As we noted earlier, when finished goods are sold, their cost is called the cost of goods sold (COGS).  The cost of goods sold is based on the cost of goods manufactured (COGM).

Refer to the below illustrations showing how COGS and COGM are determined.

Illustration 17: Formula for cost of goods manufactured (COGM)

Illustration 18: Formula for cost of goods sold (COGS)

Manufacturing companies have to prepare the schedule of costs of goods manufactured before they prepare the income statement. Using the same data as in the previous sections, let's prepare the schedule of cost of goods manufactured for Friends Corporation for the month of March 20X9:

Illustration 19: Schedule of cost of goods manufactured for Friends Corporation

A few notes in relation to the above table are presented below:

• Direct material purchases included $2,000 of paint and $7,000 of plastic and metal parts.
• Friends Corporation also purchased some light bulbs. The $500 of light bulbs purchased was included in the Raw Materials Inventory account, but since the bulbs are not direct materials, they were not recorded as part of the direct materials cost. Later, Friends Corporation used $100 of light bulbs in the manufacturing process, and this cost was recorded as part of the Factory Overhead cost.
• Factory Overhead of $1,100 = $100 (light bulbs) + $400 (depreciation of factory equipment) + $600 (factory utilities).

Friends Corporation could use a slightly different format as well, refer to the below illustration:

Illustration 20: Schedule of cost of goods manufactured for Friends Corporation

Note that the resulting cost of goods manufacturing does not change between the two formats.  The only difference is the order of accounts presentation.

Raw Materials, Work-in-Process, and Finished Goods Inventory accounts are real accounts. That is, they are not temporary accounts and are not closed to Retain Earnings at the end of the accounting period. These inventory accounts are reported in the assets section of the balance sheet.

Using information from the previous sections (including the schedules for cost of goods manufactured), Friends Corporation prepared the below income statement:

Illustration 21: Income statement for Friends Corporation

Note that the COGS account is a nominal account. That is, it is a temporary account that is closed to Retained Earnings at the end of the accounting period.  The same is true for other income statement accounts.