Textbook

1. External financial reporting decisions

2. Planning, budgeting, and forecasting

3. Performance management

4. Cost management

4.1 Measurement concepts

4.1.1 Cost behavior, cost objects, and cost pools

4.1.2 Product and period costs, cost drivers, and cost measurement methods

4.1.3 Inventory cost flow: trading vs. manufacturing

4.1.4 Absorption vs. variable costing: impact on inventory and income

4.1.5 Absorption vs. variable costing: illustrative problem

4.1.6 Joint and by-product costing: key concepts

4.1.7 Joint and by-product costing: cost allocation methods and by-product costing

4.2 Costing systems

4.3 Overhead costs

4.4 Supply chain management

4.5 Business process improvement

5. Internal control

6. Technology and analytics

Wrapping up

4.1.3 Inventory cost flow: trading vs. manufacturing

Achievable CMA Part 1

4. Cost management

4.1. Measurement concepts

Our CMA Part 1 course is currently in development and is a work-in-progress.

Inventory cost flow: trading vs. manufacturing

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Flow of inventory

There are two types of companies typically presented in the CMA examinations, trading and manufacturing, although in practice there are now different types of organizations and even hybrid ones.

Trading companies

For trading companies, the focus of cost accumulation is simpler than in manufacturing because there is no production process involved. Instead, inventory typically consists of purchased finished goods that are held for resale without any additional processing.

Inventory consists of merchandise held for resale, and cost flow is primarily affected by the inventory system used: either perpetual or periodic. As discussed in previous chapters, these systems determine when and how inventory and COGS are recorded.

While cost accumulation systems like job order or process costing are not applicable, trading companies still use inventory valuation methods such as FIFO, LIFO, or weighted average to determine the cost assigned to COGS. (LIFO is permitted under U.S. GAAP but prohibited under IFRS.)

The main objective is to track the cost of inventory purchases and determine the cost of goods sold (COGS) when sales occur. The inventory flow for trading businesses usually involves just two key accounts:

Merchandise inventory

Or simply “Inventory”. At the time of purchase, the cost of inventory (including any freight-in or acquisition costs) is recorded as an asset.

Cost of goods sold (COGS)

When the goods are sold, their cost is transferred from inventory to COGS, reflecting an expense on the income statement.

Cost of Goods Sold for a trading company

Manufacturing companies

For manufacturing companies, we focus on the systematic accumulation of costs to accurately value inventory and determine the cost of goods sold (COGS) and the various inventory items.

Manufacturing companies carry three inventory accounts: raw materials (materials purchased but not yet put into production), work-in-process (WIP), and finished goods. Costs flow from one account to the next as production proceeds - raw materials move into WIP once they enter production, WIP becomes finished goods once production is complete, and finished goods become COGS once the goods are sold. Along the way, cost of goods manufactured (COGM) equals beginning WIP plus total manufacturing costs (direct materials used, direct labor, and manufacturing overhead applied) minus ending WIP, and COGS equals beginning finished goods plus COGM minus ending finished goods. Costs are accumulated using a job order costing or process costing system, with overhead - a product cost inventoried right along with direct materials and direct labor - assigned using traditional rates or activity-based costing; these topics are covered in later chapters.

Work-in-process (WIP) inventory

This includes raw materials, labor, and overhead associated with goods that are partially completed. These are items that are in the middle of production but not yet finished.

Finished goods inventory

This includes all costs accumulated for goods that are completed and ready for sale. When these goods are eventually sold, their costs are transferred out of inventory and into COGS.

Cost of goods sold (COGS)

This represents the total cost of manufacturing or acquiring the products that were sold during a specific accounting period. It includes all costs that were previously accumulated in inventory accounts, specifically finished goods, and reflects them as an expense once the sale occurs.

Example: Manufacturing cost flow with beginning and ending inventories

Achievable Manufacturing starts the month with $2,000 of raw materials, $4,000 of WIP, and $6,000 of finished goods. It purchases $10,000 of raw materials, incurs $5,000 of direct labor, and applies $3,000 of overhead, ending the month with $1,500 of raw materials, $2,500 of WIP, and $3,000 of finished goods.

