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Lesson 16 – The Manufacturing Account

FAC1502 · Study Unit 16 · Manufacturing Accounts | Lexicon

FAC1502 · Financial Accounting · Study Unit 16

The Manufacturing Account

From Raw Material to Finished Good — Costing the Factory Floor

SU 16 UNISA BCom Topic 5 ~4 hr study

FAC1502 Course ProgressSU 16 of 17
SU 1–6 SU 7–9 SU 10–12 SU 13 SU 14 SU 15 SU 16 SU 17

Trading vs Manufacturing Entities

A trading entity buys goods in a finished state and resells them. A manufacturing entity converts raw materials into finished goods before selling them. This fundamental difference means a manufacturer needs an additional financial statement — the Manufacturing Account — to determine the cost of goods it produced during the period.

Trading Entity

Buys finished goods from suppliers. Cost of goods sold = Opening stock + Purchases − Closing stock. One inventory account: Merchandise Inventory.

Financial statements needed: Trading Account → Income Statement.

Manufacturing Entity

Transforms raw materials using labour and machinery. Must calculate the cost of production before it can calculate COGS. Three inventory accounts in play simultaneously.

Financial statements needed: Manufacturing Account → Trading Account → Income Statement.

// NOTE

The Manufacturing Account produces a single output figure: Cost of Production (also called Cost of Goods Manufactured). This figure flows directly into the Trading Account as the equivalent of “Purchases” in a trading entity.

Cost Classification

Manufacturing costs are classified in two ways: by nature (what was spent on) and by behaviour (how the cost changes with output). Both classifications are tested in FAC1502.

Classification by Nature

Direct Materials — Raw materials that become physically part of the finished product and can be traced to it economically (e.g. steel in a car, fabric in a shirt).

Direct Labour — Wages of workers who physically convert raw materials into finished goods (e.g. machine operators, assembly line workers). Directly traceable to units produced.

Manufacturing Overhead — All other factory costs that cannot be directly traced to individual units: factory rent, depreciation of machinery, factory supervisor salaries, indirect materials, factory electricity.

Variable Cost Changes in direct proportion to production volume. If output doubles, total variable cost doubles. Direct materials and direct labour are typically variable. Variable cost per unit stays constant. Fixed Cost Remains constant in total regardless of output level (within a relevant range). Factory rent, depreciation, and supervisors’ salaries are typically fixed. Fixed cost per unit decreases as output rises. Semi-variable Has both a fixed component and a variable component. Factory electricity (fixed connection fee + variable consumption) is a classic example. Also called a mixed cost.
// EXAM

Only factory / manufacturing costs appear in the Manufacturing Account. Selling expenses, distribution costs, and administrative expenses are period costs — they go directly to the Income Statement, never into the Manufacturing Account.

The Three Inventory Accounts

A manufacturing entity maintains three separate inventory accounts, each representing a different stage in the production process. Understanding what sits in each account is fundamental to building the Manufacturing Account correctly.

Raw Materials Inventory Materials purchased but not yet put into production
Stage 1 — Unprocessed
Work-in-Progress (WIP) Inventory Partially completed units still on the factory floor
Stage 2 — In Process
Finished Goods Inventory Completed units awaiting sale
Stage 3 — Complete
Total Inventories on the Balance Sheet All three balances combined under Current Assets
Balance Sheet Item

The Flow of Costs

Raw Materials → (issued to factory) → Work-in-Progress → (completed) → Finished Goods → (sold) → Cost of Sales.

At each stage, costs accumulate. The Manufacturing Account captures the movement from Raw Materials and WIP through to Finished Goods — calculating the Cost of Production that emerges from the factory each period.

Prime Cost & Conversion Cost

Two composite cost concepts appear throughout manufacturing accounting. You must know both by heart.

Prime Cost Direct Materials Used + Direct Labour = the most basic cost of making something
DM + DL
Conversion Cost Direct Labour + Manufacturing Overhead = cost of converting raw material into finished product
DL + MOH
Total Manufacturing Cost Direct Materials + Direct Labour + Manufacturing Overhead
DM + DL + MOH
PRIME COST = Direct Materials Used + Direct Labour where: Direct Materials Used = Opening RM + Purchases − Closing RM CONVERSION COST = Direct Labour + Manufacturing Overhead TOTAL MANUFACTURING COST = Prime Cost + Manufacturing Overhead = Direct Materials Used + Direct Labour + Manufacturing Overhead
// MEMORY AID

Prime = the primary, most direct costs (DM + DL). Conversion = what it costs to convert materials into product (DL + MOH). Direct Labour appears in both — it is the bridge between the two concepts.

The Manufacturing Account

The Manufacturing Account is a nominal account — it is closed off each period. Its purpose is to calculate the Cost of Production (also called Cost of Goods Manufactured) for the period. This single figure is then passed to the Trading Account.

