When it comes to inventory valuation, manufacturing cost accounting methods puts value on inventory by considering cost associated with the manufacturing process. Valuation of this important asset is important to profitability because it simultaneously determines the cost of goods sold. This article looks at inventory valuations as it pertains to the various steps in the manufacturing process.
Cost Accounting and the Manufacturing Process
Inventory values can differ from one manufacturing process to the next. In general terms, there are usually three different inventory asset level values throughout the production process:
- raw materials
- work in process
- finished goods
Inventory is first purchased as raw materials. The raw materials are then introduced into the manufacturing process, known as work in process. Once the raw materials are processed, the end result is known as finished goods.
Manufacturing Cost Accounting and Inventory Valuation Methods
The two basic methods for assigning value to inventory are the absorption costing and variable costing methods. With these two methods of cost accounting, various expense costs related to the manufacturing process are assigned to the inventory value. The expenses used to value inventory are not reported on the income statement. Instead the expenses are deducted from total revenue as they are sold to determine gross profit.
Manufacturing Cost Accounting and Raw Materials
Since raw materials haven’t been introduced to the manufacturing process, cost accounting methods aren’t normally used for inventory valuation. For this reason, assigning value is very simplistic. With the exception of valuing inventory for income tax purposes, the value assigned to raw materials is normally at acquisition cost.
Manufacturing Cost Accounting and Work in Process
Work in process or work in progress, is a bit trickier than valuation of raw materials. Certain costs associated with the manufacturing process must be assigned to work in process, depending on what stage of production the raw materials are in. The cost associated will work in process also depends on what inventory valuation method is used, absorption or variable method.
Manufacturing Cost Accounting and Finished Goods
Assigning inventory values to finished goods will also differ depending on inventory valuation methods. Absorption costing takes into consideration the majority of costs associated with manufacturing expense. The following are typical examples of costs assigned to finished goods valuation.
Expenses Associated with the Absorption Costing Method:
- direct materials cost
- direct labor cost
- variable manufacturing cost
- variable sales costs
- fixed manufacturing overhead
- fixed selling costs
Using the variable costing method will exclude the fixed costs associated with production.
Variable costing may not be acceptable for external reporting of the income statement for income tax purposes. A CPA or tax professional should be consulted before implementing the variable costing method. Inventory costing methods will also have an affect on asset valuation as reported on the balance sheet.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
Join the Conversation