6. COGS

Let's talk about cost of goods sold. COGS is one of those really important parts of accounting that you see everywhere, and you really need to understand pretty well. We've already talked about the two inventory systems, perpetual and periodic.

And we decided that under perpetual, since perpetual literally means always, we always know inventory, and we always know cost of goods sold. And under periodic, we decided that since periodic means sometimes, we sometimes know inventory, and we sometimes know cost of goods sold. So we're gonna spend our time right now focusing on periodic, because under perpetual, we always know cost of goods sold. We always record the entries directly to cost of goods sold. Under periodic, we don't. We sometimes know it, which means we have to calculate it. So we're not gonna address this. We're just gonna look at the periodic system.

Now, cost of goods sold, like every good accounting concept, has a formula. Let's see if we can figure one out here. So we know that beginning inventory plus any cost of goods purchased, so anything we purchased during the year, minus the cost of goods sold will leave us with ending inventory.

I mean, that's not super complicated, right? You started the year with some amount, you bought some more, you sold a bunch, and whatever you have at the end of the year is whatever's left over. So let's draw this out a different way. We'll say beginning inventory plus cost of goods purchased minus cost of goods sold equals ending inventory. Now, this is good because what we're trying to figure out is cost of goods sold, and we've got a formula here that includes cost of goods sold. The problem is we know ending inventory. We count this, right? We count it at the end of the year on a periodic system.

So why are we solving for ending inventory? And fortunately, because most of us passed seventh or eighth grade math, we can swap those around and say this. See this complicated stuff I did here? So we say beginning inventory plus whatever we added during the year minus whatever we count at the end of the year, well, that difference must be whatever we sold. So let's draw this back vertically. Beginning inventory plus cost of goods purchased minus ending inventory gives us cost of goods sold. So where do these three things come from? Start with ending inventory. This one, like I said, is counted at the end of whatever the period is.

It could be month, year, quarter, whatever, but we physically count that, which means beginning inventory was also counted. Now, do you ever count beginning inventory? Not technically, but the previous year's ending inventory becomes beginning inventory. So N minus 1 ending becomes N beginning. Last year's ending becomes this year's beginning. So we know that that's counted also.

Now, what about this cost of goods purchased? Well, we did a video on cost of goods purchased, and we decided the cost of goods purchased was purchases minus any returns or allowances minus any discounts gave us net purchases, and then we add in any transportation in, and that gives us cost of goods purchased.

So we know that one too. So you can see that this is just building up on itself. So if you wanted to, you could expand this to say beginning inventory plus purchases minus purchase returns and allowances minus purchase discounts plus transportation in minus ending inventory gives you cost of goods sold. Because functionally, this is cost of goods purchased, but you can do it all in one formula if you want. It doesn't matter.

I wanna go back just real quickly and talk about how awesome it is that we can just make this stuff up, because this is what's really gonna help you learn. If you can look a little bit into the process of how would I figure this out if I didn't know it? So we decided we were looking to try to figure out how do we know how much cost of goods sold is under a periodic system when we're not just keeping track of it? Well, I pretty much can just make it up that beginning inventory plus anything I added minus anything I sold gives me ending inventory.

Then we know three of those things. And fortunately, the one we don't know is the one we're looking for. So it just becomes a solve-for-X problem. So I want you to be encouraged that this isn't all about memorization, and if you forget some formula on the test, calm down, take a breath, and see if you can figure it out.