What Are the COGS (Cost of Goods Sold)?

COGS (Cost of goods sold) is referred to the direct costs of the production of the goods which is sold by a company.

This amount contains the cost of the labor and the material directly used to create the good. It rejects indirect expenses, such as salesforce costs and distribution costs.

The COGS can also be mentioned as the “cost of sales.”

Inventory  been sold can be appear in P&L statement of income under the number of COGS.

The beginning inventory for the year includes the leftover stock from the previous year: the merchandise that failed to get sold in the last year.

Any additional purchases or productions made by a manufacturing or retail company have been added to the beginning inventory.

At the end of the year, the item not sold is subtracted from the sum of beginning additional purchases and inventories.

The final number has been derived from calculating the cost of goods sold for the year.

The balance sheet has an account which is called the current assets account. Under this account, there is an item called inventory.

The balance sheet individually captures a company’s financial health at the end of an accounting period. It means that the inventory’s value is recorded under current assets is the ending of merchandise.

Since the beginning of inventory, it is the inventory that a company has in stock at the start of its accounting period. The beginning merchandise is also considered the company’s ending list at the end of the previous accounting period.

How to calculate cost of goods sold ?

Cost of goods sold formula

In order to Calculate COGS its is straightforward. In order to find cost of goods sold, use the below COGS formula:

COGS =  Inventory in Beginning + Purchases made during the Period –  Inventory at ending period

Not sure where to get this above information in order to plug it into the formula?

Inventory in Beginning : Amount of an inventory which is left over from the previous period  (quarter, month, etc.)
Purchases made during the period: Cost of what you had purchased during the Financial period
Inventory at ending period : Inventory you are not able to sell during the period

What Does the COGS Tell You?

The COGS (Cost of Goods Sold) is a critical metric found on the financial statements as it has been subtracted from a company’s revenues for determining its gross profit.

The gross profit is a profitability method that evaluates how efficiently a company manages its labor and supplies in the production process.

Because COGS is a cost of business that is done, it is recorded as a business expense on the side of income statements.

Knowing the COGS can help analysts, investors, and even managers estimate the company’s bottom line.

If COGS is increasing, then the net income will start decreasing. While this movement can be helpful for income tax, it will also have less profit for its shareholders.

Thus, Businesses can try to keep their COGS low so that the net profit can be higher.

COGS (Cost of Goods Sold) is considered as the cost of acquiring or manufacturing of the products that a company is selling during a period, so the only prices which can be included in the estimation are those that are directly tied with the production of the products which comprise of the cost of labor, materials, and manufacturing of overhead.

E.g., the COGS for an automaker would include the material costs for the parts that are going into making the car plus the labor costs used for putting the car together.

The cost of sending the cars for dealerships and the labor used for selling the vehicle can be excluded.

Furthermore, costs that are incurred on the cars that were not sold during the year would not be included while calculating COGS, whether the prices are direct or the prices are indirect.

In other words, COGS would be including the direct cost of producing goods or services which customers purchase during the year.

COGS and various Accounting methods

When the sum of a cost of goods sold can depend on the inventory costing method, which a company adopts.

There are 3 methods that a company can use while recording the level of inventory that is sold during a period: First In, First out (FIFO), Last In, First Out (LIFO), and the Average Cost Method.

FIFO

The earliest goods which have been manufactured or purchased are sold first. Since prices are tend to go up over time, a company that uses the FIFO method would sell its slightest expensive products first, which results in lower COGS than the COGS recorded under LIFO.

Hence, the net income would be using the FIFO method, which has increased over time.

LIFO

The latest goods which are added to the inventory are sold first. During rising prices, goods with higher costs are sold first, which leads to a higher amount of COGS.

Over time, the net income can tends to decrease.

Average Cost Method

Nevertheless, of date of purchase, the average price of all the stock of goods is used to value the goods sold.

Taking the average product cost over some time can have a soothing effect that prevents COGS from being highly impacted by unnecessary expenses of one or more achievements or purchases.

Special Method of Identification

The unique method of identification uses the specific cost of each merchandise unit which is also called inventory or goods, for calculating the ending inventory and COGS for each period.

In this method, a business can precisely know which items have been sold and the exact cost. Further, this method can be typically used for industries selling unique items like cars, real estate, and precious and rare jewels.

Eliminations from COGS Deduction

Many of the service firms do not have any cost of goods sold. COGS is not spoken in any other detail in GAAP (Generally Accepted Accounting Principles), but COGS can also be defined as only the cost of inventory items sold during a given period.

Not only do service firms have no goods for selling, but purely service firms also do not have inventories. If COGS have not being listed on the income statement, no deduction is applied for those costs.

Examples of pure service companies can include accounting firms, law offices, real estate appraisers, business consultants, professional dancers, and many more.

Even though these industries have business expenses and typically spend money to provide their services, they are not listed in COGS.

Instead, they have a “cost of services,” which is not counted towards the deduction under COGS.

Cost of Revenue vs. COGS

Costs of revenue which are exist for ongoing contract services, including raw materials, direct labor, shipping costs, and commissions paid to the employees of sales.

