ICAI Notes- Unit 2: Final Accounts of Manufacturing Entities | Principles and Practice of Accounting - CA Foundation PDF Download

 Page 1


 
 
 
    
 7.75
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
LEARNING OUTCOMES 
UNIT – 2 FINAL ACCOUNTS OF MANUFACTURING 
ENTITIES 
 
 
After studying this unit, you would be able to:  
? Understand the purpose of preparing Manufacturing Account. 
? Learn the items to be included in the Manufacturing Account 
? Draw Manufacturing accounts of Manufacturing entities 
 
 
 
 
 
 2.1 INTRODUCTION  
The manufacturing entities generally prepare a separate Manufacturing Account as a part of 
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The 
objective of preparing Manufacturing Account is to determine manufacturing costs of finished 
goods for assessing the cost effectiveness of manufacturing activities. Manufacturing costs of 
finished goods are then transferred from the Manufacturing Account to Trading Account. 
 
MANUFACTURING BUSINESS ENTITIES
Final  Accounts
Manufacturing 
Account
Trading Account
Profit & Loss 
Account
Balance Sheet
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
Page 2


 
 
 
    
 7.75
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
LEARNING OUTCOMES 
UNIT – 2 FINAL ACCOUNTS OF MANUFACTURING 
ENTITIES 
 
 
After studying this unit, you would be able to:  
? Understand the purpose of preparing Manufacturing Account. 
? Learn the items to be included in the Manufacturing Account 
? Draw Manufacturing accounts of Manufacturing entities 
 
 
 
 
 
 2.1 INTRODUCTION  
The manufacturing entities generally prepare a separate Manufacturing Account as a part of 
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The 
objective of preparing Manufacturing Account is to determine manufacturing costs of finished 
goods for assessing the cost effectiveness of manufacturing activities. Manufacturing costs of 
finished goods are then transferred from the Manufacturing Account to Trading Account. 
 
MANUFACTURING BUSINESS ENTITIES
Final  Accounts
Manufacturing 
Account
Trading Account
Profit & Loss 
Account
Balance Sheet
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING
1.76 
 7.76 
(a) Trading account shows Gross Profit while Manufacturing Account shows cost of 
goods sold which includes direct expenses. 
(b) Manufacturing account also deals with the raw materials, and work in progress while 
the trading account would deal with finished goods only. 
 2.2  PURPOSE 
A manufacturing account serves the following functions: 
(1) It shows the total cost of manufacturing the finished products and sets out in detail, 
with appropriate classifications, the constituent elements of such cost. It is, therefore, 
debited with the cost of materials, manufacturing wages and expenses incurred directly 
or indirectly to manufacture. 
(2) It provides details of factory cost and facilitates reconciliation of financial books with 
cost records. It also serves as a basis of comparison of manufacturing operations from 
period to period.  
(3) The Manufacturing Account may also be used for various other purposes. For example, 
if the output is carried to the Trading Account at market prices, it shows the profit or 
loss on manufacture. Similarly, it may also be used to fix the amount of production 
linked bonus when such schemes are in force. 
 2.3  MANUFACTURING COSTS 
Manufacturing costs are classified into: 
+ Raw Material Consumed .…..…. 
+ Direct Manufacturing Wages ……… 
+ Direct Manufacturing Expenses ……… 
+ Direct Manufacturing Cost ……… 
+ Indirect Manufacturing expenses or  
 
+ Manufacturing Overhead ……… 
    Total Manufacturing Cost _____ 
 
  
© The Institute of Chartered Accountants of India
Page 3


 
 
 
    
 7.75
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
LEARNING OUTCOMES 
UNIT – 2 FINAL ACCOUNTS OF MANUFACTURING 
ENTITIES 
 
 
After studying this unit, you would be able to:  
? Understand the purpose of preparing Manufacturing Account. 
? Learn the items to be included in the Manufacturing Account 
? Draw Manufacturing accounts of Manufacturing entities 
 
 
 
 
 
 2.1 INTRODUCTION  
The manufacturing entities generally prepare a separate Manufacturing Account as a part of 
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The 
objective of preparing Manufacturing Account is to determine manufacturing costs of finished 
goods for assessing the cost effectiveness of manufacturing activities. Manufacturing costs of 
finished goods are then transferred from the Manufacturing Account to Trading Account. 
 
