What is Cost of Goods Manufactured Formula?

One important thing we need to understand is the flow of costs through the manufacturing process. The cost flows move from the raw materials account, to the work in process account, to the finished goods inventory account.

These three inventory accounts are all balance sheet accounts.

Once a product is sold, the cost is moved to cost of goods sold account, which is on the income statement.

In fact, when we flash back to Financial Accounting, here's the journal entry to record the sale of products assuming perpetual inventory. Recall it requires two journal entries to record the sale of goods, because we need to record a revenue entry and an expense entry.

The revenue entry is a debit to cash or possibly accounts receivable, and a credit to sales revenue. The expense entry is a debit to cost of goods sold and a credit to inventory, or in this case. finished goods inventory.

Once the products have been sold, the cost moves from the balance sheet to the income statement as cost of goods sold. You can see why it's important to properly track product costs vs period costs.

Product costs only end up on the income statement as costs of goods sold and only in the period in which the products were sold. Period costs end up on the income statement primarily as operating expenses and in the period in which they were incurred.

So the schedule of costs of goods manufactured is basically a numerical summary of the cost flows we've just seen. In fact, a complete schedule looks like this, but before you get overwhelmed with this example let's go through the steps, and I think you'll find it pretty understandable.

For starters, let's recall the costs of goods sold model from Financial Accounting. I've presented two ways here in hopes that at least one of these ways is something you'll remember from Financial Accounting.

This model is for merchandisers, which is what you learned in your Financial Accounting course. Basically, we start with beginning inventory, we add to it the net purchases for the period. These two together are called the costs of goods available for sale. It represents all the goods we can sell. We can't sell more than everything we had on hand, plus everything we bought. 

Finally, there are only two things we can do with our products. We can sell them, which call cost of goods sold, or we can have them - still have them at the end of the period which we call ending inventory. and if we know one of those amounts we can calculate the other.

Manufacturers don't buy goods for resale though, they make goods. So, the concept is the same but instead of purchases, we will replace that with the cost of goods manufactured. This name is exactly what it represents. It's how much it costs us in materials, labor, and overhead, to make our products.

So the cost of goods manufactured is a debit to finished goods inventory. 

But, what account is credited?

Well, cost of goods manufactured, represents the cost of our manufactured and completed products so it's the credit to move the costs from WIP to FGI, and that amount is is the cost of goods manufactured. In fact the cost of goods manufactured is just a numeric schedule or report that demonstrates what's happening in the WIP account.

Direct materials, direct labor and manufacturing overhead is added to beginning inventory. These items, together, represent everything we can manufacture for the period.

There are only two things we can do with our manufacturing costs. We can complete products, which we call the cost of goods manufactured or we can still have them as partially completed products which we call ending inventory. So let's revisit that intimidating schedule of costs of goods manufactured for a second.

Here you can see some of the main headings like beginning work in process inventory. That's just the same as the T account.

Then we add direct materialsand direct laborand manufacturing overhead. So the beginning inventory plus our added  manufacturing costs equal the manufacturing costs we need to account for.
Since there are only two things that can happen to these costs, we can subtract ending inventory to arrive at our costs of goods manufactured. So, the only part of the schedule we haven't reviewed yet is the materials section.

This section is basically the transactions that occurred in our raw material inventory account and it is how we calculate direct materials if we aren't given that information. So, you can see that this section starts with beginning raw materials inventory.

Again, that's just the same as the T account. Then we add purchases of raw materials. So the beginning inventory plus our purchases of raw materials equal the raw materials available for use.

Since there's only two things that can happen to be available raw materials we can subtract ending inventory to arrive at direct materials used in production.

Summarizes the cost flows through a manufacturing system. For the most comprehensive accounting for manufacturing solutions, Contact us today. Our team will help revitalize your manufacturing business through the best accounting principles.