Wholesale and retail companies purchase goods that are primarily in finished form. These companies are intermediaries in the process of moving goods from the manufacturer to the end-user. They often are referred to as merchandising companies and their inventory as merchandise inventory. The cost of merchandise inventory includes the purchase price plus any other costs necessary to get the goods in condition and location for sale. We discuss the concept of condition and location and the types of costs that typically constitute inventory later in this chapter.
Unlike merchandising companies, manufacturing companies actually produce the goods they sell to wholesalers, retailers, or other manufacturers. Inventory for a manufacturer consists of (1) raw materials, (2) work in process, and (3) finished goods. Raw materials cost of components purchased from other manufacturers that will become part of the finished product. represent the cost of components purchased from other manufacturers that will become part of the finished product. For example, Apple's raw materials inventory includes semiconductors, circuit boards, plastic, and glass that go into the production of personal computers.
Inventory for a manufacturing company consists of raw materials, work in process, and finished goods
Work-in-process products that are not yet complete. inventory refers to the products that are not yet complete. The cost of work in process includes the cost of raw materials used in production, the cost of labor that can be directly traced to the goods in process, and an allocated portion of other manufacturing costs, called manufacturing overhead. Overhead costs include electricity and other utility costs to operate the manufacturing facility, depreciation of manufacturing equipment, and many other manufacturing costs that cannot be directly linked to the production of specific goods. Once the manufacturing process is completed, these costs that have accumulated in work in process are transferred to finished goods costs that have accumulated in work in process are transferred to finished goods once the manufacturing process is completed..
The cost of work in process and finished goods includes the cost of raw materials, direct labor, and an allocated portion of manufacturing overhead.
Manufacturing companies generally disclose, either in a note or directly in the balance sheet, the dollar amount of each inventory category. For example, Dell Inc.'s note disclosure of inventory categories was shown on page 118. Sara Lee Corporation reports inventory categories directly in the balance sheet, as illustrated in Graphic 8-1.
Inventories Disclosure—Sara Lee Corporation
Real World Financials
The inventory accounts and the cost flows for a typical manufacturing company are shown using T-accounts in Graphic 8-2. The costs of raw materials used, direct labor applied, and manufacturing overhead applied flow into work in process and then to finished goods. When the goods are sold, the cost of those goods flows to cost of goods sold.
Inventory Components and Cost Flow for a Manufacturing Company
The costs of inventory units follow their physical movement from one stage of activity to another.
We focus in this text primarily on merchandising companies (wholesalers and retailers). Still, most of the accounting principles and procedures discussed here also apply to manufacturing companies. The unique problems involved with accumulating the direct costs of raw materials and labor and with allocating manufacturing overhead are addressed in managerial and cost accounting textbooks.