Topic: Manufacturing Account
Subtopic: Cost Classification
Manufacturing Account
Manufacturing accounts tend to be produced for internal use by the owners and managers and are
rarely shown to other people outside the organization. The manufacturing account is prepared to
show the production cost of making goods. These costs build up starting with the direct
materials, direct labour and direct expenses to give us the prime cost. Indirect manufacturing
costs, also known as factory overheads, are then added to give the production cost of
manufacture. The production cost is then shown in the trading account Total cost of
manufacturing.
Direct Cost (prime cost)
direct cost or prime cost are directly related to the manufacturing of the units of products. There
are two major cost elements that comprise the direct cost of manufacturing- raw materials and
labour.
Elements of Direct Cost
Raw Materials- is termed a direct cost because it is essential to the making the final product.
The raw materials are the items that can be directly traced to the final product
for example when we think of making a cake the obvious items needed are: the flour, sugar,
butter and eggs. These would therefore be the raw materials needed.
The computation of cost raw materials used or consumed is illustrated below:
Items $
Opening stock of raw materials 3,000
Add: purchase of raw materials 12,000
Total raw materials 15,000
Less: Closing stock of raw materials (5,000)
Cost of raw material consumed 10,000
Labour
In order to make the cake we will need someone to physically put the raw materials together.
This is the labour needed in production. Only the labour that can be actually attributed to the
manufacturing of the finished goods is deemed as direct labour. So the person can charge labour
for cake making at per pound.
Other Direct Expense
These are other expenses that can be incurred while producing goods. Such as royalties and
patents, Coca-Cola, cannot be bottled locally without payment of said fee.
Computing Prime Costs
Continuing the same example from above
Items $
Opening stock of raw materials 3,000
Add: purchase of raw materials 12,000
Total raw materials 15,000
Less: Closing stock of raw materials (5,000)
Cost of raw material consumed 10,000
Add: Direct labour 20,000
Direct expense 15,000
Prime cost 45,000
Direct cost = all direct raw material + direct labour + any other direct expense
Indirect Cost (Factory Overheads)
The second part of the manufacturing account focuses on the indirect items that are in the
manufacturing of products but cannot be traced directly back to the individual product.
In the making of the cake, we also use flavoring but there is not anyways of say exactly how
much is used or the cost per a drop.
These are the costs that are incurred in manufacturing the product, but they are no specific to it.
Indirect costs will therefore include factory electricity, depreciation of equipment and machinery
and salaries of supervisors and managers.
To continue with the example above we will add the indirect cost into the computation to get the
manufacturing cost.
$ $
Prime cost 45,000
Add: Indirect Cost
Factory electricity 1,200
Telephone 800
Factory supervisor’s salary 10,000 17,000
Total Manufacturing cost 62,000
Direct cost + indirect cost = Total Manufacturing cost
Administration expenses
Administration expenses consist of such items as managers’ salaries, legal and accountancy
charges, the depreciation of office equipment, and secretarial salaries.
Selling and distribution expense
Selling and distribution expenses are items such as sales staff salaries and commission, carriage
outwards, depreciation of delivery vehicles, advertising, and display expenses.
Finance charges
Finance charges are those expenses incurred in providing finance facilities such as interest
charged on a loan, bank charges and discounts allowed.
Work In Progress
A work in progress (WIP) account is an inventory account that includes goods that are in the
process of being produced but are not yet finished.
Working in Progress (WIP) can be classified into:
WIP at the start
WIP at the close
The work in progress at close (particularly completed goods on hand at year end) form the
manufacturer’s inventory or stock.
The stock is determined by a physical count
The cost of these partially finished units is determined by estimating the cost of the raw
materials, direct labour and overhead associated with these units.
Adding WIP to the example
$
Total manufacturing cost 62,000
Add: opening work in progress 3,000
65,000
Less: closing work in progress (5,000)
Total production cost of completed goods 60,000
Note
Total manufacturing cost is direct cost plus indirect cost
While the total production cost is direct material plus indirect cost plus work in progress.
After the total production cost of completed goods has been calculated, it is transferred from the
manufacturing account to the trading profit and loss account.
Trading account
This account includes:
• production cost brought down from the manufacturing account
• opening and closing inventory of finished goods
• sales.
When completed, this account will disclose the gross profit.
Worked example
The following information is available for the business of T. Hawkins:
SOLUTION
ACTIVITY
