How to Calculate Cost of Goods Manufactured?

Cost of Goods Manufactured (COGM) represents the total cost associated with products completed and moved from work-in-process inventory to finished goods inventory during a specific accounting period. This metric provides a clear picture of the expenses incurred to transform raw materials into sellable products. Understanding COGM allows companies to assess their production efficiency and gauge the true cost of each unit produced. It directly impacts financial reporting, helping businesses determine profitability by comparing manufacturing costs against sales revenue, and is also crucial for internal decision-making regarding pricing strategies and production planning.

Components of Manufacturing Costs

Manufacturing a product involves three primary cost categories that are carefully tracked by businesses. These costs combine to form the total expense of creating goods within a specific period. Proper classification of these expenses is important for accurate financial reporting and tax compliance.

Direct materials are the raw inputs that become an integral and traceable part of the finished product. Examples include the lumber used to build furniture, the fabric for clothing, or the steel for car frames. The cost of direct materials includes the purchase price, less any trade discounts, plus transportation costs and other expenses incurred to acquire the materials. Businesses must track these costs to ensure accurate inventory valuation and proper expense recognition.

Direct labor refers to the wages paid to employees who physically work on converting raw materials into finished goods. This includes the salaries of assembly line workers, machinists, or bakers directly involved in production. These costs are directly tied to the production volume and increase or decrease with the number of units manufactured.

Manufacturing overhead encompasses all other indirect costs associated with the production process that are not direct materials or direct labor. Examples include indirect materials like lubricants for machinery, indirect labor such as factory supervisors’ salaries, factory rent, utilities for the production facility, and depreciation on manufacturing equipment. Under the “full absorption” method of inventory costing, both direct and indirect production costs must be included in inventoriable costs. This means allocating a portion of these indirect costs to each unit produced, ensuring a comprehensive view of total manufacturing expense. (IRC 471 and IRC 1.471-11 govern aspects of these cost classifications).

Understanding Inventory in Manufacturing

Manufacturing companies track three types of inventory, each representing a different stage in the production cycle. Changes in these inventory balances directly influence the final COGM figure.

Raw materials inventory consists of basic inputs a company purchases before they enter the production process. This includes items like unrefined metals, raw chemicals, or unprocessed agricultural products. To determine the direct materials used in production, businesses add their beginning raw materials inventory to new purchases and then subtract their ending raw materials inventory.

Work-in-process (WIP) inventory represents goods that have begun the manufacturing process but are not yet completed. These partially finished products have incurred some direct material, direct labor, and manufacturing overhead costs. The beginning WIP inventory reflects the value of partially completed goods carried over from the previous period. The ending WIP inventory includes the value of goods still in production at the close of the current period. These beginning and ending balances are adjustments in the COGM calculation, ensuring only costs of completed goods are captured.

Finished goods inventory comprises products that have completed the manufacturing process and are ready for sale. COGM represents the value of goods transferred into finished goods inventory, but the finished goods inventory balance itself is not a direct component in the COGM calculation.

Calculating Cost of Goods Manufactured

Calculating COGM involves combining all production costs and adjusting for changes in work-in-process inventory. The process begins by determining total manufacturing costs incurred during the period, then adjusting for partially completed goods.

The first step is to calculate the total manufacturing costs incurred during the specific period. This sum includes the direct materials used, the direct labor costs, and the allocated manufacturing overhead. For instance, if a company used $50,000 in direct materials, incurred $30,000 in direct labor wages, and allocated $20,000 in manufacturing overhead for the month, its total manufacturing costs incurred would be $100,000.

Once total manufacturing costs incurred are determined, the calculation incorporates work-in-process inventory balances. The beginning work-in-process inventory is added to the total manufacturing costs incurred.

Finally, the ending work-in-process inventory is subtracted from this sum. The resulting figure is the Cost of Goods Manufactured.

For example, assume a company has $15,000 in beginning work-in-process inventory. During the period, it incurs $50,000 in direct materials used, $30,000 in direct labor, and $20,000 in manufacturing overhead. This results in total manufacturing costs incurred of $100,000. If the ending work-in-process inventory is $10,000, the calculation would be: $15,000 (Beginning WIP) + $100,000 (Total Manufacturing Costs Incurred) – $10,000 (Ending WIP) = $105,000 (Cost of Goods Manufactured).