Content Standard 16.2

Manufacturing Account

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Explanation

The Manufacturing Account is prepared by a manufacturing firm to determine the cost of producing finished goods during an accounting period. Unlike a trading firm that only buys finished goods and resells them, a manufacturing firm buys raw materials and converts them into finished goods through a production process. Because such a firm has no Purchases account for finished goods, it must calculate for itself the cost of completing those goods. The Manufacturing Account is prepared before the Trading Account, and its final figure, the Cost of Production, is transferred to the Trading Account to replace Purchases.

The main purposes of preparing a Manufacturing Account are: (i) to determine the total Cost of Production of finished goods produced in the period; (ii) to compute the cost per unit as a basis for setting the selling price; and (iii) to allow management to control and compare production costs over time. Costs in the Manufacturing Account are grouped into two categories. First, direct costs, made up of Direct Material Cost, Direct Labour Cost and Direct Expenses; the total of these three direct costs is called the Prime Cost. Second, Production Overhead (factory overhead), that is, indirect costs such as indirect labour, factory rent, depreciation of machinery, factory insurance and factory power/electricity.

Direct Material Cost is not the same as Purchases of raw materials. It is calculated using the formula: Opening inventory of raw materials + Purchases of raw materials + Carriage inwards on raw materials - Closing inventory of raw materials = Raw materials consumed (Direct Material Cost). Direct Labour Cost is the wages of workers directly involved in producing the goods (direct wages). Direct Expenses are costs that can be traced directly to producing each unit, for example royalties and design costs. After the Prime Cost is obtained, Production Overhead is added to arrive at the cost before the Work in Progress adjustment.

Work in Progress (WIP) refers to goods that are still partly finished at the end of the period. Because production does not stop exactly at year end, some goods are not yet fully complete. The Manufacturing Account must therefore be adjusted: add Opening WIP (partly finished goods from last year completed this year) and deduct Closing WIP (partly finished goods this year not yet complete). The full formula is: Prime Cost + Production Overhead + Opening WIP - Closing WIP = Cost of Production. Students must be able to prepare the Manufacturing Account both without WIP (no adjustment) and with WIP (add/deduct required).

The Manufacturing Account can be presented in two forms. The T form (T-shaped account) has debit and credit sides like an ordinary ledger, where all costs are recorded on the debit side and the Cost of Production is transferred out on the credit side. The statement form (vertical format) is easier to read because it shows the computation of Direct Material Cost, Prime Cost and Cost of Production step by step vertically, and is commonly used in examinations. Once the Cost of Production is finalised, it is transferred to the Trading Account with the double entry: Debit Trading Account; Credit Manufacturing Account. In the Trading Account this Cost of Production replaces the Purchases figure used by an ordinary retailer, and is used together with opening and closing inventory of finished goods to compute the Cost of Sales.

Worked examples

Example 1: Manufacturing Account without Work in Progress (statement form)

Mawar Indah Furniture Factory produces wooden chairs. Data for the year ended 31 December 2025: Opening inventory of raw materials RM8,000; Purchases of raw materials RM52,000; Carriage inwards on raw materials RM2,000; Closing inventory of raw materials RM6,000; Direct wages RM30,000; Royalty (direct expense) RM4,000; Factory supervisor's salary RM12,000; Factory rent RM9,000; Depreciation of machinery RM5,000; Factory insurance RM3,000; Factory electricity RM4,000.

Direct Material Cost = 8,000 + 52,000 + 2,000 - 6,000 = RM56,000. Prime Cost = Direct Material Cost 56,000 + Direct Labour Cost 30,000 + Direct Expenses 4,000 = RM90,000.

Production Overhead = 12,000 + 9,000 + 5,000 + 3,000 + 4,000 = RM33,000. Cost of Production = Prime Cost 90,000 + Production Overhead 33,000 = RM123,000. As there is no WIP, the Cost of Production is RM123,000.

