Manufacturing accounts

To prepare a manufacturing account, you must first classify costs. This classification determines where the cost appears in the financial statements.

Direct costs are expenses that can be specifically traced to the product being made. These form the Prime Cost.

Indirect costs (also called Factory Overheads) are expenses necessary for the factory to operate but cannot be easily traced to a single unit of product. These are added after Prime Cost.

Cost Type	Definition	Examples
Direct Material	Raw materials that become part of the finished good.	Wood for furniture, fabric for clothes.
Direct Labour	Wages paid to workers directly involved in making the product.	Assembly line workers, machine operators.
Direct Expense	Other direct costs specific to production.	Royalties per unit, hire of special machinery.
Factory Overhead	Indirect factory costs. Cannot be traced to one unit.	Factory rent, depreciation of factory machines, factory supervisor salaries.
Non-Factory Cost	Costs related to selling or administration (Office).	Office rent, advertising, sales commissions.

Building on the concept of cost classification: Non-factory costs are never included in the Manufacturing Account. They appear later in the Statement of Profit or Loss.

A common error is using 'Purchases' directly. You must adjust for inventory changes to find the Cost of Materials Consumed.

\text{Cost of Materials Consumed} = \text{Opening Raw Material Stock} + \text{Purchases} - \text{Closing Raw Material Stock}

• Opening Stock: Materials available at the start of the year.
• Purchases: New materials bought during the year.
• Closing Stock: Materials remaining at the end of the year (not yet used).

Logic: You start with what you had, add what you bought, and subtract what is left over. The result is what was actually used to make goods.

Work in Progress (WIP) refers to goods that are partially completed at the start or end of the accounting period.

To calculate the Factory Cost of Production for the current year, you must adjust Prime Cost + Factory Overheads by WIP:

\text{Factory Cost of Production} = \text{Prime Cost} + \text{Factory Overheads} + \text{Opening WIP} - \text{Closing WIP}

Why add Opening WIP? These goods were started last year but finished this year, so their costs belong to this year's production.

Why subtract Closing WIP? These goods were started this year but are not finished. Their costs should not be counted as 'completed production' yet.

The Factory Cost of Production calculated in the Manufacturing Account becomes the Cost of Goods Manufactured. This figure is transferred to the Statement of Profit or Loss (specifically the Trading Section) for a manufacturer.

For a manufacturer, the Trading Section differs from a sole trader because we do not use 'Purchases'. Instead, we use the Cost of Production.

\text{Cost of Goods Sold} = \text{Opening Finished Stock} + \text{Factory Cost of Production} - \text{Closing Finished Stock}

Statement of Profit or Loss (Trading Section) Template for Manufacturer:

Item	$
Sales	XXX
Less: Cost of Goods Sold:
Opening Finished Stock	XXX
Add: Factory Cost of Production (from Manuf. Acc.)	XXX
Less: Closing Finished Stock	(XXX)
Gross Profit	XXX

Note on Adjustments (LO 6): The adjustments made in the Manufacturing Account (e.g., prepaid factory rent, accrued wages) must also be reflected in the Statement of Financial Position:

• Prepaid Factory Rent: Appears as a Non-current Asset (or Current Asset depending on period) under 'Prepayments'.
• Accrued Factory Wages: Appears as a Current Liability under 'Trade and Other Payables'.