How cost of goods sold or COGS is calculated

Cost of goods sold is shown in the income statement of a company which is into manufacturing, wholesaling, retailing or into similar kind of business. Cost of goods sold or COGS is calculated by taking all direct expenses that a company has incurred to manufacture its product. After calculating COGS, you need to offset it against revenue to find out gross profit.

In this article we will discuss the steps to calculate cost of goods sold and how its shown in company’s Income Statement.

What is included in cost of goods sold

Cost of goods sold includes all direct expenses that a business incur in producing a product. Its calculation depends on the type of business. However, whatever be the business, COGS includes following type of expenses;

  • Purchase price of raw materials
  • Supplies to produce a finished product
  • Payments for items purchased to resale a product
  • Labour payments to produce a product
  • Shipping expenses
  • Freight in
  • All other direct overhead expenses such as rent of the factory building, power and fuel consumed by manufacturing units

In simpler terms, COGS includes everything from the purchase price of the raw material to the expenses of transforming it into a product.

How to calculate COGS

To calculate COGS, you first need to gather following data;

  • Beginning inventory values – This is the total value of the inventory at the beginning of the year, when you started the year. You can take this figure from last year company’s financial statements shown as closing stock or inventory in balance sheet.
  • Closing inventory – Stock left out with the company at the end of the year.
  • Value of the items sold during the period

To find out the value, you first required to look for the method the company adopts for inventory valuation.

After getting above values, you need to use following formula to calculate cost of goods sold.

Beginning Inventory + Cost of materials for the items sold during the year – Closing inventory = COGS

As COGS is the cost of doing business, its allowed as a business expenditure while calculating income tax liability.

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.