CHAPTER 8: ACCOUNTING FOR MANUFACTURING
1. INTRODUCTION
Manufacturing businesses maintain a Factory Ledger to record all manufacturing-related
transactions summarized in the Manufacturing Account.
Purpose: To ascertain cost of goods manufactured, evaluate efficiency, and transfer manufacturing
cost to the Trading Account.
2. TYPES OF BUSINESSES BY ACTIVITY
Type of Business Description Examples
Service Business Provides intangible products like expertise Salons, schools
Trading Business Buys and sells goods without altering form Retailers, shops
Manufacturing Business Buys raw materials and converts them into finished goods Textile mills, furniture maker
3. DIRECT AND INDIRECT COSTS
Direct Costs (Prime Costs) are those traced directly to the product, including direct materials,
labour, and expenses.
Formula: Prime Cost = Direct Materials + Direct Labour + Direct Expenses
Indirect Costs (Overheads) are not directly traceable and include rent, factory insurance, indirect
wages.
4. FACTORY LEDGER
A Factory Ledger records production-related costs. Two accounting systems are used: Integrated
and Interlocking systems.
5. MANUFACTURING ACCOUNT
Purpose: To calculate cost of goods manufactured during the period for transfer to the Trading
Account.
Step Description Formula / Compo
1. Cost of Materials Consumed Opening Raw Materials + Purchases – Closing Raw Materials
2. Prime Cost Materials Consumed + Direct Labour + Direct Expenses
3. Factory Overheads Indirect materials, wages, rent, depreciation
4. Factory Cost Prime Cost + Factory Overheads
5. Cost of Goods Manufactured Factory Cost + Opening WIP – Closing WIP
6. FORMATS
Manufacturing Account:
Particulars Rs.
Purchases of Raw Material XXX
Add: Opening Stock - Raw Material XX
Material Available for Use XXX
Less: Closing Stock - Raw Material (XX)
Cost of Materials Consumed XXX
Add: Direct Labour XX
Add: Direct Expenses XX
Prime Cost XXX
Add: Factory Overheads XX
Factory Cost XXX
Add: Opening WIP XX
Less: Closing WIP (XX)
Cost of Goods Manufactured XXX
7. KEY FORMULAS
Concept Formula
Prime Cost Direct Materials + Direct Labour + Direct Expenses
Factory Cost Prime Cost + Factory Overheads
Cost of Goods Manufactured Factory Cost + Opening WIP – Closing WIP
Cost of Goods Available for Sale COGM + Opening Finished Goods + Purchases
Cost of Goods Sold Cost of Goods Available – Closing Finished Goods
Gross Profit Sales – Cost of Goods Sold
8. IMPORTANT NOTES
• Non-production costs like administration and selling are excluded from inventory valuation.
• Factory rent, depreciation, and utilities are part of factory overheads.
• Closing inventories are valued at lower of cost or NRV.
• COGM is transferred to Trading Account to determine Gross Profit.