{"id":190,"date":"2024-09-06T16:47:19","date_gmt":"2024-09-06T16:47:19","guid":{"rendered":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/cost-of-goods-sold\/"},"modified":"2024-09-11T19:06:00","modified_gmt":"2024-09-11T19:06:00","slug":"cost-of-goods-sold","status":"publish","type":"chapter","link":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/cost-of-goods-sold\/","title":{"raw":"Cost of Goods Sold","rendered":"Cost of Goods Sold"},"content":{"raw":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\r\n<ul>\r\n \t<li>Describe cost of goods sold in relation to the matching principle<\/li>\r\n<\/ul>\r\n<\/section>Remember, under accrual basis accounting, we recognize revenue as it is earned and expenses as they are incurred in order to match those expenses with the revenue.\r\n\r\nIt means when we buy inventory, and it is sitting on the lot, lying on the shelf, or hanging on a rack, it is not an expense.\r\n\r\nAgain, inventory is not recorded as an expense when we buy it from the wholesaler or distributor. It is an asset: something we own that will produce future revenue.\r\n\r\nLet\u2019s say Chan Ming owns a sporting goods store. He buys 10 baseball bats from his supplier, AshBats, Inc. at $10 per bat. He just spent $100 on inventory (probably on account, so he now owes AshBats $100). He places three bats on display right inside the front door in a nice rack with some other wooden and aluminum bats, and he puts the other seven in the back storage area.\r\n\r\nWe won\u2019t write the journal entry for this transaction. Instead, as the sporting good store\u2019s accountants, we\u2019ll just use T accounts to describe the entry:\r\n<div class=\"table-wrapper\">\r\n<table class=\"fin-table tchart\"><caption>Inventory<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"u-sr-only\" scope=\"col\">Debit<\/th>\r\n<th class=\"u-sr-only\" scope=\"col\">Credit<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td class=\"r\">100<\/td>\r\n<td class=\"r\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<td class=\"r\"><\/td>\r\n<td class=\"r\"><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<table class=\"fin-table tchart\"><caption>Accounts Payable<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"u-sr-only\" scope=\"col\">Debit<\/th>\r\n<th class=\"u-sr-only\" scope=\"col\">Credit<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td class=\"r\"><\/td>\r\n<td class=\"r\">100<\/td>\r\n<\/tr>\r\n<tr>\r\n<td class=\"r\"><\/td>\r\n<td class=\"r\"><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\nNext, let\u2019s record the sale of a bat to a customer for $15 using a debit card, described below with T accounts in order to save space. The only balance included is inventory because we don\u2019t have room or time to put all the other data into those accounts.\r\n\r\n<a href=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134049\/Cost-of-goods-sold2.png\"><img class=\"alignnone size-full wp-image-5594\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134049\/Cost-of-goods-sold2.png\" alt=\"Two T accounts side by side. On the left is a checking account. There is a debit entry of 15 dollars labeled (a). On the right is an inventory chart. On the debit side, there's a balance carried forward of 100 dollars. There is a credit entry labeled (b) of 10 dollars. There is a total debit balance of 10 dollars.\" width=\"640\" height=\"180\" \/><\/a>\r\n\r\n<a href=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134051\/Cost-of-goods-sold3.png\"><img class=\"alignnone size-full wp-image-5595\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134051\/Cost-of-goods-sold3.png\" alt=\"Two T accounts side by side. On the left is a sales revenue chart. There is a credit entry of 15 dollars, labeled (a). On the right is a cost of goods sold chart. There is a debit entry of 10 dollars, labeled (b).\" width=\"733\" height=\"197\" \/><\/a>\r\n\r\nThe sale increased the businesses checking account by $15, so we debited checking and credited Sales Revenue (a).\r\n\r\nIn addition, one $10 bat left the store in the hands of a happy customer, so inventory decreased by $10 and we recorded a corresponding expense that offsets the $15 revenue (b).\r\n\r\nUnder the matching principle, we record the expense when we recognize the revenue from the bats. This is one of the most direct examples of the matching principles you will ever use.