Cost of goods sold

For thoughtful child sponsors

In accounting, the cost of goods sold describes the direct expenses incurred in producing a particular good for sale, including the actual cost of materials that comprise the good, and direct labor expense in putting the good in salable condition. Cost of good sold does not include indirect expenses such as office expenses, accounting, shipping department, advertising, and other expenses that are not attributable to a particular item for sale.

Subtracting the cost of goods sold from the money collected by selling the good (sales revenue) produces the gross profit on the good.

The net profit, what most people understand as the business' income or profit, is determined by subtracting the cost of goods sold and the indirect expenses from the sales revenue.

Accounting method

The revenue from merchandise sold must be matched with the cost of goods sold. Cost of sales or cost of goods sold is the identification of the cost of those items sold in the most recent accounting period. It can be done by specific identification, taking inventory, or different methods using estimates such as the "retail" method.

Cost of Goods sold is also the determining factor in arriving at Gross Profit and is determined as follows:

Sales----------------------------------$100,000
Cost of Goods Sold 
 Inventory 01/01/03---$ 5,000

 Purchases-------------45,000

 Direct Labor----------30,000

 ------------------------------80,000

 Less: Inventory 12/31/03------10,000

 Net Cost of Goods Sold-----------------70,000

Gross Profit on Sales-------------------$30,000

To determine the net profit one would then compute the indirect expenses such as office expenses, light & heat etc. Determining the cost of goods sold is the first step in arriving at the net profit.

If the cost of goods sold is too high gross profit will not support the indirect expenses and will result in a loss for the accounting period.