MANUFACTURING BUSINESS ENTITIES
Final  Accounts
Manufacturing 
Account
Trading Account
Profit & Loss 
Account
Balance Sheet
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING
1.76 
 7.76 
(a) Trading account shows Gross Profit while Manufacturing Account shows cost of 
goods sold which includes direct expenses. 
(b) Manufacturing account also deals with the raw materials, and work in progress while 
the trading account would deal with finished goods only. 
 2.2  PURPOSE 
A manufacturing account serves the following functions: 
(1) It shows the total cost of manufacturing the finished products and sets out in detail, 
with appropriate classifications, the constituent elements of such cost. It is, therefore, 
debited with the cost of materials, manufacturing wages and expenses incurred directly 
or indirectly to manufacture. 
(2) It provides details of factory cost and facilitates reconciliation of financial books with 
cost records. It also serves as a basis of comparison of manufacturing operations from 
period to period.  
(3) The Manufacturing Account may also be used for various other purposes. For example, 
if the output is carried to the Trading Account at market prices, it shows the profit or 
loss on manufacture. Similarly, it may also be used to fix the amount of production 
linked bonus when such schemes are in force. 
 2.3  MANUFACTURING COSTS 
Manufacturing costs are classified into: 
+ Raw Material Consumed .…..…. 
+ Direct Manufacturing Wages ……… 
+ Direct Manufacturing Expenses ……… 
+ Direct Manufacturing Cost ……… 
+ Indirect Manufacturing expenses or  
 
+ Manufacturing Overhead ……… 
    Total Manufacturing Cost _____ 
 
  
© The Institute of Chartered Accountants of India
 
 
 
    
 7.77
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
Raw Material consumed is arrived at after adjustment of opening and closing Inventory of raw 
materials: 
Raw Material Consumed = Opening inventory+ Purchases – Closing inventory  
                                          of Raw Materials                           of Raw Materials 
If there remain unfinished goods at the beginning and at the end of the accounting period, 
cost of such unfinished goods (also termed as Work-In-Process) is shown in the Manufacturing 
Account. 
Opening inventory of Work-in-Process is posted to the debit of the Manufacturing Account 
and closing inventory of Work-in-Process is posted to the credit of the Manufacturing 
Account. 
DIRECT MANUFACTURING EXPENSES 
Direct manufacturing expenses are costs, other than material or wages, which are incurred for 
a specific product or saleable service.  
Examples of direct manufacturing expenses are (i) Royalties for using license or technology if 
based on units produced, (ii) Hire charge of the plant and machinery used on hire, if based on 
units produced, etc. 
When royalty or hire charges are based on units produced, these expenses directly vary with 
production. 
ILLUSTRATION 1 
1,00,000 units were produced in a factory. Per unit material cost was ` 10 and per unit labour 
cost was ` 5. That apart it was agreed to pay royalty @ `  3 per unit to the Japanese collaborator 
who supplied technology. 
Required 
Calculate Manufacturing Cost. 
SOLUTION
In this case Manufacturing Cost comprises of – 
Raw Material consumed (1,00,000 × 
`
 10) 
`
 10,00,000 
Direct Wages (1,00,000 × 
`
 5) 
`
 5,00,000 
Direct Expenses (1,00,000 × 
`
3) 
`
 3,00,000 
  
`
 18,00,000 
© The Institute of Chartered Accountants of India
Page 4


 
 
 
    
 7.75
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
LEARNING OUTCOMES 
UNIT – 2 FINAL ACCOUNTS OF MANUFACTURING 
ENTITIES 
 
 
After studying this unit, you would be able to:  
? Understand the purpose of preparing Manufacturing Account. 
? Learn the items to be included in the Manufacturing Account 
? Draw Manufacturing accounts of Manufacturing entities 
 
 
 
 
 
 2.1 INTRODUCTION  
The manufacturing entities generally prepare a separate Manufacturing Account as a part of 
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The 
objective of preparing Manufacturing Account is to determine manufacturing costs of finished 
goods for assessing the cost effectiveness of manufacturing activities. Manufacturing costs of 
finished goods are then transferred from the Manufacturing Account to Trading Account. 
 
