Why Does a Business Need to Prepare a Cost of Goods Sold Schedule?

(Last Updated On: May 10, 2021)

Businesses constantly evaluate their operation and production practices to make sure they are running as efficiently as possible. One accounting tool which helps companies locate a weakness in their production strategies is the cost of goods sold schedule. This report is a valuable part of the income statement that provides tremendous insight into the net profit earned during a particular tax year, the end of the year, or even a smaller period of time.

There are many different types of costs. Sometimes referred to as a cost of sales report, the determination of cost of goods sold schedule or COGS calculation includes only the purchases and expenses that are directly necessary for the production of a product. Specifically, the manufacturing business or manufacturing plant schedule includes materials, factory equipment with depreciation cost, manufacturing overhead expenses such as utilities, rent, factory insurance, and direct labor required to manufacture the product. It does not include any labor incurred to market or sell the product. For example, if a company manufactures bicycles, their cost of goods sold schedule could include items such as parts and the labor costs or cost of labor of those who actually put the bicycles together. It would not include the costs of distribution, and it also would not include the costs of any bicycles that did not sell during that reporting period. It is also important to note that the cost of goods sold schedules are only prepared for companies that sell products. Businesses that produce only services do not require a cost of goods sold schedule.

In general, most COGS schedules are prepared the same way. The first entry is the beginning raw materials inventory or beginning inventory plus the amount of additional raw material cost during the period. The actual purchases of raw materials used are subtracted to give the final raw inventory balance. Direct labor and overhead costs are added to give a total manufacturing cost and the manufacturing cost per unit. That number is used to calculate the costs of goods sold by starting with the beginning finished goods inventory account, adding the cost of goods manufactured, and subtracting ending inventory or finished goods inventory to find the true costs of goods sold. You can process inventory by either using the FIFO method or the LIFO method, standing for first in, first out and last in, and first out.

Why Is The Cost Of Goods Sold Schedule Important To A Business?

It is important to calculate the cost of goods sold, including the schedules of raw materials, annually based on the company’s fiscal year. It is necessary in order to prepare a proper business tax return, and it is also a useful tool to formulate strategies for the upcoming year. However, a schedule of the cost of goods sold can be prepared for shorter periods in order to provide comparison testing data throughout the year.

Having a good understanding of how the cost of goods sold schedule affects a business financially overall is critical because it usually represents the largest expense the company will incur. The expense of direct materials and direct labor costs has a direct correlation with the net profit of a company, and an increase in COGS will usually mean a decrease in the net profit. This can be observed in the company’s financial statements.

The fact of the matter, it is possible for the costs of goods sold to increase even when sales are decreasing. This could be caused by many factors. However, one of the most common reasons is the number of materials purchased. The ability to buy in bulk will help to reduce the costs of goods sold and help to meet margins of lower sales numbers.

Another way to decrease the amount of cost of goods sold, which results in the finished product price when gross receipts are down, is to attempt to lock the price of products for a long period of time. Being a great negotiator is key to securing positive price points for materials, and the longer those can be locked in, the better.

Automation of the manufacturing process can also be a big benefit of reducing COGS. Machines tend to be much more efficient and productive, and a fully automated system can run all day long without a need to stop. This could help to increase the output of finished products while decreasing operating expenses to the company.

There are some personal service businesses that do not include COGS on their income statements, such as painters, lawyers, and carpenters.

Investors, such as external financial statement users, need to know the final cost of goods COGS when analyzing the financial health and stability of a company so they can compare the business against competitors. When it comes time for taxes, sole proprietors and single-member LLCs will include COGS on their tax return under Schedule C, part III, which will determine the company’s results and affect the company’s net income and tax bill. Management accountants specialize in the allocation of production and proper cost assignment. The FASB has specific guidelines for reporting the allocation of production overhead to inventory.