Accounting and Finance for Lawyers

COGS

"COGS" is an abbreviation of "cost of goods sold."

A perpetual inventory system just adds journal entries as soon as goods are purchased and sold.

A purchase decreases Cash and increases Inventory by the purchase price.

A sale increases Cash and Sales (Revenue) by the sale price and decreases Inventory and increases COGS by the purchase price of the goods.

Periodic Inventory System

A periodic inventory system only logs COGS entries on fixed dates.

A purchase still immediately decreases Cash and increases a Purchases account by the purchase price.

A sale increases Cash and Sales (Revenue) by the sale price.

Then, on a fixed date, the Inventory is reassessed, and the cost of goods sold during the period is calculated by adding the beginning Inventory and the Purchases and subtracting the ending Inventory. (It's the consumed inventory.)

The purchase price for COGS has various ways of determination:

Specific Identification Method

The specific identification method looks at the actual cost of purchasing/producing the exact good sold.

Cost Flow Assumption Method

There are three ways of assuming cost flows:

FIFO

FIFO stands for "first in, first out." The goods purchased the longest ago are assumed to be sold first.

FIFO is more accurate for balance sheets as the assets left at the end of the month are closest to the current price of purchasing them.

LIFO

LIFO stands for "last in, first out." The last goods purchased are assumed to be sold first.

LIFO most accurately reflects the costs at the time of sale and is thus most accurate for the income statement. However, this messes up balance sheets.

Average

The third possible assumption averages the costs.