A manufacturing business is one that is involved in the production of goods. A separate account, known as a manufacturing account, is prepared to show the costs associated with the business.
A simple manufacturing account has 2 sections:
- Prime cost section: Prime costs are the direct costs associated with production, such as direct labor and materials.
- Factory overheads: Overheads are the indirect costs associated with production, costs that cannot be traced to individual units of a product. Factory overheads are the overheads that are incurred by a factory, such as rent, electricity and supervisor’s salary.
Both of these types of costs are combined in the manufacturing account to give the cost of production.
Hence, the Cost of Production = Prime Cost + Factory Overheads
There are 3 types of inventories that are held by a manufacturing business. Raw materials refer to the factor inputs that are used to manufacture products. Finished goods are goods that have undergone the entire manufacturing process and are ready to be sold to consumers. Lastly, work-in-progress goods are those goods that are still in the process of being manufactured.
In the manufacturing account, you must start with the opening inventory value for raw materials followed by purchases of raw materials (and any adjustments, like carriage inwards) and net purchases. Then, the closing inventory is subtracted from the total of these two figures to get the cost of raw materials consumed.
Then, other direct costs such as wages of direct labor, are added to this figure to calculate the total prime cost. The next section is the factory overheads section which includes things like insurance, depreciation and rent.
To the total of all of these sections, the opening inventory of work in progress goods is added and its closing inventory is subtracted. The final figure is the cost of production of manufactured goods.