Inventory VS COGS: What’s The Difference?

It’s important to note that COGS only includes the direct costs of goods sold. It does not include indirect costs, such as marketing, administrative, or research and development expenses. Answering off the cuff, it is a good idea to be meticulous when it comes to inventory accounting because it gives you the real picture of your product’s success – gross profit margin and cost of goods sold. That concept (as we are diving into thoroughly here) also means it requires a high degree of accuracy on the bookkeeping end to avoid inaccuracies. Running an inventory based goods company doesn’t have to be an accounting nightmare, there are upsides to diving in deep. With the right team that is knowledgeable at the helm, and with a great foundation to document your supply chain to draw from, it can be quite beneficial.

If there are 125 units on hand at the end of the year, the ending inventory will report the cost of 125 units. The cost of goods sold for the year will be the cost of the 1,475 units that are no longer available. Inventory for a retailer or distributor is the merchandise that was purchased and has not yet been sold to customers.

Example of Inventory Cost and Cost of Goods Sold

The balance sheet has an account called the current assets account. The balance sheet only captures a company’s financial health at the end of an accounting period. This means that the inventory value recorded under current assets is the ending inventory. Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the good.

A manufacturer’s inventory consists of raw materials, packaging materials, work-in-process, and the finished goods that are owned and on hand. Calculating the cost of goods sold, often referred to as COGS in accounting, is essential to determining whether your business is making a profit. It involves a simple formula and can be calculated monthly to keep track of progress or even less frequently for more established businesses. The calculation starts with the inventory of products for sale or raw materials to produce products, at the beginning of the year, which should be the same as the ending inventory from the previous year.

The Cost of Producing a Product or Service

In December, you sell a lot of goods and are flush with cash to buy more goods for the coming year of 2022. The goods you sold in December were all items you purchased in 2021. But now you have a lot of inventory that you won’t sell until 2022. All of the new purchases and whatever is left in stock from prior purchases will be the balance in Inventory Asset as of Year End 2021. Only the cost of what sold in 2021, will be expensed in Cost of Goods sold to offset your income earned. That way, all of the costs you have on hand, will be expensed later, when those goods actually sell in order to offset their relative income.

It excludes indirect expenses, such as distribution costs and sales force costs. A major part of product companies and those who have a lot of raw materials involved in their products are samples, testers, spoilage and breakage. Remember, inventory is an asset and not all of it gets to the point where it is sold.

Inventory vs Cost of Goods Sold

This means your taxable income, and therefore your tax liability in this year will be much higher and likely not anticipated. You got the tax deduction in 2021, so you underpaid on income that year. In 2022, you don’t get the tax deduction again because you already took it the year before, so you overpay on income that year in order to even out how your costs actually occurred. By not tracking Inventory and expensing only the cost of what sold, your taxable income is directly impacted, whereas when you do track it and expense appropriately, your taxable income is more even. A hybrid based system is nice for small businesses that want to even out their taxable income year over year. This way, you don’t have to worry about paying tax on income not yet earned for invoices sent out to wholesalers, for example before they’ve actually paid.

• Even though all of these industries have business expenses and normally spend money to provide their services, they do not list COGS.
• Inventory for a retailer or distributor is the merchandise that was purchased and has not yet been sold to customers.
• I need to calculate cost of goods and inventory to determine my profits.
• The special identification method uses the specific cost of each unit of merchandise (also called inventory or goods) to calculate the ending inventory and COGS for each period.
• Further, this method is typically used in industries that sell unique items like cars, real estate, and rare and precious jewels.

Accountfully is a leader in the inventory entrepreneur space because we dive into the details and help automate systems for our clients. It also gives us a central document from which we can make finite adjustments and better calculate margins. Vedder Bikes makes innovative motorcycles from basic purchased components. On its December 23, 2019 balance sheet, its ending inventory cost is the beginning inventory cost for 2020, which is listed at $6.25 million. A company must shrewdly budget for its operating expenses while maintaining its competitive edge.

Examples of COGS

There will certainly be lag time involved between the product selling and receiving this information. This is an example of where (and why) it makes sense to apply the sale to the shipping date versus the sale date. You can read all about the inner workings of the Inventory Workbook here. As COGS is considered a cost of doing business, it is written into income statements as a business expense.

By using small business accounting software, you can calculate the cost of goods sold in every sale transaction automatically. Check out our roundup of the best https://online-accounting.net/ small business accounting software to learn about the leading platforms. Cost of goods sold (COGS) represent the total costs in making or purchasing a product.

Alternative Inventory Costing Methods

When you add your inventory purchases to your beginning inventory, you see the total available inventory that could be sold in the period. By subtracting what inventory was leftover meaning of depreciation at the end of the period, you calculate the total cost of the goods you sold of that available inventory. Report inventory at the cost to make or buy it, not the cost to sell it.

• You want to ensure that you’re making a profit, but you also don’t want to price yourself out of the market.
• This means your taxable income, and therefore your tax liability in this year will be much higher and likely not anticipated.
• For this reason, companies sometimes choose accounting methods that will produce a lower COGS figure, in an attempt to boost their reported profitability.
• If COGS is not listed on a company’s income statement, no deduction can be applied for those costs.
• Unlike inventories, which are on the Balance Sheet as an asset, you can find the cost of goods sold on the Income statement as an EXPENSE.
• To drill down even further into freight costs, you need to consider a few more things.

But you are moving out of Inventory Asset only the cost of what sold to offset the Sales Income. This is helpful to prevent fluctuations in tax liability caused by buying more in one year than the next, or less income in one year and more in another. For example, airlines and hotels are primarily providers of services such as transport and lodging, respectively, yet they also sell gifts, food, beverages, and other items.

How To Calculate Ending Inventory and Cost of Goods Sold

The value of COGS can be used on the annual balance sheet to determine gross profit or gross income. The balance sheet is designed to look at your business’s financial health during the year. Knowing your gross profit can help you see how well your business is managing costs versus generating revenue. The formula for calculating ending inventory and COGS is relatively simple, but gathering the data itself can be complex depending on your business operations. Keeping careful records of purchase costs, labor costs and manufacturing costs can make this process much easier.