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Form 4 MANUFACTURING ACCOUNTS
Manufacturing Accounts
What are Manufacturing Accounts?
A Manufacturing Account is an extra account that must be prepared by businesses who manufacture (make/produce) goods for resale. In this case the owners of the business do not only buy goods with the intension of reselling them (ex: buy clothes or shoes to resell), but they are buying raw materials and other goods that are used in a process to make something else – the finished good (ex: buying cloth, zips, buttons etc to make the clothes themselves). The manufacturing account is therefore used to calculate the cost of manufacturing those goods and is used to help the business owners to set realistic and profitable selling prices to their products. In other words, this account helps to accurately calculate the mark-up.
The Manufacturing Account
The Manufacturing Account shows a collection of costs that are linked to production. These costs are divided into two groups:
• Direct Costs
• Factory Overheads
Form 4 MANUFACTURING ACCOUNTS
Direct Costs
Direct Costs are costs that can be directly linked to the item being made and include: a) Costs of Raw Materials = This is merely the cost of materials bought to make the company’s products. However, one must take into account the opening and closing balances of stocks of raw materials, adjustments for returns to suppliers and include transport costs. This calculation is similar to the Cost of Sales formula used in the Statement of Profit or Loss. b) Direct Labour Costs = The cost of wages paid to factory workers who are directly involved in the manufacturing of the products (ex: wages of machine operators). c) Direct Expenses = This includes all other expenses which are directly linked to the products being made, such as Royalties and Patent fees.
Factory Overheads
This includes all expenses that are related to manufacturing but cannot be directly linked to the items being made. Examples include:
- Wages of factory cleaners,
- Internal transport expenses,
- Repairs to machinery (machines used for different items of production),
- Depreciation of factory machines,
- Wages of foremen,
- Rent of a factory,
- Electricity bills related to the factory,
- Water bills related to the factory.
Form 4 MANUFACTURING ACCOUNTS
Example 1:
Assuming there was no opening or closing balances of work in progress, produce the Manufacturing account for Borg Manufacturers for the year ended 31st^ December 2015 based on the details provided. € Inventory of Raw Material as at 1st^ January 2015 5, Inventory of Raw Material as at 31st^ December 2015 6, Raw Materials purchased throughout the year 75, Direct wages 175, Royalties 1, Indirect wages 55, Rent (proportion related to factory) 5, Depreciation of plant and machinery in factory 4, General indirect expenses 3, Carriage inwards 900 Returns outwards of raw materials 800 Borg Manufacturers Manufacturing Account for the year ending 31st^ December 2015 € € Cost of Raw Materials consumed Inventory of raw materials (01.01.15) Purchases of raw materials Add Carriage inwards Less Returns outwards Less Inventory of raw materials (31.12.2015) Cost of Raw Materials Direct Wages Other Direct Expenses Prime Costs Factory Overhead Expenses Production Cost of Goods Completed
Form 4 MANUFACTURING ACCOUNTS
Work in Progress
Work in progress refers to all the goods that have started the production process but have not been finalized, so they are partly finished goods. Since they are not completed goods, they cannot be sold. This implies that they should not appear in the Trading Account. Although they have not been finalized they still have a value, which must be accounted for in the Manufacturing Account as shown in the Manufacturing Account Format. This value is based on the cost of raw materials, wages and other direct expenses spent to reach the various levels or stages of production. Taking Example 1, if the value of work in progress at 01.01.2015 was €3,000 while the value of work in progress at 31.12.2015 was €1,750, then Production Cost of Goods Completed would have been adjusted as follows:
Costs calculated in example 1 183, Add Work in progress (01.01.2015) Less Work in progress (31.12.2015) Production Cost of Goods Completed c/d
The Statement of Profit or Loss
If the business does not buy other finished goods for resale, then the Production Costs of Goods Completed takes the place of total purchases as shown in The Statement of Profit and Loss A. If the business does buy other finished goods for resale then the value of the purchases of finished goods also appears in the Income statement as shown in the Statement of Profit and Loss B.
Form 4 MANUFACTURING ACCOUNTS
The Unit Cost of Finished Goods Produced
This is a calculation to find the cost of each single item produced. The formula is as follows: If in Example 1 the total number of units produced was say 50,000 units then the unit cost of production would be: 184,250 = €3.69 per unit 50,
Fixed and Variable Expenses
Expenses may be further distinguished as fixed or variable. Fixed expenses are expenses that do not change with the level of production taking place. These are expenses that will be incurred in the same amount whether production is nil or goes up to a large amount of units. Examples of such expenses include rent; insurance of premises, machinery and motor vehicles; payments on loans, depreciation and management salaries. Variable expenses on the other hand change and are affected by the level of production activity going on. These expenses increase as production volume increases and decrease as production volume falls. Examples of variable expenses include cost of raw materials used; direct labour; carriage inwards and factory power expenses. Unit Cost of Production = Cost of Production Number of units produced
Form 4 MANUFACTURING ACCOUNTS
Example 2:
An ice-cream manufacturer gives you the following information related to production for the month of July 2014: Cost of raw material used per ice-cream € Direct wages per unit €1. Factory power per unit €0. 10 Factory rent per annum €2, Depreciation on machinery per annum €1,2 00 Knowing that the manufacturer produced 15,000 ice-creams for the month, produce the manufacturing account for this month. Manufacturing Account for the month ended 31st^ July 2014 € € Cost of Raw Materials consumed Direct Factory Wages Prime Costs Factory Overhead Expenses: Factory rent Depreciation of Factory Machinery Factory Power Production Cost of Goods Completed c/d
Form 4 MANUFACTURING ACCOUNTS Notes at 31.12.
- Inventory of raw material €24,000; Inventory of finished goods €40,000; Work in progress €15,
- Water and electricity, rent and insurance are to be apportioned: factory 5/6, administration 1/6.
- Depreciation on productive machinery and administrative computers at 10% per annum on cost.
Summary
Businesses which produce and sell items prepare the following accounts at the end of its accounting year:- a. The Manufacturing account (to calculate the total cost of production) b. The Statement of Profit or Loss (to find out the net profit or loss) c. The Statement of Financial Position (to show the financial position of the business) The total cost of production = Prime cost + Factory overhead The Prime cost = Direct material + Direct labour + Direct expenses Direct material cost = Opening stock of raw materials + purchase of raw materials + carriage inwards – returns outwards – closing stock of raw materials. Factory overhead expenses = All expenses related to the factory (indirect expenses)
Form 4 MANUFACTURING ACCOUNTS
Exercise:
Tick the appropriate column for each of the following cost items Direct materials Direct labour Direct Expenses Indirect Manufacturing costs Administrative expenses Selling and Distribution expenses Financial Charges a. Purchases or raw materials b. Direct wages c. General factory expenses d. Depreciation of machinery e. Commission on sales f. Factory rent g. Carriage inwards of raw materials h. Royalties paid i. Inventory of raw materials j. Administration salaries k. Indirect labour l. Bank charges m. Carriage outwards n. Discounts allowed o. Factory lighting
