Lecture 6
Manufacturing Cost Statements
Learning outcomes
At the end of this learning unit, a student should:
Be able to distinguish between the three cost components for the
manufacturing of finished goods:
• Materials
• Labour
• Manufacturing
Be able to explain the physical flow of materials during the
manufacturing process and the recognition thereof.
Be able to do the accounting entries for a manufacturing entity.
Be able to compile a manufacturing cost statement.
Introduction
• The unit on IAS 2, Inventories explained the definition,
recognition and measurement and disclosure of inventory.
• The latter referred to the purchase of finished goods with the
purpose of selling them at a higher price.
• In the case of a manufacturing entity the components of raw
materials and consumable materials are purchased and
processed to make a finished product.
Introduction
• In contradistinction to a trading entity (where the cost of
purchase was available from the suppliers invoice), the
objective of a manufacturing entity is to ensure accurate cost
allocations to determine the cost to manufacture an item.
• If the cost allocations are not done correctly, this will result in
incorrect cost of sales and closing inventory amounts.
Paragraph 10.11 of the
prescribed textbook
Materials
• Materials (raw materials) is one of the primary components of
manufacturing cost.
• Please note that ‘raw materials’ are for the purpose of this
lecture, materials or substances used in the primary production
or manufacturing of goods.
• Materials that are an essential part of the manufactured product
are referred to as direct materials.
Materials
• Other materials, usually with a low value that cannot be
identified in the final product are know as indirect materials and
forms part of manufacturing overheads.
• If the entity is registered for Value Added Tax (VAT), VAT must
be excluded from the purchase price by multiplying the
purchase price with 100/115.
• The fraction of 100/115 is applied when the consideration
includes VAT.
Labour
• Direct labour is the other component of primary manufacturing
costs.
• Direct labour is the labour performed by the workers in the
factory who are actively involved in the manufacture of the
product.
• Indirect labour does relate to the actual manufacturing activities
but forms part of the factory overheads.(for example wages of
cleaners, security guards, supervisors et cetera.)
Labour
• Costs of direct labour that is directly involved in the
manufacturing process, changes in relation to the quantities
manufactured.
• Indirect labour is not directly involved in the production process
and therefore changes in quantities produced do not result in
any change in indirect labour cost.
Manufacturing overheads
• Manufacturing overheads do not form part of primary costs.
• Examples are rent of the factory, depreciation on machinery and
tools in the factory, maintenance of factory machinery et cetera.
Manufacturing overheads
• A cost item must be associated with the manufacturing process
before it can be included in overheads. Administration costs, the
salary of the managing director, rent of offices, depreciation on
office furniture, salaries of sales personnel et cetera do not form
part of manufacturing overheads.
• If the entity is registered for Value Added Tax (VAT), VAT can be
claimed on certain overheads and VAT must be excluded from
qualifying expenses.
The physical flow of materials during the
manufacturing process and the recognition thereof
• When raw materials are received, they are packed in the material
warehouse and debited to the raw materials account in the ledger.
• Upon receipt of a requisition from the factory, materials are issued to the
factory and the ‘work in progress account’ is debited, while the raw
materials account is credited.
• Finished goods are transferred to the storeroom.
The physical flow of materials during the
manufacturing process and the recognition thereof
• The accounting entry for the latter is that the ‘work in progress account’ will
be credited and the finished goods account will be debited with the cost of
the finished goods manufactured.
• Inventory accounts thus exists for the following and is disclosed (including
the value of each item) as such in the notes to the financial statements;
• Raw materials
• Work in progress
• Finished goods
• For control purposes, inventory is recognised according to the perpetual
inventory system.
The following questions serves as exercises:
Sparky Limited (Question 1 Page 115 of the Study Guide)
HD Manufacturers Limited (Class Exercise 5 Page 106 of the Study Guide)
Gasco Manufacturers Limited (Question 4 Page 122 of the Study Guide)
Alpha Limited (Question 5 Page 134 of the Study Guide)
Smoothies Limited (Question 7 Page 139 of the Study Guide)