Lecture 8 Manufacturing Accounts. Self Study PDF

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Emmanuel Namawa
MBA, CPA, BCOM...

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BAM 1

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MANUFACTURING ACCOUNTS Businesses which produce and sell the 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 Trading and profit & loss account (to find out the net profit or loss) c. The balance sheet. (to show the financial position of the business) For manufacturing organizations, manufacturing accounts will be needed in addition to a trading and profit and loss accounts. This will be for internal purposes/ use in the company. In place of purchases we will instead have the cost of manufacturing the goods. For a manufacturing business the manufacturing costs are divided into the following types: i)

Direct material costs

Direct material costs are those materials used directly in the manufacture of products i.e. materials that can be identified in the final products. E.g. in the manufacture of tables, direct materials consists of timber, nails, glue etc. ii)

Direct labor costs

These are wages paid to those who are directly involved in the manufacture of a product e.g. in the manufacture of tables; direct labor consists of wage paid to those workers who saw, shape of join the piece of timber into table. iii)

Direct expenses

These are expenses that must be incurred in the manufacture of a product. That is, they can be directly allocated a particular unit of a product e.g. live charges for a special equipment used in the process of manufacture, royalties NB: The sum of all the direct costs is known as prime costs iv)

Indirect manufacturing costs / factory overheads

These are any other expenses (apart from the direct costs) for items being manufactured: E.g. cleaners’ wages, factory rents, depreciation of plant and equipment, factory power and lighting NB: prime cost + indirect manufacturing costs = PRODUCTION COSTS

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v)

Self Study notes

Administrative Expenses

These are expenses that are administrative in nature, that is, expenses incurred in the process of panning, controlling and directing the organization. e.g. office rents, office electricity, depreciation of office machinery, secretarial salaries. vi)

Selling and distribution expenses

These are expenses incurred in the process of selling, promoting and distributing the goods manufactured. E.g. advertising expenses, carriage outwards, depreciation of motor van, salesmen salaries etc. vii)

Finance Costs

These are expenses such as bank charges, discount allowed. Format of the financial statements Manufacturing account part This is debited with the production cost of goods completed during the accounting period: It consists of: Direct materials Direct labor Direct expenses Indirect manufacturing costs. It also includes adjustments for work in progress (goods that are part- completed at the end of a period). STEPS 1. Add opening stock of raw materials to purchases and subtract the stock of raw materials. This is to get the cost of materials used during the period. 2. Add in all the direct costs to get the prime costs 3. Add all the indirect manufacturing costs. 4. Add the opening stock of WIP and subtract the closing stock WIP to get the production cost of all goods completed in the period. This is because WIP cannot be sold and therefore should not be included in the trading account. 5. The manufacturing account when completed shows the total that is available for sale during the period. This will be used in trading account in place for purchases.

BAM 1

Self Study notes

The total cost of production = Prime cost + Factory overhead The Prime cost = Direct material + Direct labor + 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)

Final accounts of a manufacturer 1)

Manufacturing accounts – used to determine the cost of production.

2)

Trading account- Used to determine the gross profit on trading.

3)

Balance sheets

Treatments of loose materials The cost of loose tools consumed during the year is considered as a factory overhead in the manufacturing account and is determined as follows: Opening stock of loose tools

xx

Add purchases of loose tools

xx xx

Less closing stock of loose tools

(xx)

Cost of loose tools consumed

xx

BAM 1

Self Study notes

THE FORMAT OF A MANUFACTURING ACCOUNT Manufacturing account for the year ended . . . . . . . . . . . . . . Opening stock of raw materials Add purchase of raw materials Add carriage inwards ( if any ) Less Returns outwards (of raw materials) Less Goods drawings ( if any ) Less Closing stock of raw materials Cost of Direct Materials Add Direct labor Add Direct expenses (E.g.: royalties) Prime Cost Add Factory overhead expenses Factory lighting Factory heating Factory insurance Factory rent Factory maintenance Factory indirect wages Factory supervisor’s wages Depreciation on plant & machinery Depreciation on factory building Depreciation on factory furniture Depreciation on factory motor van Depreciation on other factory fixed assets

xxxx xxxx Xxxx Xxxx xxxx Xxxx xxxx xxxx xxxx xxxxxxx xxxxxxx xxxxxxx xxxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx

