Cost of Goods Sold : Accounting Treatment, Methods etc.

Cost of Goods Sold (COGS)

Cost of Goods Sold (COGS) is the cost which is directly attributable with the cost of production against product sales. The expenses included in the Cost of Goods sold are Raw Materials, Packaging Materials, Salary and Wages of the factory, Depreciation of Factory Machinery and other costs used in the production to manufacture the goods.

Cost of Goods Sold (COGS) is considered as one of the important items to calculate the business profit of the company. This is the cost of determining all costs associated with the selling of the product. The Cost of Goods Sold (COGS), or Cost of Sales is directly attributable to the cost of the commodities sold to its customers. The Cost of Goods (Sold) is deducted from the revenue of the company to ascertain the Gross Profit of the company.

Methods to Calculate COGS

The inventory which is already sold is taking on the consideration to calculate Cost of Goods Sold (COGS). Cost of Goods Sold appear on the income statement and presented as Cost of Sales. The beginning inventory which is unsold in the previous year to be carried and will be added with the purchase made during the year. The Beginning Inventory plus Purchase made during the year equal the Raw materials available for the consumption. The Ending Inventory will be deducted from the Raw materials available for the consumption and will produce the Cost of Goods Sold.

The formula of Cost of Goods Sold are follows:

COGS = Beginning Inventory + Purchase Made during the year – Ending Inventory

Cost of Goods Sold is varied according to inventory method using the the company. If the company using FIFO method the COGS will be lower and in case of LIFO method the COGS will be higher. However, a company may use following three formula to calculate Cost of Goods Sold:

  • First in First out Method (FIFO)
  • Last in Last out Method (LIFO), and
  • Average Cost of Method

Steps of COGS Calculation

Not only direct cost but also indirect costs would be the part of the Cost of Goods Sold. So, an accountants have to be sound knowledgeable person to identify Cost of Goods Sold. Otherwise, Gross Profit would be overstated or understated. To determine the Cost of Goods Sold you have to follow the below mentioned steps:

Step – 1 : This is the step where you have to identify some basic components associated with the Cost of Goods Sold. The basic components include the following items:

  • Beginning Inventory of the product
  • Plus, Purchase made during the period
  • Less, Ending Inventory
  • Finally, COGS calculated.

This is the cost which is allow to duct the cost of the product which is sold in the market. This provision is allow for manufacturer as well as Trader.

Basically, two types of cost are associated with the COGS, such as:

  • Direct Costs – Costs associated with the production and Purchase
  • Indirect Costs – Warehouse cost, Carrying Charge, Labour bill etc.

Step – 2: At this is Stage you will determine the direct costs of the product. Direct costs includes the following:

  • Cost of the resale product
  • Raw materials purchase price
  • Cost packaging
  • Work-in-Progress (WIP)
  • Cost of Finished Goods (FG)
  • Direct Overhead costs associated with the production i.e.utilities, rent of the factory

Step – 3: Identify the indirect costs associated with the manufacturing of materials and purchase. Indirect costs include the following:

  • Labour cost of the production
  • Store Department cost
  • Depreciation of Machinery
  • Salaries of Manager who are involve with the production

Step – 4: Interest expenses, Mortgage interest or Lease rent associated with the production to be considered.

Step – 5: Beginning inventory to be accounted for. this includes Merchandise stock, raw materials, work in progress, finished goods, etc. Beginning inventory to be same the ending inventory of previuos year.

Step – 6: Purchased made during the year to be considered to calculate the COGS.

Step – 7: Some items to be unsold which is considered as Ending Inventory. Ending inventory to be deducted from the summation of Beginning inventory plus Purchase.

Journal Entries of COGS

Cost of Goods Sold AccountDebit
Inventory Account Credit

Limitations to Calculate COGS

Cost of Goods can be manipulated by accountants or managers for their own interest. This can be manipulated by:

  • Higher manufacturing cost can be allocated to inventory
  • Discounts could be overstated
  • Value of ending inventory can be altered
  • failing to write off obsolete inventory