Cost of Goods Sold

Direct costs in producing a good or providing a service

Cost of Goods Sold

The cost of goods sold (COGS) is often the second line item appearing on the income statement, coming right after sales revenue. COGS is deducted from revenue to find gross profit.

Cost of goods sold consists of all the costs associated with producing the goods or providing the services offered by the company. For goods, these costs may include the variable costs involved in manufacturing products, such as raw materials and labor. They may also include fixed costs, such as factory overhead, storage costs and depending on the relevant accounting policies, sometimes depreciation expense.

COGS does not include general selling expenses, such as management salary and advertising expense. These costs will fall below the gross profit line under the selling, general and administrative (SG&A) expense section.

Accounting for Cost of Goods Sold

IFRS and US GAAP allow different policies for accounting for cost of goods sold. Very briefly, there are four main types of cost of goods sold classifications.

  1. First-in-first-out (FIFO)
  2. Last-in-first-out (LIFO)
  3. Weighted average
  4. Specific identification

The first two are self-explanatory. Under FIFO, COGS consists of earlier costs, whereas under LIFO, COGS consists of later costs. For example, assume that a company has purchased materials to produce four units of their goods. The first three units cost $5 to produce. However, due to rising material prices, the last unit cost $10 to produce. In the subsequent period, the company sells three units. Under FIFO, COGS would consist of the first three units produced, totaling $5 x 3 = $15. Under LIFO, COGS would consist of the last three units produced, totaling $10 x 1 + $5 x 2 = $20.

Under weighted average, total cost of goods available for sale is divided by units available for sale to find the unit cost of goods available for sale. This is multiplied by the actual number of goods sold to find cost of goods sold. In the above example, the weighted average per unit is $25 / 4 = $6.25. Thus, for the three units sold, COGS is equal to $18.75.

Specific identification is special in that this is only used by organizations with specifically identifiable inventory. Costs can be directly attributed and are specifically assigned to the specific unit sold. This type of COGS accounting may apply to car manufacturers, real estate developers, and others.

Depending on the COGS classification used, ending inventory costs will differ.