Cost of Sales: A Definitive Guide (With Example)

Cost of sales (also known as “cost of goods sold”) refers to the cost required to manufacture or purchase a product that is then sold to a customer. Essentially, the cost of sales refers to what the seller has to pay in order to create the product and get it into the hands of a paying customer.

Cost of Sales: definition and calculation

What to include in cost of sales

All expenses that are directly related to producing or selling goods are included in the cost of sales. Cost of sales always includes direct labor and direct materials. When some employees are directly in charge of selling the product to customers, the cost of sales may occasionally also include the cost of the commissions they receive.

Depending on the circumstances, some organizations may also include overhead, sales, and distribution costs if they directly contribute to getting the product to consumers:

What is cost of sales?

The total of all expenses incurred to produce a good or service that has been sold to customers is the cost of sales. It assesses a company’s capacity to develop, procure, and produce a product at a competitive price.

The terms “cost of sales,” “cost of goods sold,” and “cost of revenue” can all be used interchangeably, but depending on their industry, some companies may prefer one over the others. Businesses that provide both products and services may occasionally include both costs of sales and costs of goods sold in their financial statements. For example:

Since many of the same components are used in both, the cost of sales and the cost of the product are closely related. However, product costs show up as inventory on a balance sheet, whereas cost of sales appears on an income statement.

How to use cost of sales in financial reporting

On an income statement, the cost of sales is near the top. Nevertheless, a portion of its value is initially recorded in a number of accounts on a balance sheet. Many companies may do this when using the periodic inventory system to record their costs of sales.

The steps for utilizing cost of sales in financial reporting are as follows:

You can use the following formula to quickly determine the cost of sales:

Cost of Sales is equal to Beginning Inventory minus Purchases minus Ending Inventory.

This facilitates the transfer of costs to an income statement, but more details are required to determine the total costs of sales.

What to leave out of cost of sales

In general, general and administrative (G&A) costs and the costs of a business marketing department are excluded from a company’s cost of sales. In some cases, costs incurred by the sales department are not included in the cost of sales. Here are some reasons why:

How to calculate the total costs of sales

A company may first take the following steps to determine the total cost of sales:

Example of cost of sales on financial statements

As an illustration, Jerrys Retail Shop just spent $10 each on a crate of 50 T-shirts. Jerry, the store’s owner, will first need to include the costs of the t-shirts in his balance sheet for one month, after which he will transfer the costs of goods sold. Jerry might sell other goods throughout the month, but for the purposes of this illustration, we will only keep track of the T-shirt sales, as shown in the areas with short-term assets and all liabilities.

Purchase on a balance sheet

At the end of October, Jerry’s balance sheet looked something like this.

Jerry had $11,000 in debt to creditors at the end of the month, so the accounts payable were $11,000.

He placed an order for 50 T-shirts worth a total of $500 at the start of November. If Jerry increases the cost of each shirt to $20 each, that would be worth $1,000. He will credit his accounts payable account with the sum after deducting it from his accounts receivable account.


Jerry sells half of the T-shirts he bought by the end of the month. That means he has half left in inventory. Jerry will transfer $500 from the accounts payable account to his inventory account in order to reflect this on his balance sheet. Jerry’s inventory at the end of the month is worth $1,500 because he only sold half of his T-shirts.

Income statement

Jerry found no difference between the book inventory and the actual inventory, so he will now calculate the cost of sales. His cost of sales will appear as follows because he began with $1,000 in inventory, his purchases had a final value of $1,000, and he finished with $1,500 in inventory:

Cost of Sales is equal to Beginning Inventory minus Purchases minus Ending Inventory.

Cost of Sales = $1000 plus $1000 less $1500 equals $500.

He will mark this in his income statement.

The $500 amount is added to the “Direct materials” line:

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