12 Annual Accounts: preparation of manufacturing and Trading Account
S.S Narta
AIMS AND OBJECTIVES
i.To know the purpose of preparing Manufacturing account.
ii. To identify the items debited and credited in Manufacturing account. iii) To understand the method of preparing Manufacturing account.
INTRODUCTION
Every firm likes to measure the performance of its performance of its business operations in terms of profit or loss. It also likes to know the values of its assets and liabilitites on the closing date of accounting period. In order to ascertain its income and also to access the position of assets and liabilities, financial statements are prepared. Final Statements generally refer to two statement prepared by a business concern at the end of every accounting year. They are (I) Income statement and (2) Balance sheet. In case of trading concerns these statements are prepared under the headings ‘Trading and profit and loss account’ and ‘Balance sheet.’ In case of manufacturing concerns these statements are titled ‘Manufacturing, Trading, and Profit and Loss Account’ and ‘Balance Sheet.’ In case of Limited companies, they are called ‘Profit and Loss Account’, ‘Profit and Loss appropriation account’ and ‘Balance sheet’.
MEANING OF MANUFACTURING ACCOUNT
Manufacturing concerns prepares manufacturing account before trading account, manufacturing account shows cost of production which is transferred to trading account to ascertain gross profit or loss. This is necessary because they have to ascertain cost of goods manufactured, gross profit and net profit.
PURPOSE OF MANUFACTURING ACCOUNT The main purpose of manufacturing account is to show:
i. Cost of goods manufactured; and
ii. Major items of costs such as raw material consumed, productive wages, direct and indirect expenses of production.
Expenses on manufacturing goods:
The factories or the manufacturing concerns have to consume certain manufacturing expenses. These expenses are the part of the value of goods manufactured by the firm. It is therefore, necessary that expenses must be added to the cost of goods produced and debited to trading account. Wages and salaries should be treated as productive and should also be shown at the debit side of trading account.
Coal, gas, water and fuel
Wages (Productive)
Fuel, power and motive power
Consumable stores
Factory Expenses
VARIOUS ITEMS SHOWN IN MANUFACTURING ACCOUNT
DEBIT SIDE ITEMS
Raw material consumed:
Manufacturing account starts with value of raw materials consumed, i.e., opening stock of raw materials plus Purchases and incidental expenses of purchase less closing stock of raw materials.
Direct wages and expenses:
Direct wages and direct expenses are debited to manufacturing account. These are the wages and expenses directly identifiable with the output produced.
Indirect factory expenses:
Expenses like factory rent, salaries, lighting, power, heat and fuel, machinery repairs, depreciation and other factory expenses are debited to manufacturing account. Total of Raw materials consumed, direct wages, direct expenses and factory expenses is the total manufacturing cost.
Opening work in progress:
Work-in-progress is the semi-finished output. Opening work-in-progress is shown on the debit side of manufacturing account. The assumption is that it is completed into finished output during the current accounting period.
Sale of Scrap:
Scrap can be raw material scrap or indirect material scrap. It may be reduced from material cost on debit side. Alternatively, it can be shown on credit side of manufacturing account, like an income.
CREDIT SIDE
Closing work-in-progress:
It represents the semi-finished output at the end of the accounting period and is credited to manufacturing account.
Sale of scrap:
If it is direct material scrap, it can be reduced from raw material on debit side. However, in the absence of specific details, the amount from sale of scrap can be credited to manufacturing account. In that case, whether it is direct material scrap or indirect factory material scrap makes no difference.
Cost of Finished goods manufactured:
This is the balancing figure in the manufacturing account. It is transferred to trading account.
Note: The closing work-in-progress and sale of scrap may also be reduced on debit side and then credit side shows the cost of goods manufactured alone. That approach makes the above account look like a cost sheet prepared in cost A/c.
Manufacturing A/c for the year ended …….
To work-in-progress (opening) (by Closing work in progress)
To Material used (by Sale of Scrap)
Opening stock
Add: Purchases by (Cost of Finished Goods Manufactured)
Less: Closing stock
To Wages
To Factory expenses
To Purchase expenses
To Import duty
To Carriage inward
To Depreciation on machinery
To Repairs to Machinery
Example 1:
From the following balances in the ledger of Mr. Kannusamy for the year ended 31-3-2015, prepare manufacturing account.
Solution
Manufacturing Account of Ms Vijeta for the year ended 31-3-2015
Example 2
From the following ledger balance of Mr. Senthil prepares manufacturing account for the year ended 31-3-2015.
