You started the course working on the accounting records of a service company. A service company provides a service, rather than a product. Examples of service companies include accounting firms, law firms, and real estate agents. Service companies do not sell a product and do not have an inventory account.
After reviewing the accounting system for a service company, you began looking at the accounting records related to a merchandising company. A merchandising company purchases inventory from manufacturers and other suppliers and resells the merchandise to the general public or other companies. A merchandise company has one inventory account called "Merchandise Inventory."
In this lesson, you will begin to look at accounting for a manufacturer. A manufacturer uses materials, labor, equipment, supplies, and so on to convert raw materials into finished products. A manufacturer has three inventory accounts: raw materials, work in process, and finished goods. Raw materials are materials or substances that are used in the production or manufacturing of a product. Work in process inventory includes products that have been started, but are not yet fully completed; this inventory contains partially completed products. Finished goods inventory includes products that have been completed, but have not yet been sold.
As you study manufacturing, you must identify the costs that are part of the process of creating a product. Some costs are easy to identify and allocate to the products, while others are not. Below are some of the terms you will need to understand as you move forward.
Manufacturing costs, or product costs, are all of the costs related to the manufacturing process. These costs become part of the work in process inventory costs for a manufacturer when they are added or incurred. They include the following:
The difference between direct and indirect materials can be confusing, as both can be included in the finished product. The difference is in your ability to easily and conveniently determine the cost. If you were building a wooden bookcase, you would need a number of raw materials. You could calculate the cost of the wood fairly easily. What about glue? Wood glue is fairly inexpensive. You would be using it in small amounts and would have difficulty measuring how much glue was used. Would you take the time to calculate the cost of the glue you used? Probably not. Most likely, in this case the wood used for the bookcase would be a direct material, and the glue would be an indirect material. The cost of glue would be included in factory overhead costs.