Cost of Goods Sold (COGS): Definition, Formula, Calculation and Example

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Tally Solutions | Jan-13-2020

Cost of Goods Sold: Definition

The cost of goods sold (COGS) is any direct cost related to the production of goods that are sold or the cost of inventory you acquire to sell to consumers. It does not include overhead expenses related to the general operation of the business, such as rent. It doesn't include overhead expenses associated with the overall operation of the business, like rent. Cost of goods sold is reported on a company's income statement, where costs are directly related to either the product or goods sold by a company, or the costs of acquiring inventory to sell to consumers. If the COGS>Revenue generated by the company during the reporting period, it means that there has been no profit. The formula to calculate cost of goods sold is extremely crucial to the management as it helps analyse how well purchasing and payroll costs are being managed.

Cost of goods sold is also used to calculate the gross margin and analyse what percentage of revenues is available to cover operating expenses by creditors and investors. Both manufacturers and retailers list cost of goods sold on the income statement as an expense directly after the total revenues for the period. COGS is then subtracted from the total revenue to arrive at the gross margin.

Formula

The cost of goods sold formula is calculated by adding purchases for the period to the beginning inventory and subtracting the ending inventory for the period.

Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory

Example

Cost of goods sold (COGS) is the cost of acquiring or manufacturing the products that a company sells during a period, so the only costs included in the measure are those that are directly tied to the production of the products, including the cost of labour, materials, and manufacturing overhead. For example, the COGS for an automaker would include the material costs for the parts that go into making the car plus the labour costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labour used to sell the car would be excluded.

Let's apply it to an example. Say you are a car manufacturer and had a beginning inventory of INR 2,50,64,900 last month and purchased another INR 5,37,10,500 in inventory. Last month was a good month, and your remaining inventory at the end of the month was INR 89,50,187. Try and calculate COGS by yourself before you scroll down to see the answer.

Okay, now let's apply the formula.

COGS = 2,50,64,900 + 5,37,10,500 - 89,50,187

Therefore, COGS = INR 6,98,25,213

This information will not only help you plan out purchasing for the next year, it will also help you evaluate the costs. For instance, you can list the costs for each of your product categories and compare them with the sales. This comparison will give you the selling margin for each product, so you can analyse which products you are paying too much for and which products is enabling him to make the most money.

Calculation of COGS Using Different Methods

The value of the cost of goods sold depends on the inventory costing method adopted by a company. There are three methods that a company can use when recording the level of inventory sold during a period: First In, First Out (FIFO), Last In, First Out (LIFO), and the Average Cost Method.

FIFO

The earliest goods to be purchased or manufactured are sold first. Since prices tend to go up over time, a company that uses the FIFO method will sell its least expensive products first, which translates to a lower COGS than the COGS recorded under LIFO. Hence, the net income using the FIFO method increases over time.

LIFO

The latest goods added to the inventory are sold first. During periods of rising prices, goods with higher costs are sold first, leading to a higher COGS amount. Over time, the net income tends to decrease.

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