. When looking at the costs that are associated with these goods, it includes not only the time, labor, and material that has gone into production, but the costs of holding or storing your inventory.
Inventory management is crucial. You need to know what inventory is, not only for supply but for valuation. Simply put, you need to know what your inventory is worth. This helps to establish the cost of goods sold (COGS), profits earned, as well as keeping you informed about whether you have too little supply or too much.
Two ways of keeping track of your inventory are a periodic inventory system and a perpetual inventory system.
Periodic inventory is typically done at the end of an accounting period, whether that be every month or annually. This involves taking a physical count of all of the products on hand. This method can be very time-consuming and is usually only used when there is a small amount of inventory. Therefore, this method is less common in manufacturing.
Perpetual inventory, or continuous inventory, is when products coming in or going out are continuously being updated in the system. Since this method uses software, it keeps business owners up to date so that they can make informed decisions. This method tends to be more commonly used because of the accuracy and it can be used for inventories of any size.
Since your inventory is being sold and then restocked through your manufacturing, and their prices may also be changing, you also need to value your inventory. As a business owner, you want to do an inventory valuation so that you can evaluate the cost of goods sold (COGS) and eventually, what your profit is. However, to understand this, businesses need to understanding inventory costing.
There are two main types of costing, inventory costing and production costing. Each of these can be used to assign a value to inventory, and to ensure that inventory is calculated properly.
Inventory costing is the amount of money that is associated with the goods that you have in inventory, at the end of a specified accounting period. This valuation is all of the costs that you incurred to create your inventory and get it ready for sale and again, this includes your raw materials, any work in process as well as finished goods.
Production costing, on the other hand, is the manufacturing and inventory cost of all resources consumed during the production process at the end of a period. Although these may seem similar—depending on the time period and inbound and outbound costs—they can provide very different results.
There are four ways to value inventory. The most common ways to determine your valuation is first-in, first-out (FIFO), last-in, last-out (LIFO), weighted average cost (WAC), and specific cost.
First-in, first-out (FIFO) is exactly what it sounds like, the first items into inventory are the first ones to be sold. Not only is it one of the more common methods, but it is also easy to understand. The remaining inventory is then matched to raw materials that are most recently purchased. This typically provides a better correlation of material costs that are associated with a sale.
Last-in, first-out (LIFO) is when the newer inventory is sold before the older inventory. This isn’t typically used since the older inventory will be more unlikely to be sold, as well it will likely lose its value. The only time you may see this method being used is if one cannot discern between the newer or older product that was manufactured.
Weighted average cost (WAC) is when you divide the total cost of goods in inventory by the total number of goods in inventory to achieve the ‘average cost’. This method is done when items aren’t distinguishable from each other, or due to volume.
Specific identification assigns a specific cost to each inventory item. This method is usually used when you are purchasing and selling items that are quite expensive.
To determine which method is best for your manufacturing company, it is best to speak with your bookkeeping or accounting professional.
In addition to understanding inventory management and costing, another crucial aspect of bookkeeping in manufacturing is the production accounting. Like inventory accounting, there are also a number of ways of production accounting, and as always, there are benefits and drawbacks.
Standard costing is one of the more common costing methods used in manufacturing. This method establishes standard rates for material and labor used in the production of your goods. You can then determine the cost of each individual good for pricing. This method allows you to notice any trends or variances, such as one of your material costs being increased, and adjust your pricing as necessary. This is useful when you are making large quantities of a specific product, though a manufacturer needs to be careful in determining what is ‘standard’ labor.
Job costing is typically used when you are working on a small number of units or manufacturing a specific made-to-order (MTO) product. Essentially, this is where you work out the cost of your labor and raw materials and apply markup as desired. This method typically requires more time than some of the other methods.
Activity-based costing aligns the manufacturer’s resources and activities to the products, as it relates to their cost consumption. This method incorporates more indirect costs to help achieve the pricing of their products. Those that use this method believe that it helps with cost control and allows them to make better decisions, while others believe that the amount of time required to do this, simply isn’t worth it.
Direct costing is when the manufacturer looks at costs that increase or decrease proportionally with the production input. These costs are referred to as variable costs. This method is typically only used with short-term pricing. Longer-term, it simply wouldn’t provide accurate pricing and profitability.
The costing method that a manufacturer chooses to use will vary depending on what they are manufacturing and what their volume is.
As with any industry, there are specific software programs designed for the manufacturing industry. As a business owner, you want to ensure that your software meets your company’s needs and that it is scalable as your business grows. Figuring out which program works for you and your business can be complicated and should involve the assistance of your bookkeeper or accountant, as they are aware of what you need to control.
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This article is written for informational purposes only. It is current at the date of posting and changes to laws and regulations may result in the information becoming outdated. It is not intended to provide legal, tax, or financial advice. It is recommended that readers get advice from a tax professional before making any final decisions.