Manufacturing Account Explained – Meaning, Inventory Types & Preparation Steps

As we know, at the end of every accounting period, trading firms which buy ready-made goods and resell them at a profit, prepare the trading and profit & loss account. like that for those firms which manufactured the goods they sell, a manufacturing account is prepared in addition to these two final accounts to know the cost of the goods produce.

Meaning of Manufacturing Account

A manufacturing business is the most complete form of a business because it buys raw materials, converts them into finished items and then sells these items to its customers. Businesses that make their own products must prepare a manufacturing account to determine the total manufacturing or production cost of goods completed during the accounting period. The production cost includes all costs incurred in converting raw materials into finished goods, i.e., cost of materials, direct labour, and factory overhead expenses.

Why it is Important?

Manufacturing accounting is obligatory for any business looking to stay competitive in a market. It helps you will have greater control over your cash flow, improving operational efficiency by understanding the financial aspects of their production process, businesses can make decisions about how to use of their resources in better way and making profitable. 

Purpose of Manufacturing Account

Manufacturing Account are prepared to determine the cost of goods manufactured during the financial year. Therefore, manufacturing accounts have the following purposes.

1. To ascertain the cost of production
2. To determine the profit on the manufacturing process.

Manufacturing or Production Cost

Production cost can be divided into two categories, i.e., direct cost and factory overhead expenses. Both these costs are charged to the manufacturing account for the calculation of production cost. The following is a description of the different components which make up prime cost and factory overhead expense. 

1. Direct Costs or Prime Cost – prime cost includes all costs which relate directly to the manufacturing process. They include raw materials, labour and expenses which are traceable to the particular unit of goods manufactured. These prime costs will vary with the units of output produced. Increasing in Output means uses of more raw materials, direct labour and direct expenses, e.g., if production is increased by 50%, the cost of raw materials, manufacturing wages and direct expenses will be rise by approximately the same extent. direct Costs are costs that can be directly linked to the item being made and include:
• Costs of Raw Materials - This is just the cost of materials bought to make the company’s products. However, one must take into account the opening and closing balances of stocks of raw materials, adjustments for returns to suppliers and include transport costs. This calculation is similar to the Cost of Sales formula used in the Statement of Profit or Loss.
• Direct Labour Costs - The cost of wages paid to factory workers who are directly involved in the manufacturing of the products.
• Direct Expenses - This includes all other expenses which are directly linked to the products being made, such as Royalties and Patent fees.
2. Factory Overheads – These costs are not directly related to the actual manufacturing of goods but to the general operations of running of the factory where production is carried on.  Overhead expense does not vary with output. Even if output is increased or decreased, the overhead expenses remain relatively fixed. This includes all expenses that are related to manufacturing but cannot be directly linked to the items being made. Examples include: Wages of factory cleaners, Internal transport expenses, Repairs & maintenance used for production, Depreciation of factory machines, Wages of foremen, rent of a factory, Electricity & water bills related to the factory  

Production cost measures the total cost of goods during the period and is made up of prime cost and factory overhead expenses used in production. Let’s see with the diagram below 

Types of Inventories in Manufacturing Businesses

We also need to know that there are three types of stock in manufacturing account: 

1. Raw Material: The raw material account is the first stage in the manufacturing process. This account tracks all of the raw materials or physical items necessary to create a product. This includes any items used in the production process but is not yet part of the finished product.
2. Work in Process: The work-in-process Manufacturing account tracks all of the costs associated with producing a product. As items enter the production, this account balance increases. The balance decreases once the company completes goods as dollar amounts enter the finished goods account.
3. Finished Goods: The finished goods Manufacturing account represents all finished products ready for sale. The cost for produced products remains here until the company sells the goods to distributors or consumers.

Manufacturing Activities cost flow

MANUFACTURING ACTIVITIES COST FLOW
MATERIAL	PRODUCTION	SALES
Beginning Materials	Beginning Work in Progress	Beginning Finished Goods
(+) Materials Purchase	(+) Materials Used	(+) Cost of Goods Manufactured
(-) Ending Materials	(+) Labour Used	Goods Available for Sale
	(+) Overhead Used	(-) Ending Finished Goods
	(-) Ending Work in Progress
Materials Used	Cost of Goods Manufactured	Cost of Goods Sold

Note: 

Cost of Goods Sold Manufacturing Account - The cost of goods sold Manufacturing account tracks information on all inventory items sold by the firm.

• Goods Available for Sale = Beginning or Opening Finished Goods + Cost of Goods Manufactured
• Cost of Goods Sold = Goods Available for Sale – Ending or Closing Finished Goods

How to prepare Manufacturing Account in books

In manufacturing business, the manufacturing account needs to be prepared before completing the trading and profit and loss accounts. It is a general ledger which is used to accumulate all the manufacturing costs of goods completed by a business during an accounting period.

