Unit 4

INTRODUCTION TO MANUFACTURING CONCERNS

After studying this chapter, you should be able to:

 Discuss the concept of ‘manufacturing ‘ and distinguish between a manufacturing entity and a trading entity
 Describe what manufacturing costs entail;
 Describe the different components of manufacturing costs;
 Distinguish direct and indirect manufacturing costs;
 List the specialized accountings needed to record the transactions of a manufacturing entity;
 Record the inventory and cost transactions in the general journal of a manufacturing entity and post the
general journal to the appropriate ledger accounts;
 Classify and do cost allocations between the manufacturing and administrative departments of the
manufacturing entity;
 Prepare a manufacturing cost statement;
 Calculate and record the unrealized profit in the finished products inventory; and
 Prepare a statement of profit or loss and other comprehensive income of a manufacturing entity to comply
with the requirements of IFRS.

4.1 INTRODUCTION

In the preceding chapters, the discussion of accounting systems and procedures was devoted to service and trading
entities whose activities are conducted through different types of ownership ,for example sole traders , partnerships
and close corporations. In contrast to the activities of a trading entity, which buys manufactured products and sells them at
a profit, a manufacturing entity manufactures the products that the trading entities buy and sell. A manufacturing entity
transforms basic raw materials into marketable products, for example a manufacturer of motorcars buys steel, rubber,
aluminium, plastics and other materials, from which manufactures motorcars. These materials are called ‘raw materials’ and
during the manufacturing process they change form and shape to become marketable products. The manufactured cars are
delivered to car dealers and the trading entities who sell them to the customers.
Although keeping a set of accounting records for a manufacturing entity does not differ markedly from that of a trading
entity, the unique characteristics of a manufacturing entity require additional accounting applications and procedures with
regard to cost allocations. In the case of a trading entity, the cost of purchases can easily be determined by adding the
purchase invoices. The cost of sales and closing inventories are therefore easy to calculate. On the other hand, the cost of
finished products for a manufacturing entity cannot be calculated from invoices alone. The manufacturing costs that include
other items, for example materials used, labour and other manufacturing costs that must be taken into account before the
cost of a finished product can be determined .The objective of accounting for manufacturing entities is to ensure that
accurate cost allocations are made so that the entity can determine the manufacturing cost of its products accurately.
Accurate cost allocations will also ensure that closing inventories of finished products are shown at the correct cost price. In
most manufacturing entities there are three main stages for which the inventory must be accounted for, at the end of the
financial period. These stages are:

 Unprocessed inventory( raw materials) ;

 Partly completed inventory (work-in-progress); and
 Completed inventory (finished products).

4.2 Introducing a manufacturing cost statement

A manufacturing cost statement is used by the management of the entity for the purposes of assessing the
manufacturing efficiency and determining the cost of finished manufactured products. The manufacturing cost
statement is not a financial statement and, as such , the format and preparation thereof is not prescribed by IFRS.
However ,information disclosed in the manufacturing cost statement is used in the preparation of the annual
financial statements of a manufacturing entity. The following is an illustration of the framework of a manufacturing
cost statement.

Framework of a manufacturing cost statement

ABC Manufacturers
Manufacturing cost statement for the year ended 31 December 20.1
N$
Direct material used xxxx
Inventory: Raw materials (1 January 20.1) xxxx
Purchases: Raw materials xxxx
xxxx
Inventory :Raw manufacturing ( 31 December 20.1 ) (xxxx)
Direct labour xxxx
Primary costs
Manufacturing overheads xxxx
Indirect material used xxxx
Indirect labour ( for example ,factory cleaning and maintenance workers) xxxx
Depreciation (on factory plant and equipment ) xxxx
Rental expenses (allocated to the factory) xxxx
Water and electricity (allocated to the factory) xxxx
Salaries (factory foreman and supervisors) xxxx
Rates and taxes (allocated to the factory) xxxx
Total manufacturing cost xxxx
Inventory : work-in-progress (1 January 20.1) xxxx
xxxx
Inventory :work-in-progress (31 December 20.1) (xxxx)
Cost of finished products manufactured xxxx
Manufacturing profit xxxx
Cost of finished manufactured products transferred to the sales department xxxx

4.3 Defining manufacturing costs

The above framework highlights the three elements which make up the total manufacturing turning costs, namely :
direct material used , direct labour and manufacturing overheads. Material and labour costs can either be a
direct or an indirect cost . direct costs are those cost which are possible to trace to the manufactured p roduct.
An example would be the cost of steel plates used in the manufacturing of cars and wages paid to employees
working on the assembly line. Indirect costs are usually referred to as manufacturing overhead ’ and represent the
manufacturing costs that cannot be specifically trace to individual units of finished products, for example water
and electricity consumed in the factory during the manufacturing process.

