Question

A company may report high net income through a number of means including normal revenues, one-time tax benefits, or other accounting activities. If a company sales merchandise, it is important to understand their operating revenues which will include income statement reporting of both Cost of Goods Sold and Gross Profit on Sales.

Class, what is Cost of Goods Sold? Provide examples of the types of entries recorded to this account. Next, what is Gross Profit on Sales? Why is understanding this section of the Classified Income Statement so important to managers, investors, and creditors?

Answer 1

Cost of goods sold (COGS):

This is the aggregate amount of expenses which is directly associated with making a product and selling it to the market. It includes direct material cost (like leather cost for the product of leather jacket), direct labor cost (like stitching of leather jacket), direct expenses, etc. but should not be included with indirect material cost (like hangar for jackets), overheads, etc.

Examples:

No.1) Charging purchase to COGS: in this case COGS is debit and purchase account is credit – the direct material cost is included there.

Journal entry

Date	Account titles & explanation	Ref.	Debit	Credit
	COGS		XXX
	Purchase account			XXX
	To charge direct material cost through purchase

No.2) Charging inventory to COGS: in this case COGS is debit and inventory account is credit – the direct material in inventory is included there.

Journal entry

Date	Account titles & explanation	Ref.	Debit	Credit
	COGS		XXX
	Inventory account			XXX
	To charge direct material cost through inventory

No.3) Charging labor cost to COGS: in this case COGS is debit and wages account is credit – the direct labor cost is included there.

Journal entry

Date	Account titles & explanation	Ref.	Debit	Credit
	COGS		XXX
	Wages account			XXX
	To charge direct labor cost

No.4) Charging direct expense to COGS: in this case COGS is debit and freight charge is credit – the direct expense is included there.

Journal entry

Date	Account titles & explanation	Ref.	Debit	Credit
	COGS		XXX
	Freight charges			XXX
	To charge direct expense

Gross profit:

Gross profit = Total net revenues – COGS

Gross profit on sales = (Gross profit / Total net revenues) × 100

This is highly important, since it shows strictly how the firm fulfilling its main objective. The main course of business highlights through this section; as long as the firm is in the main course (instead of earning through indirect way like, interest income) by earning higher margin of gross profit on sales, the future of the firm is secured and the interest of managers, investors, and creditors are protected.