Manufacturing accounts: practice questions

How to approach these questions

Manufacturing accounts confuse students mainly because of the vocabulary. Fix the three cost stages in your mind before you write anything. Prime cost is direct materials used, plus direct labour, plus any direct expenses.

Factory cost of production is prime cost plus factory overheads, adjusted for the movement in work in progress. The cost of the finished goods then moves into the trading section of the income statement, where it replaces purchases.

Sketch this three-step ladder at the top of your page. Every figure has to fit one of the levels, and knowing where each item goes earns the classification marks.

Begin with direct materials used. Take opening inventory of raw materials, add purchases of raw materials and carriage on raw materials, then subtract returns of raw materials and closing inventory of raw materials. For example, opening raw materials of RM8,000 plus purchases of RM25,000 minus closing raw materials of RM6,000 gives materials used of RM27,000.

Carriage inwards on raw materials belongs here and is not a general expense. Only raw material inventories enter this stage. Do not bring in finished goods or work in progress.

Add direct labour, usually the wages of the workers who make the goods, and any direct expenses such as royalties, to reach prime cost. Then add factory overheads. These are the indirect factory costs: factory rent, factory power, depreciation of factory machinery, indirect wages such as supervisors' pay, and factory insurance.

The key skill is telling direct from indirect, and factory from office. Direct costs go into prime cost. Indirect factory costs go into overheads.

Office and selling costs stay out of the manufacturing account and appear later in the income statement. When a cost such as rent or electricity is shared between factory and office, split it using the ratio given and take only the factory share.

Work in progress is the classic trap. It means partly finished goods. Adjust for it after factory overheads, not in the materials working.

Add opening work in progress and subtract closing work in progress to reach the factory cost of production. Adjusting it alongside raw materials corrupts both figures.

Keep the three inventories in separate stages. Raw materials come at the start, work in progress at the end of the factory account, and finished goods in the trading section. Label each closing inventory by type.

Once you have the cost of production, move to the income statement. The finished goods section works like an ordinary trading account. Instead of purchases, use opening finished goods plus the cost of production, minus closing finished goods, to give the cost of goods sold.

Deduct it from revenue to reach gross profit. Then deduct the office, administrative and selling expenses, including any non-factory share of shared costs, to reach profit for the year.

Some questions transfer goods to the trading section at cost plus a percentage. Read whether the transfer is at cost or at a mark-up, and handle any unrealised profit on unsold goods if the question includes it.

Finish with quick checks. Carriage on raw materials sits with materials. Direct wages are in prime cost and indirect wages in overheads.

No office cost has strayed into the factory. Raw material inventory adjusts the materials figure and work in progress adjusts the production figure. Label the subtotals "Prime cost" and "Cost of production" so the examiner can see each milestone.

If you cannot decide which costs belong in the factory, we can help. One of our teachers can work through a list of costs with you and give you a simple test for each. Book a trial class