cost of goods manufactured

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

overhead rateshow to pay unemployment taxesfiguring gross profitbi weekly income tax calculatorstraight line method depreciation calculatoradjusting entries for inventoryweighted average excel templatecalculate sales tax percentagejournal entry for accrued revenueexamples of absorption costingcalculate direct materialsprice maker price takerpreparing income statement from trial balancewhat are the closing entriesa post-closing trial balance will showprovision of doubtful debts journal entriestabel present value annuitytoo much social security tax withheldaccounts receivable valuation methodsapplying manufacturing overheadmonth end closing journal entries exampleshow to remember debits and credits in accountingcontribution margin ratepayroll ledger sampletotal overhead appliedwhat is the normal balance for accounts payabledeclining balance method examplewrite off uncollectible accountsdebits and credits balance sheetcalculating depreciation on a vehiclereconciliation of variable costing and absorption costing net operating incomescalculating factory overheadwhat is outstanding check in bank reconciliationpv discount factorcalculate overhead rate formulacalculate depreciable costpv annuityincome statements for dummiesperiodic inventory methodaccounting calculations and formulascalculating discount factoraccounts receivable journal entriesaccounting wages payablewage deductions calculatora federal unemployment tax is levied ontop side adjusting journal entrybond premium calculatordisadvantages of variable costingallowance for doubtful accounts t accountunearned revenue accountingcost of good sold ratiotabel present valuejournal entry format accounting exampleaccount receivable is asset or liabilitiesaccounts receivable entriesprovision for doubtful debts meaningassets liability owners equityhow much federal withholding from paycheckaccounting entry for prepaid insurancehow to get the salvage valuehow do you calculate cogshow do i calculate federal tax withholdingformula for cogsunearned revenue is classified asperpetual and periodic inventory systemretained earning on balance sheetcalculate wip inventorywrite off bad debt allowance methodexample of predetermined overhead ratepresent value of an annuity due of 1cost variance percentage formulastraight bond value calculatorannuity discount factor tablethe formula for computing annual straight-line depreciation isstraight line amortization