You have two types of inventory making up your cost of goods sold: 1. Direct materials: This is the inventory the you purchase to make the products. For example, to handcraft a leather purse, you may purchase leather, zippers, snap, grommets etc. 2. Work in process: This inventory category includes direct materials that have been partially but not completely made into sellable products - for example, your leather purse is missing a zipper closure or straps. Ok, now that you understand the two different types of inventory showing up your COGS, let's walk through the accounts you affect while making the calculation. Make sure to reference the image on this page as you go:
Beginning direct materials: how much is in your material inventory at the beginning of the accounting period. Net purchases: all material purchases less purchase returns or purchase discounts. Ending direct materials inventory: What is left in your material inventory at the end of the accounting period? Direct labor: This expense includes only what the company pays to workers who are directly involved in making the items the company manufactures. So if your arts or crafts business makes leather purses, direct labor includes the payroll for the employees who make the purse patterns, cut out the leather pieces, and assemble the leather pieces into a finished purse.
Factory overhead: This expense includes all costs you incur to make your leather purses except those already included in direct materials and direct labor. It also includes indirect materials and labor. Indirect materials: These are materials you use for more than one product. For example, if you use grommet for both leather purses and leather belts - the grommets are indirect rather than direct material. That's because the grommets aren't directly associated only with the purses. Indirect labor: This item includes employee payroll that does not directly tie to a specific finished product. A good example...
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