ICAI Notes- Unit 2: Final Accounts of Manufacturing Entities- 1 - CA Foundation PDF Download

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.
(a) Trading account shows Gross Profit while Manufacturing Account shows cost of goods sold which includes direct expenses.
(b) Manufacturing account deals with the raw material, 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 on manufacture.
(2) It provides details of factory cost and facilitates reconciliation of financial books with cost records and also serves as a basis of comparison of manufacturing operations from year to year.
(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 discloses the profit or loss on manufacture. Similarly, it may also be used to fix the amount of production of profit sharing bonus when such schemes are in force.

2.3 MANUFACTURING COSTS :- 

Raw Material consumed is arrived at after adjustment of opening and closing Inventory 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 –

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 dicult 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 “Miscellaneous 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.

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:

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.
(b) The Manufacturing Account will show the quantity of raw materials in inventory at the beginning and at the end of the year and the purchases during the year. As regards finished goods, it will only show the quantity manufactured and, as regards work-in-progress, the opening and closing amounts.
(c) The Trading Account will show the quantities of finished goods manufactured and sold and the opening and closing inventory. It will not show the quantity of raw materials or work-in-progress.
(d) For determining the value of closing inventory, in the absence of specific instruction to the contrary, it must be assumed that sales have been on “first in-first out” basis, that is, the closing inventory consists as far as possible of goods produced during the year, the opening inventory being sold out.
It may be mentioned here that nowadays no manufacturing business entity prepares manufacturing account as part of its final set of accounts. Even the items of manufacturing account are shown either in trading account (in case of non-corporate entities) or in Statement of profit and loss (in case of corporate entities).
The procedure of preparation of Trading Account, Profit and Loss Account and Balance Sheet have already been explained in Unit 1 of this chapter. Students should refer the earlier unit for attempting the problems based on the preparation of complete set of final accounts of a sole proprietor.

ILLUSTRATION 2:- Mr. Vimal runs a factory which produces soaps. Following details were available in respect of his manufacturing activities for the year ended on 31.3.2016:

Required:- Prepare a Manufacturing Account of Mr. Vimal for the year ended 31.3.2016.

SOLUTION:- 


Working Notes:-