2.1 Distinguish between Merchandising, Manufacturing, and Service Organizations
3 min read•june 18, 2024
Organizations come in three main flavors: , , and . Each type has unique characteristics that shape how they operate and manage costs. Understanding these differences is crucial for effective managerial accounting and decision-making.
firms buy and resell products, focusing on management. companies transform raw materials into finished goods, dealing with complex production costs. offer intangible benefits, primarily managing labor and overhead expenses. These distinctions impact cost calculations and strategic considerations.
Types of Organizations
Characteristics of business organization types
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- Merchandising organizations
- Purchase and resell them without altering their basic form (clothing, electronics, groceries)
- Focus on buying products, managing inventory levels, and selling goods to customers
- Cost structure mainly includes (price paid for products purchased for resale) and operating expenses (selling and administrative costs)
- Utilize management to optimize product flow from suppliers to customers
- Manufacturing organizations
- Acquire raw materials and transform them into finished products using a production process (automobiles, furniture, processed foods)
- Engage in purchasing materials, overseeing production operations, and selling the manufactured goods
- Cost structure encompasses (raw materials directly used in the product), (labor costs for manufacturing), (indirect factory costs like utilities and maintenance), and operating expenses (selling and administrative costs)
- May implement systems to reduce carrying costs and improve efficiency
- Service organizations
- Offer intangible services or activities to clients (consulting, healthcare, education)
- Deliver services to customers using the knowledge, skills, and expertise of their workforce
- Cost structure primarily consists of operating expenses (costs incurred to deliver services, such as labor, supplies, and overhead)
- Generally do not have a since they do not sell tangible products
Cost of goods sold calculation differences
- Merchandising firms
- Calculate cost of goods sold using the formula:
- represents the cost of products on hand at the start of the period
- Purchases include the cost of products acquired during the period
- is the cost of products remaining at the end of the period
- Determine by subtracting cost of goods sold from :
- Calculate cost of goods sold using the formula:
- Manufacturing firms
- Compute cost of goods sold using a different formula:
- is the cost of completed products available at the start of the period
- represents the total product cost incurred during the period
- is the cost of completed products on hand at the end of the period
- Calculate by adding used, , and :
- Determine gross profit by subtracting cost of goods sold from net sales, similar to merchandising firms
- Compute cost of goods sold using a different formula:
Revenue and costs in service organizations
- Revenue sources
- Charge fees for services provided (hourly billing rates for consultants, project fees for architects, retainer fees for lawyers)
- Collect subscription or membership fees for continuous access to services (gym memberships, software-as-a-service)
- Earn commission income by facilitating transactions or sales (real estate agents, insurance brokers)
- Major cost categories
- Direct labor costs for employees who directly provide services to clients (wages for consultants, healthcare professionals)
- Supplies and materials used in delivering services (medical supplies, training materials)
- Overhead costs associated with facilities, equipment, and support functions (rent, utilities, administrative staff salaries)
- Selling and administrative expenses related to marketing, customer service, and general management (advertising, customer support, executive salaries)
Strategic considerations across organization types
- analysis: Organizations assess and optimize activities that add value to their products or services, from design to customer support
- management: Firms adapt strategies and operations as products move through introduction, growth, maturity, and decline stages
- : Organizations seek to achieve cost advantages by increasing production or service delivery scale, particularly in manufacturing and some service industries
Key Terms to Review (47)
Balance Sheet: The balance sheet is a financial statement that provides a snapshot of a company's assets, liabilities, and equity at a specific point in time. It is a fundamental tool for understanding a company's financial position and is crucial for both merchandising, manufacturing, and service organizations.
Beginning Finished Goods Inventory: The beginning finished goods inventory refers to the value of completed products available at the start of an accounting period, before any additional production or sales have occurred. It represents the leftover finished goods from the previous period that are carried forward to the current period.
Beginning Merchandise Inventory: Beginning merchandise inventory refers to the value of goods available for sale at the start of an accounting period. It represents the leftover inventory from the previous period and is a crucial component in determining the cost of goods sold and net income for the current period.
Contribution margin: Contribution margin is the amount remaining from sales revenue after variable expenses have been deducted. It is used to cover fixed expenses and contribute to profits.
Contribution Margin: Contribution margin is the amount of revenue that remains after deducting the variable costs associated with producing a product or service. It represents the portion of sales revenue that contributes to covering fixed costs and generating profit. This concept is crucial in understanding the financial performance and decision-making processes of organizations, whether they are merchandising, manufacturing, or service-based entities.
