Cost of Goods Sold & Gross Profit

Cost of Goods Sold is the true cost of everything a business actually sold in a period — calculated on a schedule from opening inventory, net purchases, and closing inventory.

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Key things to remember

1COGS = Opening Inventory + Net Purchases − Closing Inventory.
2Cost of Goods Available for Sale = Opening Inventory + Net Purchases.
3Gross Profit = Net Sales − Cost of Goods Sold.
4A schedule presents the COGS calculation's detail; only the final total flows to the income statement.
5A higher closing inventory (all else equal) means a LOWER Cost of Goods Sold for the period.

The Cost of Goods Sold (COGS) is a record of all costs associated with merchandise that has been sold. It is the single most important number in merchandising accounting: it is subtracted from Net Sales to get Gross Profit, the amount left over to cover operating expenses and (hopefully) leave a profit.

Opening Inventory + Net Purchases - Closing Inventory = Cost of Goods Sold

The core COGS formula

Think of it as a bathtub. Opening Inventory is the water already in the tub. Net Purchases is water poured in during the period. Closing Inventory is the water still in the tub at the end. Whatever is missing must have gone down the drain — and that "drain" is exactly what was sold. That is Cost of Goods Sold.

Fig 1Opening inventory + net purchases − closing inventory = Cost of Goods Sold

The Cost of Goods Sold schedule

A Schedule is a supporting statement that provides details of an item on a main statement. Because the COGS calculation has several moving parts, it is almost always presented as its own schedule, feeding a single total number into the income statement.

Line	Amount
Opening Merchandise Inventory	$42,000
Purchases	$185,000
Less: Purchases Returns and Allowances	($6,500)
Less: Purchases Discounts	($3,200)
Add: Transportation-in	$4,700
Net Purchases	$180,000
Cost of Goods Available for Sale	$222,000
Less: Closing Merchandise Inventory	($38,000)
Cost of Goods Sold	$184,000

Cost of Goods Sold schedule — Trailside Outfitters, year ended December 31

Gross Profit

Gross Profit = Net Sales − Cost of Goods Sold. It measures how much a business made purely on the mark-up of its merchandise, before any rent, wages, or utilities are paid. A retailer watches its gross profit percentage (Gross Profit ÷ Net Sales) closely — it is one of the fastest ways to sense whether pricing or purchasing has gone wrong.

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1

Trailside Outfitters reports: Opening Merchandise Inventory $42,000; Purchases $185,000; Purchases Returns and Allowances $6,500; Purchases Discounts $3,200; Transportation-in $4,700; Closing Merchandise Inventory $38,000; Net Sales $260,000. Prepare the Cost of Goods Sold schedule and calculate Gross Profit.

Example 2

A smaller shop reports: Opening Inventory $15,000; Purchases $60,000; Purchases Returns and Allowances $2,000; Transportation-in $1,000 (no purchase discounts were taken); Closing Inventory $12,000. Calculate Cost of Goods Sold.

Where marks get lost

Adding Closing Inventory instead of subtracting it — closing inventory is what's LEFT, so it must come OUT of the calculation.
Forgetting to net Purchases before adding it to Opening Inventory (skipping returns, discounts, or transportation-in).
Confusing Gross Profit with Net Income — Gross Profit has not yet had operating expenses subtracted.
Using gross Sales instead of Net Sales when calculating Gross Profit.
Mixing up which inventory figure is "opening" and which is "closing" when two years of data are given side by side.

Flashcards 5

The Cost of Goods Sold

Schedule

COGS formula

Cost of Goods Available for Sale

+ 1 more

Practice

Opening Inventory $30,000; Net Purchases $120,000; Closing Inventory $25,000. Find Cost of Goods Sold.

Net Sales $310,000; Cost of Goods Sold $198,000. Find Gross Profit.

If Closing Inventory is overstated (too high) by mistake, Cost of Goods Sold for the period will be:

What do we call Opening Inventory plus Net Purchases, before subtracting Closing Inventory?

Purchases $75,000; Purchases Returns and Allowances $1,000; Purchases Discounts $1,500; Transportation-in $2,500. Find Net Purchases.

Cost of Goods Sold is subtracted from which figure to get Gross Profit?

Name the schedule accountants prepare to show the detailed calculation of Cost of Goods Sold.

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