4.3.1 Direct material

Direct material is raw material which is consumed in the manufacturing process and is physically incorporated in
the finished product. It can be identified and measured as an integral part of the finished product. For example,
the wood that is used to manufacture desk can easily be traced as part of the finished product and can
therefore be classified as direct material . the cost of direct material includes the purchase price, import duties ,
other non-recoverable taxes, transport costs handling costs, and any other directly attributable cost of acquisition,
less trade discounts and rebates. Direct material used is recorded as a separate cost element in the manufacturing
cost statement ( refer to the framework in paragraph 4.2)

4.3.2 Direct labour

Direct labour consists of the cost of salaries and wages as well as other salary-related expenses of personnel
directly involved in the manufacturing process .example of direct labour cost include the wages of workers who
assemble part of the manufactured product and operators of machine engaged in the manufacturing process, as
well as salary –related expenses for the mentioned workers ,such as unemployment insurance fund contributions
skills development levies and pension fund contributions paid by the employer. Direct labour is recorded as a
separate cost element in the manufacturing cost statement ( refer to the framework in paragraph 4.2 )

4.3.3 Primary costs

“Primary costs “refer to total direct costs, i.e. the total monetary value of direct material used and direct labour costs ,
primary costs are usually the major part of total manufacturing costs ( refer to the framework in paragraph 4.2)

4.3.4 Manufacturing overheads

Manufacturing overheads consist of that portion of manufacturing costs which cannot be directly traced to the final product.
The concept “manufacturing overheads” is an encompassing term which includes all other manufacturing costs with the
exception of primary costs. Manufacturing overheads can be divided into three main categories:
 Indirect materials include those material items used in the manufacturing process which cannot be directly and
accurately traced to a specific product or which are so insignificant in value that it may not be cost-effective to trace
it to a specific finished product. For example, nails and screws used in the manufacture of wooden furniture can be
so inexpensive in relation to other direct material costs that it maybe uneconomical to trace their costs to a specific
finished product. These items, however, still form part of the cost of manufacturing of that product ( refer to the
framework in paragraph 4.2)
 Indirect labour includes the wages of all employees who do not work on the manufacturing product itself, but who
assist in the overall manufacturing operations. Examples of indirect labour are the wages factory cleaners, security
and maintenance personnel as well as the salary-related expenses rather as you use it throughout of these
employees such as unemployment insurance fund contributions, skills development levies and pension fund
contributions paid by the employer. The salary of a production supervisor or foreman is also indirectly by nature, as
this person’s role in the manufacturing process. For information purposes, however, these salaries and salary-
 related expenses are normally disclosed separately in the manufacturing cost statement (refer to frame work in
paragraph 4.2).
 Other manufacturing overheads consist of that portion of the costs, other than indirect materials and indirect labour,
that are linked to the manufacturing process, but which cannot be directly allocated to a specified product. This
includes costs such as factory insurance, maintenance and depreciation of factory equipment. In certain instances,
it may be necessary to allocate certain shared cost items between the manufacturing and other administrative
departments, such as the general administration and sales departments housed within the entity. Examples of
shared costs are rent, water and electricity and telephone expenses. Normally management formulates allocation
criteria that are used to allocate these types of costs to the administrative and manufacturing departments of the
entity. For example, the floor space occupied by each department could be used as the basis to allocate the cost of
rent for the entire premises between the administrative and the manufacturing departments. A fixed percentage
allocation can also be used, for example 60% of water and electricity consumed by the entity is allocated to the
administrative department and 40% to the manufacturing department. Selling, administrative and other general non-
production costs do not form part of the manufacturing process and are not included in manufacturing overheads.
These costs are incurred by the selling and administrative departments of the entity and are reported on the
statement of profit or loss and other comprehensive income as distribution, administrative and other expenses.