MANUFACTURING BUSINESS ENTITIES
Final  Accounts
Manufacturing 
Account
Trading Account
Profit & Loss 
Account
Balance Sheet
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING
1.76 
 7.76 
(a) Trading account shows Gross Profit while Manufacturing Account shows cost of 
goods sold which includes direct expenses. 
(b) Manufacturing account also deals with the raw materials, and work in progress while 
the trading account would deal with finished goods only. 
 2.2  PURPOSE 
A manufacturing account serves the following functions: 
(1) It shows the total cost of manufacturing the finished products and sets out in detail, 
with appropriate classifications, the constituent elements of such cost. It is, therefore, 
debited with the cost of materials, manufacturing wages and expenses incurred directly 
or indirectly to manufacture. 
(2) It provides details of factory cost and facilitates reconciliation of financial books with 
cost records. It also serves as a basis of comparison of manufacturing operations from 
period to period.  
(3) The Manufacturing Account may also be used for various other purposes. For example, 
if the output is carried to the Trading Account at market prices, it shows the profit or 
loss on manufacture. Similarly, it may also be used to fix the amount of production 
linked bonus when such schemes are in force. 
 2.3  MANUFACTURING COSTS 
Manufacturing costs are classified into: 
+ Raw Material Consumed .…..…. 
+ Direct Manufacturing Wages ……… 
+ Direct Manufacturing Expenses ……… 
+ Direct Manufacturing Cost ……… 
+ Indirect Manufacturing expenses or  
 
+ Manufacturing Overhead ……… 
    Total Manufacturing Cost _____ 
 
  
© The Institute of Chartered Accountants of India
 
 
 
    
 7.77
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
Raw Material consumed is arrived at after adjustment of opening and closing Inventory of raw 
materials: 
Raw Material Consumed = Opening inventory+ Purchases – Closing inventory  
                                          of Raw Materials                           of Raw Materials 
If there remain unfinished goods at the beginning and at the end of the accounting period, 
cost of such unfinished goods (also termed as Work-In-Process) is shown in the Manufacturing 
Account. 
Opening inventory of Work-in-Process is posted to the debit of the Manufacturing Account 
and closing inventory of Work-in-Process is posted to the credit of the Manufacturing 
Account. 
DIRECT MANUFACTURING EXPENSES 
Direct manufacturing expenses are costs, other than material or wages, which are incurred for 
a specific product or saleable service.  
Examples of direct manufacturing expenses are (i) Royalties for using license or technology if 
based on units produced, (ii) Hire charge of the plant and machinery used on hire, if based on 
units produced, etc. 
When royalty or hire charges are based on units produced, these expenses directly vary with 
production. 
ILLUSTRATION 1 
1,00,000 units were produced in a factory. Per unit material cost was ` 10 and per unit labour 
cost was ` 5. That apart it was agreed to pay royalty @ `  3 per unit to the Japanese collaborator 
who supplied technology. 
Required 
Calculate Manufacturing Cost. 
SOLUTION
In this case Manufacturing Cost comprises of – 
Raw Material consumed (1,00,000 × 
`
 10) 
`
 10,00,000 
Direct Wages (1,00,000 × 
`
 5) 
`
 5,00,000 
Direct Expenses (1,00,000 × 
`
3) 
`
 3,00,000 
  
`
 18,00,000 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING
1.78 
 7.78 
INDIRECT MANUFACTURING EXPENSES OR OVERHEAD EXPENSES 
These are also called Manufacturing overhead, Production overhead, Works overhead, etc. 
Overhead is defined as total cost of indirect material, indirect wages and indirect expenses.  
Overhead = Indirect Material + Indirect Wages + Indirect Expenses 
Indirect material means materials which cannot be linked directly with the units produced, 
for example, stores consumed for repair and maintenance work, small tools, fuel and 
lubricating oil, etc.  
Indirect wages are those which cannot be directly linked to the units produced, for example, 
wages for maintenance works, holding pay, etc.  
Indirect expenses are those which cannot be directly linked to the units produced, for 
example, training expenses, depreciation of plant and machinery, depreciation of factory shed, 
insurance premium for plant and machinery, factory shed, etc. 
Accordingly, indirect manufacturing expenses comprise indirect material, indirect wages and 
indirect expenses of the manufacturing division. 
BY-PRODUCTS  
In most manufacturing operations, the production of the main product is accompanied by the 
production of a subsidiary product which has a value on sale. For example, the production of 
hydrogenated vegetable oil is accompanied by the production of oxygen gas and the 
production of steel yields scrap. The subsidiary product is termed as a by-product because its 
production is not consciously undertaken but results out of the production of the main 
product. It is usually very difficult to ascertain the cost of the product. Moreover, its value 
usually forms a very small percentage of the main product. 
By-product is a secondary product. This is produced from the same raw materials, which are 
used for producing the main product and without incurring any additional expenses from the 
same production process in which the main product is produced. Some examples of by-
product are given below: 
(i) Molasses is the by-product in sugar manufacturing; 
(ii) Butter milk is the by-product of a dairy which produces butter and cheese, etc. 
By-products generally have insignificant value as compared to the value of main product. They 
are generally valued at net realizable value, if their costs cannot be separately identified. It 
is often treated, as Other Operating income” but the correct treatment would be to credit the 
sale value of the by-product to Manufacturing Account so as to reduce to that extent, the cost 
of manufacture of main product. 
© The Institute of Chartered Accountants of India
Page 5


