The accounting profession has its own distinct set of terms used to describe various functions and applications. Within the profession, there are accountants who specialize in service industries, financial planning, tax accounting and other sub-categories. Each has its own terminology and manufacturing accounting is no exception.
Cost of Goods Sold
The cost of goods sold is a total of all costs involved in producing an item for sale. This includes raw materials, production labor and allocated overhead such as electricity and supervisory labor.
Direct labor is the cost of production personnel who are directly involved in the manufacturing of an item. These employees are identified with a particular machine or product.
Factory overhead costs are those expenses involved in operating a manufacturing facility that are not directly related to a specific product or machine. Examples would be rent, utilities and property taxes. Overhead costs may be assigned to departments or machines on a prorated basis.
Finished Goods Inventory
A company's finished goods inventory is its stock of manufactured products that have been completed, passed any quality control inspections and are ready to be sold to customers.
The term inventory can apply to physical items such as raw materials, manufactured goods that are either complete or in process or the procedure of physically counting items on hand.
The department or process of actively controlling the supplies and raw materials needed for the manufacturing process is called material control. This department will normally be responsible for ensuring the storage and identification of materials and work-in-process as well as controlling the environment for storage and access to the materials.
Scrap can be manufactured product that fails to feel quality control demands and is therefore unable to be sold or it may be used to represent materials that remain after the process is complete. It may have a given value.
Spoilage is the term used to describe materials that are ruined or wasted during the manufacturing process.
Standard Cost System
The standard cost to produce an item is a predetermined number that represents a benchmark for comparison to actual costs. Ideally, actual production costs should not exceed standard costs. A standard cost system takes into account all factors involved in producing one unit of a product and will include both indirect and direct labor, raw materials, administrative and sales costs, and allocated overhead expenses.
In the manufacturing process, variance refers to the difference between the standard cost of producing an item and the actual cost. Variances can be favorable, where the actual cost is lower than standard or unfavorable, where the actual cost is higher than the standard cost.
In manufacturing, work-in-process represents goods that are not yet complete and ready for sale. These may be sub-components or goods that require multiple steps and have not yet been processed through all steps.
Stock Rotation: FIFO Versus LIFO
FIFO is an acronym for "first in, first out" and is a method of stock rotation where the oldest products in inventory are used to fill orders first. If a company chooses the FIFO method and product costs increase, the cost of goods sold appearing on the income statement for the current time period will be lowered and the value of the inventory appearing on the balance sheet will be increased.
LIFO stands for "last in, first out" and is a method of rotating inventory that uses the most recently produced inventory for shipment first. If the LIFO method is chosen and the cost of goods sold increases, the cost of goods sold shown on the income statement will be increased for the current time period while the value of the inventory on the balance sheet will be represented as a lower number.