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?
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.