Connect with us
Uncategorized

# How to Calculate Cost of Inventory

Published

on

One of the most common questions we get is, “how do you calculate cost of inventory?” The answer is actually quite simple. It’s calculated by taking the cost of the item and adding the depreciation on it, then dividing it by the number of units.

I have seen a lot of questions about the cost of inventory and how to calculate it. This blog post will explain how to calculate the cost of inventory.

Home » Bookkeeping » Finding Your True Cost of Goods Manufactured

Jun 25, 2020
Bookkeeping by Adam Hill
Cost of Goods Manufactured (COGM)

Direct materials, direct labor, and overhead all get input into the production process. Therefore, to compute the cost of goods manufactured, think about all product costs, including not only direct materials but also direct labor and overhead. 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.

The costs of goods manufactured is an accounting term used to describe a statement or schedule that depicts the total costs of production for a company during a specific time period. The COGM is the total amount a company spends to produce goods, turn them into inventory and put them up for sale. This calculation takes into account all expenses related to the manufacturing of inventory including direct materials, factory overhead and labor expenses.

The value of an accurate COGS calculation can provide a company with insight into profitability, allow long term strategic planning, improve the pricing of products and act as a guideline for taxes and investment. Whether done manually or using software, the COGS calculation should be accurate and based on real data to provide these things. Start with the Beginning Raw Materials Inventory value and add all raw materials purchased during the selected accounting period.

The cost of goods manufactured is a calculation of the production costs of the goods that were completed during an accounting period. Manufacturing overhead is all costs tied to your organization’s manufacturing operations. These are the ancillary costs in addition to direct materials and labor, and they all must be listed under the cost of goods sold on a financial statement. Accountants within your company have to note the overhead cost for each unit created by your production team. Property taxes and insurance costs need to be factored in when you’re coming up with the total overhead cost per unit as well.

COGS may also be affected depending on the inventory costing method used by the company such as First in First Out (FIFO), Last in First Out (LIFO), or Average Cost Method. As companies have different levels of complexity and scale, each will have to choose the method that works best for their business.

The costs of goods manufactured may also be referred to as the cost of goods completed. 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.

Cost of goods manufactured\$1,100,000Note how the statement shows the costs incurred for direct materials, direct labor, and manufacturing overhead. The statement totals these three costs for total manufacturing cost during the period. When adding beginning work in process inventory and deducting ending work in process inventory from the total manufacturing cost, we obtain cost of goods manufactured or completed. Cost of goods sold does not appear on the cost of goods manufactured statement but on the income statement. This formula will leave you with only the cost of goods that were completed during the period.

Raw materials are inventory that is waiting to be used in the production of goods. To calculate the cost of goods manufactured, you must add your direct materials, direct labor, and manufacturing overhead to get your businesses’ total manufacturing cost. Next, you will add the beginning work-in-process and subtract the ending work-in-process from the total manufacturing cost to get the cost of goods manufactured. The last part of the calculation you need to make for the cost of goods manufactured formula is for the ending WIP inventory. This concept describes all inventory that shows signs of completion, but it stills needs to be confirmed if production can be finalized.

This statistic must be known so it can be reported after each accounting period. You might be able to see if your production is on schedule or if you have to make key decisions on production costs. Make sure to subtract this figure once you add up the previous figures to get your total cost of goods manufactured. The direct labor part of the total manufacturing calculation refers to how much was paid in labor costs for a certain time period. This is usually straightforward and can be calculated by multiplying the number of hours of work with the hourly rate for each employee.

Cost of goods manufactured\$1,100,000Note how the statement shows the costs incurred for direct materials, direct labor, and manufacturing overhead.
The statement totals these three costs for total manufacturing cost during the period.

Again, the total manufacturing cost is the aggregate of direct labor cost, direct material cost and factory overhead. Cost of goods manufactured is based on the amount of work-in-process completed. This work-in-process includes costs of direct materials put into production, plus direct labor and overhead. As a reminder, COGS is it’s the amount of money a company spends on labor, materials, and certain overhead costs relating to producing a product or service.

