0452 · 5.4Manufacturing accounts

Manufacturing costs and inventories

0:00Rowan Furniture makes wooden tables instead of buying completed tables for resale. Its timber, production workers and factory all contribute to the amount spent making those tables. This video covers direct and indirect costs, direct material, direct labour, prime cost and factory overheads. It also shows how to make adjustments for work in progress and how to calculate factory cost of production. We will prepare a manufacturing account, a statement of profit or loss and a statement of financial position with year-end adjustments.

0:28Financial statements are summaries that show a business's profit or loss for a period and what it owns and owes at a date. Revenue is the income a business earns from its main activity, such as selling goods or providing services. Rowan Furniture earns its revenue from table sales. Expenses are the costs used up in running the business and earning revenue during a period. A manufacturer separates production costs from office and selling expenses, so the cost of completed goods is found first.

0:54Inventory means goods held for resale. For a manufacturer, this category also includes materials awaiting use and goods being made for eventual sale. Timber is a raw material, because raw materials are the basic inputs used to manufacture products. Finished goods are completed products ready for sale, while work in progress means partly finished goods at the end of the period. Timber enters the workshop, workers shape it, and completed tables leave the production area.

1:18Opening inventory is the value of goods held for resale at the start of a financial period. The goods remaining at its end are called closing inventory. A manufacturer values opening and closing inventories of raw materials, work in progress and finished goods. The manufacturing account separates the costs belonging to completed products from costs still held in those earlier stages.

Direct costs and factory overheads

1:39Direct costs are costs that can be traced to each unit made. Timber in a table is direct material, because the cost of that input can be traced to the product. Payments to workers who make the products are direct labour. Direct expenses are other costs traceable to production units, such as royalties payable for each item manufactured. Adding direct material, direct labour and direct expenses gives prime cost. Indirect costs are factory costs that cannot be traced to individual units made.

2:05In the manufacturing account, these indirect costs are called factory overheads. Examples include factory rent, factory power, supervisors' wages, factory insurance and depreciation of factory machinery. A supervisor supports production across the workshop, so the supervisor's wages are factory overheads. The wages of someone assembling the tables belong in direct labour because their work makes the products. Office salaries and selling costs belong outside the manufacturing account. Classify each amount according to the activity it supports, even when several amounts have similar names.

Calculating materials consumed

2:37A manufacturing account calculates the factory cost of production for a period. Factory cost of production is the production cost of goods completed during that period. We begin with materials consumed, add the other direct costs, and then include factory overheads. Finally, adjustments for work in progress separate completed production from unfinished goods. Our example covers the year ended on the thirty-first of December. Rowan Furniture began with raw materials of two thousand four hundred dollars and bought another eighteen thousand six hundred dollars.

3:05Carriage inwards is the cost of transporting purchased goods into the business. Delivery of the timber cost five hundred dollars, and unused raw materials at the year end were valued at three thousand one hundred dollars. Two thousand four hundred plus eighteen thousand six hundred plus five hundred equals twenty-one thousand five hundred dollars of materials available. Subtract the unused three thousand one hundred dollars. The cost of raw materials consumed is eighteen thousand four hundred dollars.

3:29We include opening materials because they were available for use this year, and exclude closing materials because production has not used them. Production workers earned direct labour of twelve thousand six hundred dollars, and direct expenses for royalties were nine hundred dollars. Eighteen thousand four hundred plus twelve thousand six hundred plus nine hundred equals thirty-one thousand nine hundred dollars. This is prime cost. If raw materials were returned to suppliers, their cost would also be deducted when calculating materials consumed.

Year-end adjustments and production cost

3:56Year-end adjustments must be made before expenses enter either financial statement. The matching or accruals concept means income and expenses are recorded in the period to which they relate, not when cash is received or paid. Rowan Furniture has rent paid in advance and an unpaid power bill to adjust. A prepaid expense is a cost paid in advance that belongs to a future period. Rowan Furniture paid ten thousand dollars in rent, including one thousand dollars for the following year.

4:22Ten thousand minus one thousand gives this year's expense of nine thousand dollars. Seven tenths relates to the factory, so nine thousand multiplied by seven tenths gives six thousand three hundred dollars. The office uses the remaining three tenths, which gives two thousand seven hundred dollars. Adjust the total expense before applying the allocation given in the question. Factory rent enters the manufacturing account, while office rent is an office expense.

