Supplies and raw materials of the business.
What is Cost of Goods Sold or (COGS)?
Cost of goods sold (COGS) is the cost associated with producing a product or service by a company to the consumer. COGS includes direct material expenses and direct labor expenses that are directly associated with the production of a product or service. Cost of goods sold does not include indirect expenses such as marketing, overhead, and electricity.
The formula for calculating COGS is shown below:
COGS = Beginning Inventory + Purchases – Ending Inventory
The beginning inventory is inventory that was not sold in the previous accounting period and has been carried over into the now current period. Purchases made during the current accounting period that is directly correlated to inventory is added to beginning inventory. At the end of the accounting period, COGS is calculated by summing the beginning inventory and purchases and subtracting the ending inventory. The result is the cost of goods sold for the accounting period.
FIFO, LIFO, and Average
During an accounting period, the method a firm uses to calculate COGS will directly affect the ending COGS. If a firm is using the FIFO (first in, first out) method, the firm is selling their existing inventory before accounting for the purchases made during the accounting period. This usually results in a lower cost of goods sold.
If a firm is using the LIFO (last in, first out) method, the firm is selling the latest version of their goods or services and this results in a generally higher cost of goods sold.
If a firm utilizes the average method however, a firm can achieve a more balanced COGS by averaging current inventory for an accounting period to determine cost of goods sold.
Cost of Goods Sold in Business
Cost of goods sold is an important concept for businesses in many aspects. To start, a business has to determine their costs associated with a product to determine a reasonable sale price for the business to make a profit and continue to operate. Accountants use COGS to determine the gross profit during an accounting period and is used to compare to previous years to determine a year-over-year growth percentage.