Manufacturing and Nonmanufacturing Costs

4.2. Raw materials inventory, T-accounts and related accounting

Raw materials inventory represents items that the manufacturer has purchased or produced to use in manufacturing a product.

The cost of all raw materials at any point in time comprises raw materials inventory.

Raw materials can be classified as direct or indirect materials. As we have discussed earlier, direct materials are raw materials that can be physically and directly associated with the finished product.

For example, Friends Company will classify plastic parts, paint, and metal parts as direct materials because those can be directly associated with a valve (or batch of valves) produced.

Indirect materials do not physically become part of the final product or their association with the final product is too small to be easily traced to the final product.

For example, Friends Company will classify janitorial supplies for the factory, grease for the machinery, and light bulbs as indirect materials because they do not physically become part of the final product.

When materials (both direct and indirect) are purchased, they are recorded in the Raw Materials Inventory account. For example, during March 20X9 Friends Company purchased $2,000 of paint, $7,000 of plastic and metal parts, and $500 of light bulbs on account ($2,000 + $ 7,000 + $500 = $9,500). The journal entry to record the purchase is as follows:

1) Purchase of raw materials:

Account Titles

Debit

Credit

Raw Materials Inventory

9,500

 

      Accounts Payable

 

9,500

The Raw Materials Inventory T-account includes the following information (also refer to the T-account illustration presented below):

  • Amount of raw materials available at the beginning of an accounting period (i.e., beginning balance as a debit because inventory is an asset account).
  • Cost of materials purchased during the accounting period (debit side).
  • Cost of materials used in the manufacturing process (credit side).
  • Available (not used) raw materials at the end of the accounting period (ending balance as a debit). The ending balance in this accounting period becomes the beginning balance in the following accounting period.

Illustration 8: Raw materials inventory T-account

Raw materials inventory T-account

When a manufacturing company uses raw materials in the production process, the Raw Material Inventory account is credited (decreased) and the Work-in-Process Inventory account is debited (increased). Therefore, raw materials used in production (both direct and indirect) are the cost transferred out of the Raw Materials Inventory account and the cost added to the Work-in-Process Inventory account.

Going back to our Friends Company example, assume that in March 20X9 the company used $1,000 of paint and $4,000 of plastic and metal parts for a total of $5,000.

The journal entry to record this inventory consumption is posted as follows:

2) Use of direct raw materials in production:

Account Titles

Debit

Credit

Work-in-Process Inventory

5,000

 

      Raw Materials Inventory

 

5,000

In addition, assume that Friends Company used $100 worth of light bulbs (indirect materials or overhead) during the same period. The journal entry to record their use is presented below:

3) Use of indirect raw materials in production:

Account Titles

Debit

Credit

Factory Overhead

100

 

      Raw Materials Inventory

 

100

Let's see how the amounts above are reflected in the Raw Materials Inventory T-account. In our example, on March 1, 20X9 Friends Company had the beginning balance (BB) in the Raw Materials Inventory account of zero ($0). The raw materials purchased and raw materials used are recorded in the T-account format as follows:

Illustration 9: Friends Company raw materials inventory T-account

Friends Company raw materials inventory T-account

As we can see from the T-account above, Friends Company debited $9,500 for materials purchased (i.e., the cost added) and credited $5,100 for materials used (i.e., the cost transferred out (debited) to the Work-in-Process Inventory account). The ending balance in the account is $4,400.

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