Inventories are an important part of any business, as they represent the goods that the business has available for sale or use in the production of other goods. Inventories can be classified into two main categories: those of merchandising businesses and those of manufacturing businesses. Merchandising businesses, also known as retail businesses, purchase goods for resale and therefore have merchandise inventories. Manufacturing businesses, on the other hand, produce physical goods and have three types of inventories: raw materials, work in process, and finished goods.
Raw material inventory refers to the goods and materials on hand that have not yet been placed into production. Work in process inventory includes the raw materials that are in the process of being transformed into finished goods, along with the direct labor and manufacturing overhead costs applied to these materials. Finished goods inventory represents the completed but unsold units that are on hand at the end of each accounting period.
In this unit, we will focus on the determination of merchandise inventory, which is the inventory of goods purchased by a merchandising business for resale. The proper accounting for inventories is important, as it affects the cost of goods sold and the value of the inventory on the balance sheet.