Cost of Goods Manufactured (COGM) is a term used in managerial accounting that refers to a schedule or statement that shows the total production costs for a company during a specific period of time. Just like the name implies, COGM is the total cost incurred to manufacture products and transfer them into finished goods inventory for retail sale.
In order to determine the actual direct materials used by the company for production, we must consider the Raw Materials Inventory T-account. Raw materials inventory refers to the inventory of materials that are waiting to be used in production. For example, if a company were to make a raw material purchase for use, these would be recorded in the debit side of the raw materials inventory T-Account.
In addition, if a specific number of raw materials were requisitioned to be used in production, this would be subtracted from raw materials inventory and transferred to the WIP Inventory. Raw materials inventory can include both direct and indirect materials. Beginning and ending balances must also be used to determine the amount of direct materials used. Let’s also examine the following raw materials T-account.
Raw Materials Inventory
Beginning Balance a
Purchases of Raw Materials b
d Raw materials used in production
Ending Balance c
The raw materials used in production (d) is then transferred to the WIP Inventory account to calculate COGM.
Determining Direct Labor and Manufacturing Overhead
Determining how much direct labor was used in dollars is usually straightforward for most companies. With time logs and timesheets, companies just take the number of hours worked multiplied by the hourly rate. For information on calculating manufacturing overhead, refer to the Job order costing guide.
Linking COGM to COGS
Once all the individual parts are calculated and used to figure out the total cost of goods manufactured for the year, this COGM value is then transferred to a final inventory account called the Finished Goods Inventory account, and used to calculate the Cost of Goods Sold.
Finished Goods Inventory, as the name suggests, contains any products, goods, or services that are fully ready to be delivered to customers in final form. The following T-account shows the Finished Goods Inventory. Beginning and ending balances must also be considered, similar to Raw materials and WIP Inventory.
Finished Goods Inventory
Beginning Balance a
Cost of Goods Manufactured b
d Cost of Goods Sold
Ending Balance c
With all the pieces together, we can construct a full Schedule of Cost of Goods Manufactured and Cost of Goods Sold.
In general, having the schedule for Cost of Goods Manufactured is important because it gives companies and management a general idea of whether production costs are too high or too low relative to the sales they are making.
For example, if a company earned $1,000,000 in sales revenue for the year and incurred $750,000 in Cost of Goods Sold, they might want to look at ways to reduce their manufacturing costs to increase their gross margin percentage.
Comparatively, if another company earned $800,000 in sales revenue and incurred only $400,000 in COGS, even though the company’s sales were lower, their gross margin percentage is much higher, which makes the latter company substantially more profitable.
Therefore, by having a general picture of what the company is incurring in terms of manufacturing costs in all its specific components of materials, labor, and overhead, management can examine these areas more thoroughly to make any necessary adjustments or changes to maximize the company’s net income.