Last reviewed: July 2026.
Cost of goods sold (COGS), also called cost of sales, is the carrying amount of inventory recognised as an expense when the related goods are sold. It links inventory accounting to gross profit.
For a periodic trading business, the basic formula is:
Opening inventory + Net purchases − Closing inventory = Cost of goods sold
COGS components
| Component | Treatment in a periodic system | Examples |
|---|---|---|
| Opening inventory | Add | Goods available at start of period. |
| Net purchases | Add | Purchases + carriage inward − returns − qualifying discounts/rebates. |
| Conversion cost | Add for manufacturers | Direct labour and allocated production overhead. |
| Closing inventory | Subtract | Unsold goods measured under IAS 2. |
| Inventory write-down or loss | Expense as required | Damage, obsolescence, shortages or NRV reduction. |
Worked trading example
A retailer has:
- Opening inventory: 80,000 CU
- Purchases: 420,000 CU
- Purchase returns: 15,000 CU
- Carriage inward: 10,000 CU
- Closing inventory: 95,000 CU
Net purchases = 420,000 − 15,000 + 10,000 = 415,000 CU.
COGS = 80,000 + 415,000 − 95,000 = 400,000 CU.
If sales are 650,000 CU, gross profit is 250,000 CU.
What belongs in inventory cost?
IAS 2 includes purchase costs, conversion costs and other costs incurred to bring inventory to its present location and condition. Purchase cost is after trade discounts, rebates and similar reductions.
Abnormal waste, many storage costs, unrelated administration and selling costs are normally expensed rather than included in inventory.
Read the IAS 2 inventory guide.
Carriage inward versus outward
Carriage inward to bring purchased goods to their present location and condition is generally part of inventory cost. Delivery costs incurred to sell or distribute finished goods are selling expenses unless another requirement applies.
Classify freight consistently using contract terms and the point when the entity controls the goods.
Trade discounts, settlement discounts and rebates
Trade discounts and supplier rebates reduce purchase cost. Settlement discounts require analysis of the economics and applicable policy, especially where linked to financing rather than the price of inventory.
The separate accounting for discounts guide covers IFRS 15 and purchaser treatment.
Periodic versus perpetual inventory
Under a periodic system, COGS is calculated at period end using the physical closing inventory. Purchases are accumulated during the period.
Under a perpetual system, each sale records an immediate cost-of-sales entry and reduces inventory. The system balance is still compared with a physical count, and differences are adjusted.
Journal entries in a perpetual system
Goods costing 6,000 CU are sold for 10,000 CU on credit:
- Debit trade receivables 10,000 CU; credit revenue 10,000 CU.
- Debit cost of goods sold 6,000 CU; credit inventory 6,000 CU.
The two entries separate sales value from inventory cost and produce gross profit of 4,000 CU before other expenses.
Manufacturing cost of sales
Manufacturers include direct materials, direct labour and systematic allocation of fixed and variable production overhead. Fixed overhead is allocated based on normal capacity; abnormal idle capacity is expensed.
Cost of goods manufactured is transferred from work in progress to finished goods, then recognised in COGS when products are sold.
Closing inventory and stocktaking
Closing inventory must be supported by quantity records, ownership, cut-off and valuation. Errors directly reverse into COGS.
Overstating closing inventory by 20,000 CU understates COGS by 20,000 CU and overstates gross profit by 20,000 CU.
Use the stocktaking procedures guide for count controls.
Lower of cost and net realisable value
If inventory cost is 50,000 CU but net realisable value is 44,000 CU, write inventory down by 6,000 CU. IAS 2 recognises the write-down as an expense in the period.
When conditions improve, a permitted reversal is limited to the original write-down, so inventory is not carried above cost.
Sales returns and purchase returns
Sales returns normally reverse revenue and restore inventory at the appropriate carrying amount when goods are returned in saleable condition. Purchase returns reduce purchases, trade payables or cash and remove the related inventory cost.
Damaged returned goods may need an NRV write-down rather than restoration at full original cost. Link credit notes to the original invoice and inventory movement.
Inventory shortages and abnormal losses
Physical shortages reduce inventory and increase expense. Analyse whether the loss is normal operational shrinkage, abnormal waste, theft or recording error. Abnormal losses should not be hidden within standard product cost.
Maintain separate variance reporting so management can distinguish price, usage, volume and count differences.
Service businesses and cost of services
Businesses that provide services may present cost of services or cost of revenue rather than inventory-based COGS. Direct labour, subcontractors and attributable delivery costs may form the cost measure, while general administration and selling costs remain operating expenses.
Presentation should reflect the nature of operations and applicable reporting requirements.
COGS and gross margin analysis
Gross margin percentage is:
Gross profit ÷ Revenue × 100
A rising COGS percentage can result from supplier prices, discounts, product mix, waste, theft, write-downs, pricing decisions or cut-off errors. Compare margins by product and period rather than relying only on the total.
Reconciliation controls
- reconcile inventory subledger to general ledger;
- match purchases to receipts and supplier invoices;
- review negative inventory and unusual costs;
- reconcile physical count differences;
- test purchase and sales cut-off;
- review slow-moving and damaged goods;
- compare standard cost variances with actual cost;
- analyse gross margin exceptions.
The trial balance to income statement guide shows how COGS affects profit reporting.
Common mistakes
- adding closing inventory instead of subtracting it;
- including selling and distribution costs in inventory;
- ignoring purchase returns and rebates;
- using recorded closing inventory without a reliable count;
- failing to recognise NRV write-downs;
- recording revenue but omitting the perpetual COGS entry;
- treating abnormal waste as inventory cost.
Key takeaway
COGS measures the inventory consumed by sales. Build it from reliable opening inventory, net purchases or production cost, closing inventory and IAS 2 valuation adjustments.
Official references: IAS 2 Inventories, ACCA process for preparing financial statements, and IFRS 15 Revenue from Contracts with Customers.