The cost of goods manufactured is the cost assigned to units either completed or still in the process of being completed at the end of an accounting period. This cost is most useful when disaggregated into its component parts and examined on a trend line. By doing so, you can determine the costs that a company is incurring over time to produce a certain mix and quantity of units. The concept is useful for examining the cost structure of a company's production operations.
This cost structure usually includes all of the following:
- The cost of direct materials used in the manufacturing process during the period.
- The cost of direct labor used in the manufacturing process during the period.
- The amount of overhead allocated to manufactured goods during the period.
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.
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:
- 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.
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.