5.5 Manufacturing Accounts – Adjustments for Work‑in‑Progress (WIP)
Learning Objective
By the end of this lesson you should be able to:
- Explain why a manufacturing account is prepared and how it links to the profit‑and‑loss account.
- Distinguish between direct and indirect (overhead) costs and between variable and fixed costs.
- Define opening and closing work‑in‑progress and show how they are treated in the accounts.
- Calculate Cost of Production, Cost of Goods Manufactured (COGM) and Cost of Goods Sold (COGS), including all required adjustments.
- Interpret the effect of the WIP adjustments on the final accounts.
- Prepare a manufacturing account when only partial information is supplied (incomplete records).
1. Why a Manufacturing Account?
A manufacturing account records the total cost incurred in converting raw materials into finished goods during a specific period. It provides the Cost of Goods Manufactured (COGM), which is transferred to the Finished‑Goods Account. After adjusting for opening and closing finished‑goods inventories, the Cost of Goods Sold (COGS) is obtained and shown in the profit‑and‑loss account, allowing the calculation of gross profit and net profit.
2. Key Terminology
- Opening Work‑in‑Progress (WIP) – Value of partially completed goods at the start of the period.
- Closing Work‑in‑Progress (WIP) – Value of partially completed goods at the end of the period (carried forward as opening WIP for the next period).
- Cost of Production – Period costs only: raw materials used + direct labour + factory overheads allocated for the period.
- Total cost to be accounted for – Opening WIP + Cost of Production.
- Cost of Goods Manufactured (COGM) – Cost of the units that were completed in the period.
- Cost of Goods Sold (COGS) – Cost of the units that were sold in the period (COGM adjusted for opening and closing finished‑goods inventories).
3. Classification of Manufacturing Costs
| Cost Item | Direct / Indirect | Variable / Fixed (examples) |
|---|
| Raw Materials (used in production) | Direct | Variable – cost varies with output |
| Direct Labour | Direct | Variable – wages depend on hours worked |
| Factory Overheads – Power | Indirect | Variable – rises with machine‑hours |
| Factory Overheads – Depreciation of plant | Indirect | Fixed – same amount each period |
| Factory Overheads – Rent of factory building | Indirect | Fixed |
Factory overheads are a mixture of variable and fixed elements. In exam questions you may be asked to separate them, so be ready to identify examples.
4. Allocation of Factory Overheads
Overheads must be allocated to production on a systematic basis. Common bases are:
- Machine‑hours
- Labour‑hours
- Percentage of direct labour cost
Example – Allocation on machine‑hours
- Total overheads to be allocated: £12 000
- Total machine‑hours for the period: 3 000 mh
- Overhead rate = £12 000 ÷ 3 000 mh = £4 per machine‑hour
- If a product uses 250 mh, overhead allocated = 250 mh × £4 = £1 000
Journal entry (allocation)
| Date | Account | Debit (£) | Credit (£) |
|---|
| 31 Mar 2025 | Factory Overheads (allocated) | 1 000 | |
| Overheads Control (or Accrued Overheads) | | 1 000 |
5. Structure of a Manufacturing Account (Debit / Credit Format)
| Debit (Dr) | Amount (£) | Credit (Cr) | Amount (£) |
|---|
| Opening WIP | | | |
| Raw Materials Consumed | | | |
| Direct Labour | | | |
| Factory Overheads (allocated) | | | |
| Total Production Costs | | | |
| | Closing WIP | |
| | Cost of Goods Manufactured (transferred to Finished Goods) | |
The credit side contains only the amounts that leave the WIP account – closing WIP (carried forward) and COGM (moved to Finished Goods).
6. Fundamental Equation
Opening WIP + Cost of Production = Closing WIP + COGM
Re‑arranged for COGM:
COGM = Opening WIP + Cost of Production – Closing WIP
7. Step‑by‑Step Procedure for Adjusting WIP
- Opening WIP: Take the balance from the previous period’s trial balance.
- Calculate Cost of Production (period costs only):
- Raw materials used = Opening RM stock + Purchases – Closing RM stock.
- Direct labour = total wages paid to production staff.