4.4 Stages of the manufacturing process

Raw materials pass through various stages of manufacturing before the finished product is ready for sale. The first stage
occurs when raw materials are purchased and stored ready for production but not yet released into the production process.
The cost of these materials is recorded in the inventory: raw materials account.
The second stage of manufacturing is uncompleted work somewhere in the production process, referred to as “work in
progress”. The inventory: work in-progress account is opened to record all the manufacturing costs that are incurred n
transforming raw materials into finished products. These include direct material costs- raw materials that are consumed in
the manufacturing process; direct labour costs- salaries, wages and fringe benefits for personnel who work directly on the
manufactured product; and manufacturing overhead costs- all other manufacturing costs other than direct material and
labour cost.
As products are completed, the final stage of manufacturing is reached. Completed products are then moved to the finished
products are completed; the final stage of manufacturing is reached. Completed products are then finished products
warehouse. The accumulated allocated costs of the finished products are recorded in the inventory: finished products
account. In practice, manufacturing entities add a manufacturing profit to the cost of completed manufactured products in
order to arrive at a price approximating that which the entity would have paid if the products were to be purchased externally
(refer to the framework in paragraph 4.2). This manufacturing profit is also recorded in the inventory: finished products
account.

4.5 Recording the transactions of a manufacturing entity

Example 4.1 will illustrate and explain the recording of the transactions relating to manufacturing entities. The example
emphasizes two aspects in the manufacturing process, namely:
 The compilation of manufacturing costs; and
 Keeping track of the manufacturing costs through the consecutive stages of:
 work-in progress;
 finished products; and
 Cost of goods sold.
For the purpose of this example, only those accounts that are unique to manufacturing entities are dealt with
.
Example 4.1 Recording the transactions relating to the manufacturing activities of a manufacturing entity

The following is an extract from the accounting records of Khaya Manufacturers, a sole trader, for the year ended 31
December 2008:
Inventory balances 1 January 31 December
2008 2008
N$ N$
Raw materials 90 000 45 900
Work-in-progress 28 000 43 000
Finished products 65 000 88 400

Transactions for the year ended 31 December 2008: N$

Raw materials purchased on credit 52 000
Railage paid on purchase of raw materials 1 000
Returns of raw materials 7 500
Direct materials issued to production 79 600

Indirect materials issued to production 10 000

Direct and indirect labour cost 15 500
Water and electricity 500
Repairs to factory machinery 1 000
Depreciation (factory machinery) 20 000
Credit sales 150 000
Salaries and wages (administrative personnel) 5 000
Cost of sales 115 975

Additional information:
1. The total of raw materials purchased on credit includes indirect materials amounting to N$ 10 000, all of which was
issued to the manufacturing process.
2. The factory manager’s remuneration amounts to 35% of the labour cost and represents the only indirect labour
cost.
3. It I estimated that 80% of the water and electricity is used in the factory.
4. Finished products are transferred to the sales department at cost price plus 25%.
5. On 1 January 2008, the allowance for unrealized profit in finished products inventory reflected a balance of N$ 13
000.
6. Khaya Manufacturers uses a perpetual inventory system.

Required:

Record the transactions relating to the manufacturing activities in the general journal of Khaya Manufacturers for the year
ended 31 December 2008. Post the general journal to the following accounts in the general ledger of Khaya Manufacturers:
 Inventory: raw materials
 Railage: raw materials
  Labour costs
 Manufacturing overheads
 Inventory: work-in-progress
 Inventory: finished products; and
 Manufacturing profit mark-up.

Close off and balance all the accounts at 31 December 2008:

Solution:
Purchase of raw materials, Railage cost incurred returns and issuing of raw materials to production:

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Inventory: Raw materials 52 000
Creditors control 52 000
Purchases of raw materials
Railage: Raw materials 1 000
Bank 1 000
Railage paid on purchases of raw materials
Creditors control 7 500
Inventory: Raw materials 7 500
Raw materials returned
Inventory: Work-in-progress 79 600
Manufacturing overheads – indirect Material 10 000
Inventory: Raw materials 89 600
Issue of direct and indirect materials
Inventory: Raw materials 1 000
Railage: Raw materials 1 000
Transfer of Railage cost to inventor of raw materials

