South African Grade 11 and 12 Accounting: Manufacturing Accounts - Production Cost Statement

This post assumes that you are familiar with the ledger accounts of a manufacturing business. This post and this post look at the ledger accounts.

The Production Cost Statement

At the end of the year, we will make a new financial statement that summarises some of the information from the manufacturing accounts in the General Ledger. This is to help people reading the financial statement understand how certain key figures -- such as Cost of Sales -- were arrived at. By putting it into a financial statement, we make the information more accessible to people, as everything is explained quite clearly. Imagine having to dig through the ledgers every time you wanted to work out the net operating expenses, for example, and you'll quickly see the benefit!

In order to show manufacturing information in an accessible way, we draw up a couple of statements and notes to those statements.

Production Cost Statement

The first statement drawn up is a production cost statement. This is essentially the Work-in-Progress Account, but in the form of a statement.

For example, suppose we have a Work-in-Progress Stock account as follows:

An example Work-in-Progress Stock account

The resulting Production Cost Statement would look like this:

An example Production Cost Statement

Note that the coloured "+", "-", and "=" are there to help with understanding, and are not normally part of the statement.

Notes to the Financial Statements for the Production Cost Statement

Also note that the statement refers to notes for Direct Materials Cost, Direct Labour Cost, and Factory Overhead Cost. These are drawn up as notes to the financial statements, and are also essentially ledger accounts in statement form. The Direct Materials Cost note is based on the Raw Materials Stock account, the Direct Labour Cost note is based on the Direct Labour Cost account, and the Factory Overhead Cost note is based on the Factory Overhead Cost account. Continuing the above example, the notes would look like this (the notes are empty for now, but I'll put numbers in when I get a chance):

Example Notes to the Financial Statements for the Production Cost Statement - error in note 1 to be corrected!

Note that any custom duties would be added in Note 1 above.

Again, note that the coloured signs on the left of each note are just there to help, and are not usually included!

Cost of Finished Goods Sold

This note bridges the gap between the Production Cost Statement and the Trading Statement (or Income Statement). It is essentially the Finished Goods Stock ledger account in the form of a statement:

Example of the Cost of Finished Goods Sold note.

The cost of finished goods sold is the same as Cost of Sales.

Once again, the coloured signs on the left are not normally included. Also, note that the "Total Cost of Production of Finished Goods" amount is the total from the Production Cost Statement.

Trading Statement

The trading statement is the last of these additional statements, and is just used to show how the Gross Profit is calculated. It is essentially the same as the first three lines of an income statement.

Example of a Trading Statement

An important reminder

Marks are sometimes deducted in tests and exams if negative amounts are not shown in brackets. For example, in the Trading Statement, the Cost of Finished Goods Sold amount should be enclosed in brackets, because it represents an expense.

South African Grade 11 and 12 Accounting: Manufacturing Accounts - Ledgers at the Year-End

This post looks at the year-end transactions of a manufacturing business. It follows on from other posts on different types of costs, as well as the recording of buying direct and indirect raw materials in the general ledger.

Year-End Transaction in the General Ledger

In Grade 10 we saw how businesses closed off accounts at the end of the financial year: Sales and Cost of Sales were closed off to the Trading Account, which was in turn closed off to the Profit and Loss account. All other income and expenses were closed off to the Profit and Loss account, which was then closed off to the Capital account.

In a manufacturing business, we still follow a process related to the one we learnt in Grade 10, but there are some new accounts that we have to deal with when closing off.

The following diagram shows us how all the accounts will be closed off, or the "flow" of the accounts:

To help with understanding and remembering all this, I've used different shapes and colours to represent the different types of accounts.

The most important new accounts that we have to know about are the Cost Accounts. There are five that we use: Direct Materials Cost, Direct Labour Cost, Factory Overhead Cost, Administration Cost, and Selling and Distribution cost. The first three deal with production costs (and are all closed off to Work-in-Progress stock), while the last two deal with non-production costs (and are closed off to Profit and Loss).

One question that I am sometimes asked is why the expenses related to production don't appear in the Profit and Loss Account. Remember that the Trading Account has Sales and Cost of Sales in it -- and Cost of Sales is all the combined costs of production of the goods that we have sold. The cost of production of goods that we haven't sold is still contained in the Finished Goods Stock account.

