What Is Included in Cost of Goods Manufactured?
Grasp Cost of Goods Manufactured (COGM) to understand your true production costs and how inventory moves through your business.
The Cost of Goods Manufactured (COGM) is a key financial metric for manufacturing businesses. It represents the total expenses a company incurs to convert raw materials into finished products during a specific accounting period. Understanding COGM is important for assessing production efficiency, managing costs, and making informed decisions about product pricing and profitability. It provides a clear picture of direct and indirect production costs, excluding general business expenses like marketing or administrative fees, helping businesses determine the true cost of bringing a product to market.
Understanding the Core Components
The Cost of Goods Manufactured comprises three primary categories of manufacturing expenses: direct materials, direct labor, and manufacturing overhead. Accurately classifying and tracking these expenses is important for precise cost accounting.
Direct materials are the raw materials that become an integral and traceable part of the finished product. For instance, the wood used to construct furniture, the steel for manufacturing automobiles, or the fabric for clothing are all examples of direct materials.
Direct labor refers to the wages paid to employees who are directly involved in converting raw materials into finished goods. Examples include assembly line workers, machine operators, or skilled craftspeople directly working on the product.
Manufacturing overhead includes all other manufacturing costs that are not direct materials or direct labor. These are indirect costs necessary for the production process but cannot be directly traced to specific units.
Indirect materials are supplies used in the factory that support the production process but are not directly traceable to individual products, or their cost is too insignificant to track precisely. Examples include lubricants for machinery, cleaning supplies for the factory floor, or small fasteners like screws and bolts.
Indirect labor consists of wages paid to factory personnel who do not directly work on the product itself but are essential for the overall manufacturing operation. This includes roles such as factory supervisors, maintenance staff, quality control inspectors, or security guards for the production facility.
Other manufacturing overhead costs include utilities consumed by the factory, such as electricity, water, and gas, as well as depreciation on factory equipment and buildings. Factory rent, factory insurance premiums, and property taxes on the manufacturing facility are common components of manufacturing overhead.
Calculating the Cost of Goods Manufactured
Calculating the Cost of Goods Manufactured involves a specific formula that accounts for the flow of costs through the production process. This calculation provides the total cost of products that have been completed and moved out of the work-in-process stage during an accounting period. The formula for COGM is: Beginning Work-in-Process Inventory + Total Manufacturing Costs – Ending Work-in-Process Inventory = Cost of Goods Manufactured.
Work-in-Process (WIP) inventory represents partially completed goods that are still undergoing the manufacturing process at a given time. These items have absorbed some direct materials, direct labor, and manufacturing overhead, but are not yet finished products ready for sale. The beginning WIP inventory reflects the value of unfinished goods carried over from the prior accounting period.
Total manufacturing costs are the sum of direct materials used, direct labor incurred, and manufacturing overhead applied during the current accounting period. These are the expenses added to production in the current period. This sum is added to the beginning work-in-process inventory.
The ending work-in-process inventory is then subtracted from this total. This subtraction is necessary because these costs belong to goods that are still incomplete at the end of the period and have not yet become finished products.
The flow of costs generally begins with raw materials moving into work-in-process inventory as they enter production. As goods are completed, their accumulated costs, represented by COGM, are then transferred from work-in-process inventory to finished goods inventory.
Distinguishing from Other Inventory Costs
COGM must be distinguished from other important inventory-related financial terms, particularly the Cost of Goods Sold (COGS). While both relate to product costs, they represent different stages in the inventory lifecycle and serve distinct purposes in financial reporting.
Cost of Goods Manufactured represents the total cost of products that have been completed and transferred from work-in-process inventory to finished goods inventory during a specific period. It signifies the cost of producing all goods that are ready for sale, regardless of whether they have actually been sold.
In contrast, the Cost of Goods Sold represents the direct costs associated with the goods that a company has actually sold during a specific period. This includes the cost of direct materials, direct labor, and manufacturing overhead allocated to those specific units that were sold to customers. COGS is recognized on the income statement when the sale occurs, matching the expense with the revenue generated.
COGM is an input for calculating COGS for manufacturing businesses. The COGM figure flows into the Finished Goods Inventory account. The calculation for COGS involves adding the Cost of Goods Manufactured to the beginning finished goods inventory and then subtracting the ending finished goods inventory.
The journey of inventory in a manufacturing company involves distinct stages: Raw Materials Inventory, Work-in-Process Inventory, and Finished Goods Inventory. Raw Materials Inventory holds the basic components awaiting production. Work-in-Process Inventory contains goods that are partially complete. Finished Goods Inventory comprises products that are fully manufactured and ready for customer purchase.
COGM acts as the transfer cost between the Work-in-Process Inventory and the Finished Goods Inventory. It quantifies the value of products moving from the state of being partially completed to being ready for sale.