Manufacturing accounts

by Ronnie Patton and Simon McCarthy

05 Nov 2002

An important feature of the syllabus for Paper B1, Maintaining Financial Records and
Accounts is that candidates are required to develop an awareness of the need to present
information in a format which reflects the needs of particular types of organisations.

The final accounts of sole traders comprise of a Trading and Profit and Loss Account
and Balance Sheet. Candidates will be familiar with the broad format of these accounts
as shown in Figure 1.
Figure 1: Proforma Layout for final accounts of a Sole Trader
Ronnie Patton
Trading and Profit and Loss Account for the year ended 30 September 2002

£ £
Sales 120,000
Opening stock 5,000
Purchases 75,000
80,000
Closing Stock (7,000)
Cost of sales (73,000)
Gross Profit 47,000
Expenses (40,000)
Net Profit 7,000
Ronnie Patton
Balance Sheet as at 30 September 2002

£ £
Fixed Assets (Net book value) 85,000
Current Assets
Stock 7,000
Debtors 13,000
Cash on hand 75
20,075
Current Liabilities
Creditors (6,700)
Bank overdraft (1,500)
(8,200)
Net Current Assets 11,875
96,875

Financed by:
Capital 96,875
It is important to remember that the format of accounts, as shown in Figure 1, is suitable
for a trading business which buys items for immediate resale. Thus the trading account
calculates gross profit as the difference between the revenue earned by selling the items
and the cost of buying them.

The Manufacturing Process

The manufacturing process involves buying raw materials which are then converted by
the manufacturing process to produce finished goods. It is the finished goods which are
traded by the organisation. The final accounts must reflect this.

For this reason, we need a preliminary accounting statement which calculates the cost of
the goods which have been manufactured. We call this statement the Manufacturing
Account. A proforma manufacturing account is shown in Figure 2.

Figure 2: Manufacturing Account Pro-Forma

McCarthy Manufacturing
Manufacturing Account for the year ended 30 September 2002

£ £
Opening stock of Raw Materials 13,000
Purchases 100,000
113,000
Closing Stock of Raw Materials (20,000)
Cost of Materials Consumed 93,000
Direct Labour / Factory Wages 50,000
PRIME COST 143,000

Manufacturing Overheads*
Rent (60%) 6,000
Depreciation of Machinery (100%) 55,000
Depreciation of Building (60%) 12,000
Light Heat and Power (80%) 32,000
Total Overheads 105,000
248,000
Opening Work in Progress 8,000
Closing Work in Progress (6,000)
Factory Cost of Goods Manufactured 250,000
* This list of expenses is not exhaustive. Other expenses may be included, depending
on the expense headings and apportionment given in a question.
There are three points to note regarding the manufacturing account:

• calculation of prime cost;

• treatment of stock;
• shared expenses.

Calculation of Prime Cost

‘Prime cost’ is the term used for the total of the direct costs (raw materials consumed,
direct labour and direct expenses). A detailed consideration of how we differentiate
between direct costs and indirect costs falls within the syllabus of Paper B2, Cost
Accounting Systems. For that reason, any questions on the topic of manufacturing
accounts on Paper B1 will clearly indicate whether a cost should be treated as a direct or
indirect cost. Candidates should note however, that prime cost is an important figure and
the Paper B1 syllabus requires candidates to demonstrate the ability to calculate it
accurately.

Treatment of stock
As preparing the final accounts of a manufacturing organisation may involve three types
of stock, a clear understanding of the nature of each type of stock is important.

Basic Principle
First consider the treatment of stock in a trading organisation. The trial balance will
include a debit balance representing opening stock. Opening stock must always be
treated as a periodic cost. It will consequently be written off in the accounts. The value
of closing stock will be given as additional information. Closing stock will therefore
give rise to a double entry, (a credit entry to reduce expenses and a debit entry to create
the asset which is reflected on the balance sheet). This applies to all types of
organisations.

