You have seen how product costs 'flow' through accounts. The ending account balances of the three inventory accounts along with the amount of cost of goods sold are used in preparing external financial statements. This chapter illustrates the reporting of product costs including the cost of goods manufactured statement.

 


Cost of Goods Manufactured


Cost of goods manufactured (CGM) represents the total cost of products that have been completed during the current period and transferred out of Work in Process into Finished Goods. Manufacturing companies prepare a separate cost of goods manufactured (CGM) report for management purposes. It is often referred to as a schedule or statement, however, it is not part of GAAP financial reporting. It is used internally by managers in determining and controlling manufacturing costs. Because of the need to monitor production costs closely, this report is created monthly or quarterly, rather than waiting until the end of the fiscal year. This enables managers to make changes in production if needed.

 

The CGM statement summarizes the manufacturing costs flowing in and out of the factory work area, i.e., the Work in Process account. The bottom line (total) on the CGM statement is used on the manufacturer’s income statement to calculate cost of goods sold. Exhibit 1 shows the flow of costs into and out of work in process.

 

Exhibit 1 - Flow of Manufacturing Costs

 

In addition to the beginning and ending Work in Process amounts, certain activity occurs in the Work in Process account. There are three current period manufacturing costs added when normal costing is used:

        Direct materials used

        Direct labor incurred

        Manufacturing overhead applied

The cost of goods manufactured is transferred out (i.e., cost of completed products). The ending Work in Process balance is carried over to the next period.

 

Format of the Cost of Goods Manufactured Statement

The cost of goods manufactured statement essentially summarizes the activity in the Work in Process account. When an expanded raw materials section is displayed, the activity is based on a summary of the Raw Materials account.

 

Only one reduction occurs to the Work in Process account---the CGM. The CGM is the cost of products that have been completed during the period. From a practical standpoint, there may be a number of transfers, perhaps on a daily basis. However, you can assume that the CGM reduction to Work in Process is the total cost of all the completed goods that have been transferred out.

 

The manufacturing overhead cost that is added to Work in Process during the period differs under normal and actual costing. If normal costing is used, the amount added for manufacturing overhead is the amount of overhead applied. If actual costing is used, the amount added is actual overhead costs incurred.

 

Because we track the acquisition and use of raw materials in inventory, it is important to remember that direct materials used are considered product costs. Do not confuse 'used' with the ending Raw Materials balance, which is an asset, or materials purchased, which may or may not be entirely used. The activity in the Raw Materials inventory account is used as a basis of calculating direct materials used. The format of the CGM report follows:

 

ABC Company

Cost of Goods Manufactured

Month Ending January 31, 2018

Direct materials used:

   Beginning raw materials inventory

   + Raw materials purchases

   ─ Indirect materials issued to production

   ─ Ending raw materials inventory

= Direct materials used

+ Direct labor

+ Manufacturing overhead

= Total manufacturing costs

+ Beginning work in process inventory

Ending work in process inventory

= Cost of goods manufactured

 

A CGM statement contains a three-line statement heading similar to financial statements. Because the CGM report covers a period of time, the date format is similar to the income statement and must specify the time period covered. 

 


Income Statement Presentation of Product Costs


Cost of goods manufactured is added to beginning Finished Goods inventory because it represents completed inventory items that are ready to be sold. The cost of inventory sold, known as cost of goods sold, is subtracted from finished goods to arrive at ending Finished Goods inventory.

 

The income statement of a manufacturing company is similar to that of a merchandising company. The cost of goods sold section of a merchandiser is typically prepared in an expanded format which calculates cost of goods sold based on the activity in the merchandise inventory account.

 

The cost of goods sold section of a manufacturing company is similar to that of a merchandiser, as it is based on the activity of an inventory account---Finished Goods inventory. A partial income statement appears below for a manufacturing company:

 

 Partial Income Statement 

 Sales revenue

 Cost of goods sold:             

 

         Beginning finished goods

 

         + Cost of goods manufactured

 

         +/- Underapplied (overapplied) overhead

 

         = Cost of goods available for sale

 

         - Ending finished goods

 

         = Cost of goods sold

 

 Gross profit

 

 

There are three major differences in the merchandising company calculation of cost of goods sold compared to the manufacturing company calculation:

Inventory Account Names

 

Purchases vs. CGM

 

Overhead Application

For companies that do not prepare an expanded cost of goods sold section of the income statement, cost of goods sold is displayed the same regardless if the company is a merchandising or manufacturing company.

