cost of goods sold
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The Cost of Goods sold is not the title of a movie. Though for many a small business owner it can feel like a horror movie.

As a small business owner you really just want to get down to business. Do You.

But this pesky term COG keeps popping up. Ughhh.

However, the COG is not all bad.

Before you start calculating your business’s profit, you need to know your cost of goods sold. And, knowing what the cost of goods sold is plays an important role in setting prices. But what is the cost of goods sold?

Understand what the cost of goods is, how to calculate it, and why it’s important for your small business.

What is cost of goods sold?

The cost of goods sold (COGS), also referred to as the cost of sales or cost of services, is how much it costs to produce your products or services. COGS include direct material and direct labor expenses that go into the production of each good or service that is sold.

When calculating the cost of goods sold, do not include the cost of creating goods or services that you don’t sell.

COGS does not include indirect expenses, like certain overhead costs. Do not factor things like utilities, marketing expenses, or shipping fees into the cost of goods sold.

If you own a cabinetry company, examples of COGS would include the wood, screws, hinges, glass, paint, and labor used to make the cabinets you sell. However, the costs to market the cabinets, the electricity needed to operate the machinery, and shipping are not included in the COGS.

To find the COGS on a product, add up the cost of raw materials and direct labor needed to create it.

Cost of goods sold formula

To find the cost of goods sold during an accounting period, use the COGS formula:

COGS = Beginning Inventory + Purchases During the Period – Ending Inventory

Your beginning inventory is whatever inventory is left over from the previous period. Then, add the cost of what you purchased during the period. Subtract whatever inventory you did not sell at the end of the period.

Accounting periods might be months, quarters, or calendar years.

cost of goods sold

Cost of goods sold example

Let’s say your business is using the calendar year for recording inventory. Beginning inventory is recorded on January 1st, and ending inventory is recorded on December 31.

Your business has a beginning inventory of $9,000, makes purchases valued at $5,000, and is left with an ending inventory of $2,000. Use the COGS formula.

COGS = $9,000 + $5,000 – $2,000

COGS = $12,000

Your cost of goods sold for the year is $12,000. Knowing this number helps you make decisions, such as finding new vendors with better direct material prices.

Now that you know your COGS, you can find your business’s gross profit for the period.

Let’s say you have revenues of $50,000. Subtract your COGS of $12,000 from $50,000. For the period, your gross income is $38,000.

Why do you need to know your COGS?

Here are some reasons why you must know your cost of goods sold.

COGS and pricing

Product pricing is one of the most difficult responsibilities you have. You need to price items just right to sell them and turn a profit.

If you know your cost of goods sold, you can set prices that leave you a healthy profit margin. And, you can determine when prices on a particular product need to increase.

Let’s say your cost of goods sold for Product A equals $10. You need to price the product higher than $10 to turn a profit.

COGS and business profits

Once you know your cost of goods sold, you can calculate your business’s gross income or profit, which is the amount your business earns from selling your offerings before subtracting taxes and other expenses. And when you know your business’s gross profit, you can calculate your net income or profit, which is the amount your business earns after subtracting all expenses.

Here is the gross profit formula:

Gross Income = Gross Revenue – COGS

And, here is the formula to find net profits:

Net Income = Revenue – COGS – Expenses

As you can see, knowing your business’s COGS is an integral part of calculating your overall business profits. And, you need to know your business profits to seek financing and make financial decisions.

Accounting for the cost of goods sold

Which financial statements do you record cost of goods sold on?

Record your business’s COGS on your small business income statement. COGS appears under your business’s sales, or revenue. Deduct your COGS from your revenue to get your gross profit.

Your COGS also play a role when it comes to your balance sheet. The balance sheet for small business lists your business’s inventory under current assets. List your ending inventory for the accounting period.

Changes in COGS

Your cost of goods sold can change throughout the accounting period. Your COGS depends on changing costs and the inventory costing methods you use.

The three inventory costing methods are:

  • FIFO (first in, first out)
  • LIFO (last in, first out)
  • Average

If you use the FIFO method, the first goods you sell are the ones which you purchased or manufactured first. Generally, this means that you sell your least expensive products first. As a result, you record a lower cost of goods sold.

Under the LIFO method, you sell the latest goods you purchased or manufactured. Your COGS might be higher.

