- Cost of goods sold is the total of all costs used to create a product or service, which has been sold.
- These costs fall into the general sub-categories of direct labor, materials, and overhead.
- Direct labor and direct materials are variable costs, while overhead is comprised of fixed costs (such as utilities, rent, and supervisory salaries).
- In a service business, the cost of goods sold is considered to be the labor, payroll taxes, and benefits of those people who generate billable hours (though the term may be changed to “cost of services”).
- In a retail or wholesale business, the cost of goods sold is likely to be merchandise that was bought from a manufacturer. It does not include any general, selling, or administrative costs of running a business.
Calculation of Cost of Goods Sold
The cost of goods sold is derived by adding together beginning inventory and all inventory purchases made during the reporting period, and then subtracting out the ending inventory balance. Beginning inventory is the value of the raw materials and finished goods in stock at the beginning of the reporting period. Purchases made during the reporting period include all raw materials, components, and merchandise acquired from other parties during the period. Ending inventory is the amount counted as being on hand at the end of the reporting period
Opening stock + Purchases + Direct expenses – Closing Stock= Cost of good sold
Included in the Cost of Goods Sold
- The costs included in the cost of goods sold are essentially any costs incurred to produce the goods being sold by a business.
- The most likely costs to be included within this category are direct labor, raw materials, freight-in costs, purchase allowances, and factory overhead.
- The factory overhead classification includes manufacturing and materials management salaries, as well as all utilities, rent, insurance, and other costs related to the production facility. Direct labor and direct materials are classified as variable costs, while factory overhead is mostly comprised of fixed costs.
- Costs that are not included in the cost of goods sold are anything related to sales or general administration. These costs include administrative salaries, as well as all utilities, rent, insurance, legal, selling, and other costs related to selling and administration.
- In addition, the cost of any inventory items remaining in stock at the end of a reporting period are not charged to the cost of goods sold. Instead, they are reported as a current asset on the company’s balance sheet.
- In the income statement presentation, the cost of goods sold is subtracted from net sales to arrive at the gross margin of a business. This information appears near the top of the income statement.
Cost of Goods Sold vs. Operating Expenses
While conducting its operations, a business incurs expenses in the areas of both the cost of goods sold and operating expenses. As we have just described, the cost of goods sold relates to those expenses used to create a product or service, which has been sold. Operating expenses are incurred to run all non-production activities, such as selling, general and administrative activities. The cost of goods sold is presented immediately after the revenue line items in the income statement, after which operating expenses are presented. Examples of cost of goods sold expenses are direct materials and direct labor, while examples of operating expenses are administrative staff compensation, rent, office supplies, travel, insurance, and training expenses.
