Definition: Cost of goods sold (COGS), also called the cost of sales, is total price of all inventory sold to customers during a period. Keep in mind that this isn’t the retail price that the customers paid for the goods. Instead, this is the purchase price that it cost the retailer to acquire or the manufacturer to produce.
What Does Cost of Goods Sold Mean?
The cost of goods sold equation equals the beginning inventory plus any purchases made during the period less the ending inventory.
Beginning + Purchases – Ending = Cost of Goods Sold
This formula computes the cost that a retailer or manufacturer had to pay for merchandise that was sold to customers during the period. This is an important calculation because it is used to compute the gross profit on the income statement.
Depending on the inventory valuation method (FIFO, LIFO, Weighted Average), the cost of this inventory sold to customers during the period can vary greatly. For example, a company using the FIFO method would report lower costs because it is selling inventory that was purchased first. Presumably, this inventory is older and was cheaper to purchase. Thus, the cost of goods sold would be less than a company that uses a LIFO system. FIFO companies typically report less cost and higher profits on their income statement and higher inventory values on their balance sheet than companies using LIFO.
Example
Let’s assume that Chris’ Tennis Shop has $10,000 of merchandise at the beginning of the year. Throughout the year, Chris purchases $50,000 of tennis gear and apparel. At the end of the accounting period, Chris takes a physical inventory count and finds out that he has $35,000 of inventory remaining.
Chris’ cost of goods sold for the year equals $25,000 ($10,000 + $50,000 – $35,000). In other words, Chris was about to sell inventory to customers that he paid $25,000 for. With this cost number, Chris will be able to compute several different ratios including gross profit and gross margin.