- Factory overheads = total overheads allocated using the chosen basis (see Section 4).
- Total cost to be accounted for: Add opening WIP to the Cost of Production.
- Closing WIP: Obtain the value from the production manager’s report or a physical count.
- Compute COGM using the fundamental equation.
- Transfer COGM to the Finished‑Goods Account.
- Adjust for finished‑goods inventories to obtain COGS:
COGS = Opening Finished Goods + COGM – Closing Finished Goods.
- Link to the Profit‑and‑Loss Account: COGS is shown as the first expense; gross profit and net profit follow.
8. Worked Example – Full Manufacturing Account
ABC Ltd. – Manufacturing Account for the year ended 31 March 2025
| Debit (Dr) | Amount (£) | Credit (Cr) | Amount (£) |
|---|
| Opening WIP | 12,000 | | |
| Raw Materials Consumed | 45,000 | | |
| Direct Labour | 30,000 | | |
| Factory Overheads (allocated on machine‑hours) | 18,000 | | |
| Total Production Costs | 93,000 | | |
| | Closing WIP | 10,000 |
| | Cost of Goods Manufactured | 95,000 |
Calculations
- Cost of Production = 45,000 + 30,000 + 18,000 = £93,000
- Total cost to be accounted for = Opening WIP + Cost of Production = 12,000 + 93,000 = £105,000
- Applying the fundamental equation:
12,000 + 93,000 = 10,000 + COGM ⇒ COGM = £95,000
Finished‑Goods Account (to obtain COGS)
| Debit (Dr) | Amount (£) | Credit (Cr) | Amount (£) |
|---|
| Opening Finished Goods | 8,000 | | |
| Cost of Goods Manufactured | 95,000 | | |
| | Closing Finished Goods | 12,000 |
| | Cost of Goods Sold | 91,000 |
COGS (£91,000) appears in the profit‑and‑loss account as the first expense, from which gross profit and net profit are derived.
9. Incomplete‑Records Exercise
Question
- Opening WIP: £9,500
- Total cost to be accounted for (i.e., Opening WIP + all production costs): £78,200
- Closing WIP: £7,300
- Opening Finished Goods: £5,400
- Closing Finished Goods: £6,200
Using only the information above, calculate:
- Cost of Production
- Cost of Goods Manufactured (COGM)
- Cost of Goods Sold (COGS)
Solution
- Cost of Production = Total cost to be accounted for – Opening WIP
= £78,200 – £9,500 = £68,700
- COGM = Opening WIP + Cost of Production – Closing WIP
= £9,500 + £68,700 – £7,300 = £70,900
- COGS = Opening Finished Goods + COGM – Closing Finished Goods
= £5,400 + £70,900 – £6,200 = £70,100
10. Common Mistakes to Avoid
- Omitting the opening WIP balance – this understates the total cost to be accounted for.
- Confusing closing WIP with closing finished‑goods inventory.
- Leaving out any component of factory overheads or using an inconsistent allocation basis.
- Using the wrong period’s opening balances, which breaks the continuity between periods.
- Treating “Cost of Production” as including opening WIP; remember it is **only** the period’s manufacturing costs.
11. Quick Revision Checklist
- Record opening WIP (debit).
- Calculate and record raw materials used, direct labour and allocated factory overheads.
- Sum these to obtain Cost of Production and add opening WIP to get the Total cost to be accounted for.
- Enter closing WIP (credit) and solve for COGM using the fundamental equation.
- Transfer COGM to the Finished‑Goods Account.
- Adjust for opening and closing finished‑goods inventories:
COGS = Opening FG + COGM – Closing FG.
- Show COGS in the profit‑and‑loss account and calculate gross profit.
- If only partial data are given, use the “total cost to be accounted for” method (Section 9).
12. Summary
Adjusting for work‑in‑progress ensures that the manufacturing account reflects the true cost of production for the period. By correctly incorporating opening and closing WIP, allocating both variable and fixed overheads on a stated basis, and linking the result to the finished‑goods and profit‑and‑loss accounts, students can accurately determine COGM and COGS – essential steps for preparing reliable financial statements in the Cambridge IGCSE Accounting (0452) syllabus.