Ever stared at your income statement and wondered, “What type of account is cost of goods sold?” Don’t worry; you’re not alone. The Cost of Goods Sold (COGS) sounds like some secret code accountants use to confuse the rest of us. Spoiler alert: it’s not an asset or liability lurking on your balance sheet. Nope, it’s actually an expense that shows up on your income statement. Mind blown yet?

In this article, we’ll unravel the mystery of COGS and explain why it’s the unsung hero (or villain) of your business profits. Strap in; we’re diving deep into the world of COGS—bringing clarity, a sprinkle of humor, and actionable insights to help you master your finances.

Related: What Type of Account is Sales Discounts?

What Is Cost of Goods Sold?

So, what is this Cost of Goods Sold everyone keeps talking about? Simply put, COGS (also known as cost of sales) represents the direct costs tied to producing the goods or services your company sells. Think materials, labor, and manufacturing overhead—the whole shebang that gets your product ready for prime time.

Picture this: If your business was a rock band, COGS would be the drummer—keeping the beat but rarely getting the spotlight. It’s essential, but often overlooked.

The cool thing (if accounting can be cool) is that COGS appears on your income statement. That’s right, it’s rubbing shoulders with revenue and expenses, showing you the nitty-gritty of your profitability during a specific period—be it a month, quarter, or year. You’ll typically find COGS nestled right below “Revenue” or “Sales” on the income statement. They’re like that inseparable duo you always see together at parties.

For example, check out Apple’s statement of operations. (Because who doesn’t want to be like Apple?) Right after the top-line figure “Net Sales,” you’ll spot COGS making its grand appearance.

COGS is all about the direct costs—the stuff that goes straight into making your products or services. It excludes indirect expenses like distribution costs, marketing, or the coffee budget for your sales team (sorry, folks).

Here’s a quick rundown of what typically makes up COGS:

• The cost of raw materials
• Parts used to make a product
• Containers or packaging
• Direct labor costs (including payroll taxes and benefits)
• Supplies used in production
• Items purchased for resale
• Manufacturing overhead directly tied to production

Imagine you’re an automaker. Your COGS includes the steel, rubber, glass, and wages of the workers assembling the cars. What it doesn’t include? The cost of shipping those cars to dealerships or the commissions of the slick salespeople convincing customers they need an upgrade. Only the direct costs get a VIP pass into COGS.

And here’s a fun tax twist: The IRS requires businesses that produce or sell goods to calculate COGS. Why? Because it lowers your taxable income. Higher COGS means less profit, which means fewer taxes. Uncle Sam is generous like that—sometimes.

Calculating COGS

Ready for some number magic? Calculating COGS isn’t as scary as it sounds. Here’s the formula that accountants dream about:

COGS = Beginning Inventory + Purchases During the Period – Ending Inventory

Let’s break that down without putting you to sleep:

• Beginning Inventory: What you had in stock at the start of the period.
• Purchases During the Period: Any new inventory you bought or produced.
• Ending Inventory: What’s left unsold at the end of the period.

So, if you started the year with $3,000 in inventory, bought $1,200 worth of new supplies, and ended the year with $1,000 in inventory, your COGS would be:

COGS = $3,000 + $1,200 – $1,000 = $3,200

Voila! Your cost of goods sold is $3,200. Easy peasy, right?

Remember, only the costs of goods that were actually sold during the period make it into the COGS calculation. Unsold inventory? That’s like the leftovers in your fridge—still there, waiting for their moment.

What Type of Account Is Cost of Goods Sold?

Drumroll, please! 🎉 The Cost of Goods Sold is an expense account. Yes, it’s classified as an expense on your income statement—not an asset, liability, or equity account. It’s the financial embodiment of “you gotta spend money to make money.”

The income statement (also known as the profit and loss statement) is all about capturing revenue and expenses over a specific period. Assets, liabilities, and equity? Those hang out on the balance sheet—a different party altogether.

Expense accounts on the income statement include all the usual suspects:

• Cost of Goods Sold
• Operating Expenses
• Finance Expenses
• Non-Operating Expenses
• Prepaid Expenses
• Accrued Expenses

In accounting terms, expenses are like the villains that decrease the owner’s equity. They have a debit balance, which means debiting an expense account increases it, while crediting decreases it. But don’t worry, we won’t make you relive Accounting 101 nightmares.

Cost of Goods Sold as an Expense Account

Let’s get into the nitty-gritty of journal entries (hold your excitement). When you record COGS, you’re essentially moving costs from inventory (an asset on your balance sheet) to an expense on your income statement (when you sell the inventory). It’s like transferring funds from your savings to checking—only less fun.

Here’s how the journal entry typically looks:

Date	Account	Notes	Debit	Credit
01/01/2022	Cost of Goods Sold Expense	Sold materials cost	$3,200
	Inventory			$3,200

This entry shows that you’re debiting the COGS expense account (increasing it) and crediting the inventory account (decreasing it). Essentially, you’re acknowledging that goods have been sold, and their costs are now expenses.

Why does this matter? Because expenses reduce your net income, which in turn affects your equity. It’s the financial circle of life—cue the Lion King music.

Takeaways

• COGS is an Expense Account: It shows up on your income statement as a deduction from revenue, impacting your gross profit.
• Direct Costs Only: COGS includes direct costs like materials and labor but excludes indirect expenses like marketing and distribution.
• Important for Taxes: Calculating COGS accurately can lower your taxable income, but be cautious—it also lowers your reported profit.
• Formula to Remember: COGS = Beginning Inventory + Purchases During the Period – Ending Inventory.
• Affects Business Decisions: Understanding COGS helps you price your products correctly and identify areas where you can cut costs to improve profitability.

Now that you’re armed with this knowledge, go forth and conquer your financial statements! Or at least, don’t let them conquer you.

Related: Is Sales Discount Debit or Credit?