Question

When you produce finished goods from raw materials, labour and other items, what are the journal entries to reflect that?

For example, in the lecture #5 Solved Examples in Inventories section, you calculated the cost of one unit of finished product as follows:

Item Total cost Allocation Unit cost
Raw materials (flour, etc.) n/a n/a 10.00
Indirect materials (oil) 1 200 1 200/1 000 1.20
Salary of bakers 1 500 1 500/1 000 1.50
Salary of production manager 1 000 1 000/1 000 1.00
Electricity 100 100/1 000 0.10
Packaging n/a n/a 2.00
Total     15.80

 

How do we account for each item?
 

Answer

The specific journal entries really depend on your accounting system, so I give you one example only:

  • Debit Inventories of finished goods: CU 15.80;

  • Credit Inventories of raw materials: CU 10;

  • Cr. Inventories of indirect materials (oil): CU 1,20;

  • Cr. Salaries (baker+managers): CU 2.50;

  • Cr. Electricity expenses: CU 0.10;

  • Cr. Inventories of packaging: CU 2.

However, instead of crediting relevant expense accounts directly, some accounting systems use “activation” accounts, or they give them various other different names. This is to monitor total electricity cost and its split between admin and production, just as an example.

The net effect on profit or loss and the statement of financial position is the same though as if you use the entry I showed above.