Tuesday, May 25, 2010

Cost of Goods Manufactured : Cost of Goods Sold







Cost of Goods Sold

Like any other company, a manufacturing company has to create an income statement. On that income statement they will report Sales less Cost of Goods Sold to determine their Gross Profit.

For a manufacturing company the calculation of Cost of Goods Sold will differ from a merchandising company because a manufacturing company makes its inventory (the product it plans to sell), while a merchandiser purchases it.

If you remember - the calculation for Cost of Goods Sold (for a merchandiser) is;

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold


When a manufacturer does this calculation, the cost of purchases is replaced by the cost to produce/make product - this is cost of goods manufactured - so the calculation looks like this;

Beginning Inventory + Cost of Goods Manufactured - Ending Inventory = Cost of Goods Sold



Cost of Goods Manufactured

Cost of Goods Manufactured is comprised of the total costs incurred to make the product - these include all Direct Labor, Direct Materials and Overhead incurred - in other words total manufacturing costs.

So, to calculate Cost of Goods Manufactured for a period, a manufacturing company has to identify Direct Labor, Direct Materials and Overhead costs (i.e. manufacturing costs) incurred to make product during that period of time.

The calculation of cost of goods manufactured is;

Beginning Work In Process $
+ Manufacturing Costs ($) Incurred
(Direct Labor + Direct Materials used + Overhead costs)

- Ending Work in Process $

= Cost of Goods Manufactured.

In order to do this calculation the company will create a Cost of Goods Manufactured Statement. (see above)

On the Cost of Goods Manufactured statement;

Direct Materials used is derived from the following calculation;
Beginning Raw Materials Inventory + Purchases - Ending Raw Materials Inventory = Direct Materials Used
Direct Labor is based on time charged by workers in the manufacturing process.
Overhead costs are an accumulation of costs, such as production-related indirect materials and indirect labor as well as depreciation, property taxes, insurance for production related facilities.



Inventories

All companies have to report the value of their inventory on their financial statements. For merchandising companies this is based on the cost to acquire the inventory (Purchase price, Freight, etc.) However, manufacturing companies MAKE the product that they plan to sell.

So, at the end of their fiscal year, or at any time that they need to report on inventory - it is very unlikely that everything that they are making (in order to sell) is in a completed state. There will be product that is partially complete. However, we cannot ignore these items - we have incurred costs to make them, so far - and as we have learned, all costs incurred to create the product (i.e. manufacturing costs) are considered part of inventory.

This leads manufacturing companies to categorize their inventory as follows;

Finished Goods: Product fully complete and ready for sale.
Work In Process: Product that is partially complete and still needs more work to be done for it to be ready for sale.
Raw Materials: Items which are the components needed to create the product. Not sold individually, used collectively in the manufacturing process to create the finished product to be sold.

Monday, May 24, 2010

Manufacturing Costs

Manufacturing Costs

Like any other kind of company, a manufacturing company is in business to make money. It wants to generate revenues and in order to do that it will incur costs. What makes a MANUFACTURING company different from a MERCHANDISING company is HOW it views and records the costs that it incurs.
A MERCHANDISING company buys inventory for the purpose of re-selling it at a profit - A MANUFACTURING company on the other hand, MAKES the product it intends to sell. This distinction is at the root of the challenge a manufacturing company has as it records the costs it incurs. Costs incurred to make the product are considered maufacturing costs.


So - what is important to take away from a discussion of manufacturing costs......

The SIMILARITIES to a MERCHANDISING company

  • Costs incurred are for the most part very similar to the costs a merchandising company incurs - salaries, wages, utilities, rent, depreciation, insurance, etc.
  • Costs are recorded in the journal and posted to the ledger.
  • Costs are recorded with DEBITs and CREDITs.
  • If payment is with cash - Credit is to CASH
  • If purchase is on account - Credit is to Accounts Payable

The DIFFERENCES......

  • Inventory for a manufacturing company is not purchased - it is MADE
  • Costs incurred for wages, salaries, depreciation etc. which are incurred as part of the production process (i.e. manufacturing costs) are NOT recorded as EXPENSES
  • So, before recording a cost, a determination has to be made regarding the REASON the cost was incurred. If the cost was incurred as part of the process to manufacture the product then the cost is not an expense - instead it is included in account treated as part of INVENTORY cost (an asset).
  • This means that the Chart of Accounts for a Manufacturing company is quite a bit expanded when compared to a merchandising company- for example, there may be multiple accounts for 'depreciation' - one depreciation account in the Chart of Accounts may be classified as expense, another may be part of inventory. Either account is subject to be DEBIT-ed when a depreciation charge is incurred - which account gets Debit-ed depends on why the cost was incurred.
  • If the depreciation is related to the Factory where the product is made - then the charge is related to the manufacturing process and is debit-ed to the depreciation account in Inventory.
  • If, however, the charge is related to the headquarters office building then the charge is not part of the manufacturing process - it is therefore treated as an expense and is debit-ed to depreciation expense.

Manufacturing Cost Categories

Manufacturing Costs can be categorized as Labor, Materials or Overhead costs. All manufacturing costs incurred can be slotted into one of these three categories.

Direct Labor - Costs incurred for the employees directly involved with creating the product

Direct Materials - Costs of materials used directly in each unit created in the production process

Overhead - Costs incurred in the manufacturing process which cannot be directly assocuated with or attributed to specific units of production. Overhead costs include costs such as depreciation, insurance, utilities - as long as these costs were incurred for a production-related facility.

Also included in Overhead are Indirect Labor and Indirect Materials

  • Indirect Labor - Costs incurred for the employees who are part of the manufacturing process but who are not directly making the product (e.g. Factory supervisor)
  • Indirect Materials - Materials used out of inventory which were were used in the production process, but cannot be associated with a specific unit of production.