The flow of production — from raw materials to work-in-process to finished goods — is essentially what manufacturing businesses are all about. Manufacturing inventory accounting follows that flow, tracking inventory volume and assigning values to every piece of inventory at each stage of production. Effective inventory accounting accurately reflects inventory values and ensures seamless production without tying up more cash in inventory than is absolutely necessary. Missteps in inventory accounting can cause lost sales, reduce manufacturing efficiency and lead to discrepancies in financial reporting.

This article explains different inventory accounting methods and the importance of precise inventory valuation, which directly influences manufacturers’ cost of goods and overall profitability.

What Is Manufacturing Inventory Accounting?

Manufacturing inventory accounting involves tracking and assigning values to all the different types of inventory that manufacturers need to produce their products, from raw materials to work-in-process (WIP) inventory and finished goods. Its dual goals are to provide information that business managers can use to optimize operational and cost efficiency and to ensure that inventory is accurately represented on the company’s balance sheet.

In the big picture of a manufacturing business, inventory accounting is a kind of linchpin, or bridge, between demand forecasting and purchasing/procurement on one side and production, sales and order management on the other. Without inventory accounting’s core functions of tracking and accurately valuing inventory, many down-the-line processes would be far more difficult or impossible, including production scheduling and setting prices.

At the hands-on level, manufacturing inventory accounting is about identifying inventory items’ direct and indirect costs, determining the organization’s cost of goods sold (COGS) and valuing remaining inventory using one of several different cost-flow methods, such as first in, first out (FIFO) or last in, first out (LIFO). Direct costs include expenses like the purchase of raw materials and the direct labor needed to transform those materials into finished goods. Indirect costs include the overhead associated with production and with storing inventory, such as depreciation of production equipment, the cost of small supplies used in manufacturing processes, utilities, rent and employee salaries (for nonproduction staff).

Though it’s possible to do this accounting manually, it’s often impractical. Manufacturing accounting software can automate most of the bookkeeping, like properly coding invoices for raw materials purchases, while increasing the amount of available information for business managers to use in improving financial insight and inventory management efficiency.

Key Takeaways

  • Manufacturing inventory accounting tracks and assigns values to all types of inventory, from raw materials to finished goods.
  • Key aspects of inventory accounting for manufacturers include identifying direct and indirect costs of inventory items, determining the organization’s cost of goods sold (COGS) and valuing remaining inventory using different inventory cost-flow methods.
  • Manual inventory accounting can be challenging and prone to errors, while automating the process with manufacturing accounting software can increase financial insight and improve inventory management efficiency.
  • Effective manufacturing inventory accounting can improve a company’s profitability by optimizing inventory levels and monitoring inventory costs.

Manufacturing Inventory Accounting Explained

All manufacturers face a common set of vexing challenges, such as understanding the true profitability of a product, knowing what inventory is on hand for manufacturing production planning, accurately valuing inventory for financial reporting, avoiding tying up more cash in inventory than absolutely necessary and obtaining the most up-to-date information for decision-making, such as setting prices. Manufacturing inventory accounting can be a strategic tool that helps address these challenges head-on.

Misjudgments in valuing inventory, for example, can lead to financial discrepancies and affect the company’s bottom line. But manufacturing inventory accounting systems can automatically track inventory costs and items’ progress through the production process, reducing errors and improving the accuracy of inventory valuations. Good manufacturing inventory accounting processes will accurately assign direct costs to products and more precisely allocate overhead costs, providing a clear picture of a product’s true profitability.

Furthermore, tying up too much cash in inventory can strain a company’s liquidity and having more inventory on hand than necessary increases the likelihood of damage and obsolescence, which, in turn, increases costs and lowers profitability. Good manufacturing inventory accounting processes optimize inventory by providing alerts when stock is too high or too low, so that manufacturing production proceeds smoothly without tying up more cash than is necessary — that is, as long as the demand forecast also was accurate. And by producing the most up-to-date inventory information and valuations, manufacturing inventory systems can feed trend analyses that lead to better financial insights and increase inventory management efficiency.

Methods of Inventory Accounting

Manufacturing businesses generally choose between two primary methods of inventory accounting — periodic and perpetual — that come with different advantages and disadvantages in terms of accuracy and availability of real-time inventory information. Some organizations combine features of both to create hybrid systems.

