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By the end of this topic, you should be able to:
A manufacturing business is one that makes the goods it sells. Instead of buying finished products and reselling them, it buys raw materials (the basic inputs needed to make something) and converts those materials into finished products inside a factory.
For example, a furniture company might buy wood, nails, and varnish, then use factory workers and machinery to turn those materials into chairs and tables.
Because of this production process, manufacturing businesses need to prepare an extra financial statement called a manufacturing account, in addition to the usual income statement and statement of financial position.
| Statement | Purpose |
|---|---|
| Manufacturing Account | Calculates the total cost of making the goods (the "cost of production") |
| Income Statement | Calculates the gross profit and net profit from selling those goods |
| Statement of Financial Position | Shows what the business owns and owes at a specific date |
All costs in a manufacturing business fall into one of two categories.
Direct costs are costs that are directly linked to making the product. If the business makes more products, direct costs go up. If it makes fewer products, direct costs go down. In other words, they change with the level of output.
Think of it this way: if you are making wooden chairs, the wood itself is a direct cost — more chairs means more wood needed.
Indirect costs are costs that are not directly linked to making each individual product. They stay roughly the same regardless of how many items are produced. These are the costs of keeping the factory running — the "background" expenses.
For example, the rent for the factory building stays the same whether the business makes 100 chairs or 1,000 chairs.
| Direct Costs | Indirect Costs |
|---|---|
| Directly tied to each unit produced | Not tied to individual units |
| Change as output changes | Remain roughly the same regardless of output |
| Examples: raw materials, factory workers' wages | Examples: factory rent, depreciation of machinery |
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