Manufacturing Account-Ref.
Material
Syllabus
Manufacturing accounts with subheadings for prime cost, factory overhead, work in
progress and production cost.
Allocation and apportionment of costs between products and functions
Unrealised profit resulting from goods manufactured
Manufacturing account is prepared by the manufacturer. It is prepared to calculate the cost of
production incurred at the various stages of production. It enables the manufacturer to know the
total cost of production as well as cost per unit. By manufacture, we mean, conversion of raw
materials into finished products.
Classification of costs:
Cost is the aggregate amount of expenditure. Mainly there are three elements of
costs, Material, Labour and Overheads. For the purpose of manufacturing accounts these costs
can be classified into two, viz, direct cost and indirect cost.
a) Direct costs: These are costs incurred at the primary level of production. In other words,
the items of costs which can be directly identified to a product are called direct costs.
Therefore the total of all direct costs is known as prime cost. For e.g.: Cost of wood used
for the manufacturing of furniture, the carpenter’s wages, cost of fish in a tuna
processing unit, etc
b) Indirect costs: Expenses which cannot be identified directly to a product are called
indirect costs. In other words, these are common costs, apportioned or allocated among
the units of production. These are the secondary level costs and that is why they are
collectively known as overheads. For e.g.: Supervisors salary, electricity, depreciation on
factory equipments etc.
The following chart illustrates the classification of costs:
Material Labour other expenses
Direct Indirect Direct Indirect Direct Indirect
Prime cost
Overheads
Factory Office & administration Selling & distribution Financial
(Pre-production expenses) (Post-production expenses)
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Manufacturing Account-Ref.Material
Preparation of a manufacturing account:
A manufacturing account shows the total cost of production when the product comes out
of the factory. Such cost of production is calculated by means of a manufacturing account.
Usually to know the costs at different stages, they are classified into the following categories:
a) Prime cost: It is the total of all costs at the primary level. In other words it is the total of direct
material, direct labour and direct expenses.
b) Factory cost of production: it is the total of prime cost and factory overheads (any indirect
expenses incurred in factory). The total cost of production will be transferred to the Trading
section of the statement of profit or loss and other comprehensive income.
(All overheads, excluding the factory, are transferred to the profit and loss section of the
statement of profit or loss and other comprehensive income account)
Important
The order of items shown in manufacturing account
Cost of raw materials consumed (Direct material)
Direct labour (Production wages/ Factory labour)
Direct expenses (Royalty/import duty)
Factory overheads (all factory indirect expenses)
Prime cost = Direct material + Direct labour + Direct expenses
Cost of production = Prime cost + factory overheads
Work-in progress:
It refers to the semi-finished product. In other words, it is the amount of cost spent on
partly finished products. So as to arrive at the precise cost of production, the value of work-in
progress is treated in the manufacturing account as follows :( prudence and matching concept
of accounting). For accounting, the cost of opening work-in progress is added to the works cost,
where as closing work-in progress is deducted, so as to arrive at the actual cost of production.
Cost –Cost centre - Cost unit – Cost per unit
Cost is the aggregate amount of expenditure for the production of goods and services
Cost centre is the person, department or activity by whom/which the cost can be directly
allocated to a product
Cost unit is the unit by which cost can be calculated. It may be a countable unit, meter,
kilogram, liter, mile etc
Cost per unit is the cost of production per unit at which it is transferred to the trading
section. it may be with or without adding a certain percentage of profit.
Cost per unit = Total cost of production/transfer price
Number of units produced
Apportionment of expenses/overheads:
The overheads, also known as indirect costs shall be apportioned or allocated to different
sections benefiting from this. For allocation, different criteria may be applied such as floor area,
cost of machinery, volume of revenue, number of employees etc.
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Manufacturing Account-Ref.Material
Specimen:
Manufacturing account for the year ended…………………..
$ $
Opening inventory of raw materials xxx
Add Purchase of raw materials xxx
,, Carriage/ Freight xxx
XXX
Less Materials lost/ returned xxx
,, Closing inventory of raw materials xxx (xxx)
Cost of raw materials consumed (or Direct Materials) XXX
+ Direct Labour / manufacturing wages xxx
+ Direct expenses / charges/ royalty xxx
PRIME COST XXX
+ Factory Overheads:
Indirect materials xxx
Factory lighting / heating xxx
Production manager’s salary xxx
Crane driver’s salary xxx
Grease waste water etc xxx
Foreman’s salary xxx
Cleaning charges xxx
Factory rent and rates xxx
Lift operating expenses xxx
Depreciation on Non-current assets(factory) xxx
Any other factory expenses xxx xxx
Works Cost/Factory cost XXX
Add opening inventory of work-in-progress xxx
Less closing inventory of work-in-progress (xxx)
COST OF PRODUCTION xxx
Add profit on cost(mark-up) xx
(transferred to Trading section of Income statement) XXXX
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Manufacturing Account-Ref.Material
Manufacturing profit/Factory profit
Some businesses transfer their products from the factory to the cost of sales in the statement of
profit or loss and other comprehensive income, at the production cost. This replaces the
‘purchases’ while calculating cost of sales.
However, certain manufacturing businesses add an assumed profit to the cost of production,
calculated in the manufacturing account. In other words, the cost of production is added with
certain mark-up to arrive at the transfer price.
Objectives of adding assumed profit to cost of production
It enables to compare the cost of production with market price
It helps to decide whether to produce or buy based on the cost of production
It helps the manufacturing department not to sacrifice their efficiency to marketing/sales
department
The manufacturing profit added to the cost of production will be added to the profit calculated in
the statement of profit or loss and other comprehensive income, to arrive at the actual profit
Treatment of unrealized factory profit included in closing inventory
When completing the statement of profit or loss and other comprehensive income, the
factory profit included in the closing inventory will have been overstated by the value of
the factory profit.
According to the realisation concept of accounting profit cannot be recognized until
product is sold to customers.
Therefore, factory profit if any included in the closing inventory of finished goods shall be
calculated and provided for as unrealized profit to arrive at the actual profit. (Otherwise
the closing inventory will be overstated leading to a overstated profit and current asset
value)
The unrealised profit must be removed from the statement of profit or loss and other
comprehensive income and the overvalued closing inventory must be adjusted in the
statement of financial position.
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Manufacturing Account-Ref.Material
The amount of unrealised profit is calculated:
%
Unrealised profit = x Value of closing inventory
%
It is only the difference in provision (opening and closing) for unrealised profit that is
accounted for in the statement of profit or loss and other comprehensive income.
if the provision for unrealised profit has increased, this represents expense to the
business and if it has decreased, it will be other income (like the provision for doubtful
debts)
Advantages of adding factory profit Disadvantages of adding factory profit
Allows the business to identify the profits Profit levels are probably not set with any
made by different cost centres. degree of accuracy
It allows a common comparison to be made The factory profit should equate to the profit
directly with possible suppliers of the product, earned by possible suppliers and this might
as their price include a profit element. not be available
(comparison with market rate)
Manufacturing profit is separated from the Overall profit is not different.
trading operations of the business
Efficiency of production department is not Overall efficiency of the business is to be
sacrificed to the inefficiency of selling and analyzed.
distribution section.
Provision for unrealised profit on inventory
$ $
Balance b/d xx
Income statement (as income) xx Income statement(as expense) xx
(if opening balance >closing (if closing balance >opening
balance) balance)
Balance c/d xx
xxx xxx
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