The term Cost Of Sales (COS) generally refers to the costs a business bears on the revenues it generates. Businesses calculate their COS to comply with the matching concept of accounting, which requires them to match their costs with their revenues.
This means that they have to calculate the cost of their products or services only if they have sold them during that period. Businesses don’t calculate the cost for items they have not sold.
While Cost Of Sales consists of all costs related to a product, its main component is the Cost Of Service or Cost Of Goods Sold.
For service-based businesses, the COS will consist of Cost Of Service while for businesses that deal with goods, it will include the Cost Of Goods Sold.
Cost of Services vs Cost of Goods Sold
As mentioned above, the Cost Of Services relates to service-based businesses. On the other hand, the Cost Of Goods Sold relates to businesses that deal in physical goods. Both of these costs refer to the direct costs of a business that it incurs on its revenues.
Direct costs are costs that directly contribute to the value of the products of a business, whether goods or services. The COS does not contain any indirect costs. Indirect costs are costs that do not directly contribute to the value of a product.
While in essence, the Cost Of Services and Cost Of Goods Sold are the same there are still some differences between the two. The differences are summarized below.
Direct costs
Although the only thing that is similar between the Cost Of Service and Cost Of Goods Sold is that both of them consider the direct costs of a business, these costs are different for service-based and inventory-based businesses.
For services-based businesses, the Cost Of Service will consist of mostly labor costs that contribute to the revenues generated. On the other hand, for businesses that calculate the Cost Of Goods Sold, the direct costs will include both material and labor costs, with material costs being the main focus.
Calculation
Due to their differences, businesses calculate the Cost Of Service and Cost Of Goods Sold using different methods.
For service-based businesses, the calculation of Cost Of Service will be the aggregate of all the direct costs. They use the following formula to calculate the Cost Of Service.
Cost Of Service = Sum of all direct costs
The direct costs for services, as mentioned above, will generally focus on labor costs. However, it may also contain other costs, such as shipping costs or raw material costs.
While most service-based businesses don’t have any direct material costs, some of them may require direct material costs to provide their services.
On the other hand, the calculation of the Cost Of Goods Sold requires a business to consider its inventories as well. Cost Of Goods Sold mainly consists of the costs of raw material and finished goods consumed.
Therefore, the calculation of the Cost Of Goods Sold requires businesses to perform an inventory valuation to determine the value of closing inventory. The formula for the Cost Of Goods Sold is below.
Cost Of Goods Sold = Opening Inventory + Purchases or Production costs – Closing Inventory
For most businesses, the majority of the Cost Of Goods Sold will consist of material purchase or production costs. Labor costs will make a small portion of the total cost of sales.
However, some businesses may still be labor-intensive. Similarly, COGS will also consist of other costs, such as transportation costs, shipping costs, storage costs, etc.
Type of Cost
Finally, the Cost Of Service and Cost Of Goods Sold are different because of the type of cost they represent. Cost Of Service, as the name suggests, only represents costs incurred by a business on services.
Services are intangible products that a business cannot store or carry over to the next period. Therefore, there are no opening or closing balances of services. Similarly, the cost of services is also straightforward. Most service-based businesses determine the cost of services on an ongoing basis.
On the other hand, the Cost Of Goods Sold represents the costs incurred on physical products. Goods, unlike services, are tangible that a business can store and carry over to the next periods. Determining the costs of products is also more complicated as compared to the cost of services.
Businesses need to follow different standards, such as IAS 2 – Inventories. Usually, businesses use different valuation methods such as First-In, First-Out, and Weighted Average Cost to determine the cost of products.
Conclusion
Cost Of Service and Cost Of Sales are both a part of the Cost Of Sales of a business. However, Cost Of Service only applies to service-based businesses, while the Cost Of Goods Sold is for inventory-based businesses.
While they are both essentially the same because they represent the direct costs of a business, there are some differences between them as well. The differences are mainly due to which direct costs they represent, their calculation methods, and the type of costs they represent.
