Calculating the cost of goods sold allows accountants and executives to accurately estimate the costs incurred by the company. This value takes into account the specific cost of warehouse materials (including those associated with the construction of the warehouse itself, if the company produces its goods from raw materials). Inventory costs can be calculated in several ways, but to comply with the rules, the company must choose one and use it constantly. Read on to learn how to calculate the cost of goods sold for a business using First In, First Out (FIFO), First In, Last Out (FILO), and Average Cost.
Method 1 of 3: Use the Average Inventory Cost
Step 1. Find the average cost of purchased inventory
This is not only an acceptable method for a financial statement, but it can also prove useful for valuing stock over a large period. Add up all the prices of purchased goods for a single product type and divide the result by the number of goods to find the average value.
For example: (€ 1.00 / € 1.50) / 2 = € 1.25 is the average cost
Step 2. Calculate the average cost of the goods produced
If the company buys the raw materials to produce its own warehouse, this method involves a subjective judgment. Establish a period and the number of goods produced. Add up the total cost (which is often an estimate) of both the materials and the labor used to make the goods; at this point, divide the sum by the units present in the warehouse in the given period.
- Make sure you always comply with the company's internal laws and regulations regarding accounting procedures, as there may be rules for calculating the cost of goods produced for the warehouse.
- This cost obviously varies according to the product, but could fluctuate over time even with the same product.
Step 3. Do an inventory count of the warehouse
Take note of the stocks at the beginning of the count and at the end; multiply the average cost by the shrink.
Step 4. Calculate the cost of goods sold using the average inventory cost
The total expenditure on goods is € 1.25 x 20 goods = € 25. For 15 pieces, the cost of the goods sold, according to this method, is € 18.75 (15 x € 1.25).
- Companies use this procedure when they produce goods that are easily traded or that are physically indistinguishable from each other, such as commodities such as minerals, oil or gas.
- Most businesses that use the average cost of inventory method calculate the cost of manufactured goods on a quarterly basis.
Method 2 of 3: Use the FIFO System to Value Inventory
Step 1. Choose a start date and an end date for the period
FIFO is an alternative method used to assign a value to inventory. To calculate the cost of goods produced with this procedure, you must first perform a physical inventory count at a precise start and end date; it is important that the counts are 100% accurate.
It is worthwhile to assign a different part number to each type of material
Step 2. Find the cost of purchasing the goods
You can consult the invoices of the suppliers. Costs may vary, even if the related assets are all part of the same inventory. Be sure to count the final inventory value to better understand how it is being altered. The FIFO method assumes that the first goods bought or produced are the first to be sold.
- For example, consider stocking up by buying 10 items at € 1 each on Mondays and another 10 at € 1.50 on Fridays.
- Also note that the final inventory data shows you sold 15 items by Saturday.
Step 3. Calculate the cost of goods sold
Subtract the quantities sold from inventory, starting with those with the oldest date; multiply the figure by the purchase cost.
- The cost of goods sold should be 10 x € 1 = € 10 plus 5 x € 1.50 = € 7.50 for a total of € 17.50.
- The value of the cost of goods sold is lower with the FIFO method and the profit is higher when the inventory costs increase. In this case, stock bought first costs less than stock bought at the weekend, assuming that both are resold to the consumer at the same price.
- Use this procedure if the cost of inventory tends to increase over time And you need to present an appropriate income statement to convince investors or to obtain a loan from the bank. The reason is that inventories are more expensive.
Method 3 of 3: Using the FILO System to Valorize Inventory Inventory
Step 1. Divide the purchased stocks by ordering date
The FILO method is based on the concept that the goods purchased last are the first to be sold. However, you must perform an inventory count on a start and end date.
Step 2. Find the price you paid to buy the goods
You can consult the invoices of the suppliers. Costs may vary, even if the related assets are all part of the same inventory.
Consider having stocked with 10 items bought at € 1 each on Monday and with another 10 items bought at € 1.50 on Friday; by Saturday you have sold 15 items
Step 3. Add up the costs of the goods you sold
In this case, the cost of goods sold is given by all 10 pieces you bought at € 1.50 each (which you first sold according to the FILO criterion) and therefore 10 x € 1.50 = € 15, 00. Next, you must add 5 pieces that you bought at € 1 each (5 x € 1 = € 5) for a total cost of the goods sold equal to € 20. When the inventories are sold, their cost is 5 x € 1 = € 5.
Companies use the FILO method when they have large inventories that increase in cost; with this calculation, the profits are lower and therefore less taxes are paid
- There are Italian accounting principles and generally accepted ones that establish the financial functions that rely on the calculation of the cost of goods sold. Listed companies must submit financial reports based on these principles, so it is important to choose the calculation and reporting method that best suits your company's needs. It is not recommended to change methods.
- There are other accounting transactions that affect the cost of goods sold. For example, returns and shrinkage due to theft or damage increase or decrease this value, which may not fluctuate due to a change in inventory numbers.
- Small businesses and those dealing with uncommon goods must use a method based on the total cost to calculate that of the goods sold.
- The value of the cost of goods sold represents a revenue item in a company's income statement, which is then subtracted from revenue.
- The actual inventory value represents the last item in a company's income statement.