Cost Accounting for Small Manufacturers in Egypt: EAS 2 and Tax

Executive summary

• Under Egyptian Accounting Standard No. 2, "Inventories", issued by Minister of Investment Decree No. 110 of 2015 and not amended by any later decree to date, cost comprises the costs of purchase, the costs of conversion and the other costs incurred in bringing the inventory to its present location and condition (paragraph 10).
• Fixed production overheads are allocated on the basis of normal capacity; units are not loaded with any increase caused by low production or idle plant, and unallocated overheads are recognised as an expense in the period incurred (paragraph 13).
• Examples of costs excluded from inventory cost: abnormal waste, storage costs not necessary to production, general administrative overheads that do not contribute to bringing the inventory to its present location and condition, and selling costs (paragraph 16).
• The standard does not prescribe a costing system: job costing suits production to order, process costing continuous production.
• For tax, net profit is determined on the basis of the income statement prepared under the Egyptian Accounting Standards (article 17 of Law 91 of 2005). None of the texts on books that we read (the Commerce Law, and the Unified Tax Procedures Law and its regulations) requires a factory to keep a separate cost book.

Why a small factory needs costing

A factory needs the cost of each unit or job for three purposes: pricing, measuring inventory (raw materials, work in progress and finished goods), and determining the cost of sales that flows into the income statement and from there into the tax return. Cost formulas and write-downs to net realisable value are covered in Inventory Valuation in Egypt. The cost used to set a price may include a share of administrative and selling expenses; inventory cost excludes selling costs and general administrative overheads that do not contribute to bringing the inventory to its present location and condition (paragraph 16).

What goes into production cost

Paragraph 10 provides that "the cost of inventory comprises all costs of purchase, costs of conversion and other costs incurred by the entity in bringing the inventory to its present location and condition". Purchase costs cover the price of materials, import duties, non-recoverable taxes and charges, transport and handling, after deducting trade discounts and rebates (paragraph 11).

Conversion costs are the costs directly related to units of production, such as direct labour, plus a systematic allocation of fixed and variable production overheads (paragraph 12). Fixed overheads remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and equipment and the cost of factory management; variable overheads vary directly or nearly directly with volume, such as indirect materials and indirect labour.

The cost of sales consists of the costs previously carried in the inventory sold, plus the production overheads not allocated to inventory and abnormal amounts of production cost (paragraph 38).

Normal capacity and the allocation of fixed overheads

Normal capacity is the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the capacity lost through planned maintenance; the actual level of production may be used if it approximates normal capacity. Paragraph 13 then provides:

"Care must be taken not to load the units produced with any increase in the amount of fixed production overheads resulting from a fall in the level of production or from idle plant. Overheads that are not allocated to production are recognised as an expense in the period in which they are incurred." (paragraph 13, our translation)

Variable overheads are allocated to each unit on the basis of the actual use of the production facilities. A mistake seen repeatedly in practice is dividing a month's actual fixed overheads by that month's actual output, which raises the unit cost, and the inventory value, in slow months.

A simple method: job costing or process costing

The standard sets what enters cost, the techniques for measuring it and the cost formulas (paragraphs 10 to 27); none of its paragraphs deals with a particular system for accumulating costs. In job costing, which suits production to customer order, each job has a cost card collecting its materials from stores requisitions, its direct labour hours and its share of overheads at a predetermined rate. This is consistent with paragraph 23, under which goods produced, segregated and tied to specific projects carry their own specific costs. In process costing, which suits continuous production of a uniform product, the costs of each stage for the period are divided by its equivalent units. Standard costs may be used if the results approximate actual cost, with the standards reviewed regularly (paragraph 21).

Illustrative example (hypothetical figures): a metal-furniture workshop working to order has fixed production overheads of EGP 120,000 a month and a normal capacity of 2,000 machine hours a month, assuming that figure is the average over several periods under normal circumstances; the overhead rate is therefore EGP 60 an hour. We assume variable overheads of EGP 15 per actual machine hour and a direct labour cost of EGP 150 an hour:

If the workshop runs only 1,500 hours in the month, assuming that level does not approximate normal capacity, EGP 90,000 (1,500 × 60) is allocated to jobs and the remaining EGP 30,000 is recognised as an expense in the same month within the cost of sales. Had the fixed overheads been spread over actual hours (120,000 ÷ 1,500 = EGP 80), the job would have carried EGP 8,000 instead of 6,000: an increase caused by idle capacity, which paragraph 13 forbids loading onto units.