Notice how the final transaction of all is to close the Profit and Loss account off to Capital -- just like we did in Grade 10. This represents the Net Profit that has been made over the past year. Because the owner owns the business, the Net Profit belongs to him or her, and thus gets added to Capital.

The best way to understand this process is to practise it. Don't think that you'll have remembered everything just by reading this!

The flow of accounts shown above is only an image; for higher quality pdfs, click here for colour and here for black and white.

South African Grade 11 and 12 Accounting: Manufacturing Accounts - Buying Raw Materials

Note that this post is aimed at South African high school Accounting, and assumes that students are at a Grade 11 level. It also assumes that learners understand the basic concepts behind manufacturing, such as direct and indirect costs, fixed costs, variable costs, etc.

Buying Materials

Direct raw materials

This section assumes that you know that the "Raw Materials Stock" account represents direct materials.

Buying raw materials is perhaps the simplest transaction to deal with. By now you should be happy with buying an asset: If the business pays cash, we credit Bank (to decrease it) and we debit the asset; if we buy it on credit, we credit Creditors' Control (to show that we owe them more) and we debit the asset.

Over the year, the business will probably buy raw materials fairly frequently, but we only post through journal totals at the end of the period. This means that if, over the course of the year, we purchased R50 000 worth of raw materials with cash and we also bought R75 000 worth of raw materials on credit, our ledger will look like this:

The beginnings of the Raw Materials Stock account

Note that we had a starting balance of R14 000. This means that at the beginning of the year, the business had raw materials to the value of R14 000.

For the year-end transactions for Raw Materials Stock -- as well as other accounts -- see the post on the end-of-year procedures.

Carriage on Purchases

Now is a good time to mention Carriage on Purchases. This is a fancy name that just means the cost of transporting an asset from the seller to our business, but we must be careful in how we handle it.

As you should remember, we always record assets at the lower of historic cost and net realisable value. This means that we usually record assets at their historic cost price -- the price that we originally paid for the asset. The important thing to remember is that the cost price of an asset is the total of all the costs that get the asset to our business in a useful condition. If we buy an asset but it sits in our supplier's warehouse, it's useless to us. If it isn't doing anything for our business, it's not really an asset.

Because all these costs make up the historic cost, we add costs like carriage on purchases directly to the asset account. This means we treat carriage on purchases as though we were just buying more stock at that price.

As an example, let's say that we also paid R1 200 for carriage on purchases out of petty cash. Our ledger would now look like this:

Raw Materials Stock -- now with carriage on purchases paid from Petty Cash.

Normally in the exercises that we will do, carriage on purchases will just be added to the bank or the creditors' control amounts, depending on whether we pay with or use credit.

Note that carriage on purchases is probably going to appear in every test and exam that covers this section!

Indirect Raw Materials (Consumable Stores)

Some tests and exams will tell you that indirect raw materials have been purchased. Do not confuse these with the direct raw materials dealt with above.

Buying Consumable Stores

When we buy indirect raw materials, we usually put them into the expense account Consumable Stores, which we treat like Stationery or any of the other consumable stores accounts that we have dealt with. We will credit bank and debit Consumable Stores. After purchasing consumable stores on cash and credit, the ledger account will look something like this:

Buying Consumable Stores

This makes it seem as if Consumable Stores behaves like Raw Materials Stock or another asset, but remember that Consumable Stores is an expense!

Consumable Stores at the end of the year

At the end of the year, if any consumable stores are left over, we put them into the asset account Consumable Stores on Hand, and close off the rest to Factory Overhead Cost (See the post on closing-off ledger accounts at the end of the year for more on that).

For example, if we have only R500 of consumable stores left over at the end of the year, we will put the R500 into the Consumable Stores on Hand account (an asset), and the rest will be closed off to the Factory Overhead Cost account:

Consumable Stores at the end of the year

Consumable Stores on Hand will be balanced at the end of the year.

Consumable Stores at the beginning of the year

At the start of the next financial period, this balance will be transferred back to Consumable Stores, like this:

Consumable Stores on hand and Consumable Stores at the beginning of the year.

For more end-of-year transactions, look at the other post on the year-end process.