Journal entry to record cost of goods sold

Overview

Cost of goods sold is the cost of goods or products that the company has sold to the customers. In a manufacturing company, the cost of goods sold includes the cost of raw materials, cost of labor as well as other overhead costs that are used to produce the goods.

And, in the merchandising company, the cost of goods sold is the cost that the company pays to acquire the inventory goods before selling them further to the customers for a margin of profit.

In accounting, we usually need to make a journal entry to record the cost of goods sold after the sale of such goods or products if we use the perpetual inventory system in our company. This is because we need to update the balance of the inventory in the accounting record as the perpetual inventory system requires the inventory balance to be updated perpetually (i.e. every time there is a movement of inventory).

However, if we use the periodic inventory system, we usually only make the journal entry to record the cost of goods sold at the end of the accounting period. And this is usually done in order to close the company’s accounts at the end of the period after taking the physical count of the ending inventory.

Cost of goods sold under perpetual inventory system

Under the perpetual inventory system, we can make the journal entry to record the cost of goods sold by debiting the cost of goods sold account and crediting the inventory account.

Account	Debit	Credit
Cost of goods sold	000
Inventory		000

Under the perpetual inventory system, the inventory balance is constantly updated whenever there is an inventory in or an inventory out. Likewise, we usually record the reduction of the inventory immediately after making the sale.

Hence, we usually see the cost of goods sold journal entry is made together with the sales revenue journal entry as below:

Sales revenue:

Account	Debit	Credit
Accounts payable/cash	000
Sales revenue		000

Cost of goods sold:

Account	Debit	Credit
Cost of goods sold	000
Inventory		000

Example of cost of goods sold under perpetual inventory system

For example, on January 31, we makes a $1,500 sale of merchandise inventory in cash to one of our customers. The original cost of merchandise goods was $1,000 in the inventory balance on the balance sheet.

We use the perpetual inventory system in our company to manage the merchandise goods.

What is the journal entry to record the sale and cost of goods sold of the merchandise inventory above?

Solution:

Under the perpetual inventory system, we can make the journal entry to record a $1,500 sales revenue and a $1,000 cost of goods sold on January 31 as below:

Sales revenue:

Account	Debit	Credit
Cash	1,500
Sales revenue		1,500

Cost of goods sold:

Account	Debit	Credit
Cost of goods sold	1,000
Inventory		1,000

In this journal entry, the cost of goods sold increases by $1,000 while the inventory balance is reduced by $1,000. Likewise, we can view the updated outstanding balance of inventory on the balance sheet as well as the updated figures of the cost of goods sold in the income statement if we use an accounting system such as QuickBooks.

On the other hand, if the company uses the periodic inventory system, there will be no recording of the $1,000 cost of goods sold immediately after the sale. Hence, the balance of the inventory on the balance sheet will not be updated either as there will be no recording of a $1,000 reduction of inventory balance yet.

Cost of goods sold under periodic inventory system

Under the periodic inventory system, we usually need to take the physical count of the ending inventory before we can determine and record the cost of goods sold to the income statement.

Likewise, we can calculate the cost of goods sold with the formula of the beginning inventory plus purchases minus the ending inventory.

Cost of goods sold formula:

Cost of goods sold = Beginning inventory + Purchases – Ending inventory

In this case, we can make the journal entry to record the cost of goods sold by debiting the cost of goods sold account and crediting the purchases account and inventory account if the inventory balance decreases compared to the beginning inventory.

Cost of goods sold if inventory decreases:

Account	Debit	Credit
Cost of goods sold	000
Purchases		000
Inventory		000

On the other hand, if the inventory increases, we can make the journal entry to record the cost of goods sold by debiting the cost of goods sold account and the inventory account instead and crediting the purchases account as below:

Cost of goods sold if inventory increases:

Account	Debit	Credit
Cost of goods sold	000
Inventory	000
Purchases		000

The amount of inventory in the above journal entries is the difference between the beginning inventory balance and the ending inventory balance. Likewise, if the ending inventory is less than the beginning inventory, it means that the inventory balance has decreased; so we need to credit the inventory account.

On the other hand, if the ending inventory is more than the beginning inventory, it means the inventory has increased instead. Hence, we need to debit the inventory account as in the journal entry above.

Additionally, in the calculation of the cost of the goods sold, the beginning inventory is the balance of the inventory in the previous period of accounting. And, the ending inventory is usually determined with the actual physical count of the inventory and then applying the inventory valuation method, such as FIFO, LIFO, or weighted average cost method, to the count result.

Example of cost of goods sold under periodic inventory system

For example, at the end of the accounting period, we take the physical count of the inventory and determine that the ending balance of inventory is $40,000 using the weighted average cost method.

We had a beginning inventory of $50,000 which was shown on last year’s balance sheet. And during the year, we have made a total of $200,000 in purchases.

We use the periodic inventory system to manage our inventory.

What is the journal entry to record the cost of goods sold at the end of the accounting period?

Solution:

With the information in the example, we can calculate the cost of goods sold as below:

Cost of goods sold = Beginning inventory + purchases – ending inventory

Cost of goods sold = $50,000 + $200,000 – $40,000 = $210,000

And the ending inventory is $10,000 ($50,000 – $40,000) less than the beginning inventory. This means that the inventory balance decreased by $10,000 compared to the previous year.

In this case, we can make the journal entry to record the $210,000 cost of goods sold with a $10,000 decrease in inventory at the end of the accounting period as below:

Account	Debit	Credit
Cost of goods sold	210,000
Purchases		200,000
Inventory		10,000

In this journal entry, the credit of $10,000 in the inventory account comes from the balance of the beginning inventory ($50,000) minus the balance of the ending inventory ($40,000). And the purchases account of $200,000 will be cleared to zero when we close the company’s accounts at the end of the accounting period.

Example 3

For another example, assuming that we still use the periodic inventory system and we still have the beginning inventory of $50,000 on the previous year’s balance sheet. And during the current year, we still have a total purchase of $200,000. However, the ending inventory is determined to be $65,000 instead.

In this case, the inventory balance has increased instead by $15,000 ($65,000 – $50,000) and we can calculate the cost of goods sold to be as below instead:

Cost of goods sold = $50,000 + $200,000 – $65,000 = $185,000

And, we can make the journal entry to record the cost of goods sold as below instead:

Account	Debit	Credit
Cost of goods sold	185,000
Inventory	15,000
Purchases		200,000

In this example, the inventory balance increases by $15,000 compared to the previous year. Hence, we debit the $15,000 to the inventory account instead of crediting it.