Khaya Manufacturers
General ledger
Dr Inventory: Raw materials Cr
2008 N$ 2008 N$
Jan 1 Balance b/d 90 000 Dec 31 Creditors control 7 500
Dec 31 Creditors control 52 000 Inventory: Work-
Railage: Raw 1 000 in-progress 79 600
materials Manufacturing
Overheads 10 000
Balance c/d 45 900
143 000 143 000

1 b/d 45 900
 Balance

Dr Inventory: Raw materials Cr

2008 N$ 2008 N$
Dec 31 Bank 1 000 Dec 31 Inventory: Raw 1 000
materials

Comment:
When raw materials are purchased, both the direct and indirect materials are recorded in the inventory: raw materials
account. The inventory: raw materials account is debited with the cost price of inventory purchased (N$ 52 000). The cost of
transporting the purchased raw materials to the production site is debited in the Railage: raw materials account (N$ 1000).
When issuing direct materials to the manufacturing process, the inventory: raw materials account is credited with the direct
materials issued to manufacturing (N$ 79 600) and a new account, unique to manufacturing entities, the inventory: work-in-
progress account, is debited with direct materials cost (N$ 79 600). The indirect materials which were issued to the
production process must be transferred to the manufacturing overheads account. Therefore, inventory: raw materials
account is credited with N$ 10 000 and manufacturing overheads debited. At the end of the accounting period, the Railage:
raw materials account is closed off to the inventory: raw materials account to record the total cost of raw materials
purchased during the accounting period.

Incurrence of labour cost:

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Labour costs 15 500
Bank 15 500
Payment of direct and indirect labour costs
Inventory: Work-in-progress (direct labour cost) 1 0 075
Manufacturing overheads (salary of a factory manager) 5 425
Labour costs 15 500
Allocation of labour costs between direct and indirect
costs
 Khaya Manufacturers
General ledger
Dr Labour costs Cr
2008 N$ 2008 N$
Dec 31 Bank 15 500 Dec 31 Inventory: 10 075
Work-in-
progress
Manufacturing 5 425
overheads
15 500 15 500

Comment:
When labour costs are incurred, the total N$ 15 500 is recorded in the labour costs account. Labour costs are then allocated
according to the nature of labour, i.e. N$ 10 075 (N$ 15 500 x 65%) direct labour cost is allocated to the inventory: work-in-
progress account and the salary of N$ 5 425 (N$ 15 500 x 35%) paid to the factory manager is recorded in the
manufacturing overheads account.

Incurrence of other manufacturing expenses and allocation thereof to manufacturing overheads:

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Water and electricity 500
Repairs: Factory machinery 1 000
Bank 1 500
Recording of payments
Depreciation: Factory machinery 20 000
Accumulated depreciation on factory machinery 20 000
Recording of annual depreciation
Manufacturing overheads 21 400
Water and electricity (factory) (N$ 500 x 80%) 400
Repairs: factory machinery 1 000
Depreciation: factory machinery 20 000
Transfer of other manufacturing expenses to
manufacturing overheads
 Khaya Manufacturers
General ledger
Dr Manufacturing overheads Cr
2008 N$ 2008 N$
Dec 31 Inventory: raw 10 000 Dec 31 Inventory: 36 825
materials Work-in-
Labour costs: 5 425 progress
salary factory
foreman
Water and 400
electricity
Repairs: 1 000
Factory
machinery
Depreciation: 20 000
factory
machinery
36 825 36 825

Comment:

The allocation of other manufacturing costs (excluding indirect material and indirect labour already dealt with) to production,
is recorded in the manufacturing overheads account. This account is a control account for all indirect manufacturing costs.
The total expense incurred in respect of water and electricity is N$ 500, of which N$ 400 relates to the manufacturing
activity and is therefore treated as manufacturing overheads. The difference of N$ 100 (N$ 500- N$ 400) is a general
expense which must be disclosed on the statement of profit or loss and other comprehensive income as part of selling,
administrative and general expenses. Repairs and deprecation on factory machinery are also factory-related costs, and
therefore form part of manufacturing overheads.
At the end of the accounting period, the total of the manufacturing overheads account (N$ 36 825), is transferred to
inventory: work-in-progress by debiting the inventory; work-in-progress account and crediting the manufacturing overheads
account.
This is illustrated as follows:

