FINANCIAL ACCOUTING

BA & BAF

ACCOUNTING FOR A MANUFACTURING FIRM

3.1 Nature of manufacturing process;

Manufacturing of goods is the transformation of raw materials into finished or semi finished goods. Some
firms have to manufacture their goods before selling them to the general public e.g Coca-Cola, Nestle etc.,
while some merely sell products which are acquired in finished form.

A manufacturing organisation will acquire raw materials, engage labour, and other inputs necessary to
change the raw materials into finished goods. The main aim of preparing the manufacturing account is to
ascertain the cost of goods manufactured during the financial year. It is an extension of the trading account.

PURPOSE OF MANUFACTURING ACCOUNTS

The purpose of manufacturing accounts are as follows
• To ascertain the cost of goods manufactured.
• To ascertain the amount of any profit or loss on the manufacturing process

3.2 . Components of factory cost of production

In the case of a manufacturing enterprise, the manufacturing costs are divided into the following types,
which are listed below:

i) Direct material costs

These types of costs are those materials which are used directly in the manufacture of products or goods.
They are the materials that can be identified in the final products. Example; During the manufacturing
process of tables, direct materials consists of timber, nails, glue, paints etc.

ii) Direct labor costs

Direct labor are wages paid to those who are directly involved in the manufacturing processes of a product.
Example: During the manufacturing processes 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

Direct expenses are expenses that must be incurred in the manufacture of a product. I.e, 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: You have to note that the sum of all the direct costs is known as PRIME COSTS

iv) Indirect manufacturing costs / factory overheads

Indirect manufacturing costs are also known as Factory overheads. They are any other expenses (apart
from the direct costs) for items being produced. Examples are: cleaners’ wages, factory rents, depreciation
of plant and equipment, factory power and lighting.
Indirect manufacturing costs are all those costs which occur in the factory or other place where
production is being done, but which cannot easily be traced to the items being manufactured.

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Examples are:
• wages of cleaners
• wages of crane drivers
• rent of a factory
• depreciation of plant and machinery
• costs of operating forklift trucks
• factory power
• factory lighting

Note that: prime cost + indirect manufacturing costs = PRODUCTION COSTS

v) Administrative Expenses
Administrative expenses are expenses that are administrative in nature. I.e, they are expenses which are
incurred in the process of planning, controlling and directing the business organization. e.g. office rents,
office electricity, depreciation of office machinery, secretarial salaries.

vi) Selling and distribution expenses

Selling and distribution expenses are expenses which are incurred in the process of selling, promoting and
distributing the goods manufactured. Examples are; advertising expenses, carriage outwards, depreciation
of motor van, salesmen salaries etc.

vii) Finance Costs

These are expenses such as bank charges, discount allowed and every other monetary expenses

3.3 Prepare final accounts for manufacturing Firms

In Manufacturing accounts, the following statements are prepared
1. Manufacturing accounts – The manufacturing account is prepared to determine the cost of production.
2. Trading account- The aim of preparing Trading Account is to determine the gross profit or loss on
trading.
3. Balance sheets- The balance sheet is the statement that shows the assets and liabilities of a business

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3.3.1 Manufacturing accounts

This is debited with the production cost of goods completed during the accounting period. It
contains costs of:
• Direct materials
• Direct labour
• Direct expenses
• Indirect manufacturing costs
The manufacturing account includes all purchases of raw materials, including the stock adjustments for raw
materials. It also includes stock adjustments for work in progress (goods
that are part-completed at the end of a period). Let’s put this into a series of steps:

1 Add opening stock of raw materials to purchases and subtract the closing stock of raw
materials.
2 Add in all the direct costs to get the prime cost.
3 Add in all the indirect manufacturing costs.
4 Add the opening stock of work in progress and subtract the closing stock of work in progress to get the
production cost of all goods completed in the period.

Thus, when completed, the manufacturing account shows the total of production cost that
relates to those manufactured goods that have been available for sale during the period. This figure will then
be transferred down to the profit and loss account where it will replace the entry for purchases.

Manufacturing Account
Production costs for the period: £
Direct materials xxx
Direct labour xxx
Direct expenses xxx
Prime cost xxx
Indirect manufacturing costs xxx
Production cost of goods completed c/d to trading account xxx

3.3.2 Trading account and Profit/Loss account.

This account includes:

• Production cost brought down from the manufacturing account
• Opening and closing stocks of finished goods
• Sales
When completed this account will disclose the gross profit. This will then be carried down to the profit and
loss account part.
The manufacturing account and the trading account can be shown in the form of a diagram:

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(A) is production costs of goods unsold in previous period.
(B) is production costs of goods unsold at end of the current period.

