Business, Legal & Accounting Glossary
Materials, labour and other costs directly related to the goods or services provided.
The total cost of buying raw materials
Cost of goods sold, COGS, or “cost of sales”, includes the direct costs attributable to the production of the goods sold by a company. This amount includes the materials cost used in creating the good along with the direct labour costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs. COGS appears on the income statement and can be deducted from revenue to calculate a company’s gross margin.
COGS is the costs that go into creating the products that a company sells; therefore, the only costs included in the measure are those that are directly tied to the production of the products. For example, the COGS for an automaker would include the material costs for the parts that go into making the car along with the labour costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labour used to sell the car would be excluded.
The exact costs included in the COGS calculation will differ from one type of business to another.
The cost of goods attributed to a company’s products is expensed as the company sells these goods. There are several ways to calculate COGS but one of the basic ways is to start with the beginning inventory for the period and add the total amount of purchases made during the period, and then deducting the ending inventory. This calculation gives the total amount of inventory (the cost of this inventory) sold by the company during the period. Therefore, if a company starts with $10 million in inventory, makes $2m in purchases and ends the period with $9m in inventory, the company’s cost of goods for the period would be $3m ($10m + $2m – $9m).
Subtracting the cost of goods sold from the amount billed when selling the goods (sales revenue) produces the gross profit on the goods.
The net income, what most people understand as the business’ income or profit, is determined by subtracting the cost of goods sold and the indirect expenses from the sales revenue.
Figuring out the Cost of Goods Sold on a per-item basis is a tedious and unnecessary process. In most cases, goods or products enter the Inventory at varying times and at varying costs. There are changes in the cost of raw materials, labour, transport, etc, from period to period and from time to time. It will be very difficult to be accurate even with the aid of a computer.
The science of accounting has established a procedure for figuring out the Cost of Goods Sold on a wholesale basis, thus avoiding the tedious process of a per item costing.
To the beginning Inventory of a period (which is the ending Inventory of the previous period), the value of Purchases during the same period is added. From the result is subtracted the ending Inventory of the period. The final result is the Cost of Goods Sold corresponding to the Sales during the period.
The revenue from merchandise sold must be matched with the COGS. Cost of sales or cost of goods sold is the identification of the cost of those items sold in the most recent accounting period. It can be done by specific identification, taking inventory, or different methods using estimates such as the “retail” method.
COGS is also the determining factor in arriving at gross profit and is determined under the periodic method as follows:
Sales--------------------------------- $100,000 Cost of Goods Sold Inventory 01/01/03-- $ 5,000 Purchases------------ 45,000 Direct Labor--------- 30,000 _______ 80,000 Less: Inventory 12/31/03----- 10,000 _______ Net Cost of Goods Sold---------------- 70,000 ______ Gross Profit on Sales------------------ $30,000
To determine the net profit, one would then compute the indirect expenses such as office expenses, light, heat, etc. Determining the cost of goods sold is the first step in arriving at the net profit.
If the COGS is too high, then the gross profit will not support the indirect expenses and the result will be a loss for the accounting period.
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This glossary post was last updated: 19th April, 2020 | 5 Views.