Lesson 34 - Beginner accounting course

34. Understanding Cost of Goods Sold (COGS)

The Cost of Goods Sold (COGS) represents the direct costs incurred by a business to produce or purchase goods sold during a specific period. It is a crucial metric in determining a company's gross profit and financial health.

Formula for COGS

This formula calculates the total cost of inventory used to generate revenue during the period.

Components of COGS

1. Beginning Inventory – The value of inventory at the start of the accounting period.

2. Purchases – Additional inventory bought during the period, including raw materials, freight-in costs, and direct labor.

3. Ending Inventory – The value of unsold inventory at the end of the period.

Example Calculation

A company has the following inventory data:

Using the formula: 

This means the company spent $12,000 on goods that were sold during the period.

Impact of COGS on Financial Statements

Inventory Costing Methods

Different accounting methods affect how COGS is calculated:

1. FIFO (First-In, First-Out) – Oldest inventory costs are recorded as COGS first. Used when prices are rising to report higher profits.

2. LIFO (Last-In, First-Out) – Newest inventory costs are recorded as COGS first. Used when prices are rising to lower taxable income.

3. Weighted Average Cost – Calculates an average cost per unit for inventory.

4. Specific Identification – Assigns actual costs to individual items, used for unique or expensive products.

Journal Entry for Recording COGS

When a company sells inventory, it records the following entry:

Key Takeaways

• COGS represents the direct costs of producing or purchasing goods sold.

• It is crucial in determining gross profit and overall profitability.

• The choice of inventory costing method (FIFO, LIFO, etc.) impacts financial results.

• Proper COGS accounting helps businesses price products effectively and manage profitability.