Merchandising Company vs. Manufacturing Company: Videos & Practice Problems

Merchandising companies primarily resell finished goods, maintaining a single inventory account known as merchandise inventory. In contrast, manufacturing companies produce goods, managing three distinct inventory accounts: raw materials, work in process, and finished goods. The flow of inventory in manufacturing involves purchasing raw materials, converting them into finished products, and ultimately selling them, which impacts the cost of goods sold on the income statement. Understanding these differences is crucial for grasping the accounting cycle and the accounting equation.

Merchandising Companies

Understanding the distinction between merchandising and manufacturing companies is essential for grasping how different business models operate. A merchandising company primarily focuses on reselling goods that have already been produced by other manufacturers. This type of company maintains a single inventory account, commonly referred to as "inventory" or "merchandise inventory." The primary function of a merchandising company is to purchase finished products, such as t-shirts, and sell them directly to consumers or other businesses.

For instance, when a merchandising company like XYZ purchases goods worth $10,000 on account, it records this transaction by debiting the inventory account to reflect the increase in inventory. The corresponding credit is made to accounts payable, indicating that the company owes this amount to the supplier. This transaction can be summarized in the accounting equation, where both inventory and accounts payable increase by the same amount, ensuring that the equation remains balanced:

Inventory (debit) = Accounts Payable (credit)

In contrast, a manufacturing company engages in the production of goods. This type of company not only sells finished products but also incurs costs related to raw materials, labor, and overhead to create those products. Manufacturing companies typically have multiple inventory accounts, including raw materials, work-in-progress, and finished goods, reflecting the various stages of production.

In summary, while merchandising companies focus on buying and reselling finished products, manufacturing companies are involved in the entire production process, from sourcing raw materials to selling the final product. This fundamental difference influences their accounting practices, inventory management, and overall business strategies.

Manufacturing Companies

In a manufacturing company, the inventory management system is structured around three key accounts that reflect the stages of production. These accounts are essential for tracking the flow of materials and finished products through the manufacturing process.

The first account is Raw Materials Inventory (RM), which includes all the inputs necessary for production. For example, in a cookie manufacturing business, this would encompass ingredients like flour and sugar. These materials are purchased and stored until they are needed in the production process.

The second account is Work in Process Inventory (WIP). This account represents the products that are currently being manufactured but are not yet complete. At any given time, there may be items in various stages of production, which are tracked in this account. As raw materials are used in production, their cost is transferred from the Raw Materials Inventory to the Work in Process Inventory.

Finally, the third account is Finished Goods Inventory (FG). Once the production process is complete, the finished products are recorded in this account. These goods are ready for sale to customers. When a product is sold, its cost is transferred from Finished Goods Inventory to Cost of Goods Sold (COGS), which is recorded as an expense on the income statement.

The flow of inventory in a manufacturing company can be summarized as follows: raw materials are purchased and stored, then moved to work in process as they are used in production, and finally transferred to finished goods when completed. Upon sale, the cost of these goods is recognized as an expense, reflecting the cost of goods sold. Understanding this flow is crucial for managing inventory effectively and ensuring accurate financial reporting.

Here’s what students ask on this topic:

What is the main difference between a merchandising company and a manufacturing company?

The main difference between a merchandising company and a manufacturing company lies in their inventory and production processes. A merchandising company resells finished goods and maintains a single inventory account called merchandise inventory. In contrast, a manufacturing company produces goods from raw materials and manages three distinct inventory accounts: raw materials, work in process, and finished goods. This distinction affects how each type of company records and tracks inventory and cost of goods sold.

How do the inventory accounts differ between merchandising and manufacturing companies?

Merchandising companies have one main inventory account called merchandise inventory, which includes all the finished goods they purchase for resale. Manufacturing companies, on the other hand, have three separate inventory accounts: raw materials (RM), work in process (WIP), and finished goods (FG). Raw materials inventory includes the basic inputs for production, work in process inventory tracks partially completed goods, and finished goods inventory contains products ready for sale.

What is the flow of inventory in a manufacturing company?

In a manufacturing company, the inventory flow starts with purchasing raw materials (RM). These raw materials are then used in production, moving into the work in process (WIP) inventory. As production progresses, labor and overhead costs are added to WIP. Once the goods are completed, they are transferred to the finished goods (FG) inventory. Finally, when the finished goods are sold, the cost is moved to the cost of goods sold (COGS) on the income statement.

Why is it important to understand the differences between merchandising and manufacturing companies in accounting?

Understanding the differences between merchandising and manufacturing companies is crucial in accounting because it affects how inventory and costs are recorded and managed. Merchandising companies have simpler inventory systems with one account, while manufacturing companies have more complex systems with three inventory accounts. This impacts financial statements, cost tracking, and overall financial analysis. Grasping these differences helps in accurately preparing and interpreting financial reports, ensuring proper cost allocation, and making informed business decisions.

What are the three types of inventory accounts in a manufacturing company?

The three types of inventory accounts in a manufacturing company are: raw materials (RM), work in process (WIP), and finished goods (FG). Raw materials inventory includes the basic inputs for production. Work in process inventory tracks goods that are partially completed, including labor and overhead costs. Finished goods inventory contains products that are fully completed and ready for sale to customers.