Periodic Inventory System

In a periodic approach, inventory is physically counted at predetermined times, usually a fiscal period such as a month, quarter or year. In between those times, inventory purchases are recorded in a purchase account and then transferred to the inventory account (along with any other necessary adjustments) through journal entries at the time of the count. COGS is also calculated at the time of the physical inventory count. Periodic inventory systems are often used in smaller businesses with less diverse inventories, such as a manufacturer that produces a single product and conducts inventory checks at the end of each quarter. Its simplicity is a big advantage — it doesn’t require continuous tracking of raw material, WIP and finished goods inventory. But inventory accuracy is ensured only immediately after counting.

Perpetual Inventory System

Perpetual inventory systems continuously collect and aggregate data on the movement of all inventory items through the production process, so they — in theory, at least — are always accurate, up to the minute. So, a manufacturer can calculate its COGS at any time, confidently expecting a high degree of accuracy. Perpetual methods are typically used by larger businesses with diverse inventories, such as an electronics manufacturer that needs to track inventories for different products in order to reach production decisions in real time. Perpetual systems usually require advanced inventory management software. But their scalability and data visibility make them the right choice for businesses with large, complex inventory management challenges.

Hybrid Systems

Sometimes, companies at either side of the size spectrum may configure hybrid solutions that combine features of periodic and perpetual systems to deal with their unique challenges. For example, small manufacturing companies may not have the resources to build a fully perpetual system that continuously updates in real time, while very large companies with many locations and enormous inventory storage requirements may also find a perpetual system difficult to implement well. Or, manufacturers with diverse inventories may treat them differently — say, perpetual for fast-moving/high-value inventory and periodic for slow-moving/low-value inventory. Hybrid systems typically have some type of perpetual base with periodic physical checks and related adjustments. In this context, the classic inventory cycle counting approach can be part of a perpetual-periodic hybrid system.

Manufacturing Inventory Accounting and Valuation Methods

Properly valuing inventory is vital for manufacturing companies because the value of inventory directly affects a company’s COGS and, therefore, its profitability. In addition, the value of inventory remaining at the end of a fiscal period can be one of the biggest assets on a manufacturer’s balance sheet and represent a large use of cash.

Selecting the right inventory valuation method is also important because it usually involves a long-term commitment. In the U.S., for example, the IRS requires companies to commit to a method in their first-year tax filing. If they wish to change the method later, they must seek IRS approval. And public companies must disclose any changes in inventory methods in the notes to their financial statements to comply with U.S. generally accepted accounting principles (GAAP). As part of that compliance, they need to show a calculation of the monetary impact of the change.

There are four main inventory valuation methods — also referred to as cost flow assumptions — each with its own benefits and drawbacks:

First In, First Out (FIFO)

FIFO assumes that the oldest items in inventory are the first ones used in production. Purchase cost data is stratified by date, and an average cost per unit is assigned to each layer of inventory. As products are manufactured (and, later, as finished goods are sold), each layer of inventory is depleted in the order of oldest to newest, using the cost per unit for each layer. The units left in ending inventory reflect the most recent purchases — only for accounting purposes, though, because there doesn’t have to be a direct link between the accounting approach and the actual movement of manufacturing inventory.

Last In, First Out (LIFO)

Conversely, LIFO dictates that the last items purchased are the first ones used in production. Because it’s FIFO in reverse, LIFO results in ending inventory that is valued at the cost from the oldest supplier purchases. This can be advantageous for reducing tax burden because it maximizes COGS, which lowers net income, and minimizes ending inventory values.

Weighted Average Cost

This method calculates an average cost per unit for each period during which additional items are purchased (or produced). For example, an apparel maker might sum its costs for materials, labor and manufacturing overhead to make dresses during a fiscal quarter and divide that sum by the number of dresses it produced, yielding an average cost it can use to value its ending dress inventory and COGS. It would calculate separate averages for shorts, skirts and tops, if it also makes those items.

Specific Identification

This method tracks individual items of inventory, so it can really be used only if each item has a unique identifier, like a serial number or RFID tag. With specific identification, a manufacturer’s accountants must assign specific costs to make or purchase each individual item in inventory. It is the most accurate method, but it has limited application because it’s so hard to do in practice. It’s often employed for unique, high-value products, such as automobiles or jewelry.

Cost Flow Assumptions and Their Impact

Each inventory valuation method (aka cost flow assumption) described above has different implications for a manufacturing company’s profit, tax liabilities and administrative costs. Let’s explore the impacts of the four primary cost flow assumptions.