 


Balance Sheet Presentation of Product Costs


Both merchandising and manufacturing companies report inventories on their respective balance sheets in the current assets section. Manufacturing companies report raw materials, work in process, and finished goods, while merchandising companies report merchandise inventory.

 


Walk Through Problem


Karmon Audio, Inc. manufactures speakers. The company tracks both direct and indirect materials in its materials storeroom in its Raw Materials account. During March, Karmon’s transactions and accounts included the following:  

     

Raw materials acquired for cash

$65,000

Raw materials received on account

18,000

Indirect materials issued to production

1,000

Costs to ship products to customers

2,000

Direct labor cost incurred

41,000

Total manufacturing overhead applied

25,000

Total manufacturing overhead incurred

24,700

Raw materials inventory, beginning

3,500

Raw materials inventory, ending

3,600

Finished goods inventory, beginning

9,000

Finished goods inventory, ending

11,300

Work in process inventory, beginning

12,000

Work in process inventory, ending

14,200

 

Part 1: If Karmon employs a normal costing system, calculate the cost of direct materials transferred to production and prepare a expanded cost of goods manufactured report.        

Solution - Part 1

Set up a Raw Materials t-account and post all amount to it. All activity from the raw materials account is used to calculate the cost of direct materials transferred to production.

 Raw Materials 

 

 Beg. balance

       3,500

 

 

 Purchases 

     65,000

 

 

 Purchases 

     18,000

 

 

 

     1,000

 Indirect materials issued 

 

   81,900

 Direct materials issued 

End. balance

      3,600

 

 

Once all amounts are posted, determine the missing amount---a credit is needed for $81,900 to make the t-account balance. Costs of shipping products to customers is a period cost because it is not part of the cost of getting the materials or products ready to use or sell.

 

An expanded cost of good manufactured statement shows the Raw Materials account activity rather than a single line item for the cost of direct materials used in production. The cost of goods manufactured statement for March based on normal costing appears as follows:

Expanded CGM Normal Costing

Raw materials inventory, beginning

$  3,500

 

Materials purchased ($65,000 + $18,000)

83,000

 

Indirect materials to production

(1,000)

 

Raw materials inventory, ending 

  (3,600)

 

Direct materials issued to production

 

$81,900

Direct labor cost incurred

41,000

Manufacturing overhead cost applied

   25,000

   Total manufacturing costs

147,900

Add: Work in process inventory, beginning

12,000

Less: Work in process inventory, ending

 (14,200)

Cost of goods manufactured

$145,700

The three primary costs added to work in process during the period are direct materials used (issued to production), direct labor cost incurred, and manufacturing overhead applied: $81,900 + $41,000 + $25,000.

Part 2: If Karmon employs a actual costing system, indicate what amounts will differ, and by what amount.

Solution - Part 2

The only difference between actual and normal costing is the amount of manufacturing overhead. Actual manufacturing overhead is $24,700 under actual costing, and applied manufacturing overhead is $25,000 under normal costing, a difference of $300. Total manufacturing costs will be $147,900 plus $300, or a total of $148,200. CGM will be $146,000 with the additional $300.

Part 3: How much is cost of goods sold after disposal of the over or underapplied overhead if Karmon uses a normal costing system?

Solution - Part 3

The amount credited to Manufacturing Overhead under normal costing is the amount of overhead applied, $25,000. The actual cost of $24,700 of overhead is a debit to the same account. The overapplied overhead is calculated by subtracting incurred overhead from applied manufacturing overhead: $25,000 - $24,700 = $300 overapplied. Because overhead is overapplied, the adjustment is a debit to Manufacturing Overhead and a credit to Cost of Goods Sold. Take special note that estimated manufacturing overhead is not posted to any account. It is used only for budgeting purposes.

Manufacturing Overhead

 

 Actual MOH

 Applied MOH

 

24,700

25,000

 
     
 

     300

overapplied

The activity in the finished goods account is used to determine cost of goods sold. Once the beginning and ending balances and the cost of goods manufactured amounts are posted, the missing credit amount is calculated. The only decrease to Finished Goods is the cost of goods sold during the period.

Finished Goods

    9,000

 

145,700

 
 

    143,400

  11,300

 

The only debit entry to the Cost of Goods Sold account is the cost transferred out of Finished Goods. The credit balance of $300 that appears in the Manufacturing Overhead account is adjusted with a debit to Manufacturing Overhead and a credit to Cost of Goods Sold for $300. The amount of cost of goods sold to be reported on Karmon's income statement is the adjusted balance of $143,100.

Cost of Goods Sold

143,400

 
 

300

143,100

 

 


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