Manufacturing Accounts and examples PDF

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all you need to know about manufacuring accounts and how to pass them...

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Topic 9 MANUFACTURING ACCOUNTS In order to find the profit of a firm which is buying goods for resale, a Trading and Profit and Loss Account is prepared. In the trading section the cost price of the goods sold is compared with the selling price of those goods. In a firm which is manufacturing the finished goods from raw materials the cost of production must be compared with the sales to find gross profit. What is included in the cost of production? The cost of production can be divided into 3 elements – materials, labour and overheads. Materials are the natural resources which are used in the manufacture of any product for example; wool for a coat, cotton for a shirt, gold for a watch. Labour is the human resource which uses the materials and equipment and is paid wages or salary. Overheads are other expenses incurred for example; light and heat, rates, depreciation and insurance. Each of these 3 elements can be classed as either direct or indirect. A direct cost is one which can be traced directly to the item made. For example: the cloth in a shirt or the wages of the sewing machinist. The total of the direct costs is known as prime cost, the basic cost without which there could be no finished article/good. An indirect cost is one which cannot be directly identified with any particular product for example; electricity or supervisor’s wages. Indirect costs are also known as overheads and add to the cost of production. During the year, these manufacturing costs are recorded and controlled by the cost/Management accountant. At the end of the period the total figures are passed to the financial accountant for the preparation of the manufacturing account. The manufacturing account is drawn up in addition to the trading and profit and loss account and shows the calculation of the factory cost of production. The factory cost of production is carried forward to the trading account where it is compared with sales to find gross profit. The profit and loss section is the same as that of a trading firm. PREPARATION OF A MANUFACTURING ACCOUNT A manufacturing account shows the cost of producing the goods that are sold during an accounting period. It is split into the following sections: 

Prime cost - Direct costs of physically making the products (e.g. raw materials)

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

A.

Overhead cost - Other indirect costs associated with production but not in a direct manner

Prime cost

The prime cost covers all the costs involved in physically making the products and other costs that are directly related to the level of output. These are usually known as direct costs and common examples would include: 1. Direct materials: purchases of raw materials along with any adjustments necessary for example; opening and closing stocks, carriage and returns 2. Direct labour/wages: including any accruals/prepayments 3. Other direct expenses (if any) – Packaging, royalties, the preparation of special templates or designs These 3 direct costs, added together, give prime cost

Direct materials + direct wages + direct expenses = prime cost

Cost of raw materials consumed Within the prime cost adjustments will have to be made for opening and closing stocks of raw materials. There may also be carriage inwards charged on the raw materials and returns outwards of materials sent back to their original supplier. The overall charge for materials is referred to as cost of raw materials consumed, this should be highlighted when drawing up a Manufacturing account and it is calculated as follows: Opening stock of raw materials

XXX

Purchases of raw materials

XXX

Add: Carriage inwards on raw materials

XXX

Less : Returns outwards of raw materials

(XXX)

XXX

Less: Closing stock of raw materials

(XXX)

Cost of raw materials consumed

XXX

A true direct cost will vary directly with the level of output. If the output level doubles, then we would expect a direct cost to also double. If the cost does not behave in this manner then it may be an indirect cost and not a direct cost.

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Royalties Royalties is sometimes included within the prime cost. These are a cost that is paid to the owner of a copyrighted process. Usually a fee is paid for each product that uses this process and therefore the total royalty cost will be directly proportional to the level of output.

