If you noticed, the Profit and Loss of a manufacturing setup has the “finished goods” line item that is not seen in the ordinary trading organisations’ financial statements (Also see Tips for Cafe Operators in Accounting). This is obvious when manufacturing business produces its products instead of purchasing from other suppliers and sell at a higher price.
This is one of the key differences in preparing the accounts for manufacturing setup compared with accounting for a trading organisation (Also see What is an Accounting Cycle?). Unlike various other industries, a manufacturing setup mixed different ingredient to manufacture their products that are later offered to the market. The entire inventory balances, both the material and the finished goods, are required to be included in the current asset section of the balance sheet. Hence, the core area of focus then falls on the stock valuation and capturing the appropriate cost of goods sold (Also see Situations Where Having the Right Accountant Can be Handy).
Stock System adopted
Most manufacturing business either adopt the periodic or perpetual stock system to determine the value of the balance stock and indirectly, the cost of sales.
Periodic Stock system
The periodic stock system is the preferred method for a smaller manufacturing business as it is only done periodically. However, its main drawback is that the accuracy is only substantiated when a physical stock take is also performed. This is a less practical approach for a more prominent manufacturer when they have millions of goods that require physical stock count.
Perpetual Stock system
The perpetual stock system offers a higher degree of accuracy when the stock movement is updated on a real-time basis. The most obvious pitfall is the time and effort required to maintain the system. It may outweigh the benefits, so it is not always a viable method, especially for smaller manufacturers.
Different methods of stock valuation
Direct costing method
All the direct costs incurred to produce a product must be taken into consideration when performing the valuation of the stocks. This method is either done using the First-In-First-Out (FIFO) or Weighted-Average Costing, whichever is suitable for a given situation. It is worth taking note that the Last-In-First-Out (LIFO) is no longer an accepted method of valuing the stock (Also see Financial Reporting Standards 2: Inventories).
Overhead costing method
In addition to the direct cost, the overhead incurred was also included and systematically allocate to the different production line. Each production line then shares a part of the cost incurred throughout the accounting period.
This screening is done with the primary aim to ensure the value of the stock is never higher than the net realisable value. In a situation where the stock value exceeds the net realisable value, adjustment is required and generally conducted on the last day of the accounting period.
Cost of Goods Sold
The cost of good sold is obtained by looking at the changes in inventory in any given financial period. The link becomes apparent when the way the stocks are valued has a direct impact on the cost of good sold. On top of that, other direct costs such as the logistic costs are also included in the cost of goods sold despite the fact that it is never taken up at the stock level.
Hence, preparing an account for a manufacturing business is far more in-depth and taxing than companies in other industries. The best way to get away with it is, of course, outsourcing the tedious tasks to the accounting firm in Johor Bahru.