The Cost of Goods Manufactured (COGM) is an accounting term that signifies the total cost of manufacturing products and transferring them into finished goods inventory during a set accounting period.
That means the Cost of Goods Manufactured (COGM) only accounts for finished products that have either already been sold or are ready to be sold. As such, it is a good tool to get the big picture of production costs and gauge the profitability of a business.
What is the Cost of Goods Manufactured?
The cost of goods manufactured is the cost assigned to produced units in an accounting period. The concept is useful for examining the cost structure of a company’s production operations.
The best approach to examining the cost of goods manufactured is to disaggregate it into its component parts and examine them on a trend line. By doing so, one can determine the types of costs that a company is incurring overtime to produce a certain mix and quantity of goods.
The Formula to Calculate the Cost of Goods Manufactured COGM is:
The cost of goods manufactured (COGM) is a calculation that is used to gain a general understanding of whether production costs are too high or low when compared to revenue. The equation calculates the manufacturing costs incurred with the goods finished during a specific period. In other words, the total amount of expenses for a company to turn inventory into the finished product.
Add: Direct Materials Used
Add: Direct Labor Used
Add: Manufacturing Overhead
Add: Beginning Work in Process (WIP) Inventory
Deduct: Ending Work in Process (WIP) Inventory
Total manufacturing cost
Total manufacturing cost is the total cost of materials, labor, and overheads incurred for manufacturing. The formula for calculating total manufacturing cost is:
Total manufacturing cost = direct materials + direct labor costs + manufacturing overhead
Each of the components that go into the total manufacturing cost has to be considered separately.
This is the cost of all the raw materials consumed during the accounting period consideration. The direct materials formula is:
Direct materials = beginning raw materials + purchases – ending raw materials
This calculates the cost of net raw materials used for production in the given accounting period.
Direct labor costs
It’s easy to calculate direct labor costs for a manufacturing facility. You can find the number of hours worked by each employee in the accounting period in the employee records.
Multiply the number of hours worked by the employee’s hourly rate of pay to determine the labor cost for that employee. Take the sum of the labor cost for all employees to find the direct labor cost incurred by the manufacturer in the accounting period.
This variable is the sum of all the indirect costs that are involved in the manufacturing of goods. These include:
- Rent of the building
- Depreciation of equipment used in manufacturing
- The labor cost of supervisory staff
- Property taxes incurred
- Salary of maintenance staff
- Utility charges incurred
- Other indirect costs
Any other costs incurred for the manufacturing process that is not part of direct materials and direct labor will be part of manufacturing overheads.
Relevance and Uses
Cost of Goods Manufactured or Manufacturing Account calculations serve the following purposes:
- It shall help in setting out with appropriate classification of the elements of the costs in detail.
- This will also aid the management in the reconciliation of financial records with the costing records.
- Further, this statement will also serve as the basis for the comparison of operations of manufacturing on a year-to-year basis.
- All of the above will also allow the firm to properly plan its resource utilization planning, product pricing strategy, volume production planning, etc.
- If the firms have schemes such as profit-sharing plans and are in force, then it may also help them in fixing the amount of production along with profit-sharing bonuses.
Why is the Cost of Goods Manufactured important?
As said above, COGM is a good way to get a general idea of your production costs and how they correspond to the profitability of the business. Knowing the COGM allows you to increase the bottom line by making adjustments where necessary.
Furthermore, knowing the COGM helps companies to:
- Better manage their inventory
- Keep better financial records
- Develop better pricing strategies
- Track business development.
These benefits make COGM an important KPI to track in every manufacturing company.
Example- Cost of Goods Manufactured
At the start of a quarter, a furniture manufacturer has $12,000 worth of furniture in the making. This is the Beginning WIP Inventory.
Beginning WIP Inventory = $12,000
Furthermore, the company has $8,000 worth of raw materials in stock, waiting to be made into furniture. Within the quarter, the raw material inventory is replenished with $5,000 worth of stock altogether. At the end of the period, $3,000 worth of stock remains as raw materials. Using these figures, we can calculate the Direct Materials used.
Direct Materials = $8,000 + $5,000 – $3,000 = $10,000
The company employs eight shop floor workers that are directly responsible for the execution of production processes. Four of them have seniority or special skills and make $2,600 a month, the other four make $2,200 a month. The sum of their three-month salaries (as we decided that the accounting period for the calculations is a quarter, i.e. three months) is the Direct Labor Costs.
Direct Labor = [($2,600 x 4) + ($2,200 x 4)] x 3 = ($10,400 + $8,800) x 3 = $19,200 x 3 = $57,600
The Manufacturing Overhead is $28,600 altogether, comprising indirect labor costs for maintenance (wages $9,000 in a quarter) and warehouse (wages $12,000 in a quarter), additional materials such as glue and sandpaper ($800), rent ($6,000 per quarter), insurance ($200 per quarter), and an equipment depreciation of $2,400 a year, i.e. $600 per quarter.
Manufacturing Overhead = $28,600
So, the Total Manufacturing Cost for the quarter is the sum of the direct material and labor costs, plus manufacturing overhead.
Total Manufacturing Cost = $10,000 + $57,600 + $28,600 = $96,200
At the end of the quarter, $11,000 worth of furniture was still in the production process. This is the Ending WIP Inventory.
Ending WIP Inventory = $11,000
And finally, we get the Cost of Goods Manufactured by adding the Beginning WIP Inventory to the Total Manufacturing Cost and subtracting the Ending WIP Inventory.
COGM = $12,000 + 96,200 – $11,000 = $97,200
According to these basic calculations, the quarterly COGM of the furniture company is 97,200 dollars.