 
 
 
    
 7.75
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
LEARNING OUTCOMES 
UNIT – 2 FINAL ACCOUNTS OF MANUFACTURING 
ENTITIES 
 
 
After studying this unit, you would be able to:  
? Understand the purpose of preparing Manufacturing Account. 
? Learn the items to be included in the Manufacturing Account 
? Draw Manufacturing accounts of Manufacturing entities 
 
 
 
 
 
 2.1 INTRODUCTION  
The manufacturing entities generally prepare a separate Manufacturing Account as a part of 
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The 
objective of preparing Manufacturing Account is to determine manufacturing costs of finished 
goods for assessing the cost effectiveness of manufacturing activities. Manufacturing costs of 
finished goods are then transferred from the Manufacturing Account to Trading Account. 
 
MANUFACTURING BUSINESS ENTITIES
Final  Accounts
Manufacturing 
Account
Trading Account
Profit & Loss 
Account
Balance Sheet
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING
1.76 
 7.76 
(a) Trading account shows Gross Profit while Manufacturing Account shows cost of 
goods sold which includes direct expenses. 
(b) Manufacturing account also deals with the raw materials, and work in progress while 
the trading account would deal with finished goods only. 
 2.2  PURPOSE 
A manufacturing account serves the following functions: 
(1) It shows the total cost of manufacturing the finished products and sets out in detail, 
with appropriate classifications, the constituent elements of such cost. It is, therefore, 
debited with the cost of materials, manufacturing wages and expenses incurred directly 
or indirectly to manufacture. 
(2) It provides details of factory cost and facilitates reconciliation of financial books with 
cost records. It also serves as a basis of comparison of manufacturing operations from 
period to period.  
(3) The Manufacturing Account may also be used for various other purposes. For example, 
if the output is carried to the Trading Account at market prices, it shows the profit or 
loss on manufacture. Similarly, it may also be used to fix the amount of production 
linked bonus when such schemes are in force. 
 2.3  MANUFACTURING COSTS 
Manufacturing costs are classified into: 
+ Raw Material Consumed .…..…. 
+ Direct Manufacturing Wages ……… 
+ Direct Manufacturing Expenses ……… 
+ Direct Manufacturing Cost ……… 
+ Indirect Manufacturing expenses or  
 
+ Manufacturing Overhead ……… 
    Total Manufacturing Cost _____ 
 
  
© The Institute of Chartered Accountants of India
 
 
 
    
 7.77
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
Raw Material consumed is arrived at after adjustment of opening and closing Inventory of raw 
materials: 
Raw Material Consumed = Opening inventory+ Purchases – Closing inventory  
                                          of Raw Materials                           of Raw Materials 
If there remain unfinished goods at the beginning and at the end of the accounting period, 
cost of such unfinished goods (also termed as Work-In-Process) is shown in the Manufacturing 
Account. 
Opening inventory of Work-in-Process is posted to the debit of the Manufacturing Account 
and closing inventory of Work-in-Process is posted to the credit of the Manufacturing 
Account. 
DIRECT MANUFACTURING EXPENSES 
Direct manufacturing expenses are costs, other than material or wages, which are incurred for 
a specific product or saleable service.  
Examples of direct manufacturing expenses are (i) Royalties for using license or technology if 
based on units produced, (ii) Hire charge of the plant and machinery used on hire, if based on 
units produced, etc. 
When royalty or hire charges are based on units produced, these expenses directly vary with 
production. 
ILLUSTRATION 1 
1,00,000 units were produced in a factory. Per unit material cost was ` 10 and per unit labour 
cost was ` 5. That apart it was agreed to pay royalty @ `  3 per unit to the Japanese collaborator 
who supplied technology. 
Required 
Calculate Manufacturing Cost. 
SOLUTION
In this case Manufacturing Cost comprises of – 
Raw Material consumed (1,00,000 × 
`
 10) 
`
 10,00,000 
Direct Wages (1,00,000 × 
`
 5) 
`
 5,00,000 
Direct Expenses (1,00,000 × 
`
3) 
`
 3,00,000 
  
