This chapter is under construction!
Work-in-progress
Goods which are not finished are known as work-in-progress. The opening balance of work-in-progress is added on to the production cost and the work-in-progress left at the end of the year will need subtracting to give us the cost of the goods completed during the period we are dealing with.
Factory profits and unrealised profit
One of the main reasons why firms manufacture their own goods, rather than purchasing them from another firm, is that the goods can be manufactured at a lower cost than the purchase price from elsewhere. Factory profits reflecting the relative cheapness of manufacturing goods compared with buying them from outsiders
In order to assess the efficiency and performance of the production process in the factory, a manufacturing profit is calculated either by:
i) Market value of goods produced - Manufacturing cost of goods produced
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OR
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ii) applying a fixed mark-up on manufacturing cost of goods produced
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The difference between the cost of manufacture and the cost of 'bought in' goods is known as factory profit, or profit on manufacturing. Any factory profit will boost the overall profits for the firm but is kept separate from the gross profit until the net profit has been calculated, when they would be added together. Any factory loss incurred should also be kept separate until the net profit is calculated. By keeping the profits separate, this allows the managers of a firm to see how profit had been earned - did it arise out of efficiency in manufacturing, or other areas of the firm?
It is hard to estimate how much a firm would 'save' by manufacturing its own products rather than purchasing them from elsewhere. As a result, factory profit is usually calculated by simply adding on an additional percentage of the production cost to give us the 'transfer price' which will replace the purchases figure in the trading account. This procedure is known as marking-up the production cost.
However, if we mark-up the production cost then the value for the cost of goods sold in the trading account will be higher. This means that the final gross and net profits for the firm would be lower. To cancel out this effect, the factory profit is added on again at the end of the profit and loss account. This time it is added on to the net profit.
| Account | Action |
| Manufacturing | Add factory profit to cost of production |
| Deduct factory loss from cost of production | |
| Profit & loss | Add factory profit to net profit |
| Deduct factory loss from net profit |
Unrealised manufacturing profit from unsold stock
Unrealized Profit occurs where it is the policy of the firm to value stocks of finished
goods at market value rather than at cost.
The factory profit included in the value of closing finished goods inventory is known as
unrealised profit.
If we allow for factory profit then this will mean that the value of any closing stock would actually include an amount of factory profit in its valuation. The prudence concept disallows any anticipation of future profits - how can we say that the value of stock includes profits when we have yet to sell the stock? - and therefore we would need to deduct this profit by making a provision for any profits on unsold stock.
This provision for unrealised profit on unsold stock should be treated in the same way as any other provision. This means that the change in the provision should appear in the profit and loss account as a debit (if it is increased) or as a credit (if it is decreased) which means this would be added on to the gross profit.
9 April 2014 at 07:11
I have an MBA and sometimes find it hard to translate academic principals to my real work interactions. Your delivery is succinct and easy to navigate. The language use allows business owners, whom know their industry, safely simplify financial accounting principals. Thank you for the effort.