5.5 Manufacturing accounts
Manufacturing firm – A business that uses raw and semi-finished materials and parts to produce finished goods for sale to customers
Manufacturing account – The first part of the income statement of a manufacturing business showing its total production costs
Direct and Indirect Costs
Direct Costs:
Definition: Costs that can be directly attributed to the production of specific goods or services.
Examples:
Direct Material: Raw materials used in the production process (e.g., wood for furniture).
Direct Labour: Wages paid to workers directly involved in manufacturing (e.g., assembly line workers)
Royalties: A royalty is a payment made to an individual or company for the ongoing use of their property, including copyrighted works, franchises, and natural resources.
Indirect Costs:
Definition: Costs that are not directly attributable to specific goods or services but are necessary for the production process.
Examples:
Factory Overheads: Costs such as factory rent, utilities, and maintenance.
Indirect Labour: Wages of supervisors or managers overseeing production.
Direct wages vs indirect wages
Direct wages is the term used to describe the cost of the wages of the people who are employed in the factory making the goods whereas indirect wages refers to the wages of those staff that are not directly involved in the manufacture of the product such as supervisors.
Key Terms and Calculations
finished goods an inventory classification that consists of fully completed products
production cost the total costs incurred in the manufacture of a product
provision for unrealised profit the profit that is not recognised until the inventory has been sold
raw materials the purchase of inventory waiting to enter the manufacturing process
transfer price the production cost of manufactured goods plus a mark-up, transferred to the trading account of a manufacturing business
work in progress partly finished goods in a manufacturing business
prime cost the total of all direct costs, materials, labour and expenses, incurred in the manufacture of a product
Direct Material:
Definition: The raw materials used directly in the manufacturing process.
Direct Material= Opening Stock of Raw Material
+Purchases of Raw Material
−Closing Stock of Raw Material
Direct Labour:
Definition: The wages paid to workers who are directly involved in the production of goods. e.g. total wages of production workers.
Prime Cost:
Definition: The total of direct costs involved in production.
Calculation: Prime Cost= Direct Material + Direct Labour
Factory Overheads:
Definition: Indirect costs related to manufacturing. e.g depreciation of factory equipment, factory rent, utilities.
Work in Progress (WIP):
Definition: Partially finished goods that are still in the production process at the end of the accounting period.
Adjustment: opening WIP - closing WIP in the manufacturing account.
Factory Cost of Production
Calculation:
Calculate Prime Cost. 2 Add Factory Overheads. 3. Adjust for Work in Progress.
Factory Cost of Production=Prime Cost +Factory Overheads +Opening WIP−Closing WIP
Preparing Manufacturing Accounts
Steps:
Direct Materials:
Opening stock of raw materials
Add: Purchases of raw materials
Less: Closing stock of raw materials
Direct Labour: Total wages of production workers
Prime Cost: Direct materials + Direct labour
Factory Overheads: Total of all indirect costs related to manufacturing
Work in Progress: Adjust for opening and closing WIP
Factory Cost of Production: Prime Cost + Factory Overheads + Opening WIP - Closing WIP
Statement of Profit or Loss (Income Statement):
Gross profit calculation: Sales - Cost of Sales (COS)
COS calculation includes factory cost of production and adjustments for finished goods inventory.
Statement of Financial Position:
Include assets (current and noncurrent), liabilities (current and long-term), and equity.
Reflect factory cost of production in inventory valuation.
Practice Question
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