Merchandising and Manufacturing

MERCHANDISING AND
MANUFACTURING
Need for a Physical Count
• In the periodic inventory system, purchases of merchandise are accumulated in the purchases
account. During the accounting period, no entry is made to the merchandise inventory account
such that its balance at the end of the period, before adjusting and closing entries, is the same as
the beginning inventory. With no perpetual record of the cost of sales during the period, the only
way to obtain the cost of the ending inventory is to make a physical count.
• It should be noted that the ending inventory amount is needed in the computation of the cost of
sales. The steps involved in the physical count follows:
a. All merchandise owned by the entity is counted.
b. The quantity counted is multiplied by the cost per unit for each inventory item.
c. The costs of various items are added to determine the total cost of inventory.
Merchandise Inventory at the end of the period
• At the end of the period, entries are made to reflect in the inventory account the ending balance.
The objectives of these entries are as follows:
a. To remove the beginning balance from the merchandise inventory account and to transfer it to
income summary;
b. To enter the ending balance in the merchandise inventory account and to establish it in the
income summary.
MANUFACTURING
Elements of Manufacturing Costs
• Manufacturing costs include all costs related to the production process. They are classified into
three categories
1. Direct Materials. These materials become a physical part of a finished product. Their costs can
be conveniently and economically traceable to the finished product. Consider a pair of Nike
basketballs shoes as the finished product; its leather uppers, the rubber and plastic soles, and
the laces are among its direct materials.
2. Direct Labor. It is the compensation of employees or workers who physically convert raw
materials into finished goods. For Nike, direct labor includes the wages of the machine
operators and the persons who assembles the shoes. The efforts of these persons are directly
traceable to the finished product.
Elements of Manufacturing Costs
3. Manufacturing Overhead. This includes all manufacturing costs that cannot be classified as
direct materials or direct labor. Major classifications of this cost follow:
• Indirect materials and supplies. Glue, thread, nails, rivets, lubricants and small tools.
• Indirect labor costs. Salaries of plant managers and engineers, wages of forklift operators,
maintenance and inspection labor, and machine helpers.
• Other indirect manufacturing costs. Includes building, machinery and tool maintenance, real
property taxes, property insurance, rent expense, utilities expense and depreciation on property
and equipment.
These major cost elements are at times combined into prime costs or conversion costs. Prime costs
consist of direct materials and direct labor. Conversion costs consist of direct labor and
manufacturing overhead.
Manufacturing Inventory Accounts
• Accounting for inventory differs between merchandisers and manufacturers. Merchandisers need
only one category of inventory for the finished goods they buy and sell. In contrast,
manufacturers have various inventory accounts, as follows:
• Finished Goods Inventory. It is the cost of completed goods that have remained unsold at the
end of the accounting period. This inventory is what the manufacturers sell to the merchandisers.
• Work in Process Inventory. This account gives the cost of goods that are in the manufacturing
process but are not yet complete at the end of the accounting period.
• Raw Materials Inventory. This account holds the cost of direct materials on hand that is intended
for use in the manufacturing process.
• Factory Supplies Inventory. It is the cost of unused indirect materials at period end.
• Finished goods inventory, work in process inventory, raw materials inventory and factory supplies
inventory are assets to the manufacturers and are reported as current assets in the statement of
financial position.

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