A chart of accounts for a business that makes things

Most small-business charts of accounts have one inventory account and one cost of sales account. That works until you make anything, at which point you can no longer answer the only question that matters: what did the goods you sold actually cost to produce?

Split inventory four ways

• Raw materials — bought and not yet issued to production
• Work in process — issued and not yet finished
• Packing materials — kept separate because they are consumed at a different point and are often a meaningful cost on their own
• Finished goods — complete and available to sell

Each is an asset, and the movement between them is what a cost of goods manufactured schedule describes. With one combined inventory account that schedule cannot be produced from the ledger at all — it has to be rebuilt from stock records every period, by hand, and then it does not tie.

Split cost of sales three ways

• Direct materials — what went into the product
• Direct labour — the people who made it
• Factory overhead — power, depreciation on plant, factory rent: real costs of production that are not traceable to a single unit

The distinction that matters here is between factory overhead and administrative expense. Both are overheads; only one belongs in the cost of what you made. Putting factory power in administrative expense understates cost of sales and overstates gross margin, and the error compounds because it also mis-values closing inventory.

Make the roll-forwards identities, not formulas

Closing work in process equals opening plus debits less credits. That is an identity — it is true because of how the account works, not because of a calculation you performed. The same for finished goods.

Building the schedule this way means cost of goods sold is what actually left stock, and the last line shows how much of that was written off rather than sold. Building it as a formula means it agrees with the ledger only when you have anticipated every kind of movement, which you have not.

Why a retailer should use the same structure

For a business that does no manufacturing, the schedule collapses to opening plus purchases less closing — which is exactly the periodic cost of sales a retailer expects to see. Nothing is lost by having the structure available and unused, and the day a shop starts making its own product, the accounts are already there.

One rule about the tree

Group headings must not be postable. If a balance can sit on "Inventories" as well as on "Raw materials" beneath it, every grouped statement has to choose between double-counting the parent and dropping it, and different reports will make that choice differently. Enforce it at the point of posting rather than by convention.