Cost of goods sold (COGS)

In financial accounting , cost of goods sold (COGS) 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 goods along with the direct labor 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 labor costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labor used to sell the car would be excluded.

The accounts 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 .

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[edit ] Accounting method

{The method of calculating Cost of goods sold is: Opening stock + Purchase of goods - Closing Stock }

This table makes it easy to grasp the concept of cost of goods sold for a merchandising business.

Beginning Inventory $100	Cost of Goods Purchased $400
Goods Available for Sale	= ($100+$400) $500
Cost of Goods Sold $300	Ending Inventory $200

Note that the sum of Beginning Inventory and Cost of Goods Purchased is equal to Goods Available for Sale , and so is the sum of Cost of Goods Sold and Ending Inventory .

Cost of goods purchased is calculated as follows. Purchases minus Purchases returns and allowances and minus Purchases discounts gives us Net Purchases. Net Purchases plus Freight-In gives us Cost of Goods Purchased .

Cost of Goods Sold is calculated by subtracting Ending Inventory from Goods Available for Sale.

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 in a manufacturing business 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.

[edit ] Critics and a new point of view by TOC

According to a new management philosophy, the Theory of Constraints (TOC), and its Throughput Accounting approach, COGS would include only direct costs, excluding direct labour costs, once in the real world its is hard to quantify in most cases.

So, according to TOC, the costs of COGS would be only the costs of raw material, tax, and direct selling commissions. It is claimed that this is a more logical and intuitive way to calculate COGS.^{[ 1]}