Example 2: Manufacturing Account with Work in Progress

Using the data in Example 1, add the following: Opening Work in Progress RM7,000; Closing Work in Progress RM5,000.

Prime Cost remains RM90,000 and Production Overhead remains RM33,000, so the total before the WIP adjustment = RM123,000. Add Opening WIP RM7,000 = RM130,000. Deduct Closing WIP RM5,000 = RM125,000.

Therefore the Cost of Production (cost of goods completed) = RM125,000. Note that Opening WIP is added because it is completed this year, while Closing WIP is deducted because it is not yet complete.

Example 3: Transfer of Cost of Production to the Trading Account

Using the Cost of Production of RM125,000 from Example 2, the double entry for the transfer is: Debit Trading Account RM125,000; Credit Manufacturing Account RM125,000.

In the Trading Account, the Cost of Production of RM125,000 replaces Purchases. If opening inventory of finished goods is RM10,000, closing inventory of finished goods is RM15,000 and sales are RM200,000, then: Cost of Sales = 10,000 + 125,000 - 15,000 = RM120,000. Gross Profit = Sales 200,000 - Cost of Sales 120,000 = RM80,000.

Practice

State two purposes of preparing a Manufacturing Account and explain the difference between Prime Cost and Production Overhead.

Answer: Two purposes: (i) to determine the Cost of Production of finished goods produced in the accounting period; (ii) to compute the cost per unit as a basis for setting the selling price. Difference: Prime Cost is the total of direct costs, namely Direct Material Cost + Direct Labour Cost + Direct Expenses, which can be traced directly to producing the goods. Production Overhead is indirect cost that relates to factory operations but cannot be traced directly to each unit, for example factory rent, depreciation of machinery and factory insurance.

Zaitun Factory has the following information for the year 2025: Opening inventory of raw materials RM5,000; Purchases of raw materials RM40,000; Carriage inwards RM1,000; Closing inventory of raw materials RM4,000; Direct wages RM22,000; Direct expenses RM3,000. Calculate the Direct Material Cost and the Prime Cost.

Answer: Direct Material Cost = Opening inventory of raw materials 5,000 + Purchases 40,000 + Carriage inwards 1,000 - Closing inventory of raw materials 4,000 = RM42,000. Prime Cost = Direct Material Cost 42,000 + Direct Labour Cost (direct wages) 22,000 + Direct Expenses 3,000 = RM67,000.

A factory's Prime Cost is RM67,000 and its Production Overhead is RM25,000. Opening Work in Progress is RM6,000 and Closing Work in Progress is RM4,000. Calculate the Cost of Production and give the double entry to transfer it to the Trading Account.

Answer: Cost before WIP adjustment = Prime Cost 67,000 + Production Overhead 25,000 = RM92,000. Add Opening WIP 6,000 = RM98,000. Deduct Closing WIP 4,000 = RM94,000. Therefore the Cost of Production = RM94,000. Double entry: Debit Trading Account RM94,000; Credit Manufacturing Account RM94,000.

Explain why Opening Work in Progress is added while Closing Work in Progress is deducted in the Manufacturing Account.

Answer: Opening Work in Progress is partly finished goods from the previous year that are completed in the current year, so its cost must be added because it contributes to the finished goods produced this year. Closing Work in Progress is partly finished goods at the end of the current year that are not yet complete, so its cost must be deducted because it is not part of the finished goods that have been produced; this cost will be carried forward as the opening WIP of the following year.

Exam tips

Key terms

Prime Cost: The total of direct costs, that is, Direct Material Cost + Direct Labour Cost + Direct Expenses.
Production Overhead: Indirect factory costs such as factory rent, depreciation of machinery and factory insurance that cannot be traced directly to each unit of goods.
Work in Progress (WIP): Goods still partly finished at the end of the accounting period; opening is added and closing is deducted in the Manufacturing Account.
Cost of Production: The total cost of completing finished goods in a period, transferred to the Trading Account to replace Purchases.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 5

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