Cost of Good Sold - Part 2

PART 2.  The Ending Inventory Budget for a Manufacturer

The following formula is used to determine a Manufacturer's Cost Of Goods Sold.

Beginning Inventory (in dollar) $XXX
Add: Raw Materials Purchased During the Year (in dollars) $XXX
Add: Direct Labor Budget for the Year $XXX
Add: Factory Overhead Budget for the Year $XXX
Equals: Cost of Goods Available For Sale $XXX
Less: Ending Inventory (in dollars) $XXX
Equals: Cost of Goods Sold $XXX


As you can see, the formula is similar to the formula used in calculating a retailer's Cost of Goods. Two additional variables, however, are required - the Direct Labor Costs and the Factory Overhead Costs. Why are these two costs required in calculating a manufacturers' Cost of Goods Sold?

Recall from previous discussions, a retailer and a manufacturer consider different variables when calculating its Total Product Cost Per Unit. The Total Product Cost Per Unit represents all the costs or expenses required to purchase or produce one finished unit of product. For instance, a clothing retailer, for example, would purchase finished product (clothing) from their supplier. Therefore, the retailer's Total Product Cost would consist of: 1) the cost to purchase an article of clothing and 2) the cost to ship each piece of clothing to the place of business. A manufacturing company, on the other hand, does NOT purchase finished products. Rather, they purchase raw material, and by applying direct labor and factory overhead, converts these raw materials into finished products. As a result, Raw Material Purchases, Direct Labor Costs and Factory Overhead Costs make up a manufacturer's Total Product Cost. And since the Cost of Goods Sold calculates all the costs of all the products sold, a manufacturer must consider these three cost items.

If you have been developing the Budgets in sequence, then you would have already calculated the five items needed to determine your Cost of Goods Sold. Moreover, the Total Cost of Raw Material Purchases was calculated in Budget 3 entitled "Developing Your Purchase Budget" . The Total Direct Labor Cost was calculated in Budget 4 entitled "Developing your Direct Manufacturing Labor Budget". The Factory Overhead Cost was calculated in Budget 5 entitled "Developing your Factory Overhead Budget". And the Beginning & Ending Inventories were calculated in Budget 6 entitled "Developing Your Ending Inventory Budget".

Assume the 4U2C Manufacturing Company developed the following Budgets for each forecasted year;

200X 200Y 200Z
Inventory at the Beginning of each Year $0.00 $9,000 $10,000
Inventory at the End of each Year $9,000 $10,000 $12,000
Raw Materials to be Purchased During the Year $50,000 $65,000 $80,000
Direct Labor Cost Budget for the Year $75,000 $80,000 $90,000
Factory Overhead Cost Budget for the Year $20,000 $24,000 $27,000


Using the above information, the 4U2C Manufacturing Company would calculate each year's Forecasted Cost of Goods Sold in the following fashion.

200X 200Y 200Z
Inventory at the Beginning of each Year $ 0.00 $ 9,000 $ 10,000
Add: Raw Materials Purchased during the Year $ 50,000 $ 65,000 $ 80,000
Add: Direct Labor Cost Budget for the Year $ 75,000 $ 80,000 $ 90,000
Add: Factory Overhead Cost Budget for the Year $ 20,000 $ 24,000 $ 25,000
Cost of Goods Available for Sale $145,000 $178,000 $205,000
Less: Inventory at the End of each Year $ 9,000 $ 10,000 $ 12,000
Cost of Goods Sold $136,000 $168,000 $193,000


Therefore, the 4U2C Manufacturing Company's Forecasted Cost of Goods Sold would be $136,000 in 200X, $168,000 in the year 200Y, and $193,000 in 200Z. These Cost of Goods Sold amounts would appear on the company's Forecasted Income Statements.


The above Cost of Goods Sold Budgets assume all units are finished and ready to be sold. Manufacturers, however, generally have ending inventory of raw materials (non-finished products) and work in process (partially completed products). Moreover, existing manufacturing firms would use these items to determine their cost of goods manufactured. The cost of goods manufactured would then be added to beginning finished inventory. The Ending Finished Inventory would then be subtracted to produce the Cost of Goods Sold. Individuals determining the feasibility of a manufacturing company, however, normally omit costs associated with non-finished products and deal entirely in finished units. As a result, we have based our Manufacturing examples on this standard.

Categories: Forecasting