What is cost of Goods Sold (COGS)?

The term “cost of selling goods” (COGS) is the direct expenses of creating the products that are sold by a business. The amount is comprised of the price of the material and labor that is directly involved in the creation of the item. It does not include indirect costs, like distribution and sales force expenses.

C O G S

Cost of sales of products is also known by the term “cost for sales.”

Key Takeaways

  • Cost of Goods Sold (COGS) comprises all fee and expenses directly connected to the manufacturing of goods.
  • COGS does not include indirect costs, such as overhead , sales, and marketing.
  • COGS is subtracted from revenue (sales) to determine Gross profit and gross margin. The higher COGS means lower margins.
  • Value of COGS will fluctuate based on the accounting standards utilized for the calculation.

What’s included in the Cost of Good Sold?

The items that constitute the cost of selling goods include:

  • Cost of items that are intended to be resold
  • The cost of materials for raw
  • The cost of the components used in the production of an item
  • Direct cost of labor
  • Materials used for making products or selling them
  • Overhead expenses, such as energy for manufacturing sites,
  • Charges for shipping or freight
  • Indirect costs include sales force or distribution costs
  • Costs for containers

What is the Cost of Goods Sold Formula?

Method One

The price of the goods sold is calculated by using an equation like:

(Beginning Inventory plus the cost of goods) – – Ending Inventory is the cost of goods sold.

At the beginning each year starting inventory represents the value of the inventory, which is the conclusion prior year. Cost of goods means the price for any item purchased or produced during the year. Ending inventory represents the value that inventory has at the close of the year.

This formula calculates the price of goods produced and sold during the year.

This price of the goods you sell calculator can aid you in this calculation quickly.

Method 2

The cost of items made or purchased will be adjusted to the change in inventory. For instance, if 500 units are produced or purchased, but inventory increases to 50 teams, the price of 450 units represents the cost of the goods sold. If inventory shrinks in 50 units, then the amount of 550 units is the cost of the goods that are sold.

COGS’s use in other Formulas

The cost of goods sold is used to calculate the turnover of inventory which tells how often a company sells and then replaces its inventory. It’s an indication of the production rate and selling-through. The formula to calculate the ratio of inventory turnover is:

Cost of Goods Sold/Average Inventory = Turnover Ratio

COGS can also be utilized to determine gross margin.

Handling Cost Changes to Inventory

The cost to create or purchase a product to sell may vary throughout. This fluctuation must be handled in order to be acceptable to the IRS. There are four options:

Specific Identification The technique is usually employed with regard to very expensive products to ensure that the cost is comparable to the items in the inventory.

“FIFO”: or “first first in, last out.” The first products bought or manufactured are the first to be sold.

LIFO, also known as “last in, first out.” The last item purchased or made are the first to be sold.

Cost average: cost average per item is determined.

COST OF GOODS SOLD Example

An e-commerce site sells fine jewelry. To determine the cost of items sold, companies must calculate the value in their stock at the start of the year. This is the actual value of its inventory at the previous year’s closing.

Then, the price for making the jewelry throughout all year long is added on to its beginning value. The costs may include raw materials, labor expenses, and shipping costs to jewelry customers.

Then, the stock value gets subtracted from starting value and the costs. This provides the e-commerce site with the exact price of products sold to its business.

cost of goods sold vs. Asset

The cost of selling goods is not considered an asset (what the business owns), nor is it an obligation (what the company has to pay). It’s an expense. The expense account includes the costs of running a business.

It can be considered one of the five principal accounts in the accounting process: assets, liabilities, and equity. And revenue.

In the event of an expense, it is documented in a journal entry as debits for the account of expenditure, and the credit is made to either the liability or asset account.

If the method is accrual, businesses must simultaneously document the price of goods and the sale of those products. The expense then is called “matched,” according to Accounting Coach.

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