How to Calculate Total Cost of Goods Manufactured

Understanding Manufacturing Cost Components

The total cost of goods manufactured represents the overall expense incurred to produce goods completed during a specific accounting period. This figure is a measure of the production activities of a manufacturing business, rather than its sales. It helps businesses understand their operational efficiency and accurately value their inventory. Knowing this cost is foundational for financial reporting, setting product prices, and evaluating profitability.

Manufacturing costs are broadly categorized into three primary elements: direct materials, direct labor, and manufacturing overhead. These cost components combine to represent the total expense involved in the production process.

Direct materials are the raw substances that become an integral part of the finished product and can be directly traced to it. Examples include wood for furniture, fabric for clothing, or steel for automobiles.

Direct labor refers to the wages paid to employees who are directly involved in the physical creation of the product. This includes the compensation for workers operating machinery, assembling components, or performing hands-on tasks that transform raw materials into finished goods.

Manufacturing overhead encompasses all other indirect costs associated with the production process that are not direct materials or direct labor. This category includes expenses such as factory rent, utilities for the production facility, depreciation on manufacturing equipment, and the wages of factory supervisors or maintenance staff.

Work-in-Process (WIP) inventory represents goods that have entered the production process but are not yet complete. This inventory includes direct materials, direct labor, and manufacturing overhead that have been applied to partially finished products. WIP inventory acts as a bridge, carrying costs from one accounting period to the next as products move through various stages of production.

Gathering Production Cost Data

Accurately calculating the cost of goods manufactured begins with diligently gathering all relevant production cost data. This preparatory step involves identifying and quantifying the values for beginning and ending work-in-process inventory, the cost of direct materials used, the total direct labor incurred, and the total manufacturing overhead applied during the period.

Determining the beginning and ending work-in-process inventory figures requires a review of inventory records from the start and close of the accounting period. These amounts are typically derived from a company’s internal cost accounting system, which tracks the accumulated costs of partially completed units.

The cost of direct materials used during a period is not simply the amount of materials purchased. Instead, it is calculated by taking the value of the beginning raw materials inventory, adding the cost of raw materials purchased during the period, and then subtracting the value of the ending raw materials inventory. This calculation ensures that only materials actually consumed in production are included, rather than materials still held in storage.

The total cost of direct labor incurred is obtained from payroll records specifically for production employees. This includes their gross wages, and potentially related costs such as employer-paid payroll taxes and benefits, if these are considered part of the direct labor cost structure by the company’s accounting policy.

Ascertaining the total amount of manufacturing overhead involves accumulating all indirect production costs. This includes expenses such as factory rent payments, utility bills for the manufacturing plant, insurance premiums for the factory, and depreciation schedules for production machinery. Many companies also include indirect labor costs, like the salaries of quality control personnel or factory supervisors, in this category.

Executing the Cost of Goods Manufactured Calculation

Once all the necessary cost data has been meticulously gathered, the final step involves applying these figures to the Cost of Goods Manufactured (COGM) formula. The formula systematically combines the costs of direct materials, direct labor, and manufacturing overhead incurred during the period with the changes in work-in-process inventory. This calculation yields the total production cost of units that were completed and transferred out of the production process during the specific period.

The complete formula for calculating the Total Cost of Goods Manufactured is: Beginning Work-in-Process Inventory + Total Manufacturing Costs – Ending Work-in-Process Inventory. Total Manufacturing Costs, in turn, are the sum of Direct Materials Used, Direct Labor Incurred, and Manufacturing Overhead Applied.

To illustrate, consider a hypothetical manufacturing company at the end of its fiscal year. Assume the company’s records show a Beginning Work-in-Process Inventory of $15,000 for January 1. During the year, the company determined it used $100,000 in Direct Materials, incurred $70,000 in Direct Labor costs, and applied $80,000 in Manufacturing Overhead.

First, the Total Manufacturing Costs for the period are calculated by summing the direct materials used, direct labor, and manufacturing overhead. In this example, Total Manufacturing Costs would be $100,000 (Direct Materials) + $70,000 (Direct Labor) + $80,000 (Manufacturing Overhead), totaling $250,000. This sum represents the new costs added to production during the period.

Next, this total is added to the beginning work-in-process inventory. So, $15,000 (Beginning WIP) + $250,000 (Total Manufacturing Costs) equals $265,000. This combined figure represents the total costs that were in the production pipeline during the entire period, including what was already there and what was added.

Finally, if the company’s Ending Work-in-Process Inventory on December 31 was $20,000, this amount is subtracted from the previous sum. Therefore, $265,000 – $20,000 (Ending WIP) results in a Total Cost of Goods Manufactured of $245,000. This final figure signifies the cost of all products that were completed and moved out of the work-in-process stage during the year, ready for sale or transfer to finished goods inventory.