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Today we are here to explore manufacturing inventory
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Welcome to Accounting How To. I'm your host, Carolyn Grimm, and that is my ever so cool Mr. T sidekick Terrence
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And we are here to put the fun in accounting fundamentals. Now, when we talk about merchandising businesses, we talk about inventory in a different way
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than we talk about it with a manufacturing business. With a merchandising business
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a company is buying something that's already made, and then they're selling it to their customer
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So it comes into inventory, and then it goes out through cost of goods sold. But when we're
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talking about a manufacturing business, we're actually dealing with three different types of
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inventory. We've got raw materials, we've got work in process, and we've got finished goods inventory
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So we're going to use a guitar manufacturer as our example company
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So in the case of a guitar manufacturer the first thing that we going to need to do is we going to need to buy those raw materials that go into making a guitar So we got to have wood for the front and back We got to have wood for the guitar neck We got to have frets We got to have strings
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We've got to have little tuners. So all of these different pieces plus more are what we bring into
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raw materials in order to do what we do, manufacture guitars. Now those raw materials don't just
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magically become finished goods. We have to actually put some labor to that in order to
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make it happen. And not only do we have raw materials and labor to talk about, we also have
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to talk about the factory as a whole. There are a lot of costs that are involved in running a
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factory. We've got to have electricity. We've got to pay for insurance. So all of those other costs
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we lump into this category called manufacturing overhead or factory overhead. So now we've got
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three pieces. We've got raw materials, we've got direct labor, and we've got manufacturing overhead
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All of those costs are necessary for us to make what we make so we can sell it to our customers
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So when we talking about making guitars we have all of those things in play We going to take our raw materials and we going to use labor in order to make those guitars And we have to have a place to
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make them and electricity and things like that. So all of those costs flow into the cost of
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manufacturing our guitars. Now let's say over the course of a month, every single guitar that we
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start, we finish. In that case, we don't have anything in that middle work in process inventory
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account. Everything would go directly to our finished goods account. But because accounting
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is periodic, it's based on a time period, there's always going to be a point where the month ends
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or the year ends, and we have things that we haven't finished yet in our production. That's
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what that work in process inventory account is for. It's for anything that's been started, but not
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finished. So at each point in the process, we are looking at costs because that's going to help us
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to determine what our inventory costs are overall And that based on our manufacturing costs including direct materials direct labor and manufacturing overhead Once we get things into that finished goods category you can think of that as goods ready for sale So those are sitting
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there and we can ship those out to our customers. So from that finished goods point, that's basically
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like our merchandising business, where once you've got your inventory, whether it's merchandise
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inventory that you've purchased or a finished goods inventory that's ready for sale to your
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customer. Once you sell that merchandise, that's when you're going to move your costs
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all of those costs that have been incurred along the way for your manufacturing company
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that's when you're going to apply those to cost of goods sold. In your merchandising business
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the point where you moved things out of inventory and into cost of goods sold was when you sold to
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your customer. It's the same thing with a manufacturing company. They are selling their
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finished goods to their customer. But it's at that point, the point of sale, where we actually
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determine what the cost is that we're moving out of our inventory account and into our cost of goods
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sold account. And that's how costs move through a manufacturing business. Until next time, stay
