Understanding Cost of Goods Sold
When you sell an inventory item, the asset is reduced and the Cost of Goods Sold account is increased, moving the item from an asset to an expense. It’s no longer an asset once it’s sold, and the cost of the item sold reduces your profit and is expensed into the Cost of Goods Sold account.
Some accountants will abbreviate the Cost of Goods Sold account to COGS, and you might hear them call it that.
In the case of wholesale and retail businesses, the cost of goods sold is the amount that was paid for the inventory items to be sold.
Service businesses will typically not have a balance in the Cost of Goods Sold account. If they do have direct costs, the costs are often coded to a Supplies account under expenses.
At any point in time, the cost of items you purchase are in two different accounts:
It’s important that the Cost of Goods Sold balance is accurate, because there are many good things you can learn from it when you compare it with inventory. You can learn how fast your inventory is selling, and you can determine your gross profit margin.
If your inventory purchases have not been coded correctly, you can take inventory and arrive at the correct cost of unsold items. If your physical inventory does not match your books, your accountant can make a correcting entry between Cost of Goods Sold and the Inventory account so that both are accurate.
If you have further questions about the Cost of Goods Sold account, feel free to reach out any time. And if you are still manually handling inventory tracking, please schedule an appointment to discuss options to more efficiently account for your inventory and COGS.
This is general information and should not be acted upon without first determining its application to your specific situation. Please contact us, your CPA or tax adviser for additional details.
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