The cost of sales is the accumulated total of all costs used to create a product or service, which has been sold. The term is most commonly used by retailers. A manufacturer is more likely to use the term cost of goods sold. The cost of sales line item appears near the top of the income statement, as a subtraction from net sales. The result of this calculation is the gross margin earned by the reporting entity.
The various costs of sales fall into the general sub-categories of direct labor, direct materials, and overhead and may also be considered to include the cost of the commissions associated with a sale. The cost of sales is calculated as beginning inventory + purchases - ending inventory. A retailer or distributor might instead use a "merchandise" classification for the goods that it sells.
The cost of sales is a key part of the performance metrics of a company, since it measures the ability of an entity to design, source, and manufacture goods at a reasonable cost.
For example, a company has $10,000 of inventory on hand at the beginning of the month, expends $25,000 on various inventory items during the month, and has $8,000 of inventory on hand at the end of the month. What was its cost of sales during the month? The answer is:
|- Ending inventory||8,000|
|= Cost of sales||$27,000|
The cost of sales does not include any general and administrative expenses. It also does not include any costs of the sales and marketing department.
Cost of Sales Accounting
If a company is using the periodic inventory system, which is represented by the calculation just shown for the cost of sales, then the costs of purchased goods are initially stored in the purchases account. This is typically a debit to the purchases account and a credit to the accounts payable account. At the end of the reporting period, the balance in the purchases account is shifted over to the inventory account with a debit to the inventory account and a credit to the purchases account. Finally, the resulting book balance in the inventory account is compared to the actual ending inventory amount. The difference is written off to the cost of goods sold with a debit to the cost of goods sold account and a credit to the inventory account. This is a simple accounting system for the cost of sales that works well in smaller organizations.
The cost of sales is also known as the cost of goods sold or COGS.