Welcome to our lesson on accounting for manufacturing businesses! In this tutorial we'll look at how manufacturing businesses differ from trading and other businesses in terms of their income statement and cost of goods sold.
Manufacturing means to make a product, whether by hand or by machine or both.
The word manufacture originates from Latin manu facere meaning "make by hand" (manus = "hand" and facere = "to make").
Unlike trading businesses, manufacturing businesses do not buy products at a low price and sell at a higher price.
Instead manufacturing businesses make products, which they then sell.
In this tutorial I'm going to show you one of the primary differences when accounting for manufacturing businesses (instead of service or trading businesses). This difference can be seen in the income statement.
Okay, let's recap. Here is the income statement for a trading business (including the calculation of the cost of goods sold):
We can see that the cost of the goods sold was determined as follows:
The formula above was based on the calculation of the value of closing inventories:
The income statement for a manufacturing business is a bit different to that of a trading business:
As you can see, the income statement for a manufacturing business is a multiple-step income statement, meaning that there are multiple sections or categories for income or expenses.
The initial section of Sales, Cost of Goods Sold and Gross Profit is one separate step in this multiple-step income statement.
Now, where do we get those new lines in the income statement above about finished goods, and what exactly does this mean?
First of all, here is the definition of this key term for manufacturing businesses:
Finished goods are inventories that have been fully manufactured and are ready for sale.
Now, the cost of goods sold calculation in the above income statement was derived from a formula...
In a manufacturing business the closing value of finished goods are calculated as follows:
Or, to write it out:
Closing Finished Goods = Opening Finished Goods + Cost of Finished Goods Manufactured - Cost of Finished Goods Sold
By switching things around and making the cost of goods sold the subject, we can get another formula.
The cost of finished goods that were sold (cost of sales) is calculated as follows:
Or, to write it out:
Cost of Finished Goods Sold = Opening Finished Goods + Cost of Finished Goods Manufactured - Closing Finished Goods
As you can see, this Cost of Finished Goods Sold formula is represented exactly in the above income statement for manufacturing businesses.
Before you start, I would recommend to time yourself to make sure that you not only get the questions right but are completing them at the right speed.
Beginner --> Intermediate
Important: The solution sheet on the following page only shows the solutions and not whether you got each of the questions right or wrong. So before you start, get yourself a piece of paper and a pen to write down your answers. Once you're done with the quiz and writing down your answers, click the Check Your Answers button at the bottom and you'll be taken to our page of solutions.
Alrighty. So accounting for manufacturing businesses is not too bad so far, right?
If you're happy with this lesson move on to the second lesson on the subject, which goes over the manufacturing cost statement.
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