Transferring manufacturing overheads to inventory – work in progress

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Inventory 36 825
Manufacturing overheads 36 825
Allocation of manufacturing overheads
 Khaya Manufacturers
General ledger
Dr Inventory: Work-in-progress Cr
2008 N$ 2008 N$
Jan 1 Balance b/d 28 000 Dec 31 Inventory: finished 111 500
Dec 31 Inventory: raw 79 600 products
materials Balance c/d 43 000
Direct labour costs 10 075
manufacturing 36 825
overheads 154 500 154 500

1 Balance b/d 43 000

Comment:

The inventory: work-in-progress account is used to accumulate the total manufacturing cost as it is incurred in the
manufacturing process. This account shows that N$ 154 500 worth of resources was put into the production process. This
amount is represented by the opening balance of inventory: work-in-progress (production not completed in the previous
production cycle) of N$ 28 000, raw materials issued to production of N$ 79 600, direct labour cost incurred of N$ 10 075,
and manufacturing overheads of N$ 36 825. At the end of the current production cycle, production amounting to N$ 43 000
is still incomplete, which implies that N$111 500 (N$ 154 500 – 43 000) production resources put into the manufacturing
process, was completed and transferred to the sales department. The following journal entries illustrate the recording of the
transfer of completed products from inventory: work-in-progress account to the inventory: finished products account.

Transfer of costs of completed products to inventory – finished products:

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Inventory: finished products 111 500
Inventory: work-in-progress 111 500
Transfer to finished products

It was mentioned previously that when finished products are transferred from the manufacturing department to the sales
department, a profit mark-up is added to the cost of products manufactured (refer to paragraph 4.4). in this example,
products are transferred to the sales department at a cost plus 25%. To account for the profit mark-up on manufactured
products, the following entry is necessary:
Adding the profit mark-up to inventory – finished products:

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Inventory: finished products 27 875
Manufacturing profit mark-up (111 500 x 25%) 27 875
Recording of profit mark-up

Khaya Manufacturers
General ledger
Dr Inventory: Work-in-progress Cr
2008 N$ 2008 N$
Jan 1 Balance b/d 65 000 Dec 31 Cost of sales 115 975
Dec 31 Inventory: work-in- 111 500 Balance c/d 88 400
progress
Manufacturing profit 27 875
mark-up
204 375 204 375

Balance b/d 88 400

1

Manufacturing profit mark-up

2008 N$ N$
Dec 31 Profit and loss 27 875 27 875

Comment:

The profit mark-up on finished products is recorded on the debit side of the inventory: finished products account. This will in
effect adjust the cost of finished products to approximate the cost at which similar products can be purchased externally by
the approximate the cost at which similar products can be purchased externally by the entity. The manufacturing profit mark-
up account is credited with the profit mark-up of N$ 27 875 on manufactured products. At the end of the financial period, the
manufacturing profit mark-up account is normally closed off to the profit and loss account. For the sake of simplicity, the
profit and loss account is not prepared in this chapter. The manufacturing profit mark-up is therefore directly disclosed on
the statement of profit or loss and other comprehensive income.

4.6 Preparing a manufacturing cost statement

In paragraph 4.2, the use of a manufacturing cost statement was discussed and the type of information that must be
included in this statement was outlined in the framework. In this section, the preparation of the manufacturing cost
statement is illustrated. The manufacturing cost statement is prepared after all the transactions related to the manufacturing
process have been recorded in the general journal and posted to the general ledger. The statement summarizes the
information in the ledger accounts. That is it shows the specific costs incurred in the manufacturing process during the
period and identifies costs of completed products that are transferred to inventory: finished products and the cost of
products remaining in the inventory: work-in-progress.

Example 4.2 Preparation of a manufacturing cost statement

To illustrate the preparation of a manufacturing cost statement, use the information supplied in Example 4.1

Required:
Prepare the manufacturing cost statement of Khaya Manufacturers for the year ended 31 December 2008.

