Companies prepare financial statements to report their financial position and performance after every period. This period may differ from one company to another. On top of that, the interval for which they report those activities may also vary. For example, companies can prepare those statements monthly, quarterly or annually. However, they must use the same formats provided by accounting standards and frameworks.
One of the crucial financial statements is the income statement. It reports on various aspects of a company’s financial performance. Essentially, it includes the revenues, expenses and profits made from operations for a specific period. The income statement segregates the income of a company into different categories. For that, it must also classify expenses into various classes.
The topmost expense classification within the income statement is the cost of goods sold. This amount is crucial in determining the gross profits for a specific period. Usually, companies obtain this figure from accounting records. Once they do so, they may adjust it to reach the adjusted cost of goods sold. Before discussing them, it is crucial to understand what these expenses are.
What does the Cost of Goods Sold (COGS) mean?
The cost of goods sold (COGS) is an accounting classification of expenses based on their function. Companies use this head to report any costs incurred on producing or obtaining products or services. However, it only includes the direct expenses associated with the process. Essentially, the COGS is a figure to report all production-related costs. These costs contribute directly to the production process.
The cost of goods sold applies to companies that sell physical stock. However, it does not cover the direct expenses of a service firm. Those firms can use the cost of services instead. Nonetheless, the primary premise of both will be the same. The COGS is also crucial in reporting any costs associated with the production process. However, these costs must be direct to the manufacturing process.
The COGS may consist of the expenses associated with manufacturing or obtaining a product. For companies that acquire goods to resell them, the acquisition cost will be the primary expense in the COGS. Moreover, companies involved in manufacturing will also report the COGS. For those companies, it will also include the acquisition costs of materials. However, they will also add labour and factor overheads to the COGS.
The cost of goods sold will differ from one company to another. However, it usually stays within a specific level for companies operating within the same industry. While the COGS is primarily a variable cost for companies, it may include fixed elements. Nonetheless, this cost will vary based on the activity levels for a specific period. These activity levels directly relate to the revenues a company earns.
The cost of goods sold is a metric to determine the gross profits within the income statement. It shows the expenses a company incurs in generating revenues for a period. Essentially, it reports all the direct costs associated with manufacturing or obtaining sold products. The COGS is the top expense category within the income statement. Before presenting this amount, companies adjust it to reach the adjusted cost of goods sold.
What is the Unadjusted Cost of Goods Sold?
The unadjusted cost of goods sold includes the direct costs associated with the production process. However, it does not account for the changes in inventory levels over a specific period. Instead, it only enlists the expenses associated with producing goods for that period. The unadjusted COGS does not involve any complex calculations involving inventory.
The unadjusted cost of goods sold includes various items. These items contribute to producing the goods a company sells. However, it does not consider the difference in opening and closing inventory. While companies must make those adjustments, the unadjusted COGS is still helpful in accounting. It allows companies to understand the direct costs for a single period.
The adjustments related to inventory levels can impact the cost of goods sold reported in the income statement. Therefore, companies use the unadjusted amount to understand what the COGS would be without those adjustments. However, this figure does not go into the income statement. Companies must still report the adjustments to reach the adjusted amount.
The calculation for the unadjusted cost of goods sold will still be a part of the notes to the financial statements. Companies report this amount first before including the adjustments for inventory levels. Therefore, users can get the unadjusted COGS from the notes. This amount does not go to the income statement as the cost of goods sold. Instead, the adjusted COGS ends up on that statement.
What is the Adjusted Cost of Goods Sold?
The adjusted cost of goods sold considers the unadjusted amount. However, it applies some adjustments to that amount before reporting it in the income statement. As stated above, these adjustments relate to how inventory levels have changed during a period. Essentially, the adjusted COGS reflects the actual cost of the goods sold in that period. It does not include any unsold items in that amount.
The adjusted cost of goods sold comes after adjustments to the normal COGS. It considers the variances that occur during the production process. Usually, these include differences in production or variable costs. On top of that, it also consists of inventory adjustments during an accounting cycle. However, the latter adjustment makes the most prominent item within the adjusted cost of goods sold calculation.
The adjusted cost of goods sold may be higher or lower than the actual overhead or manufactured costs. The adjustments to this amount may increase or decrease it based on the movement in those amounts. Since these movements can be positive or negative, the calculation for adjusted COGS may differ. If the adjustments are higher, they get added to the manufactured costs.
Essentially, the adjusted cost of goods sold removes the effect of one-year changes in inventory. It is crucial in establishing the actual or arm’s length gross profits from purchases or production. Similarly, it provides a more reliable measure of operating profits. However, it still considers the unadjusted COGS a part of the calculation.
Adjusted Vs. Unadjusted Cost of Goods Sold: What is the differences?
The differences between the adjusted and unadjusted cost of goods sold fall under the following areas.
The unadjusted cost of goods sold only includes the manufacturing or production costs for a period. However, they fail to consider the impact of the inventory changes for that period. On the other hand, the adjusted COGS allows companies to contain those changes. The calculation for the latter amount also includes the unadjusted COGS.
The unadjusted cost of goods sold reports all the production costs for a specific period. However, it also includes any expenses incurred for goods that the company has not sold yet. Reporting these goods in the income statement can create inaccurate results. Therefore, the adjusted COGS removes the impact of those goods. Consequently, it presents the cost associated with goods sold for that period.
Companies may use various inventory valuation techniques. The unadjusted cost of goods sold does not consider those techniques. Therefore, it can provide more comparable results for several companies. On the other hand, the adjusted cost of goods sold gets impacted by those valuation techniques. While it can create varied results, it helps with a more accurate reporting of the cost of goods actually sold.
The cost of goods sold is metric companies use to report the expenses directly associated with production. However, companies make various adjustments to the amount to reach the adjusted COGS. This figure still considers the unadjusted COGS. However, it also includes the adjustments that remove the effect of one-year changes in inventory.