Cost of Sales
Cost of sales refers to the direct costs attributable to the production of the goods or supply of services by an entity. It is also commonly known as the “cost of goods sold (COGS)”.
Cost of sales measures the cost of goods produced or services provided in a period by an entity. It includes the cost of the direct materials used in producing the goods, direct labor costs used to produce the good, along with any other direct costs associated with the production of goods. In case of services cost of sales includes the labor cost or salaries of the employees and other directly attributable costs.
Cost of sales does not include indirect expenses such as distribution costs and marketing costs. It appears on the income statement and is deducted from the sales revenue for the calculation of gross profit (or gross margin).
The exact costs included in the calculation of cost of sales will differ from one type of business to another. The cost of sales attributed to a company's products or services are expensed as the company sells these goods.
As the cost of sales does not include overhead costs, it has a higher proportion of variable cost than the operating costs. Some fixed costs, such as labor costs, might be included in the cost of sales. But in most of the cases, the cost of sales consists almost entirely of variable costs.
Because inventory may be revalued, the cost of sales in a particular period reflects both any revaluation of inventory and the methods of allocating the cost of inventory such as first in, first out (FIFO), and average cost. The methods of allocation of overhead costs to particular products will also affect the cost of sales.
There are several ways to calculate cost of sales. The basic, and commonly used, method is described here. This method starts with the opening inventory for the period and adds the total amount of purchases made during the period and then deducts the closing inventory. This calculation gives the cost of the inventory sold by the entity during the period.