Unit 2: Final Accounts of Manufacturing Entities Chapter Notes | Accounting for CA Foundation PDF Download

Unit Overview

• Manufacturing Account shows the total manufacturing cost of finished goods and the cost of work-in-process (if any).
• The amount representing the cost of finished goods is transferred from the Manufacturing Account to the Trading Account.
• The Manufacturing Account deals with raw materials, direct wages, direct expenses and factory overheads plus opening work-in-process and less closing work-in-process.

Trading Account vs Manufacturing Account

• The Trading Account shows Gross Profit or Gross Loss by comparing sales revenue with the cost of goods sold (COGS) which includes the cost of finished goods transferred from the Manufacturing Account.
• The Manufacturing Account shows the detailed computation of manufacturing cost and handles raw materials and work-in-progress (WIP); the Trading Account deals only with finished goods.

Purpose

• Total Cost of Manufacturing: It records the entire cost involved in producing finished products, broken down into materials, wages and manufacturing expenses.
• Factory Cost and Reconciliation: It provides the factory cost and helps reconcile financial accounts with cost accounts for comparison of manufacturing efficiency across periods.
• Profit or Loss on Manufacture: If output is shown in Trading Account at market prices, Manufacturing Account helps indicate whether manufacture itself resulted in profit or loss.
• Production-Linked Benefit Computation: It can be used to determine production-linked bonuses or similar incentives where applicable.

Manufacturing Cost

Manufacturing costs are typically classified into:

Raw material consumed is arrived at after adjustment of opening and closing inventory of raw materials.

If there are unfinished goods at the beginning or end of the accounting period, the cost of such unfinished goods (termed Work-in-Process or WIP) is shown in the Manufacturing Account.

• Opening inventory of Work-in-Process is posted to the debit side of the Manufacturing Account.
• Closing inventory of Work-in-Process is posted to the credit side of the Manufacturing Account.

Computation of Raw Material Consumed (standard formula)

• Raw material consumed = Opening raw materials + Purchases of raw materials + Freight inwards + Other direct charges - Closing raw materials.

Direct Manufacturing Expenses

Direct manufacturing expenses are costs incurred specifically for a particular product and are directly attributable to production, other than material and labour.

Examples include royalties based on units produced and hire charges for plant or machinery charged per unit produced. Such expenses vary directly with the level of 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
Manufacturing Cost comprises of direct material, direct labour and direct manufacturing expense (royalty).
Direct material = Number of units × Material cost per unit
Direct labour = Number of units × Labour cost per unit
Royalty = Number of units × Royalty per unit
Direct material = 100,000 × ₹10
Direct labour = 100,000 × ₹5
Royalty = 100,000 × ₹3
Total Manufacturing Cost = Direct material + Direct labour + Royalty

Indirect Manufacturing Expenses (Factory Overheads)

• Indirect manufacturing expenses are also known as manufacturing overheads, production overheads or works overheads.
• They include the total cost of indirect materials, indirect wages and indirect expenses related to the manufacturing division.
• Overhead = Indirect Material + Indirect Wages + Indirect Expenses
• Indirect material refers to materials that cannot be directly linked to production units (e.g., stores consumed for repairs, small tools, fuel, and lubricants).
• Indirect wages are wages not directly traceable to product units (e.g., maintenance staff wages, holding pay).
• Indirect expenses include costs such as training, depreciation of plant and machinery and factory buildings, insurance of plant and factory, factory lighting (pro-rated), etc.

By-Products

In many manufacturing processes, the main product is accompanied by a secondary product known as a by-product. By-products arise from the same raw materials used for the main product without incurring additional significant costs.

By-product definition: A by-product is a secondary product recovered incidentally in the course of manufacturing the main product, having some realisable value but not being the primary output.

Examples of by-products

• Molasses in sugar manufacturing
• Buttermilk in dairy processing
• Scrap metal or gases in certain chemical/metal processes

Valuation and Accounting Treatment of By-Products

• By-products usually have a negligible or small value relative to the main product and are often valued at their Net Realisable Value (NRV) if separate costing is not practicable.
• The sale proceeds of by-products are typically credited to the Manufacturing Account, thereby reducing the overall cost of manufacturing the main product.
• Alternative treatments sometimes used (but less appropriate) are to record by-product sales as Other Operating Income. However, for clarity of manufacturing cost, crediting the Manufacturing Account is preferred.

Format of a Manufacturing Account

A Manufacturing Account does not have a single fixed design for presentation, but commonly it includes the following elements:

• Final accounts refer to financial statements prepared at the end of an accounting period to summarise the financial performance and position of a business.
• The main components are the Trading Account, the Profit and Loss Account and the Balance Sheet.
• Final accounts present income, expenses, assets, liabilities and capital, enabling stakeholders to assess profitability and financial health.

Need for Preparation of Final Accounts

• To determine profit or loss for the accounting period.
• To present the financial position of the business at a specific date.
• To comply with legal and regulatory requirements and taxation obligations.
• To provide information for creditors, investors, managers and other stakeholders.
• To assist in financial planning, decision-making and performance comparison across periods or with industry benchmarks.

Features of Final Accounts

• Accuracy: Should faithfully represent all relevant transactions.
• Completeness: All relevant items must be included.
• Compliance: Must conform to applicable accounting standards and regulations.
• Timeliness: Prepared within a reasonable time after the period end.
• Transparency: Clear disclosure of basis of preparation and assumptions.
• Comparability: Enables comparison with prior periods and industry norms.

Types of Final Accounts

• Trading Account: Computes gross profit or loss by matching sales with cost of goods sold.
• Profit and Loss Account: Summarises all revenues and expenses to find net profit or loss for the period.
• Balance Sheet: Shows the financial position (assets, liabilities and capital) at the period end.

ILLUSTRATION 2

Mr Vimal runs a factory which produces soaps. The following details were available in respect of his manufacturing activities for the year ended on 31.3.2022:

Required

Prepare a Manufacturing Account of Mr Vimal for the year ended 31.3.2022.

SOLUTION

Working Notes:

ILLUSTRATION 3

On 31st March, 2022, the Trial Balance of Mr White were as follows:

The following additional information is available:
Stocks on 31st March, 2022 were:
Raw Materials ₹ 16,200
Finished goods ₹18,100
Semi-finished goods ₹ 7,800
Salaries and wages unpaid for March 2022 were respectively, ₹900 and ₹ 2,000
Machinery is to be depreciated by 10% and office furniture by 71/2 %
Provision for doubtful debts is to be maintained @ 1% of sales
Office premises occupy 1/4 of total area.
Lighting is to be charged as to 2/3 to factory and 1/3 to office.
Prepare the Manufacturing Account, Trading Account, Profit and Loss Account and the Balance Sheet relating to 31st March 2022.

SOLUTION