4:46The prepaid one thousand dollars remains a resource for the next year. It is carried forward and shown with the assets at the year end. Factory power payments were eighteen hundred dollars, and another three hundred dollars remained unpaid. Eighteen hundred plus three hundred gives a factory power expense of two thousand one hundred dollars. The factory used all that power during this year, so the full amount belongs in production costs.

5:06An accrued expense is a cost of the current year that is still unpaid at the year end. This accrued factory power of three hundred dollars is also shown with the amounts owed. Depreciation is the loss in value of a non-current asset over its useful life. It is an estimate that is charged as an expense in each year of use. Rowan Furniture's machinery depreciation for the year is two thousand five hundred dollars.

5:26Because the machinery makes the tables, this charge belongs in factory overheads. Supervisors' wages of four thousand two hundred dollars are another indirect cost. Six thousand three hundred plus four thousand two hundred plus two thousand one hundred plus two thousand five hundred equals fifteen thousand one hundred dollars. That is total factory overheads. Add prime cost of thirty-one thousand nine hundred dollars to obtain total manufacturing costs of forty-seven thousand dollars.

5:51Opening work in progress contains costs incurred before this year on products that were then unfinished. We add it because those earlier costs contribute to goods available for completion this year. Closing work in progress contains costs belonging to products still unfinished now. Subtracting it leaves the production cost of completed goods. Opening work in progress is sixteen hundred dollars, and closing work in progress is two thousand three hundred dollars.

6:14Forty-seven thousand plus sixteen hundred gives forty-eight thousand six hundred dollars. Subtract two thousand three hundred dollars to obtain factory cost of production of forty-six thousand three hundred dollars. The deducted amount remains in unfinished goods at the year end.

Profit or loss calculation

6:27The statement of profit or loss is the financial statement that shows the revenue, expenses and profit or loss for a period. For a manufacturer, its first section uses finished goods rather than purchases. Cost of sales is the cost of inventory sold during a period. Completed production enters this calculation, but completed tables still unsold must be excluded. Opening finished goods are three thousand eight hundred dollars, and closing finished goods are four thousand five hundred dollars.

6:52Three thousand eight hundred plus forty-six thousand three hundred gives fifty thousand one hundred dollars of finished goods available. Subtract four thousand five hundred dollars. Cost of sales is forty-five thousand six hundred dollars because the closing tables have not yet been sold. Gross profit is revenue minus cost of sales. Rowan Furniture's revenue is seventy-two thousand dollars. Seventy-two thousand minus forty-five thousand six hundred gives gross profit of twenty-six thousand four hundred dollars.

7:18Office and selling expenses must still be deducted because they support running the business and selling its products. Irrecoverable debts are amounts owed by customers that the business considers uncollectable. Rowan Furniture must remove four hundred dollars from customer amounts owed and include that expense in the statement of profit or loss. An allowance for irrecoverable debts is an estimate of trade receivables that may not be paid. Its existing allowance is two hundred dollars, and the required closing allowance is three hundred dollars.

7:44Three hundred minus two hundred gives an increase of one hundred dollars. Only that increase is this year's additional expense, while the full closing allowance reduces customer amounts at the year end. Office salaries are six thousand four hundred dollars, and selling expenses are two thousand two hundred dollars. Office equipment depreciation is six hundred dollars and belongs with these non-production expenses. Add two thousand seven hundred plus six thousand four hundred plus two thousand two hundred dollars.

8:10That gives eleven thousand three hundred dollars. Four hundred plus one hundred plus six hundred adds another eleven hundred dollars. Total expenses deducted from gross profit are twelve thousand four hundred dollars. Profit for the year is the amount by which revenue exceeds expenses over one financial year. Twenty-six thousand four hundred minus twelve thousand four hundred gives fourteen thousand dollars. Factory costs have already entered through cost of sales, so we include each expense once.

8:35Any other year-end adjustments follow the same matching concept, with production-related amounts assigned to the manufacturing account.

Statement of financial position

8:42A statement of financial position shows assets, liabilities and owner's equity at a particular date. Assets are resources owned or controlled by a business that bring future benefit. Rowan Furniture's machinery and office equipment are listed first, under non-current assets. Non-current assets are assets held for continuing use in the business rather than for resale. Accumulated depreciation is the running total of depreciation charged on an asset since it was acquired.

