All Form Four Book Keeping topics
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- Topic 1Manufacturing AccountsFree preview below
- Topic 2ConsignmentsIn the app
- Topic 3Accounting for Department StoresIn the app
- Topic 4Accounting for Joint BusinessIn the app
- Topic 5Elements of AuditingIn the app
Section 1Key terms and concepts
Learn these definitions carefully. Examiners often award full marks for precise wording.
- Manufacturing cost
- The total cost incurred to convert raw materials into finished goods. It comprises prime cost plus factory overhead.
- Prime cost
- The total of all direct costs: Direct materials + Direct labour + Direct expenses.
- Direct materials
- The cost of materials that become part of the finished product and can be directly traced to it (e.g. wood in furniture).
- Direct labour
- Wages of workers who are physically involved in converting raw materials into finished goods (e.g. machine operators, assemblers).
- Direct expenses
- Expenses that can be directly attributed to a specific product (e.g. royalties, special packaging).
- Factory overhead (Manufacturing overhead)
- All indirect manufacturing costs that cannot be economically traced to specific units (e.g. factory rent, supervisor’s wages, depreciation of plant).
- Cost of raw materials consumed
- Opening stock of raw materials + Purchases + Carriage inwards − Returns outwards − Closing stock of raw materials.
- Work in progress (WIP)
- Partly finished goods that are still in the production process at the end of the accounting period.
- Cost of production
- Prime cost + Factory overhead ± Adjustment for work in progress. This figure is transferred to the Trading Account as the cost of goods manufactured.
- Manufacturing account
- A financial statement prepared by a manufacturing business to calculate the total cost of production for the accounting period.
Section 2Learning objectives
By the end of this topic, you should be able to:
- Explain the meaning of manufacturing cost
- Describe the types of manufacturing cost
- Compute manufacturing costs
- Describe a statement of manufacturing cost
- Construct a statement of manufacturing cost
Section 3Introduction to manufacturing accounts
Businesses that produce and sell goods prepare three main statements at the end of the accounting year:
- Manufacturing account — to calculate the total cost of production
- Trading and profit & loss account — to find the net profit or loss
- Balance sheet — to show the financial position of the business
Why a separate Manufacturing Account?
A trading business buys ready-made goods and simply resells them. A manufacturing business must first convert raw materials into finished goods. The Manufacturing Account shows the true cost of making those goods before they enter the Trading Account.
Section 4The three basic types of manufacturing cost
Manufacturing costs are the costs necessary to convert raw materials into products. They are divided into three categories:
1. Direct materials
The cost of materials that become part of the finished product. Example: wood used to make furniture; steel used to make appliances.
2. Direct labour
Wages of individuals who are physically involved in converting raw materials into finished goods. Example: wages of woodcutters and assemblers in a furniture factory.
3. Factory overhead (Manufacturing overhead)
All other manufacturing costs that cannot be directly traced to specific units in an economically feasible way. Examples: wages of inspectors, depreciation of factory equipment, factory rent, factory insurance, supervisor’s salaries.
Section 5Direct vs Indirect manufacturing costs
Direct costs are immediately associated with the production of a specific product or service (raw materials, direct labour, royalties).
Indirect costs cannot be easily traced to a single product. They support the whole production process (factory rent, utilities, supervisor wages, cleaning, depreciation of shared equipment).
Section 6Prime cost and cost of raw materials consumed
Prime cost is the sum of all direct costs:
Cost of raw materials consumed
This is calculated as follows:
| Opening stock of raw materials | xxxx |
| Add: Purchases of raw materials | xxxx |
| Add: Carriage inwards on raw materials | xxxx |
| xxxx | |
| Less: Returns outwards of raw materials | (xxxx) |
| xxxx | |
| Less: Closing stock of raw materials | (xxxx) |
| Cost of raw materials consumed | xxxx |
Royalties are sometimes included in prime cost. They are fees paid to the owner of a copyrighted process and usually vary directly with the number of units produced.
Section 7Factory overhead
Factory overhead includes all production expenses that are not direct. Common examples:
- Factory rent / factory rates
- Factory lighting and heating
- Factory insurance
- Factory maintenance and repairs
- Indirect wages / factory supervisor’s wages
- Depreciation of plant & machinery, factory buildings, factory furniture, factory motor vans
Once overheads are totalled they are added to the prime cost to give the production cost (before adjusting for work in progress).
