There are several ways to classify the costs associated with the production of goods. Production managers rarely need to look away from total manufacturing costs, which consist of direct material costs, direct labor costs, and manufacturing overheads. However, production accountants and business owners often need to see the bigger picture.
- Total Manufacturing Cost
- Cost of Goods Manufactured and Cost of Goods Sold
- Fixed vs. variable production costs
- Total cost, average cost, and marginal cost
- Accounting costs vs. economic costs
- Key takeaways
Total Manufacturing Cost
The total manufacturing cost represents the total sum that has been spent solely on production activities. It consists of three key costs:
- Direct material costs. This shows the value of the raw materials and components you have used to produce goods in this period. Direct materials only include goods that are part of a product’s bill of materials, as opposed to indirect materials which are used in insignificant quantities per product (e.g. adhesives, screws, nails) or as auxiliary goods that do not end up in the finished product (sandpaper, disposable protective equipment, factory floor cleaning supplies, etc.)
- Direct labor costs. These include only this part of your staff that is directly involved in the manufacturing of products, i.e. line workers, craftspeople, machine operators, etc. Other production department staff such as supervisors, quality assurance, cleaning staff, maintenance, etc. are considered indirect labor.
- Manufacturing overhead costs. Manufacturing overhead includes indirect costs related to the production of goods such as facility rent, utilities, indirect materials, indirect labor costs (production supervisors, quality assurance, shop floor cleaning staff, etc.), maintenance, depreciation, and so forth.
The total manufacturing cost is an important metric for measuring the productivity and profitability of the company. Likewise, it can be used to identify and eliminate inefficiencies and overspending.
Read more about Total Manufacturing Cost.
Cost of Goods Manufactured and Cost of Goods Sold
The total manufacturing cost is also used to calculate the cost of goods manufactured (COGM) as well as the cost of goods sold (COGS). If the total manufacturing cost indicates the spend on all production activities, the COGM accounts for only the production of those goods that were finished during the period, and the COGS for those goods that were sold.
The formula for the cost of goods manufactured is therefore:
COGM = Beginning WIP Inventory + Total Manufacturing Cost – Ending WIP Inventory
The cost of goods sold formula, on the other hand, is:
COGS = Beginning Finished Goods Inventory + COGM – Ending Finished Goods Inventory
Fixed vs. variable production costs
The main difference between fixed costs and variable costs is that fixed production costs are incurred even if no production occurs while variable production costs can be adjusted quickly according to the volume of production.
Fixed production costs (also referred to as sunk costs) include facility rent or mortgage, monthly payments on machinery, facility and equipment depreciation, but also some labor costs when there are long-term service contracts with set f