Manufacturing Businesses (Copy)

Chapter 20: Manufacturing Account

Introduction to Manufacturing Accounts

• A manufacturing business produces goods rather than purchasing and reselling them.
• Manufacturing accounts record production costs to determine the total cost of manufactured goods.
• These accounts are prepared before the Statement of Profit or Loss.
• Manufacturing accounts replace the purchases figure in the trading section with the cost of goods manufactured.
• Three types of inventory must be considered:
  1. Raw materials – materials before production.
  2. Work-in-progress (WIP) – partially completed products.
  3. Finished goods – completed products ready for sale.

20.1 Components of a Manufacturing Account

1. Prime Cost Calculation

• Prime cost consists of direct costs:
  • Direct materials (e.g., raw materials used in production).
  • Direct labor (e.g., factory workers’ wages).
  • Direct expenses (e.g., royalties paid per unit produced).
• Formula:

  Prime Cost = Direct Materials + Direct Labour + Direct Expenses
  

• Example Calculation:
  • Raw Materials Consumed: $50,000
  • Direct Labor: $20,000
  • Direct Expenses: $5,000
  • Prime Cost:

    50,000 + 20,000 + 5,000 = $75,000
    

2. Factory Overheads and Manufacturing Cost

• Factory overheads include indirect costs related to production:
  • Indirect materials (e.g., cleaning materials for machinery).
  • Indirect labor (e.g., factory supervisors, maintenance staff).
  • Factory overhead expenses (e.g., depreciation, rent, electricity, insurance).
• Formula:

  Factory Cost = Prime Cost + Factory Overheads
  

• Example:
  • Prime Cost: $75,000
  • Factory Overheads: $30,000
  • Total Factory Cost:

    75,000 + 30,000 = $105,000
    

3. Work-in-Progress (WIP) Adjustments

• WIP represents goods that are partially completed.
• The formula accounts for the opening and closing WIP:

  Cost of Goods Manufactured = Factory Cost + Opening WIP - Closing WIP
  

• Example:
  • Factory Cost: $105,000
  • Opening WIP: $10,000
  • Closing WIP: $8,000
  • Cost of Goods Manufactured:

    105,000 + 10,000 - 8,000 = $107,000
    

20.2 Transfer Pricing and Factory Profit

• Transfer Pricing: Some companies treat the factory as a separate unit selling to the sales department at a markup.
• The transfer price includes a factory profit margin:

  Transfer Price = Factory Cost of Goods Manufactured + Factory Profit
  

• If a factory profit of 20% is applied to a cost of $107,000:

  Factory Profit = 20% of 107,000 = $21,400
  

  Transfer Price = 107,000 + 21,400 = $128,400
  

20.3 Statement of Profit or Loss Adjustments

• Instead of purchases, the cost of manufactured goods is used in the trading section.
• Formula for Cost of Sales:

  Cost of Sales = Opening Finished Goods Inventory + Transfer Price - Closing Finished Goods Inventory
  

• Example Calculation:
  • Opening Finished Goods: $20,000
  • Transfer Price: $128,400
  • Closing Finished Goods: $25,000
  • Cost of Sales:

    20,000 + 128,400 - 25,000 = $123,400
    

20.4 Adjusting for Unrealised Profit in Inventory

• Unrealised profit occurs if factory profits are included in closing inventory.
• To adjust, the formula removes unrealised profit:

  Unrealised Profit = (Factory Profit % / (100 + Factory Profit %)) × Closing Finished Goods Inventory
  

• Example:
  • Factory Profit: 20%
  • Closing Finished Goods: $25,000
  • Unrealised Profit Adjustment:

    (20 / 120) × 25,000 = $4,167
    

• The adjusted closing inventory becomes:

  25,000 - 4,167 = $20,833
  

20.5 Apportioning Costs Between Factory and Administration

• Some costs apply to both factory and office administration.
• Example apportionments:
  • Rent and Rates (Factory 70%, Office 30%)
  • Depreciation (Factory 60%, Office 40%)
• Example Calculation:
  • Rent Expense: $50,000
  • Factory’s Share (70%):

    50,000 × 70% = $35,000
    

  • Office’s Share (30%):

    50,000 × 30% = $15,000
    

20.6 Worked Example and Exam-Style Questions

Question 1:

• Given:
  • Opening Raw Materials: $15,000
  • Purchases: $60,000
  • Closing Raw Materials: $10,000
  • Direct Labour: $25,000
  • Factory Overheads: $40,000
• Calculate Cost of Goods Manufactured:

  Prime Cost = (15,000 + 60,000 - 10,000) + 25,000 = $90,000
  Factory Cost = 90,000 + 40,000 = $130,000
  

Conclusion

• Manufacturing accounts help track production costs effectively.
• Costs are divided into direct materials, direct labor, and overheads.
• Adjustments for work-in-progress, transfer pricing, and unrealised profits ensure accurate financial reporting.
• Correctly apportioning shared costs enhances accuracy in financial statements.
• Understanding manufacturing accounting ensures fair valuation and cost control.