In a manufacturing environment, there’s usually a specific process that inventory takes on its journey to become a finished product. The actual process can vary from one company to another depending on the product, as well as the production model. This article looks at basic accounting methods of inventory valuation as materials are used in the manufacturing process.
Manufacturing Inventory Process and Valuation
In order to put a value on inventory throughout the manufacturing process, many factors can come into play at certain points in the production progression. As an example, overhead costs that are applied to inventory costs will have varying values at certain points in production. In simplistic accounting terms, inventory value is generally broken down into three phases:
- Raw Materials
- Work-In-Process
- Finished Goods
Inventory and Accounting for Raw Materials
Raw materials are inventory that has not yet been used in the manufacturing process. Generally it consists of any inventory that is purchased from suppliers in its unused form. Putting a value on raw materials can be as simple as using the acquisition price from the suppliers. However depending on how associated costs are accounted for, there can be other factors involved in valuation.
Overhead costs that are associated with the handling of raw materials could be a factor in inventory valuation. As an example, freight costs could be figured into the value of raw materials. As an alternative certain overhead costs could be taken as an expense. Depending on the business model, there can be advantages and disadvantages to applying overhead costs to raw materials valuation.
Production Inventory Management and Work-in-Process
Work-in-process is unfinished goods or products that are between raw materials and finished goods. Raw materials that are currently being used somewhere in the production process would qualify. The actual value of inventory can vary depending on what stage the unfinished product is at. For this reason putting a value on work-in-process inventory is much more difficult than the valuation of raw materials
As a simplistic example, let’s assume XYZ Mfg. makes widgets and there are four stages of production. XYZ Mfg is taking a physical inventory and has a total of 100 widgets that are in various stages of work-in-process.
- Stage 1 – 15 widgets
- Stage 2 – 20 widgets
- Stage 3 – 40 widgets
- Stage 4 – 25 widgets
The value of inventory needs to be determined at each stage of production. Some considerations like raw materials and overhead costs that are applied to cost of goods must be determined at each stage. For illustrations purposes we’ll assign the following values of raw materials and overhead costs to each widget in the various production stages.
- Stage 1 – $3 per widget
- Stage 2 – $2 per widget + $3 from stage 1 = $5
- Stage 3 – $6 per widget + $5 from stage 2 = $11
- Stage 4 – $4 per widget + $11 from stage 3 = $15
With the two examples of widgets and the values at each stage of production the total inventory value of work-in-process is determined.
- Stage 1 – 15 widgets x $3 = $45
- Stage 2 – 20 widgets x $5 = $100
- Stage 3 – 40 widgets x $11 = $440
- Stage 4 – 25 widgets x $15 = $375
- Total work-in-process = $960
Inventory Value for Finished Goods
Naturally the last stage of production is finished goods or finished product. Determining the value of inventory will consist of raw materials used as well as certain overhead costs. There are various methods that can be used in determining finished goods values. Two common procedures used for determining inventory value is the absorption costing method and the variable costing method.
Both methods use the cost of raw materials but vary in the types of overhead cost used to determine value. If an expense is used to determine the inventory value and in reciprocal the cost of goods sold, the cost is diverted to the revenue section of the income statement. Otherwise the expense would be taken on the expense section of the income statement.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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