Professional Documents
Culture Documents
MANUFACTURING ACCOUNTS
So far, we have considered the final accounts of sole traders who do not make the
goods that they sell. In all prior examples, the firms generate profits by purchasing stock
and then selling this stock for a price higher than the cost, meaning a profit has been
earned - i.e. the difference between sales and the cost of those goods that were sold. In
reality, most firms do not act in this way. Even if a firm does not make its own products,
it is likely to add something to the products themselves.
If a firm actually produces the goods that they sell then there will be no obvious
'purchases' figure to include in the trading account. The costs incurred in the production
of goods will appear instead and these will be calculated in a manufacturing account.
A manufacturing account shows the cost of producing the goods that are sold during an
accounting period.
1. Raw materials - the purchases of these will be adjusted for opening stock and
closing stock in the prime cost.
2. Work-in-progress - partly completed goods will be dealt with at the end of the
manufacturing account.
3. Finished goods - opening and closing stocks will be dealt with, as is normal, in
the trading account
All three types of closing stocks will appear as current assets on the balance sheet.
Select from the trial balance those expenses that relate to the company’s
manufacturing operation. The expenses are either direct (e.g the cost of materials from
which the goods are made, and the wages of the workers who actually make the goods)
or indirect (all other manufacturing expenses).
1. Direct material: material from which goods are made. The cost includes carriage
inwards on raw material. For example “raw material”.
2. Direct labour : the wages of the workers who actually make the goods. For
example “manufacturing wages”
3. Direct Expenses: royalties, licence fees, etc. Which have to be paid to other
persons for the right to produce their products or to use their processes. The
payment is a fixed sum for every unit of good produced.
4. Prime cost : the total of the direct costs. This description must always be shown.
5. Indirect materials: all materials purchased for the factory but which do not form
part of the goods being produced for example cleaning materials, lubricating oil
for the machinery.
6. Indirect wages: the wages of all factory workers who do not actually make the
goods for example factory managers, supervisors, stores staff, cleaners, etc.
8. Work in progress: goods in process of being made at the end of the previous
year but which were not finished are brought into the current year as an input to
this year’s production. Goods that are not completely finished at the end of the
current year must be deducted from the year’s costs in order to arrive at the cost
of finished goods.
9. Factory cost of finished goods : either these words or the alternative, cost of
production, should be shown at this point in the account.
10. Factory profit : the percentage to be added to cost of production as profit. The
amount is decided by management and will always be given in questions if
necessary. It is debited in the Manufacturing Account and credited in the Profit
and Loss Account.
11. The total of the Manufacturing Account is debited in the Trading Account under
the heading cost of sales.
It is fairly common for a manufacturing business to transfer finished goods from the
manufacturing account to trading account at a value which exceeds production cost.
This policy might be adopted for the following reasons:
(a) The business may wish to allocate its gross profit between manufacturing and
trading operations so that the extra profit earned as a consequence of making its
own products (rather than buying them in) is clearly identified.
(b) The business may sell a mixture of manufactured goods and bought-in goods. In
this case it is desirable to transfer manufactured goods between manufacturing
and trading at their market value so that the trading account is prepared on a
consistent basis.
Sample Layout of
Trading and profit and Loss Account
For the year ended 31.12.07
$000 $000
Sales xxxx
(-) Cost of sales:
Inventory (Stocks) of finished goods (1.1.07) xxx
Transfer of finished goods xxx
xxx
(-) Inventory (Stocks) of finished goods (31.12.07) (xxx)
Cost of sales xxxx
Gross profit xxxx
(-) Operating Expenses:
Selling and distribution expenses xxx
Administration expenses xxx
(xxxx)
Net profit on Trading xxxx
(+) Factory Profit xxx
(-) Unrealised Profit on closing stock of F.G (xxx)
Net profit xxxx
In manufacturing account:
Add factory profit to cost of production
Deduct factory loss from cost of production
The entries to be made for the annual adjustment to the provision are as
follows:
Increase in provision:
Debit profit and loss account
Credit provision for Unrealised profit account with the amount of the increase
Decrease in provision:
Debit provision for Unrealised profit account
Credit profit and loss account with the amount of the decrease
$000 $000
Current Assets:
(a) The opening and closing inventory of finished goods are shown in the trading
account at transfer value.
(b) The closing inventory of finished goods is shown in the balance sheet at transfer
value, less a provision for unrealized profit. The amount of this provision is equal
to the amount of manufacturing profit included in the transfer value of the
inventory.
(c) When a provision for unrealized profit is first established, the amount of the
provision is debited to the profit and loss account. In subsequent accounting
periods, only the increase or decrease in the provision is debited or credited to
the profit and loss account. The accounting treatment of a provision for
unrealized profit is very similar to that of a provision for doubtful debts.
Worked Example:
The following balances have been extracted from Makeit & Co.’s trial balance at 31
December 2004.
$000 $000
Inventory (Stock) at 1 January 2004:
Direct materials 10
Work in progress 38
Finished goods 40
Further information:
Required:
Prepare the Manufacturing, Trading and Profit and Loss Account for the year ended 31
December 2004.
Answer:
Makeit & Co
Manufacturing, Trading and Profit and Loss Account
For the year ended 31 December 2004
$000 $000
Direct materials Inventory (stock) at 1 January 2004 10
Purchases 140
Carriage inwards 24
174
Less stock at 31 December 2004 (18) 156
Direct labour 222
Direct expenses 46
Prime cost 424
Indirect materials 45
Indirect labour 72
Rent of factory 100
Heating, lighting and power 45
Depreciation: factory 20
Machinery 36 318
742
Work in progress 1 January 2004 38
Work in progress 31 December 2004 (20) 18
Factory cost of finished goods 760
Factory profit (15%) 114
Transferred to Trading Account 874
Sales 1 300
Cost of sales
Inventory (Stock) of finished goods at 1 January 2004 40
Transferred from factory 874
914
Inventory (Stock) of finished goods at 31 December 2004 60 854
Gross profit 446
Wages and salaries 173
Rent of office 90
Heating and lighting 35
Depreciation of office equipment 24 322
Net profit on trading 124
Add factory profit 114
Less Unrealised profit on closing stock of finished goods
(60-40)x15/115 3 111
Net profit 235
$000 $000
Current Assets:
Inventory(Stocks)-Direct materials 18
Work-in-progress 20
Finished goods 60
(-) Provision for Unrealised Profit (8) 90
SUMMARY: