Journal Entry for Cost of Goods Sold
The Cost of Goods Sold (COGS) refers to the total cost of producing goods that are sold to customers during the accounting period. This amount includes the cost of raw materials, labor expenses, and any other direct costs associated with manufacturing/buying a product. COGS is an important part of financial analysis as it helps companies calculate their gross profit and decide on pricing strategies to maximize profit.
When determining the total cost of producing or buying goods to be sold, businesses first need to identify what costs should be included in the COGS calculation. Generally, these are the direct cost related to bringing a product to markets such as material purchases, labor wages, and other direct production costs like the packaging. COGS excludes indirect expenses linked to production such as advertising and tax expenses.
The COGS amount is reported on financial statements under its own section. Businesses must determine which type of cost best fits their operations before calculating COGS in order to prepare accurate income statements.
Although estimates are necessary when calculating some parts of COGS (especially when dealing with manufactured products), accuracy is key since those figures are directly related to the company’s bottom line at year-end. So making sure all qualifying costs are classified in the correct category. It is very critical for getting an accurate measure of profitability. Additionally, business owners should update their recordings regularly as prices for raw materials fluctuate throughout the year. They can ensure the costing is prepared accurately.
Calculate Cost of Goods Sold
Cost of goods sold refers to the total cost to a business for the goods it has sold over a specific period. To calculate the cost of goods sold, use the following steps:
Cost of Goods Sold = Beginning inventory + Purchases – Closing Inventory
- Calculate the ending inventory amount from the prior period. This number represents how many goods were on-hand at the end of the current period.
- Calculate all purchases made during the reporting period, minus returns and discounts.
- Calculate the beginning inventory (inventories at the start of that time period). We can use the ending inventory report from prior period.
Method to Calculate COGS
Accounting Methods used Cost of Goods Sold (COGS) methods include: First In First Out (FIFO), Last In First Out (LIFO), Average, and Specific Identification.
The FIFO method assumes that the oldest inventory is sold off first; this most accurately reflects real life as the company tends to sell the older products before the expiration date. The FIFO method, short for First In First Out, is a calculation method that values inventory based on the chronological order in which it was purchased or produced. This means the items that were bought first are sold first, and their cost is recognized as COGS when their sale occurs. It’s commonly used in accounting to calculate costs of goods sold (COGS) when valuing inventory.
LIFO assumes the opposite, the newest items are sold first, which does not always reflect actual scenarios in business. LIFO (last in, first out) is an accounting method that utilizes the last recorded costs in inventory valuation layers to record costs. This means that older inventory will be valued at current market prices, while newer inventory will be reported at the original cost when purchased. This method can result in recording a lower profit than with other methods such as FIFO if the inventory cost is increasing. LIFO is often used by companies who want to reduce their taxable income and keep reporting higher costs of goods sold on financial statements.
The Average cost system is exactly what it implies: the average cost per item is taken into account when calculating COGS. The cost of goods sold will base on the average cost of all inventory available in the warehouse.
Finally, Specific Identification assigns costs to specific inventory items thus providing the most detailed information regarding the specific cost of each item. It is used for expensive items with specific costs in production or purchase.
Each COGS method has its own benefits and drawbacks, and which method is chosen depends upon a company’s specific needs as each one affects both gross income and net income. It will increase or decrease company profit due to differences in inventory cost assigned to COGS. It’s important for all companies to understand these different methods of cost calculation as this impacts their bottom line at tax time as well as day-to-day operations when trying to manage profits over any given period of time.
Journal Entry for Cost of Goods Sold
The cost of goods sold is recorded when the inventory deliver to the customers. It is also the time which the company records revenue. Based on the matching principle, the company should record revenue and cost in the same period.
COGS is also the same as the other costs, it needs to record in the same period as the revenue.
The journal entry is debiting COGS and credit inventory.
| Account | Debit | Credit |
|---|---|---|
| COGS | $$$ | |
| Inventory | $$$ |
The entry record COGS on the income statement. The inventory is decreased from the company balance sheet as the items are already been delivered to the customers.
Example
Company ABC is a trading company which sells many types of products. At the beginning of the period, the company has inventory amount $ 20,000 and it purchases new inventory amount $ 30,000. By the end of the month, the company has perform a physical inventory count, and the amount remains only $ 15,000. Please calculate COGS and make journal entry.
COGS = Begining inventory + Purhase – Ending Inventory
COGS = 20,000 + 30,000 – 15,000 = $ 35,000
The company has sold invneotry cost $ 35,000 to the customers.
The journal entry is debiting COGS $ 35,000 and credit $ Inventory 35,000.
| Account | Debit | Credit |
|---|---|---|
| COGS | 35,000 | |
| Inventory | 35,000 |
Limitation of Cost of Goods Sold
Cost of goods sold (COGS) is one of the most important financial terms used in accounting. It presents the exact amount spent on inventory that a company sells during any given period. While COGS is one of the components used for calculating profits and losses, there are several limitations to this concept.
Firstly, COGS do not include costs such as those associated with running a business, such as annual rent or insurance payments. These indirect costs are not taken into account when calculating COGS, so they must be added separately if we wants an accurate representation of financial performance.
The complexity involved in determining appropriate amounts to be included within COGS can also present a limitation because certain variable expenses, such as marketing or research and development costs, sometimes arise during the production process. These costs cannot easily be categorized under the traditional definition of the cost of goods sold. Consequently, companies should periodically review their procedures and determine whether costs have been allocated correctly under relevant categories to ensure proper financial reporting.
Finally, pricing pressure from competitors will impact negatively companies’ abilities to make a successful markup on goods sold. It will impact bottom-line profitability which impacts net income after all expenses have been deducted from gross sales including Cost of Goods Sold (COGS). This means losses can occur while still managing to reduce total costs through improved cost-saving measures over time.
Conclusion
The cost of goods sold is a significant figure in the accounting process and can have a major impact on how a company runs its operation. It is important for a company to accurately determine the costs of its inventory, as this can help them make informed financial decisions. By accurately determining the cost of goods sold, companies can better understand their cost and set a proper price to compete in the market.