HBC 2107: INTRODUCTION TO ACCOUNTING II COURSE OUTLINE

(Course Prerequisite: HBC 2101 Introduction to Accounting I)

Course purpose:
To introduce students to aspects of financial reporting and analysis fundamentals for various
types of business entities particularly Partnerships, Not-for-profit Organisations, Manufacturing
entities and Companies.
Content:
1. Manufacturing Accounts
• Cost Classifications
• Manufacturing Income Statement
• Manufacturing Balance Sheet
2. Accounting for Incomplete Accounting Systems
• Types of incomplete recording
• Recognising double entry system
• Use of the trial balance and correction of errors
3. Introduction to Accounting for Partnerships.
• Partnership Law in Kenya and Provision affecting Accounting
• Application of Substance over form Accounting Principle to Partnerships
• Income statement for Partnerships
• The Statement of Financial Position for Partnerships
• Appropriation of Partnership income and the various Partnership Capital Accounts
4. Introduction to Accounting for Limited liability companies
• The companies Act of 2015 and Provisions affecting Accounting
• Types of Capital for a Limited Liability Companies
• The Company Income statement an Appropriations Account
• The Company Statement of Financial Position
• Published Accounts
5. Accounting for Not-for-profit Organisations.
• Accounting rules for not-for-profit Organisations
• The Statement of Affairs
• The Receipts and Payments Account
• The Income and Expenditure Account
• The Statement of Financial Position
6. Financial Statement Analysis
• Common-size Analysis
• Financial Ratio Trend and Cross-sectional Analysis
• Uses and Limitations of Financial Ratio Analysis

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7. The Statement of Cash Flows
• Provisions of the Accounting Standards
• Cash Accounting Vs Accrual Accounting
• The Direct Approach to the Statement of Cash Flows
• The Indirect Approach to the Statement of Cash Flows
Mode of Instruction:
• Class lectures both Physical and Online
• Group discussions
Course Evaluation
Assignments 10%
Cats 20%
Final exam 70%
Total 100%

Course instructor: Oluoch J. Oluoch

Course References:
1. IASB (2024) International Financial Reporting Standards
2. Oluoch Oluoch (2014) College Introductory Financial Accounting
3. Business accounting 1, Frank Wood and Sangster, latest edition
4. Business accounting 2, Frank Wood and Sangster latest edition

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 ACCOUNTING FOR MANUFACTURING OPERATIONS

The Nature of Manufacturing Operations

• Manufacturing, also called production, is the value addition process that involves the
conversion of raw materials into finished products.
• The conversion process involves incurrence of costs that are ultimately accounted for as part
of the cost of the manufactured inventory.
• A manufacturing firm is the most complete and comprehensive type of a business enterprise
because its operations incorporate almost all the functions of a business enterprise. These
functions are identified as:
✓ The production functions of converting raw material into finished goods.
✓ The selling and distribution function of creating time and place utility by ensuring that the
manufactured output reaches the target customers.
✓ The administrative function that incorporates the day to day running and management
functions of the business enterprise.
• The consequent accounting challenges emanate from the fact that a manufacturing enterprise
must account for all these types of costs.
• The management of a manufacturing concern must account for the cost of manufacturing so as
to make various assessments.

Merchandising versus Manufacturing Firms

• Their points of convergence include:

i. Types of functions: both merchandising firms and manufacturing firms carry out similar
functions especially the administrative functions and the selling and distribution functions.
Such management functions as planning; organizing; directing and controlling must be
exercised by both types of businesses. Similarly, they must ensure that they create place,
form and time utility by carrying out similar trading activities.
ii. The business objectives: all businesses, manufacturing, merchandising or otherwise have
similar business objectives. The most common of these are profit maximization; revenue
maximization; shareholder wealth maximization; pursuit of growth and business
expansion; corporate wealth maximization and possibly pursuit of social responsibility
activities.
iii. Trading activities: both manufacturing and merchandising firms engage in similar trading
activities. They generate their revenues and profits by ensuring that they buy inputs at a
lower price and sale their merchandise at a margin. They also carry out many other similar
functions to ensure that their merchandises are sold to their respective customers.

