Definition

Cost of goods sold (COGS) is a key accounting metric that represents the direct costs incurred by a company in the production or purchase of the goods or services it sells during a specific period.

What is the cost of goods sold?

COGS is a key component in calculating a company’s gross profit, and is a crucial figure in the income statement as it is deducted from revenue to calculate gross profit.

Calculation of COGS:

COGS = Opening inventory + Purchases or production costs − Closing inventory

Different industries may have different methods for calculating and presenting COGS. For example, a manufacturing company’s COGS will include costs like raw materials and direct labour, while a retail company’s COGS may include the cost of purchasing goods for resale.

COGS is a deductible expense when calculating taxable income. The lower the COGS, the higher the potential taxable income and tax liability.

Example of cost of goods sold

Suppose ABC Electronics is a company that manufactures smartphones. Here’s how you might calculate COGS for a specific period, such as a quarter:

• Opening inventory (Beginning of the quarter): ABC Electronics had $500,000 worth of smartphones in inventory at the beginning of the quarter.
• Purchases or production costs (During the quarter): During the quarter, ABC Electronics incurred direct costs associated with manufacturing smartphones, including raw materials, labour, and manufacturing overhead. Let’s say these costs amounted to $1,000,000.
• Closing Inventory (End of the quarter): At the end of the quarter, ABC Electronics had $300,000 worth of smartphones still in inventory.

Now, COGS can be calculated:

COGS = $500,000 + $1,000,000 – $300,000 = $1,200,000

In this example, ABC Electronics incurred $1,200,000 in costs directly associated with producing or purchasing smartphones for sale during the quarter.