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Continue in the appSection 8Format of a manufacturing account
Manufacturing Account for the year ended …
| Opening stock of raw materials | xxxx |
| Add: Purchases of raw materials | xxxx |
| Add: Carriage inwards | xxxx |
| xxxx | |
| Less: Returns outwards | (xxxx) |
| Less: Goods drawings (if any) | (xxxx) |
| xxxx | |
| Less: Closing stock of raw materials | (xxxx) |
| Cost of Direct Materials | xxxxxxx |
| Add: Direct labour | xxxxxxx |
| Add: Direct expenses (e.g. royalties) | xxxxxxx |
| Prime Cost | xxxxxxx |
| Add: Factory overhead expenses | |
| Factory lighting | xxxxxx |
| Factory heating | xxxxxx |
| Factory insurance | xxxxxx |
| Factory rent | xxxxxx |
| Factory maintenance | xxxxxx |
| Factory indirect wages / supervisor’s wages | xxxxxx |
| Depreciation on plant & machinery | xxxxxx |
| Depreciation on factory building | xxxxxx |
| Depreciation on factory furniture / motor van | xxxxxx |
| Total Factory Overhead | XXXXXXX |
| XXXXXXX | |
| Add: Opening stock of work in progress | xxxxxx |
| XXXXXXX | |
| Less: Closing stock of work in progress | (xxxxxx) |
| Cost of Production | XXXXXXX |
Where does Cost of Production go?
The final figure “Cost of Production” is transferred to the Trading Account, where it replaces the usual “Purchases” figure of a merchandising business. Finished goods stock (opening and closing) is then adjusted in the Trading Account to arrive at Cost of Goods Sold.
Section 9Work in progress adjustment
At the end of the year some goods may still be unfinished. These are called work in progress.
- Opening WIP is added (these goods were completed this year).
- Closing WIP is deducted (these goods are not yet finished).
Section 10Manufacturing companies vs Merchandising companies
| Aspect | Manufacturing company | Merchandising company |
|---|---|---|
| Activity | Converts raw materials into finished goods | Buys finished goods and resells them |
| Inventory types | Raw materials, Work in progress, Finished goods | Merchandise inventory only |
| Key account | Manufacturing Account + Trading A/c | Trading Account only |
| Cost focus | Prime cost & factory overhead | Purchase cost of goods |
Section 11Chapter summary
Key take-aways
- Manufacturing cost = costs of converting raw materials into finished goods.
- Three types: Direct materials, Direct labour, Factory overhead.
- Prime cost = Direct materials + Direct labour + Direct expenses.
- Cost of raw materials consumed adjusts for opening/closing stock, carriage and returns.
- Factory overhead = all indirect factory costs (rent, light, insurance, depreciation of factory assets, indirect wages).
- Cost of Production = Prime cost + Overhead ± WIP adjustment; transferred to Trading Account.
- Only factory-related costs appear in the Manufacturing Account; office and selling costs go to Profit & Loss.
Section 12End of topic questions
Test Yourself
1. Define manufacturing cost and list its three main components.
2. Distinguish between direct costs and indirect costs. Give two examples of each in a manufacturing context.
3. Calculate the cost of raw materials consumed given:
Opening stock of raw materials TZS 40,000; Purchases TZS 280,000; Carriage inwards TZS 12,000; Returns outwards TZS 8,000; Closing stock TZS 35,000.
4. State the formula for: (a) Prime cost (b) Cost of production.
5. Why is depreciation of factory machinery included in the Manufacturing Account while depreciation of office equipment is not?
6. Explain the treatment of opening and closing work in progress in the Manufacturing Account.
7. List five items that typically appear under factory overhead.
8. How does the inventory structure of a manufacturing firm differ from that of a merchandising firm?
Section 13Suggested answers
Answers to end-of-topic questions
1.
Show answer
Manufacturing cost is the total cost of converting raw materials into finished goods. Its three components are: Direct materials, Direct labour and Factory overhead.
2.
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Direct costs can be traced directly to a product (e.g. raw materials, direct labour wages, royalties).
Indirect costs cannot be economically traced to a single product (e.g. factory rent, supervisor’s salary, factory insurance).
3.
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40,000 + 280,000 + 12,000 − 8,000 − 35,000 = TZS 289,000
4.
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(a) Prime cost = Direct materials + Direct labour + Direct expenses
(b) Cost of production = Prime cost + Factory overhead + Opening WIP − Closing WIP
5.
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Depreciation of factory machinery is a production (factory) cost and therefore belongs in the Manufacturing Account. Depreciation of office equipment is an administrative expense and is charged in the Profit & Loss Account.
6.
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Opening work in progress is added (these goods were completed during the current period). Closing work in progress is deducted (these goods are not yet finished and should not be included in the cost of production of finished goods).
7.
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Any five of: factory rent, factory lighting/heating, factory insurance, factory maintenance, indirect wages, supervisor’s wages, depreciation of plant & machinery, depreciation of factory buildings, factory power, etc.
8.
Show answer
A manufacturing firm has three types of inventory: raw materials, work in progress and finished goods. A merchandising firm has only one type: merchandise inventory (finished goods ready for sale).
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