Cost of goods sold (cost of sales) is the cost to produce or resell products that were sold to an entity’s customers. Manufacturing companies usually use cost of goods sold account because they create products. They want to know how much they spent to produce certain item. This figure can be estimated or actual. On the other hand, retailers calculate cost of sales because they just resell what other firms produced. Organizations that do not manufacture anything, buy already finished merchandise, concern only about cost associated with actual sales of products rather than the production itself.
Cost of goods sold for a manufacturing company
Cost of goods sold is direct and indirect expenses related (tied) to manufacturing some certain products along that an entity sells. The costs that go into creating the products are the cost of the direct and indirect materials used, the direct and indirect labor costs (wages expense) used to produce the good, and other expenditures that ties to the production process. Everything what is not direct materials or labor is manufacturing overhead. Manufacturing overhead includes cost of indirect materials, indirect labor (salaries) and other expenses which are an integral part of the manufactured product.
How to calculate cost of goods sold
There are few ways exist on how to calculate cost of goods sold. Manufacturers or producers will use three inventory accounts raw materials, work in process, and finished goods.
Ties between three inventory accounts to find cost of goods sold for a manufacturing company
|Dr. Direct Materials (DM) Cr.||Dr. Work in process (WIP) Cr||Dr. Finish goods (FG) Cr.|
- DM used >>>
+ DM used
- COGM3 >>>
|Avail -able for sale||
|End. DM||End. WIP||End. FG|
1DL – direct labor
2MOH – manufacturing overhead
3COGM – cost of goods manufactured
4COGS – cost of goods sold
- first step, a bread making company needs to add cost of all ingredients for baking the bread from previous period and any additional items purchased this period to find out what direct materials is available for use. Then they need to subtract cost of raw materials at the end of the period to know what was actually used in the production.
- second step, the entity needs to add cost of beginning Work in process account (if any) and costs of WIP for the current period (costs of direct materials used, direct labor, and manufacturing overhead) then subtract ending balance of WIP to find out cost of goods manufactured.
- third step, the organization should calculate cost of finish goods available for sale by adding beginning FG account to COGM from step 2. After that they will subtract cost of goods available or sale from ending balance of finish goods inventory to find out cost of goods sold.
What are other costs incurred in a manufacturing company that should be charged to cost of goods sold
Other expenses* related to the creation process of products are distribution costs, sales force costs, costs of containers, freight-in, rent, utilities, insurance, depreciation, taxes, maintenance, and supervision.
*Other expenses are those that are an integral part of the product manufactured.
Where does cost of goods sold appear on financial statement?
While inventory account is a balance sheet account, the cost of goods sold is reported on the income statement when an entity sells the goods. COGS appears on the income statement to be deducted from sales revenue account in order to calculate the manufacturing company's gross margin for the period. For more information please read “What is inventory?”