Updated July 7, 2023
Definition of Cost of Goods Manufactured
The cost of goods manufactured in the calculation of the total production cost of the company at a specific point in time. As the name suggests, the COGM calculates the total manufacturing cost incurred on a product that has been manufactured and is ready to be sold.
It considers all the expenses as direct material, direct labor, and factory overheads incurred on producing the goods.
Explanation
The various components comprise the cost of goods manufacture (COGM), including direct labor costs, direct material costs, and factory overheads. We add the sum total of all three components to the net finished goods inventory, calculated by subtracting the closing work-in-progress goods inventory from the opening work-in-progress inventory. It is important not to confuse COGM with the cost of goods sold (COGS). COGM represents the total cost of manufactured goods ready for sale. In contrast, COGS represents the total cost of goods manufactured during the period, which is then added to the net unsold finished goods inventory (calculated by subtracting the closing finished goods inventory from the opening finished goods inventory).
The Formula for the Cost of Goods Manufactured
The formula of COGM is as follows:
Wherein,
How to Calculate Cost of Goods Manufactured
The step-wise step method to calculate COGM is as follows:
- Step 1: Determination of Indirect and Direct Cost: Since the calculation of the cost of goods manufactured includes both direct and indirect cost components, therefore, in the first step, we will have to determine all the indirect costs like facilities, equipment, warehousing, etc. related to manufacturing and all direct cost like direct labor cost and direct material cost.
- Step 2: Calculation of Total Manufacturing Cost: After determining all the direct and indirect costs incurred in the manufacturing process, we need to add them up to get the figure for total manufacturing cost for the specific period.
- Step 3: Opening Work-in-progress Goods Inventory: In the next step, we must determine the opening value of the inventory. It would be the same as the closing work-in-progress inventory of the last period.
- Step 4: Closing Work-in-progress Inventory: In this step, we must determine the total value of the ending or closing work-in-progress inventory.
- Step 5: Cost of Goods Manufactured: In this final step, we will add the total manufacturing cost to the opening work-in-progress inventory, and deducting the value of the closing work-in-progress inventory from the total will give us the value of the COGM.
Example of Cost of Goods Manufactured
ABC Limited company wants to calculate the cost of goods manufactured for the year and provides the following information regarding its direct and indirect costs:
- Direct material = $4,000
- Direct labor= $2,000
- Factory/ manufacturing overhead = $5,000
- Opening work-in-progress (WIP) inventory was $1,000, and closing or ending work-in-progress (WIP) inventory was $3,000 for the year.
Solution:
Total Manufacturing Cost is calculated using the formula given below:
Total Manufacturing Cost = Direct Material Cost + Direct Labor Cost + Factory Overheads
- Total Manufacturing Cost = $(4,000 + 2,000 + 5,000)
- Total Manufacturing Cost = $11,000
COGM is calculated using the formula given below:
Cost of Goods Manufactured = Total Manufacturing Cost + Opening WIP Inventory – Closing WIP Inventory
- Cost of Goods Manufactured = $11,000 + $ 1,000 – $ 3,000
- Cost of Goods Manufactured = $9,000
Therefore, the total COGM for the year is $9,000
Cost of Goods Manufactured Schedule
The cost of goods manufactured schedule is prepared to calculate the total manufacturing cost for the period, which is then added to the net work-in-progress inventory. Below is the general sample schedule that can be used to calculate the COGM.
| Direct Material cost | D | (A+B -C) |
| Opening raw material | A | |
| ADD: raw material purchased | B | |
| Less: Closing Raw material | C | |
| Direct Labour cost | E | |
| Factory overhead | F | (G+H+I) |
| Indirect Material | G | |
| Indirect Labour | H | |
| Depreciation, Insurance, taxes | I | |
| Add: Opening Work in progress inventory. | J | |
| Less: Closing Work in progress inventory | K | |
| Cost of Goods Manufactured | D+E+F+J-K |
Importance
- First, the COGM gives information regarding each cost element involved in the manufacturing process, which helps further analyze each component.
- COGM helps the company maximize its net income by providing a detailed view and analysis of each component of manufacturing cost.
- It helps the company plan and devise its price strategies for different products; it also helps compare manufacturing operations from one period to the other.
Advantages
- It gives the companies an idea of whether their production cost is too high or too low compared to their sale.
- It helps the company plan and modifies its price strategies for different products.
- It helps the company to apply measures for optimum utilization of the inventory and other resources used.
Disadvantages
- COGM includes direct and indirect costs, as the process does not use direct allocation, i.e., applying the specific amount of each type of cost to the individual product. Hence, it may lead to over-pricing or underpricing of the products.
- Calculation of work-in-progress inventory is a little complicated and sometimes done on an estimation basis which leads to an inaccurate result of cost and also leads to inefficient management of the inventory.
- Failing to calculate COGM correctly will lead to incorrect calculation of the cost of goods sold and inaccurate pricing strategy and planning.
Conclusion
COGM is one of the critical components of process costing. It helps calculate the cost of goods sold, which is used to calculate gross profit. The calculation at first seems simple but is a little tricky and should be carefully looked upon by management and cost accountants because any inaccuracy would lead to a series of mistakes and overshadow all of its plus points.
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