Your Guide to Accounting for Manufacturing Businesses

Leading a manufacturing business requires attention to detail for a variety of moving parts, and each part comes with its own set of unique challenges. To no surprise, accounting for manufacturing companies is one of them.

There are complex manufacturing costs and operations, inventory valuation and management, and detailed data tracking on an individual product, job, and production basis.

However, the complexities shouldn’t scare you away. In fact, this creates an opportunity for firms who specialize in this industry as there is always more demand in niche services.

In this guide, we'll cover basic manufacturing accounting terms you should know and key elements to look for in manufacturing accounting software.

Manufacturing Cost Terms to Understand

The following manufacturing cost terms are ever-present in accounting for manufacturing businesses. Understanding them allows you to make informed business decisions, accurately calculate your costs, price your products effectively, and improve efficiency.

Manufacturing Overheads aka Indirect Costs

Manufacturing overheads are the indirect cost associated with running a business. This means they are not directly related to the cost of materials or labor. Typically, overheads are associated with the facility or the manufacturing process. A few examples of these include:

Property taxes on the production facility
Depreciation on equipment
Expenses on utilities

Overheads are often left overlooked but can take a large bite out of your revenue, so you should evaluate them often.

Production Costing Methods

Production costing methods are ways to find the total cost of producing a product or service. You will need to understand the three common production costing methods we cover below.

1. Job Costing

The job costing method is used to assign a unique cost to each production run or batch of products. It takes into account the labor, materials, and overhead required for each individual job.

2. Process Costing

The process costing method is essentially an average of costs across all of the units produced. It’s most commonly used for products produced in larger quantities.

3. Activity-Based Costing (ABC)

The ABC method assigns costs to all of the activities involved in producing a product. It’s most often used when manufacturing companies have a complex production process.

A production cost method should be selected based on the manufacturing business as each has its benefits and drawbacks.

Inventory Valuation

Inventory valuation is assigning a monetary value to your business’s current inventory. Because inventory is considered an asset, this is an essential piece of the accounting process.

There are three common methods for inventory valuation, all of which are common terms in manufacturing accounting for businesses.

1. First-In, First-Out (FIFO)

This method of inventory management indicates that the first items to arrive are also the first items sold. Using this method ensures that older inventory is sold before the newer inventory.

2. Last-In, First-Out (LIFO)

This inventory management method assumes that the last items to arrive are also the first ones sold. When this method is used the item’s cost price and sell price are tracked. The business will sell new inventory at the lowest price and gradually increase selling prices until it has sold all of its old inventory.

However, you should keep in mind that LIFO is permitted under GAAP accounting standards but banned by IFRS accounting standards.

3. Average Cost Method

This inventory management method calculates the average cost of all inventory items. Then, the average cost is assigned to the COGS (Cost of Goods Sold) and ending inventory.

The inventory valuation method you use matters because the numbers can have an impact on financial statements.

What You Should Look for in Your Manufacturing Accounting Software

Along with many other benefits, the right manufacturing accounting software is crucial for optimizing processes and identifying profitable product lines and customers.

Because we covered some of the more common manufacturing cost terms, we’ll dive into how your manufacturing accounting software can support them.

Production Cost Tracking

Finding manufacturing accounting software with production cost tracking features is crucial.

It will allow you to calculate costs based on your preferred method so you can optimize business performance.

Inventory Control

Inventory management capabilities are a necessity in accounting software for manufacturing businesses.

The software you use needs to be able to track :

Inventory levels
Bills of materials
Expenses related to each product or batch of products

Reporting Capabilities

We’ve covered so many terms associated with accounting for manufacturing companies. However, there’s one that is common in all forms of accounting - financial reporting.

It’s a critical element in all accounting software, but for businesses in the manufacturing industry, the software needs to be able to create financial, production, and inventory reports.

Systems Integration

Last, but certainly not least, your accounting software should be able to integrate with other systems.

It’s likely that your software won’t check every box, but with compatible management tools and databases, you’ll be able to fill the gaps.

The Opportunity for Advisors

One of the greatest things an accounting firm can do is bring simplicity out of the complex. Manufacturing businesses are dealing with a lot of complexity and numbers to navigate. As an accounting advisor, your opportunity through technology, is to simplify their systems and provide clarity.

When this happens, your growth will be inevitable.