Definition of Cost of Goods Sold
The cost of goods sold is the cost of the products that a retailer, distributor, or manufacturer has sold.
The cost of goods sold is reported on the income statement and should be viewed as an expense of the accounting period. In essence, the cost of goods sold is being matched with the revenues from the goods sold, thereby achieving the matching principle of accounting.
When the cost of goods sold is subtracted from net sales, the result is the company’s gross profit.
Examples of Calculating the Cost of Goods Sold
One way to calculate a retailer’s cost of goods sold is to begin with the cost of the goods it had purchased during the accounting period and then adjust it for the change in inventory. For example, if 1,000 units of a company’s only product were purchased but its inventory increased by 100 units, then the cost of 900 units will be the cost of goods sold. If 1,000 units of the product were purchased but the inventory decreased by 100 units then the cost of 1,100 units will be the cost of goods sold.
Using dollar amounts, let’s assume that a retailer’s cost of its merchandise purchases for a year was $300,000 while the cost of its inventory increased from $100,000 to $120,000. The result is that its cost of goods sold is $280,000 (purchases of $300,000 minus the $20,000 increase in inventory).
A second way to calculate the cost of goods sold is: the cost of the beginning inventory + the cost of goods purchased = cost of goods available – cost of ending inventory. Using the amounts above, we have $100,000 + $300,000 = $400,000 – $120,000 = $280,000.
If the cost of the ending inventory were $65,000, the cost of goods sold would have been $335,000 (purchases of $300,000 + the $35,000 decrease in inventory).
Cost Flow Assumption Is Needed
When costs change during the accounting period, a cost flow will have to be assumed. Some common cost flow assumptions include FIFO, LIFO, and average.