• Despite these similarities, the addition of the production function to the ambit of the functions
of a manufacturing firm introduces some important accounting differences.

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 o Manufacturing firms involve conversion of raw materials to finished goods
o Whereas merchandisers have only finished goods as inventory, manufacturing firms
have 3 sets of inventory:
▪ Raw materials
▪ Work in progress
▪ Finished goods

Inventory Flows Associated with Manufacturing Activities

The flow of inventories in a manufacturing process follows three main steps as depicted in figure
below:
i. The acquisition of raw materials: the relevant costs of materials are the purchase price
plus all the incidental and necessary expenses needed to bring such inventory of materials
to their condition and location in the factory (IAS 2, Inventory).

Manufacturing Inventory Flows Chart

Raw Work in progress Finished Goods

Materials

Conversion: Cost inputs

labour and other expenses
ii. The conversion process: this is where raw materials are introduced to the production
system and manipulated through various processes to come up with the finished output.
The conversion process involves value addition through the use of labour effort; the
consumption of extra materials as well as the incurrence of further production costs. These
costs include direct production costs and factory overheads.
iii. The transfer of the finished output: this involves the transfer of the output from the factory
into the finished goods store in readiness for use or sale.

The inventory flows in the figure shows that there are three types of inventories maintained by a
manufacturing operation. These are:
i. The raw materials inventory: the inventory awaiting conversion
ii. The work in progress inventory: the inventory undergoing conversion
iii. The finished goods inventory: the inventory output of the conversion process

Conversion costs are the expenses of the manufacturing process and the inputs that are necessary
to fine-tune the raw material inventory into finished output. Such include both direct expenses and
manufacturing overheads. Examples of conversion costs are:

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 • Factory direct labour i.e factory wages.
• Factory direct expenses like plant hire and factory power.
• Factory indirect expenses or production overheads such as supervisory wages, plant
depreciation expense, factory heat and lighting and similar expenses.

Journal Entries used to recognize Inventory Flows

The following accounting entries in the journal book are used in accounting for inventory (in
perpetual inventory system) in the manufacturing process in the various stages of the inventory
flows:

a) Upon acquisition of raw materials on cash/through the bank or on credit

DR. Raw materials inventory account XX
CR. Cash/Bank/Creditors account XX

b) Upon transfer of the raw materials in the production plant

DR. Work in Progress Inventory Account XX
CR. Raw materials inventory account XX

c) Upon incurrence of conversion costs paid in cash, the bank or on account

DR. Conversion costs accounts XX
CR. Cash/Bank/Accruals accounts XX

d) Upon recognition of conversion costs as inventory costs

DR. Work in progress inventory account XX
CR. Conversion costs accounts XX

e) Upon transfer of inventory from the processing plant into the finished goods store
DR. Finished goods inventory account XX
CR. Work in progress account XX
f) Upon recognition of manufacturing profit margin
DR. Finished goods inventory account XX
CR. Manufacturing income account XX

Illustration: Kilimanjaro Ltd

Kilimanjaro Ltd uses the perpetual inventory system to account for its raw materials inventory. In
a given manufacturing period, the following events and transactions took place:
i. Inventory at the beginning of the period was identified as finished goods of Sh.400,000; work
in progress of Sh.320,000 and raw materials of Sh.240,000.

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 ii. The company purchased raw materials inventory at a cost of Sh.720,000. It paid cash of
Sh.250,000 and gave out a cheque of Sh.Sh.280,000 for the raw materials. The rest of the
purchases were made on credit.
iii. The company uses materials in production on a first in first out basis. In line with this policy,
besides the work in progress, 80% of the raw materials purchased were transferred to the
processing plant.
iv. The conversion costs incurred, all paid in cash included: labour costs of Sh.160,000; direct
expenses of Sh.80,000 and factory overheads of Sh.140,000.
v. By the end of the period, 90% of the work in the conversion plant in the course of the period
had been transferred to the finished goods store at a factory profit margin of 10%.

