Manufacturing accounts Revision Notes

Manufacturing businesses incur various costs to produce goods. These costs are classified into direct and indirect costs based on their traceability to the product.

Direct costs are expenses that can be directly attributed to the production of specific goods. The two main direct costs are:

Direct materials: raw materials that become an integral part of the finished product. For example, wood used to make furniture or fabric for clothing manufacture. The cost is measured by the quantity used multiplied by the purchase price, adjusted for any returns or discounts. Direct labour: wages paid to workers who are directly involved in making the product, such as assembly line workers or machine operators. This cost is calculated by multiplying hours worked by the hourly wage rate. Indirect costs, also called factory overheads, are costs related to production but cannot be directly linked to a specific product. Examples include factory rent, depreciation of machinery, factory utilities, and salaries of supervisors. These costs support production but are allocated across all products rather than charged to one item.

• Direct costs are traceable to specific products.
• Indirect costs support production but are not directly traceable.
• Examples: direct materials and labour vs factory rent and utilities.

Prime cost is the sum of all direct costs involved in manufacturing. It is calculated as:

Prime Cost = Direct Materials + Direct Labour This figure represents the core cost of producing goods before considering overheads.

Factory overheads (indirect costs) are added to prime cost to find the total factory cost: Total Factory Cost = Prime Cost + Factory Overheads This total reflects the full cost of production within the factory, including all expenses necessary to manufacture the goods. For example, if direct materials cost $10,000, direct labour $5,000, and factory overheads $3,000, then: Prime Cost = $10,000 + $5,000 = $15,000 Total Factory Cost = $15,000 + $3,000 = $18,000 These calculations are essential for pricing, cost control, and financial reporting.

• Prime cost includes only direct materials and direct labour.
• Total factory cost adds factory overheads to prime cost.
• Accurate calculation ensures correct valuation of production costs.

Work in progress refers to partially completed goods at the end of an accounting period. Since these goods are not finished, their costs should be accounted for separately to avoid overstating expenses.

To adjust for WIP: Add the opening WIP value to the total factory cost, representing the cost of unfinished goods brought forward.

Subtract the closing WIP value, representing unfinished goods at period end that should not be charged as expenses yet. Formula: Adjusted Factory Cost = Total Factory Cost + Opening WIP – Closing WIP For example, if total factory cost is $18,000, opening WIP is $2,000, and closing WIP is $3,000: Adjusted Factory Cost = $18,000 + $2,000 – $3,000 = $17,000 This adjustment ensures that only the cost of goods completed during the period is charged to the income statement.

• WIP represents unfinished goods at period start and end.
• Adjust factory cost by adding opening WIP and subtracting closing WIP.
• Ensures accurate cost of goods manufactured is reported.

The manufacturing account summarises all production costs and calculates the cost of goods manufactured. Its structure typically includes:

Opening raw materials plus purchases minus closing raw materials to find direct materials used.

Direct labour costs added to direct materials used to find prime cost. Factory overheads added to prime cost to find total factory cost. Adjustments for opening and closing work in progress to find cost of goods manufactured. This cost then flows into the income statement, where it is combined with other expenses and revenues to calculate gross profit and net profit. The statement of financial position (balance sheet) reflects the closing inventories of raw materials, work in progress, and finished goods as current assets. For sole traders, adjustments may be needed to account for drawings, capital introduced, or other personal transactions affecting the business financials.

• Manufacturing account calculates cost of goods manufactured.
• Income statement uses manufacturing costs to find profit.
• Statement of financial position shows inventory balances as assets.
• Adjustments for sole traders include drawings and capital changes.

Consider a sole trader manufacturing wooden tables. During the year:

Opening raw materials inventory: $4,000 Purchases of raw materials: $20,000 Closing raw materials inventory: $3,000 Direct labour: $15,000 Factory overheads: $7,000 Opening work in progress: $2,000 Closing work in progress: $1,500 Step 1: Calculate direct materials used = Opening raw materials + Purchases – Closing raw materials = $4,000 + $20,000 – $3,000 = $21,000 Step 2: Calculate prime cost = Direct materials used + Direct labour = $21,000 + $15,000 = $36,000 Step 3: Calculate total factory cost = Prime cost + Factory overheads = $36,000 + $7,000 = $43,000 Step 4: Adjust for work in progress = Total factory cost + Opening WIP – Closing WIP = $43,000 + $2,000 – $1,500 = $43,500 This $43,500 is the cost of goods manufactured and will be used in the income statement to calculate gross profit. The closing inventories of raw materials ($3,000), work in progress ($1,500), and finished goods (if any) will appear as current assets in the statement of financial position.

• Stepwise calculation ensures accuracy.
• Adjustments reflect true production costs.
• Integration into financial statements completes reporting cycle.