Chapter 14: Cost Flows and Cost of Goods

Manufacturing activities consist of the sequential processes of materials procurement, production, and sales. Each stage in this process incurs costs that flow through various inventories, reflecting the transformation of materials into finished products. Here’s a breakdown of these activities and the flow of manufacturing costs. 1. Flow of Manufacturing Activities The manufacturing process involves three main activities: • • • Materials Activity: This stage involves managing raw materials inventory. At the beginning of each period, there is typically a starting inventory of raw materials. As new materials are purchased during the period, they are added to the beginning inventory, giving the total available materials. These materials are then either used in production or retained in inventory for future use. Production Activity: During production, raw materials are combined with direct labor and factory overhead to create finished goods. At the beginning of the period, any unfinished goods from the previous period are included in the work in process (WIP) inventory. Throughout production, costs of direct materials, direct labor, and factory overhead are added to WIP. Completed products then move to finished goods inventory, while the cost of unfinished goods remains in WIP. Sales Activity: This final stage involves finished goods. The beginning finished goods inventory, along with any newly completed goods, makes up the total goods available for sale. When products are sold, their cost moves from finished goods inventory to cost of goods sold on the income statement. Any unsold finished goods remain as inventory on the balance sheet. 2. Schedule of Cost of Goods Manufactured (COGM) The schedule of cost of goods manufactured summarizes manufacturing costs and their flow through the production process. It typically includes four sections: 1. Direct Materials Used: This calculation begins with the beginning raw materials inventory and adds the cost of materials purchased, resulting in the total raw materials available. After subtracting the ending raw materials inventory, we get the direct materials used during the period. 2. Direct Labor Used: This is the total direct labor cost incurred, which includes wages, payroll taxes, and employee benefits for workers directly involved in production. 3. Factory Overhead: This includes indirect costs related to manufacturing, such as indirect labor, utilities, depreciation on factory equipment, and other costs not directly traceable to specific products. 4. Cost of Goods Manufactured: Adding direct materials, direct labor, and factory overhead gives total manufacturing costs. After adding beginning WIP inventory and subtracting ending WIP inventory, we arrive at the cost of goods manufactured, which represents the total cost of completed products. 3. Example of a Schedule of Cost of Goods Manufactured Here’s how this might look for Rocky Mountain Bikes: Schedule of Cost of Goods Manufactured For the Year Ended December 31, 20XX Account Direct Materials Used Beginning Raw Materials Plus: Purchases Raw Materials Available Less: Ending Raw Materials Direct Materials Used Amount ($) 8,000 86,500 94,500 (9,000) 85,500 Direct Labor 60,000 Factory Overhead Indirect Labor Factory Utilities Depreciation—Factory Total Factory Overhead 10,000 5,000 15,000 30,000 Total Manufacturing Costs 175,500 Plus: Beginning WIP Inventory 2,500 Total Work in Process 178,000 Less: Ending WIP Inventory (7,500) Cost of Goods Manufactured 170,500 4. Links Between COGM and Financial Statements The COGM links to both the income statement and the balance sheet. Here’s how: • • Income Statement: COGM is used to calculate the cost of goods sold, a crucial expense on the income statement. Balance Sheet: Ending balances of raw materials, WIP, and finished goods inventories are listed under current assets. This reflects the portion of manufacturing costs not yet expensed, as they relate to unsold products. The COGM report helps managers assess manufacturing efficiency, control costs, and forecast per-unit costs.