Is the cost of goods sold an expense: exploring COGS

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Is the cost of goods sold an expense: exploring COGS

is cost of goods sold an expense

In this article, we’ll break down what COGS is, why it’s important for your business, and how to calculate it, and how to use it in relation to other important metrics. But when it comes to a business’s finances, COGS is something else altogether — something neither little nor insignificant. FIFO uses inventory that was purchased first before inventory that was purchased later, while LIFO uses inventory that was purchased last before inventory that was purchased earlier. An expense is a cost of doing business, but a cost is not necessarily always an expense. The easiest way to illustrate the difference between these two terms is to look at a simple example. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Net profit, on the other hand, needs to subtract out all expenses; therefore, expenses are listed in an entirely separate section, with all non-COGS expenses listed in that section. On the income statement, the cost of goods sold is not listed as a revenue account but as a type of expense account. Expense is one of the main five accounts in accounting; the others are assets, liabilities, revenue and equity.

What is beginning inventory in relation to COGS?

This line item is the aggregate amount of expenses incurred to create products or services that have been sold. The cost of goods sold is considered to be linked to sales under the matching principle. Thus, once you recognize revenues when a sale occurs, you must recognize the cost of goods sold at the same time, as the primary offsetting expense. It appears in the income statement, immediately after the sales line items and before the selling and administrative line items.

How do you record cost of goods sold?

Create a journal entry

When adding a COGS journal entry, debit your COGS Expense account and credit your Purchases and Inventory accounts. Inventory is the difference between your COGS Expense and Purchases accounts. Your COGS Expense account is increased by debits and decreased by credits.

The cost of goods sold is a type of expense account and therefore has a debit entry. As an expense account, a debit increases a COGS account and a credit decreases it. When making a journal entry, the cost of goods sold account is debited and the inventory and purchases account (which are asset accounts) are credited. This journal entry shows that these assets have been sold and their costs have been moved to the cost of goods sold account. COGS is sometimes referred to as the cost of sales; it refers to the costs a company has for making products from parts or raw materials or buying products and reselling them.

COGS vs. operating expenses

It is not considered to be an asset or liability on the financial statements but rather recorded as an expense. In this article, we will discuss the cost of goods sold and the type of account it is on the income statement. Costs of revenue exist for ongoing contract services that can include raw materials, direct labor, shipping costs, and commissions paid to sales employees. These items cannot be claimed as COGS without a physically produced product to sell, however. The IRS website even lists some examples of “personal service businesses” that do not calculate COGS on their income statements. Cost of sales is very similar to COGS, in that it also looks at the costs required to sell a good or service.

They may also include fixed costs, such as factory overhead, storage costs, and depending on the relevant accounting policies, sometimes depreciation expense. At first glance, COGS vs. operating expenses (OpEx) might appear virtually identical with minor cash book excel differences, but each provides distinct insights into the operations of a company. Contrary to a common misconception, operating expenses do not solely consist of overhead costs, as others can help drive growth, develop a competitive advantage, and more.

Expenses vs. Costs

Both operating expenses and cost of goods sold (COGS) are expenditures that companies incur with running their business; however, the expenses are segregated on the income statement. Unlike COGS, operating expenses (OPEX) are expenditures that are not directly tied to the production of goods or services. Operational expenses (OpEx) are the day-to-day costs of running a business. This way, OpEx comprises administrative expenses like rent, utilities, salaries, marketing, and taxes.

For this reason, companies sometimes choose accounting methods that will produce a lower COGS figure, in an attempt to boost their reported profitability.
Our post on “Cost of Goods Sold vs. Operating Expenses” will focus on the differences between the two types of costs, but we’ll start with the similarities.
Contrary to a common misconception, operating expenses do not solely consist of overhead costs, as others can help drive growth, develop a competitive advantage, and more.
You make electronic gadgets that people love such as a watch that tells you when it’s going to rain so you’ll always know when you need to bring an umbrella.
In order to record the figure for the cost of goods sold account, one must collect the purchased inventory costs, beginning inventory balance, and ending inventory count.

You can rest assured that we will work closely with you to create actionable business plans and accurate financial reporting. We offer our toolkit of financial intelligence that will be your greatest asset for business growth. When inventory is artificially inflated, COGS will be under-reported which, in turn, will lead to a higher-than-actual gross profit margin, and hence, an inflated net income. The cost of goods sold is an important concept for businesses to understand and accurately track. This way, businesses can ensure that their books are balanced, their customers are charged appropriately, and their bottom line is healthy.

Cost of Operating vs Cost of Goods Sold

Because COGS is a cost of doing business, it is recorded as a business expense on income statements. Knowing the cost of goods sold helps analysts, investors, and managers estimate a company’s bottom line. While this movement is beneficial for income tax purposes, the business will have less profit for its shareholders. Businesses thus try to keep their COGS low so that net profits will be higher. The cost of goods sold (COGS) is considered an expense because it is directly related to the amount of money a company spends to acquire or produce the goods it sells.

The end-of-year inventory value is subtracted from the beginning of the year’s inventory value when calculating COGS.
Under the matching principle of accounting, the expense must be recognized in the same period as when the benefit (i.e. revenue) is earned.
It’s also likely to have better cash flow with a lower COGS, which is KING.
Imagine that you are the owner of a business that sells electronics.

COGS and operating expenses (OpEx) each represent costs incurred by the daily operations of a business. Manufacturers also use a lot more inventory Accounts than a service or construction businesses. For example, they may have Accounts for raw material inventory, work in process inventory and finished good inventory. When they sell 100 widgets, they take the cost of production and move it from the balance sheet to the Income Statement as COGS.

Typically, Accounts would be numbered 4xxx for Revenue Accounts, 5xxx for COGS and 6xxx for Expenses, but there is no rule here. Rachel is a Content Marketing Specialist at ShipBob, where she writes blog articles, eGuides, and other resources to help small business owners master their logistics. By correctly determining how much money you spend acquiring or making goods, you empower your business to make better decisions based on that information. To see our product designed specifically for your country, please visit the United States site. This free cost of goods sold calculator will help you do this calculation easily. This article explores the world of SaaS analytics and the importance of SaaS analytics tools for modern businesses.

Is cost of goods sold an expense or asset?

The cost of goods sold is considered to be linked to sales under the matching principle. Thus, once you recognize revenues when a sale occurs, you must recognize the cost of goods sold at the same time, as the primary offsetting expense. This means that the cost of goods sold is an expense.

At the beginning of the year, the beginning inventory is the value of inventory, which is actually the end of the previous year. Cost of goods is the cost of any items bought or made over the course of the year. Volha is an experienced copywriter with 10+ years experience writing for the information technology and services industry and a 5+ years sole proprietorship background.