It is an asset which a business uses the following year.Īs discussed earlier, COGS determines the profitability of a business. The closing inventory is recorded in the balance sheet. However, to calculate the final profitability, he also deducts other indirect costs. He deducts the COGS from his revenue to calculate the profitability of his business.ĭirect costs are included in the calculation of COGS. Instead, they calculate the Cost of Services.Ī seller records the COGS in the profit & loss statement of his business. Companies that provide only services do not calculate COGS. Hence, we exclude the value of closing inventory for the calculation of the COGS.Īlso, COGS is applicable for companies that manufacture products. These are termed as closing inventory and are available for sale next year. Some goods remain unsold at the year-end. Three primary methods are FIFO (First In, First Out), LIFO (Last In, First Out), and WAC (Weighted Average Cost).ĬOGS is calculated for producing only those goods which we sell during the year. Now, let us find the Cost of Goods Sold for the business of Sam, for this year:ĬOGS = Opening Inventory + Purchases made during the year – Closing InventoryĬalculation of COGS involves the valuation of inventory. This is the closing inventory of this business. He calculated the value of this remaining inventory at USD 3,000. At the end of the year, some inventory remained in his business. Thus, Sam purchased additional inventory worth USD 5,000 during the year. But this might not suffice to meet the demand for the entire year. Now let us assume that the cost of his opening inventory was USD 10,000. This becomes the opening inventory on April 1st of the next financial year. Thus, he records the closing inventory on March 31st every year. He uses a financial year to record the accounting entries of his business. The cost of goods sold is the summation of all direct costs associated with these three components. This apart, a business also produces/purchases goods during the year to meet demand. Hence, they become the ‘Opening Inventory’ of the following year. These goods are available for sale in the next year. These are referred to as ‘Closing Inventory’ of that year. Not all of it is sold during the year hence some goods remain at the year-end. These include administration costs, interest, depreciation, and selling expenses.ĬOGS is calculated using the following formula:ĬOGS = Opening Inventory + Purchases – Closing inventoryĮvery business, in anticipation of demand, produces goods. The indirect costs are those which cannot be directly attributed to the production. These are costs of raw materials, labor, packing, transportation, etc.ĬOGS does not include the indirect costs of a business. It includes all the direct costs a company incurs for producing such goods. Let us understand it in detail.Ĭost of goods sold, or COGS, is also known as ‘Cost of Sales.’ As the name suggests, COGS is the cost of producing goods a company sells. For this, it is essential to understand various components of cost in a business.Ĭost of Goods Sold, or COGS is one such cost component. Thus, one always aims to minimize the cost. Cost: A critical term that determines the profitability of a business.
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