OPERATING DECISIONS 123
between production capacity and customer demand to be smoothed. This is of
course not possible in the supply of services.
Manufacturing firms purchaseraw materials(unprocessed goods) and under-
take theconversion processthrough the application of labour, machinery and
know-how to manufacturefinished goods. The finished goods are then available
to be sold to customers. There are actually three types of inventory in this example:
raw materials, finished goods and work-in-progress.Work-in-progressconsists
of goods that have begun but have not yet completed the conversion process.
There are different types of manufacturing and it is important to differentiate
the production of the following:
žCustom:Unique, custom products produced singly, e.g. a building.
žBatch:A quantity of the same goods produced at the same time (often called a
production run), e.g. textbooks.
žContinuous:Products produced in a continuous production process, e.g. oil
and chemicals.
For custom and batch manufacture, costs are collected through ajob costing
system that accumulates the cost of raw materials as they are issued to each
job (either a custom product or a batch of products) and the cost of time spent
by different categories of labour. In a manufacturing business the materials are
identified by abill of materials, a list of all the components that go to make up the
completed project, and arouting, a list of the labour or machine processing steps
and times for the conversion process. To each of these costs overhead is allocated
to cover the manufacturing costs that are not included in either the bill of materials
or the routing (this will be explained in Chapter 11).
The bill of materials and routing contain standard quantities of material and
time. Standard quantities are the expected quantities, based on past and cur-
rent experience and planned improvements in product design, purchasing and
methods of production.Standard costsare the standard quantities multiplied by
the current and anticipated purchase prices for materials and the labour rates of
pay. The standard cost is therefore a budget cost for a product or batch. As actual
costs are not known for some time after the end of the accounting period, standard
costs are generally used for decision-making. Standard costs are usually expressed
per unit.
The manufacturing process and its relationship to accounting can be seen in
Figure 9.2. When a custom product is completed, the accumulated cost of materials,
labour and overhead is the cost of that custom product. For a batch the total job
cost is divided by the number of units produced (e.g. the number of copies of the
textbook) to give a cost per unit (cost per textbook). The actual cost per unit can
be compared to the budget or standard cost per unit. Any variation needs to be
investigated and corrective action taken (this is the feedback cycle described in
Chapter 4, to which we return in Chapter 15).
A simple example is the job cost for the printing of 5,000 copies of a textbook.
The costing system shows: