How to Find Cost of Goods Sold in Managerial Accounting
Understand how to accurately determine Cost of Goods Sold for strategic internal financial management and performance analysis.
Cost of Goods Sold (COGS) represents the direct costs of producing goods a company sells. In managerial accounting, COGS is crucial for internal decision-making, cost control, and performance analysis. It provides insights into production efficiency, helping businesses manage expenses and optimize profitability, distinct from its role in external financial reporting.
Understanding Cost of Goods Sold for Managerial Purposes
From a managerial accounting perspective, COGS comprises direct materials, direct labor, and manufacturing overhead. Direct materials are raw goods that become part of the finished product, such as wood for furniture. Direct labor refers to wages paid to employees directly involved in production, like assembly line workers. Manufacturing overhead encompasses all other indirect costs associated with the production facility, including indirect materials (e.g., glues), indirect labor (e.g., factory supervisors), factory rent, utilities, and equipment depreciation. Breaking down these costs allows businesses to identify areas for cost reduction, improve production efficiency, and make informed pricing decisions. This detailed analysis helps managers assess the profitability of individual products or production lines.
Information Needed for COGS Calculation
Calculating COGS requires specific financial data, varying between merchandising and manufacturing businesses. For merchandising operations, which purchase finished goods for resale, information includes beginning inventory, total cost of new purchases (including freight-in), and ending inventory. For manufacturing businesses, data requirements are more extensive due to raw material transformation. This involves beginning and ending inventories for raw materials, work-in-process goods, and finished goods. Beyond inventory values, direct labor costs and all manufacturing overhead components, such as indirect materials, factory utilities, and equipment depreciation, must be accounted for.
Calculating COGS for Merchandising Operations
Calculating Cost of Goods Sold for a merchandising business follows a straightforward formula. It begins with beginning merchandise inventory, adds new purchases, and subtracts ending inventory. The formula is: Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold. The timing of COGS calculation depends on the inventory system. Under a periodic inventory system, COGS is calculated at the end of an accounting period, requiring a physical count. A perpetual inventory system continuously updates inventory records, allowing for real-time COGS calculation.
Calculating COGS for Manufacturing Operations
For manufacturing businesses, determining Cost of Goods Sold involves a multi-step process, beginning with the calculation of the Cost of Goods Manufactured (COGM). The first step is to ascertain total manufacturing costs incurred during the period, including direct materials, direct labor, and total manufacturing overhead. These costs are then adjusted for the change in work-in-process inventory: beginning work-in-process inventory is added, and ending work-in-process inventory is subtracted. This yields the Cost of Goods Manufactured, representing the cost of goods completed and transferred to finished goods inventory. Finally, to calculate Cost of Goods Sold, add beginning finished goods inventory to COGM and subtract ending finished goods inventory.