## How a Manufacturing Company Calculates Cost of Goods Sold

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

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

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

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

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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## Most Important Steps for Calculating Work in Process

Determining per unit cost may be taken as a very common aspect in the manufacturing industry, but it is no surprise that it has to be handled professionally. No matter what one may argue, calculating work in process requires utmost brilliance and perfection in technical accounting knowledge. Obviously, determining raw material, labor and overhead costs incurred in manufacturing a certain good is no easy feat. You have to carefully examine and evaluate the costs of each and every aspect of producing a finished good at various stages of the production process before you can determine the total cost incurred on producing a good or a commodity. The term WIP (Work In Process) is usually used in production and supply chain management which bears an immense importance in the manufacturing and distribution industry.

# What Is Work in Process?

According to Investopedia, “it is the sum of all costs put into the production process to manufacture products that are partially completed”. A careful analysis has to be made at various stages of the production process in order to determine all the costs incurred on raw material, labor, and overhead costs. For determining the exact unit cost, you must have a clear picture of all the costs incurred from the raw material to the finished good.  It is important that your bookkeeping shows all of the costs in order to come up with your final cost.

As far as the calculations are concerned, the formula for calculating work in process is:

Work in process = (operating inventory goods in process + raw material used during the period + direct labor during the period + factory overhead for period) – ending inventory

## WIP–In Light Of Automation and Technology

Fortunately, we have opened our eyes in such an era of modern accounting and bookkeeping where processes have become easier than before through superior automation and technology. Now, we have access to advanced accounting software and solutions which have made calculation easier, quicker, and more accurate. This indicates that calculating work in process is now considered a piece of cake for most individuals who have command and control on these contemporary accounting and manufacturing software. Plus, we now also have access to accounting and bookkeeping professionals who make the process easier and help reduce manufacturing costs at various stages of the production process.

## Benefits of Reducing Manufacturing Work in Process

There are numerous benefits associated with reducing manufacturing work in process costs. The top benefits include better cash flows, higher liquidity, and diminished business risks. However, a brilliant execution strategy is required in order to make things go in your favor. Since the ultimate aim of every manufacturing establishment is to reduce raw material, labor and overhead costs in each unit produced, you must integrate innovative procedures and techniques to eradicate manufacturing bottlenecks. Moreover, calculating work in process may seem hard at first, but once you commence to sort things out piece by piece (costs), everything becomes relatively easier to handle.

## Strategic Forecasting and Planning and the Need for Calculating Work in Process

Undoubtedly, strategic forecasting and planning is critical to business success. The more you get yourself involved in reducing per unit costs, the more you will save at the end of the day. For determining how many units should be produced, raw material costs, labor costs, and overhead costs, you must have a clear picture in mind about your production requirements and specifications. Strategic variety usually involves realistic vision, mission and out of the box thinking for making future projections related to manufacturing and production.

Moreover, strategic planning and analyses will define where your company is heading and what the company aims to achieve in both short and long-term time periods. For attaining ideal results, machines can be added or integrated into the manufacturing process and the workforce can be educated with newer and advanced techniques for optimal utilization of resources. Calculating work in process must be handled with the utmost care because it directly influences your profitability index.

About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.