What Is Cost of Goods Sold (COGS) in Accounting?

 

Nov 24, 2021 | By Brett Hughes

Have you ever laid in bed at night and had trouble falling asleep because you didn’t know the answer to “What is the cost of goods sold?” 

Oh, so that’s never happened to you? 

Even if you’ve never lost sleep from COGS, all business owners should have an understanding of what it is and, more importantly, why it’s important.

The short answer is that COGS are your production costs, and it’s important because it helps determine your company’s profits. 

And I’d argue that COGS is more about inventory than sales. I know you’re thinking, “How does what I don’t sell (inventory) change the value of what I do sell (COGS)?” But stick around, and we’ll get into more detail about both of these so you can rest easier tonight.

WHAT IS INCLUDED AND EXCLUDED IN THE COST OF GOODS SOLD?

As the name suggests, COGS are the:

• Cost
• Of the
• Goods that you
• Sold

This includes the variable direct costs (both the direct labor and the raw materials) and fixed costs like factory overhead. 

An easy way to think about COGS is to ask yourself, “Would I incur these costs if I didn’t make a product?” If the answer is no, then these expenses are included in your COGS calculations.

Our bodies were designed for motion and need to move in order to stay fit and healthy. Walking is one of the best exercises there is for your body. It doesn't stress your joints as much as running does, but still gets your body working hard enough for it to benefit from the exercise. Hiking is walking. So it is good for you, but it's more than just walking. It’s also communing with nature. I don't know about you, but I find the infinite and ever changing variety found in nature to be one of the most beautiful things we have here on our planet. The clouds in the sky, the waves crashing on a seashore, the wind blowing in a meadow or amongst the tree tops, streams swirling and bounding toward the sea, and all of the other plants and animals that inhabit our earth along with us are all truly wondrous and beautiful things. Now combine the one of the best exercises there is, walking, with some of the most spectacular beauty to be found on our planet, nature, and you have hiking, or walking in the wilderness.

Some of the standard inputs for COGS are:

• Raw materials
• Freight costs to receive raw materials
• Items purchased for resale
• Direct labor costs (e.g., factory workers’ wages and payroll taxes)
• Parts used in production (e.g., screws, glue, paint)
• Storage costs 
• Factory overhead (e.g., utilities, maintenance)

But some ordinary business expenses excluded from the COGS calculation are:

• Selling and marketing costs
• Shipping costs to get a product to the customer
• Accounting and legal fees
• Indirect labor costs (e.g., management and administrative salaries, cost of labor, etc.)
• Interest
• Ending stock you still have on hand. This sits on the balance sheet as inventory.