Cost of Goods Sold Basics

Introduction to Cost of Goods Sold

The Cost of Goods Sold sometimes abbreviated to COGS or referred to as Cost of Sales, is the costs associated with producing the goods which have been sold during an accounting period. The items must have been sold otherwise there is no Cost of Goods Sold.

Cost of Goods Sold can equally refer to a service as well as a physical product hence the uses of the more general term Cost of Sales.

The costs included in Cost of Goods sold are those necessary to bring the product to its present state and condition prior to sale. They do not include selling expenses, distribution costs, marketing etc such costs are termed costs of selling or selling costs or sales and marketing costs.

For a manufacturing, retailing or distribution business the cost of the goods sold refers to the physical product and the costs of bringing it to the point of sale. This might include direct material and labor costs, product costs, purchase returns and allowances, purchase discounts, freight inwards (that is the costs of bringing the product to your place of manufacture or distribution warehouse), and direct labor costs and factory production overhead.

In a services business, the cost of sales is more likely to be wages, salaries and personnel costs for staff delivering the service, or perhaps subcontracting costs. It might include items such as costs of research, photocopying, and production of presentations and reports.

Why is Cost of Goods Sold Important?

In accounting, costs of sales or costs of goods sold are subtracted from sales to calculate gross margin, so the definition of Cost of Goods Sold determines the Gross Margin % of your business and as a consequence important factors such as your Break Even Point.

How do you Record Cost of Goods Sold?

Cost of Goods Sold is calculated at the end of an accounting period in relation to the items sold during that period.

What you record during the accounting period are your normal accounting costs such as purchases of stock, wages, salaries, factory overheads, carriage inwards. It is only at the end of the accounting period that the calculation of Cost of Goods Sold is made.

Using a very simple (but unrealistic) example. If you purchase for resale one item at 100 and the carriage costs to deliver the item to your warehouse are 20 then the double entry would be as follows:

Purchase of products for resale
Account Debit Credit
Purchases 100
Carriage inwards 20
Accounts payable 120
Total 120 120

At this stage there has been no sale, the costs are simply the costs of purchasing the product and the costs of carriage, you have not recorded cost of goods sold as there have been no sales.

Suppose now the product is sold in the same accounting period for £200, the costs are transferred to profit and loss account via the cost of goods sold account as follows:

Transfer to Cost of Goods Sold account
Account Debit Credit
Purchases 100
Carriage inwards 20
Cost of Goods Sold 120
Total 120 120

And the final income statement follows:

Income Statement
Sales 200
Cost of Goods Sold 120
Gross profit 80
Gross Margin % 40%
Cost of Goods Sold Basics November 6th, 2016Team

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