FAC1502 · Financial Accounting · Study Unit 16
The Manufacturing Account
From Raw Material to Finished Good — Costing the Factory Floor
Contents
01
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.
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.
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.
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.
02
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.
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.
03
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.
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.
04
Prime Cost & Conversion Cost
Two composite cost concepts appear throughout manufacturing accounting. You must know both by heart.
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.
05
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.
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.
06
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.
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.
07
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.
| Item | R | R |
|---|---|---|
| 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 | ××× | |
08
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
| Item | R |
|---|---|
| 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 materials | 310 000 |
| Carriage on raw materials | 8 200 |
| Direct labour (factory wages) | 185 000 |
| Factory rent | 48 000 |
| Depreciation — machinery | 22 000 |
| Factory supervisor salary | 55 000 |
| Indirect materials | 12 400 |
| Factory electricity | 19 600 |
| SALES & PERIOD COSTS | |
| Sales revenue | 1 250 000 |
| Selling & distribution expenses | 78 000 |
| Administrative expenses | 95 000 |
| 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
| Item | R | R |
|---|---|---|
| DIRECT MATERIALS | ||
| Opening raw materials stock | 42 000 | |
| Add: Purchases | 310 000 | |
| Add: Carriage on raw materials | 8 200 | |
| Raw materials available | 360 200 | |
| Less: Closing raw materials stock | (38 000) | |
| Direct materials used | 322 200 | |
| Direct labour | 185 000 | |
| Prime Cost | 507 200 | |
| MANUFACTURING OVERHEAD | ||
| Factory rent | 48 000 | |
| Depreciation — machinery | 22 000 | |
| Factory supervisor salary | 55 000 | |
| Indirect materials | 12 400 | |
| Factory electricity | 19 600 | |
| Total Manufacturing Overhead | 157 000 | |
| Total Manufacturing Cost | 664 200 | |
| Add: Opening WIP | 18 500 | |
| Less: Closing WIP | (22 000) | |
| Cost of Production | 660 700 | |
Trading and Income Statement
| Item | R | R |
|---|---|---|
| Sales revenue | 1 250 000 | |
| COST OF GOODS SOLD | ||
| Opening finished goods stock | 65 000 | |
| Add: Cost of Production | 660 700 | |
| Goods available for sale | 725 700 | |
| Less: Closing finished goods stock | (71 000) | |
| Cost of goods sold | (654 700) | |
| Gross Profit | 595 300 | |
| OPERATING EXPENSES | ||
| Selling & distribution expenses | (78 000) | |
| Administrative expenses | (95 000) | |
| Net Profit Before Tax | 422 300 | |
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.
09
Practice Exercises
Classify each item below as: Direct Material (DM), Direct Labour (DL), Manufacturing Overhead (MOH), or Period Cost (P):
- Steel sheets used in making car bodies
- Salary of the factory floor supervisor
- Wages of assembly line workers (traceable to units)
- Depreciation on delivery vans
- Factory building insurance
- Lubricating oil for production machinery
- Commission paid to sales representatives
- Depreciation on production machinery
- CEO’s salary
- Packaging materials that become part of the finished product
- DM — directly traceable raw material
- MOH — indirect factory labour (supervisor, not production worker)
- DL — directly traceable factory labour
- P — delivery is a selling/distribution cost, not factory
- MOH — factory overhead (fixed)
- MOH — indirect material (supports production but not part of product)
- P — selling expense
- MOH — factory overhead (fixed)
- P — administrative expense
- DM — becomes physically part of the saleable product
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.
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
| Item | R | R |
|---|---|---|
| Direct materials used | 135 000 | |
| Direct labour | 95 000 | |
| Prime Cost | 230 000 | |
| Factory rent | 20 000 | |
| Machine depreciation | 15 000 | |
| Indirect labour | 18 000 | |
| Total Manufacturing Overhead | 53 000 | |
| Total Manufacturing Cost | 283 000 | |
| Add: Opening WIP | 14 000 | |
| Less: Closing WIP | (9 500) | |
| Cost of Production | 287 500 |
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.