Everything turns on cost per unit
A manufacturer that values stock at materials cost is misstating inventory, margin and taxable profit at the same time — and pricing from a figure that omits a third of the real cost.
Manufacturing is the sector where the difference between a bookkeeper and an accountant shows most clearly. Everything turns on cost of production — and a manufacturer that values inventory at materials cost alone is misstating its stock, its margin and its taxable profit simultaneously.
What belongs in the cost of a finished unit
| Element | Treatment under IAS 2 |
|---|---|
| Direct materials | Included, at landed cost including freight and duty |
| Direct labour | Included, at full employment cost rather than basic salary |
| Variable production overheads | Included, allocated on actual usage of production facilities |
| Fixed production overheads | Included, allocated based on normal capacity, not actual output |
| Unallocated overhead from idle capacity | Expensed in the period — it must not be capitalised into stock |
| Abnormal waste | Expensed as incurred |
| Storage of finished goods, selling and admin | Excluded from inventory cost |
The normal-capacity rule is the one most often missed and the one with the largest effect. In a slow month, a manufacturer allocating fixed overhead across actual output inflates the unit cost of everything produced, capitalises the cost of idleness into stock, and defers a loss that should have been recognised. Over a downturn, that compounds into a materially overstated balance sheet.
Work in progress and the other moving parts
- WIP valuation — partly completed units valued at the appropriate stage of completion, which requires a defensible basis rather than an estimate at year end.
- Standard costing and variances — useful for control, but standards must be reviewed and material variances cleared to cost of sales rather than left sitting in stock.
- Bill of materials accuracy — the foundation of everything. A BOM that has drifted from actual usage produces confidently wrong costing throughout.
- Scrap, rework and yield — measured, because they are usually the difference between the theoretical margin and the real one.
- Capex and depreciation — plant depreciated over realistic useful lives, with major overhauls and spare parts treated correctly rather than expensed by default.
- Free zone position — manufacturing is treated specifically within the qualifying activities framework, which frequently makes the QFZP analysis more favourable for a genuine manufacturer than for a service business.
A reliable cost per unit. Pricing, quoting, make-or-buy decisions, capacity planning and inventory valuation all depend on it, and manufacturers who do not have one confidently price from a figure that omits a third of the real cost. It is the highest-return piece of accounting work available in this sector.
Reviewed 18 August 2026 by Ahmed Nabil Selim. UAE tax rates, thresholds and deadlines change — confirm the position for your period before relying on it.
Manufacturing — frequently asked questions
Under IAS 2, the costs of purchase, the costs of conversion and any other costs incurred in bringing inventories to their present location and condition. In practice that means direct materials at landed cost, direct labour at full employment cost, variable production overheads on actual usage, and fixed production overheads allocated on normal capacity. Selling costs, general administration and storage of finished goods are excluded, and abnormal waste and unallocated idle-capacity overhead are expensed rather than capitalised.
The production expected to be achieved on average over a number of periods under normal circumstances, allowing for planned maintenance and expected downtime. It matters because fixed production overhead must be allocated to units on that basis rather than on actual output. In a low-output period, allocating on actual output inflates unit cost and capitalises the cost of idleness into inventory — overstating both stock and profit, and deferring a loss that belongs in the current period.
Potentially. Manufacturing and processing of goods or materials sits within the qualifying activities framework, which generally makes the analysis more favourable for a genuine manufacturer than for a service business — but the full Qualifying Free Zone Person conditions still apply, including adequate substance in the zone, the de minimis limits on non-qualifying revenue, transfer pricing compliance and audited financial statements. Sales into the UAE mainland are the usual pressure point on the de minimis test, so the revenue mix needs monitoring during the year.
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