Make sure that each costs of good sold journal entry is accurate so you’re how to record cost of goods sold journal entry not overreporting or underreporting COGS. Overreporting results in a lower gross profit and net income, which means higher income tax liability. It also gives you a distorted idea of your business’s profitability. Use the same inventory valuation method throughout each accounting period and from one period to the next.
- Simply put, COGS accounting is recording journal entries for cost of goods sold in your books.
- An item returned after it’s sold means a debit to Sales Returns and Allowances so it’s not included in your sales revenue.
- As a note, the credits that you make to your purchases and inventory accounts should equal your COGS.
- Recognition of cost of goods sold and derecognition of finished goods (Inventories) should also be consistent with the recognition of sales.
Does COGS go on your income statement?
As a note, the credits that you make to your purchases and inventory accounts should equal your COGS. Hence, under this perpetual inventory system, the company does not need to physically count the inventory to know how much the inventory remains in the accounting record as it is updated perpetually. Of course, the counting may still be done to verify the actual physical count with the accounting records. On the other hand, if the ending inventory is more than the beginning inventory, it means the inventory has increased instead. Hence, we need to debit the inventory account as in the journal entry above. For example, on January 31, we makes a $1,500 sale of merchandise inventory in cash to one of our customers.
Step-by-Step Guide: How to Record a COGS Journal Entry
These transactions related to cost of goods sold general journal entry, give a clear picture of the initial steps of production which is used to ultimately arrive at the profitability figure. In this example, the inventory balance increases by $15,000 compared to the previous year. Hence, we debit the $15,000 to the inventory account instead of crediting it. Let’s say you have a beginning balance in your Inventory account of $4,000. Along with being on oh-so important financial documents, you can subtract COGS from your business’s revenue to get your gross profit.
These pens are now known as inventory because they are purchased with the intention of resale. Recording a COGS journal entry is a relatively straightforward process. When prices are going up, FIFO (First-In, First-Out) results in lower COGS and higher net income. LIFO (Last-In, First-Out), on the other hand, results in higher COGS and lower net income. Weighted Average provides a smoother COGS calculation since it averages the cost of all units purchased.
Step 3: Calculate Ending Inventory
For example, freight-in charges may be added to COGS, but only if specific criteria are met. Knowing the rules will help ensure auditors and business owners alike agree with the costs recorded for inventory. Your income statement includes your business’s cost of goods sold.
To avoid all kinds of trouble from incorrect profitability assumptions to IRS penalties, make sure your records are clean. Failing to make a costs of good sold journal entry for returns or unsellable goods can lead to inaccurate financial statements and overstated profits. This costs of good sold journal entry is basically a physical count of all inventory items.
Then, you would make a corresponding credit to Inventory to reduce inventory value. An item damaged after it’s sold means a debit to COGS to increase COGS and a credit to Inventory to reduce inventory value. A lower COGS results in higher gross profit and better profitability.
Common Mistakes to Avoid When Recording COGS
Consider a company that starts the accounting period with a beginning inventory value of $45,000. During the period, the company spends an additional $10,000 on new inventory, and it ends the period with an ending inventory value of $35,000. In order to calculate and record your company’s COGS, you’ll first need to define your reporting period. Are you calculating COGS on a yearly, quarterly, or monthly basis?
Without knowing the reporting period, it’ll be impossible to perform the calculations that you need to in order to find your COGS. And the ending inventory is $10,000 ($50,000 – $40,000) less than the beginning inventory. This means that the inventory balance decreased by $10,000 compared to the previous year. Likewise, we can calculate the cost of goods sold with the formula of the beginning inventory plus purchases minus the ending inventory. When you purchase materials, credit your Purchases account to record the amount spent, debit your COGS Expense account to show an increase, and credit your Inventory account to increase it.
If your business is service oriented and does not sell physical goods, you would calculate cost of sales (COS) or cost of revenue (COR) instead of COGS. Cash and credit purchases require a debit to Inventory and a credit to either Cash or Accounts Payable. Direct COGS are costs that are directly related to the production of the goods or services you sell. If you use accounting software, look for features that automate inventory transactions. If you are dealing with a unique situation, consider consulting with an accountant or professional bookkeeper.
When that inventory is sold, it becomes an Expense, and we call that expense the Cost of goods sold. In this method of valuation of inventory, the company values the cost of goods sold and closing inventory at a specific cost specially identified for a specific product. These are feasible in only certain industries such as car manufacturers, real estate businesses, furniture, and other on-demand manufacturers industries. For another example, assuming that we still use the periodic inventory system and we still have the beginning inventory of $50,000 on the previous year’s balance sheet.
And the purchases account of $200,000 will be cleared to zero when we close the company’s accounts at the end of the accounting period. As the cost of goods sold is a debit account, debiting it will increase the cost of goods sold and reduce the company’s profits. The inventory account is of a debit nature, and crediting it will decrease the value of closing inventory. The cost of goods sold is also increased by incurring costs on direct labor. However, if we use the periodic inventory system, we usually only make the journal entry to record the cost of goods sold at the end of the accounting period. And this is usually done in order to close the company’s accounts at the end of the period after taking the physical count of the ending inventory.