How to calculate cost of goods sold

Because business.gov.au's definition takes in services as well as goods, the figure looks different from one kind of business to the next:

• A shop or wholesaler counts the cost of the stock it sold.
• A maker counts the materials and production labour in what it sold. business.gov.au's inventory guidance lists the main types of inventory as raw materials, work in progress and finished goods.
• A service business counts the costs that go straight into delivering its work, such as subcontracted labour and job materials.

Administrative rent, office wages and marketing commonly sit outside cost of goods sold, but production-related costs may be treated differently. Settle the treatment of production costs, packaging and freight with your accountant and apply it consistently.

Where stock is counted rather than tracked item by item, cost of goods sold is worked out at the end of each period in words like this: stock on hand at the start, plus stock bought during the period, less stock still on hand at the end.

• Opening stock is the closing stock figure from the end of the previous period. It should not be recounted or re-estimated.
• Purchases are the stock bought in the period at cost, less anything returned to suppliers or credited by them.
• Closing stock is the value of stock still on hand at the last day of the period, taken from a stocktake.

business.gov.au calls this a periodic system: stock is counted by hand and the records are updated manually on paper or in a spreadsheet.

Closing stock carries a lot of weight here. If the count had missed a rack of bikes, closing stock would be lower, cost of goods sold higher and gross profit lower by the same amount. A count that included stock already sold would do the reverse.

In a perpetual system, as business.gov.au describes it, software or the point-of-sale system adjusts the stock records with every purchase and sale. Each sale records the cost of the item that left, so cost of goods sold builds up through the period instead of being worked out at the end.

The records still need checking against the shelves. business.gov.au describes a stocktake as counting the stock by hand to test it against the inventory records, and says most businesses count monthly or quarterly.

A difference can be a shortage or an overage. Look for miscounts, sales or returns that were never entered and deliveries recorded twice before treating it as lost stock. Which account a confirmed difference is recorded in is a question for your accountant.

A business that sells its time may hold little or no stock, but it can still have direct costs: subcontractors on client work, materials used on jobs and pay for staff whose hours are charged to clients. Recording those in their own accounts, separate from overheads, gives a cost of goods sold figure, often called cost of sales, that can be compared with sales each month.

Work that has been done but not yet billed at the end of a period raises its own questions about which period the costs belong to. Ask your accountant how to handle it.

• Counting stock on a different day from the period end, so sales or deliveries in between land in the wrong period.
• Entering a supplier's bill after the period closes when the stock arrived before it, on books kept on an accrual basis. Accrual books, business.gov.au explains, record a cost when it is incurred, whether or not it has been paid.
• Leaving stock that is in transit, or held by someone else, out of the count without checking who owns it.
• Not recording stock the owner takes for personal use, or gives away as samples. How to record it is a question for your accountant.
• Coding overheads, such as shop rent or office wages, to a cost of sales account.

Where sales are above zero, divide cost of goods sold by sales for the same period and compare the result with earlier periods. A sudden jump or drop with no change in prices or suppliers usually points to a counting or entry error rather than a change in trading.

Keep the stocktake sheets and the workings with the period's records. business.gov.au suggests setting the latest and previous stocktake counts beside your sales records, which picks out the fast sellers and the lines that haven't moved.