Solution:
Khaya Manufacturers
Manufacturing cost statement
31 December 2008
N$
Direct materials used 79 600
Inventory: materials (1 January 2009) 90 000
Purchases: raw materials (N$ 52 000 – 7500 – 10 000)* 34 500
Railage: raw materials 1 000
125 500
Inventory: raw materials (31 December 2009) (45 900)
Direct labour 10 075

Primary costs 89 675

Manufacturing overheads 36 825
Indirect materials used* 10 000
Salary: factory manager 5 425
Water and electricity: factory 400
Repairs: factory machinery 1 000
Depreciation: factory machinery 20 000

Total manufacturing costs 126 500

Inventory: work-in-progress (1 January 2009) 28 000
154 500
Inventory: work-in-progress (1 December 2009) (43 000)
Cost of finished products manufactured 111 500
Manufacturing profit (N$ 111 500) 27 875
Cost of finished products manufactured transferred to the sales department 139 375

* The amount of direct raw materials purchased is calculated by subtracting the amount of indirect raw materials of N$ 10
000, and raw materials returned of N$ 7 500.
4.7 Recording the transactions relating to the sale of finished products inventory and incurrence of
administrative expenses by a manufacturing entity

The sales of finished products inventory and the incurrence of administrative and selling expenses by a manufacturing entity
are dealt with in the same way as in the case of a trading entity. The only difference is the treatment of the unrealized pro fit
on unsold inventories at the end of the accounting period and is discussed in paragraph 4.8.

Example 4.3 Sale of finished products inventory and incurrence of administrative expenses
To illustrate the sales and the incurrence of administrative expenses, use the same information as supplied in Example 4.1

Required:

Record the transactions relating to the sale of finished products inventory and the incurrence of administrative expenses in
the general journal of Khaya Manufacturers for the year ended 31 December 2008. Post the general journal to the following
accounts in the general ledger of Khaya Manufacturers:
 Cost of sales
 Sales
 Debtors control
Close off and balance the accounts at 31 December 2008

Solution:
Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
Cost of sales 115 975
Inventory: finished products 115 975
Recording the cost of sales
Debtors control 150 000
sales 150 000
Recording of sales
Salaries and wages (administrative personnel) 5 000
bank 5 000
Recording of salaries and wages

Khaya Manufactures
General ledger
Dr Cost of sales Cr
2008 N$ N$
Dec 31 Inventory: finished 115 975 Trading account 115 975
products
 Dr Sales Cr
2008 N$ N$
Dec 31 Trading account 150 000 Debtors control 150 000

Dr Debtors control Cr
2008 N$
Dec 31 sales 150 000

Comment:
When products are sold, the cost thereof is debited to the cost of sales account (perpetual inventory system) and the
inventory: finished products account is credited. At the same time, the selling price of the products sold on credit is debited
to the debtors control account and credited to the sales account. The cost of sales and sales accounts are normally closed
off to the trading account. However, in this chapter, the trading account is not prepared and therefore the cost of sales and
sales are directly disclosed on the statement of profit or loss and other comprehensive income.

4.8 Adjusting the allowance for unrealized profit in finished products inventory

Finished products that are transferred to the sales department are normally inclusive of the profit mark-up added by the
manufacturing department. This profit, however, is only realized when these products are sold by the entity. If at the end of
the accounting period there is finished products inventory on hand, the cost of this closing inventory will be inclusive of the
profit mark-up. This profit is referred to as “unrealized profit” because it relates to profit that has not yet materialized.
When the financial statements of a manufacturing entity are prepared, an allowance for unrealized profit in the closing
inventory of finished products is created in order to ensure that the profit made by the entity is stated correctly. The creation
of the allowance for the unrealized profit in the closing inventory of finished products is intended to adjust the value of the
closing inventory of finished products to the manufacturing cost price thereof.
At the beginning of each accounting period there will be a balance on the allowance for the unrealized profit in finished
products inventory that relates to the profit mark-up in the opening inventory of finished products. Because of the changes in
inventory levels during the year, the balance on the allowance for unrealized profit in finished products inventory must be
adjusted to equal the unrealized profit in the finished products closing inventory at the end of the financial period.

Example 4.4 Adjusting of the allowance for unrealized profit in finished products inventory

The same information supplied in example 4.1 is used to illustrate the adjustment of the allowance for unrealized profit n
finished products inventory.

