Introduction to Manufacturing Accounts

• Thus far we have taken it for granted that businesses purchase everything they sell

• While it is true that a lot of business purchase inventory and sell it at a

profit

• There are some businesses that manufacture products

• These manufacturing businesses typically:

o Acquire Raw materials

o Process these raw materials using various processes and

o Ultimately transform these raw materials into finished goods of sorts

o These finished goods are then sold by the business usually at a profit

• For such businesses a Manufacturing Account has to be prepared in addition to the Trading
and Profit and Loss Account (Income Statement)

• A manufacturing account is prepared internally in order to establish the production cost of

• The production cost of goods is the sum of all the costs incurred in bringing the goods into
their saleable condition

• It is made up of:

o the cost of raw materials used

o The Direct Costs,

o Direct Labour Costs as well as

o All the indirect costs

• This production cost is used instead of purchases in order to establish the cost of sales

Direct costs

• A cost that can be traced directly into the product or are easily identified with the product

• Examples include:

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• Direct Labour costs such as those of the actual bakers that are making the bread

• Other direct costs such as royalties and patents paid out to designers of the products

• Royalties-is compensation, consideration, or fee paid for a license

or privilege to use an intellectual property (brand, copyright, patent, process) or a natural

• For example, a local company might start making Lenovo laptops, they will have to pay the
Lenovo company royalties on each laptop made

• Royalties are paid to the patent holder

• Patents are granted to individuals or businesses that come up with inventions

• They are a form of licence that grants exclusive rights to use that idea to the patent holder
only

• Anyone else that wants to use the idea has to pay royalties to the patent holder

• Patents are especially popular in technology for example the touch screen in modern smart
phones is patented

• The total of direct costs in a given period is known as Prime Cost

• It is important to note that Direct costs by their very nature vary directly in proportion to the
level of production

• What this means is that Direct costs increase if the level of production (number of units
made increases) and decrease if the number of units made decreases

Indirect Costs/ Factory 0verheads

• This comprises all the other costs that are part of the manufacturing process but cannot be
directly traced to each unit of production

• These include examples such as:

• Property Plant and Equipment rentals

• The cost of lubricants used on machines

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• Salaries and Wages for supervisors

• Depreciation of machinery etc

• Overheads do not really vary with the level of production

Carriage Inwards

• Raw materials usually have to be ferried to the manufacturing business

• The cost of transporting raw materials is known as carriage inwards

• Carriage Inwards must be added to the purchase cost of raw materials

• Also any returns must be deducted from the raw materials figure

Work in progress

• It is not unusual for there to be goods that have not yet been completely

processed at the end of the period

• This is especially true if the business makes large items for example builds and sells ships
or even small items like furniture

• The opening inventory of work in Progress is added to the total cost of production for the
period

• The closing inventory of Work In Progress is deducted from the production cost

Administration and Selling and Distribution Expenses

• Normally every manufacturing business has an administrative arm

• In such instances it is important to note that only manufacturing expenses are to be included
in the manufacturing account

• Administration and Selling and Distribution Expenses are to be put in the Trading and Profit
and Loss Account (Income Statement)

• Examples include:

o Depreciation of office equipment

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o Advertising expenses

o Carriage outwards

o Salaries of Administration staff

Apportionment of costs

• Often there are costs that cover both manufacturing and administrative aspects of a
manufacturing business

• For example:

o A business whose electrical supply measures power used by the entire business

o A van that is used to transport both raw materials and finished goods to customers

• In such instance, costs must be apportioned using an appropriate basis

• Usually in the exam you are given the basis to use Manufacturing profit/loss

• Most businesses manufacture goods with the hope that they can do it cheaply than they
would otherwise have to pay by purchasing the products

• The difference between the production cost and expected purchase price of the goods

• Is known as Manufacturing profit if the expected purchase price of the goods exceed their
production costs

• The opposite is known as manufacturing loss

• In cases where there is such a profit it means at least part of Gross Profit is attributable to
the fact that we chose to manufacture products instead of purchasing inventory for resale

• In such instances the business may opt to use the market value [expected purchase price] of
the goods instead of the cost of production in the calculation of Cost of Sales

• Once the Gross Profit (Loss) is calculated the gross profit (loss) on manufacturing is added
{subtracted back) to the gross profit

• The Net Profit is not affected

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Proforma

Name of business’

Manufacturing account for the year ended 31 December 20x1

Raw materials:
Opening stock xx
Add purchases xxx
Freight on raw materials xx
Import duty x
Carriage inwards x
Railage inwards xx
xxx
Returns inwards [xx]
xx
xxx
Closing inventory [xx]
Cost of raw materials consumed xx
Add Direct Labour xx
Royalties x
xx
Prime Cost xxx
Add Factory overhead
Indirect labour xx
Factory supervision x
Factory electricity and water xx
Provision for depreciation for plant and machinery xx
Factory repairs and maintenance x
xx
Production cost of goods c/d (transferred to Trading account) xxxx

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Name of business’

Manufacturing account for the year ended 31 December 20x1

Raw materials:
Opening stock xx
Add purchases xxx
Freight on raw materials xx
Import duty x
Carriage inwards x
Railage inwards xx
xxx
Returns inwards [xx]
xx
xxx
Closing inventory [xx]
Cost of raw materials consumed xx
Add Direct Labour xx
Royalties x
xx
Prime Cost xxx
Add Factory overhead
Indirect labour xx
Factory supervision x
Factory electricity and water xx
Provision for depreciation for plant and machinery xx
Factory repairs and maintenance x
xx
opening work in progress xx
closing working progress [x]]
xx
Production cost of goods c/d (transferred to Trading account) xxxx

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• These is just a typical template if items shown here are not in the question then you can
omit them altogether. For example, in the first year of manufacturing there is no opening
stock of raw materials so don't show an empty line simply omit the entire raw materials. You
can also omit Import duty where there is no import duty.

• This is a simple manufacturing account where there is no work in progress.

• You can also add or remove overhead costs depending with the question

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