Cost of Goods Manufactured

Learning Outcomes

  • Describe the flow of costs for a manufacturing company

A manufacturing company has three general categories of inventory:

  • Raw materials
  • Work in process
  • Finished Goods

Raw materials consist of both direct materials and indirect materials.

Work in process are products that are not yet ready for sale.

Finished goods are products that are completely done and ready to go out the door.

Let’s look at an example.

ClockCo makes clocks. The gears and casings they buy from their supplier are the direct raw materials the employees will convert into clocks. Each clock gets a certain number of gears and one case. However, the paint the company purchases in 5-gallon buckets are spread out over a number of clocks and can’t be traced to any one particular clock (cost object), and paint is treated as indirect materials and therefore is part of manufacturing overhead (MOH).

Remember that manufacturing overhead is anything that can’t be directly assigned to a specific product.

Two images. The first image shows gears and states "Purchase direct raw materials (parts used in production). The second image shows a splatter of paint and says "Purchase indirect raw materials (paint)".

Assuming ClockCo has no clocks in production yet, the company only has raw materials inventory. However, as the company moves gears into the production line and starts painting, raw materials inventory is reduced, and a new category of inventory called Work in Process arises.

On the left is an area called Raw Materials with two images. The first image shows gears and states "Use raw materials in production (gears)". The second image below that shows a splatter of paint and says "Use indirect raw materials in production (paint)". To the right is an area called Work in Process with an image of the gears again labeled as "Direct Materials". Below that is an image of the paint splatter again labeled "Manufacturing Overhead".

Work in process also includes direct and indirect labor and other manufacturing overhead costs.

On the left is an area called Raw Materials with two images. The first image shows gears and states "Use raw materials in production (gears)". The second image below that shows a splatter of paint and says "Use indirect raw materials in production (paint)". To the right is an area called Work in Process with an image of the gears again labeled as "Direct Materials". Below that is an image of people labeled "Direct Labor" and it says "Add direct labor to convert raw materials to finished goods". Below that is an image of the paint splatter and people again labeled "Manufacturing Overhead" and it says "Add indirect labor (production supervision) and indirect materials".

As a clock is finished, all of the costs associated with building that clock (prime and conversion costs) are transferred to an inventory account called Finished Goods.

On the left is an area called Raw Materials with two images. The first image shows gears and states "Use raw materials in production (gears)". The second image below that shows a splatter of paint and says "Use indirect raw materials in production (paint)". To the right is an area called Work in Process with an image of the gears again that says “Needs more direct materials (prime cost)”. Below that is an image a person that says “Needs more direct labor (prime and conversion). Below that is an image of the paint splatter and person again. To the right is an area called Finished Goods. This area has images of gears, paint splatters, and people and states “Allocate manufacturing overhead to finished product - total cost = DM + DL + MOH”.

Cost of goods manufactured is the total of all the raw materials, direct labor, and allocated manufacturing overhead used during the period to create completed products.

Determine transfers from Raw Materials to Work in Process and from Work in Process to Finished Goods inventory accounts according to this formula:

Beginning inventory balance + additions during the month – ending inventory balance = transfers out.

RAW MATERIALS

For instance, assume ABC Manufacturing Company had $12,000 in raw materials at the beginning of July, determined by taking a physical count at the end of June and assigning costs to the items.

During the month, the company bought $160,000 of raw materials. We’ll assume for this example that all raw materials are direct materials, just to simplify the calculations.

Raw materials available for use during the month were $172,000 (12,000+160,000). At the end of the month, a physical count established that the cost of ending raw materials inventory was $5,000. Therefore, raw materials used up during the month (transferred to Work in Process) was $167,000 (172,000 – 5,000).

Description Amount
Direct Materials Used:
      Beginning Direct Materials $ 12,000
      Purchases of Direct Materials (including Freight In) 160,000
      Direct Materials Available for Use Single Line172,000
      Ending Direct Materials (5,000)
Direct Materials Used Single Line167,000

WORK IN PROCESS

Assume ABC incurred $88,000 in direct labor and $90,000 in manufacturing overhead. Total costs incurred in the manufacturing process would then be $345,000 as shown below.

Description Amount Total
Direct Materials Used 167,000
Direct Labor 88,000
Manufacturing Overhead 90,000
Total Manufacturing Costs Incurred during the Year Single Line 345,000

 

The total manufacturing costs we need to account for include the $345,000 in July costs, plus work in process from June. Let’s assume that amount was $66,000. Most likely, those products were finished in July (although that’s not necessarily true). In any case, for July, we have the $66,000 in work in process carried forward plus $345,000 in new costs for a total of $411,000.

Description Amount Total
Beginning Work-in-Process Inventory $ 66,000
Direct Materials Used:
      Beginning Direct Materials $ 12,000
      Purchases of Direct Materials (including Freight In) 160,000
      Direct Materials Available for Use Single Line172,000
      Ending Direct Materials (5,000)
Direct Materials Used Single Line167,000
Direct Labor 88,000
Manufacturing Overhead 90,000
Total Manufacturing Costs Incurred during the Year Single Line 345,000
Total Manufacturing Costs to Account For Single Line411,000

 

It’s likely at this point that we either know, from a physical count:

  1. Cost of ending work in process, or
  2. Cost of goods manufactured (completed and ready to be sold).

In this managerial accounting course, you’ll be learning how to calculate those amounts using either job costing or process costing, but for now, let’s assume we know the cost of goods manufactured is $395,000. For instance, we could have calculated that our cost per unit, taking into account direct materials, direct labor, and allocated manufacturing overhead, is $395, and we manufacture 1,000 completed units. Therefore, the cost of items sitting in work in process–started but not yet completed–is $16,000 (411,000 – 395,000).

Now we can complete the schedule of cost of goods manufactured.

ABC Manufacturing Company
Schedule of Cost of Goods Manufactured
Month Ended July 31, 2021
Description Amount Total
Beginning Work-in-Process Inventory $ 66,000
Direct Materials Used:
      Beginning Direct Materials $ 12,000
      Purchases of Direct Materials (including Freight In) 160,000
      Direct Materials Available for Use Single Line172,000
      Ending Direct Materials (5,000)
Direct Materials Used Single Line167,000
Direct Labor 88,000
Manufacturing Overhead 90,000
Total Manufacturing Costs Incurred during the Year Single Line 345,000
Total Manufacturing Costs to Account For Single Line411,000
Ending Work-in-Process Inventory (16,000)
Cost of Goods Manufactured Single Line$ 395,000Double line

 

Here is a video review of how to complete a schedule of cost of goods manufactured.

You can view the transcript for “How to Prepare a Cost of Goods Manufactured Statement (Cost Accounting Tutorial #24)” here (opens in new window).

In the next section, we’ll see how the cost of goods sold flows to the income statement, but first, let’s review cost of goods manufactured.

Flow chart for balance sheet and income statement that summarizes the work flow

 

Description Equation
Direct Materials Used Beginning Raw Materials Inventory + Raw Material Purchases – Ending Raw Materials Inventory – Indirect Materials Used
Total Manufacturing Cost Direct Materials + Direct Labor + Overhead applied
Cost of Goods Manufactured Total Manufacturing Cost (Direct Materials + Direct Labor + Overhead applied) + Beginning Work In Process Inventory – Ending Work in Process Inventory

 

Now, check your understanding of the flow of costs in a manufacturing environment:

Practice Question