Cost of sales is a direct cost required to manufacture the product or sell the services.
It’s shown right after net sales in the income statement. Usually, the breakdown for the cost of sales can be shown as follows.
- Direct Material Cost
- Direct Labor Cost
- Direct overheads
Direct material cost is the cost for material that can be traced in the product. For instance, the cost of wood used in table manufacturing can be traced directly to the table. Hence, it’s a direct cost.
Direct Labor Cost is the cost of labor that can be traced in the product. For instance, the cost of labor used in table manufacturing can be directly traced in the table. Hence, it’s a direct cost.
If overheads are directly absorbed in the cost of the table, these are called direct overheads. For instance, the glue used in the process of table manufacturing is direct overheads.
When all direct costs are combined, these costs are called the cost of sales.
Also read, Journal entries for recording inventory.
The formula for cost of sales
Cost of sales = opening inventory + purchases – closing inventory.
Opening inventory balance is brought forward from the last accounting period.
Purchases are the cost of the goods purchased during the accounting period.
Closing inventory can be extracted from the physical count sheet.
Example & calculation for cost of sales
For instance, the following are attributes for the
Opening inventory = $20,000
Purchases = $10,000
Closing inventory = $5,000
We can apply the formula below.
COS = opening inventory + purchases – closing inventory.
COS = $20,000 + $10,000 – $5,000
COS = $25,000
How to do accounting for the cost of sales
If the company is using a periodic inventory system, the cost of sales can be traced to the purchase accounts.
Throughout the accounting period, purchases are debited to the purchase account and credited to the account payable. At the end of the accounting period, the purchase account is credited and transferred to the cost of sales via the following formula.
COS = opening inventory + purchases – closing inventory.
Wrap up
The COS is the amount that can be directly attributed to the product. Usually, the COS includes direct material, direct labor, and direct overheads.
If the company uses a periodic accounting system, the purchases throughout the accounting period are accumulated in the purchase account. At the end of the accounting period, the purchase account is credited and the amount is transferred to the COS via the following formula.
COS = opening inventory + purchases – closing inventory.
