Financial Statements of a Manufacturing Entity — full notes
Paper No. 1: Financial Accounting · Financial Statements of a Manufacturing Entity
Financial Statements of a Manufacturing Entity
1. Why manufacturers need an extra statement
A trading business buys finished goods and resells them. A manufacturer makes what it sells, so before Cost of Sales it needs to work out what it cost to produce those goods. That is what the Manufacturing Account does — it sits before the income statement, not instead of it.
2. Manufacturing account — structure
Direct materials consumed (opening + purchases - closing raw materials)
Add Direct labour
Add Direct expenses
= PRIME COST
Add Factory overheads (indirect production costs - factory rent,
power, depreciation of factory plant, supervisors' wages)
Add Opening work-in-progress
Less Closing work-in-progress
= COST OF PRODUCTION
Cost of production carries forward into the income statement — the same role "purchases" plays for a trading business.
3. Work-in-progress (WIP)
Partly-finished goods at year end. Opening WIP is added (finished off this year, so its cost belongs to this year's production); closing WIP is deducted (started but not finished, belongs to next year).
4. Worked example — Juma Manufacturers
Raw materials: opening KES 40,000, purchases KES 380,000, closing KES 55,000. Direct labour KES 250,000. Direct expenses KES 20,000. Factory overheads KES 150,000. WIP: opening KES 30,000, closing KES 45,000.
Manufacturing account:
| KES | |
|---|---|
| Opening raw materials | 40,000 |
| Add purchases | 380,000 |
| Less closing raw materials | (55,000) |
| Materials consumed | 365,000 |
| Add direct labour | 250,000 |
| Add direct expenses | 20,000 |
| Prime cost | 635,000 |
| Add factory overheads | 150,000 |
| Add opening WIP | 30,000 |
| Less closing WIP | (45,000) |
| Cost of production | 770,000 |
Feeding into the income statement: Sales KES 1,400,000. Opening finished goods KES 80,000. Closing finished goods KES 95,000.
| KES | |
|---|---|
| Sales | 1,400,000 |
| Opening finished goods | 80,000 |
| Add cost of production | 770,000 |
| Less closing finished goods | (95,000) |
| Cost of goods sold | 755,000 |
| Gross profit | 645,000 |
Same Cost of Sales pattern as a trading business (opening + additions - closing), with "cost of production" standing in for "purchases." Everything after gross profit works exactly as it does for any other entity.