Question

Explain the flow of inventory through a typical manufacturing company, and the accounts that would be involved in this flow (Hint: start at the raw materials account and proceed all the way through cost of goods sold).

Answer 1

Raw Materials

The raw materials inventory account records the cost of materials not yet put into production. For Custom Furniture Company, this account includes items such as wood, brackets, screws, nails, glue, lacquer, and sandpaper.

Work in Process

The work-in-process (WIP) inventory account records the costs of products that have not yet been completed. Suppose Custom Furniture Company has eight tables that are still in production at the end of the year. All manufacturing costs associated with these incomplete eight tables—direct materials, direct labor, and manufacturing overhead—are included in the WIP inventory account.

Once goods in WIP inventory are completed, they are transferred into finished goods inventory. The cost of completed goods that are transferred out of WIP inventory into finished goods inventory is called the cost of goods manufactured.

This account is debited with the total
cost of production, which includes—direct materials, direct employee,
direct expenses, production overhead recovered, and is credited with the
amount of finished goods completed and transferred. The balance in this
account represents total balances of jobs/works-in-process, as shown by
several job accounts.

Finished Goods

The finished goods inventory account records the manufacturing costs of products that are completed and ready to sell. Suppose Custom Furniture Company has five completed tables at the end of the year (in addition to the eight partially completed tables in work-in-process inventory). The manufacturing costs of these five tables—direct materials, direct labor, and manufacturing overhead—are included in the finished goods inventory account until the tables are sold. (For the purposes of this example, assume the tables are “sold” when delivered to the customer.

This account is debited with the value
of goods transferred from Work-in-process Control Account,administration costs recovered (if relates to production activities). This
account is credited with Cost of Sales Account. The balance of this account
represents the value of goods unsold at the end of the period..

Wage Control Account

This account is debited with total wages paid
(direct and indirect). Direct wages are further transferred to Work-inProcess Control Account and indirect wages to Production Overhead;
Administration Overhead or Selling & Distribution Overhead Control
Accounts, as the case may be. Wages paid for abnormal idle time are
transferred to Costing Profit & Loss Account either directly or through
Abnormal Loss Account.

Administrative Overhead Account

This account is debited with
overhead incurred and credited with overhead recovered. The overhead
recovered are debited to Finished Goods Control Account, if administrative
overhead is related with production activities otherwise to Cost of Sales A/c.
The difference between administrative overheads incurred and recovered is
transferred to Overhead Adjustment Account.

Selling And Distribution Account

This account is debited
with selling and distribution overheads incurred and credited with the selling and
distribution overheads recovered. The difference between overheads incurred and
recovered is transferred usually to Overhead Adjustment Account.

Cost of goods sold account

This account is debited with the cost of finished
goods transferred from Finished Goods Control Account for sale,
General Administrative overhead recovered, Selling and distribution
overhead recovered. The balance of this account is ultimately transferred to
Sales Account or Costing Profit & Loss Account.