Cost Accounting (14th Edition)

Types of Inventory
BUSINESS SECTORS, TYPES OF INVENTORY, INVENTORIABLE COSTS, AND PERIOD COSTS 37
Manufacturing-sector companies purchase materials and components and convert them
into various finished goods. These companies typically have one or more of the following
three types of inventory:
1. Direct materials inventory. Direct materials in stock and awaiting use in the manufacturing
process (for example, computer chips and components needed to manufacture
cellular phones).
2. Work-in-process inventory. Goods partially worked on but not yet completed (for
example, cellular phones at various stages of completion in the manufacturing
process). This is also called work in progress.
3. Finished goods inventory. Goods (for example, cellular phones) completed but not
yet sold.
Merchandising-sector companies purchase tangible products and then sell them without
changing their basic form. They hold only one type of inventory, which is products
in their original purchased form, called merchandise inventory. Service-sector companies
provide only services or intangible products and so do not hold inventories of tangible
products.
Commonly Used Classifications of Manufacturing Costs
Three terms commonly used when describing manufacturing costs are direct material
costs, direct manufacturing labor costs, and indirect manufacturing costs. These terms
build on the direct versus indirect cost distinction we had described earlier, in the context
of manufacturing costs.
1. Direct material costs are the acquisition costs of all materials that eventually become
part of the cost object (work in process and then finished goods) and can be traced to
the cost object in an economically feasible way. Acquisition costs of direct materials
include freight-in (inward delivery) charges, sales taxes, and custom duties. Examples
of direct material costs are the steel and tires used to make the BMW X5, and the
computer chips used to make cellular phones.
2. Direct manufacturing labor costs include the compensation of all manufacturing
labor that can be traced to the cost object (work in process and then finished goods)
in an economically feasible way. Examples include wages and fringe benefits paid to
machine operators and assembly-line workers who convert direct materials purchased
to finished goods.
3. Indirect manufacturing costs are all manufacturing costs that are related to the cost
object (work in process and then finished goods) but cannot be traced to that cost object
in an economically feasible way. Examples include supplies, indirect materials such as
lubricants, indirect manufacturing labor such as plant maintenance and cleaning labor,
plant rent, plant insurance, property taxes on the plant, plant depreciation, and the compensation
of plant managers. This cost category is also referred to as manufacturing
overhead costs or factory overhead costs. We use indirect manufacturing costs and
manufacturing overhead costs interchangeably in this book.
We now describe the distinction between inventoriable costs and period costs.
Inventoriable Costs
Inventoriable costs are all costs of a product that are considered as assets in the balance
sheet when they are incurred and that become cost of goods sold only when the product
is sold. For manufacturing-sector companies, all manufacturing costs are inventoriable
costs. Consider Cellular Products, a manufacturer of cellular phones. Costs of direct
materials, such as computer chips, issued to production (from direct material inventory),
direct manufacturing labor costs, and manufacturing overhead costs create new assets,
starting as work in process and becoming finished goods (the cellular phones). Hence,