Manufacturing Accounts Format

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 Opening stock Purchases Closing Stock Cost of sales Gross Profit Expenses Net Profit Ronnie Patton Balance Sheet as at 30 September 2002

5,000 75,000 80,000 (7,000) (73,000) 47,000 (40,000) 7,000

£ Fixed Assets (Net book value) Current Assets Stock Debtors Cash on hand Current Liabilities Creditors Bank overdraft Net Current Assets

Financed by: Capital

£ 120,000

£ 85,000

7,000 13,000 75 20,075 (6,700) (1,500) (8,200) 11,875 96,875

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 Purchases Closing Stock of Raw Materials Cost of Materials Consumed Direct Labour / Factory Wages PRIME COST Manufacturing Overheads* Rent (60%) Depreciation of Machinery (100%) Depreciation of Building (60%) Light Heat and Power (80%) Total Overheads

£ 13,000 100,000 113,000 (20,000) 93,000 50,000 143,000

6,000 55,000 12,000 32,000

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 Opening Stock of Finished Goods Factory Cost of Goods Manufactured Closing Stock of Finished Goods Gross Profit

27,000 250,000 277,000 (29,000)

£ 420,000

(248,000) 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 Prepayment £2,000 Apportionment Manufacturing Administration Selling and Distribution thus:

Balance per TB less Prepayment Total charge

Apportioned

£12,000 (say) 60% 20% 20% £12,000 £2,000 (current asset - report on Balance Sheet) £10,000

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 Stock Raw Materials

Work in Progress

Finished Goods

Opening

Closing

Include as cost in calculation 1 Deduct from total of Opening stock + of cost of materials consumed Purchases to calculate cost of materials consumed 2 Include in Balance Sheet (Current Assets) Include as cost in 1 Deduct in Manufacturing account Manufacturing Account 2 Include in Balance Sheet (Current Assets) Include as Cost In Trading Account

1 Deduct in Trading Account to calculate 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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