Financial Statement Issues that are Unique to Manufacturers

Unlike retailers, manufacturers have three unique inventory categories: Raw Materials, Work in Process, and Finished Goods. Below is the inventory section from the balance sheet of an actual company:

For this company, observe that the finished goods is just a small piece of the overall inventory. Finished goods represent the cost of completed products awaiting sale to a customer. But, this company has a more significant amount of raw materials (the components that will be used in manufacturing units that are not yet started) and work in process. Work in process is the account most in need of clarification. This account is for goods that are in production but not yet complete; it contains an accumulation of monies spent on direct material (i.e., the raw materials that have been put into production), direct labor, and applied manufacturing overhead.

Your earlier studies should have ingrained these formulations: Beginning Inventory + Purchases = Cost of Goods Available for Sale, and Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold. If you need a refresher, look at the Current Assets book . Of course, these relations were necessary to calculate the cost of goods sold for a company with only one category of inventory.

For a manufacturer with three inventory categories, these "logical" formulations must take on a repetitive nature for each category of inventory. Typically, this entails a detailed set of calculations/ schedules for each of the respective inventory categories. Don't be intimidated by the number of schedules, as they are all based on the same concept.

Schedule of Raw Materials

Focusing first on raw material, a company must determine how much of the available supply was transferred into production during the period. The schedule below illustrates this process for Katrina's Trinkets, a fictitious manufacturer of inexpensive jewelry.

purchases determined from accounting records. Or, Katrina might utilize a sophisticated perpetual system that tracks the raw material as it is placed into production. Either way, the schedule summarizes the activity for the period and concludes with the dollar amount attributed to direct materials that have flowed into the production cycle. This material transferred to production appears in the schedule of work in process that follows.

Schedule of Work in Process

The following schedule presents calculations that pertain to work in process. Pay attention to its details, noting that (1) direct materials flow in from the schedule of raw materials, (2) the conversion costs (direct labor and overhead) are added into the mix, and (3) the cost of completed units to be transferred into finished goods is called cost of goods manufactured. The amounts are assumed, but would be derived from accounting records and/or by a physical counting process.