Conversion costs: Conversion costs are the combined costs of direct labor and manufacturing overhead incurred to transform raw materials into finished goods. These costs are crucial for determining the total production cost in manufacturing environments.
Conversion Costs: Conversion costs refer to the costs incurred in the manufacturing process to convert raw materials into finished goods. These costs are associated with the transformation of inputs into outputs and include direct labor and manufacturing overhead expenses. Conversion costs are a critical component in understanding the total product costs for manufacturing organizations, as well as in the application of costing methods like job order costing and process costing.
Cost of goods manufactured: Cost of Goods Manufactured (COGM) represents the total production cost incurred by a company to produce goods in a specific period. It includes direct materials, direct labor, and manufacturing overhead costs.
Cost of Goods Manufactured: The cost of goods manufactured (COGM) refers to the total cost of producing finished goods during a specific accounting period in a manufacturing organization. It represents the sum of direct materials, direct labor, and manufacturing overhead incurred in the production process.
Cost of goods sold: Cost of Goods Sold (COGS) represents the direct costs attributable to the production of goods sold by a company. This amount includes the cost of materials and labor directly used to create the product.
Cost of Goods Sold: Cost of Goods Sold (COGS) represents the direct costs associated with the production or acquisition of the goods or services sold by a business during a specific accounting period. It is a fundamental concept in managerial accounting that helps organizations track and manage their inventory and profitability.
Direct labor: Direct labor refers to the wages and salaries of employees who are directly involved in the production of goods or services. This cost is directly traceable to specific products or jobs within a manufacturing environment.
Direct Labor: Direct labor refers to the cost of the workforce directly involved in the production of goods or the provision of services. It encompasses the wages and salaries paid to employees who physically transform raw materials into finished products or perform tasks that are essential to the completion of a service.
Direct materials: Direct materials are raw materials that can be directly traced to the production of a specific product. These materials are essential components in manufacturing and are included in the cost of goods sold.
Direct Materials: Direct materials are the raw materials that can be directly traced to the production of a specific product. They are a key component of product costs, along with direct labor and manufacturing overhead, and are a crucial element in understanding the differences between merchandising, manufacturing, and service organizations, as well as the various costing methods used in managerial accounting.
Economies of Scale: Economies of scale refer to the cost advantages that businesses can exploit by expanding their scale of production. As a company increases its output, its average costs per unit typically decrease due to more efficient utilization of resources and processes.
Ending Finished Goods Inventory: Ending finished goods inventory refers to the value of completed products that a manufacturing organization has on hand at the end of an accounting period. It represents the cost of goods that have been manufactured but not yet sold, and it is a crucial component in determining a company's cost of goods sold and net income for the period.
Ending Merchandise Inventory: Ending merchandise inventory refers to the value of goods or products that a business has on hand at the end of an accounting period, which is typically the end of a fiscal year or quarter. It represents the unsold portion of a company's total merchandise inventory and is a critical component in determining the cost of goods sold and the overall profitability of a merchandising organization.
Finished goods inventory: Finished goods inventory consists of products that have completed the manufacturing process but have not yet been sold to customers. These goods are ready for sale and are accounted for as an asset on the balance sheet.
Finished Goods Inventory: Finished goods inventory refers to the completed products that are ready for sale to customers in a manufacturing organization. It represents the final stage of the production process, where the manufactured goods are held in storage awaiting distribution and sale.
Gross Profit: Gross profit is the difference between a company's net sales and the cost of goods sold. It represents the amount of revenue a business retains after accounting for the direct costs associated with producing or acquiring the goods or services it sells. This metric is crucial in understanding a company's profitability and financial performance across different business models, including merchandising, manufacturing, and service organizations.
Income Statement: An income statement is a financial report that summarizes a company's revenues, expenses, and profits or losses over a specific period. It provides insight into a company's operational performance and is crucial for assessing profitability. The income statement varies based on the type of organization, including merchandising, manufacturing, and service organizations, as each has different revenue recognition and expense reporting methods.
Intangible products: Intangible products are goods that lack physical substance and cannot be touched or stored. Common examples include services, digital products, and intellectual property.
Inventory: Inventory refers to the stock of goods, materials, and supplies that a business holds for the purpose of resale or use in the production of goods and services. It is a crucial component in the operations of merchandising, manufacturing, and service organizations, as it represents the physical assets that are central to their business activities.
Just-In-Time Inventory: Just-in-time (JIT) inventory is a production and inventory control strategy that aims to improve a business's efficiency, competitiveness, and profitability by receiving goods only as they are needed in the production process, thereby reducing inventory costs and storage requirements. This approach is closely connected to trends in today's business environment and the distinctions between different types of organizations.