B. Overhead cost /Factory overheads – all indirect expenses incurred in the factory, including any accruals/prepayments. This section includes all other expenses concerned with the production of output but not in a direct manner. This means that if the level of production increased, then these expenses may also increase but not by the same proportion. These are sometimes known as indirect costs, factory overheads or indirect manufacturing costs. Common examples of overhead costs would include: 1. Factory rent 2. Indirect labour 3. Depreciation of factory plant and equipment Depreciation of fixed assets should be included in this section only if it is depreciation on assets included for production. For example, depreciation of machinery would appear as an overhead cost but depreciation of office equipment would appear in the profit and loss account as an expense as would be expected in a non-manufacturing organization. Once the overhead costs have been calculated they will need adding to the total of the prime cost. This will give us the production cost of the goods. However, the production cost will need adjusting for goods which are not yet finished. Make sure you add the total for factory overheads to the prime cost and don't subtract! Factory overheads added to prime cost give the factory cost of production. Direct materials + Direct wages + Direct expenses

) ) ) ) )

=

Prime cost

Prime cost + Factory overheads

) ) )

=

Factory cost of production

Work-in-progress Goods which are not finished are known as work-in-progress. The opening balance of work-inprogress is added on to the production cost and the work-in-progress left at the end of the year will need subtracting to give us the cost of the goods completed during the period we are dealing with. Page

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Stocks in manufacturing organizations There are three types of stock that we deal with in manufacturing accounts. These are as follows: 1. Raw materials - the purchases of these will be adjusted for opening stock and closing stock in the prime cost. 2. Work-in-progress - partly completed goods will be dealt with at the end of the manufacturing account. 3. Finished goods - opening and closing stocks will be dealt with, as is normal, in the trading account All three types of closing stocks will appear as current assets on the balance sheet. Other Expenses. These are charged to the Profit and loss Account C.

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. D. 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. E. Finance Costs These are expenses such as bank charges, discount allowed Allocation of expenses Some expenses may be split between two areas of the financial statements. For example, an expense may be split between the prime cost and the overhead costs. Similarly, expenses may be split between the manufacturing account and the profit and loss account. The term office expense is often used to illustrate an expense that will be allocated to the profit and loss account. If there are prepayments or accruals to adjust for then this should be completed before any split between the sections of the financial statements.

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Manufacturing Accounts Formats KAMARA ENTERPRISES MANUFACTURING ACCOUNTS FOR THE YEAR ENDED 31/12/2019 Shs. Opening Stock of Raw Materials Add: Purchases of raw materials Carriage inwards of raw materials Less: Returns outwards of Raw Materials Raw materials available for production Less: Closing stock of raw materials Cost of raw materials consumed Add: Direct Wages Royalties Direct Expenses Prime Cost Indirect Manufacturing Costs/Factory overheads Factory lighting Factory Rent Depreciation of factory Machinery Indirect Labour Indirect Materials Loose tools consumed (opening bal. + purchases –closing bal.) Production cost Add work in progress 1.1.2011 Less work in progress 31.12.2011 Production costs of goods produced Add: Manufacturing profit/(loss) Transfer price of Goods Completed

Shs. xx

xx xx xxx (xx) xxxx xxxx (xx) xxx xx xx xxx xxx x xx xx xx xx x xxxx xxxx xxx xxxx (xx) xxxx xx xxxx

Note The goods are transferred to trading a/c at production cost or transfer price

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KAMARA ENTERPRISES INCOME STATEMENT FOR THE PERIOD ENDED 31/12/2019 Shs. Sales Less: Returns inwards Less cost of goods Sold Opening stock of Finished goods xx Add: Production cost of goods completed b/d/ /Transfer price of Gds completed xx Purchase of finished goods (if any) xx xxxx Less: Returns outwards (x) Fire loss (x) Less closing stock of finished goods (xx) Cost of sales Gross profit Add: Factory Profit Discount Received Less operating Expenses Office rent (e.g. 65%) Office electricity Depreciation-office Machinery Selling & Distribution expenses Advertising Delivery van expenses Carriage outwards Salesmen salaries Provision for Unrealized Profit Fire Loss Total Expenses Net Profit/loss

Note: Expenses should be apportioned as follows: Page

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Shs. xxxx (x) xxxx

xxx xxxx xx xx xxxx

xx xx x xx xx x xx xxx xx xx xxxx xxx/(xx)

i. ii.

