How to Record a Cost of Goods Sold Journal Entry

Cost of Goods Sold (COGS) represents the direct costs of producing or acquiring goods sold by a business during a specific period. Accurately recording COGS is important for financial reporting, as it directly impacts a company’s gross profit and net income. Understanding this expense allows businesses to assess profitability and ensures financial statements accurately reflect operational performance.

Understanding Cost of Goods Sold

Cost of Goods Sold encompasses the direct costs connected to producing goods sold. These costs are incurred only when a product is sold, distinguishing them from other operating expenses. For manufacturing companies, COGS typically includes direct materials, direct labor, and a portion of manufacturing overhead. Manufacturing overhead includes indirect costs like factory rent, utilities, and depreciation on manufacturing equipment.

For businesses that purchase goods for resale, such as retailers or wholesalers, COGS primarily consists of the purchase price from suppliers. It can also include directly attributable costs, such as freight-in charges. Costs not included in COGS are indirect expenses like selling and administrative costs, marketing expenses, or research and development expenditures. These are considered operating expenses and are recorded separately on the income statement, below the gross profit line.

Information and Calculation for the Entry

Before recording the Cost of Goods Sold journal entry, a business must gather specific information to accurately determine the COGS amount. The method for calculating COGS depends on the inventory accounting system a company uses: either the perpetual inventory system or the periodic inventory system. Each system dictates how and when the COGS figure is derived.

Under the perpetual inventory system, inventory records are updated continuously with each purchase and sale. This system tracks the cost of each item sold at the time of sale. As goods are sold, the system simultaneously reduces the inventory balance and records the corresponding Cost of Goods Sold. This provides real-time information on inventory levels and COGS.

The periodic inventory system does not maintain continuous records of inventory movement. Businesses determine their inventory levels and Cost of Goods Sold at the end of an accounting period, typically by conducting a physical count. The COGS is then calculated using a specific formula: Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold. Beginning inventory is the value of goods on hand at the start of the period, purchases include all goods acquired during the period, and ending inventory is the value of goods remaining at the end of the period.

Making the Journal Entry

Recording Cost of Goods Sold involves debiting the Cost of Goods Sold account and crediting the Inventory account. This reflects the decrease in inventory and the recognition of an expense as goods are sold. The specific timing and mechanism of this entry depend on the inventory system employed by the business.

When a perpetual inventory system is in use, the Cost of Goods Sold entry is typically made automatically by accounting software at the moment of each sale. For every item sold, the system records the expense of the goods sold. For example, if an item costing $50 is sold, the system simultaneously debits Cost of Goods Sold for $50 and credits Inventory for $50.

For businesses using the periodic inventory system, the Cost of Goods Sold entry is an adjusting entry made at the conclusion of an accounting period. After the COGS amount has been calculated using the formula (Beginning Inventory + Purchases – Ending Inventory), a single journal entry is prepared. This entry involves debiting the Cost of Goods Sold account for the total calculated amount and crediting the Inventory account. This adjusting entry records the total cost of goods sold for the period.

Recording Cost of Goods Sold impacts both the income statement and the balance sheet. On the income statement, COGS is subtracted from sales revenue to arrive at gross profit. On the balance sheet, the Inventory account is reduced, reflecting the goods that have been sold. This ensures that financial statements accurately portray the company’s financial position and performance.