Cost of Goods Sold
Identify the Component
State whether each item is Included or Excluded from COGS
Beginning inventory
➛ Included
Ending inventory
➛ Excluded | It is subtracted in the formula
Freight-in
➛ Included
Sales returns
➛ Excluded | Affects net sales, not COGS
Purchase discounts
➛ Excluded | Reduces purchases before calculating COGS)
Fill in the Blanks
1. COGS represents the cost of goods sold..
2. COGS is reported on the Income Statement.
3. Higher COGS results in lower profit.
4. Freight-in is included in COGS.
COGS Calculation
A business reports
Beginning Inventory
Purchases
Freight-In
Purchase Returns
Ending Inventory
Purchases
Freight-In
Purchase Returns
Ending Inventory
= $10,000
= $40,000
= $2,000
= $3,000
= $9,000
= $40,000
= $2,000
= $3,000
= $9,000
Calculate Cost of Goods Sold.
Step 1
Calculate Net Purchases
Net Purchases = 40,000 + 2,000 − 3,000 = 39,000
Step 2
Apply COGS Formula
COGS = Beginning Inventory + Net Purchases − Ending Inventory
= 10,000 + 39,000 − 9,000 = 40,000 Final Answer
Final Answer
Cost of Goods Sold = $40,00
Error Analysis
Ending inventory was overstated by $4,000.
Questions
➛ Effect on COGS?
➛ Effect on profit?
Error Analysis
Ending inventory was overstated by $4,000.
Effect on COGS
➛ COGS is understated by $4,000
Effect on Profit
➛ Profit is overstated by $4,000
Ending Inventory and COGS move in opposite directions.
Mini Case Study | Model Answers
A retailer notices that profits dropped even though sales increased.
Questions
How could COGS explain this situation?
➛ If COGS increased significantly, it could reduce gross profit even if sales increased.
Name two reasons COGS might increase.
➛ Higher purchase prices
➛ Increased freight costs
➛ Inventory shrinkage
➛ Poor purchasing decisions
How can better inventory control help manage COGS?
➛ Reduce shrinkage
➛ Prevent overstocking
➛ Ensure accurate pricing
➛ Improve purchasing efficiency
Quick Quiz
What is Cost of Goods Sold?
➛ The cost of inventory that has been sold during the period.
Where does COGS appear in the financial statements?
➛ Income Statement.
Name two components of COGS.
➛ Beginning inventory, Purchases, Freight-in, Ending inventory.
How does overstated ending inventory affect COGS?
➛ It understates COGS.
Why is COGS important to management?
➛ It affects profit measurement, pricing decisions, and business performance evaluation
Stock Count & Inventory Controls ➧ Here