Required: Prepare journal entries to record the above transactions and events with regard to
manufacturing inventory flows

DR(Sh) CR(Sh.)
Raw Materials Account 720,000
Cash Account 250,000
Bank Account 280,000
Creditors Ac (720-250-280=190) 190,000
(being materials purchases)
Work in progress ac (0.8*720,000) 576,000
Raw Materials Account 576,000
(Being transfer of materials to production)
Labour Cost Account 160,000
Direct expenses account 80,000
Factory Overheads 140,000
Cash Account
(being conversion costs) 380,000
Work in Progress Account 380,000
Labour Cost Account 160,000
Direct expenses account 80,000
Factory Overheads 140,000
(recognition of conversion costs into production)
Finished Goods Account 1,263,240
Working Progress Account 1,148,400
Manufacturing Income Account 114,840
(Transfer to finished goods)

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 Wk1 Value of finished Goods Manufactured
Opening stock of WIP 320,000
Add: Costs Introduced in the period
Raw Materials 576,000
Conversion Costs 380,000 956,000
Total WIP for the year 1,276,000
Completion rate 90% *0.9
Transferred to finished goods at cost 1,148,400
Profit margin 10% 114,840
Value of goods transferred to FG 1,263,240

Financial Statements by Manufacturing Organizations

Just like all other types of organizations, manufacturing organizations are expected to prepare the
following financial statements and include them in their annual reports:
i. The manufacturing firm income statement.
ii. The statement of financial position.
iii. The statement of cash flows.
iv. The statement of changes in equity position.

The Manufacturing Income Statement

The statement of comprehensive income of a manufacturing organization communicates
information about the financial performance of a manufacturing organization. It is therefore used
by various business stakeholders to appraise the profitability of the manufacturing operations of
the accounting entity. The format of a manufacturing income statement is depicted in figure below

Format of the Manufacturers Income Statement

KSh.
Sales XX
Less: sales returns (XX)
Net sales XX
Cost of sales:
Opening stock of finished goods XX
Cost of manufactured goods XX
Cost of goods available for sale XX
Less: cost of closing stock finished
goods (XX) (XX)
Gross profit XX
Add: other income XX
Gross income XX
Less: Expenses:
Selling Expenses XX

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 Administration Expenses XX
Financing Expenses XX (XX)
Net profit XX

The format provided above is similar to that of a merchandising organization except for the
determination of gross profit. Whereas a merchandising operation has the cost of inventory
available for sale being the sum of inventory brought forward and the purchased inventory, for a
manufacturing organization, this is taken as the sum of the cost of inventory at the beginning of a
trading period and the cost of inventory manufactured in the course of that trading period.

The cost of goods manufactured is simply the sum of all the inventorable costs incurred in the
course of production. Accordingly, the cost of production is determined as:

A Schedule of the Cost of Goods Manufactured

Ksh. Ksh.
Direct Materials:
Cost of the opening stock XX
Value of net purchases XX
Cost of materials available for use XX
Less: Cost of the closing raw materials (XX) XX
Direct labour:
Wages paid XX
Wages accrued for the period XX XX
Direct Expenses:
Plant hire paid and accrued XX
Factory power and other direct expenses XX XX
Total prime cost introduced in the current period XX
Factory overheads:
Indirect labour XX
Indirect materials XX
Indirect Expenses XX XX
Manufacturing cost introduced in the period XX
Add: value of W.I.P brought forward XX
Less: value of W.I.P carried forward (XX)
Cost of manufactured goods XX