FIFO tends to increase reported profit and, consequently, tax liability, especially during inflationary periods when costs increase more rapidly over time. For instance, if a business purchases raw materials at increasing prices over time, FIFO assigns the earlier lower costs to COGS, leaving higher-cost items in ending inventory.

LIFO, on the other hand, tends to reduce net income by maximizing COGS and minimizing ending inventory values, which can be beneficial during times of rising costs, as it may lower a manufacturers’ tax burden. So, if a business purchases raw materials at increasing prices, LIFO assigns the higher recent costs to COGS, leaving the lower earlier costs in the ending inventory. An advantage is that LIFO matches the most recent costs with the most recent sales, which minimizes any profit impact from inflation (or deflation). It’s worth noting that LIFO is available only in the U.S. because it’s allowed under GAAP but not under International Financial Reporting Standards (IFRS).

Because the weighted average cost method uses an average of all inventory costs for similar items, it usually yields reported profit and ending inventory valuations that fall between those of FIFO and LIFO. That means that the tax liability typically produced by the average cost approach also falls between FIFO and LIFO. In practice, this method’s financial impact depends on how the average fluctuates over time. In terms of administrative burden, weighted average cost requires regular recalculations of a company’s average cost per unit of inventory.

Specific identification’s impact on profits and taxes depends on the actual costs of individual items in inventory. In practice, however, this method is rarely used by manufacturers because it is so administratively intensive, especially if technology, like RFID tags or unique serial numbers, is not in place for tracking. It’s more likely to be used for custom, made-to-order products or by jewelers or sellers of fine art.

From the different ways these cost flow assumptions affect a manufacturer’s finances, it’s easy to see why, whichever method is chosen, it must be applied consistently, according to GAAP. Otherwise, financial reporting would appear skewed from period to period.

Manufacturing Inventory Accounting and Overhead Costs

Manufacturing costs include overhead — indirect costs that can’t be tied to a specific product but are essential to the manufacturing process. These can include expenses for utilities, rent, depreciation of factory equipment and salaries of non-production-line employees, among other things. Accurate allocation of these overhead costs to products is vital when determining the true cost and profitability of any product, as well as the company’s COGS during a given period. There are several methods manufacturing businesses can use to allocate overhead costs to products, all of which share the idea of an “allocation base” that is directly tied to product production and, therefore, can be used to apportion the overhead cost among the products produced.

Three such manufacturing overhead allocation methods are direct labor cost, direct labor hours and machine hours. With direct labor cost, the allocation base is the total dollar amount of all the direct labor that went into the manufacturing of the company’s products for the period. This is the simplest method of the three, since it allocates one set of costs based on another set of costs.

To illustrate, suppose a company produced 10,000 BBQ grills in the third quarter of 2023, using $3 million in raw materials, $2 million in direct labor costs and $1 million in aggregate overhead costs. It would allocate 50 cents of overhead cost to each dollar of direct labor ($1m / $2m), bringing the cost to make each grill from $500 [($3m + $2m) / 10,000)] to a total cost of $600 ($500 + [($2m / 10,000) x 0.5]).

Calculations for the direct labor hours and machine hours methods are similar, but they require two steps because the allocation bases are a number of hours, rather than a dollar amount. Continuing the BBQ grill example, suppose time-clock records indicate that the $2 million in direct labor costs were for 400 labor hours for the quarter. The first step in allocating overhead based on hours is to calculate a ratio of overhead cost per labor hour, such as $1 million / 400, or $2,500. The second step is to apply the ratio to the number of labor hours required to manufacture the grills. In this example, where the company produced only BBQ grills, all 400 hours, or 100% of the overhead costs, are allocated to the grills. The same $100 per unit overhead cost is allocated to each grill ($2,500 x 400) / 10,000). When added to the per-unit costs of raw materials and direct labor, this method arrives at the same $600 total cost for each BBQ grill as the direct labor cost method.

When manufacturers produce multiple products at the same time, calculating overhead allocations requires three steps. If the hypothetical company manufactured 10,000 grills and 3,000 fire pits during the quarter, the 400 total labor hours (or machine hours) would need to be split up for each type of product. Suppose the company’s production logs show that 275 of the 400 labor hours were used to make BBQs and the remaining 125 earmarked for the fire pits. Using the previously calculated ratio of overhead cost per labor hour of $2,500, the manufacturing overhead attributed to the BBQ grills would be $687,500 (275 x $2,500) or $68.75 per unit ($687,500 / 10,000). When added to the raw materials ($300) and direct labor costs ($200) per unit, the total cost for each BBQ is now $568.75. The manufacturing overhead allocated to the fire pits would be $312,500 (125 x $2,500) or $104.17 per unit ($312,500 / 3,000), which is added to the fire pits’ raw material and labor costs.

