What Is Cost of Goods Sold (COGS)?

Cost of goods sold (COGS) is a term used in accounting to refer to the direct costs associated with producing the goods or services that a company sells. This can include the cost of materials, labor, and other expenses directly related to the production of the goods or services.

Here is an example of how COGS might be calculated:

Example

ABC Corporation is a company that produces and sells widgets. They start the year with $10,000 of inventory on hand. Throughout the year, they purchase raw materials for $40,000 to produce their widgets. They also pay $20,000 in labor costs to produce the widgets. By the end of the year, they have $12,000 of inventory remaining.

To calculate COGS for ABC Corporation, we would use the following formula:

COGS = Beginning Inventory + Purchases of Raw Materials - Ending Inventory

In this case, the calculation would be:

COGS = $10,000 + $40,000 - $12,000 = $38,000

This means that the cost of producing the widgets sold by ABC Corporation during the year was $38,000.

Importance of COGS

COGS is an important figure for a company because it is used to calculate the gross profit. The gross profit is calculated by subtracting COGS from the total revenue earned by a company. This provides a picture of how much profit the company is making from the sale of its goods or services before other expenses, such as overhead, are taken into account.

In the example above, if ABC Corporation earned $50,000 in revenue from the sale of their widgets, their gross profit would be calculated as follows:

Gross Profit = Revenue - COGS

In this case, the calculation would be:

Gross Profit = $50,000 - $38,000 = $12,000

This means that ABC Corporation had a gross profit of $12,000 from the sale of their widgets during the year.