IGCSE Accounting Ch 19: Manufacturing Accounts

Chapter 19 · Cambridge IGCSE Accounting

Manufacturing Accounts

This chapter explains how manufacturing businesses calculate the cost of producing goods. It covers direct and indirect manufacturing costs, direct materials, direct labour, direct expenses, prime cost, factory overheads, work in progress, cost of production, manufacturer income statements, inventory categories, year-end adjustments and apportionment of shared costs.

ManufacturersDirect costsPrime costFactory overheadsWork in progressCost of productionIncome statementApportionment

Manufacturing account overview showing cost flow into cost of production

Topic 1: Manufacturing Business and Cost Types

A manufacturer makes goods, so it needs an extra account to calculate the cost of production before profit is calculated.

1. What is a Manufacturing Business?

A manufacturer makes goods rather than simply buying finished goods for resale.

Manufacturers:

Buy raw materials.
Use labour and/or machinery.
Convert raw materials into finished goods.

A manufacturing business prepares an additional account called a manufacturing account to calculate the cost of producing its goods.

Statement	Purpose
Manufacturing account	Calculates cost of production.
Income statement	Calculates profit or loss.
Statement of financial position	Shows assets, liabilities and capital.

2. Direct and Indirect Costs

Direct costs

Costs that can be directly linked to the manufacture of a particular product.

Raw materials.
Direct factory wages.
Carriage inwards on raw materials.
Royalties.
Hire of a special machine for a particular job.

Indirect costs

Costs incurred in the factory but which cannot be directly linked to one particular unit of production.

Factory rent.
Factory lighting.
Factory manager’s salary.
Factory machinery depreciation.
Factory cleaner’s wages.

Indirect costs are also called factory overheads.

Topic 2: Direct Materials, Direct Labour, Direct Expenses and Prime Cost

Direct costs are added together to calculate prime cost.

Formula flow from raw materials consumed to prime cost, factory cost and cost of production

3. Direct Materials

Direct materials are the raw materials used to manufacture the goods.

Wood

Used by a furniture manufacturer.

Fabric

Forms part of the finished product.

Metal fittings

Also form part of the product.

These are direct materials because they form part of the finished product. Carriage inwards on raw materials is also treated as a direct cost.

4. Cost of Raw Materials Consumed

Not all raw materials purchased during the year are necessarily used.

Opening Raw Materials + Purchases + Carriage Inwards − Closing Raw Materials = Cost of Raw Materials Consumed

Example
Opening raw materials = $4,000
Purchases = $20,000
Carriage inwards = $1,000
Closing raw materials = $5,000
Cost consumed = $4,000 + $20,000 + $1,000 − $5,000 = $20,000

This calculation is the first stage of the manufacturing account.

5. Direct Labour

Direct labour is the cost of workers directly involved in manufacturing goods.

Examples

Assembly workers.
Machine operators working directly on production.
Workers paid per unit produced.

Not direct labour

Office staff, supervisors and cleaners are not direct labour.

Direct labour may be paid by time rate or by piece rate.

6. Direct Expenses

Direct expenses are expenses directly connected with manufacturing a particular product.

Royalties

A direct expense when linked directly to production.

Special machinery hire

Hire of machinery for a specific job.

7. Prime Cost

All direct manufacturing costs together make up the prime cost.

Prime Cost = Direct Materials + Direct Labour + Direct Expenses

Example
Direct materials = $20,000
Direct wages = $8,000
Direct expenses = $2,000
Prime cost = $20,000 + $8,000 + $2,000 = $30,000

Topic 3: Factory Overheads, Work in Progress and Cost of Production

Indirect factory costs and work in progress adjustments are added after prime cost.

8. Factory Overheads

Factory overheads are indirect manufacturing costs.

Factory rent

Factory building cost.

Factory electricity

Power used in the factory.

Factory insurance

Insurance for factory operations.

Depreciation

Depreciation of factory machinery.

Factory repairs

Repairs to factory machinery.

Factory staff

Factory supervisor’s salary and cleaner’s wages.

Indirect materials such as lubricants are also factory overheads.

9. Indirect Materials

Indirect materials are materials used in the factory but which cannot easily be linked to individual products.

Lubricants

Used in the factory but not part of one finished item.

Loose tools

Used generally in production.

Cost Used = Opening Inventory + Purchases − Closing Inventory

Example
Opening lubricant inventory = $1,000
Purchases = $800
Closing inventory = $300
Cost used = $1,000 + $800 − $300 = $1,500

10. Factory Cost Before Work in Progress

Factory Cost before WIP = Prime Cost + Factory Overheads

This gives the factory manufacturing cost before adjusting for work in progress.

Example
Prime cost = $30,000
Factory overheads = $12,000
Factory cost = $30,000 + $12,000 = $42,000

Three inventory stages for manufacturers: raw materials, work in progress and finished goods

11. Work in Progress

Work in progress means goods which have been started but are not yet complete. They cannot yet be sold as finished goods.

Partly assembled furniture

Started but not complete.

Unfinished clothing

Still in production.

Cars on the production line

Not yet ready for sale.

Last year’s closing work in progress becomes this year’s opening work in progress.

12. Cost of Production

To calculate the cost of goods completed:

Prime Cost + Factory Overheads + Opening WIP − Closing WIP = Cost of Production of Goods Completed

Example
Prime cost = $30,000
Factory overheads = $12,000
Opening WIP = $4,000
Closing WIP = $5,000
Cost of production = $30,000 + $12,000 + $4,000 − $5,000 = $41,000

The chapter uses this exact structure in the manufacturing account.

