Cost of Goods Sold Overview: Study Sheet

Accounting Terms

  • Cost of Goods Sold is a measure of the direct cost involved in acquiring or producing goods that are, in turn, sold. The methods of measuring cost of goods sold are explained below, but a company's chosen method must be consistent with their method of measuring inventory value.
  • Inventory represents finished and unfinished goods which have not yet been sold by a company.
  • Inventory Valuation is a measure of the value of a comapny's unsold inventory. The methods of measuring inventory value are explained below, but a company's chosen method must be consistent with their method of measuring cost of goods sold.

Cost of Goods Sold

The value of inventory (goods) a company has sold can be calculated using one of the following methods:

Average Cost Method

  • Assumes goods sold are non-unique (that is, every one is similar to every other one)
  • Not generally recommended where prices are volatile
  • Tends to even out price fluctuations over time
  • Like with Inventory Valuation, uses the average unit cost to calculate the cost of goods sold:
  • Average Unit Cost = (Total Unit Cost)/(Total Quantity of Units)

    Cost of Goods Sold = (Average Unit Cost) x (Number of Units Sold)

FIFO (First In, First Out) Method

  • Assumes goods sold are non-unique (that is, every one is similar to every other one)
  • Generally preferred cost of goods sold valuation method
  • Assumes inventory is sold in the order that it is stocked, with the oldest goods sold first and the newest goods sold last
  • Uses the unit cost per batch of acquired/produced goods, and counts the cost of goods forwards from the oldest batch:
  • Unit Cost per batch = (Cost/Quantity) for each batch

    Cost of Goods Sold = (Unit Cost x Quantity) for each batch

LIFO (Last In, First Out) Method

  • Assumes goods sold are non-unique (that is, every one is similar to every other one)
  • Is highly regulated (or, in some cases, illegal) as a method for measuring cost of goods sold
  • Assumes newest inventory is sold first, with the oldest goods sold last
  • Uses the unit cost per batch of acquired/produced goods, and counts the cost of goods sold backwards from the newest batch:
  • Unit Cost per batch = (Cost/Quantity) for each batch

    Cost of Goods Sold = (Unit Cost x Quantity) for each batch