CHAPTER 13 – MANUFACTURING ACCOUNTS

INTRODUCTION
For manufacturing business, a manufacturing account is prepared in addition to the
income statement. It is produced for internal use only. People other than the owners
and managers of the organization concerned rarely see a manufacturing account.

If a business is using manufacturing accounts, instead of a figure for purchases (of

finished goods), the trading account will contain the cost of manufacturing the goods
that were manufactured during the period. The manufacturing account is used to
calculate and show the cost of manufacturing those goods. The figure it produces that
is used in the trading account is known as the production cost.

DIVISION OF COSTS
In a manufacturing business, the costs are divided into different types. These may be
summarized in chart form below:

Direct materials
Direct labour Prime cost
Direct expenses Production cost
plus
Indirect manufacturing costs Total cost
plus
Administration expenses
Selling and distribution expenses
Financial charges

The prime cost items and the other production cost items are shown in the
manufacturing account. The administration expenses, selling and distribution
expenses and the financial charges appear in the income statement.

DIRECT AND INDIRECT COSTS

As shown in the chart above, the sum of all the direct costs is known as the prime cost.
If a manufacturing-related cost cannot easily be traced to the item being
manufactured, then it is an indirect cost and will be included under indirect
manufacturing costs (which are also sometimes known as ‘factory overhead
expenses’). ‘Production cost’ is sum of prime cost plus indirect manufacturing costs.
For example, the wages of a machine operator making a particular item will be direct
cost. The wages of a foreman in charge of many men on different jobs will be indirect
labour and will be part of indirect manufacturing costs. Other examples of costs being
direct cost are:
1. Cost of raw materials including carriage inwards on those raw materials
2. Hire of special machinery for a job

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INDIRECT MANUFACTURING COSTS
Indirect manufacturing costs are all those costs which occur in the factory or other
place when production is being done, but which cannot easily be traced to the items
being manufactured. 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

ADMINISTRATION EXPENSES
Administration expenses consist of such items as managers’ salaries, legal and
accountancy charges, the depreciation of accounting machinery and secretarial
salaries.

SELLING AND DISTRIBUTION EXPENSES

Selling and distribution expenses are items such as sales staff’s salaries and
commission, carriage outwards, depreciation of delivery vans, advertising and display
expenses.

FINANCIAL CHARGES
‘Financial charges’ are expense items such as bank charges and discounts allowed.

Place a tick in the appropriate column for each of the following cost items
Indirect Selling and
Direct Direct Direct manufacturing Administration distribution Financial
materials labour expenses costs expenses expenses charges
a) Purchases of raw materials
b) Direct wages
c) General factory expenses
d) Depreciattion of machinery
e) Commission on sales
f) Factory rnt
g) Carriage inwards of raw materials
h) Royalties paid
i) Inventory of raw materials
j) Administration salaries
k) Indirect labour
l) Bank charges
m) Carriage outwards
n) Discounts allowed
o) Factory lighting

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FORMAT OF FINANCIAL STATEMENTS

Manufacturing account section

This is debited with the production cost of goods completed during the accounting
period. It contains costs of:

• Direct materials
• Direct labour
• Direct expenses and
• Direct manufacturing costs

The manufacturing account includes all purchases of raw materials, including the
inventory adjustments for raw materials. It also includes inventory adjustments for
work-in-progress (goods that are partly completed at the end of a period).

This may be summarised in the following series of steps:

1. Add opening inventory of raw materials to purchases and subtract the closing
inventory 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 inventory of work-in-progress and subtract the closing inventory
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 income statement where it will
replace the entry for purchases.

Trading account section of the income statement

This account includes:
• production cost brought down from the manufacturing account;
• opening and closing inventory of finished goods;
• sales.

When completed, this account shows the gross profit. This is then carried down to the
profit and loss part.

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

Trading account
KES KES
Sales xxx
Less Production cost of goods sold:
Opening inventory of finished goods (A) xx
Add production costs of goods completed b/d xx
xxx
Less closing inventory of finished goods (B) (xx)
xxx
Gross profit xxx

(A) is the production costs of goods unsold in the previous period

(B) is the production cost of goods unsold at the end of the current period

Profit and Loss Section of the Income Statement

This is prepared as before, and therefore 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 that would normally be put in the profit and loss part are
already included in the manufacturing account e.g. depreciation on machines and
contract wages. When completed, this account will show the net profit.

Review Q1
The following are the details of production costs for XYZ Ltd. for the year ended 31
December 2017. Assume that there are no partly completed units (work in progress)
either at the beginning or end of the period.

Required
Manufacturing account for the year ended 31 Dec 2017

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 KES
1 January 2017, inventory of raw materials 5,000
31 December 2017, inventory of raw materials 7,000
Raw materials purchased 80,000
Manufacturing (direct) wages 210,000
Royalties 1,500
Indirect wages 90,00
Rent of factory – excluding administration and selling and distribution 4,400
blocks
Depreciation of plant and machinery in factory 4,000
General indirect expenses 3,100

WORK-IN-PROGRESS (WIP)
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.

Review Q2
Using the following information, calculate the transfer to the trading account in 2019:
KES
2019 total production costs 50,000
2018 production costs on goods which were not completed in 2018, 3,000
but completed in 2019 (WIP)
2019 production costs on goods which were not completed by the end 4,400
of 2019 (WIP)

Review Q3
The following are the details of production costs for Jenga kwa Nguvu Ltd. for the year
ended 31 Dec 2017.

