What Is the Cost of Goods Sold?

Sep 26, 2022 By Susan Kelly

The term "cost of goods sold" (COGS) describes an organization's expenses in making the products it sells. All the resources and time used to make the product are factored into this total. Indirect costs, such as those associated with distribution and sales staff, are not included.

Cost of Goods Sold: What You Need To Know

When calculating a company's gross profit from its sales, COGS is a crucial indicator to look at in financial accounts. Gross profit measures a company's capacity to turn a profit. It is based on how well it coordinates its use of human resources and material inputs during manufacturing.

Since COGS represents an outgoing expense incurred in running the company, it must be accounted for in the financial accounts. Analysts, investors, and managers may better predict the bottom line by understanding the cost of products sold.

Pricing Strategies and Cost of Goods Sold

How a business calculates its inventory costs directly impacts the value of its cost of goods sold. Inventory counts can be recorded in three ways: first in, first out, last in, first off, or average cost. Rare or expensive things may require a more complicated system of identification. Three FIFO Products that were acquired or produced typically go on sale first.

The FIFO technique results in lower COGS than the LIFO method since the corporation will sell its most miniature costly items first as prices tend to rise with time. Since this is the case, utilizing FIFO increases net income over time.


With LIFO, the newest items brought to stock are the ones that go first at the register. Goods with higher costs are sold first during rising prices, increasing COGS. A decline in net income is typical over several years.

Average Price Analysis

Regardless of when they were initially purchased, the average price of all inventory is used to determine the worth of items for sale. The COGS is less likely to be dramatically affected by the extremely high or low expenses of a single acquisition or purchase if the average product cost is calculated over a specific period.

Unique Detection Technique

The unique identification technique takes into account the individual unit's particular cost. This strategy allows a company to track each product's exact quantity and price. Moreover, this approach is usually employed by sectors selling one-of-a-kind products, including automobiles, real estate, and priceless gems and jewelry.

Negative COGS Deduction Exceptions

In the case of service businesses, the cost of items sold is often zero. The cost of goods sold (COGS) is defined as the sum of the purchase and selling price of all inventory items sold during the accounting period.

Service businesses are unique in that they not only don't produce any physical products but also don't stock any of those products in advance. No deduction may be made for COGS if it is not included in the income statement.

Although these sectors incur operating costs and must pay for inputs to deliver their products or services, they do not report COGS. They have something termed "cost of services," which is not eligible for a COGS deduction.

Difference Between COGS and CR

Raw materials, direct labor, transportation charges, and sales commissions are all examples of costs of income for continuous contract services. However, if there is no tangible item to sell, these costs cannot be deducted from COGS. The Internal Revenue Service's website provides a partial list of "personal service firms" exempt from including COGS in their profit and loss statements. They range from medical professionals to attorneys and builders, and painters.

Comparing Operating Costs to Cost of Goods Sold

It's important to note that while operating expenses and the cost of products sold are incurred when a company is open for business, they are reported in different places on the income statement. In contrast to COGS, operating expenses are unrelated to creating goods or services. SG&A is usually shown separately from other operational costs.

Cost of Goods Sold: How Is It Determined?

The direct expenses incurred by a business to make sales are totaled to arrive at its cost of goods sold. Importantly, COGS only includes expenditures that may be directly linked to generating that income, such as inventory or labor expenses.

Conversely, COGS does not account for fixed expenses like managerial salaries, rent, and utilities. Investing in inventory is vital when calculating the cost of goods sold (COGS). There are a few ways to do that within the confines of generally accepted accounting principles.

The Verdict

The term "cost of goods sold" refers to the monetary value placed on the time and resources used to produce a product. When deducted from sales, COGS immediately affects a company's net income. A company's bottom line will improve if it can negotiate lower prices from its suppliers or find ways to streamline its production process.

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