Cost of goods sold
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In accounting, the cost of goods sold describes the direct expenses incurred in producing a particular good for sale, including the actual cost of materials that comprise the good, and direct labor expense in putting the good in salable condition. Cost of goods sold does not include indirect expenses such as office expenses, accounting, shipping department, advertising, and other expenses that can not be attributed to a particular item for sale.
Subtracting the cost of goods sold from the amount billed when selling the good (sales revenue) produces the gross profit on the good.
The net profit, what most people understand as the business' income or profit, is determined by subtracting the cost of goods sold and the indirect expenses from the sales revenue.
Accounting method
The revenue from merchandise sold must be matched with the cost of goods sold. Cost of sales or cost of goods sold is the identification of the cost of those items sold in the most recent accounting period. It can be done by specific identification, taking inventory, or different methods using estimates such as the "retail" method.
Cost of Goods sold is also the determining factor in arriving at Gross Profit and is determined as follows:
Sales----------------------------------$100,000 Cost of Goods Sold Inventory 01/01/03---$ 5,000 Purchases-------------45,000 Direct Labor----------30,000 ------------------------------80,000 Less: Inventory 12/31/03------10,000 Net Cost of Goods Sold-----------------70,000 Gross Profit on Sales-------------------$30,000
To determine the net profit one would then compute the indirect expenses such as office expenses, light, heat, etc. Determining the cost of goods sold is the first step in arriving at the net profit.
If the cost of goods sold is too high gross profit will not support the indirect expenses and will result in a loss for the accounting period.