The cost of goods sold is the direct charge, cost, or expense associated with the manufacturing of merchandise and services that are retailed to buyers. COGS do not comprise any overhead expenses such as rent, security charges, communication charges, etc.
COGS figure is reported on the face of a firm’s income statement. COGS figures are presented under the head expenses as the costs related to goods or services traded by a business or the expenditures of obtaining inventory that is sold to end-users.
When the figure for the cost of goods sold goes beyond the income achieved by the business in the course of the reporting period, then the business is affording the loss in its activities.
For the service business, we normally use the term cost of service rather than cost of sales or cost of good sold.
The cost of goods sold is calculated by the following formula.
COGS= Opening inventory + Purchases during the period – Closing inventory
Basically, the cost of goods sold is an accounting item of profit and loss account used in the determination of profit for the period.
Profit and loss or income statement consist of revenue and expenses during the year, for example, sales, purchases, expenses, income, etc. in simple words; it shows the operating efficiency/performance of an entity during the year.
Similarly, the balance sheet consists of assets, liabilities, and equity. This shows the financial position of the entity in a given period of time. Therefore, there is a relationship between the cost of goods sold and the balance sheet.
Cost of goods sold figure is not shown on the statement of financial position or balance sheet, but it’s constituent inventory indirectly affects profit or loss figure shown on the statement of financial position that is calculated in the statement of comprehensive income under the head cost of goods sold.
For example, there is a double effect of inventory on both accounts, i.e. on the balance sheet and profit and loss account.
Inventory is a current asset shown under the head of current assets in the balance sheet as well as a cost of goods sold account item appearing twice in the form of opening inventory and closing inventory.
The balance sheet always represents the closing stock held at the year-end while, on the other hand, the cost of goods sold account shows not only the closing amount but also the opening amount of inventory.
For example, a company XYZ has opening inventory for the period is $100,000 and has made purchases of $200,000 during the period, the company has used these in the production of goods and has the remaining inventory at the end of the year amounted to $50,000.
Now the COGS figure that will be reported in the statement of comprehensive income will be calculated as:
COGS = $100,000 + $200,000 – $50,000
COGS = $250,000
In the above example, the COGS figure $250,000 will be reported in the statement of comprehensive income, while the other figure of $50,000 of closing inventory would be presented in the statement of financial position under the head current asset and will be the opening figure for the next period.
If the value of inventory is calculated incorrectly it will not only affect the balance sheet items such as the total value of assets under the head of current assets but also affect the profitability of the company in terms of cost of sale because when closing stock increases, it decreases the cost of goods sold and subsequently increases gross profit and vice versa.
As a result of these errors the reporting value of assets and owners’ equity on the balance sheet to be wrong.
Review by Sinra