Manufacturing Inventories
Introduction to Manufacturing Inventories
Overview of the shift from merchandising organizations to manufacturing organizations.
Understanding that accounting procedures and financial reporting standards differ for manufacturers compared to merchandising companies.
Key T Accounts for Manufacturing Companies
Three separate T accounts are necessary:
Raw Materials Inventory
Work in Process (WIP) Inventory
Finished Goods Inventory
These accounts reflect different stages of inventory transformation from raw materials to the final products ready for sale.
Raw Materials Account
Definition: The account where different raw materials used in manufacturing are recorded.
Example: For a company manufacturing jars of marmalade, the raw materials could include:
Oranges
Sugar
Jars
T accounts for raw materials must be individually created for each raw material type.
Calculating the ending balance of each raw material account:
Similar to the merchandise inventory account.
Purchases and freight are debited; returns and discounts are credited.
Key Variation: The plug number used in manufacturing (cost of raw materials used - CORMU) differs from the cost of goods sold (COGS) in merchandising contexts.
Cost Tracking in Raw Materials Account
Ending Balance Calculation: Adjusting for raw materials used in the manufacturing process.
Methods for calculating ending balance (same as merchandising inventories):
Specific Identification
Weighted Average
First In, First Out (FIFO)
Difference between trial balance and ending balance indicates raw materials consumed in manufacturing.
Transformation to Work in Process (WIP) Account
Description of WIP Account:
Includes all product costs incurred during manufacturing, such as:
Raw Materials (already calculated)
Direct Labour
Factory Overhead
Direct Labour: Refers only to individuals directly involved in the production; supervision does not count.
Factory Overhead: All manufacturing costs not classified as raw materials or direct labour.
Classification of Costs
Product Costs: Costs related directly to manufacturing. Includes:
Raw Materials
Direct Labour
Factory Overhead
Period Costs: Costs not related to manufacturing. Example:
Administrative salaries (e.g., accountant's salary).
Understanding the matching principle in accrual accounting:
Product costs are capitalized as assets in inventory until they generate revenue after sales.
Identifying costs as either product or period is crucial in inventory calculations.
Work in Process Account Analysis
Beginning Inventory: WIP account may include partially completed goods from the previous fiscal year.
As the period progresses, new costs for products enter WIP.
Ending WIP Balance: Represents goods partially completed at the end of the period.
Example of manufacturing: Car production may leave various vehicles at different stages of completion.
Key characteristics in determining product costs:
Rent, utilities, insurance often split into product and period costs.
Dividing Costs Between Product and Period
Using Square Footage: A method for dividing rent costs:
Example:
Manufacturing area: 4,000 sq. ft
Total area: 5,000 sq. ft
Allocation of 80% of rent as product cost and 20% as period cost.
Similar allocations apply to utilities and insurance costs.
Ending Balance Valuation in WIP Account
Formula for WIP Ending Balance:
Where:
PRM = Partial Raw Materials Cost
PDL = Partial Direct Labour Cost
PFOH = Partial Factory Overhead Cost
Estimating Partial Factory Overhead: Challenging as it spans overall production costs.
Estimation of Partial Factory Overhead
Estimation Methodology:
Use proxies for estimating overhead based on production costs.
Characteristics of effective proxies:
Must be measurable
Should act as a cost driver
Spread evenly throughout production
Common proxies include:
Machine hours
Direct labour dollars
Raw materials
Calculation of Partial Factory Overhead
Formula:
Example scenario:
If partial direct labour is $1,000, total direct labour dollars are $100,000, and total factory overhead is $50,000:
The calculation leads to:
Insight into how much factory overhead contributes to incomplete products can help manage resources efficiently.
Final Steps in Valuing Inventory
After calculating costs in WIP, sum the components to establish the cost of finished goods manufactured.
Post this cost to the finished goods account.
Finished Goods Inventory Account Analysis: Contains two debits before subtotal:
Opening balance of finished goods.
Cost of goods manufactured during the period.
Cost of Goods Available for Sale: Reflects all goods ready for potential sale.
End of period calculations lead to the cost of goods sold expense, which connects to revenue.
Valuation Method for Finished Goods: Only the Weighted Average Cost Method applies here, similar to prior inventory valuation methodologies.
Recap of Inventory Accounts in Manufacturing
**Inventory Segments:
Raw Materials
Work in Process (WIP)
Finished Goods**
WIP components:
Raw Materials, Direct Labour, Factory Overhead.
Inventory movement flows from raw materials to WIP to finished goods, culminating in the cost of goods sold.
Professor emphasizes the importance of recognizing how costs correlate to product and period classifications for effective management and financial reporting.
Conclusion and Further Study
Emphasis on reviewing challenging concepts from the video.
Encourage reaching out to lecturers for clarity on Q&A matters in accounting for manufacturing inventories.
Note on additional forthcoming videos for continuous learning and mastery of inventory accounting topics.