Raw materials used is $2,000 + $10,000 − $1,500 = $10,500, so total manufacturing costs are $10,500 + $5,000 + $3,000 = $18,500. Cost of goods manufactured is $4,000 + $18,500 − $2,500 = $20,000, and COGS is $6,000 + $20,000 − $3,000 = $23,000.

Answer: COGS for the month is $23,000.

Showing raw materials used, cost of goods manufactured, and cost of goods sold calculations. — COGS manufacturing company

Trading companies

No production process; inventory = purchased finished goods held for resale
Cost flow driven by inventory system (perpetual vs. periodic) and valuation method (FIFO, LIFO, weighted average)
- LIFO allowed under U.S. GAAP, prohibited under IFRS
Two key accounts: Merchandise Inventory (asset at purchase, includes freight-in) → COGS (expense when sold)

Manufacturing companies

Three inventory accounts, with costs flowing sequentially:
- Raw materials → Work-in-Process (WIP) → Finished Goods → COGS
WIP = partially completed goods (materials + labor + overhead); Finished Goods = completed goods ready for sale
Costs accumulated via job order costing or process costing; overhead applied via traditional rates or activity-based costing

Key formulas

Raw materials used = Beginning RM + Purchases − Ending RM
Total manufacturing costs = Direct materials used + Direct labor + Manufacturing overhead applied
Cost of Goods Manufactured (COGM) = Beginning WIP + Total manufacturing costs − Ending WIP
COGS = Beginning Finished Goods + COGM − Ending Finished Goods
Example: RM used $10,500 → Total mfg costs $18,500 → COGM $20,000 → COGS $23,000

Next | 4.1.4 Absorption vs. variable costing: impact on inventory and income

Inventory cost flow: trading vs. manufacturing

Flow of inventory

There are two types of companies typically presented in the CMA examinations, trading and manufacturing, although in practice there are now different types of organizations and even hybrid ones.

Trading companies

Merchandise inventory

Or simply “Inventory”. At the time of purchase, the cost of inventory (including any freight-in or acquisition costs) is recorded as an asset.

Cost of goods sold (COGS)

When the goods are sold, their cost is transferred from inventory to COGS, reflecting an expense on the income statement.

Manufacturing companies

For manufacturing companies, we focus on the systematic accumulation of costs to accurately value inventory and determine the cost of goods sold (COGS) and the various inventory items.

Work-in-process (WIP) inventory

This includes raw materials, labor, and overhead associated with goods that are partially completed. These are items that are in the middle of production but not yet finished.

Finished goods inventory

This includes all costs accumulated for goods that are completed and ready for sale. When these goods are eventually sold, their costs are transferred out of inventory and into COGS.

Cost of goods sold (COGS)

Example: Manufacturing cost flow with beginning and ending inventories

Achievable Manufacturing starts the month with $2,000 of raw materials, $4,000 of WIP, and $6,000 of finished goods. It purchases $10,000 of raw materials, incurs $5,000 of direct labor, and applies $3,000 of overhead, ending the month with $1,500 of raw materials, $2,500 of WIP, and $3,000 of finished goods.

Raw materials used is $2,000 + $10,000 − $1,500 = $10,500, so total manufacturing costs are $10,500 + $5,000 + $3,000 = $18,500. Cost of goods manufactured is $4,000 + $18,500 − $2,500 = $20,000, and COGS is $6,000 + $20,000 − $3,000 = $23,000.

Answer: COGS for the month is $23,000.

Achievable CMA Part 1

4. Cost management

4.1. Measurement concepts

Our CMA Part 1 course is currently in development and is a work-in-progress.

Inventory cost flow: trading vs. manufacturing

5 min read

Font

Discuss

Feedback

Flow of inventory

There are two types of companies typically presented in the CMA examinations, trading and manufacturing, although in practice there are now different types of organizations and even hybrid ones.

Trading companies

Merchandise inventory

Or simply “Inventory”. At the time of purchase, the cost of inventory (including any freight-in or acquisition costs) is recorded as an asset.

Cost of goods sold (COGS)

When the goods are sold, their cost is transferred from inventory to COGS, reflecting an expense on the income statement.