The tax side: cost of sales and cost records

Article 17 of Income Tax Law 91 of 2005 provides that "net profit is determined on the basis of the income statement prepared in accordance with the Egyptian Accounting Standards, and the tax base is determined by applying the provisions of this law to that net profit". Article 22 requires deductible costs to be connected with and necessary for the activity, and to be real and supported by electronic invoices or receipts, except costs not customarily evidenced by documents, and with the Minister able to exempt some costs from the electronic-document requirement (item 2 as replaced by Law 30 of 2023). Read together, the two texts make the cost of sales measured under EAS 2 the starting point, with raw-material purchases and the other cost components subject to the article 22 conditions (Deductible and non-deductible expenses). Machine depreciation is computed for accounting purposes under EAS 10 (Fixed Assets in Egypt) and enters cost as a fixed production overhead (EAS 2, paragraph 12); it is deducted for tax under article 25 (article 23, item 2; see Tax Depreciation versus Accounting Depreciation).

None of the texts we read (Articles 21 to 23 of the Commerce Law, Article 38 of the Unified Tax Procedures Law, and Article 45 of its executive regulations issued by Minister of Finance Decree 286 of 2021) requires a factory to keep a separate cost book. Article 21 of Commerce Law 17 of 1999 requires a trader whose capital invested in trade exceeds EGP 20,000 to keep "the books required by the nature and importance of their trade", in particular the journal and the inventory book. Article 38 of Unified Tax Procedures Law 206 of 2020, its first paragraph as replaced by Law 150 of 2026, requires every taxpayer carrying on an industrial activity to keep those books, manually or electronically, without prejudice to Law 6 of 2025 and subject to Companies Law 159 of 1981. Article 45 of its executive regulations lists the books, among them subsidiary books "determined according to the nature, type, size and activity of the establishment", with no mention of a cost book, and requires the set of books to be "complete, reliable and regular in form and to enable the determination of the net taxable profit". In our view, cost records are the subsidiary books through which a factory evidences the cost of what it sold. See Egypt's Mandatory Commercial Books.

An enterprise registered under the simplified tax regime of Law 6 of 2025 pays income tax at a percentage of its turnover (article 10), which, as we read it, means the cost of sales does not enter the calculation. It is exempt from the books of the procedures law and keeps simplified records instead (article 13), including a "raw materials inventory record" (article 3 of Minister of Finance Decree 420 of 2025). The conditions are in Egypt's Simplified Tax Regime for Small Enterprises.

What this requires

• Set the factory's normal capacity in writing, in machine hours or units, as an average over several periods allowing for planned maintenance.
• Separate fixed from variable overheads, allocate fixed overheads at a rate based on normal capacity, and expense what is not allocated in the period incurred.
• Keep a cost card for each job or a cost report for each process stage, tied to stores requisitions and labour and machine-hour records.
• Keep selling costs, abnormal waste and general administrative overheads that do not contribute to production out of inventory cost, even where they are priced in.
• Make sure raw-material purchases are supported by electronic invoices or receipts, which article 22 requires for them to be deductible.
• Reconcile inventory balances with the physical count at the monthly close. Accruing factory expenses whose invoices have not arrived at the close is covered in Prepaid and Accrued Expenses in Egypt.

The firm's Accounting & Bookkeeping Department designs costing systems sized to the factory, sets the bases for allocating overheads on normal capacity, and reconciles the cost of sales between the books, the financial statements and the tax return.

Nehal Saied, Partner
Chartered Accountant, Ministry of Finance, Egypt

Member, Egyptian Tax Society
Member, Egyptian Society for Public Finance and Taxation

Partner profile · Book a consultation

Disclaimer: This bulletin is prepared for general information on the legislation in force at the date of its publication. It does not constitute a professional opinion or tax or legal advice on any particular matter, and it should not be relied upon in place of advice based on an examination of the circumstances of each case. Nassef & Partners International accepts no responsibility for any action taken, or refrained from, in reliance on its contents. The positions stated remain subject to subsequent legislation and decisions.