ACCOUNTING ADVISE - Cost of Goods Sold

ACCOUNTING ADVICE

BACKGROUND
1. History
2. GAAP vs. OCBOA
3. Types of Accountants
4. International
5. Future

BASIC INFO
1. Financial Statements
2. Assets, Liabilities, and Equity
3. Debits and Credits
4. Double Entry
5. Software

GENERAL
1. A/R and A/P
2. Depreciation
3. Inventory
4. Leases
5. Payroll

ASSETS
1. Cash
2. Other Current
3. Fixed
4. Investments
5. Intangibles

LIABILITIES & EQUITY
1. Current Liabilities
2. Long Term Debt
3. Equity
4. Kinds of Companies

INCOME STATEMENT
1. Revenues
2. Expenses
4. Auto Expense
5. Gains & Losses

TOOLBOX
1. The Workbook
2. General Ledger
3. Adjusting Entries
4. Journals

COST ACCOUNTING
1. Methods
2. Manufacture
3. Overhead
4. Construction
5. Gov. Contracts

OTHER TOPICS
1. Ratio Analysis
2. Combining
3. Non-Profits
4. Auditing

INCOME STATEMENT

COST OF GOODS SOLD

Cost of Sales (COS) is similar to Cost of Goods Sold (CGS). They both break out large expenses and subtract them separately from the rest. The result is gross profit.

The other expenses are then subtracted from that to get net income.

So, why go through all of this?

Tax regulations require Cost of Goods Sold whenever a company carries inventory. Beyond that costs that directly drive sales and are substantial should be broken out.

Example
Construction companies may have costs for materials that go into what they build. Other costs that directly go into a construction project might be the labor of the workers, subcontractors, and travel costs. These kinds of costs would go into COS.

Today’s software (Quickbooks and Peachtree) does not handle Cost of Goods Sold correctly. That is why most financial statements present this section on a “close enough” basis.

Here’s how this section should really look.

Start the Cost of Goods Sold with Beginning Inventory. Add Purchases. The total of these two is Total Goods Available for Sale. Subtract Inventory. The result is Cost of Goods Sold. Why? The logic of this comes from simple algebra. If a – b = c, then a – c = b. Beginning Inventory (at cost) plus Purchases (the cost of additional inventory) gives us the Total Goods Available for Sale (at cost, of course). If we subtract the Cost of Goods Sold we will get Ending Inventory (at cost).

The presentation on the Income Statement switches CGS and Ending Inventory as per the equations. Neat, huh?

Purchases may be modified by Purchase Discounts and Purchase Returns and Allowances.

We have more on Purchases on our Inventory page. Special cases for manufacturing and construction companies are treated in their pages.

The software has problems with Beginning Inventory for different periods. The Beginning Inventory for the first of the month is different from the Beginning Inventory for the first of the Year. This means that if you have an Income Statement that has two columns of figures, Month activity and Year to Date activity, software will be unable to handle the proper presentation of Cost of Goods Sold.

Practice
It is a wonder to us that after all these years and all of the extras that accounting programs now provide that they still can’t deliver basic accounting functions such as this.

Typically the software produces an abbreviated CGS section. They scrunch everything into one line called “Cost of Goods Sold”. This is an area where some more detail would be helpful to management.

Author: Jack Le Moine. Copyright © Jack Le Moine CPA, PC.
E-mail: jcpa@lemoineandjames.com.
This page last revised 9/7/04.