Tuesday, 19 August 2008

Types of Inventory and Inventory Accounts for manufacturing company

In Manufacturing company, the cycle start from purchase of raw material and end at the selling of finished goods:
Purchase Raw Material >--(convert)--> Work-In-Process >--(convert)--> Finished Goods >>>> Sales of Finished Goods

Thus, there are 3 types of inventory for a typical manufacturing company:
1) Raw Material Inventory - raw material to be used as input in manufacturing process
2) Work-in-Progress (WIP) Inventory - Goods which are still in the process of converting to finished goods. It's not yet a finished good.
3) Finished Goods Inventory - Completed unit output from manufacturing process.

Correspondingly, three inventory accounts are needed.
1) Raw Material Inventory Account
2) Work-in-Progress (WIP) Inventory Account
3) Finished Goods Inventory Account

When raw material is purchased, the cost of the raw material will be posted to the Raw Material Inventory account. Raw Material Inventory Account will store the value of raw materials received but not yet issued to production department.

When the raw material is transferred to production department, the cost of the material will be transferred from Raw Material Inventory Account to WIP Inventory Account. Direct Manufacturing Labor Cost and Manufacturing Overhead Cost will also be debited into WIP Inventory Account.

When the finished good is completed, the WIP Inventory Account will be credited with the total manufacturing cost and the cost will be debited into Finished Goods Inventory account.

When the Finished Good is sold, the cost will be transferred from Finished Goods Inventory Account to Cost of Goods Sold (COGS) Account.

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