Manufacturing companies have two different types of inventory: raw materials and finished goods. Raw materials inventory is used in the production of goods while finished goods inventory is used for what the company produces and sells.
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Raw materials include plastics, metals, fabrics and wood used in producing goods. A manufacturer usually acquires raw materials from more than one supplier or producer. Raw material costs are recognised in the inventory at the time of acquisition and becomes a current asset on the company’s balance sheet. Eventually, raw materials are pulled from the inventory and used in the production of finished goods.
When manufacturers use direct and indirect materials in production, the materials transition into works-in-progress. Once the raw materials are being used, the reduction in raw materials inventory must be shown by crediting the current asset account and debiting the works-in-progress inventory. Indirect materials must be removed by crediting raw materials inventory and applying the debit to a factory overhead account.
Finished goods are products that the manufacturer relies on to earn money by selling them to retailers and wholesalers. Typically, once production is complete, the works-in-progress account will be credited and the finished goods inventory account will be debited. In short production lines, the inventory can be moved directly from raw materials to finished goods in accounting.
When a manufacturer sells finished goods, he or she earns revenue. As you recognise revenue, you need to recognise the costs of goods sold as well. For manufacturers, the revenue is equal to the price per unit multiplied by the amount of units sold. Cost of goods sold or COGS include the material costs and labour applied to each sold unit. The cost to producing your finished goods reduces revenue which result in gross profit.
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