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
To calculate 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 adequately label the amount transferred out from the account. It is crucial 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 placed right at the beginning of the cost of the 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 inventory account for one period. These materials await 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 the 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 Finished Goods Inventory is the last and most crucial part of the cost of goods sold statement for a manufacturing company. All goods are transferred from the work in progress inventory to the finished goods inventory in this 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 sold off after the entire goods transfer and manufacturing process is complete. Only the final products are sold off as final finished products. A more detailed statement includes overhead costs and other costs.
Conclusion
Regardless of the type of accounting system or tracking used, you must use the correct calculations, account for inventory accurately, note the progression on the balance sheet promptly, and understand the accounting inventory method used by the company. Consistency will result in more accurate calculations and keep companies out of dangerous territories such as over-valuing inventory.
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