Costs of Goods Sold. Definition | Calculation | Example
Cost of goods sold (COGS)
Before a business can talk about profit, it has to account for what its products actually cost to make or buy. That's cost of goods sold — the direct cost of everything a company sold in a period. It sits at the very top of the income statement, drives gross profit, and shifts depending on how you value inventory. This guide covers the formula, a worked example, FIFO vs LIFO, and what belongs in COGS and what doesn't.
Cost of goods sold (COGS) — also called cost of sales — is the direct cost of producing or buying the goods a company sold during a period: materials, direct labour and manufacturing overhead. It excludes indirect costs like marketing and administration.
The formula is COGS = Opening inventory + Purchases − Closing inventory. Revenue minus COGS gives gross profit. The figure depends on the inventory costing method (FIFO, LIFO or weighted average) — and note that IFRS prohibits LIFO, while US GAAP still allows it.
What is cost of goods sold?
COGS is the direct cost of the goods or services a company sold in a period — its "direct hit" to the bottom line from making or acquiring what it sells. For a retailer, it's the cost of buying the merchandise it resells. For a manufacturer, it's the cost of raw materials, direct labour and factory overhead used to produce finished goods. Either way, only costs directly tied to the product count — indirect costs like advertising and admin are excluded.
What's included in COGS — and what isn't
| Included in COGS | Excluded from COGS |
|---|---|
| Direct materials / cost of merchandise | Selling & marketing (advertising, commissions) |
| Direct labour | Administrative / general overheads |
| Manufacturing (factory) overhead | Research & development |
| Freight-in (inbound shipping) | Distribution & outbound shipping (usually) |
| Direct supplies consumed in production | Interest & financing costs |
Cost of goods sold formula
COGS = Opening inventory + Purchases − Closing inventory
Worked example
A retailer starts the year with ₹10 lakh of stock, buys ₹15 lakh more during the year, and ends with ₹8 lakh of stock.
| Line | Amount |
|---|---|
| Opening inventory | ₹10,00,000 |
| + Purchases | ₹15,00,000 |
| − Closing inventory | (₹8,00,000) |
| = Cost of goods sold | ₹17,00,000 |
If revenue that year was ₹30 lakh, gross profit is ₹30 lakh − ₹17 lakh = ₹13 lakh (a 43% gross margin).
How manufacturers build up COGS
A manufacturer has extra steps, because raw materials become work-in-progress and then finished goods before they're sold.
| Stage | Build-up |
|---|---|
| Total manufacturing cost | Direct materials used + direct labour + manufacturing overhead |
| Cost of goods manufactured | + Opening work-in-progress − closing work-in-progress |
| Cost of goods sold | + Opening finished goods − closing finished goods |
Inventory costing methods: FIFO, LIFO and weighted average
When purchase prices change during the year, the method you use to value inventory changes COGS — and therefore profit and tax. There are three main methods.
| Method | How it assigns cost | COGS when prices rise | IFRS | US GAAP |
|---|---|---|---|---|
| FIFO (First In, First Out) | Oldest costs charged to COGS first | Lower (older, cheaper units) | Allowed | Allowed |
| Weighted average | Average cost across all units | Between FIFO and LIFO | Allowed | Allowed |
| LIFO (Last In, First Out) | Newest costs charged to COGS first | Higher (newer, dearer units) | Not allowed | Allowed |
When prices are rising, LIFO pushes the newest, most expensive costs into COGS — raising COGS, lowering profit, and cutting tax. That's why some US companies favour it. But it also leaves old, understated costs sitting in the balance-sheet inventory, which can badly misrepresent its value — so IAS 2 prohibits LIFO entirely. IFRS reporters use FIFO or weighted average.
COGS vs operating expenses
COGS is direct product cost; operating expenses are the indirect costs of running the business. They sit in different parts of the income statement.
| Aspect | COGS | Operating expenses |
|---|---|---|
| What it is | Direct cost of goods sold | Indirect costs of running the business |
| Examples | Materials, direct labour, factory overhead | Rent, admin salaries, marketing, utilities |
| On the income statement | Deducted first — gives gross profit | Deducted next — gives operating profit |
| Behaviour | Moves with sales/production volume | Largely fixed period costs |
This is also why selling and marketing costs — advertising, sales commissions, outbound shipping — stay out of COGS: they aren't part of producing or acquiring the inventory. They're netted against sales further down the statement.
COGS and gross profit
COGS is the bridge from revenue to gross profit, the first profitability line on the income statement.
Gross margin (gross profit ÷ revenue) shows how efficiently a company turns sales into profit before overheads. COGS also feeds higher-level measures — it's the starting point for EBITDA and, ultimately, net income, and it's a key line on an income-tax return.
How COGS is presented under IFRS and US GAAP
Interestingly, neither framework defines COGS or forces companies to show it as a separate line. What they do govern is the inventory cost that flows into it:
- IFRS — IAS 2 Inventories sets how inventory is measured (lower of cost and net realisable value) and permits FIFO or weighted average, not LIFO.
- US GAAP — ASC 330 Inventory and ASC 705 Cost of Sales and Services; FIFO, LIFO and weighted average are all allowed.
Because both frameworks allow choices — whether to fold in inbound freight, depreciation or handling — COGS can be built differently from one company to the next, which makes cross-company and cross-industry comparison harder. Always check the notes before comparing.
Inventory and costing are core exam topics
COGS, IAS 2 and inventory valuation run through ACCA Financial Accounting and cost/management accounting. Build a solid base with BPP and Kaplan study materials or the ACCA Applied Knowledge online course — all through Eduyush.
Browse ACCA books Cost accounting courseFrequently asked questions
What is cost of goods sold in simple terms?
What is the cost of goods sold formula?
Is cost of goods sold the same as gross profit?
Is cost of goods sold the same as cost of sales?
Does COGS include FIFO or LIFO?
Why are selling expenses not included in COGS?
Is a higher or lower COGS better?
Conclusion
Cost of goods sold is where profitability begins: it captures the direct cost of everything a business sold, converts revenue into gross profit, and reveals how well a company controls its production or purchasing. Get the formula right, know what belongs in it and what doesn't, and understand how FIFO, LIFO and weighted average shift the number — and you'll read any income statement, and any margin, with far more confidence.
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From income-statement basics to a qualification
COGS and inventory sit inside the bigger world of financial and management accounting. Take it further with an ACCA qualification or the US CMA — both supported end-to-end by Eduyush, from materials to coaching.
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