The Cost of Goods Sold is a very important record in a company’s financial statements. But before you prepare the financial statements, you need to first get the Trial Balance. The Trial Balance seeks to ensure that the total debit entries of your company balance the credit entries. Hence, it requires that an accurate record of all transactions is properly documented. Since the Cost of Goods Sold involves certain business expenses, it is needed in drafting the Trial Balance.
What is the Cost of Goods Sold?
Whether you are manufacturing your products or you are purchasing them to resell, some expenses must be incurred along the line. Cost of Goods Sold is the totality of all these expenses. It calculates every cost involved, from acquiring products to processing them and down to the sales expenses. So, in essence, it is the total of all it costs to get your products into the hands of your customers or clients. It is worthy of mention that COGS apply to the goods you have sold already and does not include the inventory you still have at hand.
What is Trial Balance?
A Trial Balance is a report of a company’s total ledger accounts. It is usually prepared at the end of an accounting period as a draft for preparing financial statements. The Trial Balance shows only the totals of the ledger accounts and not the account in detail. It also records the final date of the accounting period. The reports on a Trial Balance are categorized into two parts: the debit and credit balances. The Debit balances include the assets and expenses accounts while the credit side records the capital and income balances. Ideally, the total debit balance of a Trial Balance must equal the total credit balance. Preparing the Trial Balance can help you identify some errors such as entry omissions and incorrect figures.
Cost of Goods Sold and Trial Balance
To balance the debit and credit accounts of a Trial balance, you need to have accurate information about all your transactions. If you miss any detail, it might result in a loophole in the ledger. The expenses involved in producing, purchasing, processing, and delivering a sold product are all debit activities. Of course, the income generated from sales is credit. This is where COGS become important. To be able to balance your account, you need to calculate the COGS on the debit side.
How to Calculate COGS?
The formula for COGS is quite simple.
COGS = (Opening Inventory + Purchases + Direct Expenses) – Closing Inventory.
The direct expenses in the equation include all the costs directly attached to the sale of a product. To determine whether a cost should be part of the COGS, take these simple tests:
Will I still incur this cost if I did not sell any goods?
Does a change in sales affect this cost?
Fixed costs such as rent or salaries do not count as COGS.
Bottom Line
If you’re able to record all expenses involved in your business, including your COGS, then you will have a more accurate Trial Balance.
Ultimately, this will help you build correct financial reports and in turn, gives you a better overview of your business’ state at each point.