A-level Accounting Year 13 Manufacturing Accounts Introduction to Financial Statements & Manufacturing Profit Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Learning Outcomea Prepare a manufacturing account showing the prime cost, work in progress and production cost of manufactured goods Distinguish between direct and indirect costs Prepare the financial statements for a manufacturing organisation Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Introduction A retailer buys and sells completed products, whereas a manufacturer has to produce the products to sell A manufacturing account is therefore prepared to show all the costs associated with the making of these products within the factory Mr. Barry A-level Accounting Year 13

The manufacturing account Section: Prime Cost Section: Manufacturing Overheads Calculates the total of the direct manufacturing cost of the products and the direct costs e.g. raw materials, direct labour and royalties Identifies all the other costs associated with the production of the products e.g. factory rent, machine maintenance and machine depreciation Section: Prime Cost Section: Manufacturing Overheads Production cost of manufactured goods Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Terms Direct costs This cost is identified with the cost unit. Costs attributable to a particular product e.g. direct materials and direct labour Manufacturing overheads indirect costs incurred in the production of the products, for example depreciation of machinery, factory insurance and factory rent. These are often known as factory overheads. Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Terms Production cost of manufactured goods (also known as ‘cost of production’ or ‘production cost of completed goods’): the total of all the costs of manufacturing the products Royalties a sum of money paid to the investor of a product for the right of use of his ideas Indirect costs this cost is not identified with the cost unit. Costs that cannot be attributed to a particular product e.g. indirect labour Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Terms Cost of raw materials consumed This calculation consists of opening inventory of raw materials + net purchases – closing inventory of raw materials and is a direct cost that is added Mr. Barry A-level Accounting Year 13

Example of a manufacturing account Mr Barry’s top tip: Ensure you only include information about the factory and actual manufacturing process. Non-production costs DO NOT GET INCLUDED e.g. warehouse, administration, finance and distribution costs 1 2 Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Work in progress (WIP) The partly finished goods The total production cost of manufactured goods in a manufacturing account is therefore made up of: Prime cost 1 + factory overheads 2 + opening work in progress 3 – closing work in progress 4 Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Example 3 4 Mr. Barry A-level Accounting Year 13

Preparing a manufacturer’s income statement Very similar to previous topics with income statements (similar layout) Only difference is in cost of sales you will have opening inventory of finished goods + Production cost of manufactured goods (manufacturing account answer) – closing inventory of finished goods Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Example Mr. Barry A-level Accounting Year 13

Preparing a manufacturer’s statement of financial position Has to show all three types of inventory held at the year end within the current assets All of the inventory in the current assets is valued at the lower of cost and net realisable value Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Example 1 The following information is available for Brown Ltd., a manufacturer of toy wooden soldiers, for the year ended 31 March 2013 Additional information: Direct wages due £16,400 Factory rent was payable a month in advance. The monthly rent was £3,000 Invoice for purchases of raw materials of £1,200 has been omitted Closing inventory included inventory which had cost £5,500 but is now only worth £3,600 due to damage £ Direct wages 133,600 Factory insurance 14,800 Inventory of raw materials at 1 April 2012 42,500 Inventory of raw materials at 31 March 2013 51,200 Factory rent 39,000 Purchase of raw materials 98,100 Royalties 15,000 Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Answer Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Manufacturing profit Some manufacturing businesses transfer their products from the factory to the income statement at total production cost plus a notional mark-up percentage This is the transfer price The difference between production cost of completed goods and the transfer price is called factory profit or manufacturing profit Mr. Barry A-level Accounting Year 13

Recording manufacturing profit Production cost of manufactured goods x percentage mark-up 781,110 x 30% = 234,333 (factory profit) Production cost of manufactured goods + Factory profit = Transfer price 781,110 + 234,333 = 1,015,443 Mr. Barry A-level Accounting Year 13

The provision for unrealised profit IAS 2 LOWER OF COST OR NRV If we use a transfer price for our financial statements, do we follow this rule? Inventory of raw materials are used in a manufacturing account, if we apply a mark up (factory profit) do we follow prudence and IAS 2? Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 A big no! If transfer price is used these inventories will include an element of unrealised profit on finished goods Unrealised profits MUST NOT BE RECOGNISED within the statement of financial position and financial statements as it contradicts both realisation and prudence concepts Mr. Barry A-level Accounting Year 13

A provision for unrealised profit is used to Remove the unrealised profit in the income statement, otherwise profits will be overstated Remove the unrealised profits from the inventory of finished goods within the current assets on the statement of financial position so that inventory is not overvalued and is valued at cost not cost plus markup Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Formula You already know this! Remember the formula for working out mark up profit from sales? It’s exactly the same! Example 1. At 31 March 2013 the inventory of finished goods was valued at £126,000, being cost plus the mark-up of 20%. What is the amount of unrealised profit? Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Record provision for unrealised profit in the statement of financial position? £ Current assets: Inventory of raw materials 71,200 Inventory of work in progress 18,100 Inventory of finished goods 126,000 Less provision for unrealised profit (21,000) 105,000 194,300 Always remove provision for unrealised profit to comply with IAS 2, prudence and realisation concept Mr. Barry A-level Accounting Year 13

Record provision for unrealised profit in the income statement? Can you remember how provision for bad debt is treated? It is exactly the same for provision for unrealised profit Difference in provision Minus from factory profit Difference in provision Add to factory profit Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Income statement £ Revenue 1,200,000 Opening inventory of finished goods 108,000 Transfer price 1,042,800 Closing inventory of finished goods (126,000) (1,024,800) Gross Profit 185,200 Factory profit 173,800 Less increase in provision for unrealised profit (3,000) 170,800 TOP TIP Always remember to bring forward factory profit from manufacturing account. The change in provision needs to be shown with this factory profit. Mr. Barry A-level Accounting Year 13

A-level Accounting Year 13 Question time! Mr. Barry A-level Accounting Year 13