Definition of Inventoriable Cost
Inventoriable cost (also known as cost of goods sold) is the total cost of closing inventory incurred for the purpose of manufacture of the end product, right from purchase of basic raw materials, expenses incurred for the production of goods (i.e. labour and factory overheads) and all incidental directly associated cost of production and it includes the cost of raw materials, works in progress and finished goods as at closing date.
- A manufacturing entity generates its revenue from sale of products. Gross profit for such company is sale price less cost of goods sold. This COGS should include all the costs incurred till the date of sale.
- Inventoriable cost is product specific costs i.e. direct cost of manufacture. The direct cost includes the cost of raw material, wages paid to labourers, the fixed & variable factory overheads and transportation cost of bringing the goods at the present location & condition.
- The Income statement has revenue figures at its top line. As per matching principle, only those cost which relates to the goods sold should reflect on the cost side of the income statement.
- Inventoriable cost is different for manufacturer and different for a retailer. The manufacturer is concerned with the cost incurred from the purchase of raw materials to the storage cost of finished goods. On the other side, the retailer is concerned with the cost of acquisition of product till storage cost of finished goods.
- Inventoriable cost includes the cost of raw materials, work in progress and finished goods. For a manufacturer, when he sells the finished goods, the cost of such goods in the inventory is transferred to the expense side. Until such goods are sold, the cost is accumulated in the balance sheet as inventory.
How to Calculate Inventoriable Cost?
- The formula for inventoriable cost goes like this:
Inventoriable Cost = Basic Cost of Raw Material + Direct Labour Incurred + Manufacturing Overheads Incidental to the Production
- The basic cost of raw material means the cost of purchases, cost of import duties and cost of freight inward till warehouse gate (if the freight is to be incurred by the buyer).
- Direct labour means the wages paid to each labourer based on the units produced. The rate of wages is fixed per unit. The labour cost is directly proportional to units produced subject to few fluctuations in case of overtime charges.
- Manufacturing overheads are those overheads which are directly or indirectly incidental to the production of goods. Such expenses include factory rent, consumable supplies, indirect factory supervisor cost, electricity cost, depreciation on plant & machinery & building and other direct overheads.
- Manufacturing overheads are not linked to each unit cost (i.e. they are not variable costs); rather, if such costs are not incurred, then the production will stop. Thus, manufacturing costs are considered in inventoriable costs.
Example of Inventoriable Cost
Let us take following data for the purpose of our example:
|Raw material Inventory as at 01/12/2019||$75,000|
|Raw material Inventory as at 31/12/2019||$65,000|
|WIP Inventory as at 01/12/2019||$16,000|
|WIP Inventory as at 31/12/2019||$18,000|
|Finished Goods Inventory as at 01/12/2019||$1,15,000|
|Purchase of raw materials (units)||42000|
|Weighted Average cost of raw materials||$15|
|Rate per machine hour||$8|
|Units Produced during the month||16,000|
|Units sold during the month||12,800|
|Sales Price per unit||$115|
We need calculation of following calculations:
- Raw Material consumed
- Production Cost
- Inventoriable Cost
Step 1: Calculation of raw materials consumed 31/12/2019
|A||Opening stock of Raw Material||75,000|
|B||Purchase of Raw material (42000*15)||6,30,000|
|C||Closing Stock of Raw material||65,000|
|D||Raw Material Consumed (A+B-C)||6,40,000|
Step 2: Calculation of production cost 31/12/2019
|A||Raw Material Consumed (from step 1)||6,40,000|
|B||Direct labour cost (25000*8)||2,00,000|
|D||Production Cost (A+B)||8,40,000|
Step 3: Calculation of inventoriable cost 31/12/2019
|A||Production cost (from step 2)||8,40,000|
|D||Opening Stock of Work in Process||16,000|
|E||Closing Stock of Work in Process||18,000|
|G||Opening Stock of Finished Goods||1,15,000|
|H||Cost of Finished goods available for sale (F+G)||10,78,000|
|I||Total units produced||16,000|
|J||Cost of production per unit (H/I)||67|
|K||Closing units of finished goods (16000-12800)||3,200|
|L||Closing Stock of Finished Goods (J*K)||2,15,600|
|M||Total Inventoriable Cost (H-L)||8,62,400|
- Inventoriable cost here includes raw materials cost, production cost & factory overheads.
