Which of the following items is not used when calculating the cost of goods manufactured?

What is the Cost of Goods Manufactured?

The cost of goods manufactured is the cost assigned to produced units in an accounting period. The concept is useful for examining the cost structure of a company's production operations. The best approach to examining the cost of goods manufactured is to disaggregate it into its component parts and examine them on a trend line. By doing so, you can determine the types of costs that a company is incurring over time to produce a certain mix and quantity of goods.  This cost structure usually includes the items noted below.

A retail operation has no cost of goods manufactured, since it only sells goods produced by others. Thus, its cost of goods sold is comprised of merchandise that it is reselling.

Cost of Direct Materials

The cost of goods manufactured includes all direct materials consumed during the reporting period. If the company is using a periodic inventory system, then it can calculate the cost of direct materials by adding the beginning inventory balance to the cumulative amount of purchases made during the period, and subtracting the ending balance. The resulting figure will include the cost of any scrap or other direct materials shrinkage that may have occurred during the period.

Cost of Direct Labor

The cost of goods manufactured includes all direct labor incurred during the reporting period. This amount is easily calculated by compiling the payroll cost of all production workers during the reporting period.

Cost of Manufacturing Overhead

The cost of goods manufactured includes all manufacturing overhead costs incurred during the reporting period. The accounts from which overhead is compiled are set by accounting policy. Examples of these accounts are manufacturing rent, manufacturing depreciation, manufacturing supervisory compensation, quality control compensation, utilities, repairs and maintenance, and production supplies.

Cost of Goods Manufactured vs. Cost of Goods Sold

The cost of goods manufactured is not the same as the cost of goods sold. Goods manufactured may remain in stock for many months, especially if a company experiences seasonal sales. Conversely, goods sold are those sold to third parties during the accounting period. There can be numerous reasons for the cost of goods manufactured and cost of goods sold to differ from each other, including the following:

• There may be no sales at all during the period, while production has continued. The cost of goods sold is therefore zero, while the cost of goods manufactured may be substantial.

• There may be lots of sales during the month from inventoried reserves, while there is no manufacturing going on at all. The cost of goods sold may therefore be substantial, while the cost of goods manufactured is zero.

• The cost of goods sold may contain charges related to obsolete inventory.

• The most likely reason for differences between the costs of goods manufactured and sold is simply that the mix of products sold does not exactly match the mix of products manufactured.

How to Calculate the Cost of Goods Sold

The cost of goods manufactured is a component of the calculation for the cost of goods sold. The calculation is:

Beginning inventory + Cost of goods manufactured - Ending inventory

= Cost of goods sold

This calculation is used for the periodic inventory method. It is not needed for the perpetual inventory method, where the cost of individual units that are sold are recognized in the cost of goods sold.

What Is Cost of Goods Sold (COGS)?

Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the good. It excludes indirect expenses, such as distribution costs and sales force costs.

Cost of goods sold is also referred to as "cost of sales."

Key Takeaways

• Cost of goods sold (COGS) includes all of the costs and expenses directly related to the production of goods.
• COGS excludes indirect costs such as overhead and sales & marketing.
• COGS is deducted from revenues (sales) in order to calculate gross profit and gross margin. Higher COGS results in lower margins.
• The value of COGS will change depending on the accounting standards used in the calculation.
• COGS differs from operating expenses (OPEX) in that OPEX includes expenditures that are not directly tied to the production of goods or services.

Examining Costs Of Goods Sold (COGS)

Understanding Cost of Goods Sold (COGS)

COGS is an important metric on the financial statements as it is subtracted from a company’s revenues to determine its gross profit. The gross profit is a profitability measure that evaluates how efficient a company is in managing its labor and supplies in the production process.

Because COGS is a cost of doing business, it is recorded as a business expense on the income statements. Knowing the cost of goods sold helps analysts, investors, and managers estimate the company’s bottom line. If COGS increases, net income will decrease. While this movement is beneficial for income tax purposes, the business will have less profit for its shareholders. Businesses thus try to keep their COGS low so that net profits will be higher.