Profit and loss account part

This is prepared in the way you learnt in earlier chapters in this book. You know, therefore, that it includes:
• Gross profit brought down from the trading account
• All administration expenses
• All selling and distribution expenses
• All financial charges

However, some of the items you would normally put in the profit and loss account part are already included
in the manufacturing account, e.g. depreciation on machines, and canteen wages.
When completed, this account will show the net profit.

Treatment of Work in progress

The production cost to be carried down to the trading account is that of production cost of goods completed
during the period. If items have not been completed, they cannot be sold.
Therefore, they should not appear in the trading account.

For instance, if we have the following information, we can calculate the transfer to the trading account:
£
Total production costs expended during the year 50,000
Production costs last year on goods not completed last year, but completed in
this year (work in progress) 3,000
Production costs this year on goods which were not completed by the year end
(work in progress) 4,400

The calculation is:

Total production costs expended this year 50,000
Add: Costs from last year, in respect of goods completed in this year
(work in progress) 3,000
53,000
Less: Costs in this year, for goods to be completed next year (work in progress) ( 4,400)
Production costs expended on goods completed this year 48,600

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Illustration 3.1
From the information bellow prepare a Manufacturing Account and a Trade Account

1 January 20X7, Stock of raw materials 8,000

31 December 20X7, Stock of raw materials 10,500
1 January 20X7, Work in progress 3,500
31 December 20X7, Work in progress 4,200

Year to 31 December 20X7:

Wages: Direct 39,600
Indirect 25,500
Purchase of raw materials 87,000
Fuel and power 9,900
Direct expenses 1,400
Lubricants 3,000
Carriage inwards on raw materials 2,000
Rent of factory 7,200
Depreciation of factory plant and machinery 4,200
Internal transport expenses 1,800
Insurance of factory buildings and plant 1,500
General factory expenses 3,300

Solution

Manufacturing Account for the year ended 31 December 20X7

£ £
Stock of raw materials 1.1.20X7 8,000
Add Purchases 87,000
Carriage inwards 2,000
97,000

Less Stock of raw materials 31.12.20X7 ( 10,500)

Cost of raw materials consumed 86,500

Direct wages 39,600
Direct expenses 1,400
Prime cost 127,500

Indirect manufacturing costs:

Fuel and power 9,900
Indirect wages 25,500
Lubricants 3,000
Rent 7,200
Depreciation of plant 4,200
Internal transport expenses 1,800
Insurance 1,500
General factory expenses 3,300
56,400
183,900
Add Work in progress 1.1.20X7 3,500
187,400
Less Work in progress 31.12.20X7 ( 4,200)
Production cost of goods completed c/d 183,200

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The trading account is concerned with finished goods. If in the foregoing exhibit there had been £3,500
stock of finished goods at 1 January 20X7 and £4,400 at 31 December 20X7, and the sales of finished
goods amounted to £250,000 then the trading account would appear:

Trading Account for the year ended 31 December 20X7

£ £
Sales 250,000
Less; Cost of goods sold:
Stock of finished goods 1.1.20X7 3,500
Add Production cost of goods completed b/d 183,200
186,700
Less Stock of finished goods 31.12.20X7 ( 4,400)
182,300

Gross profit c/d 67,700

Illustration 3.2

J Jarvis
Trial Balance as at 31 December 20X7
Dr Cr
£ £
Stock of raw materials 1.1.20X7 21,000
Stock of finished goods 1.1.20X7 38,900
Work in progress 1.1.20X7 13,500
Wages (direct £180,000; factory indirect £145,000) 325,000
Royalties 7,000
Carriage inwards (on raw materials) 3,500
Purchases of raw materials 370,000
Productive machinery (cost £280,000) 230,000
Administration computers (cost £20,000) 12,000
General factory expenses 31,000
Lighting 7,500
Factory power 13,700
Administration salaries 44,000
Sales reps’ salaries 30,000
Commission on sales 11,500
Rent 12,000
Insurance 4,200
General administration expenses 13,400
Bank charges 2,300
Discounts allowed 4,800
Carriage outwards 5,900
Sales 1,000,000
Debtors and creditors 142,300 64,000
Bank 16,800
Cash 1,500
Drawings 60,000
Capital as at 1.1.20X7 357,800
1,421,800 1,421,800

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Notes at 31.12.20X7:
1 Stock of raw materials £24,000; stock of finished goods £40,000; work in progress £15,000.
2 Lighting, rent and insurance are to be apportioned: factory 5/6, administration 1/6.
3 Depreciation on productive and administration computers at 10 per cent per annum on cost.