With the average method, you take an average of your inventory to determine your cost of goods sold. This keeps your COGS more level than the FIFO or LIFO methods.

via Cost of Goods Sold (COGS) | Definition, Formula, & More

Cost of Goods Sold (COGS) and Online Retailers

Though operating differently than traditional retail companies, online businesses can claim most of these same costs. For example, a business that builds and sells a widget through eBay (EBAY) may list any raw materials used to create the widget as a COGS. When those raw materials are shipped to the place of business, even a home, the shipping costs count towards COGS.

If a business has no real costs of production and only engages in the purchasing and reselling of goods over the internet, it may still list the amount spent on purchases as COGS. Packaging may even be included, but only so long as the packaging is unique and resembles what would appear on a shelf in a physical location. The bubble wrap, tape, and cardboard used to deliver the widget to a customer are not COGS. The cost of shipping to the customer is also not included in COGS.

The Internal Revenue Service (IRS) allows companies to deduct the COGS for any products they either manufacture themselves or purchase with the intent to resell. This deduction is available to any business that lists COGS on its income statement, including manufacturers, wholesalers, and retailers – whether they operate in physical locations or only online. 

Take, for example, a retail business that operates through Etsy (ETSY) and has less than $1 million in annual sales. It keeps track of inventory, such as unused materials, unsold goods, etc. Under these circumstances, IRS Publication 334: Tax Guide for Small Business, details how the business can use the cash method of accounting to deduct inventory expenses. If supplies are imported for the Etsy seller, then any taxes, commissions, duties, or other associated fees may count as COGS for IRS purposes. However, fees associated with online services such as PayPal may not be counted towards COGS. Additionally, the time spent marketing goods online does not count towards COGS.

The Bottom Line

Cost of goods sold (COGS) is an important line item on an income statement. It reflects the cost of producing a good or service for sale to a customer. The IRS allows for COGS to be included in tax returns and can reduce your business’s taxable income. Whether you are a traditional retailer or an online retailer, the same rules apply.

via What Are Examples of Cost of Goods Sold (COGS) for …

Examples of Cost of Goods Sold (With Excel Template)

Let’s take an example to understand the calculation of the Cost of Goods Sold in a better manner.

Cost of Goods Sold – Example #1

Patrick Inc. has the financial year beginning 1st January 2018 and ending 31st December 2018. Its inventory at the beginning of the year is $15,000. During the year, it makes purchases worth $35,000. Its inventory as on 31st December 2018 is $5,000. Calculate the Cost of Goods Sold (COGS) during the year.

 

Solution:

Cost of Goods Sold (COGS) = Opening Inventory + Purchases During the Period – Closing Inventory

 

  • COGS = Inventory as on 1st January 2018 + Purchases during the period – Inventory as on 31st December 2018
  • COGS = $15,000 + $35,000 – $5,000
  • COGS = $45,000

The Cost of Goods Sold (COGS) during the year is $45,000.

Cost of Goods Sold – Example #2

Kelly Inc. buys and sells refrigerators. The company buys Refrigerator A and Refrigerator B for $1,000 each. Then, it buys Refrigerator C and D for $1,100 each. Finally, it buys refrigerator E for $1,200. It then sells Refrigerator A and D. There are no refrigerators in Opening Stock.

Calculate the Cost of Goods Sold under:

  1. Specific Identification Method
  2. FIFO Method
  3. LIFO Method

 

Solution:

Under the Specific Identification method, we compute the costs of the refrigerators sold, which are A and D.

# Specific Identification Method

Cost of Goods Sold (COGS) is Calculated as:

Cost of Goods Sold = Cost of Refrigerator A + Cost of Refrigerator D

 

  • COGS = $1,000 + $1,100
  • COGS = $2,100

Thus, the Cost of Goods Sold under the Specific Identification Method is $2,100.

Under the FIFO method, we assume that the refrigerators that are bought first are sold first. The costs of Refrigerator A and Refrigerator B are $1,000 each

Cost of Goods Sold (COGS) is Calculated as:

Cost of Goods Sold = Cost of Refrigerator A + Cost of Refrigerator B

 

  • COGS = $1,000 + $1,000
  • COGS = $2,000

Thus, the Cost of Goods Sold under FIFO method is $2,000

Under the LIFO method, we assume that the refrigerators which are bought last are sold first.

Cost of Goods Sold (COGS) is Calculated as:

Cost of Goods Sold = Cost of Refrigerator D + Cost of Refrigerator E

 

  • COGS = $1,100 + $1,200
  • COGS = $2,300

Thus, the cost of goods sold under LIFO method is $2,300.

