What Is COGS? Cost of Goods Sold Explained
What belongs in cost of goods sold and what doesn't, the periodic formula versus perpetual posting, and why the classification decision moves your gross margin.
Cost of goods sold is what the things you sold cost you. It is the expense that sits directly beneath revenue in the income statement, and the difference between the two is gross profit — the number that determines whether a business model works at all.
The defining property of COGS is that it is matched to revenue, not to time. Stock bought in March and sold in June is a March asset and a June expense. That single rule explains most of what follows.
What goes in, what stays out
In COGS:
- Purchase cost of goods that were sold
- Inbound freight, customs duties and other landed costs that got the goods to you
- Direct materials and direct labour in manufacturing
- Production overheads attributable to making the product
- Inventory write-downs and shrinkage (usually)
Not in COGS:
- Selling and marketing costs — these are period costs
- Administrative salaries, rent, software
- Outbound shipping to customers (commonly a selling expense)
- Depreciation of office equipment (but production-machine depreciation usually is in COGS)
- Interest and tax
The unifying test: would this cost exist if you hadn't produced or acquired the specific units you sold? Rent is paid whether you sell anything or not — period cost. The steel in the product is not — cost of sales.
Where it becomes a judgement call. Warehouse rent, production supervisors, quality control and inbound logistics can each be defended in either place. What matters is that the decision is made once and applied consistently, because moving a cost between COGS and overheads changes gross margin without changing net profit by a single cent. A gross margin that improved because a cost was reclassified is a company lying to itself, and it makes cross-company comparison of gross margins unreliable unless you know what each includes.
The two ways it is calculated
Periodic — derive COGS at period end from a stock count:
COGS = Opening inventory + Purchases − Closing inventory
Simple, and blind. You cannot know gross margin until you count, and shrinkage is invisible: stolen or damaged goods simply aren't in closing inventory, so their cost silently becomes COGS with no separate record that anything went missing.
Perpetual — record COGS at the moment of each sale, using the cost of the specific units consumed under the chosen cost-flow method. Inventory and COGS are correct continuously, gross margin is knowable per order, and a discrepancy between records and a physical count is a finding rather than an invisible adjustment.
The entries
Under a perpetual system, a sale produces two independent entries. Selling for 1,000 € plus 21% VAT goods that cost 640 €:
The revenue side:
| Account | Debit | Credit |
|---|---|---|
| 2410 Trade receivables | 1,210 | |
| 5000 Goods revenue | 1,000 | |
| 4492 VAT payable | 210 |
The cost side:
| Account | Debit | Credit |
|---|---|---|
| 6000 Cost of goods sold | 640 | |
| 2040 Goods for resale (stock) | 640 |
Gross profit on this sale is 360 €, and it is knowable immediately because both halves posted together. Note that the cost entry has nothing to do with VAT and nothing to do with the customer — it is purely the movement of value from asset to expense.
The mirror case: buying stock creates no COGS. It debits inventory and credits payables, and the cost waits on the balance sheet until the goods are sold. This is why a company can spend heavily on stock and report a healthy profit while cash drains — the working capital problem.
How Nordlet posts it
Inventory is perpetual, and COGS posts automatically when stock is consumed — at invoice issue or fulfilment, not at purchase. The posting rules make the two accounts explicit and configurable: inventory.cogs debits cost of goods sold (6000 by default in the Lithuanian chart of accounts) and inventory.stock credits the stock account (2040).
The amount comes from the FIFO engine: the cost of the specific layers consumed, which means a single sale drawing on three purchase batches produces a COGS figure built from three different unit costs. Because both the revenue and cost entries derive from the same document, the financial-statements report can compute a true gross profit — sales revenue from account group 50 minus cost of sales from group 60 — without anyone allocating anything by hand.
Two things follow that are worth stating. Service lines don't touch COGS — only stock-tracked items consume inventory, so a services invoice posts revenue with no cost entry, and gross margin on services is meaningful only if you separately assign the delivery cost. And inventory write-downs are manual: shrinkage found by a stock count and net-realisable-value adjustments are posted as journal entries rather than derived automatically, though /v1/reports/stock-aging will show you where to look.
Reading the number
- Track COGS as a percentage of revenue, not in euros. 104,000 € of cost of sales means nothing; 57.8% of revenue means your gross margin is 42.2%, and a move to 60% is a problem worth a morning.
- Split it by product line where you can. A blended gross margin hides the products losing money inside the ones making it.
- Watch it against inventory. COGS rising while inventory rises faster means you are buying ahead of demand; COGS flat while inventory falls means you are selling stock you are not replacing.
- Beware period-end distortions. Under a periodic system, an inaccurate stock count moves COGS directly — the count is the calculation.
FAQ
What is included in cost of goods sold?
The direct cost of the goods sold: purchase or production cost, inbound freight and duties, direct materials and labour, and attributable production overheads. Selling, administrative and financing costs are excluded because they attach to the period rather than to units sold.
Is COGS the same as cost of sales?
In everyday use, yes. "Cost of goods sold" tends to be used by businesses selling physical products, "cost of sales" is the broader term also used by service businesses, and financial statements commonly use the latter.
Do service businesses have COGS?
They have an equivalent — the direct cost of delivering the service, typically the salaries of the people who did the work. Whether it is presented as cost of sales or within operating expenses is a presentation policy, but separating it is what makes a services gross margin meaningful.
Does buying inventory create cost of goods sold?
No. Purchasing stock converts cash (or a payable) into an asset. The cost only becomes an expense when the goods are sold — that matching is the entire reason gross profit means anything.
How does inventory valuation affect COGS?
Directly. FIFO charges the oldest costs first, weighted average charges a blended cost, and the two give different COGS and different closing inventory from identical transactions. Which method you use is an accounting policy that must be applied consistently.