In the previous few articles, we have seen how traders prepare their set of final accounts. Their Trading Account discloses their gross profit, which is simply the excess of sales over cost of goods sold in the year. Calculating the cost of goods sold by a trader in a particular year is fairly simple because he sells his goods in the same form in which he buys them.
His Purchases Account, therefore, virtually represents his entire cost of goods bought. After adjusting the balance of purchases account for opening and closing stock figures, the trader gets his cost of goods sold figure.
Things are however slightly different for a manufacturing business. It buys, not goods ready for resale, but raw materials on which it spends considerable sums of money by way of wages and production expenses to convert them into the form of finished products before they are sold.
A manufacturing business must, therefore, determine the cost of bringing its raw materials into a finished Product state before it can draw up its trading account, or income statement. In the following articles, we will see how a manufacturing concern calculates the cost of production of its finished goods.