Explanation of Cost of Goods Manufactured as It Relates to Cost Centers
The cost of goods manufactured (COGM) calculates the manufacturing costs for a period. Accountants use COGM to track costs as a product moves from raw material inventory to finished goods inventory. The cost of goods manufactured includes direct labor, direct material, and manufacturing overhead. The purpose of the calculation is to determine the cost for items manufactured to completion during the period.
COGM starts with the raw material inventory amount at the beginning of the accounting period. This number reflects the value of the raw materials that the organization bought during the last accounting period but did not use at that point. This inventory needs to be included in the calculation because the raw materials are available for manufacturing during this period. To this number, the accountant adds the cost of the raw materials purchased during the current accounting period. This new number is the total amount of raw materials that is available for manufacturing during the current period. From this amount, the accountant deducts the raw material inventory at the end of the period. This calculation shows the amount of raw materials that the organization used in production during the current accounting period.
To that raw materials cost, the accountant adds the direct labor and manufacturing overhead that were applied to the products during the current period. Doing this provides the total manufacturing costs for the period. Both direct labor and applied manufacturing overhead are also part of the work in process (WIP) inventory, which is a means of keeping track of the products that have started through the production process but are not yet complete. In determining the cost of goods manufactured, the accountant excludes the cost that is related to work in process.
To adjust for the costs related to work in process, the accountant adds the WIP inventory cost at the beginning of the period to the manufacturing costs. This provides the costs related to all inventory that has been worked on during the current accounting period. The cost of goods manufactured includes only the items that are completed, so the accountant's final adjustment needs to exclude the work that is in process.
Comparison of Cost of Goods Sold to Cost of Goods Manufactured
The cost of goods sold (COGS) and the cost of goods manufactured (COGM) provide managers with important, but different, information. The accountant needs to calculate the cost of goods manufactured first, as it is part of the cost of goods schedule.
While the cost of goods manufactured figure is important to management, other information on the COGM schedule is also valuable. First, the information on direct materials provides information on the total raw materials that were on hand to support production. The ending raw materials information lets managers compare the inventory on hand to last year's figure as well as determine how this year's figure relates to the total materials used during the year. Too much and too little inventory are both problems for manufacturing firms. If there is too much inventory, it ties up space and money that could be used for other purposes. If there is too little inventory, then the company may miss out on profitable sales.
The remaining part of the cost of goods manufactured schedule provides managers with information on WIP inventory. Managers can easily see the three costs—direct materials, direct labor, and manufacturing overhead—that make up the WIP inventory. They can also see how work in process for the end of the current accounting period compares to that from the previous period.
While the cost of manufacturing schedule includes changes in raw material and work in process inventories, the cost of goods sold focuses on the finished goods inventory. The cost of manufacturing schedule shows the flow of costs during the production process. Even though the details of this information are not included on the cost of goods schedule, this information is a necessary part of the cost of goods sold calculation. The detail regarding the changes in raw material and WIP inventory value is included in the cost of goods manufactured schedule. The summary of the cost impact is included on the cost of goods sold schedule through the cost of goods manufactured line item on that schedule.Although the calculation for the cost of goods manufactured includes manufacturing overhead, no adjustment is done at this level. The accountant does any overhead application adjustment necessary in the final step in calculating the cost of goods sold.