How to Calculate Cost of Goods Manufactured

Understanding the Foundational Cost Elements

Manufacturing a product involves various expenses, which accountants categorize into three primary types: direct materials, direct labor, and manufacturing overhead. These cost elements combine to represent the total cost of production. Additionally, work-in-process inventory plays a significant role in tracking costs for partially completed goods.

Direct materials are the raw substances that become an integral and identifiable part of the finished product. These materials are directly traceable to the goods being manufactured. For instance, the steel used to construct a car chassis or the wood incorporated into a piece of furniture are examples of direct materials.

Direct labor represents the wages paid to employees who directly convert raw materials into finished products. These are individuals whose efforts are directly involved in the physical creation or assembly of the product. Examples include assembly line workers, machine operators, or fabric cutters in a clothing factory.

Manufacturing overhead encompasses all other manufacturing costs that are not direct materials or direct labor. These are indirect costs necessary for the production process but cannot be easily traced to a specific product unit. This category includes items such as indirect materials (like lubricants for machinery), indirect labor (such as factory supervisors’ salaries or maintenance staff wages), factory utilities, rent for the factory building, and depreciation on factory equipment.

Work-in-process (WIP) inventory refers to goods that have begun the manufacturing process but are not yet complete. This inventory holds value because direct materials, direct labor, and manufacturing overhead have already been applied to these partially finished items. Beginning Work-in-Process Inventory represents the value of partially completed goods at the start of an accounting period, while Ending Work-in-Process Inventory reflects the value of partially completed goods remaining at the end of the period.

Calculating Direct Materials Used

Determining the cost of direct materials consumed during a period is a key step in understanding total production expenses. This figure, “Direct Materials Used,” accounts for raw materials physically put into production. It reflects the value of materials drawn from inventory and converted into goods.

The calculation begins with the value of raw materials available at the start of the period. To this, the cost of any new raw material purchases made during the period is added. These purchases include freight-in costs, which are expenses incurred to bring the materials to the factory, as these are considered part of the material’s total cost.

From this combined amount, the value of any raw materials remaining in inventory at the end of the period is subtracted. The resulting figure represents the total cost of direct materials that were physically consumed in the manufacturing process during that specific timeframe. For example, if a company had $10,000 in beginning raw materials, purchased an additional $50,000, and had $8,000 remaining at period-end, the direct materials used would be $52,000 ($10,000 + $50,000 – $8,000).

Determining Total Manufacturing Costs

After calculating direct materials used, the next step is to aggregate all factory costs incurred during the current accounting period to determine total manufacturing costs. This figure represents the sum of the three primary cost elements associated with production. These costs are also referred to as current manufacturing costs, reflecting expenditures made during the present operational cycle.

The total manufacturing costs are determined by combining the previously calculated direct materials used with the direct labor and manufacturing overhead incurred. Direct labor costs include the wages of production employees, and manufacturing overhead encompasses all other indirect factory expenses.

Adding these three components provides a comprehensive view of the financial resources expended to bring products through the initial stages of production during the period. For instance, if direct materials used totaled $52,000, direct labor was $30,000, and manufacturing overhead was $40,000, the total manufacturing costs would be $122,000.

Applying the Cost of Goods Manufactured Formula

The Cost of Goods Manufactured (COGM) formula is a central calculation for manufacturers, determining the total cost of products completed and moved out of production during a specific period. This figure essentially represents the cost of goods that are now ready for sale or transfer to finished goods inventory. The formula integrates the total manufacturing costs incurred during the period with the changes in work-in-process inventory.

To calculate COGM, the beginning work-in-process inventory is added to the total manufacturing costs incurred during the period. The beginning work-in-process inventory represents the value of partially completed goods carried forward from the previous period.

From this sum, the ending work-in-process inventory is subtracted. The final result of this calculation is the Cost of Goods Manufactured, which indicates the cost associated with all the products that reached completion during the period and are now available for sale. This cost is then typically transferred to the Cost of Goods Sold calculation on a company’s income statement.

Comprehensive Calculation Example

To illustrate the calculation of Cost of Goods Manufactured, consider a hypothetical manufacturing company with the following financial data for a specific period:

• Beginning Raw Materials Inventory: $15,000
• Raw Material Purchases: $70,000
• Ending Raw Materials Inventory: $12,000
• Direct Labor: $45,000
• Manufacturing Overhead: $60,000
• Beginning Work-in-Process Inventory: $20,000
• Ending Work-in-Process Inventory: $25,000

Calculate Direct Materials Used:

Direct Materials Used = Beginning Raw Materials Inventory + Raw Material Purchases – Ending Raw Materials Inventory
Direct Materials Used = $15,000 + $70,000 – $12,000 = $73,000.

Determine Total Manufacturing Costs:

Total Manufacturing Costs = Direct Materials Used + Direct Labor + Manufacturing Overhead
Total Manufacturing Costs = $73,000 + $45,000 + $60,000 = $178,000.

Apply the COGM Formula:

Cost of Goods Manufactured = Beginning Work-in-Process Inventory + Total Manufacturing Costs – Ending Work-in-Process Inventory
Cost of Goods Manufactured = $20,000 + $178,000 – $25,000 = $173,000.

This step-by-step process demonstrates how individual cost components are systematically aggregated to arrive at the final Cost of Goods Manufactured, providing a clear picture of the cost of completed production for the period.