Cost of Goods Sold (COGS) Formula | Calculation | Definition | Example

Summary

In this educational video, the speaker delves into the definition and significance of Cost of Goods Sold (COGS), illustrating its importance for retailers, distributors, and manufacturers. COGS represents the direct costs associated with the merchandise sold, transitioning from a current asset to an expense upon sale. The video outlines various formulas for calculating COGS, including the matching principle with revenue, and provides practical examples to enhance understanding. By simplifying complex accounting concepts, the speaker aims to assist viewers in grasping COGS for better financial reporting and success in their accounting studies.

Takeaways

• 😀 COGS stands for Cost of Goods Sold, representing the cost of merchandise sold by a retailer, distributor, or manufacturer.
• 📦 When inventory is sold, its cost becomes COGS; otherwise, it remains a current asset.
• 💡 COGS is classified as an expense account and is reported on the income statement.
• 🔗 The matching principle of accounting requires that COGS is matched with the revenues generated from those goods.
• 📊 Gross Profit is calculated as Sales minus COGS, providing insight into profitability.
• 📝 A detailed formula for COGS includes: Opening Inventory + Purchases - Purchase Returns - Purchase Discounts + Freight In - Ending Inventory.
• 🤝 Examples illustrate that sold inventory impacts both COGS and the remaining inventory value on the balance sheet.
• 🏪 For a shopkeeper, selling 10 footballs at $50 each results in sales of $500 and COGS of $300, yielding a gross profit of $200.
• 📉 XYZ Company example demonstrates COGS calculation with beginning inventory, purchases, and ending inventory totaling $515,000.
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Q & A

What is the definition of cost of goods sold (COGS)?

Cost of goods sold (COGS) refers to the direct costs attributable to the production of the goods sold by a company. This includes the cost of the merchandise that a retailer, distributor, or manufacturer has sold.

How does COGS change through the supply chain?

When a manufacturer sells merchandise to a wholesaler, the cost of that inventory becomes the COGS for the manufacturer. For the wholesaler, the cost of the merchandise is a current asset until it is sold to a retailer, at which point it becomes the COGS for the wholesaler.

Is COGS an asset or an expense account?

COGS is classified as an expense account. It is reported on the income statement and is considered an expense of the accounting period.

What is the matching principle in accounting?

The matching principle in accounting states that expenses should be recorded in the same period as the revenues they help to generate. This is achieved by matching the COGS with the revenues from the goods sold.

What formula can be used to calculate gross profit?

Gross profit can be calculated using the formula: Gross Profit = Sales - Cost of Goods Sold (COGS).

How can COGS be calculated using inventory data?

COGS can be calculated using the formula: COGS = Opening Inventory + Purchases - Purchase Returns - Purchase Discounts + Freight In - Ending Inventory.

What does the term 'current assets' refer to?

Current assets refer to assets that are expected to be converted into cash or used up within one year. In the context of COGS, inventory is considered a current asset until it is sold.

Can you provide an example of calculating COGS?

For example, if a shopkeeper buys 100 footballs at $30 each and sells 10 for $50 each, the COGS for the 10 sold footballs would be $300 (10 footballs x $30). The remaining 90 footballs, valued at $2,700, remain as current assets.

How do beginning and ending inventory affect COGS calculation?

In calculating COGS, beginning inventory and purchases are added together, and the ending inventory is subtracted. For instance, if beginning inventory is $100,000, new purchases are $450,000, and ending inventory is $35,000, COGS would be $515,000.

What is the importance of understanding COGS in accounting?

Understanding COGS is crucial as it directly affects the gross profit and overall profitability of a business. It also helps in inventory management and financial reporting.