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Internal Accounting: Completing Products, Factory Ledger and Closing the Books

In a factory, costs first collect in Work in process. When products are finished, their cost moves to Finished goods. When they are sold, cost moves to Cost of goods sold and the sale is recorded. Some firms keep a separate factory ledger that is linked to the head office ledger by mirror accounts. At year end a manufacturer prepares a manufacturing account (cost of goods manufactured) and then an income statement to find profit.

🎬 Step-by-step story

  1. A factory adds costs to the product: material 100, labour 60 and overhead 40. All of it sits in one account called Work in process: 200.
  2. The goods are finished. Cost 200 moves from Work in process to Finished goods. With 30 already in store, goods available for sale cost 230.
  3. Goods costing 150 are sold for 220. Cost of goods sold = 150. Finished goods left = 80. Gross profit = 220 − 150 = 70.
  4. Independent factory accounting: the factory keeps its own ledger. Its Head Office account mirrors the head office's Factory account. If the head office sends 200, both show 200.
  5. Closing the books: the manufacturing account gives cost of goods manufactured 200. Sales 220 − cost of goods sold 150 = 70. Less selling and admin costs 30 = operating profit 40.
  6. Your turn: slide the sales amount and watch the profit move. Costs stay the same.

Tip: drag the 3D scene to turn it. Use two fingers to zoom.

🤔 Common doubts, cleared

Why is the cost not an expense when the product is made?

Until it is sold the cost is still an asset, stored in WIP then Finished goods. It becomes an expense (COGS) only on sale.

What is the difference between cost of goods manufactured and cost of goods sold?

Manufactured is what we made (200). Sold is what left the store (150). Opening and closing stock explain the gap.

Why does the factory need a separate ledger?

So the factory can keep its own cost records and be checked on its own. Mirror accounts keep it linked to the head office.

Why do the Factory and Head Office accounts have opposite sides?

One side gives and the other receives. Each records the same amount, one as debit and one as credit.

Does changing sales change the cost?

No. Costs stay the same; only sales and profit move. Try the slider.

Completing and selling products

Cost moves through three accounts:

  1. Work in process (WIP): collects direct material, direct labour and overhead charged. Entry: Dr WIP, Cr Materials / Wages / Factory overhead.
  2. Finished goods (FG): when products are completed, Dr Finished goods, Cr Work in process (at the cost of goods manufactured).
  3. Cost of goods sold (COGS): when sold, Dr Cost of goods sold, Cr Finished goods (at cost) and Dr Accounts receivable / Cash, Cr Sales (at selling price).

Cost of goods manufactured = Direct material + Direct labour + Overhead + Opening WIP − Closing WIP.

Independent factory accounting

A big firm may give the factory its own factory ledger. The factory keeps accounts for materials, wages, overhead, work in process and finished goods. It does not keep sales or office accounts.

The two ledgers are tied by mirror accounts:

When the head office sends money or materials worth 200: head office Dr Factory 200, Cr Cash or Materials 200; factory Dr Cash or Materials 200, Cr Head Office 200. The two balances must be equal and opposite. If they differ, find the transfer that was not recorded on one side.

Closing accounts in manufacturing

At year end a manufacturer prepares two statements:

  1. Manufacturing account: material used + labour + overhead + opening WIP − closing WIP = cost of goods manufactured.
  2. Income statement: Sales − cost of goods sold = gross profit. Cost of goods sold = opening finished goods + cost of goods manufactured − closing finished goods. Gross profit − selling and administration costs = operating profit.

Closing stocks of materials, WIP and finished goods appear as assets on the balance sheet. Stocks are counted and valued, then the temporary accounts are closed to the profit account.

Key formulas and definitions

Worked examples

1. Material 100, labour 60, overhead 40, no WIP at start or end. Cost of goods manufactured?

100 + 60 + 40 = 200.

2. Same costs, opening WIP 30, closing WIP 20. Cost of goods manufactured?

200 + 30 − 20 = 210.

3. Opening finished goods 30, cost of goods manufactured 200, closing finished goods 80. Cost of goods sold?

30 + 200 − 80 = 150.

4. Sales 220, COGS 150, selling and admin 30. Find gross and operating profit.

Gross profit = 70. Operating profit = 70 − 30 = 40.

5. The head office sends 200 of materials to the factory. Give both entries.

Head office: Dr Factory account 200, Cr Materials 200. Factory: Dr Materials 200, Cr Head Office account 200.

6. Completed goods of cost 200 are transferred to the store. Entry?

Dr Finished goods 200, Cr Work in process 200.

Common mistakes

Practice quiz

1. When goods are completed, which account is credited?
2. Opening FG 20, made 100, closing FG 30. COGS =
3. In the factory ledger the link to the head office is the:
4. Sales 300, COGS 200, selling and admin 40. Operating profit =
5. Cost of goods manufactured includes:

Practice: answer these yourself

Type or choose your answer, then press Check. Use a hint if you are stuck; the full solution appears after you answer.

Frequently asked questions

What is cost of goods manufactured?

The total cost of products finished in a period: material, labour and overhead, adjusted for opening and closing work in process.

What is independent factory accounting?

A system where the factory keeps its own ledger, linked to the head office ledger by a Head Office account and a Factory account.

How does a manufacturer find profit?

Sales minus cost of goods sold gives gross profit; then subtract selling and administration costs for operating profit.

Where this is taught

Japan高校（専門学科）1〜3年Cost Accounting

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