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Home Valuation of Inventories Classification of Inventory

Classification of Inventory:

Learning objectives of this article:

  1. Identify major classifications of inventory.

Merchandising Companies:

Inventories are assets items for sale in the ordinary course of business or goods that will be used or consumed in the production of goods to be sold. The investment in inventories is frequently the largest current asset of merchandising and manufacturing businesses. Therefore description and measurement of inventory require careful attention.

A merchandising company ordinarily purchases its merchandise in a form ready for sale. It reports the cost assigned to unsold units left on hand as merchandise inventory. Only one inventory account, merchandise inventory, appears in the financial statements. Example of such a merchandising company is Wal-Mart.

Manufacturing Companies:

Manufacturing companies produce goods which may be sold to merchandising companies as well as directly to customers. Manufacturing companies normally have three inventory accounts. These are:

  • Raw materials

  • Work in process

  • Finished goods

These three inventory accounts are briefly explained below:

Raw Materials:

The cost assigned to goods and materials on hand but not yet placed into production is reported as raw materials inventory. Examples include the wood to make a base ball bat and the steel to make a car. These materials can be traced directly to the end product.

Work in Process:

Some units are not completely processed at any point in a continuous process. The cost of the raw material on which production has been started but not completed, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs, constitute the work in process inventory.

Finished Goods Inventory:

The costs identified with the completed but unsold units on hand at the end of the fiscal period are reported as finished goods inventory.

Comparison of current assets presentation for merchandising and manufacturing companies

Merchandising Company   Manufacturing Company
Balance Sheet
January 31, 2011
Balance Sheet
January 31, 2011
  Current assets (in millions)  
    Cash and cash equivalents $2,161
    Receivables 2,000
    Inventories at LIFO cost 22,614
    Prepaid expenses and other 1,471
  Current assets (in millions)  
    Cash and cash equivalents $77
    Short-term investments 233
    Accounts and notes receivable (net) 109
      Finished goods $32  
      Work in process 23  
      Raw materials 42  
      Packaging materials 18  
      Total inventories 115
    Prepaid expenses and other 73
    Total current assets $607

Manufacturing companies also use machine oils, nails, cleaning materials etc. These items are used in production but are not the primary materials being processed. Manufacturing companies that use these items in their manufacturing process, might include a manufacturing or factory supplies inventory account.

Flow of Costs Through Merchandising Company

Merchandise Inventory

Cost of goods purchased Cost of goods purchased

Flow of Costs Through Manufacturing Company

Raw Materials

Actual materials cost

Cost of goods purchased


Actual labor cost

Labor applied


Actual overhead cost

Overhead applied

Work in Process

  Cost of goods manufactured




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