Types of Stock
At the balance sheet date, there may be three types of stock in a manufacturing
organisation. Some raw materials will remain in stock. This is the raw material stock.
Some of the raw materials issued to production will be fully converted into finished
goods. This is the finished goods stock. There will also be some items which are partly
complete. These items are referred to as work in progress. Each of the three types of
stock is treated as follows:

Raw Materials
The cost of raw materials consumed in the period is included in Prime Cost (as shown in
Figure 2) and is calculated as follows:
Opening Stock of Raw Materials (from Trial Balance)
add
Purchases (net of returns) (from Trial Balance)
less
Closing Stock of Raw Materials (additional information)
=
Cost of Materials Consumed

The other costs of manufacturing the product (manufacturing overheads) are added to
the cost of raw materials consumed (as shown in Figure 2).

Work in Progress
The Factory Cost of Goods Manufactured is then calculated by including the work in
progress adjustment:
add
Opening Work in Progress (from Trial Balance)
less
Closing Work in Progress (additional information)

Finished Goods
The Trading Account can now be completed, with the Cost of Sales calculated as:
Opening Stock of Finished Goods (from Trial Balance)
add
Factory Cost of Goods Manufactured (Manufacturing Account)
less
Closing Stock of Finished Goods (see Figure 3) (additional information).

Figure 3: Trading Account Pro-Forma

McCarthy Manufacturing
Trading Account for the year ended 30 September 2002

£ £
Sales 420,000

Opening Stock of Finished Goods 27,000

Factory Cost of Goods Manufactured 250,000
277,000
Closing Stock of Finished Goods (29,000) (248,000)
Gross Profit 172,000
When preparing the balance sheet, the closing stock figure which is included in Current
Assets will be the total of raw materials stock, work in progress and finished goods
stock.

Shared Expenses
To make the accounts more meaningful, the classification of costs should reflect the
main activities of the business. This means that we classify costs into the following
categories:
Manufacturing overheads: which are included in the manufacturing account as part of
the factory cost of goods manufactured.
Administrative costs: which are included in the profit and loss account.
Selling and distribution costs: which are also included in the profit and loss account.

Usually, the trial balance will only include the total cost for certain expenses. This means
that shared expenses must be split into the appropriate headings on the basis of
predefined proportions. In Paper B1, these proportions will be given in the question. It is
important to remember that the costs should be adjusted for any accruals or prepayments
before being split. (Figure 4 gives an example).

Figure 4: Accruals adjustment / Apportionment of Cost

Consider: Rent
Debit Balance per Trial Balance £12,000 (say)
Prepayment £2,000
Apportionment Manufacturing 60%
Administration 20%
Selling and Distribution 20%

thus: Balance per TB £12,000

less Prepayment £2,000
(current asset - report on Balance Sheet)
Total charge £10,000

Apportioned Manufacturing 60% = £6,000

Administration 20% = £2,000
Selling and Distribution 20% = £2,000
NB: The Administration and Selling and Distribution costs will be written off to the
Profit and Loss Account.
If we combine the points set out above, we can see that a manufacturing organisation
will have an extra accounting statement (the Manufacturing Account). All candidates
should ensure that they are familiar with the layout of this statement. The purpose of the
manufacturing account is to calculate the factory cost of goods manufactured for
inclusion in the Trading Account. Care should also be taken to deal with the stock values
correctly, and to apportion the costs as directed by the question. (Table 1 shows how
each type of stock is treated when preparing the accounts).
Table 1: Treatment of Shock

Type of
Opening Closing
Stock
Raw Include as cost in calculation 1 Deduct from total of Opening stock +
Materials of cost of materials consumed Purchases to calculate cost of materials
consumed
2 Include in Balance Sheet (Current
Assets)
Work in Include as cost in 1 Deduct in Manufacturing account
Progress Manufacturing Account 2 Include in Balance Sheet (Current
Assets)

Finished Include as Cost In Trading 1 Deduct in Trading Account to calculate

Goods Account Cost of Goods Sold
2 Include in Balance Sheet (Current
Assets)
Ronnie Patton is Examiner for Paper B1

Simon McCarthy is ACCA Course Leader at the University of Glamorgan

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