The cost of goods sold is the cost of the merchandise that a retailer, distributor, or manufacturer has sold.
The cost of goods sold is reported on the income statement and can be considered as an expense of the accounting period. By matching the cost of the goods sold with the revenues from the goods sold, the matching principle of accounting is achieved.
The sales revenues minus the cost of goods sold is gross profit.
Cost of goods sold is calculated in one of two ways. One way is to adjust the cost of the goods purchased or manufactured by the change in inventory of finished goods. For example, if 1,000 units were purchased or manufactured but inventory increased by 100 units then the cost of 900 units will be the cost of goods sold. If 1,000 units were purchased but the inventory decreased by 100 units then the cost of 1,100 units will be the cost of goods sold.
The second way to calculate the cost of goods sold is to use the following costs: beginning inventory + the cost of goods purchased or manufactured = cost of goods available – ending inventory.
When costs change during the accounting period, a cost flow will have to be assumed. Cost flow assumptions include FIFO, LIFO, and average.
The calculation of the cost of goods sold for a manufacturing company is: Beginning Finished Goods Inventory + Cost of Goods Manufactured = Finished Goods Available for Sale – Ending Finished Goods Inventory = Cost of Goods Sold.
The formula can be rearranged to read: Cost of Goods Manufactured +/- the change in Finished Goods Inventory = Cost of Goods Sold. If the Finished Goods Inventory decreased, then the amount of this decrease is added to the Cost of Goods Manufactured. If the Finished Goods Inventory increased, then the amount of this increase is deducted from the Cost of Goods Manufactured.
A retailer's cost of goods sold is equal to the cost of its beginning inventory plus the cost of its net purchases (the combination of these is the cost of goods available) minus the cost of its ending inventory.
The cost of goods sold is also the cost of the net purchases plus or minus the change in the inventory during the accounting period. For example, if the inventory increased, the cost of goods sold is the cost of the net purchases minus the increase in the inventory. If the inventory decreased, the cost of goods sold is the cost of the net purchases plus the decrease in inventory.
When there is inflation, the retailer must also choose a cost flow assumption, such as FIFO, LIFO, or average. The cost flow assumption will make a difference in the amounts reported as the cost of goods sold and the costs reported as inventory. (The cost flow assumption can be different from the way inventory items are rotated or sold.)
The account Purchases is generally associated with the purchase of inventory items under the periodic inventory system. Under the periodic system the account Inventory is dormant until it is adjusted to the cost of the ending inventory at the end of an accounting period.
Under the perpetual inventory system, the account Purchases won't exist. Rather, the cost of inventory items purchased will be recorded directly into the account Inventory.
Under the periodic system, the cost in the account Purchases will be added to the cost of the beginning inventory to arrive at the cost of goods available. The cost of the ending inventory is computed through a physical count (or an estimate) and is subtracted from the cost of goods available. The resulting amount is the cost of goods sold.
Under the perpetual system, the balance in the account Inventory should be the cost of the ending inventory. Under the perpetual system, the cost of goods sold will have been removed from the account Inventory when the items were sold and placed in the account Cost of Goods Sold.
Sales commissions are a selling expense. Selling expenses are reported on the income statement as part of the operating expenses. Often the operating expenses will appear as selling, general and administrative expenses or SG&A.
Sales commissions are not part of the cost of a product and therefore are not assigned to the cost of goods held in inventory or to the cost of goods sold.
Some retailers view the goods purchased as part of the expense known as the cost of goods sold. Other retailers view the goods purchased as part of the asset inventory.
To appreciate both views, let's assume that a retailer begins the year with inventory having a cost of $800. It ends the year with inventory having a cost of $900. During the year the retailer purchased goods having a cost of $7,000. Let's also assume that the cost per unit did not change during the year.
Retailer X may view the $7,000 of purchases as an expense (cost of goods sold) except for $100, which was the cost of the goods added to its inventory ($900 vs. $800). Retailer X's income statement reports its cost of goods sold as: purchases of $7,000 minus the $100 increase in inventory = $6,900.
Retailer Y may view the $7,000 of purchases as an increase to its asset inventory and will report its cost of goods sold as: beginning inventory of $800 + purchases of $7,000 = cost of goods available of $7,800 minus the ending inventory of $900 = $6,900.
Regardless of whether the goods purchased are initially recorded in an inventory account or in a cost of goods sold account, the amounts reported on the financial statements must be the same: the expense (reported as the cost of goods sold on the income statement for the year) is $6,900 and the asset inventory (reported on the balance sheet as of the end of the year) is $900.
Inventory change is the difference between last period's ending inventory and the current period's ending inventory. If last period's ending inventory was $100,000 and the current period's ending inventory is $115,000, the inventory change is an increase of $15,000.
The inventory change is often presented as an adjustment to purchases in the calculation of the cost of goods sold. If purchases were $300,000 during the current period and the inventory amounts are those listed above, the cost of goods sold is $285,000. (Purchases of $300,000 minus the $15,000 increase in inventory. The logic is that not all $300,000 of purchases should be matched against sales, because $15,000 of the purchases went into inventory.) This is an alternative to the method used in introductory accounting: beginning inventory of $100,000 + purchases of $300,000 = $400,000 of cost of goods available – ending inventory of $115,000 = cost of goods sold of $285,000.
If last period's ending inventory was $100,000 and the current period's ending inventory is $93,000, the inventory change is a decrease of $7,000. Assuming purchases of $300,000 in the current period, the cost of goods sold is $307,000 ($300,000 of purchases plus the $7,000 decrease in inventory).