Overview:
There are always the costs associated with the product that the company sells to its customers. Some costs are directly associated and some costs are not directly associated with the products.
Direct labor and direct material are good examples of the costs directly associated with the products. And mission expenses to sellers are the best example of costs or expenses that are not directly associated with products or goods.
When the company sold the products or goods to customers, the costs directly associated with the products are recorded as the cost of goods sold in the income statement.
And the costs or expenses that are not directly associated with the products like commission expenses are recorded as sales expenses which are generally outsize costs of goods sold.
Definition and How is It Reporting in the Income Statement?
Costs of goods sold are the costs or expenses directly associated with the goods or products that the company sold in the specific accounting period.
In the income statement, these costs are generally reported under the net sales to calculate or present gross profits during the period.
Normally, the cost of goods sold included direct material, direct labor, and direct overhead associated with the goods or services sold for the production company.
It normally could be found the total cost of goods sold in the income statement, but if it is not present then you might need to calculate it by taking the opening finish goods plus purchase during the year and end deducting the ending balance.
However, for merchandising companies, the cost of goods sold is the cost of goods that they purchase from suppliers.
The recognition of the cost of goods sold is in accordance with the matching principle which means that the costs recognized in the income statement should be matched with the goods that sold.
The entity could not recognize the cost of purchasing goods that are not yet sold into the income statement.
Formula:
The formation of cost of goods sold here is applicable for merchandising companies that purchase goods from manufacturing and then sales them to customers. Here is the formula:
Cost of Goods Sold = Opening Inventories + Purchases – Ending inventories.
- Opening inventories are the inventory balance at the beginning of the period. You can find this by checking the ending balance of previous period records in the balance or inventories report.
- Purchases here include the only net purchased during the period. It is not considered a purchase return on a purchase discount.
- Ending inventories are the inventories at the end of the period. For example, inventories balance at 31 December 2016.
Example:
For example, ABC company has inventory records at the beginning of the period amount USD 2,000. During the period, it purchased inventories amount to USD 3,000.
By the of the period, the remaining inventories are 500 in the stores. What is the cost of goods sold that should be recorded in the income statement?
Answer:
Cost of Goods Sold = Opening Inventories + Purchases – Ending inventories.
Cost of Goods Sold = 2,000 + 3,000 – 500 = USD4,500
Based on the calculation, the cost of goods sold that should be recorded in the income statement is USD 4,500. Noted that the cost of goods sold could be different if we use a different method to measure inventories.
The method that we can use to calculate the value of inventories at the end of the period averages cost, FIFO and LIFO. However, LIFO is restricted by some accounting standards.
The company should record these costs of goods in the income statement by matching with the recognition of sales from sales products.
In other words, recognition of sales and costs for the same products should be in the same accounting period. This principle could improve the transparency of the income statement.
If the matching principle is not to apply, then there will be under-reporting or over-reporting of cost of goods sold as well as net sale. As a result, gross profits and net profit will also over or understate.
