cost of goods
The cost of goods sold reflects that matching of the inventory with the related sales, according to the initial definition provided by the Easton, Halsey, McAnally, Hartgraves and Morse (2013). This is one of the most important items in the income statement, usually representing the major expense for the company. The formula illustrating the calculation of cost of goods sold is as follows:
Inventory at the beginning of the reporting period + Inventory that is purchased of produced – Inventory at the end of the reporting period = Cost of goods sold within the current reporting period.
The opening inventory for one reporting period is the ending inventory from the prior reporting period. The inventory that is produced internally includes the cost of raw materials, labor, utilities, and other costs that are associated with the production of this inventory item. Ending inventory represent the items that have not been sold.
The cost of goods sold are recognized as an expense when the finished goods inventory item is sold by the manufacturing company and when the merchandise inventory is sold by the retailer. Until then these costs are capitalized, i.e. recorded in the balance sheet, as assets.
There are several options allowed under GAAP for inventory cost recognition – FIFO, LIFO and average cost method. The use of one method versus the other can have a great impact of the cost of goods sold, especially in the environments where prices are moving significantly in short period of time. FIFO (first in – first out) is the inventory cost method that recognizes the inventory costs in the order that they were initially recorded or purchased. If one item was purchased at 200 in October and second item was purchased at 250 in November, the first item to be included in the cost of goods sold will be the one from October. The other method is the reverse of the first one, LIFO (last in –first out), which will recognize the item purchased in November first and then the item in October. The third method, average cost method will average the cost of these two items and will recognize each item at 225 in the cost of goods sold.
The cost of goods sold is an important source of information in current days for management to make decisions related to their plans, budgets, strategies, etc. If in the past the companies were a lot more focused on increasing sales numbers, with the use of technology a lot of companies are building significant competitive advantage by reducing their cost of goods sold and improving their profit margins respectively. For example the technology is lowering the inventory level, it reduces labor costs and energy utilization. The technology improved significantly the company’s ability to manage their inventory. Some companies are now able to use sophisticated models to predict their inventory levels for their daily activities and they could order these quantities precisely to match their needs.
In the past century with the significant evolution of the production activities they key focus was on the recognition of certain indirect cost categories in the cost of the inventory (i. e overhead). There were multiple ways proposed, including absorption costing and variable costing. Under these methods, a rate is determined by which such costs are attributed to the cost of each unit. The debate over the advantages of these methods continue, however absorption costing is the only one recognized by FASB for published financial statements.
The cost of goods sold is the total price of producing the item sold to customers.
During the appointed sales/accounting period, the price on goods offered is the cost of the merchandise that was to consumers. The price of goods offered is reported on the income statement once the revenue in the sale of those is received.
(Easton, Halsey, McAnally, Hartgraves, Morse, 2013)
Over the past century, it may seem that prices rose considerably but compare certain items from 100 years ago to today the cost for some items has fallen. For example, “a three-minute telephone call to Chicago from New York cost $5.45; today’s cost is about five cents, a 99% fall.” (The Economist, n.d.) Globalization along with rising technology and faster shipping methods has actually brought the price down on many items. Goods that were produced by hand a century ago are now mass-produced by machine, therefore, bringing the price down and hopefully increasing the quality.
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