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.

What Does Cost of Goods Manufactured Mean?

The total manufacturing cost consists of the total cost of all goods the company has at least begun to sell during a given period. To this the owner must add work in process, or work in progress, which is the cost of goods that have begun production but are not yet ready to be sold. Using the beginning Work in Process (WIP) inventory, subtract the ending WIP inventory value and add to the Total Manufacturing Costs in step 2.This is the Cost of Goods Manufactured (COGM). Companies can also hold onto materials they receive from suppliers and list the value of them for accounting purposes.

Example calculation of Cost of Goods Manufactured (COGM)

Be sure you know the number of products you have waiting to be completed to document your inventory properly, and add them your manufacturing overhead, direct materials and direct labor costs. Unfortunately, it is not as simple as it seems, as each working part has multiple equations within. The schedule reports the total manufacturing costs for the period that were added to the work‐in‐process (WIP). It then adjusts these costs for the change in the WIP inventory account to arrive at the cost of goods manufactured.

Manufacturing overhead costs refer to indirect costs that are paid regardless of the production of inventory. For example, rent for a factory building and depreciation on equipment are considered manufacturing overhead costs. The cost of goods manufactured schedule is used to calculate the cost of producing products for a period of time. The cost of goods manufactured amount is transferred to the finished goods inventory account during the period and is used in calculating cost of goods sold on the income statement. Prepare a schedule of cost of goods manufactured; assume all raw materials used in production were direct materials.

The \$500 of light bulbs purchased was included in the Raw Materials Inventory account, but since the bulbs are not direct materials, they were not recorded as part of the direct materials cost. Later, Friends Company used \$100 of light bulbs in the manufacturing process, and this cost was recorded as part of the Factory Overhead cost. These platforms provide real-time data and advanced analytics that can help improve accurate costing in areas such as WIP calculation, manufacturing overhead, and direct labor.

Determining Direct Labor and Manufacturing Overhead

This is nothing but the cost sheet of the company and it includes prime cost as well. Hence adding all of the manufactured stage inventory and all the direct expenses will sum up to cost of good manufactured and when one divides the same by the number of units produced will yield the cost of goods manufactured. (Factory overhead will include factory expenses like rent and utilities). The total manufacturing portion of this formula refers to the direct materials, direct labor and manufacturing overhead that was paid for during a certain period of time for the production of goods. The direct materials can be calculated by adding the beginning raw materials to the purchases made and subtracting that total from the ending raw materials.{“@context”:”https://schema.org”,”@type”:”FAQPage”,”mainEntity”:[{“@type”:”Question”,”name”:”What is the formula of cost of inventory?”,”acceptedAnswer”:{“@type”:”Answer”,”text”:” The formula for cost of inventory is: Cost of Inventory = Cost per Unit x Quantity of Units Cost of Inventory = Cost per Unit x Quantity of Units”}},{“@type”:”Question”,”name”:”What is the formula of inventory?”,”acceptedAnswer”:{“@type”:”Answer”,”text”:” The formula of inventory is: Inventory = Cost of goods sold + Purchases Inventory = Cost of goods sold + Purchases – Inventory Inventory = Cost of goods sold – Inventory”}},{“@type”:”Question”,”name”:”How do you find the cost of inventory sold?”,”acceptedAnswer”:{“@type”:”Answer”,”text”:” The cost of inventory sold is the cost of goods sold divided by the number of units sold.”}}]}

### Frequently Asked Questions

#### What is the formula of cost of inventory?

The formula for cost of inventory is: Cost of Inventory = Cost per Unit x Quantity of Units Cost of Inventory = Cost per Unit x Quantity of Units

#### What is the formula of inventory?

The formula of inventory is: Inventory = Cost of goods sold + Purchases Inventory = Cost of goods sold + Purchases – Inventory Inventory = Cost of goods sold – Inventory

#### How do you find the cost of inventory sold?

The cost of inventory sold is the cost of goods sold divided by the number of units sold.

Continue Reading

#### Popular

Copyright © 2023 Better This World.