The schedule that turns a factory's costs into cost of sales, and decides how much of them waits on the balance sheet instead.
Cost of goods manufactured is direct materials used plus direct labour plus factory overhead, which gives total manufacturing cost, plus opening work in progress minus closing work in progress. On an illustrative machine shop with 34,038,816 of manufacturing cost in the year, opening WIP of 1,265,000 and closing WIP of 1,512,400, cost of goods manufactured is 33,791,416. Adjust that for the change in finished goods and cost of goods sold is 33,946,816.
Worked in full in Cost Accounting by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The schedule matters because it is where a factory's costs turn into the cost of sales on the income statement, and where they stop doing so. Every amount that sits in work in progress or finished goods at the year end, overhead included, leaves the profit and loss account and waits on the balance sheet. Three inventory accounts, three adjustments, each in the right order.
| Item | Amount |
|---|---|
| Revenue | 48,050,000 |
| Raw materials, opening | 1,420,000 |
| Raw material purchases | 15,862,300 |
| Raw materials, closing | 1,485,800 |
| Direct labour | 4,802,316 |
| Factory overhead | 13,440,000 |
| Work in progress, opening / closing | 1,265,000 / 1,512,400 |
| Finished goods, opening / closing | 2,310,000 / 2,154,600 |
| Selling, general and administrative (period cost) | 6,720,000 |
Direct materials used = opening raw materials + purchases − closing raw materials
Total manufacturing cost = direct materials used + direct labour + factory overhead
COGM = total manufacturing cost + opening WIP − closing WIP
COGS = COGM + opening finished goods − closing finished goods
In Excel, with the inputs in a column: =RM_Open+Purchases-RM_Close, then =DM+DL+FOH, then =TMC+WIP_Open-WIP_Close, then =COGM+FG_Open-FG_Close. Keep each step on its own row so each inventory account can be tied to the balance sheet.
| Line | Amount |
|---|---|
| Raw materials, opening | 1,420,000 |
| Add purchases | 15,862,300 |
| Materials available | 17,282,300 |
| Less raw materials, closing | −1,485,800 |
| Direct materials used | 15,796,500 |
| Direct labour | 4,802,316 |
| Factory overhead | 13,440,000 |
| Total manufacturing cost | 34,038,816 |
| Add WIP, opening | 1,265,000 |
| Less WIP, closing | −1,512,400 |
| Cost of goods manufactured | 33,791,416 |
| Add finished goods, opening | 2,310,000 |
| Goods available for sale | 36,101,416 |
| Less finished goods, closing | −2,154,600 |
| Cost of goods sold | 33,946,816 |
Revenue of 48,050,000 less cost of goods sold of 33,946,816 gives gross profit of 14,103,184, 29.4 per cent of revenue, and after the 6,720,000 of selling and administrative cost, operating profit of 7,383,184. Selling and administrative cost never enters the schedule: it is a period cost, expensed in the year whatever the factory produced.
The book's case reports the same factory with no movement in stock, so its total factory cost of 34,038,816 is its cost of sales and its gross profit is 14,011,184. The schedule above differs by 92,000, which is exactly the net build in inventory: WIP rose by 247,400 and finished goods fell by 155,400. Nothing about the factory's efficiency changed. Cost moved between the income statement and the balance sheet.
Overhead is 39.5 per cent of total manufacturing cost here. Under absorption costing, roughly that share of every unit added to inventory is fixed overhead carried forward to next year rather than charged this year, which is why building stock flatters gross profit. The mechanism is worked in absorption vs variable costing.
Read the schedule from the bottom up as well. Cost of goods sold is 70.6 per cent of revenue; manufacturing cost is the factory's spending in the year; COGM is what it finished. When the three diverge, inventory is absorbing the difference, and the balance sheet, not the factory floor, explains the margin.
| Closing finished goods | Change against base | Extra materials and labour spent | COGS | Gross profit | GP % | Overhead deferred, approx. |
|---|---|---|---|---|---|---|
| 1,654,600 | −500,000 | −302,578 | 34,144,238 | 13,905,762 | 28.9 | −197,422 |
| 2,154,600 | 0 | 0 | 33,946,816 | 14,103,184 | 29.4 | 0 |
| 2,654,600 | 500,000 | 302,578 | 33,749,394 | 14,300,606 | 29.8 | 197,422 |
| 3,154,600 | 1,000,000 | 605,157 | 33,551,973 | 14,498,027 | 30.2 | 394,843 |
| 3,654,600 | 1,500,000 | 907,735 | 33,354,551 | 14,695,449 | 30.6 | 592,265 |
Each 500,000 of extra finished goods made and held lifts gross profit by about 197,422 with no extra sale: the materials and labour in those units were genuinely spent, but the fixed overhead they absorbed leaves this year's cost of sales and waits on the balance sheet. A pure valuation change is worse: overstate closing finished goods by 500,000 with nothing else changed and gross profit rises euro for euro, to 14,603,184. If a margin improvement coincides with rising inventory, read the schedule before the press release.
Materials used, plus labour, plus overhead, plus opening WIP, minus closing WIP: 33,791,416 here. Then add opening and deduct closing finished goods to reach cost of sales. The schedule is simple; what matters is that every inventory figure in it carries overhead, and that overhead is only as right as the base it was absorbed on. The free workbook for this case builds the same factory's cost base from its inputs and costs every product family twice.
Cost of goods manufactured is the cost of units completed in the period; cost of goods sold is the cost of units sold. The bridge is finished goods: COGS equals COGM plus opening finished goods minus closing finished goods. On the illustrative factory, COGM of 33,791,416 plus 2,310,000 of opening and less 2,154,600 of closing finished goods gives COGS of 33,946,816.
Only when work in progress does not change. Total manufacturing cost is everything put into production in the period, 34,038,816 here. Cost of goods manufactured adds opening WIP and deducts closing WIP, so with WIP rising by 247,400 it is 33,791,416. The difference is the cost of parts still on the shop floor.
Because under absorption costing each unit in stock carries part of the fixed overhead, which moves to the balance sheet instead of cost of sales. On the illustrative factory overhead is 39.5 per cent of manufacturing cost, so making and holding an extra 1,000,000 of finished goods, with sales unchanged and overhead fixed, raises gross profit by about 394,843, the overhead deferred to next year.
This article is one calculation from Cost Accounting. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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