- The gross profit of the entity is = 1472000-862400 = 609600. This forms 41% of revenue. This is the normal range of operating profit margin in any manufacturing entity.
- The above calculations are also used by cost accountants to arrive at the total cost, including the selling, general and administrative costs.
Accounting for Inventoriable Cost
SAP accounting software-based accounting entries are as follows for inventoriable costs:
- Purchase of raw material: (only goods received)
|Raw Material – Inventory (Debit)||XXX|
|GRIR Clearing Account (Credit)||XXX|
- Recording of invoice
|GRIR Clearing Account (Debit)||XXX|
|Supplier Account (Credit)||XXX|
- Transfer to WIP warehouse
|WIP Account – Inventory (Debit)||XXX|
|Raw Material – Inventory (Credit)||XXX|
- Cost incurred
|Direct Labour (Debit)||XXX|
|Manufacturing overheads (Debit)||XXX|
|Expenses Payable (Credit)||XXX|
- Transfer of Cost incurred to WIP
|WIP Account (Debit)||XXX|
|Manufacturing overheads (Credit)||XXX|
|Direct Labour (Credit)||XXX|
- Transfer of finished goods to FG warehouse
|Finished Goods – Inventory (Debit)||XXX|
|WIP Account (Credit)||XXX|
- Transfer of COGS to inventory
|Finished Goods – Inventory (Credit)||XXX|
- The inventory (Assets) account is used for the recording of the inventoriable costs.
- The cost of goods sold is transferred to the income statement (expense side) as soon as goods are sold.
- The balance amount of inventory in hand reflects the inventoriable cost of goods in hand, i.e. closing stock.
Inventoriable Costs vs Period Costs
|Recognition timing||It is recognised in the year of sale of goods.||It is recognised in the year in which it is incurred.|
|Nature of cost||It is fixed (direct) plus variable cost.||It is mostly fixed cost.|
|Type of Entity||Such cost is incurred only by entities dealing in the manufacture of goods.||Such cost is incurred in all types of entities.|
|Inventory Cost||This is the inventory cost.||This cost is not included in the inventory rather directly expensed out to the income statement.|
|Presentation||This cost is presented in the balance sheet. For goods such, the relevant cost is transferred to the income statement.||The incurred period cost will also be presented in the income statement.|
|Capitalisation||This cost is capitalised to the inventory||Such cost is not capitalised to the inventory.|
|Relation||It is related to the production of each unit.||It is related to the passage of time.|
|Cut off point||Such cost will not be incurred if production is stopped.||Such cost will continue to incurred irrespective of the operations of the entity.|
Benefits of Inventoriable Cost
Some of the benefits are given below:
- It helps in identifying the total cost incurred in the production of goods. This way, it controls the total cost of each product. The management can decide upon low gross profit products.
- Incorrect inventoriable cost leads to incorrect decision making.
- The company can also compare per unit cost incurred on different products. The percentage of the cost to sales price gives a picture of higher cost items. The company can then decide on cost optimisation for its products.
- Cost trail helps the management to optimise the production process in order to increase efficiency.
- Recognition of inventoriable cost provides insights about future prospects of the entity, production capacity and future sales of the entity. This helps the finance providers to analyse the revenue-generating capacity.
Inventoriable cost determines the gross profit earned by the entity. Till here, we have got a glimpse of what is included in inventoriable cost. But we should know what is not to be included specifically in the inventoriable costs. These costs are head office rental cost, finance cost, repairs & maintenance expenses, marketing cost, payroll cost of the accounts department, design cost, depreciation of those assets which are not related to the production of units, printing & stationery costs, etc. Such costs are in the nature of fixed cost. These will be incurred even the production is stopped. These are unavoidable costs & hence have no relation with the manufacture of units. These are often expensed out in the income statement.
This is a guide to Inventoriable Cost. Here we also discuss the introduction and how to calculate inventoriable cost? Along with an example and benefits. You may also have a look at the following articles to learn more –