When you're determining is cost of goods sold a debit or credit, the definitive answer is that COGS is always a debit. This is because it's classified as an expense account within the rules of double-entry bookkeeping.
Understanding this principle is fundamental for accurate financial records. Since expenses decrease equity, they are recorded as debits, aligning with the standard accounting for cost of goods sold.
Is cost of goods sold a debit or a credit?
To understand why COGS is a debit, you first need to recognize its role in your accounting system.
COGS is an expense account with a normal debit balance
The answer to what type of account is cost of goods sold is simple: it’s an expense. It represents a direct cost tied to the revenue you generate from selling products.
Like all other expense accounts, the answer to does cost of goods sold have a debit or credit balance is that it has a normal debit balance. This means the account's balance increases with a debit entry.
Why is cost of goods sold recorded as a debit?
The reason why is cost of goods sold a debit becomes clear when you apply the rules of double-entry accounting. When your COGS increases, it must be recorded as a debit.
Here’s the basic logic:
- Expenses reduce a company's net income.
- A reduction in net income leads to a decrease in owner's equity.
- In accounting, a decrease in equity is always recorded as a debit.
Therefore, to properly reflect the cost of goods sold increase debit or credit rule, you must debit the COGS account to show that an expense has occurred.
How to calculate the cost of goods sold
Before you can record the journal entry, you must accurately calculate the COGS value for the accounting period.
The standard COGS formula
The most common method for calculating COGS is based on your inventory changes over a period.
The formula is: Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold
This calculation tells you the total cost of the products that were sold during that specific timeframe.
Information you need for the calculation
To use the formula correctly, you need three key pieces of information from your records:
- Beginning Inventory is the total value of your inventory at the start of the accounting period. It should be the same as the ending inventory from the previous period.
- Purchases includes the cost of all new inventory you acquired during the period. This covers raw materials or finished goods bought for resale.
- Ending Inventory is the value of inventory you have left at the end of the period. You'll typically determine this through a physical inventory count or an inventory management system.
How to record a cost of goods sold journal entry
Once you have your final COGS value, you can create the journal entry in your accounting ledger by following these three steps.
Step 1: Calculate the final COGS value
First, you must determine the precise amount for your Cost of Goods Sold. Use the standard formula you just learned: Beginning Inventory + Purchases – Ending Inventory.
This calculation gives you the exact number you'll need to use in the subsequent debit and credit entries.
Step 2: Debit the COGS account
With the final COGS value calculated, you will debit the Cost of Goods Sold account. This entry formally recognizes the expense on your company's books.
This action increases the balance of the COGS expense account, which in turn reduces your company's profitability for the period.
Step 3: Credit the inventory and purchases accounts
To complete the double-entry requirement, you must record credits of an equal amount. You will credit the Inventory account to show that your inventory assets have decreased.
Any new inventory added during the period, recorded in the Purchases account, is also zeroed out with a credit. This ensures your debits and credits are perfectly balanced.
Practical examples of a COGS journal entry
Seeing the entry in action makes the concept clearer. Here are two common scenarios where you would record a COGS journal entry.
Journal entry for a simple product sale
This example applies if you use a perpetual inventory system, where COGS is recorded with every sale.
Imagine you sell a single item that cost you $50 to acquire. The moment the sale is made, you must record the expense associated with that specific item. The journal entry would look like this:
This entry simultaneously increases your COGS expense and decreases your inventory asset value by the same amount, keeping your books balanced.
Journal entry using the periodic inventory formula
This example applies if you use a periodic inventory system, where you calculate COGS for the entire period at once.
Let's assume your business had the following financials for the month:
- Beginning Inventory: $10,000
- Purchases: $5,000
- Ending Inventory: $8,000
First, calculate your COGS: ($10,000 + $5,000) – $8,000 = $7,000.
Next, you create an adjusting entry that updates all related accounts with the final figures:
This single entry recognizes the COGS expense, zeroes out the temporary Purchases account, and replaces the beginning inventory value with the correct ending balance.
How COGS impacts your financial statements
Recording COGS correctly is crucial because it directly affects two of your main financial statements.
Determining gross profit on the income statement
Your Cost of Goods Sold is a major expense shown on the income statement. It is subtracted from your total revenue to determine your company’s profitability from selling products.
This calculation gives you your gross profit, a key performance indicator. The formula is: Revenue – Cost of Goods Sold = Gross Profit
An accurate COGS ensures your gross profit is stated correctly, giving you a clear view of your operational efficiency.
Reducing inventory value on the balance sheet
COGS also has a significant impact on your balance sheet. The Inventory account is listed as a current asset, representing a value your company holds.
When you record COGS, you credit the Inventory account. This action directly reduces the value of your inventory assets on the balance sheet.
This ensures your balance sheet accurately reflects the value of the inventory you physically have on hand at the end of the accounting period.
Common mistakes to avoid when recording your entries
Accurate COGS reporting depends on avoiding a few common errors that can distort your financial statements.
Including indirect costs in your calculation
A frequent mistake is mixing indirect costs with your COGS calculation. COGS should only include costs directly tied to producing or acquiring your products, like raw materials and direct labor.
Costs like marketing, administrative salaries, or office rent are indirect costs. These belong in a separate category on your income statement called Operating Expenses and should never be part of COGS.
Failing to adjust for inventory shrinkage or spoilage
You must account for inventory that is lost, stolen, damaged, or expired—a concept known as shrinkage or spoilage.
If you fail to adjust for these losses, your ending inventory value will be artificially high. This leads to an understated COGS and an overstated gross profit, providing a false picture of your company's performance.
To prevent this, conduct regular physical inventory counts and adjust your records before finalizing your COGS calculation.
Automate your accounting to prevent costly errors
Understanding that COGS is a debit is crucial. However, manual calculations often lead to errors that can distort your gross profit and misrepresent your company's financial health, leading to poor business decisions.
JIM's platform helps prevent these mistakes. It offers built-in AI business analytics and real-time sales reports, giving you precise data for your financial statements without the tedious manual work.
This ensures your statements are accurate, helping you make smarter business decisions. Explore how JIM’s automated tools can improve your financial management.
