Companies prepare financial statements regularly that report various aspects of their operations. These statements are crucial in providing valuable information to their users and stakeholders. Based on that information, they can analyze the company and make various decisions. However, companies must use a specific format when preparing these reports. This format also includes guidance on the items that go into the reports. Primarily, companies prepare four financial statements with notes, although these may differ.
The balance sheet usually appears as the first report in a company’s financial statements. This report consists of a list of the account balances. Usually, it includes all positive and negative, non-zero balances from when a company starts operating. Similarly, the balance sheet may include various accounts balances under the same head. Like other financial statements, the balance sheet does not cover a specific period.
The balance sheet also gets information from the income statement at each year-end. Companies prepare the latter report first. Based on the information from that report, companies can prepare the balance sheet. Accounting standards provide detailed format and guidance on which items can go on each statement. However, some people may confused about those items. One such issue is whether the cost of goods sold is on the balance sheet.
What Does the Cost of Goods Sold (COGS) Mean?
Cost of goods sold (COGS) refers to the direct costs of manufacturing a product that companies sell as a primary activity. In other words, it is the expense directly attributable to the products a company produces and sells. This cost is crucial for calculating gross profits and other types of income.
Usually, the COGS covers two items. In some cases, these may include other items besides direct material and labor.
Cost of goods sold may also appear as cost of sales in the financial statements. This cost is a crucial part of calculating gross profits. Usually, companies include it as the first reduction from revenues. Based on this calculation, companies can reach the gross income for a given period. The COGS is also a critical metric for ratio analysis. Similarly, companies can use it for various decisions for internal improvement.
The cost of goods sold includes the cost of a product to various companies. However, these companies must sell a physical product. On its own, this figure is representative of the expenses incurred on making a product. Accounting standards require companies to report the COGS expense, which reduces the profits a company makes. Usually, the more revenues a company generates, the higher its COGS.
Essentially, the cost of goods sold consists of the cost of continuing operations. Companies record it as an expense, although it may accumulate various accounts. As mentioned, it includes the expense incurred on direct material and direct labor. Similarly, it contains factory overheads that contribute to the production process directly. Companies can also use the COGS in the formula to calculate this amount.
Overall, the cost of goods sold is a critical metric in accounting. It is highly crucial for the users of financial statements. This amount represents the expense incurred by a company directly related to the sale of products. Usually, the COGS primarily contains variable costs. These costs depend on activity levels. However, these constitute controllable costs that companies can reduce based on various techniques.
How Do We Calculate the Cost of Goods Sold (COGS)?
The cost of goods sold formula requires two figures. The first includes inventory, representing the value of the physical goods. Similarly, it considers purchases, the expenses incurred during a period to acquire production items. Together, these components make up the formula for the cost of goods sold. However, this formula only represents a part of the COGS.
The cost of goods sold formula that most companies use is as follows.
Cost of goods sold = Opening inventory + Purchases – Closing inventory
The cost of goods sold only includes expenses related to items a company sells during an accounting period. It is crucial to use the above formula to exclude any unsold items. Essentially, this formula takes opening stock. From that amount, it deducts the closing inventory. This difference represents the increase or decrease in the amount.
With that amount, the formula adds the purchases for the underlying period. This way, it only considers the costs associated with the goods sold for that period. Apart from these, the cost of goods sold includes other items, such as salaries, rent, etc. These constitute the direct labor and factory overheads that go into producing items.
Is Cost of Goods Sold on Balance Sheet?
In accounting, companies can capitalize costs as a part of their assets, subject to some conditions. This process requires them to follow the standards and recognize capital expenditures. Some people may think of the cost of goods sold as an asset due to its association with the word “cost”. Similarly, some people may think of the COGS as a liability since expenses are liabilities are usually together.
On top of that, the cost of goods sold formula also creates confusion. As mentioned above, this formula includes opening and closing inventories. Similarly, it requires purchases for a period, which usually become a part of a company’s inventory. This feature further complicates the understanding of the COGS concept. Therefore, some people may think the cost of goods sold is on the balance sheet. In contrast, this amount does not appear anywhere on the balance sheet.
Instead, the cost of goods sold is a part of the income statement and notes to the financial statements. As mentioned above, this amount is an expense and is crucial for calculating gross profits. Companies subtract it from their revenues to reach those profits. Therefore, the COGS is an income statement item rather than balance sheet. Companies report it as a reduction to their income in the income statement.
The cost of goods sold is not on the balance sheet due to its type. However, it requires some items from it as a part of its formula. As mentioned above, it includes opening and closing inventory. These figures relate to the value of the physical stock a company holds at different times. Apart from this, the COGS does not appear on the balance sheet. However, it may reduce profits, affecting retained earnings in the balance sheet.
Example
A company in Australia, ABC Co., had an opening and closing inventory of $100,000 and $50,000, respectively. During the year, it purchased $200,000 in goods for production. However, ABC Co. didn’t sell all those items when the year ended. Therefore, the cost of goods sold for ABC Co. will be below.
Cost of goods sold = Opening inventory + Purchases – Closing inventory
Cost of goods sold = $100,000 + $200,000 – $50,000
Cost of goods sold = $250,000
Besides that, ABC Co. can also include other items in the cost of goods sold. As mentioned above, these usually include labor and factory overheads. However, it can also contain other expenses directly contributing to the production process.
Conclusion
Cost of goods sold refers to the total expenses incurred on the goods sold during a period. This figure constitutes the formula companies use to calculate gross profits. Usually, the COGS includes direct materials and direct labor. Companies can use the formula for the cost of goods sold to calculate the amount. Overall, the COGS is on the income statement, not the balance sheet.