Cost of Goods Sold – Example #3

Hillary runs a cake shop. She has no cakes at the beginning of April. Below are some of the transactions:

  • April 4 – She buys 500 cakes at $2 each
  • April 10 – She buys 1,000 cakes at $3 each
  • April 15 – She sells 400 cakes at $5 each

Compute the Cost of goods sold under the FIFO and LIFO method. Also, calculate the Gross Profit and value of Closing Stock under both the methods.

 

Solution:

Under the FIFO method, the 400 cakes are sold from the first lot of 500 cakes bought on April 4.

FIFO Method

Cost of Goods Sold (COGS) is Calculated as:

  • COGS = 400*$2
  • COGS = $800

Sale Value is Calculated as:

  • Sale Value = 400*$5
  • Sale Value = $2,000

Gross Profit is calculated using the formula given below

Gross Profit =Sale Value – COGS

 

  • Gross Profit =$2,000 – $800
  • Gross Profit =$1,200

While calculating Closing Stock, we have 100 cakes (500-400) from the lot purchased on April 4 and 1,000 cakes from the lot purchased on April 10.

Closing Stock is Calculated as:

 

  • Closing Stock = 100*$2 + 1,000*$3
  • Closing Stock = $200 + $3,000
  • Closing Stock = $3,200

LIFO Method

Under LIFO method, the 400 cakes are sold from the lot purchased on April 10.

Cost of Goods Sold (COGS) is Calculated as:

  • COGS = 400*$3
  • COGS = $1,200

Sale Value is Calculated as:

  • Sale Value = 400*$5
  • Sale Value = $2,000

Gross Profit is calculated using the formula given below

Gross Profit =Sale Value – COGS

 

  • Gross Profit = $2,000 – $1,200
  • Gross Profit =$800

While calculating Closing Stock, we have 600 cakes (1000-400) from the lot purchased on April 10. In addition, we have the whole lot of 500 cakes purchased on April 4.

Closing Stock is Calculated as:

 

  • Closing Stock = 600*$3 + 500*$2
  • Closing Stock = $1,800 +$1,000
  • Closing Stock = $2,800

Cost of Goods Sold – Example #4

Eat Hungry Ltd is a biscuit shop. It carries out the following transactions in June:

  • June 3 Purchase of 300 biscuits @ $4 each
  • June 6 Purchase of 200 biscuits @ $3 each
  • June 7 Sale of 100 biscuits @ $10 each

Calculate the Cost of Goods Sold on the basis of the Weighted Average Cost Method and the resultant Gross Profit.

 

Solution:

Weighted Average Cost is Calculated as:

 

  • Weighted Average Cost = 300*$4 + 200*$3
  • Weighted Average Cost = $1,200 +$600
  • Weighted Average Cost = $1,800

Total Number of Units Purchased is Calculated as:

  • Total Number of Units Purchased = 300 + 200
  • Total Number of Units Purchased = 500 units

Cost Per Unit is Calculated as:

  • Cost Per Unit = $1,800/500
  • Cost Per Unit = $3.6 per unit

Cost of Goods Sold is Calculated as:

  • Cost of Goods sold = 100*$3.6
  • Cost of Goods sold = $360

Sale Value is Calculated as:

  • Sale Value = 100*$10
  • Sale Value = $1,000

Gross Profit is calculated using the formula given below

Gross Profit =Sale Value – COGS

Gross Profit = Sale Value – Cost of Goods Sold

 

  • Gross Profit = $1,000 – $360.00
  • Gross Profit = $640

Thus, the Cost of Goods Sold is $360 and the gross profit is $640.

Conclusion

The purpose of calculating the Cost of Goods Sold is to find the Gross Profit. The organization can also compare the Gross Profit Margin with that of its competitors. But, while interpreting the Cost of Goods Sold, certain factors need to be kept in mind. The Cost of Goods Sold depends upon the valuation method of inventories used. Thus, First in First Out (FIFO), Last in First Out (LIFO) and Weighted Average gives different results for the Cost of Goods Sold. Care should be taken that the inventory valuation method used is consistent with the prescribed Accounting Standards if it is used for external reporting. All inventory valuation methods have their own advantages and disadvantages. For instance, when the FIFO method is used and there is inflation in the country, the prices used for calculating COGS are lower and outdated. Similarly, the LIFO method is not allowed to be used by Accounting Standards prescribed in various countries.

COGS can also be computed while preparing a budget and then comparing the actual results with the budget. If there are variations between the COGS number obtained for preparing a budget and the actual results, the reasons for the same should be found out and corrective action should be taken in the next period.

via Cost of Goods Sold Example | Top 4 Example of COGS

 

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