FUNDAMENTALS OF ACCOUNTING II

    MANUFACTURING ACCOUNTS

By the end of the topic you should be able to:

• Define direct and indirect costs
• Administration cost of a manufacturing firm.
• Selling and distribution costs
• Transfer price
• Prepare manufacturing accounts 1.1 INTRODUCTION

Some firms may manufacture or produce goods rather than buy due to
savings in operational costs. (i.e. it is cheaper to produce the goods
rather than buy). Due to additional costs involved in the production
process, additional information is reported in the final accounts. These
firms incur manufacturing cost. Therefore in addition to the preparation
of trading profit & loss A/c and balance sheet, they also prepare
manufacturing account to show the manufacturing costs.
The purpose of the manufacturing account is to report all the costs
incurred in producing goods. The costs incurred in the manufacture are
classified as either direct or indirect.

    Direct costs /prime costs

These are costs that one can easily identify in the product or which one
can easily associate with the
product. Direct costs are further
divided into the following categories:

    (a) Direct materials

These are the cost of raw materials which one can directly identify in
product e.g. wheat in breach, cloth in clothes e.tc.

    (b)Direct Labour

This is labour costs which is directly associated with a product e.g.
wages of a machine operator or wages of a machine operator or wages of
labourers directly involved in product process e.g. sorting out
materials, mixing etc.

    (c)Direct expenses

These are expenses which are directly incurred in the process of
manufacture of a product e.g royalties paid to the owner of a machine or
to the owner of a quarry land where minerals are extracted.
Note The total of direct materials, labour and expenses make up prime cost.

    Indirect costs overheads

These are costs not easily identified in a product or associated with
it. They are divided into: –

    (a) Indirect materials

These are costs raw materials which one cannot easily identify with a
particular product e.g. salt/sugar in bread, buttons in clothes, bolts
in furniture etc.

    (b) Indirect Labour

This is labour cost which is not easily associated with a product e.g.
salary of a foreman or supervisor. Because such a person is supervising
several production floors his/her services cannot be associated with one
single production process.

    (c)Indirect expenses

These are expenses which can’t be directly associated with the product
e.g. insurance of factory machines, buildings, rent, water, power &
lighting, depth of machines, etc
Other examples include; rent for the factory, depreciation of plant and
machinery used in production
Note The totals of indirect materials, indirect labour and indirect
expenses are refereed to as factory costs overheads.
Work in progress (W-I-P) These are materials, labour and overheads which
are in the process of manufacture. W-I-P can either be opening W-I-P or
closing W-I-P.