The factory cost of production from the manufacturing account is moved into the income statement. There it replaces purchases in the cost of sales: opening finished goods + factory cost of production − closing finished goods.
This is the link between the two statements in manufacturing accounts. It follows adjusting for work in progress and reuses the logic of calculating cost of sales, where the same layout was used for a shop.
Why does production cost replace purchases?
A shop buys finished goods, so purchases are the cost of the goods it sells. A factory makes its own goods, so the cost of the goods is what the factory spent making them. That cost is the factory cost of production.
Finished goods are a different stock from raw materials and from work in progress. Opening and closing finished goods are the unsold goods at the start and end of the year, so they are the adjustment at this step.
Worked example
Kilang Sambal Seri Kampung has a factory cost of production of RM 48,000. Opening finished goods are RM 5,000 and closing finished goods are RM 6,500. Sales are RM 70,000.
Office salaries are RM 6,000, delivery RM 2,500 and advertising RM 1,500.
Step 1, cost of sales: 5,000 + 48,000 − 6,500 = RM 46,500.
Step 2, gross profit: 70,000 − 46,500 = RM 23,500.
Step 3, expenses: 6,000 + 2,500 + 1,500 = RM 10,000.
Step 4, net profit: 23,500 − 10,000 = RM 13,500.
| Income statement extract | RM |
|---|---|
| Sales | 70,000 |
| Opening finished goods | 5,000 |
| Factory cost of production | 48,000 |
| 53,000 | |
| Less closing finished goods | (6,500) |
| Cost of sales | (46,500) |
| Gross profit | 23,500 |
| Less office salaries, delivery, advertising | (10,000) |
| Net profit | 13,500 |
Factory costs are inside the cost of sales. The office, selling and delivery costs are listed separately below gross profit.
The mistake to watch for
A common slip is to use the factory cost as the cost of sales and skip finished goods.
Mistaken answer: cost of sales = 48,000, so gross profit = 70,000 − 48,000 = 22,000.
The student assumed everything made was sold.
The factory made RM 48,000 of goods, but the business also started with RM 5,000 of unsold goods and finished with RM 6,500 unsold. Cost of sales must reflect only what was sold, which is 46,500.
The mistaken gross profit is lower by 1,500, the increase in finished goods. The correction is to ask “what was in the warehouse at the start and the end?”.
Check yourself
Try these on paper first, then open each answer.
1. Factory cost of production RM 120,000, opening finished goods RM 10,000, closing finished goods RM 8,000, sales RM 150,000. Find the cost of sales and the gross profit.
Show answer
Cost of sales: 10,000 + 120,000 − 8,000 = RM 122,000. Gross profit: 150,000 − 122,000 = RM 28,000.
2. Cost of sales was RM 55,000, factory cost of production RM 52,000 and opening finished goods RM 6,000. Find the closing finished goods.
Show answer
6,000 + 52,000 = 58,000. Closing finished goods = 58,000 − 55,000 = RM 3,000.
3. A student lists “purchases of raw materials” in the income statement of a manufacturer. What is wrong?
Show answer
The raw materials are already counted in the factory cost of production, so the cost is counted twice. The income statement should show opening finished goods, factory cost of production and closing finished goods.
Where this leads next
The last step is deciding which costs belong in the factory and which in the office. Continue with why a factory cost is not necessarily an office expense, then test everything with the manufacturing accounts practice set. The double-entry and ledger trainer can show the entries that move the figure across.
Some students lose marks because they combine the two statements in the wrong order. In online one-to-one Accounting tuition, a teacher can mark up your working and show where each figure should sit.