INTRODUCTION:

In the preceding chapters the accounting entries were made in the records of trading entities. A trading entity can be
described as an entity that purchases finished products (from the manufacturer/wholesaler) with the purpose of selling
them at a higher price. In a trading entity, the cost of purchases are readily available by looking at the supplier’s invoices.
The value of the closing inventories and cost of the sold goods are thus easy to calculate.
In the case of a manufacturing entity, components, raw materials and consumable materials are purchased and then
processed to make a finished product. The finished products are then sold to a trading entity where they are sold at a
higher price to customers. In the case of a manufacturing entity, the cost of finished goods cannot be established from an
invoice. The object is to ensure that accurate cost allocations are made so that the entity can determine how much it costs
to manufacture an item. In
a manufacturing entity the cost of goods sold is calculated as follows. + Finished Goods -

Opening inventories (finished goods) R1 000 Balance 1 000 Balance (end) 800

Plus: Cost of finished goods manufactured during the year 900 Finished Stock that left

Less: Closing inventories (finished goods) (800) during year 900 the entity 1 100

Cost of goods sold R1 100 Cost of sales

Raw materials, labour, machinery and tools, (as well as the depreciation and maintenance on these assets), building, water
and electricity in the factory, etc, are required to manufacture a product. The accounting records are therefore extended
(adapted) in order to obtain the necessary information for the purpose of cost accounting…see slides 5,6.
The 3 cost components in the manufacturing process.
1. MATERIALS
The cost of all the materials that are an essential part of the manufactured product should be
calculated and forms part of the cost of the manufactured product. These materials are known as
direct materials (to which a value per product can be attached). Other materials, also included in
the manufacturing process (with a low value per item/meaningless to attach a value to them) are
known as Indirect materials, which forms part of the manufacturing overheads.
Ex. Difference between direct and indirect materials.
Materials to make a jersey:
 WOOL is the direct material, because the value can be attached to the quantity of
wool used for each jersey.
 The THREAD used to sew the sections together is also direct material, but the value of
the thread used per jersey is so low that it is impossible to attach a value to it. The
cost of the thread is therefore an indirect material cost (part of the manufacturing
overheads).
2. LABOUR

Direct labour is the other component of primary manufacturing cost. It is the labour performed by the
workers in the factory who are actively involved in the manufacture of the product. Direct involvement in the
manufacturing process may be done by hand, with tools, or as machine operators. Indirect labour is also
important in the manufacturing process, but does not relate to the actual manufacturing activities. Indirect
labour is therefore part of the factory overheads. These labour costs include the wages of cleaners, security
guards, supervision, and so forth.
Direct labour cost (directly involved in the manufacturing process) changes in relation to the quantities
manufactured. The more units that are produced, the more the direct labour cost will increase.
Indirect labour cost (not directly involved in the manufacturing process). Does not change in relation to the
quantity produced.
[However, fundamental increases in production may lead to more cleaners and security guards being
employed, which would result in an increase in indirect labour. This is a concept for next year]
3. MANUFACTURING OVERHEADS

These costs (not part of the primary costs) must be included in manufacturing overheads, as they are part of the
rent of the factory,
cost incurred in the manufacturing process. Examples of manufacturing overheads are :
depreciation on machinery and tools, maintenance of factory machinery, water and
electricity used in the factory, indirect material, indirect labour, etc. NB cost must be
associated with the manufacturing process.
Costs such as administrative costs, the salary of the managing director, rent of office, depreciation on office
equipment, salaries of sales personnel, cannot be associated with the manufacturing process, therefore these costs
do not form part of manufacturing overheads. I will try and illustrate it for you!
Trading a/c
Cost of sales xx Sales xx Calculated: see slide 1
Profit or Loss xx
xx x xx
Profit or Loss a/c
Administrative costs xx x Trading account xx
Selling and Distribution xx Cost not part of the manufacturing process
 P H Y S I C A L F L O W O F M AT E R I A L S d u r i n g t h e m a n u f a c t u r i n g p r o c e s s
DR CR
+ RAW MATERIALS INVENTORY (RMI) -
Opening balance x RMI issued to factory X
Purchase of RMI X Closing balance X
Costs incurred X
Xx Xx
Opening balance X

+ WORK IN PROGRESS (Inventory) -

Opening balance X Finished Goods X
Raw materials inventory X Closing balance X
Direct Labour X
Manufacturing overheads X
xx Xx
Opening balance X
 + FINISHED GOODS (Inventory) -
Opening balance x X

Work in progress x Closing balance X

xx xx
Opening balance x

DIRECT LABOUR
Bank (paid to employees) x Work in progress X

MANUFACTURING OVERHEADS

Salaries & Wages (indirect) X Work in progress X

Rent expense (factory) X
Insurance (factory) X
Depreciation (factory X
machinery
Indirect materials X
xx Xx