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Understanding Cost of Goods Sold

7/22/2019

 
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The account on your income statement called Cost of Goods Sold can be confusing to non-accountants. In this article, we’ll attempt to de-mystify it and explain how it works.
 
Cost of Goods Sold is an account in your Chart of Accounts that is a very special type of expense. It is the amount of direct costs of items that were sold by the company. It is related to inventory, and it helps to see the flow of transactions to understand the big picture. 

​When you purchase an inventory item for sale, it’s considered an asset (not an expense yet) in your company. 
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.
  • In the case of a manufacturer, the costs can include the cost of raw materials, labor to produce the item, and sometimes additional allocations of other related costs.
  • Construction businesses may have a Cost of Construction account or Contract Costs instead of COGS.

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:

  1. The unsold items are reflected in the asset account, Inventory, on your Balance Sheet report.
  2. The sold items are reflected in the Cost of Goods Sold account, on your Income Statement report.
  
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.
Why pay more for software and services than necessary? Check out our Resources page for information on discounts available to our clients.

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    Successfully meeting the challenges inherent to new and smaller businesses provides me with a special type of satisfaction. 

    Supporting businesses that have the potential to become amazing – from both the perspective of owners and team members as well as their clients – is what I enjoy. 

    I hope to use this blog to provide information specific to businesses that are growing from small beginnings into exceptional companies.

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  • Home
  • Why Us?
    • Reviews
    • Open Positions
  • Client Services
  • Resources
    • Save on QBO Subscriptions!
    • Tax Refund Status
    • Gusto Year End Checklist
    • Videos >
      • Business Taxes >
        • 2019 Business Tax Highlights
        • 7 Ways Small Business Can Save On Tax
        • Taxes for S-Corp Owners
        • The IRS Loves Businesses
      • Personal Taxes >
        • 2019 Tax Highlights
        • Five Yearly Tax Essentials
        • 4 Common Tax Surprises
        • Retirement Can Be Taxing
        • Advance Child Tax Credit Reconciliation - 2022
        • Make the Most of Your Donations
        • Five Great Tax Secrets
        • Renting Your Property Tax Free
        • Ideas to Audit-Proof Your Tax Return
      • The Tax Cuts & Jobs Act >
        • The Tax Cuts & Jobs Act: What You Need to Do Now
        • The Tax Cuts & Jobs Act: Are Itemized Deductions A Thing of the Past?
        • The Tax Cuts & Jobs Act: The New Child Care Tax Credit
      • Tax Topics >
        • Tax Season is Coming!
        • The New World of Deductions: What Everyone Needs to Know
        • Proving Your Deductions
        • How to Fix a Mistake on Your Tax Return
        • How Long Should I Save It?
        • Tax Credit vs Tax Deduction
        • Understanding Effective Tax Rate
        • Understanding Marginal Tax Rate
      • Life Events >
        • Life Events: A New Birth
        • Life Events: Marriage
        • Life Events: Divorce
    • Articles >
      • Accounting & Bookkeeping >
        • How to Get the Most Out of Your Accounting Fees
        • The 10 Biggest Money Leaks in Your Accounting System
      • Business Factors >
        • IRS Rules for Classifying Workers
        • Checklist for a Healthy Cash Flow
        • 12 Ways to Improve Your Business Profits
        • 10 Step Annual Business Check-Up
      • Tax Topics >
        • Tax Guide for Self-Employeds
        • 15 Things Every Tax Payer Should Know
        • Disaster Casualty Losses
        • Travel & Entertainment Deductions
        • Tax Guide - A Deduction Checklist
        • What You Should Know About Tax Audits
    • Newsletters >
      • Newsletters - Monthly Editions >
        • Newsletter - Monthly Edition
      • Newsletters - Quarterly Editions >
        • Newsletter - 2019 Fall/Winter
        • Newsletter - 2019 Spring/Summer
    • How To's >
      • How To - Dext
      • How To - BILL
  • Blog
  • Appointments
    • Client Consultations