Cost of Goods Sold

A figure of cost of goods sold reflecting the cost of the product or good that a company sells to generate revenue, appearing on the income statement, as an expense. Also, referred to as "cost of sales". It is essentially a cost of doing business, such as the amount paid to purchase raw materials in order to manufacture them into finished goods. For example, if a $10 widget costs $6 to make, then the cost of goods sold is $6 per widget. That is, the cost of goods sold is equal to the beginning inventory plus the cost of goods purchased during some period minus the ending inventory. However, the meaning of the cost of goods sold differs from one company to another company. There are three types of companies such as merchandising, manufacturing, and service.

The merchandising company such as retail stores and wholesalers sells goods that are usually same physical form as what the company acquires them. Therefore, those acquisition cost would be the cost of goods sold in merchandising company. The acquisition cost includes not only the cost of acquiring the merchandise but also the cost of making the goods ready for sale such as shipping costs. Let's think of the following situation during the period. In addition to the beginning inventory, a company purchased additional merchandise so the amount of goods available for sale became the beginning inventory plus additional purchased merchandise. At the end of the period, the company wants to determine the amount of the cost of goods sold and ending inventory. How do they determine the amount of the cost of goods sold and ending inventory? There are two types of approaches: periodic inventory method and perpetual inventory method. The periodic inventory method is the following.

(Cost of goods sold) = (Goods available for sales) - (Ending inventory)

In the periodic inventory method, we determine the amount of ending inventory at the end of period, and then subtract the ending inventory from the goods available for sale.

On the other hand, the perpetual inventory method is the following.

(Ending inventory) = (Goods available for sales) - (Cost of goods sold)

In the perpetual inventory method, we determine the amount of cost of goods sold, and then subtract the cost of goods sold from the goods available for sale. Therefore, we have to keep a record for inventory constantly. Although this record keeping is burdensome for some company, there are important advantages. First, the detailed record is useful in analyzing customer trend and demand for the item. Second, the perpetual inventory record has a built-in check. Third, we can prepare an income statement without taking a physical inventory. Therefore, most stores/companies adopt the perpetual inventory method.

The manufacturing company such as vehicle producing company acquires raw material and parts, and then the company converts those materials into finished goods. Therefore, the cost of those raw material and parts and conversion costs would be cost of goods sold in manufacturing company. There are three types of inventory accounts such as material inventory, work in process inventory, and finished goods inventory. The material inventory is items of material that will be goods ready for sale. The work in process inventory is goods that is being manufactured but not have been finished yet. The finished goods inventory is goods that is manufactured but not have been shipped yet. Those three types of inventory accounts are necessary for determining the cost of goods sold. I use the periodic inventory method. First of all, we need to determine the cost of materials used that is the sum of all materials issued during the period.

(Materials used) = (Beginning materials inventory) +

(Purchased materials inventory) - (Ending materials inventory)

Next, we need to determine the cost of goods manufactured that is the manufacturing or conversion cost such as labor costs and factory's utilities and materials cost.

(Cost of goods manufactured) = (Beginning work in process inventory) +

(Material used) + (Conversion cost) - (Ending work in process inventory)

Finally, we determine the cost of goods sold.

(Cost of goods sold) = (Beginning finished goods inventory) +