Managerial Accounting 1.6: Manufacturing vs Nonmanufacturing Costs - YouTube

This is Kurt Heisinger, accounting professor  at Sierra College and author of Managerial  

Accounting. In this video we are going to talk  about the differences between manufacturing costs  

and nonmanufacturing costs. So we will start  with manufacturing costs and by the way they  

are also called product costs. With manufacturing  costs these are all the costs that are associated  

with production. So I will use the example  of producing, let's say high-end racing road  

bikes. We are going to talk about some of the  costs that will be considered production costs.  

So what are those production costs, what are they  include. Well, we will start with direct materials.  

So with direct materials, these are the items  that are easily traced to the product that we  

are building. So for example, if we are producing a  racing bike these would be things like the wheels,  

the tires, the chain, the derailers, these would  all be considered direct materials. Now they are  

also our materials called indirect materials  that I will get to in just a second that would  

fall under the manufacturing overhead category.  So the next category of manufacturing costs is  

called direct labor. And direct labor this would  be the production workers whose time is easily  

traced to the products that they are working  on. So for example, if we have a person that is  

assembling a custom racing bike, the time and the  cost associated with that production worker would  

be called direct labor, and would be considered  a manufacturing cost as we talked about up above.  

And then the third category of manufacturing  costs is manufacturing overhead. And this really  

is everything else, all other costs that are  related to production other than direct materials  

and direct labor. So what might that be. Well if  we are producing racing bikes in a factory, in  

a building, then the costs, and we'll call it the  factory, then the costs of the factory would go  

into manufacturing overhead. So costs like the  rent on the factory, or any insurance that we  

pay related to the factory, or any maintenance  on the factory, or utilities within the factory,  

any costs associated with the factory would go  into this manufacturing overhead category. Also  

as I mentioned earlier, any materials that are not  direct materials, they would be considered  

to be indirect materials, and that would be in  terms of building a bike, things like oil that we  

put on the chain, maybe it is some stickers that  we put on the bike that aren't very expensive,  

they are items, indirect materials, or items that are  used in the production of these bikes, but they are  

not easily traced to the bike, or maybe they are so  inexpensive that we really don't want to take the  

time to trace those materials to the bike. There is  also a labor, a category of labor called indirect  

labor. So it does not go into this category direct  labor, it is called indirect labor, and it is similar  

to indirect materials, this would be labor costs  that are not easily traced to the bike. For example  

if we are producing several different racing bikes  within our factory and we have a supervisor who is  

overseeing the production of let's say twenty or  thirty bikes, then that supervisor's salary would  

probably go into manufacturing overhead, into that  manufacturing overhead category, and would be called  

indirect labor. So those are the three categories  of production costs, direct materials, direct labor,  

and manufacturing overhead. So why is it important  to track manufacturing costs. Well there are a lot  

of different reasons, but some of the key reasons  we are going to talk about right here. First of all  

we have got to make sure that the costs appear  in the right place in the financial statements.  

So manufacturing costs have to be placed in the  right location, either in the income statement as  

cost of goods sold or an inventory accounts in the  balance sheet. We will talk about that a little bit  

later. But it is very important to get those costs  in the right place within the financial statements.  

Also tracking manufacturing costs enables us to  determine the cost of our products. And this is  

very important when it comes time to figure out,  for example, how much we are going to charge to  

our customer for a particular product, it becomes  important when we are trying to figure out how  

much we should pay our workforce, how much it  costs for us to get the materials that go into  

the products that we are building. So it enables  us to determine the costs of our products. And this  

then in turn leads to, hopefully, better decision  making. If we have accurate product cost information we  

could make better decisions, for example in pricing  our products. So it is important that we track our  

manufacturing costs to the individual products  that we are building. I gave you some examples  

of product costs related to the building of racing  bikes, now let's talk about another type of product  

just to give you a variety of examples. What are  some examples of production costs or manufacturing  

costs at a company that builds custom wood  furniture, and this is the example that I use  

in my book. So we have got three different categories as  we mentioned before, direct materials, direct labor,  

and manufacturing overhead. If we build custom  wood furniture, for example let's say that we build  

beautiful wood tables that are used in conference  rooms in large companies. Look at the direct  

materials, what would be some examples of direct  materials. Well, certainly the wood if it is high-end  

wood, would be  in this category of direct materials. So if we had  

cherry wood, or maple, oak, whatever the type of wood  that we use, we would track that, those materials to  

the tables that we are building. If we have  any hardware that we are using. So let's say that  

we have drawers in a particular table that we are  building, we have drawer handles that are high-end  

drawer handles that might be relatively costly, those handles would be considered direct  

materials. Now what about direct labor. Well the  workers who cut, plane, and glue the wood together  

in these tables, these high-end tables, the cost  of those workers would be considered direct labor  

costs. The workers that fill and sand the tables,  also the cost of those workers would be in the  

