Cost of goods manufactured definition
/What is the Cost of Goods Manufactured?
The cost of goods manufactured is the cost assigned to produced units in an accounting period. The concept is useful for examining the cost structure of a company's production operations. The best approach to examining the cost of goods manufactured is to disaggregate it into its component parts and examine them on a trend line. By doing so, you can determine the types of costs that a company is incurring over time to produce a certain mix and quantity of goods. This cost structure usually includes the items noted below.
A retail operation has no cost of goods manufactured, since it only sells goods produced by others. Thus, its cost of goods sold is comprised of merchandise that it is reselling.
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Cost of Direct Materials
The cost of goods manufactured includes all direct materials consumed during the accounting period. If the company is using a periodic inventory system, then it can calculate the cost of direct materials by adding the beginning inventory balance to the cumulative amount of purchases made during the period, and subtracting the ending inventory balance. The resulting figure will include the cost of any scrap or other direct materials shrinkage that may have occurred during the period.
Cost of Direct Labor
The cost of goods manufactured includes all direct labor incurred during the accounting period. This amount is easily calculated by compiling the payroll cost of all production workers during the period.
Cost of Manufacturing Overhead
The cost of goods manufactured includes all manufacturing overhead costs incurred during the accounting period. The accounts from which overhead is compiled are set by accounting policy. Examples of these accounts are manufacturing rent, manufacturing depreciation, manufacturing supervisory compensation, quality control compensation, utilities, repairs and maintenance, and production supplies.
Cost of Goods Manufactured vs. Cost of Goods Sold
The cost of goods manufactured is not the same as the cost of goods sold. Goods manufactured may remain in stock for many months, especially if a company experiences seasonal sales. Conversely, goods sold are those sold to third parties during the accounting period. There can be numerous reasons for the cost of goods manufactured and cost of goods sold to differ from each other, including the following:
There may be no sales at all during the period, while production has continued. The cost of goods sold is therefore zero, while the cost of goods manufactured may be substantial.
There may be lots of sales during the month from inventoried reserves, while there is no manufacturing going on at all. The cost of goods sold may therefore be substantial, while the cost of goods manufactured is zero.
The cost of goods sold may contain charges related to obsolete inventory.
The most likely reason for differences between the costs of goods manufactured and sold is simply that the mix of products sold does not exactly match the mix of products manufactured.
How to Calculate the Cost of Goods Sold
The cost of goods manufactured is a component of the calculation for the cost of goods sold. The calculation is:
Beginning inventory + Cost of goods manufactured - Ending inventory
= Cost of goods sold
This calculation is used for the periodic inventory method. It is not needed for the perpetual inventory method, where the cost of individual units that are sold are recognized in the cost of goods sold.