Each method has its advantages and drawbacks, and the choice depends on the nature of the manufacturing process. A highly automated electronics manufacturer, for example, might favor the machine hours method, because allocating overhead costs based on machine hours used for each product can provide a more accurate reflection of the true product cost. But a handmade-furniture maker would likely use one of the direct labor methods, due to the labor-intensive nature of its manufacturing process.

Regardless of the method chosen, accurate overhead allocation is vital for financial reporting, pricing decisions and profitability analysis. And it’s worth noting that modern accounting software can automate overhead allocation, reducing the risk of errors and improving accuracy.

The Impact of Just-in-Time (JIT) Manufacturing

Just-in-time (JIT) manufacturing is an inventory-oriented business strategy that aims to improve a business’s profitability and return on investment by reducing all types of inventory and their carrying costs. A manufacturing company’s inventory volume levels are far lower under JIT than under other approaches because inventory is purchased or produced only when needed to meet immediate demand. This significantly reduces the need to store large amounts of raw materials, WIP or finished goods, which reduces the potential for damage and lowers costs of inventory storage, insurance and obsolescence. In terms of inventory accounting, lower inventory levels mean less effort in tracking and valuing inventory, potentially lowering accounting costs.

Challenges to doing JIT well are that it requires very accurate demand forecasting and, because inventories are kept so lean, an extremely responsive and reliable supply chain. It also makes it harder for manufacturers to take advantage of low prices because they must buy when an item is needed for production, at whatever the prevailing price.

JIT contrasts with the just-in-case approach, in which a manufacturer prioritizes being prepared for unexpected demand spikes over the cost and cash flow implications of carrying reserve stock. Under just-in-case, companies maintain higher inventory levels to buffer uncertainties in demand or supply — but a company is able to choose to stock up when prices are low. The choice between JIT and just-in-case depends on a manufacturer’s ability to accurately predict demand, the reliability of its suppliers and the company’s risk tolerance.

Technology and Inventory Accounting

Technology has become indispensable to inventory accounting. Inventory management software can automate many aspects of inventory tracking, improving accuracy and providing real-time visibility into inventory levels. And when manufacturers integrate accounting software and inventory management software, they can automate many inventory accounting tasks, from assigning direct costs to allocating overhead and calculating COGS. They can even automate inventory valuations, eliminating the need for manual calculations and reducing the risk of errors. In fact, automating accounting tasks by integrating inventory and accounting systems reduces errors so much that, for example, audits become far easier to manage.

Taking technology benefits a step further, manufacturers that deploy cloud-based enterprise resource planning (ERP) systems can integrate business functions beyond inventory management and accounting. ERP provides a unified platform and centralized data repository for efficiently managing and reporting on all business operations. For example, an ERP system can automatically update inventory levels in real time as sales are made or new stock is received, so that accounting records always reflect the current state of inventory.

Challenges in Manufacturing Inventory Accounting

Technology and modern accounting methods have automated much of the inventory accounting process, trimming accountants’ workloads. But manufacturers still face several inventory accounting challenges that can seriously affect the accuracy of financial reporting and production efficiency.

Fluctuating Market Prices for Raw Materials

Volatility in raw materials prices can make it difficult for manufacturers to accurately forecast costs and maintain consistent profit margins. When this becomes an issue, there are many strategies manufacturers can use, either alone or in combination, to mitigate risk due to price fluctuations. Depending on the size of the business and its resources, it could, for example, use hedging, whereby it purchases futures contracts or options that lock in prices for a set period; enter into long-term supplier contracts at fixed prices; or stockpile raw materials when prices are low (though this would incur offsetting inventory carrying costs).

Estimating the Cost of Goods in Process

WIP inventory incurs specific production costs, such as for materials, labor and overhead, but precisely estimating those costs before the goods are finished can become problematic. And yet, accurate estimates are crucial because they influence profitability, pricing strategies and inventory valuations. To address this challenge, manufacturers may use standard costing, in which expected cost estimates are based on historical data and/or activity-based costing, which allocates overhead costs according to the activities that drive them. In either case, accountants multiply the cost by the percentage of completion.

