Merchandising Company vs. Manufacturing Company - Online Tutor, Practice Problems & Exam Prep

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

Alright. Let's quickly discuss the difference between a merchandising company and a manufacturing company. Alright. Let's start here with merchandisers. We've talked about this a little bit before. A merchandising company, they're going to have one main inventory account, right? And merchandising companies like we said, they resell goods, right? They buy stuff that's already finished and they resell it to someone else, usually the final customer, right? So, it would be like a situation of a company that buys t-shirts and then resells them as t-shirts already, right? So we usually call this inventory account, we call it inventory, excuse me inventory. Sometimes you'll see it called merchandise inventory, right? But it means the same thing.

So in a merchandising company, we would see something like this, XYZ Company purchases goods from its supplier for $10,000 on account. Well, of course, we might have talked about the periodic system, the perpetual system. Let's just say it's a perpetual system and we're just putting everything in inventory. So in this case, we would purchase goods, right? So we're buying inventory from the supplier on account. So, our entry, pretty simple like we've done before. We would debit our inventory to increase inventory and that would be $10,000, and then we would increase our accounts payable, right? We didn't pay them in cash, we gave them an IOU and that would be a credit, right? Liabilities go up with a credit, so this entry would be complete. This is something you've probably seen before in this class already. So we're seeing that inventory has gone up by $10,000. Our accounts payable AP went up by $10,000, right? So our equation stays balanced here. Alright? So a merchandising company, remember these are just resellers. This is stuff we've dealt with before. Now, let's compare it to a manufacturing company in the coming-up video. Let's do it now.

Manufacturing Companies

Alright. So let's continue here with the manufacturing company. I just want to note that in your first accounting class, you don't really go into a lot of depth with manufacturing companies. I just want to expose you to the difference here, okay? So a manufacturing company is going to have 3 inventory accounts, okay? And manufacturers, well, they're the ones that are actually producing goods, right? They're taking raw materials and turning them into a finished product, okay? So, we're going to have 3 inventories when we deal with a manufacturing company. The first one is those raw materials, and these are the inputs into the production, okay? So if you think this is a company that bakes cookies, well the inputs, you know, they would buy sugar, they would buy flour, whatever you need to make the cookies and then this is what the company is actually purchasing, right? The company actually purchases the raw materials and then they're going to take those raw materials and turn them into a finished product. So the raw materials inventory, we usually just abbreviate it RM for raw materials and then we've got work in process inventory which that is going to be WIP is what we usually call that, the work in process. So you have to think, there's going to be a cut-off point when we say how much inventory do we have at this date? Well, on that date, there's going to be some cookies that maybe were still in production or whatever kind of company there might be some that's still in production. Well, that would be work in process inventory, okay? And then all the goods once you put it all through production, they're going to be finished goods, right? This is what we sell to the customer. So, that's going to be FG for our finished goods inventory and remember in this class, we don't go into so much detail. Probably just knowing that these are the names of the accounts and how it flows will be enough, okay?

So what we see in a manufacturing company, they have their raw materials inventory, RM inventory, their work in process inventory. So remember, these are all separate balance sheet accounts for inventory. Their finished goods inventory. Right? They have those 3 and then we'll get to the last one. So the company is going to purchase stuff here, right? They're going to buy raw raw materials inventory and then as they use it, right, and remember this is a debit here for raw materials, they're going to start using it, right? They bought flour and sugar and they're going to put it into production. So at that point, they would take it out of raw materials right here and they would put it into a work in process, right? We don't have to worry about the details too much. So it would be in the work in process inventory. We would work on it and eventually, it would make its way out. And just so you know, we add some stuff in work in process, right? This is maybe the labor of the person making the cookies or whatever. So all this stuff in work in process, we're going to finish it and then we're going to take it out of work in process, right? We're going to credit it out of work in process when it's finished, and it's going to make its way down to the finished goods inventory. Right? And we'll have that value there and what's going to happen in the finished goods inventory? At this point, we're eventually going to sell this product to the customers, right? The customers are going to come in and buy the product and it's going to go to cost of goods sold, right? The cost of goods sold. So from the finished inventory, when we sell it, it ends up on the income statement as an expense. Okay?

So don't worry too much about the details here, just notice the flow, right? We buy raw materials, we turn it into a finished good, and then we sell it and it goes to cost of goods sold. Cool? Alright. Let's go ahead and move on to the next video.

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.