Manufacturing companies are companies that make a product. Because these companies have inventory in various stages of production, there are three inventory accounts that we must deal with in order to calculate cost of goods sold. The three inventory accounts are:

  1. Raw materials inventory
  2. Work-in-progress inventory
  3. Finished goods inventory

Each of these accounts must be calculated to see how much inventory from that account moves to the next account and eventually to cost of goods sold. The basic calculation for each of the accounts is the same.

Beginning Inventory
Plus: Something added to the account
Less: Ending Inventory
Equals: materials or goods transferred out of the account

The important thing here is knowing what gets added to the account and knowing the proper label for the amount that is transferred out of the account. This is where terminology is key to your understanding and performing the calculations correctly. When I’m thinking about inventory accounts, I like to imagine three rooms within the product facility, one for each of the types of inventory. Try to think about what is in each room, the costs that are added to the goods in that room and what happens to items that leave the room.

three rooms for inventory

Raw Materials Inventory

Raw materials inventory is the inventory of materials waiting to go into production. These are components of our product that have been purchased to make our product. In this case, we start with beginning inventory for the raw materials inventory account. What do you think we add to this account? We would add purchases of raw materials. Next, we subtract the ending inventory in the raw materials inventory account which is obtained by counting what is still on hand at the end of the period.

What happened to the stuff that is no longer there? Those materials were requisitioned by employees to use in the production process. They are being used to make our product. We call the materials that were taken from the room materials used in production.

Those materials were transferred into work-in-progress inventory.

RM room

Raw materials inventory is pretty straight forward.

RM formula

Work-In-Progress Inventory

Now that we have put materials into production, what else goes into the cost of our product? The three product costs are direct materials (which we have already placed in the room), direct labor, and manufacturing overhead. These three accounts are also called manufacturing costs. Add the cost of materials used in production to direct labor and manufacturing overhead costs. These costs are our “something added to the account.”

WIP Room before inventory

We have not yet figured in beginning and ending inventory for the work-in-process account. Just like the previous room, take beginning inventory and add your total manufacturing costs (our “something”) then subtract ending inventory. If goods transfer out of this room, it is because they are finished. Those goods are called cost of goods manufactured because they have finished the manufacturing process. They are now complete and have been moved to the finished goods room.

FGI Room before inventory

When calculating work-in-progress, add your materials used in production, direct labor cost, and manufacturing overhead cost to get total manufacturing costs. Then the formula is similar to our raw materials calculation.

WIP formula

Finished Goods Inventory and Cost of Goods Sold (FINALLY!!)

We have finally made it to the last room. We have transferred cost of goods manufactured into finished goods inventory. For this room, this is our “something”. Add beginning inventory and subtract ending inventory balances for finished goods inventory and we are done.

FGI room

The items that leave the finished goods inventory room leave because they have been sold and therefore, are called cost of goods sold. The formula for this calculation is very similar to both of our previous calculations.

FGI Formula

Once you have completed these calculations, the income statement for a manufacturing company is exactly the same at the income statement for a merchandising company. Both statements use cost of goods sold to calculate gross profit, then subtract selling and administrative expenses (or operating expenses) to arrive at operating income.

Manuf IS

Final Thoughts

While the calculations for cost of goods sold for a manufacturing company may seem overwhelming, remember that the calculations for each inventory account are very similar:

Beginning Inventory
Plus: Something added to the account
Less: Ending Inventory
Equals: materials or goods transferred out of the account

When you try to create a story to explain the process, you will not need to remember the formulas. Think about how the materials are moving through the company and into production, where labor and overhead are added. When goods are finished, they transfer to the finished goods inventory account. Once they are sold, they are transferred out of the finished goods account to the income statement as cost of goods sold.

Share This:


Related pages


adjusting entries for suppliescontribution to sales ratiojournalizing transactions accountingformula for double declining balance depreciationjournal entry for deferred expensespresent value lump sumwrite off bad debt allowance methoddepreciation methods fixed assetsjournal entry for depreciation of equipmentaging analysis of accounts receivablerules of debit and credit and normal balanceshow to calculate overhead ratehow to calculate social security tax withheldfavorable cost variancewhat accounts affect retained earningsmeaning of asset turnoverwhich of the following is the accounting equationjournal entries of accounts receivablethe effect of transactions on the accounting equationamortization expense exampleestimated overhead cost formulaunearned income liabilityretained earnings on cash flow statementjournal entries depreciationis merchandise inventory an assethow to figure simple interest on a loanaccounting for outstanding checksformula for cost of goods available for saledefine merchandise inventorywhat is the purpose of closing entrieshow much are fica taxeshow to calculate discontinued operationswhat are cost drivers in accountingfifo periodic and perpetualhow to calculate contribution margin per unitbad debt journal entry exampleprovision for bad and doubtful debts journal entrynormal balance of accumulated depreciationaccrued interest on bonds payablepayroll liabilities vs payroll expensesfinancial accounting vs managerial accountingpresent value of lump sum formulahow do you calculate cogspayroll tax accounting entrieshow to calculate accounts payable on balance sheetwac calculationhow to calculate beginning finished goods inventoryaccount receivable asset or liabilityoffice supplies accounting definitionclosing journal entries exampleactivity based costing calculationsales discounts income statementvariable cost per unit calculatorsteps in reconciling a bank statementmedicare taxesadjusting entries worksheetaccounting equation exampleis manufacturing overhead a fixed coststraight line depreciation method calculatorbond discount calculatorfactory overhead variance formulacharacteristics of sole proprietorship partnership and corporationuncollected debtcost of good sold ratiointro to financial accounting study guidejournal entry depreciation expensenet operating income equationstraight amortizationentries for bonds payable and installment note transactionsstraight line balance methodfifo equationjournal entry for outstanding expensesaccumulated depreciation representsexample of an accelerated depreciation methodcosting and pricing formulawhat is unearned revenue in accountingwhere is unearned revenue recordedweighted average formula accountinghow to compute gross profit percentage