Here we will explore how to calculate Cost of Goods Sold. Before we proceed it is essential to understand that the below explanation and Cost of Goods Sold represents concept applicable only to manufacturing or to trading business. It cannot be applied to the businesses which provide services, since such business do not produce or sell goods, therefore there will be no Inventory (manufactured or purchased) and there will be no Cost of Goods Sold.
For the manufacturing or trading business it is important to understand that we must apply matching principle and match revenues earned with the costs incurred to earn such revenue.
From the picture below you can note that only costs of that inventory, which was sold during the particular period of time can be included into the Income Statement. All the inventory, which was not yet sold during the accounting period is accounted for in the Balance Sheet until is being sold.
In this was we follow matching principle of the financial accounting.
Usually we analyse and account for transactions on already operating business, therefore the manufacturing and/or trading flow is continuous, i.e. inventory being purchased/manufactured, stored, sold and process runs again and again.
In order to understand how to find cost of goods sold, we will use the following Cost of Goods Sold formula:
Beginning Inventory+Purchased/Manufactured Inventory=Inventory Available For Sale
Inventory Available for Sale-Ending Inventory=Inventory Sold
In the above formula costs in monetary means are being used. Only cost of inventory sold will go to the Income Statement and will be included into the Cost of Good Sold.