Cost of Goods Sold (COGS)

What Is Cost of Goods Sold?

Cost of goods sold (COGS) is the expense tied to the sale of any completed product for delivery to customers. Expenses incorporate the raw materials and labor associated with the production of any benefit. Even however the term itself specifies goods, cost likewise applies to services, depending on the revenue generated by a company.
Cost of goods sold is a detail found on a company's income statement, and it is the main thing of expense after revenue, which is regularly the top detail in the income statement. For publicly traded companies, the income statement shows up in the financial statement documented routinely on a quarterly or annual basis with the Securities and Exchange Commission. A few companies list this first-line expense thing as cost of sales on their income statement. According to a record's point of view, it is listed helpfully below revenue for working out the difference known as gross profit, which a few companies list as a separate detail to make it simple for investors to spot right away and try not to have them do the actual calculation. In this article, cost of sales is utilized interchangeably with cost of goods sold.
It is separate from costs tied to what might be considered operating costs, including advertising, marketing, administration, and research and development. Those expenses show up below the cost of goods sold in the income statement as operating expenses.
Below is Apple's cost of goods sold — listed as cost of sales — for its fiscal years 2019-2021, and the tech goliath breaks it down for its products and services. The data show that as sales for Apple's products and services increased, the rate of expenses didn't surpass that of sales, with the exception of products in 2020. It recommends that the company generally held cost of sales in check.

How Is Cost of Goods Sold Calculated?

Cost of sales works out the costs of all goods or services over a period. Under accounting methods targeting goods, this can be calculated in what is known as the periodic method of inventory.
Below is a formula working out cost of goods sold.Cost of Good Sold = Beginning Inventory + Inventory Purchases - Ending Inventory

For instance, a hardware retailer is classifying sales of a specific brand of PCs to customers during its most memorable quarter. In the beginning of January, it had $10 million in workstations and purchased $5 million of units in February to additional lift inventory. Toward the finish of March, its inventory dropped to $8 million, demonstrating that — by utilizing the above formula — its cost of goods sold added up to $7 million. ($10,000,000 + $5,000,000 - $8,000,000 = $7,000,000.)
That would be a simplified form of computing cost of goods sold. Selling and purchasing prices can change over the long haul, and that means utilizing one more method for computing inventory valuation. There are three different famous methods utilized under accounting standards: earliest in, earliest out (FIFO); last-in, first-out (LIFO); and average cost. FIFO alludes to working out inventory by selling more established things first, while LIFO goes for the sale of the most current things, and either's utilization relies upon the company's business strategy.
On account of the hardware retailer, FIFO can assist with determining whether more established inventories sold first brought a lower price, compared to LIFO, which could demonstrate higher prices due to unexpected factors or conditions like supply imperatives that pushed up costs on purchasing PCs later in time. Average cost takes the average of the beginning inventory balance and purchases to compute the average cost per unit. Specific valuations on inventory under the FIFO and LIFO methods can be derived by utilizing inventories listed on the balance sheet.

How Is Cost of Goods Sold Used?

Cost of sales is utilized in working out gross profit and in ratios, for example, gross profit margin. It assists with showing whether executive management is efficient in sales practices or how profitable the company is. Generally, lower costs of sales relative to revenue show high gross profit.

Could Cost of Goods Sold Be Higher Than Revenue?

Cost of goods sold can be higher than revenue assuming the company is spending more than it takes in creating its goods or services. It would be rare for a company to experience costs far surpassing revenue, and events like a force majeure could lead to such a scenario.

Highlights

• The value of COGS will change depending on the accounting standards utilized in the calculation.
• Cost of goods sold (COGS) incorporates the entirety of the costs and expenses directly connected with the production of goods.
• COGS is deducted from revenues (sales) to work out gross profit and gross margin. Higher COGS brings about lower margins.
• COGS prohibits indirect costs like overhead and sales and marketing.

FAQ

How Do You Calculate Cost of Goods Sold (COGS)?

Cost of goods sold (COGS) is calculated by adding up the different direct costs required to generate a company's revenues. Importantly, COGS depends just on the costs that are directly used in delivering that revenue, for example, the company's inventory or labor costs that can be ascribed to specific sales. On the other hand, fixed costs like managerial salaries, rent, and utilities are excluded from COGS. Inventory is an especially important part of COGS, and accounting rules permit several different methodologies for how to remember it for the calculation.

Are Salaries Included in COGS?

COGS does exclude salaries and other general and administrative expenses. Notwithstanding, certain types of labor costs can be remembered for COGS, given that they can be directly associated with specific sales. For instance, a company that utilizes contractors to generate revenues could pay those contractors a commission in view of the price charged to the customer. In that scenario, the commission earned by the contractors may be remembered for the company's COGS, since that labor cost is directly associated with the revenues being generated.

How Does Inventory Affect COGS?

In theory, COGS ought to incorporate the cost of all inventory that was sold during the accounting period. In practice, nonetheless, companies frequently don't know precisely which units of inventory were sold. All things considered, they depend on accounting methods like the First In, First Out (FIFO) and Last In, First Out (LIFO) rules to estimate what value of inventory was really sold in the period. In the event that the inventory value remembered for COGS is relatively high, this will place downward pressure on the company's gross profit. Therefore, companies some of the time pick accounting methods that will create a lower COGS figure, trying to support their reported profitability.