What Is Cost of Goods Sold (COGS)?

Cost of goods sold (COGS) refers to the direct costs of producing the
goods sold by a company. This amount includes the cost of the materials
and labor directly used to create the good. It excludes indirect expenses,
such as distribution costs and sales force costs.

Cost of goods sold is also referred to as "cost of sales."

KEY TAKEAWAYS

 Cost of goods sold (COGS) includes all of the costs and expenses
directly related to the production of goods.
 COGS excludes indirect costs such as overhead and sales and
marketing.
 COGS is deducted from revenues (sales) in order to calculate gross
profit and gross margin. Higher COGS results in lower margins.
 The value of COGS will change depending on the accounting
standards used in the calculation.
 COGS differs from operating expenses (OPEX) in that OPEX
includes expenditures that are not directly tied to the production of
goods or services.

Why Is Cost of Goods Sold (COGS) Important?

COGS is an important metric on financial statements as it is subtracted
from a company’s revenues to determine its gross profit. Gross profit is a
profitability measure that evaluates how efficient a company is in
managing its labor and supplies in the production process.

or example, COGS for an automaker would include the material costs for
the parts that go into making the car plus the labor costs used to put the
car together. The cost of sending the cars to dealerships and the cost of
the labor used to sell the car would be excluded.

Furthermore, costs incurred on the cars that were not sold during the year
will not be included when calculating COGS, whether the costs are direct
or indirect. In other words, COGS includes the direct cost of producing
goods or services that were purchased by customers during the year. As a
rule of thumb, if you want to know if an expense falls under COGS, ask:
"Would this expense have been an expense even if no sales were
generated?"

COGS only applies to those costs directly related to producing goods

intended for sale.1
What Is the Cost of Goods Sold (COGS) Formula?
COGS=Beginning Inventory+P−Ending InventorywhereP=Purchas
es during the periodCOGS=Beginning Inventory+P−Ending
InventorywhereP=Purchases during the period
Inventory that is sold appears in the income statement under the COGS
account. The beginning inventory for the year is the inventory left over
from the previous year—that is, the merchandise that was not sold in the
previous year.

Any additional productions or purchases made by a manufacturing or retail

company are added to the beginning inventory. At the end of the year, the
products that were not sold are subtracted from the sum of beginning
inventory and additional purchases. The final number derived from the
calculation is the cost of goods sold for the year.

The balance sheet has an account called the current assets account.
Under this account is an item called inventory. The balance sheet only
captures a company’s financial health at the end of an accounting period.
This means that the inventory value recorded under current assets is the
ending inventory.