Cost of goods sold, often abbreviated COGS, is a managerial calculation that measures the direct costs incurred in producing products that were sold during a period.
It includes the costs of all items that are directly or indirectly associated with the production or purchase of goods that have been sold. The costs which are included are-
- Direct materials
- Direct labour
- Factory overheads
- Production supplies
COGS does not include indirect expenses, like certain overhead costs.
The cost of goods sold is reported on the income statement and should be viewed as an expense of the accounting period.
FORMULA FOR COGS :-
The formula used for calculating cost of goods sold is –
Beginning Inventory + Cost of Goods / Purchases During the Period – Ending Inventory
The beginning inventory is the value of inventory at the beginning of the year. Ending inventory is the value of inventory at the end of the year. Cost of goods is the cost of any items bought or made over the course of the year.
XYZ Ltd. Has the following information:
Beginning inventory = Rs 1,00,000
Ending inventory = Rs 50,000
New purchases = Rs 2,00,000
In this case, COGS will be calculated as follow-
COGS = 1,00,000 + 2,00,000 – 50,000
= Rs 2,50,000
Hence, the cost of goods sold for the year is Rs 2,50,000
METHODS OF CALCULATING COGS :-
Primarily, there are 3 methods for calculating cost of goods sold, namely-
- FIFO (First in first out ) Method – Under this method the earliest goods to be purchased or manufactured are sold first. During times of inflation, FIFO tends to increase net income over time by lowering the COGS.
- LIFO (Last in last out ) Method – Under this method, 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.
- Weighted Average Method – Under weighted average, the total cost of goods available for sale is divided by units available for sale to find the unit cost of goods available for sale. This is multiplied by the actual number of goods sold to find the cost of goods sold.
Thus, in simple words, COGS consists of all the costs associated with producing the goods or providing the services offered by the company which helps management and investors monitor the performance of the business.