Tuesday, October 27, 2009

Inventory in a Manufacturing Firm

Tracking inventory in a manufacturing firm is more difficult than in other types of businesses. When you boil everything down to its essence, the problem stems from a couple of tricky accounting requirements:

  • In a manufacturing environment, the manufacturer combines raw materials items into finished goods items. This means—and this is the challenging part—that the manufacturing process reduces the inventory count and value for some items (the raw materials or the components) while at the same time it increases the count and value of the other, finished goods items.

  • In a manufacturing environment, the rules say that you don't just count the value of items in the finished goods item inventory values. You also count the cost of labor and factory overhead used in manufacturing the items.

QuickBooks solves the first problem related to manufacturing inventory; however, QuickBooks doesn't solve or address the second problem. Fortunately, as long as you're a small manufacturer, you probably don't need to worry too much about the second problem. You should ask your CPA about this. But don't worry—Congress and the Internal Revenue Service have provided a bunch of loopholes for making the accounting easier for the small guys.

Manufactured Inventory the Simple Way

If you're using QuickBooks Pro or some earlier versions of QuickBooks Premier, you don't have the capability to account for the manufacture of inventory in QuickBooks. The best that you can do is to use group items to combine into individual items on a customer's invoice. This approach sounds sloppy, but it isn't quite as bad as you may think at first blush. You can choose to show only the group item on a customer invoice. This means—getting back to the example of the florist selling red roses and vases—that the florist can "manufacture" a crystal vase of a dozen red roses and then show the manufactured item as a group item on the customer's invoice.

The one thing that's problematic about the "just use a group item" approach is that it doesn't give you a way to track the finished goods' inventory values.

Inventory Accounting in QuickBooks Premier

To account for the manufacture of inventory in QuickBooks Premier, you add inventory assembly items to the Item list for those items that you manufacture. You also record the manufacture of items as you, well, manufacture them.

For example, suppose that Pine Lake Porcelain mostly just buys and resells coffee mugs and other porcelain doodads. But also suppose that once a year, Pine Lake Porcelain assembles a collection of red coffee mugs into a boxed St. Valentine's Day gift set. In this case, QuickBooks can record the assembly of a boxed gift set that combines, for example, four red coffee mugs, a cardboard box, and some tissue wrapping paper.

Adding Inventory Assembly Items

To describe manufactured items, follow these steps:

  1. Choose Lists ð Item List.

    QuickBooks displays the Item List window.

  2. Click the Item button in the Item List window and select New from the drop-down list.

    QuickBooks displays the New Item window.

  3. Select the Inventory Assembly item from the Type drop-down list.

    QuickBooks displays the Inventory Assembly version of the New Item window, as shown below.

    The Inventory Assembly version of the New Item window

  4. Specify the account to use for tracking this item's cost when you sell it.

    QuickBooks suggests the Cost of Goods Sold account. If you've created other accounts for your COGS, however, select the other appropriate account.

  5. Describe the manufactured item.

    Type in a description of the item that you want to appear on documents, such as invoices and so on, that your customers see. (QuickBooks suggests the same description that you used in the Description on Purchase Transactions text box as a default.)

  6. Enter the amount that you charge for the item into the Sales Price box.

  7. Indicate whether the manufactured item is subject to sales tax using the Tax Code box.

  8. Use the Income Account box to specify the account that you want QuickBooks to use for tracking the income from the sale of the item.

  9. Identify the components that go into the finished item.

    Use the Components Needed list to identify the individual component items and the quantities needed to make the inventory assembly. Each component item goes on a separate line in the list. Not to be too redundant, but do note that you both identify the component item and the number of component items needed.

  10. Identify the Asset Account.

    Specify the other current asset account that you want QuickBooks to use for tracking this inventory item's value.

  11. Select a Build Point.

    Use the Build Point box to specify the lowest inventory quantity of this item that can remain before you manufacture more. When the inventory level drops to this quantity, QuickBooks adds a Reminder to the Reminders list, notifying you that you need to make more of the item.

  12. Ignore the On Hand and the Total Value boxes.

    See that On Hand box? Leave it set to zero. To enter a number now is to record an uncategorized transaction, and you don't want to do that. Go ahead and leave the Total Value field set to zero, too. You can also leave the As Of box empty, or you can enter the current date here. It doesn't matter.

Recording Manufacture or Assembly of Items

To build some assembly, choose the Vendors ð Inventory Activities ð Build Assemblies command. QuickBooks displays the Build Assemblies window, as shown. All you do is select the thing that you want to build from the Assembly Item drop-down list and then the quantity that you (or some hapless co-worker) have built in the Quantity to Build box. (In Figure 1, I've created an assembly—ValentineBox—which consists of some colorful coffee mugs, an attractive gift box, and some scented tissue paper.) Then you click either the Build & Close or Build & New button. (Click the Build & New button if you want to record the assembly of some other items.)

Figure 1: The Build Assemblies version of the New Item window

While I'm on the subject, let me make a handful of observations about the Build Assemblies window and the Build Assemblies command:

  • In the top-right corner of the window, QuickBooks shows the quantities of the assembly that you have on hand and for which customers have placed orders. That's pretty useful information to have, so, hey, remember that it's there.

  • A table in the Build Assemblies window shows you what goes into your product. Not that you care, but this is a bill of materials.

  • At the bottom of the bill of materials list, QuickBooks shows you the maximum number of assemblies that you can make, given your current inventory holdings.

  • When you build an item, QuickBooks adjusts the inventory item counts. For example, in the case where you make boxed gift sets, each with four red coffee mugs and two wrapping tissues, QuickBooks reduces the item counts of red coffee mugs and wrapping tissues and increases the item counts of the boxed gift sets when you record building the assembly.

Some of the components used in an assembly may not be inventory items. You can use non-inventory parts in an assembly.

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