Last Updated on June 25, 2023 by Flavia Calina
Manufacturing accounting deals with inventory valuation and cost of goods sold. Having a solid grasp on this process can help your company improve profitability, reduce costs and avoid excessive tie-up of funds in inventory.
Choosing the best method for managing production costs depends on several factors. Some essential options include standard charges, the weighted-average approach, and cost layering plans.
Inventory Management
Whether a small business for manufacturing accounting process flow produces its products or buys them from suppliers, it must keep track of its inventory. Various lists exist for each stage in the production process: raw materials, work-in-process (WIP), and finished goods. Managing these inventories enables the manufacturer to control costs, reduce risks and meet customer expectations.
The raw material inventory consists of procured materials and components that the manufacturing staff needs to create finished products. It includes everything from simple items like wood and metals to more complex features like mechanical parts, electronic components, and chemicals. The WIP inventory consists of partially completed or finalized goods stored before shipping to customers. It is common to use a perpetual inventory system, where the stock book is automatically updated every time an item is moved, sold, or used in the business. This method reduces the risk of erroneous records and restricts cash flow, as inventory is not allowed to build up unnecessarily.
Most manufacturers also employ an inventory management technique based on sales forecasts to help plan purchases from material suppliers and prevent overstocking.
Job Costing
Job costing is a manufacturing accounting technique determining the actual costs of producing a specific product or project. It benefits organizations that make custom goods or services for individual clients, such as construction companies, ship-building, engineering concerns, repair shops, furniture-making, and machine manufacturing industries. It is also helpful in tracking overhead expenses on projects with differing timelines and production times.
With this method, you apply a cost rate to each work center and use a Standing Order Number and a Cost Center Analysis Sheet to accumulate overhead costs. You then compare the total project cost to estimates and record the difference in a job completion variance account. You can then make adjustments to future forecasts and improve your profit-making abilities.
This method can help businesses uncover efficiencies, such as labor or inventory costs, in their operations and make more informed business decisions for the future. For example, if a company is using too much material or paying for overtime because of staff shortages, it can make changes in the future to avoid these expenses.
Businesses in virtually any industry can benefit from proper job costing. For example, construction companies rely on this method to keep track of all materials and labor costs to ensure they stay within budget. Similarly, marketing and advertising agencies may use this accounting process to evaluate their profitability by quantifying all costs associated with each campaign.
Inventory Valuation
Inventory is an essential current asset, and its value can significantly impact the company’s bottom line. It is, therefore, necessary that a manufacturer have accurate methods for tracking and valuing its inventory. The most common methods include FIFO (First In, First Out), LIFO (Last In, First Out), and Weighted Average Cost (WAC). Each method has its pros and cons.
Whether the business chooses to use a cost-based valuation method or a market-based approach, its goal is to accurately capture the actual value of its inventory and represent it correctly in financial statements. This requires periodic revaluations, which can be costly and time-consuming. However, the revaluation process can be improved by using techniques and controls that ensure that the revaluation is undertaken consistently and to the required level of detail.
The accounting for the inventory process flows through the three levels of a product’s lifecycle: raw materials, work-in-progress, and finished goods. Each of these has implications for a manufacturer’s profitability and tax liabilities. Rising inventory costs call for a LIFO approach, which results in lower COGS and higher gross income; falling inventory costs may lead the company to choose a FIFO approach. A third option, the specific identification method, allows a company to track each inventory item from purchase to sale. This is ideal for businesses that deal with rare or high-value items.
Variance Analysis
Variance analysis compares a company’s actual costs or performance with the expected numbers used in spending plans. It can help businesses identify the cause of under- or over-performance and make cost savings. The key to calculating variances is knowing what to measure and how to interpret the results. This guide briefly introduces variance analysis, defines essential terms, and shares calculation examples.
For example, a maker of baseball gloves for high school, college, and professional players, wants to determine if she can reduce purchasing costs. She might look at the purchase price variance or material burden cost variance to determine if her company is purchasing more than needed and then seek ways to lower those expenses.
Another approach to reducing manufacturing costs is activity-based costing (ABC). This method sorts indirect costs into groups and calculates a per-unit rate that can be assigned to products or activities. It requires more work than applying a standard overhead rate, but it generates more accurate costs and allows businesses to factor those costs into pricing. It’s also helpful in identifying product profitability and helping spot improvement opportunities. Read more interesting articles on Today world info
