Relationship between manufacturing cost and cost of sales
Cost of sales is the unit price of the product inventory at the beginning of the month or the unit price of the current month's production cost multiplied by the number of products in the warehouse.
The manufacturing cost unit price is determined by the accumulation method, in which the fixed cost unit price is accumulated by process through allocation to the variable cost unit price calculated by the gross average method.
- Manufacturing cost = Product manufacturing unit price x Production quantity
- Production cost = Work in progress at the beginning of the month + expenses incurred during the month - Work in progress at the end of the month
The cost of products shipped to the customer in the current month is the cost of sales, but the unit price of products is different between the inventory of products at the beginning of the month and the products manufactured in the current month.
- Cost of sales = Product inventory unit price at the beginning of the month x shipping quantity + Product manufacturing cost unit price during the month x shipping quantity
- Cost of sales = Product inventory at the beginning of the month + Cost of production during the month - Product inventory at the end of the month
If we assume that all products manufactured in the current month are shipped and no inventory is kept at the end of the month, the product unit price is the manufacturing cost unit price, and since the quantity of products entering the warehouse and the quantity of products shipped are the same, the manufacturing cost and the cost of sales are the same.
The breakdown cost of product value is cost of sales and the cost of selling the product is SG&A expenses.
Cost of sales is the cost of making the product itself, which is sold, and does not include the cost of selling or administrative expenses, which are deducted from gross profit.
In Indonesia, there are two major patterns of accounting journalization for the purchase of materials.
- It is recorded in the material account (asset) and expensed only the amount used (material cost for the current month).
(It may be expensed continuously every time it is used, or it may be expensed as a lump sum at the end of the month, as with stored goods.) - The current month's material cost is calculated by recording the material inventory at the beginning of the month as an expense (plus expense) and deducting the material inventory at the end of the month (minus expense) in the purchase account (expense).
(The purchase account has a strong asset character, strictly speaking, as a prepaid expense.)
Materials are expensed when they are sold, but SG&A expenses are expensed when they occur in the relevant accounting period, so it is called period cost.
The relationship between cost of sales and gross profit
When I used to run a boutique in Bali, I bought clothes from Jakarta and sold them in Bali, and the cost of the clothes was the cost of sales.
Cost of sales is also called gross profit, and direct and indirect labor costs in the manufacturing industry are included in cost of sales.
On the other hand, a common saying in the sales business is that "management is the activity of recovering fixed costs (employee salaries and tenant rents) through gross profit.
The reason why labor costs in the manufacturing industry are included in the cost of sales, but labor costs in the sales industry are not included in the cost of sales is because the former is the labor cost to manufacture the product and the latter is the labor cost to sell the product.