Let me take a long walk of a short plank and see if I can help.
First, let me say that I am making no assumptions about how much or
how little you know about accounting. I just want to start off with
first principles. I am no account, but for a variety of reasons know a
wee bit (making it very dangerous)
first point: we have revenue, expenses, assets, liabilities and
next: revenue and expenses are recorded on the income statement
assets and liabilities are recorded on the balance sheet.
second: assets are entities to provided future economic benefit. You
give up money, time and materials to acquire assets which then at
some time in the future are exchanged (sold) for money or something
else. The main point about an asset is that its benefit is not
realized until some future date.
third: whether it be a big shop or a little one that makes something
to sell, three major entities go into making the thing it will sell in
the future. These are raw materials, direct manufacturing labour, and
shop overhead. The overhead include resources forgone that cannot be
traced to making the finished good in an economically feasible manner
so we have to allocate what we believe is a reasonable portion.
So the raw materials are assets. As one works on the raw materials to
create the item costs are recorded in what is known as the
Work-in-Process account. This account is an asset account. Once the
work, is completed we can add the cost of the overhead. Now we have a
Finished Good. This is still an asset. (Noticed that we have not used
the word “inventory”.)
When we sell the finished good we immediately recognize income (cash,
account receivable) and match it with an appropriate expense, in this
case, the Cost of the Finished Good Sold. At this instant the
finished good, having future economic benefit, becomes converted from
being asset to being an expense, a resource immediately foregone to
acquire a benefit (in this case, income). The selling provides sales,
the departure of the good is the cost of sales leaving a gross profit.
As far as I know, these are some of the very basic principles to
managing the accounting side of a business.
May I suggest that you try tracking the cost of the creation and sale
of a single item on paper alone.
Let’s pretend it is a sterling brooch.
Cost of the a sheet of silver. Fraction of the sheet used to make the
brooch. therefore cost of the Raw Material + cost of the pin back
findings. + Hours worked on the brooch x cost of labour. Direct
Manufacturing Labour + Hours worked on the brooch x cost of the
overhead. Manufacturing Overhead (the solder, gas, etc) = cost of the
finished brooch. Finished Good (asset) Sale of brooch. Revenue - Cost
of brooch to make (Cost of Sale) = Gross Profit.
What I have left out is all the really difficult stuff about making
and selling a wide variety of indistinguishable goods cross over from
one year to the next. Or what you do with the scrap? Is the saw blade
broken half way through cutting the brooch out overhead or a direct
cost, etc etc?
Hope this helps. If I can help more please contact me off line.
David Popham in Victoria BC where today at 9:00 am the sun was low and
the storm had yet to break so that the landscape was magical for very
brief five minutes