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Cost Classifications on Goods & Inventory Statements

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  • 0:03 Cost Classifications…
  • 1:52 Calculating &…
  • 3:50 An Example
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

Manufacturing companies convert raw materials into finished goods that are sold to consumers. Inventory in various stages of completion must be reported on company financial statements.

Cost Classifications of Inventory

The Super Scoop Company manufactures ice cream that is sold in grocery stores. The owner of the company, Mr. Scoop, is trying to gain an understanding of the different components of his company's inventory and how it is reported on the financial statements.

Inventory in a manufacturing company consists of raw materials, work-in-process (WIP), and finished goods that will be sold to consumers. Raw materials are unprocessed goods that the company uses at the start of its manufacturing process. For the Super Scoop Company, raw materials could include things like sugar and milk. Work-in-process (WIP) includes goods that have started the conversion process from raw materials to finished goods, but aren't yet complete. For example, the Super Scoop Company could have pasteurized its base product, but may not have added the flavoring to finish making the chocolate ice cream batch yet. Finished goods include the items that have completed the conversion process and are ready to sell to the consumer. Ice cream packaged in cartons and ready to ship to grocery stores are an example of finished goods for the Super Scoop Company.

In order to value its inventory, a company must keep track of all the costs of its inventory at each stage of the process. For example, the Super Scoop Company would want to keep track of the costs of milk and sugar, its direct labor costs (including the cost of its hourly employees), and its manufacturing overhead, which would include rent, utilities, salaries of plant supervisors, and depreciation. Depreciation is the process of allocating the cost of an operating asset, such as a machine or a piece of equipment, over its useful life as it is used in the manufacturing process to create sales for the company.

Calculating & Reporting Inventory

Financial statements summarize the financial position of a company. Types of financial statements include the income statement and the balance sheet. The income statement summarizes the sales revenue that the company earned by selling its products to customers and the expenses it incurred in order to make those sales. It also illustrates the company's net income, revenues greater than expenses, or net loss, expenses greater than revenue.

The balance sheet shows the assets, liabilities, and equity of a company. Assets represent items that a company owns, like inventory. Liabilities represent what the company owes to others, and equity represents the owner's investment in the company plus any earnings of the company over time. Inventory will impact both the income statement and the balance sheet. The amount of inventory a company has at the end of the period will be reported on the balance sheet as 'Inventory' and should include raw materials, work-in-process, and finished goods inventory. The cost of inventory is recorded on the income statement as 'Cost of Goods Sold'.

The formula for calculating cost of goods sold for a manufacturing company is:

beginning finished goods inventory + cost of goods manufactured = finished goods available for sale - ending finished goods inventory

This calculation is summarized on the cost of goods sold statement and total cost of goods sold is then reported on the company's income statement.

In order to track its costs and calculate cost of goods sold for the period, companies must prepare a cost of goods manufactured statement. This statement considers the raw materials and work-in-process inventory balances, as well as direct labor and overhead costs. In order to prepare this statement for the Super Scoop Company, we need information about its beginning and ending inventory balances, its purchases, and the amount of labor and overhead used to make ice cream throughout the year.

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