Manufacturing Accounts

Retail businesses purchase goods and sell them on directly. Because of this, they don’t have to worry about different types of stock and can calculate their cost of sales simply on their Trading Account at the end of the year. Manufacturing businesses are more complicated. They have many more calculations for their cost of sales, such as their different types of stock – raw materials, work-in-progress and finished goods – and other expenses associated with producing the goods. Instead, they work out the total cost of buying materials and producing their goods in a Manufacturing Account and transfer the total into the Trading Account.

Before looking at the account, I’ll explain the layout. The underlines are basically where I have done a calculation with the previous set of numbers. Since they are all expenses that make the cost more they are added. Some things needed to be subtracted. For these the name of the item will start with the work ‘less’. Accounts should never have blank lines; the gaps are there for clarity only.

I’ve put the account up here at the top where it can be glanced back at. I’ll go through what everything is in a second.

The Manufacturing Account has two main sections: the Prime Cost and Factory Overheads.

The Prime Cost contains the direct costs – costs that are directly linked to manufacturing products, such as the cost of raw materials, the wages of people working to create the products, and royalty payments.

The second section contains all the other expenses associated with production - those not directly linked to creating products. This includes factory rent, maintenance costs for the machinery, and the wages of supervisors and other staff that do not work directly with the products.

After the main two sections, stocks of work-in-progress need to be accounted for. This is the stock that is part way through the manufacturing process at the end of the financial year. Only the stock that the business used during the period is relevant to this year so stock left over from last year is added, and stock left over at the end of this year is subtracted.

Put together, the account calculates the cost of production. This could be the final item in the account, but there are other things a business might want to add afterwards.

Some businesses work out a 'factory profit' or 'manufacturing profit' in their manufacturing account. The Factory profit represents the profit made through the manufacturing process and not through sales. To do this, they calculate a transfer price – the total costs plus a mark-up percentage – and add that to their cost of production.

The final figures will be transferred into the Trading, Profit and Loss Account for that year¹, which should look something like:

Having a factory profit means that the closing stock of finished goods for that year is at a higher value than it should be, since profit has been added on to it. Since it has not been sold, no profit has actually been made and therefore that profit should be added back in the Trading, Profit and Loss Account. To do this, businesses creates a provision for unrealised profit – the value of the profit that has been added to the closing stock in that year.

The provision is different from other expenses and behaves like most other provisions. Put simply, the entire amount of a provision is put into the Profit and Loss Account at the end of the first year. After that, only changes to the provision are recorded. So, if the business has more stock at the end of this year than last year, then the amount of the increase in the provision is placed into the account. If there is less stock at the end of the year, the difference in provision is added back onto the profit.