Manufacturing Account

However, there is no standardized format of a Manufacturing Account. Let’s discuss with figures for better understanding

MANUFACTURING ACCOUNTS
PARTICULARS (Dr.)	DETAILS	AMOUNT	PARTICULARS (Cr.)	DETAILS	AMOUNT
To Opening Stock	0		By Cost of Goods Produced		1,470,000
Add: Raw Material	100,000		By Sale of Scarp
Add: Work in Progress	500,000	600,000	Add: Sale of Raw Material
To Purchase	1,000,000		Add: Byproduct Manufactured
Less: Return	200,000	800,000	Add: Coproduct Manufactured
To Direct Expense		200,000	By Closing Stock
To Depreciation on Factory Assets		150,000	Add: Raw Material	100,000
			Add: Work in Process	180,000	280,000
		1,750,000			1,750,000

Note: -

1. Opening Work in progress (Previous period unfinished goods)
2. Closing Work in progress (This year unfinished or incomplete goods)
3. Manufacturing Debit Side Shown total expense incurred in this period and credit side closing stock balance is in completed and cost of goods produced during the period.

Here in this manufacturing account format, we are looking at Opening working in process What is this mean the raw material which is issued in previous period but is not fully converted into finished goods, unfinished or incomplete goods which is available for this period is called Opening working in process. In same way closing working progress means raw material of which is issued in the current period but not fully converted into finished goods. After the ascertainment of the costs of finished goods, we need to transfer this cost to Trading Account.

Trading Account

The trading account shows Gross Profit.  Whereas, the Manufacturing Account depicts the cost of goods sold and also includes direct expenses. Manufacturing account addresses the raw material and work in progress and does not deal with the finished goods. We debit all the direct production expenses such as depreciation on plant and machinery and factory building, repairs on plant and machinery and factory building, salary to the factory manager, wages, cartage on raw-materials, etc. Thus, the cost of finished goods includes the cost of raw materials and all direct expenses. All indirect expenses form a part of the Profit and Loss A/c.

TRADING ACCOUNTS
PARTICULARS	DETAILS	AMOUNT	PARTICULARS	DETAILS	AMOUNT
To Opening Stock			By Sale	3,000,000
Add: Finished Goods		250,000	Less: Return	100,000	2,900,000
To Cost of Goods Produced		1,470,000	By Closing Stock
To Gross Profit c/d		1,530,000	Add: Finished Goods		350,000
		3,250,000			3,250,000

Here in this Trading Account, we are looking at Opening Stock of finished goods what is does this mean let’s discuss, manufactured (finished) good which was produced in the previous period but the goods could not be sold which is available for this period is called Opening finished goods. In same way Closing Stock of finished goods means goods are produced in the current period but stock is could not be sold or sold down due any reasons which is available for next period.

Transfer Pricing 

In the trading account, the cost of production is charged to determine profit on sales. The changing of cost of production of goods may be done in two ways.

• Actual factory cost
• Current market values

When goods manufactured are charged at the current market value to the trading account, the main objective is obtained profit on the manufacturing process. The manufacturing accounts will then have to show a balance which represents a profit or loss on production and this is transferred to profit and loss account.

Profit & Loss Account

PROFIT & LOSS ACCOUNT
PARTICULARS	AMOUNT	PARTICULARS	AMOUNT
To Indirect Expense (Except Depreciation on factory Expense)	200,000	By Gross Profit b/d	1,530,000
		By Sale of Scarp of Finished Goods
To Net Profit	1,330,000
	1,530,000		1,530,000

Note: 

1. Main Objective to prepare manufacturing account is to find out cost of good produce during the period.
2. Cost of good produce during the period = Opening Stock (Raw Material + Work in progress) + Net Purchase + Direct Expense + Depreciation on Factory Expense – Closing Stock (Raw material + Work in progress)
3. Cost of goods of sold = opening Stock of finished goods + Cost of goods products – Cost of closing stock of finished goods.
4. Gross profit = Sales – Cost of goods of Sales.
5. Sales of scarp raw material will be transferred to manufacturing account (it will have reduced the cost of product).
6. Sale of scarp of finished will be transferred to trading which is created or (produced un proper manner) or defective product sale as scarp is considered on Profit & loss Account.

Difference between Manufacturing Account vs Trading Account vs Balance Sheets

All three types of accounts are important in their ways and used for different purposes which helps business for decision making.

1. A manufacturing account tracks a manufacturing business's production costs, materials used, and inventory levels which helps companies arrive at better decisions about when to buy materials and sell products.
2. A trading account is used to track sales and purchases which helps businesses make better decisions about their pricing and inventory levels.
3. Balance sheets are used to track the assets, liabilities, and equity. 

Accountant role in manufacturing industry

A manufacturing accountant’s job is to understand the cost of purchasing raw materials, how much money it takes to turn those materials into finished goods, set optimal price to sale the products so that business making profit. They have to keep an eye on other important areas of expenditure to ensure the budget is followed throughout the financial year.

Some of the figures tracked by a manufacturing accountant include:

• Inventory holding costs
• Inventory valuations
• Labour and overheads
• Equipment maintenance
• Transportation costs

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Sandeep Ghatuary

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