An automobile manufacturer, for example, buys steel, rubber, aluminum, plastic, etc., which is used to make motor vehicles that are sold to dealers (the trading company). These dealerships, in turn, sell vehicles to the customer.

From an accounting point of view, the activities of manufacturing and trading companies are very similar, especially their administration, sales and financing activities. Therefore, accounting principles and most procedures can be applied to both manufacturing and commercial companies. The main difference between the two is their cost accumulation and cost determination method for (1) valuing inventory and (2) calculating cost of goods sold. The difference arises from the fact that trading companies buy finished products, while manufacturers manufacture the products sold by distributors.

The ‘accounting cost of manufactured goods’ element in the manufacturing company therefore corresponds to the ‘accounting cost of purchased good’ element in the trading company. In both cases, these amounts represent the cost of the finished products available for sale. The trading company, having purchased its products in a “finished” form, experiences little difficulty in determining their cost. The manufacturing company, on the other hand, has to account for the cost of converting raw materials into finished products (also known as manufacturing costs).

By converting raw materials into finished products, the manufacturer makes use of labor, machinery and equipment and also incurs other manufacturing costs such as energy consumption, machinery maintenance, etc. All of these costs must be added to the cost of raw materials to determine the cost of manufactured goods for any period.

Therefore, the accounting records of a manufacturing company should be expanded to include the recording of the various additional costs of the manufacturers.

The three most important elements of manufacturing costs are material, labor, and manufacturing overhead. In accounting cost terminology, material and labor costs together are referred to as primary costs, while the accounting term conversion costs represents the combination of labor and general manufacturing costs.

By virtue of the nature of the activities of a manufacturing company, it will require more accounting accounts than a commercial company. The general ledger should consider aspects such as machinery and equipment, inventory, raw materials, work in progress, finished products, etc. You need to pay special attention to the various inventory accounts.

At any given time, a manufacturer will have different types of inventory on hand: inventory of material ready to use in the manufacturing process; partially finished products still in the manufacturing process; and finished products to be shipped to distributors. Inventory accounting records and different inventory ledger accounts should be kept to determine the costs of each type of inventory at the end of a financial period. All three inventory accounts are asset accounts and are generally maintained according to a perpetual ledger inventory system. At the same time, they are control accounts supported by the corresponding subsidiary records.

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