What is meant by Cost of Goods Sold (COGS)? COGS importance, calculation, limitations, and FAQs.

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What is meant by Cost of Goods Sold (COGS)?

Cost of goods sold (COGS) is a financial metric that tells how much its cost has been incurred in the production of the product or services that have been sold to the consumers. 

It is important to note that the COGS metric is calculated for the sold goods (product) only.

It is the measure of the direct cost incurred such as material cost, labor cost,  factory cost, and all the other costs involved in the product production.   

In modern tech-based businesses like SaaS, the cost of goods sold is computed over web designing and development, hosting and monitoring costs, account management, license fees, support costs, training, professional services, and subscriptions.

Why do we calculate Cost of Goods Sold (COGS) 

COGS metric is useful for the managers and stakeholders to keep track of the performance and profitability of the business. It is needed for determining the gross profit and margins.

Calculation and accounting of COGS  

Formula for COGS 

COGS=B.I+P?E.I
where
B.I = beginning inventory
P=Purchases during the period
?E.I = ending inventory

Beginning inventory is the amount of goods by the company’s inventory at the start of an accounting period. 

Ending inventory is the amount of goods produced that aren’t sold yet. 

Accounting for COGS 

Four methods are there for inventory and COGS accounting: 

  1. First in first out (FIFO): The goods that are manufactured first are sold first. 
  1. Last in first out (LIFO): The goods that are manufactured last are sold first. 
  1. Weighted average: All the costs of the goods that are in stock are averaged to evaluate the goods sold. 
  1. Specific identification: Costs are directly accredited and are specifically attributed to the specific unit sold. 

Limitations of COGS 

The major issue with COGS is that it can be manipulated by the accounting individual to alter and show improved stats. 

The common ways include:

  • Stating inflated discounts
  • Overvalued returns 
  • Variations in inventory in stock at the end of accounting period
  • Overstated in hand inventory

FAQs 

Q: What is the formula for calculating the cost of goods sold? 

A: The formula for calculating the cost of goods sold is 
COGS=B.I+P?E.I
where
B.I = beginning inventory
P= Purchases during the period
?E.I = ending inventory

Q: What is the difference between COGS and expenses?

A: Cost of goods sold is accounted over a period only for the production costs of goods (or services) that have been sold.
Whereas expenses are all other costs required for the business. 

Q: Does the COGS increase on debiting? 

A: Yes on debiting any expense account increases, thus COGS increases on debiting.

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