Add Opening stock of work in progress Less Closing stock of work in progress Cost of production

(+)

XXXXXX XXXXXX xxxxxx XXXXXXX xxxxxx XXXXXXX

In a manufacturing concern, usually there are three kinds of stocks: Stock of Raw materials (the materials which are mainly used for production of the item) Stock of Work in progress (the materials on which some work process have been completed) Stock of Finished goods (The materials on which all the production processes are completed and ready for sale to the customers). NB: A manufacturing Account stops at Cost of production. Anything below cost of production constitutes the Trading Account and Profit & Loss Account

BAM 1

Self Study notes

Treatment of manufacturing Profit. Manufacturing profit occur where goods manufactured are transferred from factory to the warehouse at a higher value more than the cost of production i.e the market value. The difference between the market value and the cost of production is the manufacturing profit. Manufacturing profit should be added to the cost of production in the manufacturing account so as to arrive at the market value of goods manufactured. The market value of goods manufactured should take the place of purchases in the trading account. The double entry for the manufacturing profit is: DR Manufacturing Account CR Profit and loss account.

Treatment of unrealized Profit Unrealized Profit occurs where it is the policy of the firm to value stocks of finished goods at market value rather than at cost. The difference between the market value and the cost of the finished goods is the unrealized profit. The difference between the unrealized profit on the opening stock of finished goods and the unrealized profit on the closing stock of finished goods should be charged to the profit and loss account. The provision for unrealized profit on the closing stock by the end of year should be subtracted from the market value of the finished goods in the balance sheet. (i.e closing stock is stated at production cost on the balance sheet

Illustration 1. Jim Brothers, a manufacturing company, produces the following balances from its books at 30 th September Year 7 $ Stocks at 1 October Year 6: Raw materials Work-in-progress(factory cost) Finished goods(transfer value)

7,450 5,330 12,110

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Self Study notes

Purchases of raw materials Purchases returns Direct expenses Return inwards Carriage inwards Rates Light, heat and power Direct Wages Indirect Wages Telephone Factory repairs Insurances Factory salaries Office salaries Sales salaries Plant & machinery ( at cost) Provision for depreciation of plant & machinery at 1 October Year 6 Bad debts (written off) Sales Furniture & equipment (at cost) -Factory -Office Provision for depreciation of furniture & equipment at 1 October Year 6 -Factory -Office

128,740 310 3,280 1,215 1,055 5,250 3,270 187,240 14,320 890 2,215 1,420 38,000 24,000 27,435 160,000 64,000 325 721,560 42,000 48,000 8,400 9,600

Additional information: (1) Closing stocks at 30 September Year 7 are as follows:Raw materials Work-in-progress(factory cost) Finished goods(transfer value) (2) Prepayments at 30 September Year 7:Rates Insurance (3) Accruals at 30 September Year 7:-

$ 6,325 6,105 15,225 $ 450 220

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Direct wages Telephone Light, heat and power (4) At 30 September Year 7, depreciation is to be provided as follows: Plant and machinery Furniture and equipment (5) Expenses are to be apportioned to the factory as follows:

Self Study notes

$ 1,220 70 210 Per year on cost 20% 10%

$ Rates 4/5 Insurances 3/4 Telephone 2/3 Light, heat and power 3/4 (6) It is the policy of the company to transfer goods manufactured to the warehouse at factory cost plus 15% Required: Prepare in vertical format, Manufacturing and Trading Accounts of Jim Brothers for the year ended 30 September Year 7

