How does inventory costing method affect COGS?

Under FIFO, older costs are assigned to COGS. Under LIFO, newer costs are assigned to COGS. Weighted Average Cost blends the costs. The method shifts the allocation of total costs between COGS and ending inventory.

Are labor costs included in COGS?

For manufacturing companies, direct labor costs are included in the cost of goods manufactured, which flows into purchases/COGS. For retail companies, labor is an operating expense, not part of COGS.

What happens if ending inventory is overstated?

Because $ ext{COGS} = ext{COGAS} - EI$, an overstated ending inventory will artificially understate COGS. This results in an overstated gross profit and net income for that period.

How to calculate cost of goods sold

Cost of Goods Sold (COGS) represents the direct costs attributable to the production or acquisition of the goods sold by a company during a specific period. It applies to inventory accounting under both periodic and perpetual systems to determine gross profit.

The fundamental equation is $ext{Beginning Inventory} + ext{Purchases} - ext{Ending Inventory} = ext{COGS}$ . This calculation assigns costs to the units sold and determines the remaining value of inventory on the balance sheet.

The setup

Identify the accounting period. Gather the beginning inventory balance ( $BI$ ) from the prior period's balance sheet. Sum all inventory purchases ( $P$ ) made during the current period. Determine the ending inventory balance ( $EI$ ) via a physical count or continuous perpetual tracking.

The steps

Record the beginning inventory value ( $BI$ ).
Calculate net purchases ( $P$ ). Add raw materials or merchandise purchased, add freight-in costs, and subtract purchase returns, allowances, and discounts.
Add net purchases to beginning inventory to find the Cost of Goods Available for Sale: $ext{COGAS} = BI + P$ .
Subtract the ending inventory value ( $EI$ ) from the COGAS.
The result is the Cost of Goods Sold: $ext{COGS} = ext{COGAS} - EI$ .

Checking the result

Verify that $ext{COGS} + EI = BI + P$ . If this equality fails, recalculate. Ensure no indirect operating expenses, such as marketing or administrative overhead, have been capitalized into the purchase costs.

Common errors

Failing to adjust gross purchases for returns, allowances, and discounts. Including freight-out (a selling expense) instead of freight-in (a direct cost). Miscounting the physical ending inventory, which inversely distorts the COGS calculation.

Worked example

A retailer has a beginning inventory of $\$ 15,000 $. During the year, they purchase$ $45,000 $in merchandise, pay$ $2,000 $in freight-in, and return$ $1,500 $of defective goods. The physical count at year-end shows an ending inventory of$ $12,000$. Calculate the COGS.

First, calculate net purchases ( $P$ ): $P = 45000 + 2000 - 1500 = 45500$ Next, calculate Cost of Goods Available for Sale ( $ext{COGAS}$ ): $ext{COGAS} = BI + P = 15000 + 45500 = 60500$ Finally, subtract Ending Inventory ( $EI$ ) to find $ext{COGS}$ : $ext{COGS} = ext{COGAS} - EI = 60500 - 12000 = 48500$ The Cost of Goods Sold is $\$ 48,500$.

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References: Kieso, Weygandt, Warfield, Intermediate Accounting · OpenStax Principles of Accounting, Volume 1: Financial Accounting