As stated above, a manufacturing concern has to work out the cost of goods produced (cost of production) before finding out the cost of goods sold and gross profit. Let us now learn how the cost of goods produced is ascertained. The manufacturing concerns purchase raw materials from the market and convert them into finished goods for sale. For example, a cotton textile mill buys cotton (raw material) and convert it into cloth in its factory. Similarly, a sugar mill purchases sugar cane (raw material) and produces sugar.

Thus the cost of goods produced includes two major costs: (i) cost of raw materials consumed, and (ii) cost of conversion. These are explained below.

Cost of Raw Materials Consumed: The cost of raw materials consumed represents the cost of raw materials used in the course of manufacture. When you worked out the cost of goods sold (refer to Unit 14) you adjusted the costs of opening and closing stocks of finished goods in the cost of goods purchased.

Similarly, to work out the cost of raw materials consumed you have to adjust the costs of opening and closing stocks of raw materials in the cost of raw materials purchased.

Cost of Conversion: This includes all expenses incurred in the factory for converting raw materials into finished goods. Examples are wages paid to workers who are directly involved in the production of goods (called manufacturing wages or productive wages), motive power (steam, electricity or gas consumed in the course of manufacturing), coal, gas and water, oil and grease, etc.

Factory rates and taxes, factory lighting, factory insurance, repairs to factory building, repairs to plant and machinery, depreciation on factory building, depreciation on plant, and other factory expenses are also treated as manufacturing expenses. These are debited to the Manufacturing Account along with the expenses incurred on purchases of raw materials such as freight, import duty, dock dues, clearing charges, etc.

Scrap: Scrap is waste material coming out of the manufacturing processes. For example, cuttings of cloth in ready-made garment factory, metal cuttings in engineering factories, etc. Any amount realized from its sale should be treated as income and adjusted in the cost of goods produced.

Work-in-progress: It is quite likely that at the end of the year there may be certain goods which are still in the process of manufacture. In other words, some work still remains to be completed in respect of these goods. Take the case of a furniture manufacturer. He may have some chairs and tables which are still to be polished. Such goods in respect of which the work is incomplete as at the end of the year are called 'semi-finished goods' or 'work-in progress'. The cost of semi-finished goods or work-in-progress as at the end of the year should also to be taken into account while working out the cost of goods produced. It is done by deducting the cost of semi-finished goods from the total costs incurred during the year. Just as you have some semi-finished goods as at the end of the year, you may have some semi-finished goods at the beginning of the year.

Such goods will be completed and sold during the current year. So, the cost incurred on them during the previous year should also be taken into account for the purpose of finding out the cost of all goods completed during the current year. Therefore, we add the cost of opening work-in-progress to the costs incurred during the year and deduct therefrom the cost of closing work-in-progress.

For calculating the cost of goods produced there are two more items that are taken into account. These are (i) scrap, and (ii) Work-in-Progress. Let us understand their meaning and relevance to cost of production