Cost of Goods Sold on an Income Statement: Definition & Formula

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  • 0:01 Definition of Cost of…
  • 0:27 The Income Statement & COGS
  • 1:15 Calculating COGS - Inventory
  • 2:50 Calculating COGS -…
  • 5:28 Calculating COGS - Services
  • 7:30 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.

Just because you earn revenue doesn't mean you've made a profit. In this lesson, you'll learn about cost of goods sold, including where it fits on an income statement and how to calculate it. A short quiz follows the lesson.

Definition of Cost of Goods Sold

The cost of goods sold (COGS) is any direct cost related to the production of goods that are sold or the cost of inventory you acquire to sell to consumers. It does not include overhead expenses related to the general operation of the business, such as rent. Cost of goods sold is reported on a company's income statement.

The Income Statement and COGS

An income statement is the financial statement in which a company reports its income and expenses. If income exceeds expense during the reporting period, there is a net profit; if not, the company has suffered a loss.

COGS are reported under expenses as the costs directly related to either the product or goods sold by a company or the costs of acquiring inventory to sell to consumers. If the cost of goods sold exceeds the revenue generated by the company during the reporting period, the revenue did not generate a profit. Keep in mind that any loss due to one business activity may be offset by another income-generating activity and still result in a net profit for the company.

Sample Income Statement
Sample Income Statement

Calculating COGS - Inventory

First, we'll discuss how to calculate the cost of inventory sold.

Costs related to retail or wholesale inventory include:

  • Inventory purchases, including any discounts and allowances
  • Freight
  • Repackaging expenses

Inventory can be calculated using several formulas. Here is a relatively simple formula to use:

COGS = Beginning Inventory + Purchases Made During the Reporting Period - Ending Inventory

Let's apply it to an example. Say you operate a department store and had a beginning inventory of $350,000 last month and purchased another $750,000 in inventory. Last month was a good month, and your remaining inventory at the end of the month was $125,000. What was the cost of goods sold for the month?

Remember that COGS = Beginning Inventory + Purchases Made During the Reporting Period - Ending Inventory. Feel free to pause the video now if you want to try to calculate it yourself before you see the answer.

Okay, let's apply the formula.

COGS = $350,000 + $750,000 - $125,000

Therefore, COGS = $975,000.

Calculating COGS - Manufactured Goods

Next, we'll discuss how to calculate the cost of manufactured goods sold. This is a bit more complicated. Costs may include:

  • Inventory items used in the manufacture of the products, such as parts and raw materials
  • Labor and related expenses
  • Costs of the facilities directly used to make the product
  • Warehousing space used during the manufacturing process
  • Machinery leases
  • Production supplies
  • Any other costs that are directly related to production of the goods

You should note that for purposes of this calculation, an expense is only directly related if it MUST occur for production to happen. Administrative office space, for example, is not a direct cost because you don't need to incur the expense in order for production to occur. On the other hand, lease of necessary machinery for production is a direct expense because you can't produce the product without incurring the expense.

Here's a formula you can use to calculate the costs of manufactured goods sold:

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

You should note that costs of goods manufactured are the sum of all direct costs of production that we discussed above. For example, you may need to add up the costs of labor, materials and supplies to obtain the numbers to use in the formula.

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