Manufacturing Accounts - Part 1

A trading business buys finished goods and resells them. A manufacturing business makes the goods it sells.

For a trading business, the income statement's cost of goods sold simply uses: Opening inventory + Purchases − Closing inventory.

A manufacturing business cannot do this — instead of buying finished goods, it buys raw materials, uses labour and factory resources to convert them, and then sells the finished product.

The manufacturing account captures all production costs and produces a single figure — cost of production (also called cost of finished goods manufactured) — that is then used in the income statement exactly where "Purchases" would appear for a trading business.

The three-stage flow:

1. Raw materials → purchased, stored, issued to production.
2. Work in progress (WIP) → partially finished goods on the factory floor.
3. Finished goods → completed products ready for sale.

Each stage has its own inventory balance. The manufacturing account deals with stages 1 and 2; the income statement deals with stage 3.

Cambridge exam tip: Manufacturing account questions always appear on Paper 2 (longer questions). You must be able to identify WHICH costs belong in the manufacturing account (production costs only) vs the income statement (all other costs).

Direct costs are costs that can be specifically identified with and attributed to individual units of production. They form the prime cost.

1. Direct materials — the raw materials that physically become part of the finished product.

• Examples: timber in a furniture factory, fabric in a clothing manufacturer, steel in a machine shop.
• Calculation: Direct materials used = Opening raw materials inventory + Purchases of raw materials − Closing raw materials inventory
• Note: only USED materials enter the account; unsold raw materials remain as an asset.

2. Direct labour — wages paid to production workers who directly work on the product.

• Examples: machinists, assembly workers, welders, packers (if directly involved in production).
• NOT direct labour: factory supervisors, cleaners, maintenance staff → these are indirect.
• Direct labour = total wages of production workers for the period.

3. Direct expenses — other costs directly attributable to specific units.

• Less common at IGCSE; example: royalty fees paid per unit produced, hire of specialist machinery for a specific product.

Prime cost formula: Prime cost = Direct materials used + Direct labour + Direct expenses

Why prime cost matters: It represents the irreducible minimum cost of actually making one unit before any overhead is added. Comparing prime cost with selling price gives a basic measure of production efficiency.

Cambridge exam tip: Many students confuse factory supervisor wages as direct labour. Factory supervisors manage workers but do not directly handle the product — they are indirect labour (factory overhead).

Factory overheads are all production-related costs that cannot be directly traced to individual units of output. They support the production process generally.

Examples of factory overheads:

• Indirect materials: lubricants, cleaning fluids, small tools, factory consumables.
• Indirect labour: factory supervisors, factory cleaners, maintenance staff, security guards.
• Factory rent and rates (apportioned to the factory).
• Factory insurance and rates.
• Depreciation of factory machinery and factory buildings.
• Factory power and lighting (electricity, gas).
• Factory repairs and maintenance.

CRITICAL RULE: Only costs incurred inside the factory (production area) are factory overheads. Costs outside the factory go in the income statement:

• Selling expenses → income statement.
• Office (administration) expenses → income statement.
• Delivery/distribution costs → income statement.

Apportionment: When a cost relates to both factory and office (e.g., rent for a building shared by factory and office), it must be split. Exam questions give you the apportionment basis (e.g., "70% relates to the factory, 30% to the office").

Cambridge exam tip: A key examiner-reported error is placing selling and administration overheads in the manufacturing account. Ask yourself: "Does this cost occur IN the factory as part of making the product?" If yes → manufacturing account. If no → income statement.