A Different Approach Tuition Limited (ADApT)
April 6th 2011
So here we are in April 2011! Exams are literally right around the corner. It’s been uncanny how time has flown
so quickly … but I guess what they say is true, “Time flies when you’re having fun.” ^_^ I hope that you’ve been
learning a lot and have been enjoying the learning process.
This is one of the last topics we have to cover before we start the past papers blitz. The other major topics we
need to do are: Non-Profit Organizations (Income and Expenditure accounts), and Incomplete records. Stock
Valuation, Petty cash and Employees’ pay are minor topics that we’ll cover when we’re doing past papers.
Anyway guys, let’s get to it. I have not created my own review questions for this topic. We’ll just be tackling
past paper questions (there are about 8 of them). Let’s focus and get this done in two (2) sessions.
Regards,
Chris
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chris@adapttuition.com
A Different Approach Tuition Limited (ADApT)
Manufacturing accounts
April 6th 2011: -
Introduction
Up till this point in your accounting career you have only encountered the financial statements for trading companies, i.e.
companies that buy and sell goods (stock/merchandise) as their major line of business. Hopefully you would have
wondered at some point in time, “Where do these goods come from?” If you thought about it even a little you would have
probably come to the conclusion that these goods had to have been made (created/manufactured/produced) by some
company before they could be sold.
The entities that create these goods are called “manufacturers”.
So hopefully you are wondering, “Ok… so… what’s the new stuff that I have to learn in this topic?”
The simple answer is, “How to draw up a Manufacturing account.” This account is used to calculate the cost of the goods
manufactured (produced) for a financial period. If you’re wondering why this is important or necessary let’s just back-track
a little bit to get our brains in gear.
Q: What‘s the major point of getting into business?
A: To make (maximum) profit.
Q: How do we calculate profit?
A: Revenues – expenses (costs)
Now, new stuff:
Since manufacturers will be making their own goods (called finished goods) they will not be purchasing finished goods.
Therefore there will be no “Purchases” figure in the Trading account (oh noez :-O).
This means that our “expenses” figure in the profit calculation needs to be modified (i.e. the purchases figure needs to be replaced).
Since the manufacturer will be producing goods we can safely assume that there will be some costs attached to the
manufacturing process. It is these costs of production that will be used to replace the purchases figure in the Trading
account (please see the comparative tables below).
Trading Entity
Trading account
Manufacturing Entity
Trading account
$
$
Net Sales
Less Cost of Goods Sold
Opening stock
add Net Purchases
Cost of Goods available for sale
less Closing Stock
Cost of Goods Sold
Gross Profit
$
x
Net Sales
x
x
Less Cost of Goods Sold
Opening stock of finished goods
add Cost of Goods Manufactured
Cost of Goods available for sale
less Closing Stock of finished goods
Cost of Goods Sold
Gross Profit
x
x
x
x
$
$
$
x
x
x
x
x
x
x
As can be seen in the above tables the “Net purchases” figure is replaced by the “Cost of Goods Manufactured” figure.
The calculation of the cost of goods manufactured will be the major focus of this chapter.
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chris@adapttuition.com
A Different Approach Tuition Limited (ADApT)
The Manufacturing account (basics)
The manufacturing account will have three (3) major items in it:



Prime Costs: - all direct costs of production (materials, labor, and other)
Overheads: - all indirect costs of production (materials, labor, and other)
Work in Progress adjustment
Don’t panic if these items seem strange and unknown, I’ll explain them all.
Firstly, let’s acknowledge that if we’re making a product most likely we’re going to need some sort of raw materials. For
example, if you’re making a mobile phone you’ll probably need plastic, circuit boards, and other components that physically
become part of the phone.
Secondly, we may need some sort of labor (a person) to physically put the phone together. Now I know that you’re probably
saying, “Sir, machines put the phones together!” and you’re probably right, but for the sake of simplicity let’s say that
people physically put these phones together.
Now: IMPORTANT
Any costs attached to materials, labor, and anything else that physically goes into the product or the efforts of which can
be seen in the finished product are referred to as DIRECT COSTS.
The sum total of all direct costs is referred to as PRIME COST OF PRODUCTION (or just prime cost)
Thirdly, let’s acknowledge that there are other costs that are incurred in the production process like rental fees of the factory,
depreciation of machinery, salary of workers not involved in the production process, cost of cleaning supplies, etc. Now if
we didn’t pay these costs then we would probably not be able to engage in manufacturing, so they are included as part of
the costs of manufacturing.
But these items (material, labor, etc) do not end up as part of the finished product.
Any costs that are attached to such items are referred to as INDIRECT costs or OVERHEADS and are added to the cost of
production AFTER we find prime costs.
Work in progress adjustment
Work in progress (WIP) refers to goods that were started in production but were not completed by the end of the production
period. This adjustment is actually very simple:
Opening stock of WIP is added to the production costs (Prime costs + overheads) and Closing stock of WIP is subtracted.
The reasoning behind this will be explained a bit later on, but right now I want to show you an example of the
manufacturing account and get you familiar with the working/format involved.
Suffice it to say that if you remember which WIP to add and which to subtract you’ll be safe :-)
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A Different Approach Tuition Limited (ADApT)
Example 1(a) The Manufacturing account
You are given the following list of balances and are asked to draw up a manufacturing account for H. Ouseman Ltd.
Opening Stock of:
Raw Materials
Work in Progress
Finished Goods
Closing Stock of:
Raw Materials
Work in Progress
Finished Goods
$
5,000
6,000
7,000
8,000
9,000
10,000
Purchases of Raw Materials
Carriage in on Raw Materials
Returns outward of Raw Materials
150,000
1,000
5,000
Direct Labor (Factory wages)
Other Direct Costs
250,000
10,000
Supervisor's Salary
Indirect Factory wages
Depreciation of factory machinery
Factory cleaning expenses
25,000
50,000
30,000
15,000
Administrative expenses
Advertising
45,000
75,000
Rental (80% to factory, 20% to office)
Power (75% to factory, 25% to office)
120,000
180,000
Notes:

