understand direct material, direct labour, prime cost and factory overheads

5.5 Manufacturing Accounts

Learning Objectives

By the end of this section you should be able to:

• Define and calculate the cost of direct material and direct labour.
• Explain what prime cost is and how it is derived.
• Identify the items that make up factory overheads and allocate them on a rational basis.
• Prepare a complete manufacturing account, showing the flow from raw material to Cost of Goods Sold (COGS).
• Link the manufacturing account to other parts of the syllabus (incomplete records, overhead‑allocation adjustments, etc.).

Key Terminology

Direct Material

Definition – Raw material that can be directly identified with the product.

Calculation

Direct Labour

Definition – Wages of employees who physically transform the raw material into the finished product.

Source of data – Payroll records, time‑cards, piece‑rate sheets, overtime registers.

• Overtime, piece‑rate wages and statutory deductions (e.g., NI, tax) are **included in the total direct labour cost** unless the question states otherwise.

Prime Cost

Prime cost represents the primary (direct) cost of production.

Formula

Factory Overheads

All manufacturing costs that are indirect are classed as factory overheads.

• Depreciation of plant and machinery
• Factory rent, rates and insurance
• Power and fuel used in the factory
• Maintenance and repairs of equipment
• Factory supervisor’s salary
• Factory supplies (lubricants, cleaning materials, etc.)
• Other indirect costs (security, water, heating, etc.)

Allocation of Overheads – Rational Basis

Overheads must be spread to products using a basis that reflects how the overheads are incurred. Common bases are:

• Machine‑hours
• Labour‑hours
• Units produced
• Value of direct material

The chosen basis should be stated in the answer if the question asks you to allocate overheads.

Example of Overhead Allocation

In this example £8 000 of total factory overheads are allocated on a machine‑hour basis (total machine‑hours = 1 000). Product A receives 60 % of the overhead (£4 800) and Product B receives 40 % (£3 200).

Total Manufacturing Cost (Cost of Production)

Formula

Cost of Goods Available for Sale (COGAS)

Formula

Manufacturing Account – Complete Structure

The manufacturing account follows the exact order required by the Cambridge syllabus. Opening finished‑goods stock is added *after* the Cost of Production line.

Worked Example (Full Set of Calculations)

Data for the month:

1. Direct Material = 5,000 + 20,000 – 4,000 = £21,000
2. Direct Labour = £12,000
3. Prime Cost = 21,000 + 12,000 = £33,000
4. Factory Overheads Allocation (example) – suppose the overheads are allocated on a labour‑hour basis and the company produces only one product, so the whole £8,000 is assigned to that product.
5. Cost of Production (CoP) = Prime Cost + Factory Overheads = 33,000 + 8,000 = £41,000
6. Cost of Goods Available for Sale (COGAS) = Opening Finished‑Goods Stock + Cost of Production = 3,000 + 41,000 = £44,000
7. COGS = COGAS – Closing Finished‑Goods Stock = 44,000 – 2,500 = £41,500

The final figure (£41,500) is the amount that appears in the income statement under “Cost of Goods Sold”.

Link to Other Parts of the Syllabus

Incomplete records (Section 5.6)

• If only raw‑material data are available, the cost of work‑in‑progress (WIP) must be estimated and added to the manufacturing account.
• Example: Opening WIP = £1,200, Closing WIP = £800. Add £1,200 to the Cost of Production and deduct £800 before arriving at COGAS.

Adjustments for errors / over‑/under‑allocation of overheads

• Exam questions may ask you to correct an overhead allocation that was based on an inappropriate basis.
• Adjustment is recorded by a journal entry:
  Factory Overheads (Debit)