How to Journal Cost of Goods Sold: Steps & Examples

Cost of Goods Sold (COGS) represents the direct costs a business incurs to produce the goods it sells. This figure appears on a company’s income statement. Understanding how to accurately journal COGS is essential for any business that sells products, as it directly impacts reported profitability and financial health. Proper accounting for COGS ensures a business correctly measures its gross profit, which is the revenue remaining after accounting for the direct costs of goods sold.

Core Concepts for Journaling Cost of Goods Sold

COGS includes all direct costs tied to the production or acquisition of products sold. These direct costs encompass raw materials, direct labor, and certain manufacturing overheads. It does not include indirect expenses like administrative salaries or marketing costs, which are operating expenses.

The primary accounts involved are Inventory, an asset account tracking the value of goods held for sale, and Cost of Goods Sold, an expense account. Sales Revenue is also related, as COGS links directly to product sales revenue. Businesses use one of two main inventory systems—perpetual or periodic—to track inventory and determine COGS. The chosen system dictates how and when COGS is recorded.

Journaling Under the Perpetual Inventory System

The perpetual inventory system continuously updates inventory records and the cost of goods sold in real-time as transactions occur. This method provides an ongoing balance of inventory on hand and the cost of items sold.

When a business purchases inventory, the journal entry debits the Inventory account and credits Cash or Accounts Payable. For example, if a business buys $1,000 worth of inventory on credit, the entry is a Debit to Inventory for $1,000 and a Credit to Accounts Payable for $1,000. Upon each sale, two separate journal entries are required. The first entry records revenue by debiting Cash or Accounts Receivable and crediting Sales Revenue.

The second entry, made concurrently, recognizes the cost of goods sold. This debits the Cost of Goods Sold account and credits the Inventory account. For instance, if goods costing $600 were sold for $1,000, the first entry debits Cash or Accounts Receivable for $1,000 and credits Sales Revenue for $1,000. A second entry then debits Cost of Goods Sold for $600 and credits Inventory for $600.

Journaling Under the Periodic Inventory System

The periodic inventory system does not maintain a continuous record of inventory or COGS. Instead, inventory is physically counted at the end of an accounting period to determine the ending inventory balance and calculate the cost of goods sold. This system suits businesses with a large volume of inexpensive products.

When inventory is purchased under the periodic system, the cost is debited to a temporary Purchases account, rather than directly to the Inventory account. For example, if a business buys $1,000 worth of inventory on credit, the entry is a Debit to Purchases for $1,000 and a Credit to Accounts Payable for $1,000. Sales are recorded by debiting Cash or Accounts Receivable and crediting Sales Revenue, with no immediate entry to Cost of Goods Sold at the time of sale.

At the end of the accounting period, a physical count of inventory is performed. The Cost of Goods Sold is then calculated using the formula: Beginning Inventory + Net Purchases – Ending Inventory. After this calculation, a comprehensive closing entry records the Cost of Goods Sold and updates the Inventory account. This entry typically debits Cost of Goods Sold, debits the new Ending Inventory balance, credits the Beginning Inventory balance, and credits the Purchases account.

For example, if beginning inventory was $20,000, net purchases were $80,000, and ending inventory was $15,000, the calculated COGS would be $85,000. The closing entry debits Cost of Goods Sold for $85,000, debit Inventory for $15,000 (ending), credit Inventory for $20,000 (beginning), and credit Purchases for $80,000.

Common Adjustments Affecting Cost of Goods Sold Journaling

Various adjustments influence the final Cost of Goods Sold calculation, regardless of the inventory system. These adjustments ensure the recorded cost accurately reflects the net cost of acquiring goods.

Purchase Returns and Allowances

Purchase returns and allowances occur when a business returns purchased inventory to a supplier or receives a price reduction for defective goods. These adjustments reduce the cost of purchases and, consequently, the COGS. Under the perpetual system, a return or allowance typically debits Accounts Payable or Cash and credits Inventory. For the periodic system, the entry debits Accounts Payable or Cash and credits a separate account like Purchase Returns and Allowances, which then reduces total purchases in the COGS calculation.

Purchase Discounts

Purchase discounts are reductions in the purchase price offered by suppliers for early payment. Taking advantage of these discounts reduces the actual cost of the inventory. In a perpetual system, recording a purchase discount debits Accounts Payable for the full amount, crediting Cash for the discounted amount paid, and crediting Inventory for the amount of the discount. Under the periodic system, the entry debits Accounts Payable and credits Cash, with the discount amount credited to a Purchase Discounts account, which reduces net purchases.

Freight-in

Freight-in, also known as transportation-in, refers to the costs incurred to bring purchased inventory to the business’s location. These costs are part of the cost of acquiring the inventory. Under the perpetual inventory system, freight-in costs are added directly to the Inventory account, so the entry is a Debit to Inventory and a Credit to Cash or Accounts Payable. In the periodic system, these costs are typically debited to a separate Freight-In expense account, which is then included in the calculation of net purchases at the end of the period.