Steel Manufacturing Process Costing and Budget Analysis

Introduction to Steel Manufacturing

The objective of this paper is to present a strategy to manufacture steel. A manufacturing process involves the transformation of raw materials into finished goods and requires the acquisition of direct materials, direct labor, and manufacturing overhead. Product costs represent the total costs incurred to manufacture steel from start to finish and are the summation of direct labor, direct materials, and factory overhead. This paper applies process costing to the manufacturing of steel.

The steel manufacturing process involves a combination of direct materials, direct labor, overhead costs, and fixed costs to produce a finished product. A manufacturing process using process costing "involves a continuous flow of raw materials through various processing departments" (Garrison, Noreen, & Brewer, 2012, p. 2), and the finished product is characterized as homogenous units in which each process displays some basic characteristics. Under process costing, the manufacturing of steel involves the following steps:

1. Melt iron ore along with processed limestone and coal/coke, then
2. Skim the material and add alloys to adjust for tensile flexibility and strength, and finally
3. Blast oxygen and extrude the material into its finished product, which may include sheet steel, I-beams, coils, and similar outputs (Shim & Siegel, 2011).

Manufacturing Process of Steel

Both variable and fixed costs are critical to the manufacturing process. The following sections present the budget to be used in the manufacturing of steel.

A budget is a quantitative financial plan for a given period. It may include planned sales revenues, volumes, costs, expenses, as well as assets and liabilities. The budget for the manufacturing of steel, presented in Table 1, includes the following items: an estimated sales budget, estimated direct materials budget, estimated direct labor budget, estimated manufacturing overhead budget, estimated selling and administrative expenses, and an estimated income statement (Clinton & Van der Merwe, 2006).

Table 1: Budget for the Steel Manufacturing Process

Revenue
Sales: July $125,869 | August $155,351 | September $256,755 | November $257,881 | Total $795,856
Sales Discounts: $15,008 | $19,375 | $21,485 | $23,718 | $79,586
Net Sales: $140,877 | $174,726 | $278,240 | $281,599 | $875,442

Cost of Goods Sold: $70,000 | $73,000 | $82,190 | $93,153 | $318,343
Gross Profit: $70,877 | $101,726 | $196,050 | $188,447 | $557,100

Operating Expenses
Salaries & Wages: $22,552 | $26,875 | $30,569 | $39,382 | $119,378
Depreciation Expenses: $1,500 | $1,825 | $1,955 | $2,679 | $7,959
Office Expenses: $1,475 | $1,494 | $1,993 | $2,600 | $7,561
Rent Expense: $4,500 | $5,674 | $6,966 | $6,736 | $23,876
Travel Expenses: — | — | — | — | $3,979
Maintenance Expenses: — | — | — | — | $1,592
Advertising Expenses: $1,232 | — | — | — | $3,183
Total Operating Expenses: $31,577 | $37,758 | $43,759 | $54,434 | $167,528

Income From Operations: $39,300 | $63,968 | $152,291 | $134,013 | $389,572
Interest Income (Expense): ($300) | ($405) | ($471) | ($416) | ($1,592)
Income Before Income Taxes: $39,000 | $63,563 | $151,819 | $133,597 | $387,980
Income Tax Expense: $2,755 | $2,788 | $2,927 | $3,468 | $11,938
Net Income: $36,245 | $60,676 | $148,893 | $130,129 | $376,042

An overview of the first-quarter budget reveals that the company will generate total net income of $376,042 despite monthly increases in operating expenses. The company will achieve net sales of $875,442 at the end of the first quarter, with a total cost of goods sold of $318,343 and a gross profit of $557,100.

Budget for Steel Manufacturing

The manufacturing, selling, and administrative expenses are classified as either variable or fixed costs as follows:

Fixed Costs (General and Administrative)
Salaries & Wages: $119,378
Depreciation Expenses: $7,959
Office Expenses: $7,561
Rent Expense: $23,876
Travel Expenses: $3,979
Maintenance Expenses: $1,592
Advertising Expenses: $3,183
Total Fixed Costs: $167,528

Variable Costs
Direct Material: $115,278
Direct Labor: $125,369
Overhead Cost: $77,696
Total Variable Costs: $318,343

A contribution margin income statement deducts all variable costs from sales to arrive at the contribution margin, and then deducts all fixed costs from the contribution margin to determine net operating profit. The contribution margin for the steel production is as follows:

Contribution Margin Income
Sales: $795,856
Less: Variable Expenses: $318,343
Contribution Margin: $487,513
Less: Fixed Expenses: $167,528
Net Operating Profit: $319,985

The formula to calculate the break-even point in units is as follows:

Break-even point in units = Fixed Expenses ÷ (Price − Variable Expenses per Unit)

Break-even point in units = $167,528 ÷ ($35.00 − $12.35) = 4,774 units

Conclusion

The budget analysis reveals that the company will generate a net income of $376,042 at the end of the first quarter. Break-even analysis indicates that 4,774 units must be sold to cover all costs, and 224 units per month must be sold to achieve a profit of $5,000. The weighted-average process costing analysis yields a total cost per equivalent unit of $12.35, providing a clear basis for pricing and profitability decisions.

Clinton, B. D., & Van der Merwe, A. (2006). Managerial accounting: Approaches, techniques, and management processes. Cost Management. New York: Thomas Reuters RIA Group.

Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2012). Managerial accounting (14th ed.). McGraw-Hill.

Shim, J., & Siegel, J. (2011). Schaum's outline of managerial accounting (2nd ed.). McGraw-Hill.