Manufacturing companies

For manufacturing companies, we focus on the systematic accumulation of costs to accurately value inventory and determine the cost of goods sold (COGS) and the various inventory items.

Work-in-process (WIP) inventory

This includes raw materials, labor, and overhead associated with goods that are partially completed. These are items that are in the middle of production but not yet finished.

Finished goods inventory

This includes all costs accumulated for goods that are completed and ready for sale. When these goods are eventually sold, their costs are transferred out of inventory and into COGS.

Cost of goods sold (COGS)

Example: Manufacturing cost flow with beginning and ending inventories

Achievable Manufacturing starts the month with $2,000 of raw materials, $4,000 of WIP, and $6,000 of finished goods. It purchases $10,000 of raw materials, incurs $5,000 of direct labor, and applies $3,000 of overhead, ending the month with $1,500 of raw materials, $2,500 of WIP, and $3,000 of finished goods.

Raw materials used is $2,000 + $10,000 − $1,500 = $10,500, so total manufacturing costs are $10,500 + $5,000 + $3,000 = $18,500. Cost of goods manufactured is $4,000 + $18,500 − $2,500 = $20,000, and COGS is $6,000 + $20,000 − $3,000 = $23,000.

Answer: COGS for the month is $23,000.

Trading companies

No production process; inventory = purchased finished goods held for resale
Cost flow driven by inventory system (perpetual vs. periodic) and valuation method (FIFO, LIFO, weighted average)
- LIFO allowed under U.S. GAAP, prohibited under IFRS
Two key accounts: Merchandise Inventory (asset at purchase, includes freight-in) → COGS (expense when sold)

Manufacturing companies

Three inventory accounts, with costs flowing sequentially:
- Raw materials → Work-in-Process (WIP) → Finished Goods → COGS
WIP = partially completed goods (materials + labor + overhead); Finished Goods = completed goods ready for sale
Costs accumulated via job order costing or process costing; overhead applied via traditional rates or activity-based costing

Key formulas

Raw materials used = Beginning RM + Purchases − Ending RM
Total manufacturing costs = Direct materials used + Direct labor + Manufacturing overhead applied
Cost of Goods Manufactured (COGM) = Beginning WIP + Total manufacturing costs − Ending WIP
COGS = Beginning Finished Goods + COGM − Ending Finished Goods
Example: RM used $10,500 → Total mfg costs $18,500 → COGM $20,000 → COGS $23,000

Next | 4.1.4 Absorption vs. variable costing: impact on inventory and income

Inventory cost flow: trading vs. manufacturing

Flow of inventory

There are two types of companies typically presented in the CMA examinations, trading and manufacturing, although in practice there are now different types of organizations and even hybrid ones.

Trading companies

Merchandise inventory

Or simply “Inventory”. At the time of purchase, the cost of inventory (including any freight-in or acquisition costs) is recorded as an asset.

Cost of goods sold (COGS)

When the goods are sold, their cost is transferred from inventory to COGS, reflecting an expense on the income statement.

Manufacturing companies

For manufacturing companies, we focus on the systematic accumulation of costs to accurately value inventory and determine the cost of goods sold (COGS) and the various inventory items.

Work-in-process (WIP) inventory

This includes raw materials, labor, and overhead associated with goods that are partially completed. These are items that are in the middle of production but not yet finished.

Finished goods inventory

This includes all costs accumulated for goods that are completed and ready for sale. When these goods are eventually sold, their costs are transferred out of inventory and into COGS.

Cost of goods sold (COGS)

Example: Manufacturing cost flow with beginning and ending inventories

Achievable Manufacturing starts the month with $2,000 of raw materials, $4,000 of WIP, and $6,000 of finished goods. It purchases $10,000 of raw materials, incurs $5,000 of direct labor, and applies $3,000 of overhead, ending the month with $1,500 of raw materials, $2,500 of WIP, and $3,000 of finished goods.

Raw materials used is $2,000 + $10,000 − $1,500 = $10,500, so total manufacturing costs are $10,500 + $5,000 + $3,000 = $18,500. Cost of goods manufactured is $4,000 + $18,500 − $2,500 = $20,000, and COGS is $6,000 + $20,000 − $3,000 = $23,000.

Answer: COGS for the month is $23,000.