Is Cost of Goods Sold a Debit or Credit?

Cost of Goods Sold (COGS) represents the direct costs of producing goods a company sells. Understanding COGS accounting treatment is fundamental for comprehending a business’s financial health. Cost of Goods Sold is recorded as a debit. This classification helps accurately track profitability and maintain proper financial records.

Understanding Debit and Credit Rules

The foundation of accounting rests on the double-entry system, where every financial transaction impacts at least two accounts. This system uses “debits” and “credits” to record these changes. Debits are recorded on the left side of an account, while credits are recorded on the right side. These terms do not inherently mean increase or decrease; their effect depends on the type of account involved.

For assets and expenses, a debit increases their balance, while a credit decreases it. Conversely, for liabilities, equity, and revenue accounts, a credit increases their balance, and a debit decreases it. This consistent application ensures that the accounting equation—Assets = Liabilities + Equity—always remains in balance.

Cost of Goods Sold Explained

Cost of Goods Sold (COGS) represents the direct costs of goods sold during a specific period. These costs are directly tied to the creation or acquisition of products, including raw materials, direct labor, and manufacturing overhead. COGS does not include indirect expenses like marketing, sales, or administrative costs; these are categorized as operating expenses.

COGS is a significant figure on a company’s income statement, appearing directly below sales revenue. Subtracting COGS from sales revenue yields gross profit, which indicates how efficiently a company produces its goods. Accurate COGS calculation helps businesses understand profitability and is guided by Generally Accepted Accounting Principles (GAAP) in the United States. While GAAP provides guidelines, companies must consistently apply their chosen accounting policies for COGS.

Recording Cost of Goods Sold

When a company sells a product, the associated Cost of Goods Sold must be recorded. Since COGS is an expense account, its balance increases with a debit. In a perpetual inventory system, which continuously updates inventory records with each sale, two journal entries occur for every sale. One entry records the sale itself (debit Cash or Accounts Receivable, credit Sales Revenue).

The second entry records the Cost of Goods Sold. This involves a debit to the Cost of Goods Sold account and a corresponding credit to the Inventory account. For example, if a business sells an item that cost them $50 to produce, the journal entry to record COGS would be a debit of $50 to Cost of Goods Sold and a credit of $50 to Inventory. This action reduces the asset value of inventory while recognizing the expense of the goods sold.