How to Calculate Cost of Goods Sold

What is cost of goods sold

It is the total of all the costs involved in manufacturing a product or service that has been sold. These costs include the purchase value of certain products, processing or conversion cost and all the other costs that are associated in bringing all the inventories into its present location. In an organizational perspective, cost of goods manufactured consists of raw material cost, labour cost, and overhead costs. Inventory cost is also needed to be added for the unsold goods still at the warehouse.

Formula to calculate Cost of Goods Sold

According to the periodic review system, the cost of goods sold can be calculated as follows:

Cost of goods sold (CGS) = Opening inventory + purchases – Closing inventory

This calculation is done based on the assumption of that all the goods would be sold. However, in reality, there were some instances where the products need to be removed as they were obsolete or expired, scrapped and were stolen from the warehouse. So, the calculation needs to be included with additional costs incurred due to these damages which are related to the current period.

Calculating Cost of Goods Sold – Example

X company has $50,000 of opening inventory at the beginning of the period. It spend money for various expenses worth $32,000 relevant to the inventory items during the period, and has $12,000 of inventory left at the end of the period. The cost of goods sold during the period can be calculated as follows:

Opening inventory

$ 50,000

+ Purchases

$ 32,000

– Ending inventory

$ 12,000

Cost of goods sold

$ 70,000

In the perpetual inventory system, the cost of goods sold is calculated over a time the goods are being sold to the customers. In this method, a number of transactions such as sales, scrap and obsolescence are being recorded.

In the selected method, the type of inventory costing system used may create an impact on calculation of cost of goods sold. Following are two different types of inventory costing system.

• First in, first out method (FIFO) – According to this method, items which are sent into the inventory first should be sent out first for the use.
• Last in, first out method (LIFO) – In this method, the last items which are added to the inventory are sent out first for use.

CGS in the financial statements

Cost of goods sold is presented in the Income Statement. CGS figure is used to calculate the gross profit or gross income and finally the net profit or net income of the organization within a specific period. If the CGS exceeds the revenue within a certain period, then the company would not be able to generate profits within the period. The primary objective of most of the organizations is to generate profits compared to its expenses.

Following is an extract of an Income Statement.

 

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