How a manufacturing account fits together

A trader buys finished goods and sells them, so the cost of what was sold is easy to find. A manufacturer buys raw materials and turns them into the goods it sells, and that process has its own cost.

The manufacturing account gathers that cost. Building it one stage at a time shows why each figure sits where it does and how it feeds the income statement.

Why a manufacturer needs an extra account

A business that makes its own products must know what they cost to make before it can find the profit on selling them. The manufacturing account is prepared before the income statement to answer that.

It collects the costs of production (materials, labour and factory running costs) into one figure, the cost of production. The income statement then uses that figure much as a trader uses purchases.

Direct costs and prime cost

The account starts with direct costs, which can be traced straight to the products. There are three:

• Direct materials: the raw materials actually used.
• Direct labour: wages of the workers who make the goods.
• Direct expenses: costs tied to production, such as a royalty paid per unit made.

Together these give the prime cost, the costs most closely attached to the product before shared factory costs are added.

Adding factory overheads

Not every factory cost can be traced to one product. Factory rent, power for machinery, a supervisor’s salary, depreciation of factory equipment and maintenance keep production going but cannot be pinned to one item.

These are factory overheads, or indirect manufacturing costs. They are added to prime cost, because they are also part of the cost of running the factory.

Adjusting for work in progress

Factories are rarely empty at the year end. Work in progress is the value of goods started but not finished. A year’s costs would include money spent on goods not yet complete, and would miss goods left half-finished last year that were completed this year.

So we add opening work in progress (started last year, finished this year) and subtract closing work in progress (started this year, not yet finished). The account then reflects the cost of goods completed during the year.

Cost of production

After the work-in-progress adjustment we reach the cost of production: the total cost of goods finished during the year. It tells the owner what it cost to turn raw materials into finished goods. It crosses into the income statement and plays the part that purchases play for a trader.

A short worked example

These figures are invented for teaching. Raw materials consumed are RM56,000, direct labour RM40,000 and a direct royalty RM4,000. Prime cost is RM100,000.

Factory overheads of RM30,000 take the total to RM130,000. Opening work in progress is RM5,000 and closing work in progress is RM7,000. Cost of production is RM130,000 + RM5,000 - RM7,000 = RM128,000.

The three inventories

A manufacturer holds three kinds of inventory:

• Raw materials: inputs waiting to be used. Raw materials consumed = opening raw materials + purchases - closing raw materials.
• Work in progress: goods part-way through production, adjusted as above.
• Finished goods: completed products waiting to be sold. These behave like a trader’s inventory in the income statement.

Each sits at a different stage between material and sale, and each is counted and valued separately at the year end.

Handing over to the income statement

The cost of production moves into the trading section of the income statement. There it works like purchases for a trader: add opening finished goods, subtract closing finished goods, and you have the cost of goods sold.

Sales minus cost of sales gives gross profit. The statement then continues as usual, deducting running expenses to reach profit for the year.

Seeing the whole flow

Raw materials are consumed and joined by direct labour and direct expenses to form prime cost. Factory overheads are added. Work in progress is adjusted. The result is the cost of production, which flows into the income statement with finished-goods inventory to give cost of sales and then gross profit.

Once you can trace a cost from the raw-material shelf to gross profit, the account becomes a story of production, not a set of rules.

To check that you can build a full account unaided, one of our teachers can take you through a worked example from raw materials to gross profit. They then set you a fresh one. Book a trial class to try it.

Syllabus reference: Cambridge 0452 and 0985, syllabus for 2027 to 2029, sub-topic 5.4 Manufacturing accounts (page 17).