Required
Manufacturing account for the year ended 31 Dec 2017

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 KES
1 January 2017, inventory of raw materials 8,000
31 December 2017, inventory of raw materials 10,500
1 January 2017, work-in-progress 3,500
31 December 2017, work-in-progress 4,200
Year to 31 December 2017
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

Review Q4
Assume in the above example that there had been KES 3,500 inventory of finished
goods at 1 Jan 2017 and KES 4,400 at 31 Dec 2017, and the sales of finished goods
amounted to KES 250,000.

Required
Trading account for the year ended 31 Dec 2017

The profit and loss section is then constructed in the normal way.

APPORTIONMENT OF EXPENSES
Quite often, expenses will have to be split between:
• Indirect manufacturing costs: charged in the manufacturing a/c section
and
• Administration expenses
• Selling and distribution expenses charged in the profit and loss section
• Financial charges

An example of this could be the rent expense. If the rent is paid separately for each
part of the organisation, then it is easy to charge the rent to each sort of expense.
However, only one figure of rent may be paid, without any indication as to how much
is for the factory, how much is for the selling and distribution building and how much
is for the administration building.

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How the rent expense will be apportioned in the latter case will depend on the
circumstances using the most equitable way of doing it. A range of methods may be
used. Common ones include apportionment on the basis of:
• Floor area
• Property valuations of each part of the buildings and land.

Review Q5
The trial balance below has been extracted from the books of J. Jalango, a toy
manufacturer, as at 31 December 2017

Dr. Cr
KES KES
Inventory of raw materials 1.1.2017 21,000
Inventory of finished goods 1.1.2017 38,900
Work-in-progress 1.1.2017 13,500
Wages (direct KES 180,000; factory indirect KES 145,000) 325,000
Royalties 7,000
Carriage inwards (on raw materials) 3,500
Purchases of raw materials 370,000
Productive machinery (cost KES 280,000) 230,000
Administration computers (KES 20,000) 12,000
General factory expense 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
Accounts receivable and accounts payable 142,300 64,000
Bank 16,800
Cash 1,500
Drawings 60,000
Capital as at 1.1.2017 357,800
1,421,800 1,421,800
Notes at 31.12.2017
1. Inventory - raw materials 24k; inventory - finished goods 40k; work-in-progress 15k
2. Lighting, rent and insurance are to be apportioned; factory 5/6 administration 1/6
3. Depreciation on production machinery and administration computers at 10% per
annum on cost
Required
Manufacturing, trading and profit and loss account for J. Jalango for the year ended 31
Dec 2017 and a balance sheet as at that date

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Review Q6
A business both buys loose tools and also makes some itself. The following data is
available concerning the years ended 31 December 2018, 2019 and 2020.

2018 KES
Jan-01 Inventory of loose tools 6,000
During the year:
Bought loose tools from suppliers 8,000
Made own loose tools: the cost of wages of employees being KES 1,300 and the materials cost KES 900
Dec-31 Loose tools valued at 12,000
2019
During the year:
Loose tools bought from suppliers 4,000
Made own loose tools: the cost of wages of employees being KES 1,600 and the materials cost KES 1,200
Dec-31 Loose tools valued at 12,800
2020
During the year:
Loose tools bought from suppliers 7,200
Made own loose tools: the cost of wages of employees being KES 1,000 and the materials cost KES 1,340
Received KES 320 refund from a supplier for faulty tools returned to him
Dec-31 Loose tools valued at 14,600

You are to draw up the Loose Tools Account for the three years, showing the amount
transferred as an expense in each year to the Manufacturing Account.

Review Q7
Prepare a manufacturing account and income statement from the following balances
of Z. Vilemba for the year ending 31 December 2020.

KES
Inventory at 1 January 2020
Raw materials 50,800
Work-in-progress 62,200
Finished goods 46,520
Purchases: Raw materials 183,070
Carriage on raw materials 3,920
Direct labour 168,416
Office salaries 66,838
Rent 10,400
Office lighting and heating 8,840
Depreciation expense: Works machinery 20,400
Office equipment 4,600
Sales 637,244
Factory fuel and power 16,240

Rent is to be apportioned: Factory ¾; Office ¼;

Inventory at 31 Dec 2020 was: Raw materials KES 57,800, Work-in-progress KES
49,200; Finished goods KES 57,692.

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Review Q8
From the following information, draw up a manufacturing account and the trading
account section of the income statement for the six months ending 30 September
2020. You should show clearly:
(a) Cost of raw materials consumed
(b) Prime cost of production
(c) Production cost of finished goods
(d) Gross profit

KES
Inventory, 1 April 2020
Raw materials 2,990
Work-in-progress 3,900
Finished goods 15,300
Inventory, 30 September 2020
Raw materials 4,200
Work-in-progress 3,600
Finished goods 17,700
Purchases of raw materials 15,630
Carriage on raw materials 126
Direct wages 48,648
Factory general expenses 7,048
Office salaries 22,200
Depreciation of office furniture 420
Carriage outwards 191
Advertising 1,472
Bad debts 200
Sales less returns 112,410
Sales of scrap 1,317
Discounts received 188
Depreciation of factory equipment 4,200
Rent and business rates (factory 3/4, office 1/4) 2,800