Manufacturing 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.

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.

Production Cost
Production cost = Prime cost / Direct cost + Factory overhead expenses / Indirect cost

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

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

3.

Direct expenses

They refer to the expenses paid according to each unit of production. Examples: Royalties

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.

Indirect expenses related to the factory, machinery and vehicles

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

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 workin-progress at end. Proceeds of by-products, scrap and rejected materials, if any, are subtracted to arrive at the cost of production.

Factory 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 markup. 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 Account
It shows the production cost or transfer price of goods completed during the accounting period.

1. 2. 3. 4. 5. 6.

Direct materials Direct labour Direct expenses Factory overhead expenses Work in progress Manufacturing profit / loss
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Income Statement
This account shows the gross profit or loss resulted from the trading of manufactured and other purchased goods. The account includes:
Sales Cost 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 account Manufacturing 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 rates Electricity Insurance Depreciation on premises Motor vehicles Motor 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

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Manufacturing Income statement for the year ended 31 Dec XXXX $ $ Opening inventory of Raw Materials X Add: Purchases of Raw Materials X Carriage inwards X Less: Closing inventory of Raw Materials (X) Cost of Raw Materials Consumed X Direct material Direct Labour X Direct labour Royalties X Prime Cost X Direct Expenses Factory Overhead Expenses: Loose Tools (opening bal. + purchases closing bal.) X Rent (e.g. 25%) X Production Managers salaries X Factory Power X Overhead Maintenance of plant & Machinery X Depreciation of Plant & Machinery X X 17 X

Add: Opening Work in Progress Less: Closing Work in Progress Production Cost of Goods Completed Factory profit/(loss) Transfer price of Goods Completed Sales The goods are transferred Less: Returns inwards

Less: COGS Opening inventory of finished goods Production cost/Transfer price of Gds completed Less: Returns outwards Less: Closing inventory of finished goods Cost of Sales Gross Profit Add: Discount Received

to trading a/c at production cost/ transfer price

$ X X X X X X (X) X

X X (X) (X) X X X X
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Less: Expenses Carriage Outwards Rent (e.g. 75%) Discount allowed Administration Expenses Distribution Expenses Selling Expenses Depreciation of Delivery Van Net Profit on Trading Add : Manufacturing Profit Less : Increase in Provision for Unrealised Profit Net Profit

$ X X X X X X X

X X X (X) X X

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Production Cost Vs. Transfer Price of Goods Completed

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Production cost Vs. Transfer price

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.
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Provision 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% = Inventory (at transfer price) x 100%+ Mark up(%)

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Example 1

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A company manufactures and sells it own products. It also purchases and sells other finished goods.
Production 100 units Sales 80 units $2@ Closing stock 20 units $1@ Expenses for this period $50 $1@ $160 $20 $100

Prepare manufacturing, trading and profit and loss account for the following 2 situations would be shown:

1. 2.

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

Manufacturing, income statement(extract) $ $ 100 160

Production cost of Good completed (100 units*$1) Sales (80 units*$2) Less: COGS Production cost of Goods completed Less: Closing inventory(at cost) (20 units*$1) Gross Profit Less: Expenses Expenses 100 20

80 80

50 30
25

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

96 64 20 84

50 4

54 30
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Increase/ Decreased in Provision of Unrealized Profit

Accounting entries
Increase in Provision

Decrease in Provision Dr Provision for Unrealized Profit Cr Income statement

Dr Income statement Cr Provision for Unrealized Profit

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Example 2

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Goods manufactured are to be transferred to sales department at factory cost plus 20%.
2008 2009 2010 $ $ $ 2,400 3,600 Inventory at 1 Jan (at transfer price) Inventory at 31 Dec (at transfer price)2,400 3,600 3,000 Prepare the provision for unrealized profit account, profit and loss account and balance sheet respectively for the three years
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Provision for unrealized profit 2008 $ 2008 Dec 31 Bal c/d (2400*20/120) 400 Dec 31 Income statement Income statement (extract) 08 $ $ X

$ 400

Gross Profit Less: Expenses Increase in provision for unrealized profit

400

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Provision for unrealized profit 2008 $ 2008 Dec 31 Bal c/d (2400*20/120) 400 Dec 31 Income statement 2009 Dec 31 Bal c/d (3600*20/120) 2009 Jan 1 Bal b/d Dec 31 Income statement

$ 400 400 200 600

600 600 Income Statement (extract)

Gross Profit Less: Expenses Increase in provision for unrealized profit

09 08 $ $ $ $ X X

400

200
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Provision for unrealized profit 2008 $ 2008 Dec 31 Bal c/d (2400*20/120) 400 Dec 31 Income statement 2009 Dec 31 Bal c/d (3600*20/120) 2009 Jan 1 Bal b/d Dec 31 Income statement

$ 400 400 200 600 600

600 600

2010 2010 Dec 31 Income statement 100 Jan 1 bal b/d Dec 31 Bal c/d (3000*20/120) 500 600

600

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Income statement (extract) 08 09 10 $ $ $ $ $ $ X X X 100

Gross Profit Add: Decrease in provision for unrealized profit Less: Expenses Increase in provision for unrealized profit

400

200

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Balance Sheet Extracts For the year ending 31 Dec 2008: Current assets Inventory of: Raw materials Work in progress Finished goods Less Provision for unrealized profit $ $ X X 2400 (400) 2000

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For the year ending 31 Dec 2009: Current assets Inventory of: Raw materials Work in progress Finished goods Less Provision for unrealized profit

$ X X

3600 (600)

3000

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For the year ending 31 Dec 2010: Current assets Inventory of: Raw materials Work in progress Finished goods Less Provision for unrealized profit

$ X X

3000 (500)

2500

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