Mastering the Cost of Goods Sold Journal Entry in 2024

What Is Cost of Goods Sold and Why Track It?

As business owners, you need to understand your unit economics inside and out. A key part of that is tracking our cost of goods sold (COGS). COGS are the direct costs of creating the products you sell.

Why is COGS important?

COGS directly impacts your gross profit margin and net income. The lower your COGS, the higher your profit margins. Tracking COGS also gives you insights into potential cost-saving opportunities and helps you make better pricing decisions. If COGS rises, you may need to increase your prices to maintain strong margins.

Using COGS data to your advantage

Monitoring COGS per unit over time helps you spot trends and make adjustments. If COGS per unit rises significantly, you may need to determine why and take action. You can look for ways to reduce the cost of components, renegotiate with your suppliers, look for new suppliers, find cheaper modes of transport,  looks for alternative duties codes to product under, or reduce packaging or labor costs as examples.  

How to Make a Cost of Goods Sold Journal Entry

Keeping accurate records of your inventory and cost of goods sold (COGS) can unfortunately be more difficult than it sounds, but it is crucial to maintaining the financial health of your business. Making a COGS journal entry allows you to track your inventory costs and ensure our financial statements are correct.

Identify the Cost of Inventory Sold

First, review your sales and purchase order (PO) invoices to determine the total cost of inventory that was sold during the accounting period. This includes the purchase price you paid for the inventory, as well as any additional costs to get the inventory ready for sale like shipping or customization fees.

Calculate the Cost of Goods Available for Sale

Next,  calculate the cost of goods available for sale by adding your beginning inventory balance to the total cost of inventory purchases made during the period. From there, you subtract the cost of inventory sold to determine our ending inventory balance.  We share an examples later in this post.

Record the Journal Entry

Finally, you record the following journal entry:

- Debit Cost of Goods Sold for the total cost of inventory sold

-Credit Inventory for the same amount

This entry reduces our inventory asset account and increases our cost of goods sold expense account.

By regularly reviewing and analyzing your COGS journal entries, you can identify trends in  inventory costs and make better purchasing decisions. You can also ensure your inventory levels are appropriate for your level of sales.

Cost of Goods Sold and Your Balance Sheet

COGS is recorded on the income statement.  At the top of your income statement you will first see the components to calculate gross margin - Revenue and COGS.  

COGS also affects the inventory value reported on our balance sheet. The inventory value represents the cost of unsold goods still on hand. To calculate this, you start with the costs of materials, labor, and overhead used to produce inventory during the period. From this total, you subtract the COGS for items that were sold, leaving the cost of inventory still on hand.

For example, if it cost you $100,000 to produce inventory this month, and our COGS was $80,000 for goods sold, our inventory value would be $100,000 - $80,000 = $20,000. The inventory value is an asset on the balance sheet because it represents potential future economic benefits. As you sell more of our inventory, the asset value declines while COGS increases.

Cost of Goods Sold Journal Entry - Simple Example

Robin Golf is a company that makes modern golf equipment.  Let's look at a simple example using one of their products - the Large Junior Golf Set.  Let's assume that:

• Robin Golf sells one (1x) unit of its Large Junior Golf Set.
• The cost of goods for the Large Junior Golf Set is $100.
• There are currently 10 units of the Large Junior Golf Set in inventory.
• The selling price of the Large Junior Golf Set is $300.

Step 1: Record the sale of the Large Junior Golf Set.

Step 2: Record the cost of goods sold for the Large Junior Golf Set.

After this transaction, the inventory for the Large Junior Golf Set would be reduced to 9 units.

Step 3: Update the inventory balance. The inventory balance is automatically updated in the perpetual inventory system. The new inventory balance for the Large Junior Golf Set would be:

In summary, when Robin Golf sells one unit of its Large Junior Golf Set for $300, the following journal entries are made:

1. Debit Accounts Receivable and credit Sales for the selling price of $300.
2. Debit Cost of Goods Sold and credit Inventory for the cost of the sold item, which is $100.

The inventory balance is then automatically updated to reflect the remaining 9 units of the Large Junior Golf Set, with a total cost of $900.

Cost of Goods Sold Journal Entry - Complex Example

Now let's look at a more complex example that includes multiple products, inventory added, and sales.

Let's assume:

Beginning Inventory:

- Product A: 500 units @ $10 each

- Product B: 750 units @ $15 each

- Product C: 1,000 units @ $8 each  

Inventory Purchased:

- Product A: 200 units @ $11 each

- Product B: 300 units @ $16 each

- Product C: 500 units @ $9 each

Inventory Sold:

- Product A: 450 units @ $20 each

- Product B: 600 units @ $25 each

- Product C: 800 units @ $18 each

Connecting COGS to Inventory Management and Accounts Receivable

If you are a company that sells physical goods, you are going to live and die by your Inventory. The products you sell are assets, and you have to value them properly in our inventory accounting. If you don’t accurately track inventory, your COGS will be off, and you won’t have a clear picture of our profits. It's essential to review inventory records regularly and perform periodic physical counts to verify that what’s on the books matches what’s actually on your shelves.

Discrepancies in your inventory and COGS can cause a multitude of problems for your business including over or understating gross profit, over or underpaying taxes, reporting inaccurate financial statements, making poor pricing decisions, and having difficulty securing financing.  

Accounts receivable is also tied to COGS. When you make a sale, you record the revenue, but you don’t actually receive the cash right away. The amount the customer owes you is recorded in accounts receivable. If you sell on credit, you have to estimate the uncollectible portion of accounts receivable to properly record COGS. If you overestimate, our COGS will be too high. If you underestimate, our COGS will be too low, and you’ll end up with bad debt expense when customers default.

Monitoring inventory, accounts receivable, and COGS together helps you gain insights into your business. You can spot trends, anticipate issues, and make better decisions. Keeping a close eye on the connections between these financial metrics is key to effectively managing our company’s performance and planning for continued success and growth. With diligent record-keeping and frequent reviews, you can master the COGS journal entry and keep our business running smoothly.

FAQs About Cost of Goods Sold Journal Entries

What exactly is a cost of goods sold journal entry?

The cost of goods sold (COGS) journal entry records the costs of the goods you sold during an accounting period. It’s used to calculate our gross profit and appears on our income statement.

What costs are included in the COGS journal entry?

The COGS journal entry includes all direct costs involved in selling our products. This typically includes:

• The cost of raw materials and supplies used in production

• Direct labor costs (wages for employees who make the products)

• Overhead costs directly related to production (e.g. utilities for a factory)

• The cost of merchandise purchased for resale

When do we record the COGS journal entry?

You record the COGS journal entry whenever you sell goods. This means if you manufacture and sell goods, you record COGS when you ship the goods to customers. If you purchase goods for resale, you record COGS when you sell the goods to customers. The COGS journal entry ensures our income statement accurately reflects the costs associated with the revenue you generated from sales.

How do we calculate the amount of the COGS journal entry?

To calculate the COGS journal entry amount, you add up the costs of the goods that you sold during the accounting period. This includes the costs of raw materials, direct labor, and overhead used in production as youll as the cost of merchandise purchased for resale. The total of these costs is the amount of your COGS journal entry.

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