Cost of Goods Sold

Cost of Goods Sold Explainer

Cost of goods sold, or COGS, is the cost assigned to the products or services a business delivered during an accounting period. For a retailer, it generally includes the acquisition cost of merchandise sold. A manufacturer also includes qualifying production costs such as direct materials, direct labor, and manufacturing overhead.

Inventory costs begin as assets and become expense when the related goods are sold. A basic inventory relationship starts with beginning inventory, adds purchases or production, and subtracts ending inventory to derive COGS. The exact measurement depends on the accounting framework, cost-flow method, and the nature of the operation.

Subtracting COGS from revenue produces gross profit. Managers analyze gross margin, purchase prices, yield, labor efficiency, freight, mix, and inventory adjustments to understand changes. Service companies may use cost of revenue for direct delivery costs, but policies differ, so comparisons require reading the definitions.

COGS can be distorted by inventory count errors, obsolete stock, capitalization mistakes, or inconsistent classification between direct and operating costs. Reconcile physical and recorded inventory, document standard-cost variances, apply the policy consistently, and avoid shifting costs merely to make gross margin look stronger.