Cost of goods sold refers to the costs involved in making the goods or services that are being sold. It is basically the direct materials, direct labor, and direct expenses involved in making the products.
These are easily traceable costs and can be easily identifiable from looking at the products. The other costs that cannot be easily traceable and cannot be linked to the product are not associated with being the cost of goods sold.
Statement of Cost of goods sold
| Particulars | Amount ($) | Amount ($) |
| Beginning inventory of supplies | X | |
| + Purchases (supplies) | X | |
| – Purchases returns | X | |
| + Direct labor (salary, wages) | X | |
| Cost of goods and services | XX | |
| – Ending inventory | (X) | |
| Cost of goods sold | XX |
It’s very simple to make rational guess about what can decrease the cost of goods sold. Some of them are listed below with detailed explanation:
The Decline in Cost of Direct Material
- The entity shall buy goods in bulk at a discounted price. In this way, it will entirely decrease the cost of buying raw materials for the finished goods.
- Application of the Economic order quantity concept would reduce the carrying and holding cost including the shipping cost. This would help in reducing great deal of direct material costs.
- Negotiation with the suppliers regularly helps to sweeten the deal and can lead to a reduction in the cost of raw materials. Further, constant lookout for suppliers with the best quality of raw materials at the best price is helpful in the long term.
- Reduction of costs through the use of advanced technology in production
- Efficient utilization of all the resources creating as little waste as possible. All the operations need to be audited in order to locate the source of waste and appropriate action needs to be taken accordingly.
- When the cost of raw materials is not to change in foreseeable future, the markets remain nonvolatile and the cost of production doesn’t increase. If one feels that the prices of raw materials would increase in the future, the buyer can enter into a long-term agreement with the supplier.
The Decline in the Cost of Direct Labor
The two possible ways to reduce the direct labor cost are by negotiating better hourly rates with the laborers at work or to increase the efficiency of the labor. The labor agreements should be made in such a way that it promotes discipline and hard work enhancing efficiency.
Enhancing efficiency would mean reducing the wastages like idle time, minimizing set up time, and minimizing time to operate machines. The labor agreements should also be incentive bases so that it increases quickness among the employees.
Others Factors:
- Moving manufacturing to the onshore location: If the production cost within a country is large enough, the company can shift plan location or production to a comparative non-expensive area with low production costs.
- Automation of Work processing/Use of machines: The machines are available for every job that man can do. Despite the high initial costs of purchasing machines, over the long term, the machines are more efficient and also reduce the cost of goods sold drastically over this long period.
