Cost of Goods Sold (COGS) represents the direct costs attributable to the production of the goods sold by a company. It includes three main components:
1. Direct Materials:
These are the raw materials and components that become an integral part of the finished product and can be directly traced to it. For example, in a furniture manufacturing company, the wood, fabric, and nails used to build a chair are direct materials.
2. Direct Labor:
This refers to the wages paid to employees who are directly involved in the manufacturing process and whose time can be specifically traced to the production of a good. For instance, the wages of assembly line workers who physically put together a product are considered direct labor.
3. Manufacturing Overhead:
Also known as factory overhead or indirect manufacturing costs, this category includes all manufacturing costs that are not direct materials or direct labor. These costs are necessary for production but cannot be directly or easily traced to a specific product. Examples include:
- Indirect Materials: Materials used in the production process but not directly incorporated into the final product, such as lubricants for machinery, cleaning supplies for the factory, or glue used in small, untraceable quantities.
- Indirect Labor: Wages paid to factory employees who do not directly work on the product but support the production process, such as factory supervisors, maintenance staff, and quality control personnel.
- Other Manufacturing Costs: Rent for the factory building, utilities (electricity, water) for the factory, depreciation of manufacturing equipment, and factory insurance.