Financial statements of a manufacturer

A trader buys finished goods and resells them — Cost of Sales = Purchases adjusted for inventory.

A manufacturer makes its own goods — Cost of Sales = the cost of MAKING the goods (Cost of Production), not buying them.

The Manufacturing Account is a separate statement that calculates Cost of Production. It sits BEFORE the Income Statement in the financial reporting sequence:

1. Manufacturing Account → derives Cost of Production.
2. Income Statement → uses Cost of Production as the 'manufacturer's equivalent' of Purchases.
3. SOFP → shows three inventory types separately.

Without the Manufacturing Account, the manufacturer cannot calculate Cost of Sales for the Income Statement.

Cost type	Direct (Prime Cost)	Indirect (Factory Overhead)
Materials	Raw materials in the product	Cleaning supplies, lubricants
Labour	Production worker wages	Supervisor, cleaner, security
Expenses	Royalties, patents, design fees	Factory rent, factory depreciation, factory insurance

Direct costs are traceable to specific units. If you make 100 chairs, you can say how much wood and how many hours went into each chair.

Indirect costs (overheads) apply to the factory as a whole. The supervisor doesn't 'belong' to chair #47; the factory rent isn't split by chair. So overheads are aggregated and applied to total production.

Critical: OFFICE wages, SELLING costs, ADMIN expenses are NEITHER direct nor indirect factory costs — they are operating expenses in the Income Statement (below Gross Profit).

Manufacturing Account for the year ended [date]:

	£	£
Direct Materials:
Opening Raw Materials	X
Add: Purchases of Raw Materials	X
Add: Carriage Inwards on RM	X
Less: Returns Outwards on RM	(X)
Less: Closing Raw Materials	(X)
Cost of Raw Materials Consumed		X
Add: Direct Wages (production labour)		X
Add: Direct Expenses (royalties, patents)		X
PRIME COST		X
Add: Factory Overheads:
Indirect Wages (supervisor, cleaner)	X
Factory Rent	X
Depreciation of Factory Machinery	X
Factory Insurance	X
Factory Power, Heat & Light	X
	X
PRODUCTION COST (Sub-total)		X
Add: Opening Work in Progress		X
Less: Closing Work in Progress		(X)
COST OF PRODUCTION (to Income Statement)		X

Each bold subtotal is a mark-scheme item. Use them.

Why opening WIP is ADDED: Opening WIP was started in a previous period but is being completed THIS period. The costs were partly incurred before but the goods are now becoming part of THIS year's Cost of Production.

Why closing WIP is SUBTRACTED: Closing WIP is being made but isn't yet a 'completed unit'. Some of this year's costs went into it, but those costs belong to NEXT year's Cost of Production (when it's completed).

Think of it as a 'pipe' of in-progress work flowing through the period:

• Opening WIP enters the pipe at the start of the year.
• Production through the year flows through.
• Closing WIP exits the pipe at the year-end.
• The volume of completed goods = Opening + Production − Closing.

Manufacturer's Trading Section:

	£	£
Sales		X
Less: Returns Inwards		(X)
Net Sales		X
Less: Cost of Sales:
Opening Finished Goods	X
Add: Cost of Production	X
	X
Less: Closing Finished Goods	(X)
Cost of Sales		(X)
Gross Profit		X

From Gross Profit downward, the Income Statement is identical to a non-manufacturer's: add Other Income, deduct admin and selling expenses, arrive at Profit for the year.

Current Assets (manufacturer's SOFP):

	£
Inventory of Raw Materials	X
Inventory of Work in Progress	X
Inventory of Finished Goods	X
(or combined) Total Inventory	X

Reason for separation: each inventory type tells a different management story.

• High raw materials could indicate over-purchasing.
• High WIP could indicate production bottlenecks.
• High finished goods could indicate slow sales / over-production.