Manufacturing Cost Flows and Cost of Goods Manufactured WACE Accounting and Finance Unit 4
“Trace manufacturing costs through prime cost and conversion cost, calculate the cost of goods manufactured using work in process, and link it to cost of sales for a manufacturer”
A manufacturer turns three cost streams into finished goods: direct materials, direct labour and manufacturing overhead. Direct materials plus direct labour is prime cost; direct labour plus overhead is conversion cost. These costs flow through work in process. Cost of goods manufactured is the total manufacturing cost adjusted for opening and closing work in process. Finished goods then flow to cost of sales when sold, adjusted for opening and closing finished goods inventory.
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What this dot point is asking
SCSA wants you to classify manufacturing costs, calculate prime and conversion cost, and build the cost of goods manufactured and cost of sales figures using inventory movements.
The three manufacturing costs
Direct materials are the raw materials traceable directly to the product. Direct labour is the wages of workers who physically convert materials into finished goods. Manufacturing overhead is all other factory costs that cannot be traced directly to units, such as factory rent, power, supervision and depreciation of plant. Together these three make up total manufacturing cost.
Prime cost and conversion cost
Prime cost is direct materials plus direct labour, the costs most directly tied to making each unit. Conversion cost is direct labour plus manufacturing overhead, the cost of converting materials into finished goods. Direct labour appears in both because it is both a direct cost of the unit and part of the conversion effort. These groupings help managers analyse where manufacturing cost is concentrated.
Cost of goods manufactured
Production is rarely finished exactly at year end, so partly complete units sit in work in process. Cost of goods manufactured adjusts total manufacturing cost for the change in work in process:
Then cost of sales adjusts cost of goods manufactured for the change in finished goods:
Three inventory stages, two adjustments
A manufacturer carries inventory at three stages, and this is what makes its cost flow more involved than a retailer's. Raw materials inventory holds materials bought but not yet used; the materials used figure is opening raw materials plus purchases less closing raw materials. Work in process holds partly finished units; adjusting for its opening and closing balances converts total manufacturing cost into cost of goods manufactured. Finished goods holds completed but unsold units; adjusting for its opening and closing balances converts cost of goods manufactured into cost of sales. The logic of every adjustment is the same: add what was on hand at the start (it will be finished or sold this period) and subtract what is left at the end (it carries forward as a current asset). Tracing costs through these three stages, with the two work-in-process and finished-goods adjustments, is the heart of the manufacturing statement, and only the cost attached to units actually sold ends up as an expense in the Income Statement.
Vela Manufacturing reports direct materials used $120 000, direct labour $90 000 and manufacturing overhead $60 000. Opening work in process was $15 000 and closing work in process $20 000. Opening finished goods were $30 000 and closing finished goods $25 000.
Step 1: Calculate total manufacturing cost, prime cost and conversion cost
Total manufacturing cost is the sum of the three inputs added to production during the period. Prime cost and conversion cost are two useful sub-totals that help managers understand where manufacturing costs are concentrated: prime cost highlights the direct costs of each unit, while conversion cost highlights the cost of transforming materials into finished goods.
Step 2: Calculate cost of goods manufactured
Not all manufacturing cost becomes finished goods within the period: some units are still only partly complete at year end. Cost of goods manufactured therefore adjusts total manufacturing cost for the change in work in process. Adding opening WIP brings in costs carried from last period; subtracting closing WIP defers costs that belong to next period's output.
Step 3: Calculate cost of sales
Cost of goods manufactured measures units completed, but some completed units may still be sitting in the finished goods warehouse at year end. Cost of sales adjusts for this by adding opening finished goods (completed last period, sold this period) and subtracting closing finished goods (completed this period, not yet sold).
Step 4: Verify what reaches the Income Statement
Only the cost attached to goods actually sold flows to the Income Statement as cost of sales. The closing inventories of $20 000 work in process and $25 000 finished goods are carried forward as current assets on the Balance Sheet, matching costs to the future period in which those goods will be sold.
Final answer: Total manufacturing cost is $270 000 (prime cost $210 000, conversion cost $150 000), cost of goods manufactured is $265 000, and cost of sales is $270 000.
Cost of goods manufactured is the cost of units completed during the period; cost of sales is the cost of units actually sold. They differ whenever finished goods inventory changes. Students often report cost of goods manufactured as cost of sales without adjusting for opening and closing finished goods, which misstates gross profit whenever stock levels move.
Exam-style questions
Questions in the style of SCSA exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
WACE 2022-style8 marksTarn Manufacturing reports direct materials used $140 000, direct labour $100 000 and manufacturing overhead $70 000. Opening work in process $18 000, closing work in process $26 000. Opening finished goods $35 000, closing finished goods $28 000. Calculate prime cost, conversion cost, cost of goods manufactured and cost of sales.Show worked answer →
An 8 mark response needs all four figures with correct adjustments.
Prime cost. Direct materials plus direct labour .
Conversion cost. Direct labour plus overhead .
Total manufacturing cost. .
Cost of goods manufactured. (add opening WIP, subtract closing WIP).
Cost of sales. (add opening finished goods, subtract closing finished goods). Markers reward the prime and conversion groupings, the WIP adjustment for COGM, and the finished goods adjustment for cost of sales.
WACE 2023-style5 marksExplain the difference between cost of goods manufactured and cost of sales, and explain why direct labour is included in both prime cost and conversion cost.Show worked answer →
A 5 mark response needs both distinctions.
COGM versus cost of sales. Cost of goods manufactured is the cost of units completed during the period, found by adjusting total manufacturing cost for the change in work in process. Cost of sales is the cost of units actually sold, found by adjusting cost of goods manufactured for the change in finished goods inventory. They differ whenever finished goods stock changes; only cost of sales reaches the Income Statement as an expense.
Direct labour in both. Prime cost is direct materials plus direct labour, the costs most directly tied to each unit. Conversion cost is direct labour plus overhead, the cost of converting materials into finished goods. Direct labour belongs to both because it is both a direct cost of the unit and part of the conversion effort. Markers reward the completed-versus-sold distinction and the dual role of direct labour.