Some business owners who are not familiar with accounting may have a big doubt in their mind when they calculate the cost of goods sold for their companies: Should they include it as an expense? The answer to this question is yes, yet some of them who do not know this may end up being confused and as a result, they are unable to calculate the company’s profit correctly. If you are one of them, do not hesitate to seek help from the experts from an accounting firm in Johor Bahru. Knowing the cost of goods sold of your company well is crucial for you to have an in-depth understanding of the financial position of your business. Otherwise, your company will eventually fall into a serious financial crisis without you knowing.
Typically, the cost of goods sold is the most substantial expense incurred in a company. This line item shows the sum of expenses a business has incurred to produce goods or services that it has sold. According to the matching principle, people would assume that the cost of goods sold and the sales link to each other. Hence, when a sale takes place and you recognise the revenue that you have earned from it (Also see Can You Differentiate Net Income and Net Sales?), you should recognise the cost of goods sold as a crucial offsetting expense simultaneously. Thus, it is clear that you should take cost of goods sold as an expense. In your income statement, you will see it before the line items for selling and administrative and immediately after the line items for sales.
If your company has not made any sales on the goods or services, then theoretically, there is no cost of goods sold. Rather, you will record the costs that are related to your company’s goods or services in your inventory asset account, which is a type of current asset in your balance sheet. In fact, some of the costs that are documented in the cost of goods sold account are probably period expenses (Also see Understanding Product Costs and Period Costs), which you cannot capitalize into your fixed assets, inventories or prepaid expenses. These costs may not be directly related to the goods or services of your company and you should not allocate them as the cost of goods sold. Besides, even if the company has no production at all, it may still need to spend some expenses which are related to its production, for example, it still has to pay for the facility rent. In such situations, there may be cost of goods sold expense although the company has not made any sales.
As time passes, the cost of goods sold may vary significantly as a result of the changes in various areas of a company such as the amount of spoilage and scrap it has experienced, labour cost, costs on purchasing raw materials, the ways it allocates overhead, costs of overhead it allocates on its products, and many other issues.