MANUFACTURING ACCOUNT — Structure SECTION 1 — PRIME COST Direct materials: Opening raw materials stock ××× Add: Purchases of raw materials ××× Add: Carriage on raw materials ××× ────── Raw materials available ××× Less: Closing raw materials stock (×××) ────── Direct materials used ××× Direct labour (factory wages) ××× ────── PRIME COST ××× SECTION 2 — MANUFACTURING OVERHEAD Factory rent ××× Depreciation — machinery ××× Factory supervisor salary ××× Indirect materials ××× Factory electricity ××× Other factory overheads ××× ────── TOTAL MANUFACTURING OVERHEAD ××× ────── TOTAL MANUFACTURING COST ××× Add: Opening work-in-progress (WIP) ××× Less: Closing work-in-progress (WIP) (×××) ────── COST OF PRODUCTION (→ Trading Account) ×××
// EXAM

WIP adjustments are made after Total Manufacturing Cost — not before. The logic: Total Manufacturing Cost is what the factory spent this period. WIP opening adds costs that were started last period; WIP closing removes costs relating to units not yet finished. The result is the cost of goods completed and transferred out this period.

The Trading Account

Once the Manufacturing Account produces the Cost of Production figure, it flows into the Trading Account — which operates identically to a trading entity’s account, except that Cost of Production replaces Purchases.

TRADING ACCOUNT — Manufacturing Entity Sales revenue ××× Less: Cost of goods sold Opening finished goods stock ××× Add: Cost of Production (from Mfg A/c) ××× ────── Goods available for sale ××× Less: Closing finished goods stock (×××) ────── Cost of goods sold ××× ────── GROSS PROFIT ×××
// NOTE

In a manufacturing entity, the Finished Goods Inventory on the balance sheet is valued at Cost of Production per unit — not at raw material cost. This means closing finished goods stock carries the full manufacturing cost (DM + DL + MOH) of the unsold units.

Full Income Statement Structure

The complete income statement for a manufacturing entity has three tiers, each feeding the next:

  • 01Manufacturing Account → produces Cost of Production. Contains all factory costs plus WIP adjustments.
  • 02Trading Account → takes Cost of Production, adjusts for finished goods opening/closing stock, calculates Gross Profit.
  • 03Income Statement → deducts selling, distribution, and administrative expenses from Gross Profit to arrive at Net Profit before Tax.
Income Statement — Manufacturing Entity (Skeleton)
ItemRR
MANUFACTURING ACCOUNT
Direct materials used×××
Direct labour×××
Prime cost×××
Manufacturing overhead×××
Total manufacturing cost×××
Add: Opening WIP×××
Less: Closing WIP(×××)
Cost of Production×××
TRADING ACCOUNT
Sales revenue×××
Opening finished goods×××
Add: Cost of Production×××
Less: Closing finished goods(×××)
Cost of goods sold(×××)
Gross profit×××
INCOME STATEMENT
Selling & distribution expenses(×××)
Administrative expenses(×××)
Net profit before tax×××

Full Worked Example

Prepare the Manufacturing Account and the Trading and Income Statement for Vulcan Industries for the year ended 28 February 2025.

Given Data

Trial Balance Extracts — 28 February 2025
ItemR
INVENTORY — OPENING BALANCES
Raw materials (1 Mar 2024)42 000
Work-in-progress (1 Mar 2024)18 500
Finished goods (1 Mar 2024)65 000
MANUFACTURING COSTS
Purchases of raw materials310 000
Carriage on raw materials8 200
Direct labour (factory wages)185 000
Factory rent48 000
Depreciation — machinery22 000
Factory supervisor salary55 000
Indirect materials12 400
Factory electricity19 600
SALES & PERIOD COSTS
Sales revenue1 250 000
Selling & distribution expenses78 000
Administrative expenses95 000
CLOSING INVENTORIES (per stocktake)
Raw materials (28 Feb 2025)38 000
Work-in-progress (28 Feb 2025)22 000
Finished goods (28 Feb 2025)71 000

Manufacturing Account

Vulcan Industries — Manufacturing Account for the year ended 28 February 2025
ItemRR
DIRECT MATERIALS
Opening raw materials stock42 000
Add: Purchases310 000
Add: Carriage on raw materials8 200
Raw materials available360 200
Less: Closing raw materials stock(38 000)
Direct materials used322 200
Direct labour185 000
Prime Cost507 200
MANUFACTURING OVERHEAD
Factory rent48 000
Depreciation — machinery22 000
Factory supervisor salary55 000
Indirect materials12 400
Factory electricity19 600
Total Manufacturing Overhead157 000
Total Manufacturing Cost664 200
Add: Opening WIP18 500
Less: Closing WIP(22 000)
Cost of Production660 700

