Manufacturing Account Worked Example
Question 13
Factory profit
End of year
Opening
Opening
Closing
Depreciation on property = 5 % X 400 000 = $20 000
Depreciation on manufacturing plant and machinery = 20% X (350000 – 230000)
= $24 000 – MA
Depreciation on office equipment = 15% X 120 000 = $18 000 - IS
Manufacturing profit for the year ended 31 December 2015
Cost of Raw Materials Consumed
Opening inventory of Raw Materials 24600
Add Purchases of Raw Materials 287000
Add carriage inwards on Raw Materials 3700
315300
Less closing inventory Raw Materials (28800)
Cost of Raw Materials Consumed 286500
Add Direct Costs
Direct wages 344000
Prime Cost 630500
Add Factory overheads
Indirect wages 69000
Purchase of indirect materials 43000
Other factory overheads 32500
Water and electricity [80% X (14000 + 1500)] 12400
Depreciation property (70% X 20 000) 14000
Depreciation on manufacturing plant and machinery 24000 194900
825400
Work-In-Progress
Opening inventory work-in-progress 66800
Less closing inventory work-in-progress (72200)
Increase in work-in-progress (5400)
Cost of production at cost price 820000
Add Factory (Manufacturing) Profit (20% X 820000) 164000
Cost of production at transfer price 984000
Income Statement for the year ended 31 December 2015
Revenue 1562000
Less cost of sales
Opening inventory finished goods (transfer price) 162000
Add cost of production (transfer price) 984000
1146000
Less closing inventory finished goods (transfer price) (186000) (960000)
Gross profit 602000
Less Expenses
Administrative expenses 374000
Water and electricity [20% X (14000 + 1500)] 3100
Depreciation on property (30% X 20000) 6000
Depreciation on office equipment 18000 (401100)
Profit on trading 200900
Add Manufacturing Profit 164000
Provision for unrealized profit
Opening provision for unrealized profit 27000
Less closing provision for unrealized profit (W1) (31000)
Increase in provision for unrealized profit (4000)
Realised factory profit 160000
Profit for the year 360900
Working 1 (W1)
Closing provision for unrealized profit
= (Factory Profit / Cost of production transfer price) X Closing inventory transfer price
= (164 000 / 984000) X 186 000 = $31 000
Closing provision for unrealized profit
= Closing inventory transfer price – Closing inventory at cost
= 186 000 – 155 000 = $31 000
Closing inventory at cost = [Closing inventory transfer price / (1 + Mark -up)]
= [186 000 / (1 + 0.2)]
= 186 000 / 1.2
= 155 000
Provision for Unrealised Profit Account
Balance b/d 27 000
Balance c/d 31 000 Income Statement ?? (Increase) 4 000
31 000 31 000
Balance b/d 31 000
IAS 2 states that inventory should be valued at lower of cost and net realizable
value. The closing inventory in the income statement includes unrealized
profit. Thus, the closing inventory at transfer price is higher than the closing
inventory at cost. In such a situation, inventory should be recorded at cost and
not the transfer price. This is done to ensure that profits and assets are not
overstated to comply with the prudence concept.
The unrealized profit included in value of closing inventory at transfer price
has not yet been realized. According to the realization concept, only realized
profit should be included in the financial statement. When recording the
closing inventory in the statement of financial position, the unrealized profit
should be removed to comply with the realization concept.
The production department is considered as a department itself, and hence can
make a profit. Hence, a mark-up should be added to the cost of production at
cost price to know the profit made by the production department. From the
profit made by the production department, bonus can be paid to factory
workers, managers, and supervisors. This will improve their productivity and
efficiency which in the future will reduce cost.
It should be noted that a mark-up of 20% is subjective and might not be
realized. By including the mark-up in the value of inventory, the business will
be overstating profit and assets which will be against the prudence concept
and since the profit has not yet been realized, it will also be against the
realization concept. Including mark-up in the value of inventory is not
acceptable for external reporting as it is against IAS 2 which states that
inventory should be valued at lower of cost and net realizable value.
It is advisable to include mark-up of 20% because the factory has to make a
profit.
