1.0
INTRODUCTION
Manufacturing
Accounts are prepared by manufacturers to determine the cost of manufacture.
Although, no hard and fast rules are laid down for this. In this note, you will
learn about those expenses that make up the cost of manufacture, and the
importance and usefulness of this accounting information to the manufacturer.
2.0
OBJECTIVES
At the end of this note,
you should be able to:
• explain the meaning
of manufacturing
• explain the types
of cost in manufacturing accounts
• distinguish between
direct and indirect expenses of production
• prepare
Manufacturing, Trading, Profit and Loss Account.
3.0
MAIN CONTENT
3.1
Manufacturing
Manufacturing is the
process of taking raw materials which nature or some primary industry like
agriculture, has provided and turning them into more sophisticated and useful
products. Thus, the Steel Industry converts iron to steel, and the oil industry
converts crude oil to petrol and other products.
The textile industry
takes raw cotton, an agricultural product and converts it into cloth and
clothing. These activities are at the roof of much of our national wealth, and
the accounting activities connected with them are of great importance. Much of
these accounting activities are in the specialized field of cost accounting,
which is chiefly concerned with controlling costs to eliminate wasteful
activities and keep our goods competitive in price on world markets.
3.2
Types of Cost in Manufacturing Accounts
In the preparation of
Manufacturing Accounts, it is necessary to discover the total cost of
manufacturing goods. The costs are categorized into two main groups, each of
which has several alternative names.
3.2.1
Prime Cost or Direct or Variable Cost
The first group of
costs, that is, 'Prime Cost' is concerned with those costs, which are directly
embodies in the product. Raw materials are typical costs in this first group,
as are wages of workers employed in the actual manufacturing process. If I is
called Prime Cost — meaning 'first', Direct cost — since the cost is directly
associated with the product. A third name is variable cost since it varies
fairly directly with the output. For example, if we double the output of cars
on a production line, we shall double the quantity of sheet of steel used.
3.2.2
Overheads or Secondary Costs
The second group of
costs are not directly embodied in the product, but are necessary to the
production process just the same. These are the costs of running the factory,
they include such items as factory power light, heat, rent, rates,
depreciation, machinery and internal factory transport. Overheads are also
called Factory or Works Expenses. They are also called Indirect Costs, since they
do not vary with output. Thus a manager's salary will not be doubled just
because output is doubled, he will be expected to supervise the factory
activities whatever the output may be.
3.2.3
Gross Cost of Manufacture
Prime cost plus
overheads gives the gross cost of manufacture
3.2.4
Net Works Cost of Manufacture
Net works cost of
manufacture is obtained by adding the Gross Cost of Manufacture to Opening
Work-in-Progress and then deduct Closing Work-in-Progress,
i.e. Gross Cost of
Manufacture + Opening Work-in-Progress
x x x x x x x x x x x
x x x x
- Closing
Work-in-Progress
= Net Works Cost of
Manufacture
3.3
Stocks in Manufacturing
In manufacturing,
there will be stocks of raw materials at the start of the process and stocks of
finished goods at the end, but there will also be stocks of work-in-progress or
partly-finished goods going through the production lines as well. It always
require some calculation to decide the value of this work in progress. The
accountant will have to decide what value to place upon it and whether to
include overhead charges as well as prime cost in the calculation.
It is probably most
common to value the work-in-progress at 'factory cost' that is, to say at prime
cost (raw materials, labor and other variable costs) plus overheads (a
proportion of total overhead costs being added). If this procedure is adopted,
the work-in-progress will appear in the second part of the Manufacturing
Account, that is, in the cost of Manufacturing Goods Section.
Illustration
I
Kupson Ltd. is a
Manufacturing Company and the following details from the Year 1996 are
extracted from its books.
N
Stock of raw
materials January 1996 11,464
Stock of raw
materials 31
December, 1996 12,162
Stock of manufactured
goods 1 January 1996
14,881
Stock of manufactured
good 31 December 1996 14,238
Work-in-progress 1st January, 1996 18,291
Purchases of raw
materials
115,826
Rent Rate of office 3,000
Manufacturing wages 71,342
Sales 28,436
Factory
expenses 19,324
Rent, rates of
factory
6,000
General
administration expenses 21,642
Salesmen's salaries 6,162
Motor expenses (for
delivery to customers) 3,984
Other selling
expenses 7,046
Depreciation: Plant
and Machinery 8,000
Motor Van 1,800
Work-in-progress 31 December 1996 19,941
You are asked to
prepare a Manufacturing Account Trading and Profit and Loss Account for 1996.
You should indicate the significance of sub-totals and of balances carried
down.
Comments
1) You are required
in this problem to identify separate items, which should be debited to
Manufacturing Account, Trading Accounts and Profit and Loss Account.
2) From the working
of the question, it may be logical to show in sub-totals in the Profit and Loss
Account, the administrative expenses as distinct from the distribution
expenses.
3) The sub-totals in
the Manufacturing Account must be shown as percentages on the cost of
manufacture to show at a glance the shares of each aspect of costs.
Those in the Trading
and Profit and Loss Account are shown as percentages on sales so that the
percentage income reduced by each aspect of trading and selling and
administrative costs can be identified.
Answer
Manufacturing,
Trading and Profit and Loss Account for the Year Ended 31st December 1996
Note the effect of approximations:
Indicate the
significance of the sub-totals and balances carried down as follows:
1) In the
Manufacturing Account reduce the various sub-totals as percentages of the total
cost of manufacture. This will indicate the percentage share of each aspect of
costs.
• Prime cost =
186,370 x 100
218,047 1
= 85.5% approx.
• Factory Overheads =
33,324 x 100
218,047 1
= 15.3%.
Prime cost plus
factory overheads gives 100.8% excess represents the excess of closing
work-in-progress over the opening work-in-progress.
2) In the Trading,
Profit and Loss Accounts, the various costs are placed over the Net Sales
multiplied by 100.
4.0
CONCLUSION
In Manufacturing, the
manufacturer may determine the gross profit on manufacture by deducting his
cost of manufacture from what the goods would have cost if obtained from other
sources. Such gross profits are transferred to the credit of the Profit and
Loss Account, while the goods are transferred to the Trading Account at the
market value.
Where a manufacturer
does not prepare a Manufacturing Account, all such items that are normally
included in the Manufacturing Account are included in the Trading Account. Thus
factory rent, depreciation of a manufacturer's machinery, etc. are regarded as
a cost of bringing the goods into a saleable condition and should be debited to
the Trading Account.
5.0
SUMMARY
When preparing
Manufacturing Account, distinction must be made between factory wages and
factory salaries. Factory wages are direct wages of workers engaged in the
production line. Factory salaries are salaries paid to workers such as foremen
who, although they work in the factory, are not in the production line. They
merely supervise the direct workers to see that production is carried out on
time and according to specification. The volume of their work does not
necessarily vary with the volume of production. Factory salaries are normally
specified as indirect costs and included in overheads.
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