Common Cost of Goods Sold Categories

Cost of goods sold (COGS) is usually compressed to a single line on the income statement, but it might have several components to it. If you are a retailer or wholesaler, your only COGS would be your purchases. If you are a service business, you will have no COGS. However, if you are a manufacturer, you will have several categories of expenses directly related to the manufacture of the products sold. Here are the most common ones:

Purchases: Purchases represents the cost of the goods purchased for resale or the raw materials purchased for manufacturing, but only for those goods that were sold during the year. Costs for goods still on the premises remain in the inventory account until those goods are sold.

Direct labor: This category is the wage and benefit cost of your employees related to the manufacture of the goods your company makes. Again, the labor costs of those goods still on the premises are in the inventory account. If you have one employee that makes all your goods, and that employee worked on the goods sold as well as the goods in inventory, how can you apportion the employee's salary to each category? Most manufacturers set up a "standard cost" so that they can split the labor costs between sold items and inventoried items. Determining a standard cost requires some analysis of total units produced versus total wage costs. You must come up with a labor cost per unit. You know how many units are still in inventory (because you've counted them), so you apply that 'cost accordingly. A more detailed discussion of standard costing is beyond the scope.

Other manufacturing costs: Large manufacturers tend to apportion as many expenses as possible between operating costs and cost of goods sold. For example, the electricity cost related to the plant could be viewed as a direct cost of manufacture, whereas the electricity cost of the front office is not. This discussion involves management accounting concepts more than bookkeeping concepts, and as such, is outside the scope.