Cost of goods sold (COGS) is the cost of acquiring or manufacturing the products that a company sells during a period, so the only costs included in the measure are those that are directly tied to the production of the products, including the cost of labor, materials, and manufacturing overhead.

For example, COGS for an automaker would include the material costs for the parts that go into making the car plus the labor costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labor used to sell the car would be excluded.

Furthermore, costs incurred on the cars that were not sold during the year will not be included when calculating COGS, whether the costs are direct or indirect. In other words, COGS includes the direct cost of producing goods or services that were purchased by customers during the year. As a rule of thumb, if you want to know if an expense falls under COGS, ask: "Would this expense have been an expense even if no sales were generated?"

COGS only applies to those costs directly related to producing goods intended for sale.

Formula and Calculation of Cost of Goods Sold (COGS)

COGS = Beginning Inventory + P − Ending Inventory where P = Purchases during the period \begin{aligned} &\text{COGS}=\text{Beginning Inventory}+\text{P}-\text{Ending Inventory}\\ &\textbf{where}\\ &\text{P}=\text{Purchases during the period}\\ \end{aligned} ​COGS=Beginning Inventory+P−Ending InventorywhereP=Purchases during the period​

Inventory that is sold appears in the income statement under the COGS account. The beginning inventory for the year is the inventory left over from the previous year—that is, the merchandise that was not sold in the previous year.

Any additional productions or purchases made by a manufacturing or retail company are added to the beginning inventory. At the end of the year, the products that were not sold are subtracted from the sum of beginning inventory and additional purchases. The final number derived from the calculation is the cost of goods sold for the year.

The balance sheet has an account called the current assets account. Under this account is an item called inventory. The balance sheet only captures a company’s financial health at the end of an accounting period. This means that the inventory value recorded under current assets is the ending inventory.

Accounting Methods and COGS

The value of the cost of goods sold depends on the inventory costing method adopted by a company. There are three methods that a company can use when recording the level of inventory sold during a period: first in, first out (FIFO), last in, first out (LIFO), and the average cost method. The special identification method is used for high-ticket or unique items.

FIFO

The earliest goods to be purchased or manufactured are sold first. Since prices tend to go up over time, a company that uses the FIFO method will sell its least expensive products first, which translates to a lower COGS than the COGS recorded under LIFO. Hence, the net income using the FIFO method increases over time.

LIFO

LIFO is where the latest goods added to the inventory are sold first. During periods of rising prices, goods with higher costs are sold first, leading to a higher COGS amount. Over time, the net income tends to decrease.

Average Cost Method

The average price of all the goods in stock, regardless of purchase date, is used to value the goods sold. Taking the average product cost over a time period has a smoothing effect that prevents COGS from being highly impacted by the extreme costs of one or more acquisitions or purchases.

Special Identification Method

The special identification method uses the specific cost of each unit of merchandise (also called inventory or goods) to calculate the ending inventory and COGS for each period. In this method, a business knows precisely which item was sold and the exact cost. Further, this method is typically used in industries that sell unique items like cars, real estate, and rare and precious jewels.

Exclusions From COGS Deduction

Many service companies do not have any cost of goods sold at all. COGS is not addressed in any detail in generally accepted accounting principles (GAAP), but COGS is defined as only the cost of inventory items sold during a given period. Not only do service companies have no goods to sell, but purely service companies also do not have inventories. If COGS is not listed on the income statement, no deduction can be applied for those costs.

Examples of pure service companies include accounting firms, law offices, real estate appraisers, business consultants, professional dancers, etc. Even though all of these industries have business expenses and normally spend money to provide their services, they do not list COGS. Instead, they have what is called "cost of services," which does not count towards a COGS deduction.