`
 18,00,000 
© The Institute of Chartered Accountants of India
  
 
ACCOUNTING
1.78 
 7.78 
INDIRECT MANUFACTURING EXPENSES OR OVERHEAD EXPENSES 
These are also called Manufacturing overhead, Production overhead, Works overhead, etc. 
Overhead is defined as total cost of indirect material, indirect wages and indirect expenses.  
Overhead = Indirect Material + Indirect Wages + Indirect Expenses 
Indirect material means materials which cannot be linked directly with the units produced, 
for example, stores consumed for repair and maintenance work, small tools, fuel and 
lubricating oil, etc.  
Indirect wages are those which cannot be directly linked to the units produced, for example, 
wages for maintenance works, holding pay, etc.  
Indirect expenses are those which cannot be directly linked to the units produced, for 
example, training expenses, depreciation of plant and machinery, depreciation of factory shed, 
insurance premium for plant and machinery, factory shed, etc. 
Accordingly, indirect manufacturing expenses comprise indirect material, indirect wages and 
indirect expenses of the manufacturing division. 
BY-PRODUCTS  
In most manufacturing operations, the production of the main product is accompanied by the 
production of a subsidiary product which has a value on sale. For example, the production of 
hydrogenated vegetable oil is accompanied by the production of oxygen gas and the 
production of steel yields scrap. The subsidiary product is termed as a by-product because its 
production is not consciously undertaken but results out of the production of the main 
product. It is usually very difficult to ascertain the cost of the product. Moreover, its value 
usually forms a very small percentage of the main product. 
By-product is a secondary product. This is produced from the same raw materials, which are 
used for producing the main product and without incurring any additional expenses from the 
same production process in which the main product is produced. Some examples of by-
product are given below: 
(i) Molasses is the by-product in sugar manufacturing; 
(ii) Butter milk is the by-product of a dairy which produces butter and cheese, etc. 
By-products generally have insignificant value as compared to the value of main product. They 
are generally valued at net realizable value, if their costs cannot be separately identified. It 
is often treated, as Other Operating income” but the correct treatment would be to credit the 
sale value of the by-product to Manufacturing Account so as to reduce to that extent, the cost 
of manufacture of main product. 
© The Institute of Chartered Accountants of India
 
 
 
    
 7.79
PREPARATIONS OF FINAL ACCOUNTS OF 
SOLE PROPRIETORS 
 2.4  DESIGN OF A MANUFACTURING ACCOUNT 
There is no standardized design for the presentation of a Manufacturing Account. Given below 
is a format covering various elements: 
Manufacturing Account 
Particulars Units Amount Particulars Units Amount 
  `    `  
To Raw Material Consumed: 
 Opening inventory 
  By By-products at net 
realizable value 
  
      Add: Purchases … .  By Closing Work-in- Process   
      Less: Closing inventory …..  By Trading A/c   
To Direct Wages ….. ……  Cost of production   
To Direct expenses: ……     
 Prime cost  ……    
To Factory overheads:      
 Royalty .….     
 Hire charges …..     
To Indirect expenses: …..     
 Repairs & Maintenance .….     
 Depreciation .…. …….    
 Factory cost  …….    
To Opening Work-in-process  .……    
Tutorial Note: Frequently, problems are set, in which all the ledger balances are not given. 
Instead, details are given regarding the number of items in Inventories, quantity manufactured 
etc. the figures for Inventories, sales etc., would therefore have to be worked out 
independently from the data given.  
The following general rules may be observed. 
(a) The Manufacturing Account should have columns showing the quantities and values. 
Frequently, all the quantities are not given and the quantities applicable to one or more of 
the items would have to be worked out. For example, if the question does not state the total 
number of items sold, the quantity can be worked out by adding opening inventory and units 
manufactured and deducting closing inventory. It is, therefore, useful to have quantity 
columns in the account so that it can be seen that both sides balance. 
© The Institute of Chartered Accountants of India