Accounting for Cost of Goods Sold for a Manufacturing Company

Cost of goods sold

Definition of Cost of Goods Sold-COGS

The cost of goods sold (COGS) is the sum of all the direct costs of a product that a manufacturer, trader or distributor has sold.

The direct cost includes the cost of material, labor and other costs which are directly are directly associated with the manufacturing of the product.

This cost does not include indirect expenses such as selling and distribution expenses. Some accountant refers to the cost of goods sold as the cost of services. 

The formula for Calculating Cost of Goods Sold:

The basic formula to calculate the cost of goods sold for a manufacturing company is

  1. Calculate Opening Inventory of finished goods at the start of the period
  2. Add the total cost of goods manufactured during the period
  3. Subtract ending inventory of finished goods
  4. The result will be the cost of goods sold for the period

The general form of COGS formula is as follows:

COGS = Opening Inventory + Purchases during the period – Ending Inventory

Example:

Calculate the cost of goods sold from the following information on Chirac Cement (Pvt) Ltd.

  • Opening Inventory of cement is = 100,000 bags
  • The value of opening inventory is $ 200,000
  • The cost of material amount is $ 80,000 for the year
  • The cost of direct labor during the year amounted is $ 90,000
  • The value of ending inventory amount is $ 50,000

So the formula for calculating COGS is

Cost of Opening Inventory + All Direct Costs during the year – Ending Inventory

= $ 200,000 + $ 80,000* + $ 90,000* – $ 50,000

= $ 320,000

Direct Costs* = Cost of Material + Cost of Labor

The COGS or cost of sale for the period is $ 50,000.

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Calculate the cost of goods sold from the following information of Zerox (Pvt) Ltd for the year 2018.

  • Inventory valued at the start of the year is $ 13,000
  • The company made purchases of $ 20,000 during the year
  • The value of inventory at Dec 31 is $ 10,000

As we know,

COGS = Opening Inventory + Purchases – Closing Inventory

= $13,000 + 20,000 – 10,000

=$23,000

Cost of Goods Sold in Financial Statements:

From the definition, COGS is an expense and charged to the company’s profit & loss or income statement. COGS is deducted from the total revenue of the sales to calculate the gross profit for the period.

The amount of ending inventory is considered as current assets that come on the asset site of the balance sheet. 

How Accounting Methods Used for Valuation of Inventory Affect the Cost of Goods Sold?

Your cost of goods sold largely depends on your accounting method used for the valuation of inventory. The common accounting methods used for the valuation of inventory are

  1. FIFO (first in first out )
  2. LIFO (first in last out )
  3. Weighted Average Method.

Whenever an organization changes its accounting method for the valuation of its inventory, there is a high chance that the cost of goods sold will be largely affected.

So the management should be aware of this change, otherwise, the information may be misinterpreted.

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