The Cost of Goods Sold (COGS)

By Jeff Boulton

 The Significance of Inventory Cost of Goods Sold Calculation Cost of Goods Sold Schedule

The Significance of Inventory

Inventory adds an entirely new dimension to running and evaluating a business.

Inventory can become obsolete (summer clothing not sold by fall, too many of the hottest toys from last Christmas). Inventory also takes up space for which you pay rent, needs to be stored, stocked, and counted, which takes labour, and inventory soaks up cash to sit there on the floor and do nothing, instead of paying the business’ bills. Not the least of which, inventory can be stolen.

Inventory values can also be “played” with to alter a business’ reported Net Income. How? This is because the cost of inventory eventually makes it to the income statement as an expense called Cost of Goods Sold. The more you sell, the higher your cost of goods sold expense.

The reason all this is significant, is because inventory is usually significant. The single largest expense for a merchandise business is usually the Cost of Goods Sold expense.

The concept of Cost of Goods Sold

Since now we are selling goods, part of the cost of generating revenue is the cost of the items we are selling. This is called the Cost of Goods Sold.

This is how the Cost of Goods Sold is calculated (it would be wise to memorize this formula RIGHT NOW!):

Practice Question

A business with \$20,000 of inventory on January 1st makes the following purchases:

 Jan. 10th \$7,500 Jan. 17th 1,500 Jan. 21st return (900)

Note: when inventory was counted on January 31st, the business had \$14,000 of inventory left.

Sales in January were \$40,000 including Operating Expenses of \$17,000.

Instructions:

1. Find the Cost of Goods Sold
2. Find Net Income

 Beginning Inventory \$20,000 Add: Purchases 9,000 Less: Purchase Returns (900) Total Available 28,100 Less: Ending Inventory (14,000) Cost of Goods Sold 14,100 Sales \$40,000 Less: Cost of Goods Sold (14,100) Gross Profit 25,900 Less: Operating Expenses (17,000) Net Income \$8,900

Presenting the Cost of Goods Sold

This is the most difficult section of the four-part Income Statement. Let’s go through it step by step. When you are ready, click ‘Next’ below to begin.