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Inventory represents products held for resale and is classified as a current asset on the balance sheet. The inventories of large companies like General Electric, Procter and Gamble, and Wal-Mart are composed of thousands of different products or materials and millions of individual units that are stored in hundreds of different locations. For other companies, inventories are a much less significant portion of their total assets. When companies like Wal-Mart sell their inventory to customers, the cost of the inventory becomes an expense called cost of goods sold. Cost of goods sold, or cost of sales, represents the outflow of resources caused by the sale of inventory and is the most important expense on the income statement of companies that sell goods instead of services. Note that gross margin (also called gross profit), a key performance measure, is defined as sales revenue less cost of goods sold. Thus, gross margin indicates the extent to which the resources generated by sales can be used to pay operating expenses (selling and administrative expenses) and provide for net income. The cost of inventory has a direct effect on cost of goods sold and gross margin. Therefore, to correctly interpret and analyze financial statements, one must understand inventory accounting. These companies are often referred to as either merchandisers or manufacturers. • Merchandisers are companies that purchase inventory in a finished condition and hold it for resale without further processing. Retailers like Wal-Mart, Sears, and Target are merchandisers that sell directly to consumers, while wholesalers are merchandisers that sell to other retailers. The inventory held by merchandisers is termed merchandise inventory. Merchandise inventory is an asset. When that asset is sold to a customer, it becomes an expense called cost of goods sold which appears on the income statement. • Manufacturers are companies that buy and transform raw materials into a finished product which is then sold. Sony, Toyota, and Eastman Kodak are all manufacturing companies. Manufacturing companies classify inventory into three categories: raw materials, work-in-process, and finished goods. Raw materials inventory are the basic ingredients used to make a product. When these raw materials are purchased, Raw Materials Inventory is increased. As raw materials are used to manufacture a product, they become part of work-in-process inventory. Work-in-process inventory consists of the raw materials that are used in production as well as other production costs such as labor and utilities. These costs stay in this account until the product is complete. Once the production process is complete, these costs are moved to the finished goods inventory account. The finished goods inventory account represents the cost of the final product that is available for sale. When the finished goods inventory is sold to a customer, it becomes an expense called cost of goods sold which appears on the income statement. For assistance with your finance assignment online you can visit classof1.com.
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