\r\n\r\nIf we look at the physical inventory right after that sale, there are 9 bats left that cost $10 each, so the $90 in the accounting records for Inventory is spot on. In addition, we recorded an expense called Cost of Goods Sold that represents the one bat sold, and offsets the $15 in revenue, showing us we made a profit of $5 on that one bat. Of course, that\u2019s not really our profit because we still have to pay rent on the store, insurance, our employees\u2019 wages, and other expenses. But, for this one transaction, before any other deductions, we have a perfectly matched revenue and expense picture.\r\n\r\n<img class=\"aligncenter size-large wp-image-6307\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/18183556\/InventoryAccounting-1024x380.jpg\" alt=\"Total Opening inventory is divided in to Sold Inventory and Unsold Inventory. Sold inventory = cost minus income statement. Unsold inventory equals cost minus balance sheet.\" width=\"1024\" height=\"380\" \/>\r\n\r\nHow would this account have looked if we recorded the $100 purchase of bats as an expense? Fifteen dollars in revenue against $100 expense? That entry wouldn't have the most useful information because we will have 9 bats to sell. Thus, accrual basis accounting includes inventory and cost of goods sold. That is the major difference between accounting for merchandising (and manufacturing) and service businesses.\r\n\r\nNext, we\u2019ll take a closer look at the difference between the sales price and the cost of goods sold., But first, check your understanding of the concept of cost of goods sold.\r\n\r\n<section class=\"textbox tryIt\" aria-label=\"Try It\">[ohm2_question hide_question_numbers=1]25161[\/ohm2_question]<\/section>","rendered":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\n<ul>\n<li>Describe cost of goods sold in relation to the matching principle<\/li>\n<\/ul>\n<\/section>\n<p>Remember, under accrual basis accounting, we recognize revenue as it is earned and expenses as they are incurred in order to match those expenses with the revenue.<\/p>\n<p>It means when we buy inventory, and it is sitting on the lot, lying on the shelf, or hanging on a rack, it is not an expense.<\/p>\n<p>Again, inventory is not recorded as an expense when we buy it from the wholesaler or distributor. It is an asset: something we own that will produce future revenue.<\/p>\n<p>Let\u2019s say Chan Ming owns a sporting goods store. He buys 10 baseball bats from his supplier, AshBats, Inc. at $10 per bat. He just spent $100 on inventory (probably on account, so he now owes AshBats $100). He places three bats on display right inside the front door in a nice rack with some other wooden and aluminum bats, and he puts the other seven in the back storage area.<\/p>\n<p>We won\u2019t write the journal entry for this transaction. Instead, as the sporting good store\u2019s accountants, we\u2019ll just use T accounts to describe the entry:<\/p>\n<div class=\"table-wrapper\">\n<table class=\"fin-table tchart\">\n<caption>Inventory<\/caption>\n<thead>\n<tr>\n<th class=\"u-sr-only\" scope=\"col\">Debit<\/th>\n<th class=\"u-sr-only\" scope=\"col\">Credit<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td class=\"r\">100<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td class=\"r\"><\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<table class=\"fin-table tchart\">\n<caption>Accounts Payable<\/caption>\n<thead>\n<tr>\n<th class=\"u-sr-only\" scope=\"col\">Debit<\/th>\n<th class=\"u-sr-only\" scope=\"col\">Credit<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td class=\"r\"><\/td>\n<td class=\"r\">100<\/td>\n<\/tr>\n<tr>\n<td class=\"r\"><\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>Next, let\u2019s record the sale of a bat to a customer for $15 using a debit card, described below with T accounts in order to save space. The only balance included is inventory because we don\u2019t have room or time to put all the other data into those accounts.<\/p>\n<p><a href=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134049\/Cost-of-goods-sold2.png\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-5594\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134049\/Cost-of-goods-sold2.png\" alt=\"Two T accounts side by side. On the left is a checking account. There is a debit entry of 15 dollars labeled (a). On the right is an inventory chart. On the debit side, there's a balance carried forward of 100 dollars. There is a credit entry labeled (b) of 10 dollars. There is a total debit balance of 10 dollars.