Cost of goods sold is a major line item on the income statement, and it’s comprised of inventory expenses such as the cost of goods manufactured. Understanding cost of goods manufactured is important for accounting and business decision-making purposes. The better this cost flow is controlled, the more profit a manufacturing company or manufacturing plant will realize over the long-term. The following information outlines all the important concepts behind the Cost of Goods Manufactured.
What is Cost of Goods Manufactured?
Cost of goods manufactured is a component of COGS and is displayed on the income statement beneath sales. Cost of goods manufactured translates to completed work-in-progress inventory and consists of specific costs. These costs include direct materials, direct labor and total manufacturing cost or overhead costs. When gauging the efficiency and effectiveness of operations, the inventory cost of production runs plays a pivotal role. Total manufacturing costs also include the beginning and ending work in process inventory. The ending WIP inventory is determined by adding the beginning WIP inventory to the manufacturing costs and subtracting the COGM.
Cost of Goods Manufactured Formula
Accounting principles dictate that cost of goods be calculated using a specific methodology. The basic formula is as follows:
Cost of Goods Manufactured = Beginning Inventory + Production Costs – Ending Work-In Process
Production costs include direct materials, direct labor cost and factory overhead or manufacturing overhead. So, calculating the formula requires data collection and computation of subsets of costs such as raw materials inventory.
Calculating Cost of Goods Manufactured
The manufacturing process of calculating COGM may take place in an automated general ledger system, or in Excel, or in both. Large companies may have integrated data warehouses and accessible source documents, allowing accountants to easily calculate cost of goods manufactured in the general ledger application. However, it is common for accountants to download data from multiple applications into Excel, and manufacturing costs calculated using formulated worksheets. From the Cost of Goods Manufactured, a Schedule of Cost of Goods, which include the schedule of raw materials and work in process can be determined.
This calculation also allows for an accurate accounting of the manufacturing cost per unit which management will use to establish pricing and profit margins.
Purpose of the Statement of Cost of Goods Manufactured
A detailed statement of cost of goods manufactured is used to support COGS. It provides manufacturing costs separate from the total cost of goods manufactured. It also provides detail about direct material purchases and retained at the end of the accounting period, along with details about direct or indirect labor and manufacturing overhead. This statement gives management and accountants metrics to manage operations and identify operational efficiencies. Accounting can use this statement to identify errors in the record keeping process and financial statements.
When analyzing the profit and loss statement, COGS plays an integral role in determining gross margin and the profitability of a business, before operating and non-operating expenses. Cost of goods manufactured is incorporated into the cost of goods sold, impacting the income statement, finished goods inventory, and business decision-making.