Solution
Jarvis Manufacturing, Trading and Profit and Loss Account for the year ending 31 December 20X7.
£ £ £
Stock of raw materials 1.1.20X7 21,000
Add Purchases 370,000
‘ Carriage inwards 3,500
394,500
Less Stock raw materials 31.12.20X7 ( 24,000)
Cost of raw materials consumed 370,500
Direct labour 180,000
Royalties 7,000
Prime cost 557,500
Indirect manufacturing costs:
General factory expenses 31,000
Lighting 5/6 6,250
Power 13,700
Rent 5/6 10,000
Insurance 5/6 3,500
Depreciation of productive machinery 28,000
Indirect labour 145,000
237,450
794,950
Add Work in progress 1.1.20X7 13,500
808,450
Less Work in progress 31.12.20X7 ( 15,000)
Production cost of goods completed c/d 793,450

Sales 1,000,000
Less Cost of goods sold:
Stock of finished goods 1.1.20X7 38,900
Add Production cost of goods completed 793,450
832,350
Less Stock of finished goods 31.12.20X7 ( 40,000)
(792,350)

Gross profit 207,650

Administration expenses
Administration salaries 44,000
Rent 1/6 2,000
Insurance 1/6 700
General expenses 13,400
Lighting 1/6 1,250
Depreciation of administration computers 2,000
63,350

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Selling and distribution expenses
Sales reps’ salaries 30,000
Commission on sales 11,500
Carriage outwards 5,900
47,400
Financial charges
Bank charges 2,300
Discounts allowed 4,800
7,100
(117,850)
Net profit 89,800

J Jarvis, Balance Sheet as at 31 December 20X7

Fixed assets £ £
Productive machinery at cost 280,000
Less Depreciation to date ( 78,000)
202,000
Administration computers at cost 20,000
Less Depreciation to date ( 10,000)
10,000
212,000
Current assets
Stock
Raw materials 24,000
Finished goods 40,000
Work in progress 15,000
Debtors 142,300
Bank 16,800
Cash 1,500
239,600
Less Current liabilities
Creditors ( 64,000)
Net current assets 175,600

387,600

Financed by
Capital
Balance as at 1.1.20X7 357,800
Add Net profit 89,800
447,600
Less Drawings ( 60,000)

387,600

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Review Questions
Question one
From the following figures prepare manufacturing and trading accounts so as to show:
(a) Cost of raw materials used in production.
(b) Prime cost.
(c) Production cost of finished goods produced.
(d) Cost of goods sold.
(e) Gross profit.
£
Stocks at 1 January 20X2
Raw materials 10,500
Goods in course of manufacture (at factory cost) 2,400
Finished goods 14,300

Stocks at 31 March 20X2

Raw materials 10,200
Goods in course of manufacture (at factory cost) 2,900
Finished goods 13,200

Expenditure during the quarter:

Purchases of raw materials 27,200
Factory wages: direct 72,600
indirect 13,900
Carriage on purchases of raw materials 700
Rent and business rates of the factory 1,200
Power 2,000
Depreciation of machinery 3,900
Repairs to factory buildings 1,300
Sundry factory expenses 900
Sales during the quarter 160,400

Question Two
Prepare manufacturing, trading and profit and loss accounts from the following balances
of W Miller for the year ended 31 December 20X3.
Stocks at 1 January 20X3: £
Raw materials 25,400
Work in progress 31,100
Finished goods 23,260
Purchases: Raw materials 91,535
Carriage on raw materials 1,960
Direct labour 84,208
Office salaries 33,419
Rent 5,200
Office lighting and heating 4,420
Depreciation: Works machinery 10,200
Office equipment 2,300
Sales 318,622
Factory fuel and power 8,120
Rent is to be apportioned: Factory 3/4; Office 1/4. Stocks at 31 December 20X3 were: Raw materials
£28,900; Work in progress £24,600; Finished goods £28,840.

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Question Three
From the following information, prepare the manufacturing, trading and profit and loss
account for the year ending 31 December 20X6 and the balance sheet as at 31 December 20X6 for
the firm of J Jones Limited. (amount in £)
(DR) (CR)
Purchase of raw materials 258,000
Fuel and light 21,000
Administration salaries 17,000
Factory wages 59,000
Carriage outwards 4,000
Rent and business rates 21,000
Sales 482,000
Returns inward 7,000
General office expenses 9,000
Repairs to plant and machinery 9,000
Stock at 1 January 20X6:
Raw materials 21,000
Work in progress 14,000
Finished goods 23,000
Sundry creditors 37,000
Capital account 457,000
Freehold premises 410,000
Plant and machinery 80,000
Debtors 20,000
Accumulated provision for depreciation on plant and machinery 8,000
Cost in hand 11,000.
984,000 984,000

Make provision for the following:

(i ) Stock in hand at 31 December 20X6:
Raw materials £25,000
Work in progress £11,000
Finished goods £26,000.
(ii ) Depreciation of 10% on plant and machinery using the straight-line method.
(iii ) 80% of fuel and light and 75% of rent and rates to be charged to manufacturing.
(iv) Doubtful debts provision: 5% of sundry debtors.
(v) £4,000 outstanding for fuel and light.
(vi ) Rent and business rates paid in advance: £5,000.
(vii ) Market value of finished goods: £382,000.

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