For example, if a dressmaker’s standard cost is $25 to make a dress, and it has 125 dresses in WIP inventory that are 50% complete, its WIP dress inventory would be valued at $1,562.50 ($25 x 125 x 0.5). Manufacturers with an ERP system that integrates manufacturing, inventory management and accounting can continuously monitor production progress in real time, which makes for highly accurate estimates of goods in process.

Inventory Shrinkage Due to Theft, Obsolescence or Spoilage

Shrinkage can lead to discrepancies between physical inventory and inventory records that can disrupt production schedules, reduce profitability and potentially result in inaccurate financial statements. To deal with theft, manufacturers can install security cameras, add security personnel and increase the frequency of inventory audits. JIT strategies and better demand planning can minimize obsolescence. And for spoilage, using FIFO for actual inventory management (instead of only for inventory accounting purposes) can reduce or eliminate the issue.

Manufacturing Inventory Accounting Best Practices

These best practices in manufacturing inventory accounting can increase efficiency, provide useful insights for inventory and other business managers, and improve the accuracy of financial reporting.

  • Regularly audit physical inventory.

    A physical inventory audit is simply a manual count that verifies inventory accounting records. Regular audits either confirm that the actual count matches the recorded inventory or they reveal discrepancies that lead to adjustments. Either way, resulting financial statements become more reliable, more accurate or both.

  • Stay updated on regulatory changes.

    Although inventory accounting rules specified under both GAAP and IFRS regulations are relatively stable, minor updates arise from time to time, as do occasional major changes in guidance. Being vigilant about detecting potential updates helps businesses maintain compliance and avoid potential financial penalties.

  • Invest in training and technology.

    When companies invest in advanced technology and train employees to get the most out of it, they boost efficiency and productivity. Manufacturing inventory accounting is no exception. Technology can automate and streamline many aspects of the accounting process, and employee training empowers staff to manage the manufacturing inventory more effectively.

  • Monitor key performance indicators (KPIs).

    KPIs, such as inventory turnover rate, days inventory outstanding, carrying cost per unit and gross margin, can help business managers assess the efficiency of their inventory management and accounting processes. Regularly monitoring these KPIs can produce insights into which areas of inventory management can be improved.

Manage Inventory Accounting in One Unified Platform With NetSuite

In manufacturing, effective inventory accounting is vital for maintaining operational efficiency and financial accuracy. But the challenges of inventory management can make accurate inventory accounting a daunting task. NetSuite ERP, however, can seamlessly integrate cloud accounting software with inventory management and manufacturing modules in a unified platform with one centralized database. NetSuite offers key features for tracking inventory across multiple locations, provides real-time visibility into inventory levels and includes tools for managing inventory details, such as reorder points, safety stock and cycle counts. By unifying inventory accounting with NetSuite, manufacturers can automate manual accounting tasks and decrease errors, because having both accounting and inventory management software modules on one platform automatically synchronizes inventory and financial reporting data. The result is improved financial close efficiency and reduced back-office costs. NetSuite empowers manufacturing businesses to better manage inventory accounting challenges, fostering business growth.

Manufacturing inventory accounting helps answer the critical business questions of what it costs to produce a product and how much inventory is still on hand. It’s a complex process, one that involves tracking and valuing every raw material purchase, as well as the added costs incurred as those materials are transformed into finished goods. Any misstep may lead to financial errors that can directly impinge on a manufacturer’s cost of goods sold and overall profitability. Use of the right technology, though, can simplify inventory accounting, making it more reliable and less daunting. Software that can automate inventory accounting tasks can not only minimize errors and improve inventory valuations, but also assist manufacturers in better managing broad objectives, such as optimizing inventory levels. As a result, they can tie up less capital in inventory, set proper prices, avoid tax overpayment and, above all, increase profitability.

#1 Cloud

Free Product Tour(opens in a new tab)

Manufacturing Inventory Accounting FAQs

What’s the significance of work-in-process (WIP) inventory in financial statements?

Work-in-process (WIP) inventory is one of the three categories of inventory shown on company balance sheets; the others are raw materials and finished goods. WIP inventory covers the cost of goods that have entered the production phase but are not complete. Costs included in WIP inventory start with the original raw materials expense and add direct labor, direct materials and applied overhead.

How do manufacturers account for inventory obsolescence?

