Cost of Goods Sold Formula

Formula to Calculate Cost of Goods Sold (COGS)

Cost of Goods Sold Formula (COGS) calculates all the direct costs which are associated with the production of the various goods sold by the company and it is calculated by adding the beginning inventory of the company with the total purchases during the year and then subtracting the value of the closing inventory of the company from it.

It calculates the total cost involved in selling, including the manufacturing costs as well as the cost of preparing a product or goods for sale.

• Beginning Inventory: – inventory at the start of the year; This should be exactly the same as your ending inventory from last year.
• Purchases(Additional Inventory): – inventory that you purchased during the year;
• Ending Inventory: – inventory at the end of the year;

COGS Basic Example

Inventory recorded at the beginning of the fiscal year ended in 2017 is $2000. Additional Inventory: Inventory purchased during the fiscal year 2017-18 is $1500. Ending Inventory: Inventory recorded at the end of the fiscal year ended 2018 are $1000

Calculate the Cost of Goods Sold?

• As per the cost of sales Formula, COGS is = 2000 + 1500 -1000 =$2500
• Therefore, $2,500 is the cost of goods sold.

COGS Formula (Extended)

Below is the COGS Formula extended to include

COGS  = Starting Inventory + Purchases – Purchase Returns & Allowances – Purchase Discounts + Freight In – Ending Inventory

Components

• Starting Inventory: Opening stock for the period;
• Purchases: Any purchase made for manufacture / setting up the product (e.g., raw material)
• Purchase Returns & Allowances: (a) Purchase Returns include items that are returned to suppliers (if any) (b) Allowances include any additional benefit received in the purchase chain for the product
• Purchase Discounts: Discounts received in the supply chain; reducing it from costs as this is accountable for the increase in profits
• Freight In: Transportation costs for the product raw materials to be brought to factory (or set up location)
• Ending Inventory: Closing stock for the period.

Examples

Example #1

Consider a basic example of Company ABC manufacturing a packet of pens. The direct cost of manufacturing is $1.00 / packet. Below are statistics 

• Opening Inventory as on 01/01/2017: 3500 packets
• Closing Inventory as on 12/31/2017: 500 packets
• Costs incurred during the year are as under:
• Purchase cost: $100,000
• Discounts received: $5,000
• Freight In: $25,000

Solution:

Cost of opening Inventory: 3500 packets x $1.00 = $3500.00

Cost of closing inventory: 500 packets x $1.00 = $500.00

Hence, the calculation of Cost of Goods Sold is

• COGS = $3,500 + $100,000 – $5,000 + $25,000 – $500
• COGS = $123,000 

Example #2

Now consider an example of 2 products manufactured by a company. Below are statistics for Product X and Product Y:

For Product X-

• Opening Inventory: 5000
• Closing Inventory: 1500
• Cost per unit: $5.00
• Cost of materials: $120,000
• Cost of labor: $500,000
• Freight In: $40,000

For Product Y-

• Opening Inventory: 10,000
• Closing Inventory: 7,500
• Cost per unit: $2.00
• Cost of materials: $80,000
• Cost of labor: $300,000
• Freight In: $25,000
• Discount received: $5,000

Apart from the above direct costs, the manufacturing unit has the below overhead costs:

• Annual rent of manufacturing unit: $50,000
• Annual electricity charges: $75,000
• Salary of the supervisor: $70,000

Calculate COGS.

Solution:

For individual products, total direct cost is as below:

For Product X –

• Cost of opening inventory: 5000 X $5.00 = $25,000
• Cost of closing inventory: 1500 X $5.00 = $75,000
• Direct cost = $120,000 + $500,000 + $40,000 = $660,000

As COGS is calculated using only direct costs, we should ignore the indirect costs related to these products. So the calculation of Cost of Goods Sold using COGS formula is as below.

• COGS = $25,000 + $660,000 – $75,000
• COGS = $610,000

For Product Y –

• Cost of opening inventory: 10,000 X $2.00 = $20,000
• Cost of closing inventory: 7,500 X $2.00 = $15,000
• Direct cost = $80,000 + $300,000 + $25,000 – $5,000 = $400,000

As COGS is calculated using only direct costs, we should ignore the indirect costs related to these products. So the calculation of Cost of Goods Sold using COGS formula is as below

• COGS = $20,000 + $400,000 – $15,000
• COGS = $405,000

Example #3

Consider an example of the service industry – a courier firm. For a courier firm, the basic service is to route packets from their customers to appropriate destinations. This activity includes different types of costs. Consider, company XYZ is a courier firm, which picks up consignments from their customers and then connects it further for the right delivery. Below are statistics for the year 2017.

• Pick up cost: $200,000
• Packing Material: $50,000
• Re-routing cost: $1,500,000
• Labour: $100,000

There may be other costs involved like traveling, administrative, selling and marketing, etc. However, these are not included as they are indirect expenses.

So, the calculation of Cost of Goods Sold will be –

• COGS = $200,000 + $50,000 + $1,500,000 + $100,000
• COGS = $1,850,000

Cost of Goods Sold Calculator

You can use the following Cost of Goods Sold Calculator.

 

Use and Relevance

Calculation of Cost of Goods Sold using COGS formula is critical for the company for the following reasons:

• It directly gives a cost of manufacture of the company’s individual product.
• Considers only direct costs, it cancels all chances of including any extra cost. The allocation of other administrative and selling costs happens later, along with other products. Hence again, chances of ignoring other costs are ruled out as well.
• COGS is a requirement for the company’s profit or loss account – it is the first reduction category in the Profit and Loss statement.
• It forms an integral part in financial ratio analysis to calculate ratios like Stock Turnover and Gross Margin Ratios.

Cost of Goods Sold in Excel (with Excel Template)

In below screenshot is the Cost of Producing Product X.

So, using this data, we have done the calculation of Cost of Goods Sold (COGS) for the Product X

Therefore, COGS will be –

Conclusion

Cost of Goods Sold is slightly different from the Cost of Production. The cost of Production would include the entire cost of producing the line of products by the company. However, the cost of goods sold equation only calculates the cost incurred for the sold goods by the firm.

Recommended Articles:

This has been a guide to the Cost of Goods Sold (COGS) Formula. Here we learn how to calculate COGS using the basic and extended formula along with practical examples. You can learn more about Excel Modeling from the following articles –

• Cost of Goods Manufactured Definition
• What are Overhead Costs?
• LIFO Inventory Accounting
• Types of Inventory