Required:

Adjust the allowance for unrealized profit in finished products inventory in the general journal of Khaya Manufacturers for the
year ended 31 December 2008. Post the general journal to the following accounts in the ledger of Khaya Manufacturers:
 Allowance for the unrealized profit in inventory: finished products.
 unrealized profit in inventory: finished products
Close off and balance the accounts as 31 December 2008.
Solution:
In order to determine whether the balance of the allowance for unrealized profit in the closing inventory of finished products
must increase or decrease in example 4.1 the following calculation is necessary:
Adjustment of the allowance for unrealized profit in finished products inventory at the end of the year:

N$
Allowance for unrealized profit in inventory: finished products (opening inventory) 13 000
Allowance for unrealized profit in inventory: finished products (closing inventory) (N$ 88 (17 680)
400 x 25/125)
Adjustment – increase in the allowance (4 680)

At the beginning of the current year, the accounting records of Khaya Manufactures indicate a balance of N$ 13 000 as the
allowance for unrealized profit in the inventory of finished products. The end of the current year, the inventory level of
finished products is different. Therefore, the balance of N$ 13 000 must be adjusted to reflect a correct allowance for
unrealized profit in the inventory of finished products at the end of the current year. The allowance for unrealized profit in the
inventory of finished products must be increased by N$ 4 680 (N$ 17 680 – 13 000). To record an increase in the allowance
for unrealized profit in the inventory of finished products, the unrealized profit in the inventory of finished products account is
debited and the allowance for unrealized profit: finished products account is credited.

Khaya Manufacturers
General journal
Dec Debit Credit
2008 31 N$ N$
unrealized profit in the inventory: finished products 4 680
allowance for unrealized profit: finished products 4 680
Adjustment of the allowance for unrealized profit in
finished products inventory

Khaya Manufacturers
General ledger
Dr Allowance for unrealized profit: finished products Cr
2008 N$ 2008 N$
Dec 31 Balance b/d 17 680 Jan 1 Balance b/d 13 000
Dec 31 Unrealized profit 4 680
in inventory:
finished products
17 680 17 680
2009
Jan 1 Balance b/d 17 680
Dr Unrealized profit: finished products Cr
2008 N$ 2008 N$
Dec 31 Unrealized profit 4 680 Dec 31 Profit and loss 4 680
in inventory: finished account
products

4 680 4 680

Comment:
The unrealized profit in inventory: finished products account is a normal account that is closed off to the profit and loss
account at the end of the accounting period. The allowance for unrealized profit in inventory: finished products account is a
contra asset account which is not closed off. The balance of this account is deducted from the cost of finished products
inventory figure for disclosure purposes on the statement of financial position.

4.9 Preparing the statement of profit or loss and other comprehensive income of a manufacturing entity

The statement of profit or loss and other comprehensive income of a manufacturing entity are prepared in the same format
as that of a trading entity and must be in compliance with the requirements of IFRS. Because a trading entity purchases
completed products for resale, in comparison with a manufacturing entity that converts raw materials into completed
products, the statement of profit or loss and other comprehensive income of a manufacturing entity contains the cost of
finished products transferred from the manufacturing entity is, however, substituted by purchases in a trading entity.

Example 4.5 Preparation of a statement of profit or loss and other comprehensive income of a manufacturing
entity
The information supplied in Example 4.1 is used to illustrate the preparation of a statement of profit or loss and other
comprehensive income of a manufacturing entity:

Required:

Prepare the statement of profit or loss and other comprehensive income of Khaya manufacturers for the year ended 31
December 2008. In compliance with the requirements of IFRS. Notes and comparative figures can be ignored.
Khaya manufactures
Statement of profit or loss and other comprehensive income for the year ended 31 December 2009
N$
Revenue 150 000
Cost of sales (115 975)
Inventory: finished products (1 January 2009) 65 000
Cost of finished products transferred 139 375

204 375
Inventory: finished products (31 December 2009) (88 400)
Gross profit 34 025
Manufacturing profit 27 875
61 900
Distribution, administrative and other expenses (9 780)
Water and electricity (N$ 500 x 20%) 100
Salaries and wages 5 000
Unrealized profit in inventory: Finished products* 4 680
Profit for the year 52 120
Other comprehensive income -
Total comprehensive income for the year 52 120

The unrealized profit in the finished products inventory is disclosed as a deduction in statement of profit or loss
and other comprehensive income because the finished products inventory levels increased during the year ,
resulting in an increasing in the allowance for unrealized profit in inventory: finished products.