How much inventory did a business purchase within an accounting period? The information is useful for estimating the amount of cash needed to fund ongoing working capital requirements. You can calculate this amount with the following information: Show
The calculation of inventory purchases is: (Ending inventory - Beginning inventory) + Cost of goods sold = Inventory purchases Thus, the steps needed to derive the amount of inventory purchases are:
This calculation does not work well for the manufacturing sector, since the cost of goods sold can be comprised of items other than merchandise, such as direct labor. These other components of the cost of goods make it more difficult to discern the amount of inventory purchases. An additional problem with the calculation is that it assumes an accurate inventory count at the end of each reporting period. If there was no physical count, or if the record keeping for a perpetual inventory system is not accurate, then the inputs used for the calculation of inventory purchases are not necessarily correct. Example of Inventory PurchasesABC International has beginning inventory of $500,000, ending inventory of $350,000, and cost of goods sold of $600,000. Therefore, the amount of its inventory purchases during the period is calculated as: ($350,000 Ending inventory - $500,000 Beginning inventory) + $600,000 Cost of goods sold = $450,000 Inventory purchases The amount of purchases is less than the cost of goods sold, since there was a net drawdown in inventory levels during the period. Direct costs in producing a good or providing a service What is Cost of Goods Sold (COGS)?Cost of Goods Sold (COGS) measures the “direct cost” incurred in the production of any goods or services. It includes material cost, direct labor cost, and direct factory overheads, and is directly proportional to revenue. As revenue increases, more resources are required to produce the goods or service. COGS is often the second line item appearing on the income statement, coming right after sales revenue. COGS is deducted from revenue to find gross profit.  Cost of goods sold consists of all the costs associated with producing the goods or providing the services offered by the company. For goods, these costs may include the variable costs involved in manufacturing products, such as raw materials and labor. They may also include fixed costs, such as factory overhead, storage costs, and depending on the relevant accounting policies, sometimes depreciation expense. COGS does not include general selling expenses, such as management salaries and advertising expenses. These costs will fall below the gross profit line under the selling, general and administrative (SG&A) expense section. Purpose of Cost of Goods SoldThe basic purpose of finding COGS is to calculate the “true cost” of merchandise sold in the period. It doesn’t reflect the cost of goods that are purchased in the period and not being sold or just kept in inventory. It helps management and investors monitor the performance of the business. Accounting for Cost of Goods SoldIFRS and US GAAP allow different policies for accounting for inventory and cost of goods sold. Very briefly, there are four main valuation methods for inventory and cost of goods sold.
Under FIFO, COGS consists of finished inventory units that were produced first and thus consist of costs incurred first, whereas under LIFO, COGS consists of finished inventory units that were produced last and therefore consists of later or most recent costs. For example, assume that a company purchased materials to produce four units of their goods. The first three units cost $5 to produce. However, due to rising material prices, the last unit costs $10 to produce. In the subsequent period, the company sold three units. Under FIFO, COGS would consist of the first three units produced, totaling $5 x 3 = $15. Under LIFO, COGS would consist of the last three units produced, totaling $10 x 1 + $5 x 2 = $20. Under weighted average, the total cost of goods available for sale is divided by units available for sale to find the unit cost of goods available for sale. This is multiplied by the actual number of goods sold to find the cost of goods sold. In the above example, the weighted average per unit is $25 / 4 = $6.25. Thus, for the three units sold, COGS is equal to $18.75. Specific identification is special in that this is only used by organizations with specifically identifiable inventory. Costs can be directly attributed and are specifically assigned to the specific unit sold. This type of COGS accounting may apply to car manufacturers, real estate developers, and others. Depending on the COGS classification used, ending inventory costs will obviously differ. Download the Free TemplateEnter your name and email in the form below and download the free template now! Cost of Goods Sold TemplateDownload the free Excel template now to advance your finance knowledge! More ResourcesThank you for reading this guide to accounting for the Cost of Goods Sold. To prepare for the FMVA curriculum, these additional CFI resources will be helpful:
When merchandise is sold the revenue is reported as?In a merchandising business, when the merchandise is sold, the revenue is reported as sales and its cost is recognized as an expense. This expense is the cost of the merchandise sold.
Is merchandise inventory reported on the income statement?Merchandise inventory is not an income statement account. It's an asset, and its ending balance is reported as a current asset on your balance sheet. COGS, however, is on your income statement and changes in your merchandise inventory affect your COGS.
Is merchandise on the income statement?Financial Reporting of Merchandise Inventory. The effects of merchandise inventory on the income statement are shown as the cost of goods sold, which is usually the largest expense of merchandising companies.
Is merchandise inventory on the balance sheet or income statement?While merchandise inventory is represented as an asset on the company's balance sheet, it does not directly appear on the company's income statement, which reports revenue, expenses and profit or loss during a specific accounting period.
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