How do you prepare a manufacturing account to find the cost of goods manufactured, and how does it link to the income statement?
Preparation of a manufacturing account showing prime cost and the cost of goods manufactured, including direct materials, direct labour, direct expenses, factory overheads and the adjustment for work in progress, and its link to the income statement.
A focused answer to the SQA Higher Accounting manufacturing account content, covering prime cost, factory overheads, the work in progress adjustment, the cost of goods manufactured, and how the manufacturing account feeds the income statement.
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What this dot point is asking
The SQA wants you to prepare a manufacturing account that calculates the cost of producing finished goods. You must classify costs as direct or indirect, build up prime cost, add factory overheads, adjust for work in progress, and arrive at the cost of goods manufactured, which then feeds into the income statement in place of purchases.
Direct and indirect costs
The first skill is classifying costs. Direct costs can be traced to each unit produced: the raw materials in the product, the wages of workers who make it, and any direct expense such as royalties per unit. Indirect costs, the factory overheads, cannot be traced to a single unit: factory rent and rates, supervisors' salaries, factory power and the depreciation of factory machinery. Costs of selling and administration are not production costs at all and stay in the income statement, not the manufacturing account.
Building the manufacturing account
Work in progress
At any year end some units are part-finished: work in progress. The manufacturing account must report only the cost of goods completed during the year. Opening work in progress represents units started last year and finished this year, so its cost is added. Closing work in progress represents units started this year but not yet finished, so its cost is deducted and carried forward to next year.
Link to the income statement
The cost of goods manufactured is transferred to the trading section of the income statement. There it takes the place that purchases would occupy for a trader. Cost of sales becomes opening inventory of finished goods plus cost of goods manufactured minus closing inventory of finished goods. Note the three inventories a manufacturer holds: raw materials, work in progress and finished goods, each adjusted in its own place.
Try this
Q1. Opening raw materials £6,000, purchases £40,000, closing raw materials £5,000. Calculate materials used. [2 marks]
- Cue. £6,000 + £40,000 - £5,000 = £41,000.
Q2. Prime cost is £80,000 and factory overheads are £25,000. Opening WIP £3,000, closing WIP £2,000. Calculate the cost of goods manufactured. [2 marks]
- Cue. £80,000 + £25,000 + £3,000 - £2,000 = £106,000.
Q3. State the three types of inventory a manufacturer holds. [1 mark]
- Cue. Raw materials, work in progress and finished goods.
Exam-style practice questions
Practice questions written in the style of SQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
SQA Higher style6 marksA manufacturer has opening raw materials £5,000, raw material purchases £42,000, closing raw materials £6,000, direct wages £30,000 and direct expenses £4,000. Factory overheads are £18,000. Opening work in progress is £3,000 and closing work in progress is £4,000. Calculate prime cost and the cost of goods manufactured.Show worked answer →
Cost of raw materials used = opening + purchases - closing = £5,000 + £42,000 - £6,000 = £41,000 (1 mark).
Prime cost = direct materials used + direct wages + direct expenses = £41,000 + £30,000 + £4,000 = £75,000 (2 marks).
Add factory overheads: £75,000 + £18,000 = £93,000 (1 mark).
Adjust for work in progress: add opening WIP and deduct closing WIP: £93,000 + £3,000 - £4,000 = £92,000 = cost of goods manufactured (2 marks). Markers reward materials used, prime cost, the overhead addition and the WIP adjustment.
SQA Higher style3 marksExplain the difference between prime cost and the cost of goods manufactured, and state why work in progress is adjusted for.Show worked answer →
Prime cost is the total of all direct costs: direct materials used, direct labour and direct expenses (1 mark).
The cost of goods manufactured is prime cost plus factory (indirect) overheads, adjusted for opening and closing work in progress (1 mark).
Work in progress is adjusted for because some units were part-finished at the start or end of the period; adding opening WIP and deducting closing WIP ensures the account reflects only the cost of goods actually completed during the year (1 mark). Markers reward both definitions and a clear reason for the WIP adjustment.
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Sources & how we know this
- SQA Higher Accounting Course Specification — SQA (2023)