Cost of Sales | Definition, Formula & Calculation

Cost of Sales | Definition, Formula & Calculation 

The Cost of Sales or Cost of Goods Sold (COGS) denotes what a seller must pay for creating a product and getting it into paying customer’s hands. Companies use COGS as a measurement for calculating Gross Margin. 

What is the Cost of Sales? 

Cost of Sales means an entity’s direct cost of sales. It involves the cost required to either manufacture goods or purchase products that shall be sold to the customers.  

What does the Cost of Sales measure? 

COGS are used to measure the cost of goods/services provided during a period by any entity. In short, it includes the direct cost of sales like direct material & labor costs and other direct costs associated with production that has been used for producing and selling a product. 

Cost of Sales doesn’t measure indirect expenses like distribution costs & marketing costs.  

Major components to calculate the COGS 

The primary components for calculating the cost of sales are 

• Beginning Inventory 
• Direct Material Cost 
• Direct Labor Cost 
• Overhead Cost 
• Ending Inventory 
• Cost of acquiring/manufacturing new products 

Cost of Sales Calculation 

The Cost of Sales can be calculated in 2 different ways.  

• Adjusting the cost of goods manufactured/purchased by the inventory change during the given period 
• Adding the cost of goods manufactured/purchased to the beginning inventory and subtracting the inventory at the end 

You can use the following basic and simple formula for calculating the cost of sales 

Cost of Sales = Beginning Inventory + Inventory Additions – Ending Inventory 

Cost of Sales Example 

Let us consider a manufacturing company that needs to calculate the cost of sales based on the transaction that happened in 2020.  

Step 1: 

At first, a company must calculate the total manufacturing cost using the following formula, 

Total Manufacturing Cost = Direct Cost (Cost of Direct Materials + Cost of Direct Labor) + Overhead Manufacturing Cost + Indirect Cost (Cost of Indirect Materials Cost of Indirect Labor) 

Total Manufacturing Cost = ₹1, 68,000 

Step 2: 

Next, the company must calculate  

Cost of Goods Manufactured = Total Manufacturing Cost + Beginning Inventory – Ending Inventory 

Cost of Goods Manufactured = ₹1, 75,000 

Step 3: 

Finally, the cost of sales shall be calculated  

Cost of Sales = Cost of Goods Manufactured + Beginning Inventory – Ending Inventory 

Cost of Sales = ₹1, 62,000