\" width=\"640\" height=\"180\" \/><\/a><\/p>\n<p><a href=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134051\/Cost-of-goods-sold3.png\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-5595\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/12134051\/Cost-of-goods-sold3.png\" alt=\"Two T accounts side by side. On the left is a sales revenue chart. There is a credit entry of 15 dollars, labeled (a). On the right is a cost of goods sold chart. There is a debit entry of 10 dollars, labeled (b).\" width=\"733\" height=\"197\" \/><\/a><\/p>\n<p>The sale increased the businesses checking account by $15, so we debited checking and credited Sales Revenue (a).<\/p>\n<p>In addition, one $10 bat left the store in the hands of a happy customer, so inventory decreased by $10 and we recorded a corresponding expense that offsets the $15 revenue (b).<\/p>\n<p>Under the matching principle, we record the expense when we recognize the revenue from the bats. This is one of the most direct examples of the matching principles you will ever use.<\/p>\n<p>If we look at the physical inventory right after that sale, there are 9 bats left that cost $10 each, so the $90 in the accounting records for Inventory is spot on. In addition, we recorded an expense called Cost of Goods Sold that represents the one bat sold, and offsets the $15 in revenue, showing us we made a profit of $5 on that one bat. Of course, that\u2019s not really our profit because we still have to pay rent on the store, insurance, our employees\u2019 wages, and other expenses. But, for this one transaction, before any other deductions, we have a perfectly matched revenue and expense picture.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-large wp-image-6307\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/10\/18183556\/InventoryAccounting-1024x380.jpg\" alt=\"Total Opening inventory is divided in to Sold Inventory and Unsold Inventory. Sold inventory = cost minus income statement. Unsold inventory equals cost minus balance sheet.\" width=\"1024\" height=\"380\" \/><\/p>\n<p>How would this account have looked if we recorded the $100 purchase of bats as an expense? Fifteen dollars in revenue against $100 expense? That entry wouldn&#8217;t have the most useful information because we will have 9 bats to sell. Thus, accrual basis accounting includes inventory and cost of goods sold. That is the major difference between accounting for merchandising (and manufacturing) and service businesses.<\/p>\n<p>Next, we\u2019ll take a closer look at the difference between the sales price and the cost of goods sold., But first, check your understanding of the concept of cost of goods sold.<\/p>\n<section class=\"textbox tryIt\" aria-label=\"Try It\"><iframe loading=\"lazy\" id=\"ohm25161\" class=\"resizable\" src=\"https:\/\/ohm.one.lumenlearning.com\/multiembedq.php?id=25161&theme=lumen&iframe_resize_id=ohm25161&source=tnh\" width=\"100%\" height=\"150\"><\/iframe><\/section>\n","protected":false},"author":6,"menu_order":4,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Cost of Goods Sold\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"part":186,"module-header":"- Select Header -","content_attributions":[{"type":"original","description":"Cost of Goods Sold","author":"Joseph Cooke","organization":"Lumen Learning","url":"","project":"","license":"cc-by","license_terms":""}],"internal_book_links":[],"video_content":null,"cc_video_embed_content":{"cc_scripts":"","media_targets":[]},"try_it_collection":null,"_links":{"self":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/190"}],"collection":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/users\/6"}],"version-history":[{"count":3,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/190\/revisions"}],"predecessor-version":[{"id":920,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/190\/revisions\/920"}],"part":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/parts\/186"}],"metadata":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/190\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/media?parent=190"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=190"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/contributor?post=190"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/license?post=190"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}