TRADING ACCOUNT
AIMS AND OBJECTIVES
a) To understand the meaning of trading account
b) To know the items shown in trading account Debit side and Credit side (iii) To study the Closing entries relating to trading account.
Trading account is prepared for an accounting period to find the trading results or gross margin of the business i.e., the amount of gross profit the concern has made from buying and selling during the accounting period. The difference between the sales and cost of sales is gross profit. For the purpose of computing cost of sales, value of opening stock of finished goods, purchases, direct expenses on purchasing and manufacturing are added up and closing stock of finished goods is reduced. The balance of this account shows gross profit or loss which is transferred to the profit and loss account.
Importance and purpose of trading Account:
1. Ascertaining gross profit or gross loss: The main purpose of preparing trading account is to ascertain gross profit or gross loss. Excess of credit side over the debit side of trading account is gross profit and the excess of debit side over the credit side is gross loss.
2. Ascertaining ratio of direct expenses to gross profit: Trading account shows the details of direct expenses incurred in acquiring and manufacturing goods. Cost of production increases with the increase in direct expenses.
3. Ascertaining ratio between purchases and expenses: Relationship between purchases amnd direct expenses is ascertained through trading account. Direct expenses add to the cost of purchases.
4. Calculation of Cost of goods sold: Gross profit or loss is based upon cost of goods sold. It is based upon the information available from trading account. Cost of goods sold is ascertained by adding opening stock, purchases and direct expenses and deducting closing stock from it. It can also be calculated by deducting gross profit from sales. Cost of goods sold helps in calculating profit of the firm.
5. Calculation of gross profit ratio: The firm calculates gross profit and measures the efficiency of its performance. Gross profit ratio is calculated by comparing gross profit to net sales. Gross profit ratio should be sufficient to cover expenses. The ratio is compared with the desired ratio or with the ratio of previous year and performance evaluated.
6. Comparison of stock with the stock of previous year: Stock disclosed by trading account is compared with the closing stock of previous year. Stock is the part of goods remaining unsold with the firm. It should be the least possible. “ the more stock the lesser selling efficiency of the firm”. It is always in the interest of the firm to dispose off goods purchased or manufactured.
7. Comparing the actual performance with desired performance: The actual performance shown by the trading account as regards purchases, sales, stock and cost of production can be compared with the desired performance. In case of weakness, effective measures can be applied.
PREPARATION OF TRADING ACCOUNT
Every business likes to know, whether the firm has earned gross profit or sufficient gross loss. Gross profit or loss is ascertained by preparing trading Account. Excess of Sales and closing stock over opening stock, purchases and direct expenses is known as the gross profit. Gross loss is the excess of opening stock, purchases and direct expenses over sales and closing stock.
Gross Profit = Net Sales – Cost of goods Sold
Net Sales = Sales – Sales return
Cost of goods sold = Sales – Gross profit
Or
Cost of Sales = Opening Stock + Net purchases + Direct Expenses – Closing Stock
Net purchases = Purchases – Purchases Return
Gross Loss = Cost of goods sold – Net Sales
Trading account is a ledger account. It has to be prepared in conformity with double entry principles of debit and credit.
Items shown in trading account:
DEBIT SIDE
Opening Stock: It is the stock available with the firm on the opening day of the accounting period. It may also be termed as stock at the beginning of the year. The stock at the beginning of an accounting period is called opening stock. This is the closing stock as per the last balance sheet. It includes stock of raw materials, work in progress, (where manufacturing account is not separately prepared) and finished goods. Trading account starts with opening stock on the debit side.
Classification of opening Stock:
Stock of raw material: Factories use raw material for production of the product in which they have been dealings. Value of the raw material at the beginning of the accounting period is shown at the debit side of trading account.
Stock of Work-in process: This stock is also known as semi-manufactured or partly finished goods. It is neither raw material nor finished goods..
Finished goods: It is the value of goods which are finished and ready for sale. The firm has certain finished goods in the beginning of the year.
Purchases: The total value of goods purchased after deducting purchase returns is debited to trading a/c. Purchases comprise of cash purchases am credit purchases.
Direct Expenses: Direct expenses are incurred to make the goods sale able. They include wages, carriage and freight on purchases, import duty, customs duty, clearing and forwarding charges manufacturing expenses or factor. Expenses (where manufacturing account is not separately prepared). All direct expenses are extracted from trial balance
ITEMS SHOWN IN TRADING ACCOUNT
CREDIT SIDE:
Sales: It includes both credit and cash sales. Sales returns are reduced from sales and net sales are shown on the credit side of trading account. The sales and returns are extracted from the trial balance.
