Cost of Goods Sold

Formulas to remember first;
Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold
Beginning Inventory + Purchases = Goods Available for Sale
Goods Available for Sale - Ending Inventory = Cost of Goods Sold

There are four terms to remember beginning inventory, Purchases, ending inventory, and the cost of goods sold. This formula is important for any business that deals with inventory and sales of products. Whether we are talking about retail business or manufacturing, it is important to know the meaning of it.

Just to know Cost of Goods sold is an income statement item. It is the largest expense on your income statement. Ending inventory is a Balance Sheet item. It is a current asset, and it is the most important current asset.

Here are the elements of the formula;

- Beginning
- Purchases
- Ending
- Cost of Goods Sold

Adding the beginning inventory plus purchases creates what is called goods available for sale. When you start the business or begin new period, you will have beginning inventory on the first day of the business. If you have been in business, your beginning inventory is the prior period ending inventory. After starting the business, you will start using or selling your goods, then you will have to purchase more products. Understanding that part is important whether we are talking about numbers of units or the cost which is the dollar amount for these units. Then, when you subtract ending inventory from the goods available for sale, you get the CGS.

Inventory is the most important element because it is what determines the cost of goods sold. If inventory is not handled correctly, your ending inventory can either be overstated or understated. If your ending inventory is overstated, your CGS will be understated. If inventory is understated, your CGS sold will be overstated. Just remember, that your ending inventory is the following period beginning inventory. If your ending inventory is accurate all the time, your CGS should be at the same rate all the time.

Sometimes, looking at variances or fluctuation of CGS requires going back one or two periods. Because if the ending inventory is overstated, the beginning inventory the following period will be overstated, and that will cause to have too high cost of goods available for sale which will cause having overstated Cost of Goods Sold. Overstating or understating can be caused by miss counting, calculating the value with the wrong dollar amount, or using the wrong calculation method.

- Miss Counting
- Wrong Calculation Method

One of the most popular mistakes that causes fluctuation and variance is using the cases cost instead of using the one unit cost. Therefore, one of the important factors to have good inventory value is to be consistent with the way you calculate the products value. If you use the case dollar amount, you need to remember to use it all the time. If you want to evaluate your inventory by the single item (unit) cost, you need to remember to convert everything to one unit. Therefore, it is important to note at the end of the period whether the ending inventory was overstated or understated because it will affect on the following period's cost, and as a result of that it will affect on the bottom line.

Nader Andrews, MBA
Bachelor and MBA in Accounting
Accountant

My name is Nader Andrews. I have Bachelor of Science in Accounting. I also have Master of Business Administration in Accounting. My years of experience working in manufacturing company gave me excellent understanding of inventory and cost of goods sold. In order to have accurate cost of goods sold, you need to have accurate inventory. Please, if you have any question email me nandrewsn@yahoo.com.