Topic 4: Manufacturing Account and Manufacturer’s Income Statement

The manufacturing account calculates cost of production; the income statement then calculates gross profit and profit for the year.

13. Manufacturing Account Format

Manufacturing Account for the year ended ...

Opening raw materials$4,000

Add: Purchases of raw materials$20,000

Add: Carriage inwards$1,000

Subtotal$25,000

Less: Closing raw materials($5,000)

Raw materials consumed$20,000

Add: Direct wages$8,000

Add: Direct expenses$2,000

Prime cost$30,000

Add: Factory overheads$12,000

Factory cost before WIP$42,000

Add: Opening work in progress$4,000

Less: Closing work in progress($5,000)

Cost of production$41,000

14. Manufacturer’s Income Statement

For a manufacturer, the cost of production usually replaces normal purchases of finished goods in the trading section.

Cost of Sales = Opening Finished Goods + Cost of Production − Closing Finished GoodsIf the manufacturer also buys finished goods for resale, those purchases are added as well.

Example
Opening finished goods = $6,000
Cost of production = $41,000
Closing finished goods = $7,000
Cost of sales = $6,000 + $41,000 − $7,000 = $40,000
If sales = $60,000, gross profit = $60,000 − $40,000 = $20,000

15. Why Might a Manufacturer Buy Finished Goods?

A manufacturer may sometimes buy finished goods because:

Demand is unusually high.
Production capacity is insufficient.
An urgent customer order must be filled.
The business does not want to lose customers.

The textbook therefore allows both cost of production and purchases of finished goods to appear in the trading section when necessary.

Topic 5: Correct Placement in the Financial Statements

Manufacturing costs go into the manufacturing account, while office, selling and financial expenses go into the income statement.

16. Expenses Outside the Manufacturing Account

Not every business expense goes into the manufacturing account.

Administration expenses

Office rent.
Office salaries.
Office electricity.
Depreciation of office equipment.

Selling and distribution expenses

Advertising.
Sales commission.
Sales staff salaries.
Carriage outwards.
Depreciation of delivery vehicles.

Financial expenses

Bank charges.
Loan interest.
Discounts allowed.

These appear in the income statement, not the manufacturing account.

17. Factory Cost or Income Statement?

Item	Treatment
Raw materials	Manufacturing account
Direct factory wages	Manufacturing account
Factory rent	Manufacturing account
Factory electricity	Manufacturing account
Depreciation of factory machinery	Manufacturing account
Office salaries	Income statement
Office rent	Income statement
Advertising	Income statement
Sales commission	Income statement
Carriage outwards	Income statement
Discount allowed	Income statement

18. Inventory in the Statement of Financial Position

A manufacturer may have three types of inventory, and all three may appear under current assets.

Raw materials

Materials not yet used.

Work in progress

Partly completed goods.

Finished goods

Completed goods not yet sold.

Example
Raw materials = $5,000
Work in progress = $2,000
Finished goods = $8,000
Total inventory = $5,000 + $2,000 + $8,000 = $15,000

19. Year-End Adjustments

Manufacturers make the same normal year-end adjustments as other businesses, including:

Depreciation

Place it in the correct section.

Accrued expenses

Add amounts owing.

Prepaid expenses

Deduct amounts paid in advance.

Provision for doubtful debts

Adjust trade receivables and profit.

Example
Factory wages accrued = $500
Direct factory wages = $10,000 + $500 = $10,500
The $10,500 is included in the manufacturing account. The accrued factory wages of $500 also appear as an other payable in the statement of financial position.

The key skill is placing each adjustment in the correct section.

Topic 6: Apportionment and Final Formula Guide

Some costs must be split between the factory and the office before the manufacturing account and income statement are completed.

Apportionment of a shared electricity bill between factory and office

20. Apportionment of Costs

Sometimes one expense relates partly to the factory and partly to the office. The expense must be divided fairly. This is called apportionment of costs.

Example
Electricity bill = $10,000
Factory uses 70%; office uses 30%
Factory = 70% × $10,000 = $7,000 → manufacturing account
Office = 30% × $10,000 = $3,000 → income statement as administration expense

21. Possible Bases for Apportionment

Cost	Possible Basis
Rent	Floor area
Electricity	Usage or floor area
Insurance	Value of assets/equipment
Salaries	Employees or actual staff costs
Internet	Agreed percentage
Heating	Floor area

The book notes that this topic is included mainly to give an insight into costing principles and says detailed apportionment is outside the syllabus.

22. Quick Formula Guide

Calculation	Formula
Raw materials consumed	Opening raw materials + Purchases + Carriage inwards − Closing raw materials
Prime cost	Direct materials + Direct labour + Direct expenses
Factory cost before WIP	Prime cost + Factory overheads
Cost of production	Prime cost + Factory overheads + Opening WIP − Closing WIP
Cost of sales	Opening finished goods + Cost of production + Purchases of finished goods − Closing finished goods
Gross profit	Sales − Cost of sales

Remember

Direct Costs
Direct materials + direct labour + direct expenses.

Prime Cost
All direct costs.

Factory Overheads
Indirect factory costs.

Work in Progress
Opening WIP → Add
Closing WIP → Subtract

Manufacturing Account calculates Cost of ProductionIncome Statement calculates Gross Profit and Profit for the YearManufacturer’s Inventory = Raw materials + Work in progress + Finished goods