Inventory Accounts for a Manufacturer

A manufacturer has three inventory accounts. The following example will show how costs are accounted for in the inventory accounts.

Example 10.1

ABC Manufacturers maintains three inventory accounts: raw materials, work in process, and finished goods. At the beginning of the year, ABC had the following balances in its inventory accounts:

raw materials, $100,000;
work in process, $200,000 (the inventory of products that have been started but are only partially completed); and
finished goods, $150,000 (the inventory of completed products that have not been sold).

In addition the following things happened:

ABC purchased $550,000 worth of raw materials.
During the year, ABC incurred $400,000 worth of direct labor.
ABC also incurred factory overhead costs that totaled $150,000.

At the end of the year (December 31), ABC took an inventory and assigned costs to the three inventory accounts. ABC had the following balances in its ending inventory accounts:

raw materials, $150,000;
work in process, $250,000; and
finished goods, $350,000.

The company produced a total of 5,000 units for the year and sold 4,020 units. The average selling price for the year was $621.89 per unit.

Raw Materials Inventory

At the end of the year, the company will have the following recorded in the raw materials account: Note: Should this be Direct material for every line?

The beginning inventory, $100,000, came from a physical inventory of the company's raw materials (it had $100,000 worth of raw materials at the beginning of the year). During the year, the company purchased an additional $550,000 worth of materials. This means that $650,000 ($100,000 + $550,000) worth of materials were available for use during the year. At the end of the year, a physical inventory of raw materials found that $150,000 remained, meaning that the company used $500,000 worth of the materials during the year producing its product, thus becoming part of the work in process inventory.

Raw Materials Inventory
Beginning inventory, raw materials	$100,000
Add: purchases of raw materials	$550,000
Raw materials available for use	$650,000
Less: ending inventory, raw materials	$150,000
Direct materials used	$500,000

Note: This example did not distinguish between direct materials and indirect materials; it assumed that all raw materials used were direct materials. You will see the ledger accounts (T-accounts) for the three inventory accounts when you review job order cost systems and process cost systems. For now, the focus is on the flow of the costs and how they appear on the financial statements.

Work in Process Inventory

The beginning inventory, $200,000, came from a physical inventory taken for work in process. The company had $200,000 worth of work in process (partially completed products) at the beginning of the year. During the year, $500,000 worth of direct materials were used in the production process. In addition, $400,000 worth of direct labor costs and $150,000 worth of factory overhead was incurred in the production process. Total manufacturing costs equal the total of direct materials, direct labor, and factory overhead, or $1,050,000 ($500,000 + $400,000 + $150,000). You would add the beginning inventory of $200,000 to this amount to get the total manufacturing costs to account for. At the end of the year, a physical inventory of work in process found that $250,000 remained. This means that it cost the company $1,000,000 ($1,250,000 - $250,000) to produce 5,000 products.

The company produced 5,000 units (finished goods) for a total of $1,000,000. This means that it cost the company $200 per unit to produce 5,000 units of finished product:

Finished Goods Inventory

The beginning inventory, $150,000, came from a physical inventory taken for finished goods (completed and ready for sale). During the year, the company produced an additional 5,000 units at a cost of $1,000,000. This means that it had a total of $1,150,000 in finished goods inventory available to sell. At the end of the year, a physical inventory of finished goods found that $350,000 remained. This means that it cost the company $800,000 ($1,150,000 - $350,000) to produce the 4,020 units of product that sold. The cost per unit for the 4,020 units sold was $199:

The calculations for direct materials used, cost of goods manufactured, and cost of goods sold follow the exact same structure (see table below). You start with the beginning inventory, add costs for the period, and then subtract ending inventory.

Beginning inventory, finished goods	$150,000
Add: cost of goods manufactured	$1,000,000
Cost of goods available for sale	$1,150,000
Less: ending inventory, finished goods	$350,000
Cost of goods sold	$800,000

Beginning inventory, work in process	-	$200,000
Add: direct materials used	$500,000	-
Add: direct labor	$400,000	-
Add: factory overhead	$150,000	-
Total manufacturing costs	-	$1,050,000
Total manufacturing costs to account for	-	$1,250,000
Less: ending inventory, work in process	-	$250,000
Cost of goods manufactured	-	$1,000,000

Beginning inventory, work in process	$200,000
Add: total manufacturing costs	$1,050,000
Total manufacturing costs to account for	$1,250,000
Less: ending inventory, work in process	$250,000
Cost of goods manufactured	$1,000,000

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