What is cost of goods sold?

Definition

Cost of goods sold is the product cost that leaves the shelf when a customer buys the goods. On the books, this is an expense on the Income Statement, taken from inventory.

A candy shop that sells a box that cost $4 records that $4 here. The $8 sale is revenue; this line is only the candy's cost.

Cash-basis shops may feel the cost when they pay the supplier. Accrual books wait until the goods sell, and they hold the unsold boxes as a current asset.

This line is the cost of units that left. It is not the stock still sitting in the case.

Where it shows up

Balance Sheet: Related to inventory leaving as goods are sold.

P&L: Located below revenue, before gross profit.

Cash flow: Decreases in inventory, reported cash from operating activities increases.

See also: Gross Profit · Inventory · Gross Margin

When you look at your Income Statement, this expense sits just below revenue. The leftover after this line is gross profit.

When the figure is high relative to sales, the shop kept less after the product cost. When it is low, the goods were cheaper to replace, or the mix shifted toward higher-priced boxes.

The Balance Sheet does not keep this expense after the close. The related stock still on hand sits in inventory until the next sale.

On the Statement of Cash Flows, buying more stock is the cash event most owners notice. Paying for candy is an operating outflow; this P&L line only moves when those boxes sell.

A physical inventory count is how many shops confirm the leftover stock. The sold cost on this line should match what left the count.

How it works

The shop buys candy and records it as inventory at cost. Nothing hits this expense yet.

When a box sells, the bookkeeper moves that box's cost out of inventory and onto this line. The sale entry for revenue and cash or receivables is separate.

Inventory valuation decides which dollars leave. FIFO, LIFO, and weighted-average cost change which purchase layers are assigned to the sold units.

Stay with the sold units when you read this line. A large candy order that is still in the storeroom is still inventory, not this expense.

Freight and duties that belong on the candy can sit in the unit cost. Those extra dollars leave with the box when it sells.

Damage, theft, and shrinkage can also take cost out of inventory. Some shops run those losses through this line; others use a separate loss account.

A high balance can mean a busy week or a week of expensive ingredients. A low balance can mean slow sales or cheaper boxes.

After the close, expense accounts return to zero. Next month's sold boxes start this line again.

Keep the receiving documents and the count that support the leftover stock. Anyone tying the P&L to the case should be able to see which boxes left.

Do not treat the supplier bill as this expense if the candy is still on the shelf. The bill is accounts payable; this line waits for the sale.

Example

A candy shop sells boxed chocolates that cost $200 and rings $500 of sales on Saturday. The boxes leave the case the same day.

The sold cost is recorded:

Debit: Cost of goods sold $200

Credit: Inventory $200

Inventory (an asset) falls by $200, and this expense hits the P&L. The $500 revenue entry is separate.

The Income Statement now shows $500 of sales and $200 of product cost. The leftover $300 is gross profit for those boxes.

If $800 of unsold taffy is still in the storeroom, that $800 stays on the Balance Sheet. It is not this week's expense.

Common mix-ups

This line is not inventory. Inventory is the asset still on the shelf; this line is the cost of units that already sold.

This line is not the supplier bill. A bill raises inventory and payable; this expense waits until a customer takes the goods.

This line is not operating expenses like rent and ads. Those costs sit lower on the Income Statement, after gross profit.

Related terms

• Gross Profit: Revenue minus the direct cost of delivering it.
• Direct Materials: Materials that can be traced directly to a finished product.
• Direct Labor: Wages for the people who directly make the product or deliver the service.
• Inventory: Goods held for sale or used to produce goods for sale.
• Gross Margin: Gross profit expressed as a percentage of revenue.
• Income Statement: A statement showing revenue earned and expenses incurred over a period, ending in net income.
• Landed Cost: The full cost of getting a purchased item to your door, including freight and duties.
• Manufacturing Overhead: Indirect production costs applied to units made.
• Inventory Valuation: The method used to assign cost to units held and units sold.