Only manufacturing (factory) costs are included in the manufacturing account. So in this example
administrative costs and advertising are examples of items that are included in the information but are NOT to
be put into the manufacturing account

Rental and power are examples of expense items that are incurred by both the manufacturing and nonmanufacturing operations of the company. You will be given some way to apportion them (percentages, ratios,
and fractions being the most popular methods given).

The supervisor’s salary is treated as an indirect production cost because it is assumed that the supervisor is not
directly involved in the production process.
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A Different Approach Tuition Limited (ADApT)
H. Ouseman Ltd
Manufacturing a/c
for the year ended December 31st 2010
$
Cost of Raw Materials Consumed
Opening Stock
Purchases
Carriage Inward
Returns Outward
Net Purchases
Cost of Raw Materials Available
Closing Stock
Cost of Raw Materials Consumed
Direct Labor (Factory wages)
Other Direct Costs
Prime Costs
Overheads
Supervisor's Salary
Indirect Factory wages
Depreciation of factory machinery
Factory cleaning expenses
Rental (80% of $120,000)
Power (75% of $180,000)
Total Overheads
Production costs incurred
Adjustment for Work In Progress
add work in progress at start
less work in progress at end
Cost of Goods Manufactured
Notes:

$
$
5,000
150,000
1,000
151,000
(5,000)
146,000
151,000
(8,000)
143,000
250,000
10,000
403,000
25,000
50,000
30,000
15,000
96,000
135,000
351,000
754,000
6,000
(9,000)
(3000)
751,000
The calculation of the cost of raw materials consumed is exactly the same as the cost of goods sold calculation.

Other direct costs include such items as royalties, copyright/trademark fees, franchise costs, license fees. These
are costs that are paid for permission to use the product or brand name and are considered as direct costs because
the brand/trademark, etc. is directly identifiable with the product.

The overheads section resembles the “less Expenses” section in the Profit/Loss account. It is simply a list of costs
that are added up. The major difference is that in this case the total is added, not subtracted. Also note
that sometimes the questions may have costs/expenses that have accrued/prepaid components (you didn’t think
you’d seen the end of that did you?).

The cost of goods manufactured can also be called production cost of goods completed, or manufacturing cost of
goods completed.

This total is transferred to the trading account (this is shown below).
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chris@adapttuition.com
A Different Approach Tuition Limited (ADApT)
Example 1(b) The Income Statement (post-manufacturing)
Given that the sales revenue for H. Ouseman Ltd. was $1,500,000 you are required to prepare the Income Statement for the
year ended December 31st, 2010.
H. Ouseman Ltd
Trading and Profit and Loss a/c
for the year ended December 31st 2010
$
Sales
$
1,500,000
Less Cost of Goods Sold
Opening stock of finished goods
(7,000)
Cost of Goods Manufactured
(751,000)
Cost of Goods Available for Sale
(758,000)
Closing stock of finished goods
10,000
Cost of Goods Sold
(748,000)
Gross Profit
752,000
Less Expenses
Administrative expenses
(45,000)
Advertising
(75,000)
Rental (20% of $120,000)
(24,000)
Power (25% of $180,000)
(45,000)
(189,000)
Net Profit
563,000
As can be seen in the above statement the “Cost of Goods Manufactured” replaces the “Purchases” figure that would
normally be seen in Trading entities’ trading accounts.
Apart from that the Trading and Profit and Loss account is essentially the same for manufacturing entities as it is for trading
entities.
The only financial statement left to be seen is a Balance Sheet. The only real difference that a manufacturing entity’s balance
sheet will have is that in the Current Asset section there will be three items for closing stock (see the table below):
Balance Sheet Extract
Current Assets
Stock
Raw Materials
Work in Progress
Finished Goods
$
$
8,000
9,000
10,000
27,000
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chris@adapttuition.com