Manufacturing Account

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Manufacturing AccountManufacturing Account

•This is an account prepared by a firm that manufactures (makes) goods. If a firm manufactures more than one product than they will prepare separate manufacturing accounts for each of the products.

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Why do they make them?Why do they make them?

•The aim of a manufacturing account is to calculate the factory cost of production and hence find the profit earnt on manufacturing goods rather than purchasing them. There is great emphasis on the order and nature of costs which constitute the factory cost of the product.

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Production CostProduction Cost

Production cost = Prime cost / Direct cost + Factory overhead

expenses / Indirect cost

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1. Direct materials • Costs of the materials used during the period.• Include the purchase price of the raw materials and

the acquisition costs related to the purchase.• Examples: Purchase of raw materials

Carriage inwards / freight charges on raw materials

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2. Direct labour• Wages paid to the people who are directly involved

in the manufacturing process.• Example: Direct labour, Direct wages, Factory

wages, Production wages, Manufacturing wages

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3. Direct expenses• They refer to the expenses paid according to each

unit of production.• Examples: Royalties

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Factory Overhead Expenses / Indirect Costs Factory Overhead Expenses / Indirect Costs Cost incurred in the manufacturing process, but they

cannot be traced directly to the goods being produced. Include indirect materials, indirect labour and indirect

expenses. Examples:

Indirect materials– Lubricants– Loose tools (opening balance + purchase – closing

balance)Indirect labour– wages, salaries, bonus or commission to cleaners, crane

drivers, foremen, supervisors and production managers.

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Indirect expenses related to the factory, machinery and vehicles

– Rent and rates– Depreciation– Insurance– Repairs and maintenance– Factory power / electricity– Loss on disposal

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Gross Works Cost of Production : This is the total of prime cost and factory overheads.

Work-in-Progress : These are Partly finished goods. Cost of Production : Also called Net Works Cost of

Production, this is the Gross Works Cost of Production plus the cost of work-in-progress at start and less work-in-progress at end. Proceeds of by-products, scrap and rejected materials, if any, are subtracted to arrive at the cost of production.

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Factory Profit and Transfer PriceFactory Profit and Transfer Price

Calculating the Cost of Production is not the last step. We than have to make our Income Statement and calculate our Net Profit.

So the Cost of Producing the goods is transferred to the Trading Account under the heading - Cost of Goods Sold.

The Method we use to transfer our Cost of Production is at a mark-up.

The mark-up percentage*Cost of Production = Factory Profit. Factory Profit + Cost of Production = Transfer Price. Factory Profit is credited in the Income Statement.

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Manufacturing AccountManufacturing Account It shows the production cost or transfer price of

goods completed during the accounting period.1. Direct materials2. Direct labour3. Direct expenses4. Factory overhead expenses5. Work in progress6. Manufacturing profit / loss

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Income StatementIncome Statement

This account shows the gross profit or loss resulted from the trading of manufactured and other purchased goods.

The account includes:SalesCost of goods sold– Manufactured goods – Other goods purchased

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Profit or loss of the whole business during the accounting period.

Includes all the expenses and income related to the office and the running of the whole business such as:

Gross profit / loss from the trading accountManufacturing profit / loss

Administration expenses

Selling and distribution expenses

Increase / decrease in the provision for unrealized profit

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Some expenses are related to both the manufacturing process and the administration of the office such as:

Rent and ratesElectricityInsuranceDepreciation on premisesMotor vehiclesMotor vehicles expenses

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These expenses should be allocated to the factory and office and debited to the manufacturing account and the income statement respectively.

The bases of allocation are usually given in the examination questions.

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Format of Manufacturing Account and Income

statement

Format of Manufacturing Account and Income

statement

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Manufacturing Income statement for the year ended 31 Dec XXXX

$ $Opening inventory of Raw Materials XAdd: Purchases of Raw Materials X Carriage inwards XLess: Closing inventory of Raw Materials (X)Cost of Raw Materials Consumed XDirect Labour XRoyalties XPrime Cost XFactory Overhead Expenses:

Loose Tools (opening bal. + purchases –closing bal.) XRent (e.g. 25%) XProduction Manager’s salaries XFactory Power XMaintenance of plant & Machinery X

Depreciation of Plant & Machinery X X X

Direct material

Direct labour

Direct Expenses

Overhead

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Add: Opening Work in Progress XLess: Closing Work in Progress XProduction Cost of Goods Completed XFactory profit/(loss) XTransfer price of Goods Completed X

$ $

Sales XLess: Returns inwards (X) XLess: COGS

Opening inventory of finished goods X Production cost/Transfer price of Gds completed X

Less: Returns outwards (X)Less: Closing inventory of finished goods (X) Cost of Sales X

Gross Profit XAdd: Discount Received X X

The goods are transferredto trading a/c at productioncost/ transfer price

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$ $Less: Expenses

Carriage Outwards XRent (e.g. 75%) XDiscount allowed XAdministration Expenses XDistribution Expenses XSelling Expenses XDepreciation of Delivery Van X

X Net Profit on Trading X Add : Manufacturing Profit XLess : Increase in Provision for Unrealised Profit (X) X

Net Profit X

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Production Cost Vs.

