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• Retailer buys and then sells
• Manufacturing businesses make products to sell
• Example; buy material to sew into jackets

WHY MANUFACTURING ACCOUNT

• To show all costs associated with production of jackets
• Split into 2 sections
• Prime cost section
• Factory overheads section

PRIME COST SECTION

• Direct costs linked and totalled
• Direct costs = directly attributable to production of a product
• Example : cost of raw materials, cost of labour employed to make products and other direct costs

FACTORY OVERHEADS SECTION

• All other costs, that cannot be linked directly to the product
• Example: supervisor salaries, factory rent, machine maintenance and depreciation

COMBINE THE ABOVE TO CALCULATE COP

• Cost of production = prime cost + factory overheads

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• However, existence of partly finished goods also
• Referred to as work in progress
• Treat inventory same as any other inventory
• Add opening less closing inventory of work in progress

ALL OTHER COSTS TREATED IN STATEMENT OF PROFIT OR LOSS

MANUFACTURING PROFIT AND TRANSFER PRICE

• Transfer product to statement of profit or loss at total production cost plus a notional markup
• This is known as transfer price
• Transfer price - cost of production = factory profit

BENEFITS OF USING TRANSFER PRICE

• This process does not increase the overall profits but simply the profit made by particular department
• Recognize the part that the factory contributed to overall profitability of the business
• Allows cost manufactured to be compared with buying cost, hence enabling make or buy decision

LIMITATIONS

• Transfer price must be realistic to allow direct comparison with buying in the goods
• Factory managers may not be motivated if a set percentage is used to calculate factory profit

PROVISION FOR UNREALISED PROFIT

• IAS 2 - inventory must be valued at lower of cost and net realisable value
• In SOFP, inventory must be shown at cost of production
• If transfer price is used, these include an element of profit,which is not yet realised
• If we include this unrealised profit, against realisation and prudence concept.
• We must adjust inventory of finished goods at start and at end
• Set up a PFUP account. Accounting principle same as allowance for irrecoverable debts
• Create - increase or decrease

REALISATION CONCEPT

• Revenue must only be recorded when goods have been sold for credit or cash

PRUDENCE

• Losses must be provided for, as soon as they are anticipated
• Profits are not recorded until realised
• Profits may be understated rather than overstated.

HENCE

• Use provision for unrealised profit to:
• 1) remove unrealised profit from statement of profit or loss (else, profit overstated)
• Remove unrealised profit from inventory of finished goods within current assets (inventory not overvalued)

HOW TO CALCULATE THE PROVISION FOR UNREALISED PROFIT

• Inventory at cost + profit percentage/ 100 + profit percentage * percentage
• Or
• PFUP =factory markup x inventory at cost
• Or
• (Factory profit / cost of completed production ) x inventory at cost
• PFUP = factory margin x inventory at transfer value
• PFUP = (factory profit / completed production at transfer price ) x inventory at transfer value

COST OF INVENTORY + UNREALISED PROFIT = INVENTORY AT COST PLUS MARKUP %

PFUP IN STATEMENT OF PROFIT OR LOSS

• First year - full amount subtracted from factory profit
• Subsequent years, see increase or decrease
• Increase - subtracted from factory profit
• Decrease - added to factory profit

ACCOUNTING ENTRIES

• Creation
• Increase
• Decrease

CALCULATION

• Opening inventory of f.goods at transfer value = opening inventory at cost + PFUP at start
• Closing inventory at TP = Closing inventory at cost + PFUP at end

WORKED EXAMPLE

• Cost of completed production = $300,000
• Inventory of finished goods at 1 January 2011 at cost = $16,000
• Inventory of finished goods at 31 December 2011 at transfer value = $24,000
• Policy of company to transfer goods from factory at cost plus 20% factory profit

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• Calculate amount of factory profit
• Calculate completed production at transfer value at 31 Dec 2011.
• Prepare PFUP account for year ended 31 December 2011.
• Calculate amount of opening inventory at transfer value

WORKED EXAMPLE 2

• Cost of completed production = $148,400
• Opening inventory of finished goods at transfer value = $14,520
• Closing inventory at transfer value = $11,000
• All goods manufactured are transferred from manufacturing account at cost plus 10%

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• Calculate amount of factory profit
• Calculate completed production at transfer value at 31 Dec 2011.
• Prepare PFUP account for year ended 31 December 2011.
• Calculate amount of opening inventory at cost

ANSWER

• 1) 14840
• 2) $163,240
• 3) decrease of $220

WORKED EXAMPLE 3

• Finished goods at transfer price :
• Opening - $19,550
• Closing - $21,505
• Goods manufactured transferred at cost plus 15%.
• Prepare the PFUP account
• Calculate opening inventory of finished goods at cost
• Calculate closing inventory of finished goods at cost

WORKED EXAMPLE 4

• Finished goods inventory at cost (opening) = $32,000
• Finished goods inventory at transfer price (closing) = $54,000
• Completed products are transferred from factory at a mark-up of 20%.
• Prepare the PFUP account
• Calculate opening inventory at transfer price
• Calculate closing inventory at cost

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REMEMBER !!!!

• Opening and closing inventory of finished goods - shown at transfer value in statement of profit or loss
• In statement of financial position, inventory must be shown at cost