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 Illustration: Serengeti Ltd
The following accounting balances are extracted from the books of Serengeti Ltd at 31.12.2024.
KSh.
Capital 213,900
Accounts payable 107,500
Bank 26,750
Accounts receivable 115,000
Salaries 75,000
Administration overheads 187,950
Advertising expenses 15,000
Factory direct wages 75,000
Factory indirect wages 30,000
Factory power 45,000
Furniture and fixtures (office) 23,000
Heat and light 20,000
Plant and equipment 346,000
Sales Motor vehicle 181,000
Plant hire 5,000
Provision for bad debts 4,000
Provision for depreciation 1.1.2024: Furniture and fixtures 11,500
Plant and equipment 173,000
Motor vehicle 30,000
Raw material purchases 285,000
Rent and rates 25,000
Sales 1,061,800
Selling and distribution overheads 82,000
Inventory 1.1.2024: Raw materials 10,000
Work in progress 20,000
Finished goods 35,000
Additional information:
i. Accruals at 31.12.2024 were factory power Sh.2,600; rent and rates Sh.5,000.
ii. Prepayments on 31.12.2024 were Sh.9,200 for salaries.
iii. The cost values of inventories at 31.12.2024 were :
• Raw materials Sh.25,200
• Work in progress Sh.40,400
• Finished goods Sh.55,600.
iv. Depreciation is to be charged on plant and equipment, motor vehicles and furniture and fixtures
at 20% of cost; 25% straight line and 10% reducing balance respectively.
v. Expenditures on heat and light, rent and rates and salaries are to be apportioned between factory
and office in the ratio 3:2 respectively.

Required:
A manufacturing cost statement for the year ended 31.12.2024 and a total cost statement for that
year

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 Serengeti Ltd Cost Statement for 2024
Raw Materials:
Opening stock 10,000
Purchases 285,000
Available for use 295,000
Less: Closing stock (25,200) 269,800
Labour: factory direct wages 75,000
Direct Expenses: Factory power 45,000
Payable 2,600 47,600
Plant Hire 5,000 52,600
Prime cost input for the year 397,400
Factory Overheads
Factory Indirect wages 30,000
Salaries (75,000 – 9,200) 3/5*65,800 39,480
Heat and Light 3/5*20,000 12,000
Plant and Equipment Depreciation 69,200
Rent and Rates (25,000+5,000) 3/5*30,000 18,000 168,680
Total cost input for the period 566,080
Add: WIP bf 10,000
Less: WIF cf (25,200
Cost of goods Manufactured 550,880

KSh. Workings
Capital 213,900
Accounts payable 107,500
Bank 26,750
Accounts receivable 115,000
Salaries 75,000 Prepaid (-9,200) F:O 3:2
Administration overheads 187,950
Advertising expenses 15,000
Factory direct wages 75,000
Factory indirect wages 30,000
Factory power 45,000 + payable 2,600
Furniture and fixtures (office) 23,000 Depr = 0.1 (23,000-11,500)= 1,150
Heat and light 20,000 F:O 3:2
Plant and equipment 346,000 Depreciation = 0.2*346000= 69,200
Sales Motor vehicle 181,000 Depreciation = 0.25*181000= 45,250
Plant hire 5,000
Provision for bad debts 4,000
Provision for depreciation: Furniture 11,500
Plant and equipment 173,000
Motor vehicle 30,000
Raw material purchases 285,000
Rent and rates 25,000 + payable 5,000 F:O 3:2

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 Sales 1,061,800
Selling overheads 82,000
Inventory 1.1.2024: Raw materials 10,000 Closing stock: 25,200
Work in progress 20,000 Closing stock: 40,400
Finished goods 35,000 Closing stock: 55,600

Illustration: Andati Ltd

The following Trial Balance has been extracted from the books of Andati Ltd, a manufacturing
concern, as at 30th June 2024, the year-end for the firm.

DR (Sh.) CR (Sh.)
Sh. 10 Share capital 500,000
20% 5-year bank loan 270,000
Inventory 450,000
Interest paid 50,000
Factory plant 350,000
Provision for depreciation 100,000
Salesman motor vehicles 300,000
Provision for depreciation 180,000
Buildings 320,000
Wages 300,000
Purchases 990,000
Sales 2,088,000
Plant hire 9,000
Returns 15,000 12,000
General expenses 300,000
Debtors 500,000
Bank 60,000
Creditors 400,000
Freight of materials 80,000
Advertising 20,000
Factory supervisory salaries 120,000
Provision for doubtful debts 44,000
Production overhead expenses 40,000
Sh. 10% preference share capital 340,000
Consultancy fees 30,000 ________
3,934,000 3,934,000
Additional information:
i. The inventory figure in the trial balance incorporates:
Raw materials Sh.140,000
Work in progress Sh.100,000

