Updated July 14, 2023
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 the 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.
It includes the cost of raw materials, works in progress, and finished goods as of the closing date.
- A manufacturing entity generates its revenue from the sale of products. Gross profit for such a company is the sale price less the 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 materials, wages paid to laborers, the fixed & variable factory overheads, and transportation cost of bringing the goods to the present location & condition.
- The Income statement has revenue figures at its top line. As per the matching principle, only those costs related to the goods sold should reflect on the cost side of the income statement.
- Inventoriable cost is different for the 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 products till the storage cost of finished goods.
- Inventoriable cost includes 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:
- The basic cost of raw materials means the cost of purchases, import duties, and freight inward till the warehouse gate (if the freight is to be incurred by the buyer).
- Direct labor means the wages paid to each laborer based on the units produced. The rate of wages is fixed per unit. The labor cost is directly proportional to units produced, subject to few fluctuations in case of overtime charges.
- Manufacturing overheads are those directly or indirectly incidental to the production of goods. Such expenses include factory rent, consumable supplies, indirect factory supervisor cost, electricity cost, plant & machinery & building depreciation, and other direct overheads.
- Manufacturing overheads are not linked to each unit cost (i.e., they are not variable costs); if such costs are not incurred, production will stop. Thus, manufacturing costs are considered inventoriable costs.
Example of Inventoriable Cost
Let us take the following data for 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|
|Machine hour worked||25,000|
|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 labor 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.
- Cost accountants also use the above calculations to determine 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 to record 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 recognized in the year of sale of goods.||It is recognized 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 but 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.|
|Capitalization||This cost is capitalized to the inventory||Such cost is not capitalized in 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 costs will continue to be 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 optimization for its products.
- Cost trail helps the management to optimize the production process to increase efficiency.
- Recognition of inventoriable cost provides insights into the entity’s prospects, production capacity, and future sales. This helps the finance providers to analyze the revenue-generating capacity.
Inventoriable cost determines the gross profit earned by the entity. Until here, we glimpse what is included in the inventoriable price. But we should know what is not included 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 unrelated to the production of units, printing & stationery costs, etc. Such costs are like fixed costs. These will be incurred even if 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 Costs. 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 –