Manufacturing account: worked examples

Method and where the marks are

A business that makes its own goods cannot just buy in finished stock. It must build up the cost of what it produced.

Only then can it find gross profit in the usual way. The manufacturing account does this in layers: raw materials, the work done in the factory, and the finished cost of production.

Remember one idea. The manufacturing account collects factory costs only. It ends with the cost of goods produced, which then replaces purchases in the income statement.

The marks come from the right order and from knowing which costs belong to the factory and which to the office.

Follow this sequence. First, find the cost of raw materials used: opening inventory of raw materials, plus purchases, plus carriage inwards on those materials, minus closing inventory of raw materials.

Second, add direct labour (the wages of workers who make the goods) and any direct expenses (such as royalties paid per unit produced). This gives prime cost, a subtotal examiners expect you to label.

Third, add factory overheads. These are the indirect costs of running the factory, such as factory rent, factory power, depreciation of factory machinery and the supervisor's salary. This gives the total factory cost for the year.

Fourth, adjust for work in progress. Add opening work in progress, because those half-made goods are completed this year. Subtract closing work in progress, because those goods are not finished.

The result is the cost of production. For example, total factory cost is RM90,000, opening work in progress is RM4,000 and closing work in progress is RM6,000.

Cost of production is 90,000 + 4,000 − 6,000 = RM88,000. That RM88,000 replaces purchases when you work out the cost of sales of finished goods.

Direct costs can be traced to each unit. Indirect costs cannot, but they are still factory costs.

Selling and administration costs stay in the income statement. These include office rent, salespeople's wages, delivery vehicle costs and carriage outwards. When a cost such as rent or electricity serves both factory and office, the question usually gives a split, such as three-quarters to the factory. Show the factory share here and the office share in the income statement.

Depreciation works the same way. Factory machinery depreciation is an overhead. Office equipment depreciation is an administrative expense.

Build the account vertically with clear subtotals: prime cost, total factory cost and cost of production. Show the raw materials calculation in full.

In the income statement that follows, finished goods have their own adjustment. Opening finished goods, plus cost of production, minus closing finished goods gives cost of sales.

Marks are mostly lost on a few points. Putting office or selling costs in the manufacturing account inflates the cost of production. Carriage inwards on raw materials belongs here, but carriage outwards is a selling expense.

Adding closing work in progress and subtracting opening work in progress is the exact reverse of the correct treatment. Forgetting to split a shared cost loses marks too. So does forgetting that raw materials inventory and finished goods inventory are separate figures, adjusted at separate stages.

If you struggle to sort costs into direct, indirect and office, we can help. One of our teachers can go through a list of costs with you until the sorting is quick and reliable. Book a trial class