Difference between revisions of "Account for Cost of Goods Sold"

The cost of goods sold (COGS) for a period is the total amount of costs involved in manufacturing a product or delivering a service.  COGS varies for products and services, but it generally includes labor, materials and overhead.  On your company’s income statement, the COGS is subtracted from the total revenues to calculate the gross profit margin.  In broad terms, you calculate COGS by determining the amount of inventory used in the period.  This assumes that the inventory used in that period was used to produce what was sold in the same period.<ref name="rf1"> http://www.accountingtools.com/definition-cost-of-goods-sold</ref>

#Determine the beginning inventory value.<ref name="rf2">http://www.irs.gov/publications/p334/ch06.html#en_US_2012_publink100025284</ref> This should always be the ending inventory value from the previous reporting period. If you are a retailer, this number will consist of the cost of all the merchandise in your stock that you plan on selling to customers. If you are a manufacturer of goods, this number will consist of three kinds of inventory: raw materials (all of the materials used to manufacture the product); works-in-progress (items that are in process but aren’t completely finished); and finished goods (completed products that are ready for sale).<ref name="rf3"> http://www.dummies.com/how-to/content/accounting-for-manufacturing-company-inventory.html</ref>

#Calculate the labor costs involved for manufacturing the goods. Including indirect and direct labor costs to calculate cost of goods sold ''only'' applies to manufacturing and mining companies. Calculate the wages and salaries of all manufacturing employees plus the cost of their benefits. Typically, wholesalers or resellers will not include the cost of labor in this figure, as it cannot be properly charged to the "cost" of the goods.<ref name="rf2" />

#Choose from two methods to estimate the ending [[Keep Inventory|inventory]].  You might need to estimate the ending inventory because it’s too difficult to calculate the exact value.  This could happen because of a surge of shipping activity at the end of the period, or if the staff is unavailable to do a physical count of inventory.  These methods rely on historical trends, so they are not 100 percent accurate.  However, if your company hasn’t had any abnormal transactions during the period, you could reasonably use one of these methods.<ref name="rf4"> http://www.accountingtools.com/questions-and-answers/how-do-i-estimate-ending-inventory.html</ref>

#Use the gross profit method to estimate ending inventory.  This result is driven by the historical gross profit margin.  So it may not be completely accurate because this may not agree with the gross profit margin in the current accounting period.  It can reasonably be used during interim periods between physical counts of inventory.<ref name="rf5"> http://www.accountingtools.com/gross-profit-method</ref>

#Use the retail inventory method to estimate ending inventory.  This method does not use the historical gross profit margin.  Instead, it compares the retail price to the cost of goods in prior periods.  Note that this method is only valid if you always mark up your products by the same percentage.  If you used a different mark-up rate or offered discounts during the current period, then this method would be inaccurate.<ref name="rf6"> http://www.accountingtools.com/retail-inventory-method</ref>

#Obtain an accurate ending inventory valuation periodically with a physical count or cycle count.  For some situations, you must invest the time and resources to get an accurate physical count of your inventory.  For example, your company may be preparing for an audit of your financial statements.  Or you may be planning an acquisition or merger.  In these cases, you need a precise calculation of inventory because an estimation won’t be accurate enough.<ref name="rf4" />

#* Conduct a complete count of inventory.  This is known as a physical count.  You do it at the end of a month, quarter or year.  This method is labor intensive.  Therefore, companies typically perform a physical count a limited number of times per year.<ref name="rf7"> http://www.accountingtools.com/procedure-inventory-count</ref>

#* A cycle count is a method of counting inventory on an ongoing basis.  A small amount of inventory is calculated each day.  In a defined period, you cycle through the entire inventory.  All items are counted on a rotating basis.  This method is highly accurate and yields a high degree of confidence in the accuracy of the inventory valuation.<ref name="rf8"> http://www.accountingtools.com/cycle-counting</ref>

#Calculate the cost of goods sold (COGS) if using a periodic inventory method.  A periodic inventory method means that inventory is calculated at regular intervals.  For example, you may count inventory monthly, quarterly or semi-annually.  The formula is straightforward in this case: (Beginning Inventory + Purchases – Ending Inventory = COGS).<ref name="rf9">http://www.obliviousinvestor.com/how-to-calculate-cost-of-goods-sold-cogs/</ref>

#Calculate the COGS if using a perpetual inventory method.  You use this type of method if you keep track of inventory on an item-by-item basis.  For example, if you are a retail store that scans barcodes with point-of-sale scanners, then you are keeping track of inventory in real time<ref name="rf10">http://www.obliviousinvestor.com/periodic-vs-perpetual-method-of-inventory/</ref>.

#* If you are keeping track of changing inventory on an item-by-item basis, then when calculating the ending value of the inventory, you have to make some assumptions about which items in inventory were used first during the accounting period.<ref name="rf9" />