However, claiming these items as COGS without a physically produced product to sell is not possible. The website of IRS even has lists of examples of “personal service businesses” that are not calculating COGS on their statement of income.

Doctors, lawyers, carpenters, and painters are included in this.

Many service-based firms have some products for sale.

For example, airlines and hotels are mainly providers of services such as lodging and transport, respectively. Yet, they also sell various other things such as gifts, food, beverages, and other items.

These items are considered goods, and these companies can be certainly having inventories of such goods.

These industries can be listed in COGS on their statement of income and claiming them for tax purposes.

Operating Expenses vs. COGS

Operating expenses and the COGS (Cost of Goods Sold) are expenditures companies incur while running their business.

However, the expenses have been segregated on the income statement. Unlike COGS, OPEX Operating expenses are expenditures not tied directly to the production of goods or services.

Normally, SG&A (selling, general, and administrative expenses) have been included under operating expenses as a specific line item.

SG&A expenses are expenditures that have not been tied directly to a product, such as overhead costs.

Some examples of operating expenses which are included are below:

Insurance costs.

Legal costs.

Office supplies.

Payroll.

Rent.

Sales and marketing.

Utilities.

Limitations of COGS

COGS can be easily manipulated by managers or accountants looking to cook the books.

It can be changed by:

Allocation of the inventory has higher manufacturing overhead costs than those is incurred.

Overstatement of discounts.

Overstatements return to suppliers.

Altering the value of inventory in stock at the ending of an accounting period.

Overvaluation of inventory on hand.

Failing to write off obsolete inventory.

When the inventory have been inflated artificially, COGS can be under-reported, which, in turn, would be leading to higher than the actual gross profit margin. Hence, it has an inflated net income.

Investors are looking through a company’s financial statements can spot unprincipled inventory accounting by checking for build-up inventory, such as inventory that is rising faster than total assets or revenue as reported.

Frequently Asked Questions

How are the COGS (cost of goods sold) calculated?

The cost of goods sold (COGS) can be calculated by adding up the various direct costs required for generating a company’s revenues.

Essentially, COGS can be based only on the costs directly utilized in the production of that revenue, such as the inventory or labor costs of company is attributed to specific sales.

By contrast, fixed costs such as rent, managerial salaries, and utilities haven’t been included in COGS. Mainly, inventory is an essential component of COGS, and accounting rules can permit several different approaches for incorporating it into the calculation.

Are salaries included in COGS?

No, COGS does not include salaries and other administrative and general expenses.

However, certain types of labor costs that can be involved in COGS, provided that they can be associated directly with specific sales.

E.g., a company that is using contractors for generating revenues might be paying those contractors which are commission based on the price charged to the customer.

In that scenario, the commission which the contractors earn might be included in the company’s COGS since that labor cost can be directly connected to the revenues which have been generated.

How does inventory is affecting COGS?

In this theory, COGS should be including the cost of all inventory that has sold during the accounting period. However, in practice, companies often do not know precisely that which units of stock were sold.

Instead, they must be relying on accounting methods such as the First In, First Out (FIFO) and Last In, First Out (LIFO) rules for estimating the value of inventory which is sold in the period.

If the value of the inventory which is included in COGS is relatively high, then this will the place with downward pressure on the company’s gross profit.

Because of this reason, sometimes companies choose accounting methods that will help in the production of a lower COGS figure for boosting their profitability which is reported.

What is the relationship between COGM and COGS?

You can find the cost per good manufactured in the income statement. The word COGM is a one of key component in computing the cost of goods sold (COGS).

COGS stands for Cost of Goods Sold. It’s the sum of all costs associated with producing a product or providing services. After each COGM component has been calculated, the final amount goes into the finished goods inventory. This inventory includes any goods and services in their final form. Once all pieces are in place, it is possible to calculate the cost of goods that were sold.

Importance of the Cost of Goods Manufactured

Management can analyze each player in the COGM formula if they have a clear view of what a company produces. Then, any adjustments can be made to mainly maximize the company’s net income. COGM provides vital information to the company: the cost elements.

COGM is also a great tool for ensuring clarity and planning in a company. It allows the company to plan and modify the pricing strategy for its products. It allows for a comparison of manufacturing operations year-to-year. It will mainly allow you to basically plan for a resource consumption and the volume of each period.

Schedule cost of goods manufactured. 

This is used to calculate the cost of producing products over a specified period. The amount of cost of goods manufactured is added to the finished goods inventory account for the period. It is used in the calculation of the cost of goods sold on an income statement. To calculate the cost for goods manufactured, the cost of goods manufacturing schedule shows the total manufacturing costs added to work in process. It also adjusts these costs to account for changes in the work-in progress inventory account.

Cost of Goods Sold Schedule	$	$
Beginning raw Material of Invetory	5000
Add Purchase made during the year	2000
Total Raw Material available	7000
Less:- Raw Material at end of period	2500
Total Raw Material Consumed		4500
Direct Labor		12000
Manufacturing overdeads		2000
Total Cost of Good Sold		18500