Cost of Goods: Definition & Calculation

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  • 0:00 Cost of Goods: Defined
  • 1:17 Calculations
  • 4:54 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

It takes money to make money. In this lesson, you'll learn about the cost of goods, what it is, what it isn't and how to calculate the costs of goods sold. You'll also have a chance to reinforce your knowledge with a short quiz.

Cost of Goods: Defined

Costs of goods are the expenses directly related to the production of a company's product, the costs related to acquiring inventory to sell to customers or the costs directly involved in providing services to customers. Costs of goods do not include general expenses not directly related to the production of goods or services, such as general overhead, rent and administrative expenses.

Let's break our description down by type of business. We'll start with manufacturing. Costs of goods in manufacturing businesses include the costs of labor to manufacture the products, raw materials, pre-manufactured components, transportation costs and any costs related to outsourced manufacturing and assembly.

The next type of business we'll go over is retail. In retail businesses, the costs of goods include the expenses related to purchasing inventory to be sold to customers. This can include not only the actual purchase price for the inventory, but also transporting expenses.

Finally, let's look at the service industry. In this industry, the costs of services provided include the labor costs of employees who provide the services and the supplies they use directly in providing the services.

Calculations

The costs of goods sold can be calculated using different methods depending upon the type of business and the type of costs involved.

The period method is a basic method for calculating the costs of inventory over a certain period of time:

Cost of Goods Sold (COGS) = Beginning Inventory + Inventory Purchases - End Inventory

Now, let's look at this calculation in action. Imagine you're a retailer with a beginning inventory costing $2,500. You purchased $5,000 in additional inventory, and your ending inventory was $3,000. What are your costs for goods sold for this period? Remember:

COGS = Beginning Inventory + Inventory Purchases - End Inventory

Cost of Goods Sold = $2,500 + $5,000 - $3,000

Cost of Goods Sold = $4,500

Now, let's look at a formula you can use to calculate the costs of goods sold when the goods are manufactured by you.

Cost of Goods Sold (COGS) = Cost of Goods Manufactured + Opening Finished Goods Inventory - Ending Finished Goods Inventory

Here's an example: Imagine you have run a manufacturing company and last month you spent $10,000 to produce goods and had $5,000 of finished goods already in inventory. At the end of the month, you had $2,500 in goods remaining in inventory. What's the cost of goods sold? One more time, here's the formula:

Cost of Goods Sold = Cost of Goods Manufactured + Opening Finished Goods Inventory - Ending Finished Goods Inventory

COGS = $10,000 + $5,000 - $2,500

COGS = $12,500

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