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 Finished goods Sh.210,000
ii. General expenses and consultancy fees are to be apportioned between office and factory in
the ratio of 1: 4 respectively.
iii. Included in the general expenses are the following:
• Rates for three months to 30.9.2024 Sh.25,000
• Insurance for four months to 31.10.2024 Sh.9,000
iv. Accountancy fee incurred of Sh.10,000 is yet to be recorded nor paid by the year end.
v. A debtor of Sh.10,000 has gone bankrupt. The provision for doubtful debts needs to be
maintained at 4% of the debtors at year end.
vi. Depreciation is to be provided on all noncurrent assets at the rate of 10% using the straight-
line method.
vii. Closing inventory for materials, work in progress and finished goods was determined as
Sh.180,000; Sh.150,000 and Sh.140,000 respectively.

Required:
Prepare the manufacturing income statement for the year ended 30.6.2024 and a statement of
financial position as at that date

NOTE: in preparing the income statement, one may consider preparing a separate
production/manufacturing cost statement to determine the cost of production, which can then be
used in the trading section of the manufacturer’s income statement. As an alternative, the cost of
goods produced can be determined as an inherent component of the income statement as indicated
in the solution provided for Andati Ltd manufacturing income statement.

Andati Ltd
Statement of Comprehensive Manufacturing Income
For the year to 30th June 2024

Sh.
Sales 2,088,000
Less sales returns (15,000)
Net sales 2,073,000
Cost of goods produced:
Raw materials: opening stock 140,000
Purchases 990,000
Freight in 80,000
Less returns (12,000)
Less closing stock (180,000)
Cost of materials used 1,018,000
Labour: Wages 300,000
Plant hire 9,000
Introduced prime cost for the year 1,327,000
Factory overheads:
Factory depreciation 35,000
Factory supervisory salaries 120,000

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General Expenses: 300,000
Less: Prepaid rates (25,000)
Less: Insurance prepaid (9,000)
Net general expenses 4/5*266,000 212,800
Consultancy fee (30,000*4/5) 24,000
Production overhead expenses 40,000 431,800
Total introduced costs for the year 1,758,800
Adjusted for: Work in progress b/f 100,000
Work in progress c/f (150,000)
Total cost of goods produced 1,708,800
Add: Opening stock finished goods 210,000
Cost of goods available for sale 1,918,800
Less: Closing stock of finished
goods (140,000) (1,778,800)
Gross profit 294,200
Add other income: provision for bad debts(44,000-19,600) 24,400
Gross income 318,600
Expenses:
Interest: Paid 50,000
Payable 4,000 54,000
Salesman motor vehicles
depreciation 30,000
Buildings depreciation 32,000
General expenses (1/5*266,000) 53,200
Bad debts 10,000
Advertising 20,000
Accountancy fee 10,000
Consultancy fees (1/5*30,000) 6,000 (215,200)
Net profit 103,400

Andati Ltd
Statement of Financial Position 30th June 2024
Non Current Assets Cost Depreciation NBV
Factory plant 350,000 135,000 215,000
Salesman motor vehicles 300,000 210,000 90,000
Buildings 320,000 32,000 288,000
Total Non-current assets 970,000 377,000 593,000
Current Assets:
Raw materials 180,000
Work in progress 150,000
Finished goods 140,000
Prepaid rates 25,000
Prepaid insurance 9,000
Debtors (500,000-10,000) 490,000
Less: provision for bad debts (19,600) 470,400
Bank 60,000

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Total current assets 1,034,400
Current Liabilities:
Interest payable 4,000
Creditors 400,000
Accountancy fee payable 10,000 (414,000) 620,400
1,213,400
Financed By:
20% 5-year bank loan 270,000
Sh. 10% Preference share capital 340,000
Sh. 10 Share capital 500,000
Profit and loss account 103,400
1,213,400

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