prepare manufacturing accounts, income statements and statements of financial position

Topic 5.5 – Manufacturing Accounts (Cambridge IGCSE 0452)

Learning objectives

• Identify and classify direct costs and factory overhead (indirect costs).
• Calculate prime cost, total manufacturing cost and the cost of production (also called Cost of Goods Manufactured, COGM).
• Prepare a Manufacturing Account and use it to derive the Cost of Goods Sold (COGS).
• Prepare an Income Statement (Profit & Loss Account) and a Statement of Financial Position (Balance Sheet) from the manufacturing cycle.
• Allocate factory overhead when it is not given directly.

Why a Manufacturing Account?

The Manufacturing Account shows the flow of production costs from raw‑material purchase to the cost of finished goods. It links the three inventory accounts that appear on the balance sheet:

• Raw Materials (RM) – material bought but not yet used.
• Work‑in‑Progress (WIP) – partially completed goods.
• Finished Goods (FG) – goods ready for sale.

From the Manufacturing Account we obtain the Cost of Goods Sold (COGS), which is the starting point for the Income Statement, and the closing inventory figures that become current assets on the Balance Sheet.

Key concepts

Direct costs vs. factory overhead (indirect costs)

• Direct costs can be traced directly to the product:
  • Raw materials used
  • Direct labour (wages of workers who manufacture the product)
  • Direct expenses (e.g., power for a specific machine, special tooling)
• Factory overhead (indirect costs) cannot be traced to a single product and must be allocated. The Cambridge syllabus expects the following items (you need only list these in the exam):
  • Depreciation of plant and equipment
  • Factory rent, heating and lighting
  • Supervisory salaries
  • Maintenance of plant and equipment
  • Factory insurance

Prime cost & total manufacturing cost

• Prime cost = Raw Materials Used + Direct Labour (+ Direct Expenses if shown)
• Total manufacturing cost = Prime cost + Factory overhead

Cost of Production (Cost of Goods Manufactured – COGM)

The syllabus uses the term Cost of Production; it is exactly the same as Cost of Goods Manufactured (COGM). It represents the total cost of goods that were completed during the period.

Formula

Cost of Production (COGM) = Total manufacturing cost + Opening WIP – Closing WIP

Cost of Goods Sold (COGS)

COGS is the cost of the goods that were sold during the period.

Formula

COGS = Cost of Production (COGM) + Opening Finished‑Goods – Closing Finished‑Goods

Note: the COGS figure is the **starting point** for the Income Statement.

Structure of the Manufacturing Account

Step‑by‑step preparation

1. Calculate Raw Materials Used

   Raw Materials Used = Opening RM + Purchases – Closing RM

2. Identify all direct costs (labour & direct expenses) and allocate factory overhead (see the allocation example below).
3. Compute Prime Cost

   Prime Cost = Raw Materials Used + Direct Labour (+ Direct Expenses)

4. Add the allocated factory overhead to obtain Total Manufacturing Cost.
5. Adjust for opening and closing WIP to get Cost of Production (COGM)

   COGM = Total Manufacturing Cost + Opening WIP – Closing WIP

6. Adjust for opening and closing Finished Goods to arrive at COGS

   COGS = COGM + Opening FG – Closing FG

7. Transfer COGS to the Income Statement; add net profit to opening capital and subtract drawings to give closing capital on the Balance Sheet.

Allocation of factory overhead (example)

If total overhead for the year is £12 000 and the factory uses 3 000 machine‑hours, the overhead rate is:

Overhead rate = £12 000 ÷ 3 000 mh = £4 per machine‑hour

For a product that used 2 500 machine‑hours, the allocated overhead is:

Allocated overhead = 2 500 mh × £4 = £10 000

Worked example (including overhead allocation)

All figures are in £.

Calculations

• Raw Materials Used = 12 000 + 45 000 – 9 000 = 48 000
• Direct costs = Direct Labour + Direct Expenses = 30 000 + 5 000 = 35 000
• Factory overhead allocation:
  • Overhead rate = 12 000 ÷ 3 000 mh = £4 per mh
  • Allocated overhead = 2 500 mh × £4 = 10 000
• Prime Cost = 48 000 + 35 000 = 83 000
• Total manufacturing cost = Prime Cost + Overhead = 83 000 + 10 000 = 93 000
• Cost of Production (COGM) = 93 000 + Opening WIP 4 000 – Closing WIP 6 000 = 91 000
• Cost of Goods Sold (COGS) = 91 000 + Opening FG 8 000 – Closing FG 7 500 = 91 500
• Gross Profit = Sales 120 000 – COGS 91 500 = 28 500
• Net Profit = Gross Profit 28 500 – Selling & Distribution 10 000 – Admin 7 000 = 11 500

Completed Manufacturing Account

Income Statement (Profit & Loss Account)

Statement of Financial Position (Balance Sheet)

Closing inventory figures are taken from the Manufacturing Account; net profit adjusts capital.

Key points to remember

• The Manufacturing Account is a cost‑flow statement; it does not show profit.
• Prime cost = Raw Materials Used + Direct Labour (+ Direct Expenses).
• Factory overhead must be allocated (common bases: machine‑hours, labour‑hours, floor‑space).
• Cost of Production (COGM) = Total manufacturing cost + Opening WIP – Closing WIP.
• COGS = COGM + Opening Finished‑Goods – Closing Finished‑Goods.
• Closing inventory figures from the Manufacturing Account become current assets on the Balance Sheet.
• Net profit from the Income Statement is added to opening capital; drawings are subtracted to give closing capital.

Common exam pitfalls & tips

• Terminology – use the exact wording from the syllabus: “factory overhead”, “prime cost”, “total manufacturing cost”, “cost of production (cost of goods manufactured)”.
• Only list the overhead items required by the syllabus when answering definition questions.
• COGS is the starting point for the Profit & Loss Account – never forget to place it directly under Sales.
• Overhead allocation – always show the calculation of the overhead rate and the allocation to the product.
• Closing inventories – transfer the three closing figures (RM, WIP, FG) to the Balance Sheet exactly as they appear in the Manufacturing Account.
• Capital reconciliation – remember to add net profit to opening capital and then subtract drawings; this gives the closing capital figure required in the balance sheet.