category of direct labor, as well as the workers  that are finishing the tables. When we look at  

manufacturing overhead, let's take a look at some  examples of manufacturing overhead in our custom  

wood furniture company. Any indirect materials,  so things like glue, screws, nails, sandpaper, stain,  

any lacquer that we use, we're probably not going  to trace those materials directly to each table  

that we are building, so we would call those indirect materials. The factory supervisor, similar  

to the bike example that I gave to you earlier, the  factory supervisor that is overseeing the building  

of all of the custom wood furniture that we are  making, the salary of that factory supervisor would  

fall into this category of manufacturing overhead.  And there are lots of other manufacturing costs  

that would also fall into this manufacturing  overhead category. So any maintenance on  

the production equipment, the depreciation on  the production equipment, the utilities in the  

factory, the factory property taxes, all of those  things would be in this category of manufacturing  

overhead. I talked earlier about the importance  of why we track manufacturing costs, specifically  

for different products, but let's talk now about  where they appear in the financial statements.  

That was one important aspect of tracking our costs  accurately, that is where do those costs appear in  

the financial statements, and making sure that we  get that right. So for products that are not yet  

sold, so these this could be just the raw materials  sitting in the raw materials warehouse, this could  

be products that we've started but we haven't yet  finished, or it could  

be products that are completely finished but we  haven't yet sold. So varying levels of production  

here. And we'll talk in a different video about how  those different levels of production, where those  

costs appear in the accounts on our books. But  for now, for any products that are not yet sold,  

those costs are recorded in inventory accounts,  and of course inventory accounts go on the  

balance sheet. Now if the products are sold, then  the product costs associated with those products  

are transferred from the inventory accounts over  into cost of goods sold. And of course cost of  

goods sold will appear on the income statement.  So again product costs are comprised of direct  

materials, direct labor, and manufacturing  overhead, and those costs, if the products  

are not yet sold go into inventory accounts of  the balance sheet. Once those products are sold  

then the costs associated with those products,  direct materials, direct labor, and manufacturing  

overhead, are transferred into cost of goods  sold and appear then on the income statement.

We have looked at manufacturing costs and lots  of examples of manufacturing costs, for a bike  

company for example, a manufacturing company,  and for a company that manufactures custom  

wood furniture. So now let's take a look at nonmanufacturing costs, which are also called period  

costs, which I'll get to why that is the  case in just a minute. With nonmanufacturing  

cost, these are costs not related to production,  and are classified as selling or general and  

administrative. The selling costs would be any  cost associated with making our customers aware  

of our product and then getting our product  to the customer. So that would include things  

like advertising, any marketing efforts that  we have that we put into place, the costs of  

those marketing efforts would go into the  selling category. For example, if we run an  

ad in the newspaper or online, let's say with  Facebook, the costs of those ads would go into  

the selling category. Then we have the general  and administrative category and this category  

includes costs associated with areas such as  accounting or human resources. It would be the  

cost of the employees within those departments,  the cost of the buildings that they're in, the  

cost of the computers that they use, of maintaining  those buildings, all of those costs would go into  

this general and administrative category. So those  are just some examples for you of the costs that  

would go into these two different categories that  fall into the category of nonmanufacturing costs.  

Now that we know the nature of nonmanufacturing  costs, let's talk about how nonmanufacturing costs  

are presented in the financial statements. Nonmanufacturing costs are recorded as an expense  

on the income statement in the period in which  the cost is incurred. And that's exactly why we  

call these costs, period costs. So it is pretty  straightforward. If we pay the accounting  

department, the salary of folks that are in the accounting  department, those costs are expensed immediately,  

and of course expenses fall within the income  statement in the financial statements. Unlike  

manufacturing costs, where the costs go through  inventory accounts first, and then on the balance  

sheet, and then go to the income statement. So nonmanufacturing costs are expensed as incurred. Here  

is a summary of both manufacturing costs and nonmanufacturing costs, what goes into each of those  

categories. Here is our manufacturing, here are the  manufacturing costs, and here are the nonmanufacturing  

costs. And remember manufacturing costs are also  called product costs, and nonmanufacturing costs  

are also called period costs. So some examples  of manufacturing costs. The three categories are  

direct materials, direct labor, and manufacturing  overhead. The timing of the expense, that is when  

do these costs become an expense on the income  statement is critical. So for manufacturing costs,  

the costs are expensed when the goods are sold,  and not until the goods are sold. So if the goods  

are sitting in inventory or they're in the middle  of production the cost of those goods,

the product costs are sitting in inventory as  an asset on the balance sheet. Once those goods  

are sold, then those product costs are expensed  and become part of cost of goods sold. With

nonmanufacturing costs, as I mentioned earlier,  it is fairly straightforward, these are period  

costs. So as soon as we incur these expenses,  these costs, then they are expensed. The timing  

of the expense, they are expensed on the income  statement in the time in which they are incurred.