Understanding COGS: How to Record a Cost of Goods Sold Entry

The Cost of Goods Sold (COGS), the focal point of discussion of this article, is a fundamental concept critical for entrepreneurs, business owners, and financial advisors.

What is COGS?

An essential finance term, COGS (Cost of Goods Sold), refers to the direct costs incurred in producing goods that a company sells. This includes expenses for materials, labor, and any other direct payments made during the manufacturing process. Notably, it excludes indirect expenses such as distribution and sales force costs.

In essence, COGS highlights the raw expenses involved in creating a product up to the point of sale. Still, it does not cover costs associated with selling, marketing, or promoting the product.

Cost of Goods Sold Journal Entry

To understand what a COGS Journal Entry is, one must understand what a journal entry is. 

In general accounting, a journal entry records every company’s financial transaction. An important aspect is that each entry involves at least two parts: a debit and a credit. This is to ensure the company’s financials are balanced after each transaction. 

Now, let’s dive into journal entries and the context of the Costs of Goods Sold. An accounting cost of goods sold in a journal entry is a record in a company’s financial statements, which is the cost associated with any goods or services sold to a customer. In this case, when goods are sold, the cost of goods would have to match a credit entry that tallies against revenue generated from the sale, which is essential in calculating eventual profits.

Example of a Cost of Goods Sold Journal Entry

Let’s examine an example to understand better the cost of goods sold. Consider a soda company that manufactures and sells flavored soda cans. This company sold 500 cans of soda in the last month. Each can cost the company $25 to produce.

Let’s take a look at a detailed COGS Journal Entry example:

Accounts involved: Debit & Credit

Description of transaction: Record of COGS for 500 cans sold in March.

Journal Entry:

Here is a breakdown:

• Debit entry: In this case, the debit entry of $12,500 showcases the cost incurred for the 500 soda cans sold in March.
• Credit entry: $12,500 in the credit column showcases the outflow of inventory due to the 500 cans of soda sold. 
• An important point is that inventory is an asset account, and crediting it reduces its balance.

This cost of goods sold journal accounting entry showcases the nitty-gritty of the company’s journal entries, cost of goods sold, and financial statements in a brief, simplified, and quick manner.

How to Record a Cost of Goods Sold Journal Entry

Two key journal entries are required to accurately record sales and the associated cost of goods sold in accounting.

• The first entry involves debiting the accounts receivable to represent the expected income and crediting the sales account to reflect the revenue generated. This entry acknowledges the revenue aspect of the transaction. 
• The second entry is crucial for tracking the cost of goods sold: it involves debiting the COGS account to increase the expense and debiting the ending inventory to adjust the remaining stock value. To balance these debits, credits are made to the purchases account, which reduces the expenditure allocated for new inventory, and to the beginning inventory, which adjusts the recorded value of stock available at the start of the period. 

This systematic approach to the cost of goods sold accounting entries ensures that the revenue earned and the expenses incurred from the sale of goods are accurately recorded, maintaining a balanced and precise financial record.

What is included in COGS accounting?

COGS accounting includes all the direct costs of producing and delivering products a business sells. This typically comprises all raw materials needed to make items, wages for the labor that directly contributes to the production of the end product, and any other overhead costs included in ensuring production runs smoothly. It also consists of the costs of transporting and delivering the goods to their sale points to provide a wholesome, 360-degree overview of all expenses from manufacturing to market. This detailed accounting helps companies gauge their accurate expenditure and maintain their financial well-being.

Is the cost of goods sold a debit or credit?

COGS is an expense account in accounting, which means it is increased through a debit and decreased by a credit.

When recording financial transactions related to the cost of inventory that has been sold, an accountant would make a journal entry that debits the COGS account.

Picture this: you have a coffee shop selling coffee by the cup. In this case, your end product is the coffee. However, you require many ingredients, such as milk, beans, sugar, water, etc, to make this cuppa. You buy these ingredients at a cost, which is your cost of goods sold, that is, the amount of money you need to make the coffee to go ahead and sell it. 

Every time you sell a cup, you keep a record or make a journal entry in your financial tracker. In this journal entry:

• You make one entry as a credit to your account, which is the sale you’ve made, 
• And one entry as a debit is the cost you spent on all the raw materials. 

This debit helps you see a clear picture of your financial health; for every coffee you sell, you also spend money on buying ingredients.

Similarly, if one looks at small businesses and companies and applies COGS, COGS works as an expense account. The debit to a COGS account reflects the expenses of making a product that is then sold. To balance this book entry, corresponding credits are made to the purchase and inventory account. This credit highlights that because you have now sold units of your end product, there is a depleted amount in your stock of raw materials used for production and your overall inventory. The credit to the purchases account reflects reduced money allocated for buying new stock. In contrast, the credit to the inventory account decreases the inventory value that is no longer held as it has been sold, ensuring a clear picture of all financial transactions is recorded.

Now, why is the COGS account highly crucial to businesses? This is because if your COGS accounting entry is accurate, it can throw your company’s financial statements off track. Recording your COGS accurately is crucial to ensure you have a clear picture of your profit at the end of the accounting year. A simple way to do this is as follows:

Business Revenue – COGS = Gross Profit

This gross profit helps a business track COGS expenses and eventually calculate net profit, making COGS journal entries one of the most significant and essential tasks for ensuring a company’s success.

Conclusion

Accurately recording the Cost of Goods Sold (COGS) is crucial for any business. COGS offers valuable insights into the efficiency of a company’s production and procurement processes. Businesses can monitor expenses and ensure smooth operational flows by meticulously tracking all transactional entries. This practice aids in maintaining precise financial records, which in turn helps companies assess, refine, and enhance their financial health.

This detailed accounting practice enables businesses to manage inventory more effectively, optimize pricing strategies, and boost profitability. COGS directly impacts business decisions, making it an essential concept for entrepreneurs and financial advisors to comprehend and apply.

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This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal, or accounting advice in this article. If you would like to engage with Escalon, please contact us here.