Transfer Priceof Goods Completed

Production Cost Vs.

Transfer Priceof Goods Completed

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Inventory of raw materials, work in progress and other finished goods are valued at cost.

However, the inventory of manufactured goods can be valued at production cost or the transfer price of goods completed.

Provision of unrealized profit on inventory should be made if closing inventory of manufactured goods is valued at transfer price.

Production cost Vs. Transfer priceProduction cost Vs. Transfer price

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Provision of Unrealized ProfitProvision of Unrealized Profit

Be made on the closing inventory valued at production cost plus a percentage of factory profit.

Provision for unrealized profit Mark up% 100%+ Mark up(%)= Inventory (at transfer price) x

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Example 1Example 1

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A company manufactures and sells it own products.It also purchases and sells other finished goods.

Production 100 units $1@ $100 Sales 80 units $2@ $160Closing stock 20 units $1@ $20Expenses for this period $50

Prepare manufacturing, trading and profit and lossaccount for the following 2 situations would beshown:

1. The factory output is transferred to the trading account at factory cost.

2. The factory output is transferred to the trading account at factory cost plus 20% factory profit, and the stock of manufactured goods is valued at transfer price.

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1.

$ $

Production cost of Good completed (100 units*$1) 100

Sales (80 units*$2) 160

Less: COGS

Production cost of Goods completed 100

Less: Closing inventory(at cost) (20 units*$1) 20 80

Gross Profit 80

Less: Expenses

Expenses 50

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Manufacturing, income statement(extract)

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2.$ $

Production cost of Goods completed (100 units*$1) 100Add: Manufacturing profit (100*0.2) 20Transfer price of Goods completed 120Sales (80 units*$2) 160Less: Cost of goods sold Transfer price of Goods completed 120Less: Closing stock(at transfer price) (20+20*0.2) 24 96Gross Profit 64Add: Manufacturing profit 20

84Less: Expenses Expenses 50 Provision for unrealized profit (24*20/120) 4 54Net Profit 30

Cost + profit

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Increase in Provision Decrease in Provision

Dr Income statementCr Provision for Unrealized Profit

Dr Provision for Unrealized ProfitCr Income statement

Accounting entries

Increase/ Decreased in Provision of Unrealized Profit

Increase/ Decreased in Provision of Unrealized Profit

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Example 2Example 2

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Goods manufactured are to be transferred to sales department at factory cost plus 20%.

2008 2009 2010 $ $ $

Inventory at 1 Jan (at transfer price) - 2,400 3,600Inventory at 31 Dec (at transfer price)2,400 3,600 3,000

Prepare the provision for unrealized profit account, profitand loss account and balance sheet respectively for thethree years

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Provision for unrealized profit2008 $ 2008 $Dec 31 Bal c/d (2400*20/120) 400 Dec 31 Income statement 400

Income statement (extract)

08 $ $

Gross Profit X

Less: Expenses

Increase in provision for unrealized profit

400

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Provision for unrealized profit2008 $ 2008 $Dec 31 Bal c/d (2400*20/120) 400 Dec 31 Income statement 400

2009 2009Dec 31 Bal c/d (3600*20/120) 600

Jan 1 Bal b/d 400Dec 31 Income statement 200

600 600Income Statement (extract)

08 $ $

Gross Profit X X

Less: Expenses

Increase in provision for unrealized profit

09 $ $

400 200

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Provision for unrealized profit2008 $ 2008 $Dec 31 Bal c/d (2400*20/120) 400 Dec 31 Income statement 400

2009 2009Dec 31 Bal c/d (3600*20/120) 600

Jan 1 Bal b/d 400Dec 31 Income statement 200

2010 2010

600 600

Jan 1 bal b/d 600

Dec 31 Bal c/d (3000*20/120) 500

Dec 31 Income statement 100

600 600

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Income statement (extract)

08 $ $

Gross Profit X X XAdd: Decrease in provision for unrealized profit 100

Less: Expenses

Increase in provision for unrealized profit

09 $ $

10 $ $

400 200

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Balance Sheet ExtractsBalance Sheet Extracts

For the year ending 31 Dec 2008: Current assets $ $ Inventory of:

Raw materials X Work in progress X

Finished goods 2400 Less Provision for unrealized profit (400) 2000

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For the year ending 31 Dec 2009: Current assets $ $ Inventory of:

Raw materials X Work in progress X

Finished goods 3600 Less Provision for unrealized profit (600) 3000

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For the year ending 31 Dec 2010: Current assets $ $ Inventory of:

Raw materials X Work in progress X

Finished goods 3000 Less Provision for unrealized profit (500) 2500