Manufacturing companies survive by producing products that customers want to buy. Manufacturing companies aim to produce either the best-quality product or the cheapest product for the customer. High-quality products require higher-quality materials and cost more to produce. Cheap products use lesser-quality materials in order to keep the costs low. Inventory comprises one of the largest assets a manufacturing company owns.
Types of Manufacturing Inventory
Three different types of inventory make up total manufacturing inventory. These include raw material inventory, work in process inventory and finished goods inventory. Raw material inventory consists of the inventory received from suppliers and held in inventory until needed for production. Finished goods inventory consists of products that have completed the manufacturing process and are ready for customers to purchase. Work in process inventory consists of items in the middle of the production process. Work in process inventory has already started the manufacturing process, but has not yet completed it.
Work in process is classified as a current asset on the company’s accounting records. A current asset represents an asset that will be consumed, sold or otherwise turned into cash within one year or one operating cycle. An operating cycle begins when the company purchases raw materials and ends when the finished good is sold to a customer and payment is received.
Components of Work In Process Inventory
Work in process consists of materials, labor and overhead costs. The production process begins with the introduction of raw materials. The cost of the raw materials forms the beginning cost of the work in process inventory. Employees process the materials either by hand or by using a machine, adding labor costs to the work in process inventory. Material costs increase when raw materials are added to the process. Employees continue processing the product until it is completed, adding labor costs as the labor is incurred. The company assigns overhead costs based on a predetermined rate. This rate is often applied based on labor hours, but it could be machine hours or material quantities used.
Most companies assign work in process costs using a job-order cost sheet to accumulate costs. Employees record raw-material costs as raw materials are added to the production process. Employees add direct-labor costs to the job-order cost sheet as they work additional hours on that particular job. At the end of each accounting period, the company applies the overhead costs based on the current progress of the job.