Cost of Revenue vs. COGS

Costs of revenue exist for ongoing contract services that can include raw materials, direct labor, shipping costs, and commissions paid to sales employees. These items cannot be claimed as COGS without a physically produced product to sell, however. The IRS website even lists some examples of "personal service businesses" that do not calculate COGS on their income statements. These include doctors, lawyers, carpenters, and painters.

Many service-based companies have some products to sell. For example, airlines and hotels are primarily providers of services such as transport and lodging, respectively, yet they also sell gifts, food, beverages, and other items. These items are definitely considered goods, and these companies certainly have inventories of such goods. Both of these industries can list COGS on their income statements and claim them for tax purposes.

Operating Expenses vs. COGS

Both operating expenses and cost of goods sold (COGS) are expenditures that companies incur with running their business; however, the expenses are segregated on the income statement. Unlike COGS, operating expenses (OPEX) are expenditures that are not directly tied to the production of goods or services.

Typically, SG&A (selling, general, and administrative expenses) are included under operating expenses as a separate line item. SG&A expenses are expenditures that are not directly tied to a product such as overhead costs. Examples of operating expenses include the following:

• Rent
• Utilities
• Office supplies
• Legal costs
• Sales and marketing
• Payroll
• Insurance costs

Limitations of COGS

COGS can easily be manipulated by accountants or managers looking to cook the books. It can be altered by:

• Allocating to inventory higher manufacturing overhead costs than those incurred
• Overstating discounts
• Overstating returns to suppliers
• Altering the amount of inventory in stock at the end of an accounting period
• Overvaluing inventory on hand
• Failing to write off obsolete inventory

When inventory is artificially inflated, COGS will be under-reported which, in turn, will lead to higher than the actual gross profit margin, and hence, an inflated net income.

Investors looking through a company’s financial statements can spot unscrupulous inventory accounting by checking for inventory buildup, such as inventory rising faster than revenue or total assets reported.

How Do You Calculate Cost of Goods Sold (COGS)?

Cost of goods sold (COGS) is calculated by adding up the various direct costs required to generate a company’s revenues. Importantly, COGS is based only on the costs that are directly utilized in producing that revenue, such as the company’s inventory or labor costs that can be attributed to specific sales. By contrast, fixed costs such as managerial salaries, rent, and utilities are not included in COGS. Inventory is a particularly important component of COGS, and accounting rules permit several different approaches for how to include it in the calculation.

Are Salaries Included in COGS?

COGS does not include salaries and other general and administrative expenses; however, certain types of labor costs can be included in COGS, provided that they can be directly associated with specific sales. For example, a company that uses contractors to generate revenues might pay those contractors a commission based on the price charged to the customer. In that scenario, the commission earned by the contractors might be included in the company’s COGS, since that labor cost is directly connected to the revenues being generated.

How Does Inventory Affect COGS?

In theory, COGS should include the cost of all inventory that was sold during the accounting period. In practice, however, companies often don’t know exactly which units of inventory were sold. Instead, they rely on accounting methods such as the first in, first out (FIFO) and last in, first out (LIFO) rules to estimate what value of inventory was actually sold in the period. If the inventory value included in COGS is relatively high, then this will place downward pressure on the company’s gross profit. For this reason, companies sometimes choose accounting methods that will produce a lower COGS figure, in an attempt to boost their reported profitability.

The Bottom Line

Cost of goods sold is the direct cost of producing a good, which includes the cost of the materials and labor used to create the good. COGS directly impacts a company's profits as COGS is subtracted from revenue. Companies must manage their COGS to ensure higher profits. If a company can reduce its COGS through better deals with suppliers or through more efficiency in the production process, it can be more profitable.

Which of the following are used in the calculation of cost of goods manufactured?

Which of the following is not a product cost for a manufacturer?

Which of the following account would not appear on a schedule of cost of goods manufactured?

Which of the following items is a product cost for a manufacturing company?