BAM 1

Self Study notes

Solution: Jim Brothers Manufacturing Account for the Year Ended 30 September Year 7 $ $ Raw materials Opening stock-raw materials Purchases of raw materials Add: Carriage inwards Less: Purchases returns Raw materials available for production Less: Closing stock Add: Direct wages (W1) Add: Direct expenses PRIME COST Add: Production overhead/Factory Overhead expenses Rates(W2) Light, heat and power(W3) Indirect wages Telephone(W4) Factory repairs Insurance(W5) Salaries Depreciation of plant & machinery (W6) Depreciation of furniture & equipment(W7) Production cost Add: Opening Work-In-Progress Less: Closing Work-In-Progress Production cost of finished goods Add: Manufacturing profit (15%) (W8) Production cost transferred to Trading Account

$

7,450 128,740 1,055 310

129,485 136,935 6,325

3,840 2,610 14,320 640 2,215 900 38,000 32,000 4,200

130,610 188460 3,280 322,350

98,725 421,075 5,330 426,405 6,105 420,300 63,045 483,345

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Self Study notes

Jim Brothers Trading Account for the Year Ended 30 September Year 7

Sales Less: Returns inwards Less: Cost of sales Opening stock-Finished goods Add: Production cost Less: Closing stock-Finished goods Gross profit Add: Manufacturing profit

$ 721,560 1,215 12,110 483,345 495,455 15,255

$ 720,345

480,230 240,115 63,045 303,160

Workings: [Adjust the expenses like accruals and prepayment and to compute the expenses that relates only to manufacturing] W1 W2 W3 W4 W5 W6 W7 W8

Direct Wages A/c Rates A/c Light, Heat & Power A/c Telephone A/c Insurance A/c Depreciation of Plant & Machinery A/c Depreciation of Furniture & Equipment A/c Manufacturing profit

=$187,240+$1,220(accrued) = $188,460 = ($5,250-$450) x $3,840 = $3,480 x 3/4 =$2,610 = $960 x 2/3 =$640 = ($1,420-$220) x 3/4 =$900 = $160,000 x 20% =$32,000 =$42,000 x 10% =$4,200 =$420,300 x 15% =$63,045

BAM 1

Self Study notes

Overview; Manufacturing Account The primary objective of accounting is to arrange accounting data in a manner that the amount of profit or loss can be ascertained. It is prepared for a fixed period. For this purpose, we prepare the final accounts. Non-manufacturing entities or the trading entities are engaged in the purchase and sale of goods at profit without changing the form of the goods. Generally, Manufacturing entities prepare a separate Manufacturing Account as a part of Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The main purpose of preparing a Manufacturing Account is to ascertain the cost of goods manufactured or cost of goods sold, which is transferred to the Trading Account. This account is debited with opening stock and all items of costs including purchases related to production and credited with closing balance of work in progress and cost of goods produced transferred to Trading Account. The term "Cost of Goods Sold" refers to cost of raw materials consumed plus direct related expenses. Components of Manufacturing Account The following are the important components to be considered for preparation of Manufacturing Accounts: (1) Opening Stock of Raw Materials. (2) Purchase of Raw Materials. (3) Purchase Returns. (4) Closing Stock of Raw Materials. (5) Work in Progress (semi-finished goods). (6) Factory Expenses. (7) Opening Stock of Finished Goods. (8) Closing Stock of Finished Goods. (1) Opening Stock: The term Opening Stock refers to stock on hand at the beginning of the year which include raw materials, work-in-progress and finished goods. (2) Purchases:

BAM 1

Self Study notes

Purchases include both cash and credit purchase of goods. If any purchase is returned, the same will be deducted from gross purchases. (3) Direct Expenses: Direct expenses are chargeable expenses or productive expenses which include factory rent, wages, freight on purchases, manufacturing expenses, factory lighting, heating, fuel, customs duty, dock duty and packing expenses. In short, all those expenses incurred in bringing the raw materials to the factory and converting them into finished goods will constitute the direct expenses that are to be shown on the debit side of the trading account. Calculation of Cost of Goods Sold Cost of Goods Sold can be calculated as under: Cost of Goods Sold = Value of Opening Stock + Cost of Purchases + Direct Expenses - Value of Closing Stock....