Manufacturers usually choose either the “direct” or “indirect” method to account for inventory obsolescence. Both comply with U.S. generally accepted accounting practices (GAAP), but they impact the income statement (aka the P&L, or profit and loss statement) at different times. In the direct method, the value of identifiable products that are known to be obsolete is written off when they are discovered, so they hit the P&L at that time. Their value is charged (debited) to an expense account, typically called “inventory obsolescence expense,” and a corresponding credit directly writes down the value of the inventory asset on the balance sheet. Alternatively, under the indirect method, manufacturers record a reserve for inventory obsolescence, using historical data to determine the average percentage of production that becomes obsolete. The reserve hits the balance sheet and P&L as soon as it is established, reducing the inventory balance (as a contra asset account on the balance sheet) and increasing the cost of goods sold (COGS) on the income statement. Inventory items identified as obsolete under the indirect method do not directly impact the P&L because they are written off against the reserve instead.

How do inventory shrinkages, such as theft or spoilage, impact manufacturing accounting?

Inventory shrinkage reduces the value of the inventory asset on a manufacturer’s balance sheet and increases the cost of goods sold (COGS) on the income statement. Whenever shrinkage is discovered, a company should reflect it in those financial statements to maintain reporting accuracy. While there are multiple approaches for doing so, companies typically use the direct method, which records shrinkage-related losses by debiting (increasing) an expense account called “inventory shrinkage” or “loss due to shrinkage” (which is part of COGS) and crediting (reducing) the finished goods inventory account on the balance sheet. This decreases a company’s profitability but provides valuable information to managers, who can act on it to reduce future shrinkage.

Why is regular auditing of physical inventory important?

Regular audits are important because they ensure the accuracy of company inventory records. Audits can identify discrepancies between physical counts and inventory records, whether due to theft, damage, misplacement or clerical errors. Regular audits also can provide early detection of obsolete or slow-moving inventory, allowing for timely write-offs or markdowns. In these ways, inventory audits contribute to more accurate financial reporting and better inventory management. Inventory audits are also a requirement of generally accepted auditing standards (GAAS), a framework for independent audits that is required for public companies.

What are the potential tax implications of different inventory valuation methods?

Inventory valuations have tax implications because they impact a company’s cost of goods sold (COGS) and, therefore, its net income. Because different valuation methods usually yield disparate values, they can have dissimilar implications for a manufacturer’s tax liability. For instance, the first in, first out (FIFO) method can result in higher taxable income during inflationary periods, as it assumes older, cheaper inventory gets sold first. Conversely, last in, first out (LIFO) can result in lower taxable income during inflation, as it assumes newer, more expensive inventory is sold first, thus inflating COGS and lowering net income for the period. The weighted average cost method smooths out price fluctuations, landing between FIFO and LIFO. Finally, the specific identification method, while precise, is difficult to implement. Its tax implications depend on the exact prices of individual items in inventory. Once a manufacturer chooses a method, tax and accounting authorities require the company to stick with it or provide a detailed explanation, including the financial impact, for any change.

What are the inventory accounts for a manufacturer?

Three inventory accounts typically appear on a manufacturer’s balance sheet and are integral to accurately tracking and valuing a manufacturer’s inventory. They are:

  • Raw materials inventory: This account tracks the cost of materials not yet used in production.
  • Work-in-process inventory: This account reflects the cost of items being manufactured but not yet complete. It adds expenses, such as labor and overhead allocations, to the cost of the original raw materials.
  • Finished goods inventory: This account reflects the cost of completed products ready for sale.

What is the accounting method for manufacturing?

The accounting method for manufacturing is part of “cost accounting,” which aims to capture, record and allocate production costs. Costs are assigned to specific inventory items, including raw materials, works-in-process and finished goods, to determine a manufacturer’s cost of goods sold and the value of its ending inventory (the inventory still in-house at the end of a financial reporting period). This method includes tracking and categorizing direct costs, like raw materials and direct labor, and indirect costs, like manufacturing overhead.

What is manufacturing inventory?

Manufacturing inventory refers to all the materials and goods that a manufacturing company has on hand at any given time. It is usually bucketed into three categories (each of which is tracked and valued separately for accounting purposes):

  • Raw materials — basic components that are the inputs into manufacturing processes.
  • Works-in-process — items being manufactured but not yet finished.
  • Finished goods — completed products ready for sale.

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

The three types of inventory in a manufacturing company are raw materials, work-in-process and finished goods.