How to Record a Journal Entry for Cost of Goods Sold
Navigate the accounting process for direct product expenses. Learn to accurately record Cost of Goods Sold in your financial records.
Cost of Goods Sold (COGS) represents the direct costs a business incurs to produce the goods it sells. COGS directly impacts gross profit, calculated by subtracting it from revenue. Accurate COGS recording through journal entries is important for precise financial records and profitability reporting. This guide explores COGS, inventory systems, and journal entries.
Understanding Cost of Goods Sold
COGS includes direct expenses tied to the production of goods sold. These direct costs encompass raw materials, direct labor, and manufacturing overhead directly attributable to production. For instance, in a furniture manufacturing business, wood, fabric, and assembly line wages are included in COGS.
Expenses not directly related to production, such as selling, general, and administrative (SG&A) costs, are excluded from COGS. These indirect costs, like marketing expenses, office rent, or administrative salaries, are categorized separately on the income statement. COGS is calculated using the formula: Beginning Inventory + Purchases – Ending Inventory. Beginning inventory is the value of goods available for sale at the start of an accounting period. Purchases represent the cost of additional goods acquired during the period. Ending inventory is the value of goods remaining unsold at the end of the period. This formula determines the cost of merchandise sold during a specific period.
Inventory Systems and Recording COGS
The two inventory systems, perpetual and periodic, differ in how they update inventory records and calculate COGS. Each system dictates the timing of journal entries related to inventory and sales.
The perpetual inventory system offers continuous tracking of inventory balances and COGS for each sale. Inventory records are updated in real-time as items are purchased, manufactured, or sold. This system provides real-time visibility into inventory levels, showing the exact quantity and cost of goods on hand. A COGS entry is generated simultaneously with each sales transaction.
The periodic inventory system updates inventory balances and calculates COGS only at specific intervals, such as the end of an accounting period. Businesses using this system rely on a physical count of inventory at these predetermined times to determine the ending inventory balance. Purchases are recorded in a temporary account, and COGS is calculated at the period’s end by adjusting inventory accounts. This approach is simpler and less costly, suitable for businesses with smaller inventory or less complex operations.
Journal Entries for Cost of Goods Sold
Recording COGS through journal entries varies depending on the inventory system employed. These entries ensure financial statements accurately reflect inventory flow and sales profitability. Accounts debited and credited differ between perpetual and periodic methods.
Perpetual Inventory System
Under the perpetual inventory system, two journal entries are required at the time of each sale to capture revenue and the corresponding COGS. The first entry records the sale, recognizing revenue. For example, if a company sells goods for $1,000 on credit, the entry debits Accounts Receivable and credits Sales Revenue for $1,000.
Immediately following the sales revenue entry, a second entry records the cost of goods sold and reduces the inventory balance. If goods sold for $1,000 had an original cost of $600, the entry debits Cost of Goods Sold and credits Inventory for $600. This two-part entry ensures the inventory account continuously reflects the quantity and cost of goods on hand, providing real-time data on inventory levels and gross profit.
Periodic Inventory System
The periodic inventory system requires COGS to be determined and recorded at the end of the accounting period, often as part of the closing entries. Purchases of inventory are initially recorded in a temporary account, “Purchases.” For example, if a business buys $5,000 worth of inventory on credit, the entry debits Purchases and credits Accounts Payable for $5,000.
At the end of the accounting period, a physical count of inventory determines the ending inventory balance. COGS is then calculated using the formula: Beginning Inventory + Purchases – Ending Inventory. Adjusting entries are made to close temporary accounts related to purchases and establish the ending inventory balance. The final entry to recognize COGS involves debiting Cost of Goods Sold, crediting the Purchases account to close it, and adjusting the Inventory account to reflect beginning and ending balances. For example, if beginning inventory was $10,000, purchases were $50,000, and ending inventory was $12,000, COGS would be $48,000. The adjusting entry debits Cost of Goods Sold for $48,000, credits Purchases for $50,000, credits the old Inventory (beginning balance) for $10,000, and debits the new Inventory (ending balance) for $12,000. This consolidated entry effectively transfers the cost of goods sold out of inventory and into the expense account for the period.