Trading and Income Statement

Vulcan Industries — Trading and Income Statement for the year ended 28 February 2025
ItemRR
Sales revenue1 250 000
COST OF GOODS SOLD
Opening finished goods stock65 000
Add: Cost of Production660 700
Goods available for sale725 700
Less: Closing finished goods stock(71 000)
Cost of goods sold(654 700)
Gross Profit595 300
OPERATING EXPENSES
Selling & distribution expenses(78 000)
Administrative expenses(95 000)
Net Profit Before Tax422 300
// CHECK

Quick sanity check: Gross Profit Margin = R595 300 ÷ R1 250 000 = 47.6%. Net Profit Margin = R422 300 ÷ R1 250 000 = 33.8%. These are high margins — typical for a value-added manufacturer. If your margins come out negative or implausibly large, trace back through the WIP adjustment and overhead classification first.

Practice Exercises

Exercise 01
Classify the Cost
[expand]

Classify each item below as: Direct Material (DM), Direct Labour (DL), Manufacturing Overhead (MOH), or Period Cost (P):

  1. Steel sheets used in making car bodies
  2. Salary of the factory floor supervisor
  3. Wages of assembly line workers (traceable to units)
  4. Depreciation on delivery vans
  5. Factory building insurance
  6. Lubricating oil for production machinery
  7. Commission paid to sales representatives
  8. Depreciation on production machinery
  9. CEO’s salary
  10. Packaging materials that become part of the finished product
  1. DM — directly traceable raw material
  2. MOH — indirect factory labour (supervisor, not production worker)
  3. DL — directly traceable factory labour
  4. P — delivery is a selling/distribution cost, not factory
  5. MOH — factory overhead (fixed)
  6. MOH — indirect material (supports production but not part of product)
  7. P — selling expense
  8. MOH — factory overhead (fixed)
  9. P — administrative expense
  10. DM — becomes physically part of the saleable product
Exercise 02
Prime Cost & Conversion Cost
[expand]

Titan Plastics has the following cost data for March 2025:

  • Opening raw materials: R25 000
  • Raw material purchases: R140 000
  • Closing raw materials: R30 000
  • Direct labour: R95 000
  • Factory rent: R20 000
  • Machine depreciation: R15 000
  • Indirect labour: R18 000

Calculate: (a) Direct materials used, (b) Prime Cost, (c) Conversion Cost, (d) Total Manufacturing Cost.

(a) Direct Materials Used Opening RM + Purchases − Closing RM = 25 000 + 140 000 − 30 000 = R135 000 (b) Prime Cost = Direct Materials Used + Direct Labour = 135 000 + 95 000 = R230 000 (c) Conversion Cost = Direct Labour + Manufacturing Overhead MOH = Factory rent + Depreciation + Indirect labour = 20 000 + 15 000 + 18 000 = R53 000 Conversion Cost = 95 000 + 53 000 = R148 000 (d) Total Manufacturing Cost = Prime Cost + MOH = 230 000 + 53 000 = R283 000
Exercise 03
Manufacturing Account — Abridged
[expand]

Using the data from Exercise 02, plus the following additional information, prepare the Manufacturing Account and calculate the Cost of Production:

  • Opening WIP: R14 000
  • Closing WIP: R9 500
Titan Plastics — Manufacturing Account, March 2025
ItemRR
Direct materials used135 000
Direct labour95 000
Prime Cost230 000
Factory rent20 000
Machine depreciation15 000
Indirect labour18 000
Total Manufacturing Overhead53 000
Total Manufacturing Cost283 000
Add: Opening WIP14 000
Less: Closing WIP(9 500)
Cost of Production287 500

Note: Opening WIP > Closing WIP, so the adjustment adds net R4 500 to Cost of Production — more goods were completed this period than started (some from prior period WIP were finished).

Study Unit 16 — Key Takeaways

1. Manufacturing entities need three inventory accounts: Raw Materials, Work-in-Progress, and Finished Goods — each representing a different stage of production.

2. The Manufacturing Account calculates Cost of Production: Direct Materials Used + Direct Labour + Manufacturing Overhead ± WIP adjustment.

3. Prime Cost = DM + DL. Conversion Cost = DL + MOH. Direct Labour appears in both — it bridges materials and overhead.

4. Only factory costs go into the Manufacturing Account. Selling, distribution, and admin costs are period costs — straight to the Income Statement.

5. Cost of Production replaces “Purchases” in the Trading Account. The rest of the Trading Account logic is identical to a trading entity.

6. WIP adjustment sequence: Total Manufacturing Cost + Opening WIP − Closing WIP = Cost of Production. Opening WIP adds; closing WIP deducts.

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