9:09Machinery cost thirty thousand dollars, and its previous accumulated depreciation was six thousand dollars. Carrying amount is the asset's cost less its accumulated depreciation. Adding this year's two thousand five hundred dollars gives accumulated depreciation of eight thousand five hundred dollars. Thirty thousand minus eight thousand five hundred gives machinery carrying amount of twenty-one thousand five hundred dollars. Office equipment cost six thousand two hundred dollars, with previous accumulated depreciation of thirteen hundred dollars.

9:35Adding this year's six hundred dollars gives accumulated depreciation of nineteen hundred dollars. Its carrying amount is six thousand two hundred minus nineteen hundred, which is four thousand three hundred dollars. Twenty-one thousand five hundred plus four thousand three hundred gives total non-current assets of twenty-five thousand eight hundred dollars. Current assets are assets expected to be turned into cash or used up within twelve months. Rowan Furniture's include three inventories, customer balances and money in the bank.

10:03Trade receivables are amounts owed by credit customers who have not yet paid for goods or services. Prepaid rent is not owed by a customer, so it is listed separately. Other receivables are current assets, such as amounts due to the business and payments for benefits not yet used. Show raw materials at three thousand one hundred dollars, work in progress at two thousand three hundred and finished goods at four thousand five hundred.

10:24Customer amounts were six thousand dollars before adjustments. Six thousand minus four hundred minus three hundred gives trade receivables of five thousand three hundred dollars. Bank funds are eight thousand one hundred dollars, and other receivables for prepaid rent are one thousand dollars. Three thousand one hundred plus two thousand three hundred plus four thousand five hundred equals nine thousand nine hundred dollars of inventories. Add five thousand three hundred plus eight thousand one hundred plus one thousand dollars.

10:51Total current assets are twenty-four thousand three hundred dollars. Twenty-five thousand eight hundred plus twenty-four thousand three hundred gives total assets of fifty thousand one hundred dollars. Liabilities are amounts the business owes to others, and current liabilities are amounts due for payment within twelve months. Rowan Furniture's largest current liability is owed to its timber suppliers. Trade payables are amounts owed to credit suppliers that the business has not yet paid.

11:16Unpaid expenses and money received before it is earned are grouped as other payables, which are current liabilities. Trade payables are five thousand seven hundred dollars, and accrued factory power is three hundred dollars. Five thousand seven hundred plus three hundred gives current liabilities of six thousand dollars. Net assets are total assets minus total liabilities. Fifty thousand one hundred minus six thousand gives net assets of forty-four thousand one hundred dollars.

11:40The capital section must reach the same figure. Owner's equity, also called capital, is the owner's investment in the business, or the amount the business owes the owner. Drawings are money or goods taken from the business by its owner for private use. They are not a business expense, so they never reduce the profit for the year. Instead, drawings reduce owner's equity. Opening capital is thirty-three thousand six hundred dollars, and drawings are three thousand five hundred dollars.

12:07Thirty-three thousand six hundred plus fourteen thousand gives forty-seven thousand six hundred dollars. Subtract three thousand five hundred to obtain closing capital of forty-four thousand one hundred dollars. The accounting equation states that assets equal liabilities plus owner's equity. Here, fifty thousand one hundred dollars equals six thousand dollars plus forty-four thousand one hundred dollars. Office and selling expenses belong only in the statement of profit or loss. When calculating completed production, opening work in progress is added and closing work in progress is subtracted.

12:37Cost of sales uses the finished goods inventories, while all three closing inventories are shown as current assets. Paper One contains forty multiple-choice questions, while Paper Two contains five compulsory structured questions. Calculate means work out from given figures, prepare means present information in a suitable format, and explain means give reasons, why and how, supported by evidence. A prepared manufacturing account should identify materials consumed, prime cost, factory overheads and factory cost of production.

13:06Consider an exam-style request to explain why closing work in progress is deducted in Rowan Furniture's manufacturing account. It represents partly finished goods at the year end. Its cost is already inside this year's materials, labour and overheads. Deducting that cost leaves the production cost of completed goods, while the unfinished goods remain a current asset. Manufacturing accounts follow the movement from raw materials to unfinished products and then completed goods.

13:31Prime cost combines direct costs, while factory overheads add the indirect costs of production. Work in progress adjustments identify completed production, and finished goods adjustments identify cost of sales. Office and selling expenses then reduce gross profit, while closing inventories and unpaid or prepaid amounts appear in the statement of financial position.