Closing Stock: Closing stock is the value of goods remaining at the end of the accounting period. It includes closing stock of raw materials, work progress (where manufacturing account is not separately prepared) and finished stock. The opening stock is ascertained from trial balance but closing stock is not a part of ledger. It is separately valued and given as an adjustment. If it is given in trial balance, it is after adjustment of opening and closing stocks in purchases. If closing stock is given in trial balance it is shown only as current asset in balance sheet. If closing stock is given outside trial balance, it is shown on credit side of trading account and also as current asset in the balance sheet.
Quick Revision
Ø Sales of goods sent on consignment should be shown in the consignment account not in the trading account.
Ø Goods sent for approval or on sale or return basis should not be shown as sale.
Ø Goods sold on hire purchase system should be separately shown.
Ø Goods sold at the end of the year but remaining undelivered should also be treated as sales and not included in stock
CLOSING ENTRIES RELATING TO TRADING ACCOUNT:
For opening stock, purchases and direct expenses.
Trading A/c Dr xxx
To Opening Stock A/c xxx
To Purchases (Net) A/c xxx
To Direct Expenses A/c xxx
[Being transfer of trading a/c debit side items]
For transfer of sales (after reducing sales returns)
Sales (net) A/c
Dr xxx
To Trading A/c xxx
[Being transfer of sales to Trading A/c]
For transferring gross profit
Trading A/c Dr xxx
To Profit & Loss A/c xxx
[Being transfer of gross profit to P & L A/c]
For gross loss
Profit & Loss A/c
Dr xxx
To Trading A/c xxx
[Being transfer of gross loss to P & L A/c]
Note: Closing stock is taken into account by an adjustment journal entry along with other adjustments.
A specimen of trading account is shown below:
Trading account for the year ended ……………
Balancing figure will be either gross profit or loss in Trading A/c
Examples 3:
Prepare Trading Account of Rani for the year ending 31-3-2015.
Rs.
| Opening stock | 4,00,000 |
| Purchases | 43,00,000 |
| Carriage inward | 2,60,000 |
| Wages | 1,20,000 |
| Credit sales | 72,00,000 |
| Cash sales | 18,00,000 |
| Sales returns | 15,80,000 |
| Purchase returns | 50,000 |
| Closing stock | 5,00,000 |
Summary:
Manufacturing concerns converting raw materials into finished products. They must know the cost of production for the units produced during a particular period. In order to know the cost of production, they prepare manufacturing account. At the end of the year, trading account is prepared to know the trading results. Trade expenses like wages, carriage inward are considered. Cost of goods sold is compared with sales in order to know gross profit / gross loss. Excess of Sales and closing stock over opening stock, purchases and direct expenses is known as the gross profit. Gross loss is the excess of opening stock, purchases and direct expenses over sales and closing stock. The value of closing stock is valued at cost price or market price, whichever is low. Closing stock in case of manufacturing concerns is also classified as raw material, work in progress and finished goods.
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Few Suggested Readings:
- Ø Shashi K Gupta,R.K,Sharma(2005), “Management Accounting”, Kalyani Publishers, NewDelhi
- Ø Tulsian . P.C (2014) “Financial Accounting” Pearson Education India.
- Ø Lal, Jawahar and Seema Srivastava (2004) “Financial Accounting” S.Chand (G/L) &Company Ltd.
- Ø Goyal, V.K. and Ruchi Goyal (2012) “Financial Accounting” PHI.
- Ø Maheshwari, S.N., Suneel K Maheshwari and Sharad K Maheshwari(2012) “Financial Accounting” Vikas Publishing House Pvt Ltd.
- Ø Monga, J.R. “Avanced Financial Accounting” Mayoor Paperbacks.
- Ø Bhattacharyya Asish K., (2012)” Essentials of Financial Accounting” PHI.
- Ø A Students Guide to IFRS (2012), Kaplan Publishing.
Points to Ponder:
- Manufacturing concerns converting raw materials into finished products. They must know the cost of production for the units produced during a particular period. In order to know the cost of production, they prepare manufacturing account.
- At the end of the year, trading account is prepared to know the trading results. Trade expenses like wages, carriage inward are considered.
- Cost of goods sold is compared with sales in order to know gross profit / gross loss.
- Excess of Sales and closing stock over opening stock, purchases and direct expenses is known as the gross profit.
- Gross loss is the excess of opening stock, purchases and direct expenses over sales and closing stock.
- The value of closing stock is valued at cost price or market price, whichever is low.
- Closing stock in case of manufacturing concerns is also classified as raw material, work in progress and finished goods.