Cost of Goods Sold

Definition

Cost of Goods Sold (COGS) represents the direct costs associated with the production or acquisition of the goods or services sold by a business during a specific accounting period. It is a fundamental concept in managerial accounting that helps organizations track and manage their inventory and profitability.

5 Must Know Facts For Your Next Test

1. Cost of Goods Sold is a key component in calculating a company's gross profit, which is the difference between net sales and COGS.
2. In a merchandising business, COGS includes the cost of purchasing and delivering the merchandise sold, while in a manufacturing business, COGS includes the direct materials, direct labor, and manufacturing overhead costs associated with producing the goods sold.
3. COGS is reported on the income statement and represents the total cost of the inventory that was sold during the accounting period.
4. Accurately calculating and reporting COGS is essential for determining a company's profitability and making informed business decisions.
5. The cost flow assumption (e.g., FIFO, LIFO, or weighted average) used to value the inventory can significantly impact the COGS and, consequently, the reported gross profit.

Review Questions

• Explain how the cost of goods sold concept differs between merchandising, manufacturing, and service organizations.
  • In a merchandising organization, the cost of goods sold represents the cost of purchasing and delivering the merchandise that was sold during the period. For a manufacturing organization, the cost of goods sold includes the direct materials, direct labor, and manufacturing overhead costs associated with producing the goods that were sold. For a service organization, there is typically no physical inventory, so the cost of goods sold is primarily composed of the direct labor and other costs incurred to provide the services to customers.
• Describe how the job order costing method is used to trace the flow of product costs through the inventory accounts and ultimately to the cost of goods sold.
  • In a job order costing system, the costs associated with each job or batch of products are accumulated and assigned to the specific job. As the job progresses through the production process, the costs are transferred from raw materials inventory to work-in-process inventory and then to finished goods inventory. When the job is completed and the products are sold, the costs are recognized as cost of goods sold on the income statement. The job order costing method allows for the precise tracking of costs associated with each unique job or batch of products.
• Analyze how the treatment of under- or over-applied overhead in a job order costing system can impact the calculation of the cost of goods sold.
  • In a job order costing system, overhead costs are typically applied to jobs based on a predetermined overhead rate. If the actual overhead costs incurred differ from the applied overhead, the difference is recorded as under-applied or over-applied overhead. This balance must be disposed of at the end of the accounting period, and the method used to do so can impact the final cost of goods sold. For example, if the over-applied overhead is closed directly to the cost of goods sold account, it will reduce the reported COGS, whereas if it is allocated across inventory accounts, it will affect the valuation of ending inventory and, consequently, the COGS.

Related terms

Inventory: The raw materials, work-in-progress, and finished goods that a business holds for the purpose of resale or use in production.

Gross Profit: The difference between a company's net sales and its cost of goods sold, representing the profit earned before deducting operating expenses.

Absorption Costing: A costing method that includes all manufacturing costs, both variable and fixed, in the cost of a product.