Manufacturing: Manufacturing is the process of converting raw materials into finished products through the use of labor, machinery, and chemical processes. It involves various stages such as production planning, quality control, and inventory management to ensure efficient production operations.
Manufacturing: Manufacturing is the process of transforming raw materials, components, or parts into finished goods that have economic value. It involves the use of tools, machinery, and labor to create products that can be sold or distributed for consumption. Manufacturing is a critical component of many organizations, distinguishing them from merchandising and service-based businesses.
Manufacturing organization: A manufacturing organization is a business entity that uses raw materials, labor, and equipment to produce finished goods. These goods are then sold to customers or other businesses.
Manufacturing overhead: Manufacturing overhead includes all indirect costs associated with the production process, such as utilities, maintenance, and factory supplies. It does not include direct materials or direct labor costs.
Manufacturing Overhead: Manufacturing overhead refers to the indirect costs associated with the production of goods in a manufacturing organization. These are the costs that cannot be directly traced to a specific product but are necessary for the overall manufacturing process. Manufacturing overhead encompasses a wide range of expenses, including indirect materials, indirect labor, and other factory-related costs.
Merchandise Inventory: Merchandise inventory refers to the goods held for sale in a merchandising or retail organization. It represents the stock of products available for customers to purchase, which is a critical component of the company's operations and financial performance.
Merchandising: Merchandising involves purchasing finished goods and reselling them to consumers. It covers activities such as inventory management, pricing, and promotional strategies to attract customers.
Merchandising: Merchandising refers to the process of promoting and selling products to customers in a retail setting. It involves various strategies and techniques used to present, display, and market goods in a way that attracts and influences consumer purchasing decisions.
Merchandising firm: A merchandising firm is a business that purchases finished products and resells them to consumers or other businesses. Unlike manufacturing firms, they do not produce the goods they sell but focus on distribution and sales.
Net Sales: Net sales refers to the total revenue generated from the sale of goods or services, minus any discounts, returns, and allowances. It represents the actual amount of money a business receives from its customers after accounting for these deductions, and is a crucial metric for understanding a company's financial performance and profitability.
Periodic Inventory System: A periodic inventory system is an accounting method used to track and value a company's inventory. It involves taking a physical count of the inventory at the end of an accounting period, such as monthly or annually, to determine the cost of goods sold and the value of the remaining inventory.
Perpetual Inventory System: A perpetual inventory system is an inventory management method that continuously tracks the quantity and value of inventory in real-time. It provides up-to-date information on the current stock levels, allowing for better control and decision-making regarding inventory management.
Prime costs: Prime costs are the direct costs of production, which include direct materials and direct labor. These costs are directly attributable to the manufacturing process and are essential for producing goods.
Prime Costs: Prime costs are the direct costs associated with the production of a product or the provision of a service. They represent the fundamental expenses incurred in the core operations of a business, encompassing the essential elements required to create the final output.
Product Life Cycle: The product life cycle refers to the stages a product goes through from its introduction to the market until its eventual decline or withdrawal. It is a fundamental concept in understanding the dynamics of product management and marketing strategies across different types of organizations.
Service: Service refers to intangible activities or benefits provided by one party to another, often involving expertise or labor. Unlike goods, services do not result in ownership of anything tangible.
Service organization: Service organizations provide intangible products or services to customers rather than physical goods. Examples include consulting firms, hotels, and healthcare providers.
Service Organizations: Service organizations are businesses that provide intangible products or services to customers, rather than physical goods. These organizations focus on meeting the needs and demands of their clients through the expertise, knowledge, and labor of their employees, rather than the sale of merchandise.
Supply Chain: A supply chain is the network of organizations, people, activities, information, and resources involved in the production, distribution, and sale of a product or service. It encompasses the entire process from sourcing raw materials to delivering the final product or service to the customer.
Tangible products: Tangible products are physical items that can be touched, seen, and measured. These products are produced by manufacturing or merchandising organizations and include goods like electronics, clothing, and furniture.
Value Chain: The value chain is a framework that describes the full range of activities required to bring a product or service from conception to its end use and beyond. It encompasses the entire process of transforming raw materials into a final product or service that is delivered to the customer, with each step adding value along the way.
Work-in-Process Inventory: Work-in-process inventory refers to the partially completed goods that are currently in the manufacturing process, awaiting further processing before becoming finished products. It represents the costs incurred for materials, labor, and overhead associated with goods that are not yet ready for sale.