Financial Accounting · Lesson 12

Cost classification and manufacturing accounts

JAMBWAECNECO

What the syllabus asks

JAMB: Topic 10 Manufacturing accounts (cost classification, cost apportionment, prime cost, factory overheads, work in progress, transfer to trading account)

WAEC: Manufacturing accounts: purpose, classification of costs, preparation of manufacturing, trading and profit and loss accounts

NECO: Manufacturing accounts: purpose, classification of costs, preparation of manufacturing, trading and profit and loss accounts

What you will learn

Explain the purpose of manufacturing accounts.
Classify costs as direct or indirect, and as fixed, variable or semi-variable.
Apportion shared costs between factory and office, and between departments.
Prepare a manufacturing account showing prime cost, factory overheads and production cost.
Prepare the trading section and profit and loss section for a manufacturer.
Record transfers at market value and the allowance for unrealised profit.

Key points

Manufacturing account finds production cost; it replaces purchases in the trading section.
Raw materials consumed = opening + purchases + carriage in − returns − closing.
Prime cost = direct materials + direct labour + direct expenses.
Factory overheads are indirect production costs.
Total factory cost ± WIP = production cost of finished goods.
Three inventories: raw materials, WIP (manufacturing account) and finished goods (trading).
Apportion shared costs: floor area, employees, machine value, machine hours.
Fixed costs constant in total; variable costs vary with output; semi-variable have both.
Transfer at market value creates manufacturing profit; deduct unrealised profit on closing inventory.
Office and selling costs go to the profit and loss section.

Start here: Why manufacturers need a manufacturing account

A trader buys finished goods and resells them; the cost of goods is simply purchases. A manufacturer buys raw materials and turns them into new products: a tannery and shoe factory in Kano converts hides and skins into shoes and bags; a bakery in Ibadan turns flour, sugar and yeast into bread; a garment factory in Aba turns fabric into clothes. The cost of these products includes materials, labour and many factory costs.

The manufacturing account collects all production costs to find the production cost of finished goods for the period. This figure then takes the place of “purchases” in the trading section.

Purposes

To find the total cost of goods produced and the cost per unit, which guides pricing.
To separate production costs from selling and administrative costs, so management can see where money goes.
To compare production costs from year to year and identify waste.
To value inventories of work in progress and finished goods.
To decide whether to make a product or buy it in (by comparing factory cost with market price).

Nigeria’s government has long encouraged local manufacturing to reduce imports and create jobs; for small manufacturers, knowing true production cost is the difference between survival and failure when raw material prices rise sharply.

Who uses manufacturing accounts?

Owners and directors use them to set prices and control costs; banks study them before lending for new machinery; government agencies and investors look at production efficiency; and production managers use the cost figures to plan output. A small soap or cosmetics maker in Onitsha who knows that raw materials make up, say, 60% of production cost will watch supplier prices closely and may buy in bulk when prices are low.

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Practice questions

1. Prime cost consists of

direct materials, direct labour and direct expenses
all factory costs
administrative expenses
selling and distribution costs

Show answer

A: direct materials, direct labour and direct expenses
Only direct costs.

2. Opening raw materials ₦90 000; purchases ₦610 000; closing raw materials ₦75 000; direct labour ₦480 000; direct expenses ₦35 000. Prime cost:

₦1 215 000
₦625 000
₦1 400 000
₦1 140 000

Show answer

D: ₦1 140 000
Materials consumed ₦625 000; + ₦480 000 + ₦35 000 = ₦1 140 000.

3. Using the data above with factory overheads ₦260 000 and no work in progress, the cost of production is:

₦880 000
₦885 000
₦1 400 000
₦1 140 000

Show answer

C: ₦1 400 000
₦1 140 000 + ₦260 000 = ₦1 400 000.

4. Which is a factory overhead?

Royalties per unit
Factory supervisor’s salary
Direct wages
Raw materials consumed

Show answer

B: Factory supervisor’s salary
Indirect production cost.

5. Work in progress means

partly finished goods
finished goods awaiting sale
raw materials in store
goods sold on credit

Show answer

A: partly finished goods
Closing WIP is deducted in the manufacturing account.

Key words

Manufacturing account: An account showing the cost of producing finished goods during a period.
Direct materials: Materials that become part of the finished product and can be traced to it.
Direct labour: Wages of workers who make the product.
Direct expenses: Expenses traced to units of output, e.g. royalties, hire of special equipment.
Prime cost: Total of direct materials, direct labour and direct expenses.
Factory overheads: Indirect costs of production.
Work in progress: Partly completed goods at a date.
Production cost: Cost of goods completed in the period.
Apportionment: Sharing a common cost between departments on a suitable basis.
Fixed cost: A cost whose total does not change with output in the short run.
Variable cost: A cost whose total changes in proportion to output.
Semi-variable cost: A cost with fixed and variable elements, e.g. electricity with a standing charge.

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