How a Manufacturing Company Calculates Cost of Goods Sold

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Manufacturing companies are usually involved in the production and manufacturing of goods. These are large organizations with inventories in various stages of production. Most companies have three inventory accounts. Each inventory requires separate handling for proper calculation of the cost of goods sold. The three types of inventory are:

  • Inventory of raw materials
  • Work in progress inventory
  • The inventory of finished goods

For calculation of the cost of goods sold for a manufacturing company, each of the above inventories needs separate calculations. After calculating one segment, you move on to the next. The systematic calculation of each cost and inventory will eventually lead to the cost of goods sold statement. However, the basic calculation of each cost subhead is similar:

Initial inventory

Add: Other addition to the inventory

Minus: Ending inventory

Equals: Goods transferred from manufacturing

What Costs are Linked to the Cost of Goods Sold Statement?

The essential aspect, which is a must for accountants, is to note and properly label the amount that is transferred out from the account. It is important to write down the terminology. Using correct terms to identify each item is vital for proper calculations.

Inventory of Raw Materials

This inventory is the initial inventory that is placed right at the beginning of the cost of goods sold statement. It includes all the raw materials purchased for manufacturing a specific product. While making the cost of goods sold statement, make sure that all direct and overhead raw material costs are accounted for. After adding all raw materials, subtract the ending inventory from the raw material inventory account towards the end of one period. These materials await for transfer to the work in progress inventory, where the labor costs are included in the statement.

All raw materials left behind after the manufacturing process is complete must be included in the opening inventory of the next period. In the end, the statement will become:

Initial Inventory

Add: All raw material purchased

Less: Ending Inventory

Equals: Total raw material utilized in production

Work in Progress Inventory

The work in progress inventory is the next step in completing the cost of goods sold statement. After adding different materials to the production line, there are three additional production costs. These costs include direct materials, direct labor and overhead costs associated with manufacturing. All three costs are collectively called the “Manufacturing Costs.” The total inventory will be added to the Total Manufacturing costs and from this figure, the ending inventory will be deducted.

The goods that transfer from the work in progress inventory are termed as Finished Goods. These goods are transferred to the finished goods inventory. The equation then becomes:

Initial Inventory

Add: Total Manufacturing Costs

Less: Ending Inventory

Equals: Cost of goods manufactured

The Finished Goods Inventory

The last and most important part of the cost of goods sold statement for a manufacturing company is the Finished Goods Inventory. In this inventory, all goods are transferred from the work in progress inventory to the finished goods inventory. Now the equation becomes:

Initial Inventory

Add: Total Manufacturing Costs

Less: Ending Inventory

Equals: Cost of goods manufactured

Less: Ending inventory

Equals: Cost of Goods Sold

The final inventory includes all goods that are sold off after the entire process of goods transfer and manufacturing is complete. Only the final products are sold off as final finished products. A more detailed statement includes overhead costs and other costs.

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