We will cover here all four different methods to calculate the cost of goods sold and how to set up a markup on the cost of goods sold to reach out on gross profit.
The cost of goods sold is the combination of inventories, including opening and ending along with the purchases. The COGS can control or contained a business.
Formula of Cost of Goods Sold:
Opening Inventory + Purchases – Discounts – Returns – Ending Inventory = Cost of Goods Sold
Every area of cost of goods sold is vital to keep a company in profit and reduce chances of default. Purchasing at overpriced may bring a business towards default or difficult to sell at a profit. Defaults, in later stages become the cause of the inflation for an economy.
There are four different types of COGS, which are used to reach out on the gross profit:
- LIFO Method – Last product is sold first in this method.
- FIFO Method – Whereas, in the FIFO method the first product is sold first.
- Weighted Average Method – An average cost is calculated by dividing the total number of units regardless purchased at different prices.
- Specific Identification – A specific item is sold from the inventory and the invoice prices is considered to calculate cost of goods sold.
Whichever method is chosen to calculate cost of goods sold the result may be different because each batch price may be different.
For Example:
Ten apples were sold to a customer out of 25, and we will apply each COGS method to calculate cost goods sold of 10 apples.
- First, seven apples were purchased 7 x $2.00 =$14.00
- 13 apples were purchased 13 x $2.50=$32.50
- 5 apples purchased 5 x $3.25 = $16.25
Total dollar amount paid= $14.00 + $32.50 + $16.25 = $62.75
Under FIFO (First in First Out):
- 7 x $2.00 $14.00
- 3 x $2.50 = $7.50
Total cost of goods sold by using FIFO method$14.00 + $7.50 = $21.50
Under LIFO (Last in First Out):
- 5 apples sold 5 x $3.25 = $16.25
- 5 apples sold 5 x $2.50 = $12.50
Total cost of goods sold $16.25 + $12.50 = $28.75
Under Weighted Average:
Total Cost $ 62.75 and Each Apple Cost is calculated by $62.75/25=$2.51.
10 apple cost of goods sold is 10 x $2.51 =$25.10
Under Specific Identification:
Assuming, the customer requested to buy 3 apples from the first batch, 5 apples from the second batch whereas 2 apples from the last batch.
Cost of goods sold shall be calculated as below:
- 3 x $2.00 = $6.00
- 5 x $2.50 = $12.50
- 2 x $3.25 = $6.50
Total cost of goods sold for ten apples - $6.00 + $12.50 + $ 6.50 =$25.00
Comparison of selling 10 apples under four different methods:
- FIFO $21.50
- LIFO $28.75
- Weighted Average $25.10
- Under specific method $25.00
Revenue Vs Cost of Goods Sold
Cost of goods is the amount of the suppliers’ invoices, whereas a markup is added to the cost of goods sold to find out the company’s gross profit. Let’s use the same example of ten apples under FIFO method, assuming the markup is 25% on the cost of goods sold to calculate revenue.
Gross Profit Calculation:
COGS under FIFO of ten apple sale is $21.50 and total revenue, assuming the markup is 25% in dollar shall be $21.50 x 0.25=$5.38 + $21.50 = $26.50.
- Cost of Goods Sold = $21.50
- Whereas Revenue in Dollar = $26.50
Formula = Gross Profit Cost of goods sold less the revenue
$26.50 - $21.50 = $5.00 Gross Profit
