Manufacturing Account

Manufacturing Account

Author: Jamshed Ali
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  • A manufacturing business processes some raw material (eg wood) into finished goods/products (eg tables) using machines/tools/equipment (eg an electric saw), labour (eg machine operators) and premises (eg a workshop/factory);
  • A manufacturing business has to make/produce something before it can sell, therefore it needs to know how much it cost to produce (Cost of Production (of Finished Goods)) before it can know how much it costs to sell (Cost of goods sold) and how much profit is made on sales. It manufactures first and then trades/sells. So it needs to know its Cost of Production (of Finished Goods) before it can prepare its income statement;
  • An account/statement done at the end of a period to find out "Cost of Production (of Finished Goods)" is called a Manufacturing Account;
  • A Manufacturing Account has the following sections:

(I) Direct production Costs/Prime Cost: Costs which can be specifically/exclusively charged to a particular item (goods/services) being produced/provided. They are also called Product Costs. These include the following:

1. Cost of Direct Raw Material Consumed/used:

This sections shows how much is the cost of raw material consumed/used in production for the period. It is calculated as follows:

opening inv of raw material+purchases of raw material-purchases returns of raw material+carriage inwards on raw materials-raw materials taken out for personal use-closing inv of raw materials

2. Cost of Direct Labour (Factory/Direct/Manufacturing Wages):

This shows how much is paid/incurred to those workers who are directly involved in production eg the machine operators. It can be calculated on the basis of number of hours worked or number of pieces/units made by those workers. (Normally this is given so no calculation is required)

3. Other Direct Expenses (Costs):

This includes direct expenses other than raw material and labour. (Normally not tested). Examples of such costs are: Royalties, Copyrights, license fees etc.

(II) Indirect Production Costs (Factory/Manufacturing Overheads):

Costs which can not be specifically/exclusively charged to a particular item (goods/services) being produced/provided. Its either impossible or impractical to charge such costs to each unit of production. These are general costs of running the factory. They are also called as Period Costs. Examples of such costs are:

Factory rent, insurance, heating and lighting, repairs and maintenance of factory machines and tools, power, fuel, indirect materials, indirect labour (eg factory supervisors), general expenses of factory, depreciation of production machinery/tools etc.

(III) Adjustments for Incomplete Work/Work in Process (WIP):

At any point in time (usually at the start and at the end of a period) there is raw material which has not been completely processed into finished goods ie it is incomplete work. It is termed as Work in Process (WIP). The ending WIP becomes the opening WIP of the coming period before its completed/turned to finished goods. Ending WIP is not included in the cost of production of the current year. It is included in the following year's cost of production as opening WIP.

Formulas used in Manufacturing Account:

1. Prime Cost = Cost of Direct Raw Material Consumed/used+Cost of Direct Labour (Factory/Direct/Manufacturing Wages)+Other Direct Expenses (Costs)

2. Cost of Production (of Finished Goods) = Prime Cost+Indirect Production Costs (Factory/Manufacturing Overheads)+Opening WIP-Closing WIP

Cost of Goods Sold (COGS) of a Manufacturing business:

It is calculate in the usual manner except for Cost of Production (as in formula 2 above) replaces/adds with the purchase of finished goods (if any). The formula for COGS becomes:

opening inv of FG+purchases of finished goods+cost of production-closing inv of FG

Non Production Costs:

Costs which are not related with production of goods. These are office, administrative and selling costs. They are listed in the income statement as usual.

SOFP of a manufacturing business

SOFP of a manufacturing business is done in the usual manner except for the current assets section may contain ending inventories of:

  • Raw Materials
  • WIP
  • Finished Goods

Past Exam Questions

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Source: www.cie.org.uk