Indirect manufacturing costs Administrative expenses

Charged in manufacturing account

iii.

Selling and distribution expenses

Charged in the profit & loss account

iv.

Financial charges

Example One The following data has been extracted from the books of Namono Ltd . You are required to prepare Manufacturing and Trading Accounts for the year ended 31 December 2019 showing the following: i. Cost of raw materials consumed ii. Prime cost iii. Total factory overheads iv. factory cost of production v. cost of goods sold vi. Gross profit.

Ledger balances at 1 January 2019 Sale Stock at start: raw materials work in progress finished goods Purchases of raw materials Direct wages Royalties

£ 800,000 24,000 23,200 46,500 425,000 126,700 8,600

Factory overheads Factory light and heat Factory rent and rates Insurance of factory buildings Factory general expenses Office Rent Office electricity Notes: 1. Stock at 31 December raw materials 2019: work in progress finished goods 2.

7,800 14,500 4,500 28,000 1,000 1,410 25,460 22,850 48,500

Depreciate factory machinery by £14,000.

Suggested Solution to Example One NAMONO’S MANUFACTURING ACCOUNTS FOR THE YEAR ENDED 31/12/2019 Page

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Shs. Opening Stock of Raw Materials Add: Purchases of raw materials Less: Closing stock of raw materials Cost of raw materials consumed Add: Direct Wages Royalties Prime Cost Factory overheads Factory light and heat Factory rent and rates Insurance of factory buildings Depreciation of factory machinery Factory general expenses

Add work in progress 1.1.2012 Less work in progress 31.12.2012 Production costs of goods produced c/d

Shs. 24,000 425,000 449,000 25,460 423,540 126,700 8,600 558,840

7,800 14,500 4,500 14,000 28,000 68,800 627,640 23,200 650,840 (22,850) 627,990

NAMONO’S INCOME STATEMENT FOR THE PERIOD ENDED 31/12/2019 Shs. Shs. Sales 800,000 Less cost of goods Sold Opening stock of Finished goods 46,500 Add: Production cost of goods completed b/d 627,990 674,490 Less closing stock of finished goods (48,500) Cost of sales 625,990 Gross profit 174,010 Less operating Expenses Office rent 1,000 Office electricity 1,410 (2,410) Net Profit/loss 171,600

Practice Exercises The following data has been extracted from the books of Denzi Ltd. At 31 December 2018: Dr(£) Cr () Stocks at 1 January 2001:

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Raw materials

12,500

Work in progress

7,650

Finished goods

18,900

Purchases of raw materials

89,000

Sales

215,000

Direct labour

32,000

Rent and rates

18,000

Electricity

8,000

Office salaries

43,000

Depreciation for the year: Factory

7,000

Office

3,000

Additional information a) Stocks at 31.12.2018: £ Raw materials

11,250

Work in progress 8,420 Finished goods

21,530

b) Rent, rates and electricity are to be apportioned: Factory 75%, Office 25% c) Finished goods are to be transferred to the trading account at a profit of 20% on factory cost. Required: Prepare a manufacturing, trading and profit and loss account for Denzi Ltd for the year ended 31 December 2018.

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Treatment of manufacturing Profit and unrealized profit One of the main reasons why firms manufacture their own goods, rather than purchasing them from another firm, is that the goods can be manufactured at a lower cost than the purchase price from elsewhere. 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. Manufacturing profit is usually calculated by simply adding on an additional percentage of the production cost to give us the 'transfer price' which will replace the purchases figure in the trading account. This procedure is known as marking-up the production cost. The market value of goods manufactured should take the place of purchases in the trading account. However, if we mark-up the production cost then the value for the cost of goods sold in the trading account will be higher. This means that the final gross and net profits for the firm would be lower. To cancel out this effect, the factory profit is added on again at the end of the profit and loss account. This time it is added on to the net profit. Account

