Manufacturing accounts

Last time

Before we start: last time, in Limited companies, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Making, not just buying

A trader buys goods and resells them. A manufacturer buys raw materials and turns them into products. So a manufacturer needs an extra account to find the cost of making its goods. That is the manufacturing account.

Three kinds of inventory

Raw materials: what the goods are made from, such as cloth or wood. Work in progress: goods partly made at the year end. Finished goods: goods completed and ready to sell. All three are current assets.

Direct and indirect costs

Direct costs can be traced to each product: direct materials, direct labour such as machine operators, and direct expenses such as royalties. Prime cost is the total of direct costs. Indirect costs, or factory overheads, cannot be traced to each unit: factory rent, supervisors' wages, factory power, and machine depreciation.

Raw materials used

Raw materials used is opening inventory of raw materials, plus purchases of raw materials, minus closing inventory. With opening 3,000, purchases 21,000 and closing 4,000, raw materials used are 20,000 dollars. Carriage on raw materials is added to their cost.

A manufacturing account, worked

Raw materials used, 20,000, plus direct labour, 15,000, gives prime cost of 35,000. Add factory overheads of 9,000: 44,000. Add opening work in progress of 2,000 and subtract closing work in progress of 1,000: cost of production is 45,000.

Where cost of production goes

The cost of production replaces purchases in the income statement. Cost of sales is opening finished goods, plus cost of production, minus closing finished goods. Administration and selling expenses, such as office salaries and delivery costs, go in the income statement, not the manufacturing account.

Factory or office?

Some costs are shared, such as rent for a building that is part factory and part office. They are split in a given ratio: the factory part is an overhead; the office part is an expense in the income statement. Read the question carefully for the ratio, such as three quarters factory.

Why keep a manufacturing account?

It shows the cost of making the goods, so prices can be set to cover costs. It shows each element of cost, so managers can control them. And it lets the business compare the cost of making with the cost of buying the goods in.

Mistakes that lose marks

Mistake one: putting office salaries in factory overheads. Mistake two: adding closing work in progress instead of subtracting it. Mistake three: forgetting to split a shared cost between factory and office. The fix: direct, then overheads, then adjust for WIP.

The full-marks tip

The full-marks tip: build up cost of production in order: raw materials used, prime cost, overheads, then the work-in-progress adjustment. Put factory costs in the manufacturing account and office costs in the income statement.

On one card

So, on one card: manufacturing accounts. Keep it for revision.