What is the Cost of Goods Manufactured?
Cost of Goods Manufactured is the value of the total production cost of goods that the company produced and completed during the particular accounting period under consideration and is calculated by adding the direct material costs, direct labor costs, and manufacturing overhead costs of all the goods that were manufactured and completed during the period.
It is a schedule or statement through which a company or entity calculates its cost incurred to manufacture a product and convert it to a finished product. It had usually been prepared by entities whose primary business line is manufacturing. These manufacturing entities usually prepare this as a separate account or statement to assess the cost-effectiveness of manufacturing activity which later forms a part of the final accounts.
Components
Manufacturing costs are classified into:
If there are any remain unfinished goods at the beginning and end of the accounting period cost of such unfinished goods which is also called work in process is shown in the Cost of Goods Manufactured (COGM) as follows: Opening stock of work in process in the debit side of the account statement and Closing stock of work in process in the credit side of the account statement.
#1 – Direct Manufacturing Expenses
These are costs that include other than material or wage expenses. These are incurred for a specific product or saleable service. Example: (i) Royalties for using license or technology (ii) Hire charge of the plant/machinery etc.
Example
10000 units are produced in a factory. Per unit material cost is $10; per unit labor cost is $5. Apart it was agreed to pay royalty @ $3 per unit to the Japanese collaboration who supplied the technology.
In this case, prime cost comprises of:
#2 – Indirect Manufacturing Expenses or Manufacturing Overhead Expenses
This can also be called Production overhead, works overhead, etc.. Overhead is the total cost of indirect – material, wages and expenses. Indirect material, wages, and expenses mean materials, wages, and expenses which cannot be linked directly with the units produced.
Example of indirect material is stores consumed for repair and maintenance work, small tools, fuel, and lubricating oil, etc. Example of indirect wages is wages for maintenance work, holding pay, etc. Example of an indirect expense is training expense, depreciation of factory shed, the insurance premium for plant and machinery, factory shed, etc.
By-Product
In most manufacturing operations the production of the main product is accompanied by the production of a sub-product which has a certain value on sale. This sub-product is called as a by-product because its production is not consciously undertaken but results out of the production of the main or primary product. An example is (i) molasses is by-product of sugar, (ii) buttermilk is the by-product of a dairy which produces butter and cheese, etc.
It is usually difficult to ascertain the cost of the product. Moreover, its value usually forms a small portion of the main product. It is often treated as “Miscellaneous income” but the correct treatment would be to credit the sale value of the by-product to manufacturing account so as to reduce to that extent the cost incurred to manufacture the main product.
Examples
M/s ABC produces soaps in their factory. The following are the details available in reference to the manufacturing activities year ended 31.03.2017. Prepare and Calculate Cost of Goods Manufactured Statement for company ABC year ended 31.03.2017.
Solution:
#1 – Working Note 1 (WN1) – Direct Wages
- Direct wages contracted @$0.80 per unit manufactured = 500000 units @ $0.80 = $4, 00,000
- Direct wages contracted @ $0.40 per unit of closing WIP = 12000 units $Re. 0.40 = $4,800
- Total Direct Wages = $400000+$4800 = $404,800
#2 – Working Note 2 (WN2) – Hire charges
- Hire charges of machine @$0.60 per unit manufactured = 500000 @ $0.60 = $300,000
Purposes
Cost of Goods Manufactured or Manufacturing Account is calculated to serve the following purposes:
- It sets out in detail with the appropriate classification of the elements of cost.
- Facilitates reconciliation of financial books with cost records.
- Serves the basis of comparison of manufacturing operations from year to year.
- It shall allow the entity to plan its product pricing strategy, resource utilization planning, volume producing planning, etc.
- It may also be used to fix the amount of production of profit-sharing bonuses when such schemes are in force.
Key Points of Cost of Goods Manufactured Statement (COGM)
- It is easier with the availability of the quantity and values to compute the related information required.
- This account shows the number of raw materials in stock at the beginning and end of the year and purchases during the year.
Conclusion
Ascertaining the cost of goods manufactured is an important factor for ascertaining various other financial components of the product. Though, it may be observed that nowadays no manufacturing business or entity prepares a manufacturing account as part of its final sets of accounts. The items of the COGM are shown either in the trading account or P&L account.
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