Action

Manufacturing Add factory profit to cost of production Deduct factory loss from cost of production Profit & loss

Add factory profit to net profit Deduct factory loss from net profit

Unrealized Factory/manufacturing profit from unsold stock If we allow for manufacturing profit then this will mean that the value of any closing stock would actually include an amount of factory profit in its valuation. The prudence concept disallows any anticipation of future profits - how can we say that the value of stock includes profits when we have yet to sell the stock? - And therefore we would need to deduct this profit by making a provision for any profits on unsold stock. This provision for unrealized profit on unsold stock should be treated in the same way as any other provision. This means that the change in the provision should appear in the profit and loss account as a debit (if it is increased) or as a credit (if it is decreased) which means this would be added on to the gross profit. Page

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Increasing the provision

Increasing the provision

Debit Profit & loss with the increase

Credit Provision account with the increase

Decreasing the provision

Decreasing the provision

Debit Provision account with the decrease Credit Profit & loss with the decrease Note: The adjustment for unrealized profit on stock should only be made if implied in the question.

Balance sheet Once the factory profit on the closing stock has been calculated then the adjustment would have to be made on the balance sheet. The stock would appear as follows:

Current assets

£

Stock

XXX

Less provision for unrealized profit (X)

£

XXX

Example Two Kasikano Brothers, a manufacturing company, produces the following balances from its books at 31 st December 2012

$ Stocks 1/1/2012 Raw materials

7,450

Work-in-progress (factory cost) Finished goods (transfer value) Purchases of raw materials

5,330 12,110 128,740

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

310 3,280 1,215 1,055 5,250 3,270 187,240 14,320 890 2,215 1,420 38,000 24,000

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Sales salaries 27,435 Plant & machinery ( at cost) 160,000 Provision for depreciation of plant & machinery at 64,000 1 October Year 6 Bad debts (written off) 325 Sales 721,560 Furniture & equipment (at cost) -Factory -Office Provision for depreciation of equipment as at 1/01/2012 -Factory -Office

42,000 48,000 furniture

& 8,400 9,600

Additional information: a) Closing stocks at 31st December 2012 are as follows:$ Raw materials 6,325 Work-in-progress(factory cost) 6,105 Finished goods(transfer value) 15,225 b) Prepayments at 31st December 2012 $ Rates 450 Insurance 220 c) Accruals at 31st December 2012 $ Direct wages 1,220 Telephone 70 Light, heat and power 210 st d) At 31 December 2012, depreciation is to be provided as follows: Per year on cost Plant and machinery 20% Furniture and equipment 10% e) Expenses are to be apportioned to the factory as follows $ Rates

4/5

Insurances Telephone

3/4 2/3

Light, heat and power

3/4

f)

It is the policy of the company to transfer goods manufactured to the warehouse at factory cost plus 15% Page

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Required: Prepare the Manufacturing and Trading Accounts of Jim Brothers for the year ended 31 st December 2012

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Kasikano Brothers Manufacturing Account For The Year Ended 31st December 2012 $ $

$

Raw materials Opening stock-raw materials Purchases of raw materials Add: Carriage inwards

7,450 128,740 1,055 129,795 (310)

Less: Purchases returns

129,485 136,935 (6,325) 130,610 188,460 3,280 322,350

Raw materials available for production Less: Closing stock Cost of Raw materials Consumed Add: Direct wages (W1) Add: Direct expenses PRIME COST Add: Production overhead Rates(W2) Light, heat and power(W3) Indirect wages Telephone(W4)

3,840 2,610 14,320 640

Factory repairs Insurance(W5) Salaries

2,215 900 38,000

Depreciation of plant & machinery (W6) Depreciation of furniture & equipment(W7)

32,000 4,200 98,725 421,075 5,330 426,405 (6,105) 420,300 63,045 483,345

Production cost Add: Opening Work-In-Progress Less: Closing Work-In-Progress Production cost of goods Prod...