The calculation of the cost of goods sold or COGS (cost of goods sold or COGS) provides accountants and managers with an accurate estimate of the company's costs. HPP calculates specific inventory costs, including costs directly related to the production of inventory at companies that manufacture products directly from raw materials. Inventory costs can be calculated in a number of ways and companies should only choose one to use consistently. This article will discuss how to calculate COGS for a business using the First In First Out (FIFO), First In Last Out (FILO), and Average Cost (Average Cost) inventory methods.
Step
Method 1 of 3: Using Average Inventory Cost
Step 1. Find the average cost of purchasing inventory
The average cost method is not just a method of recording inventory, but also a way of monitoring inventory over a period of time. Add up all inventory purchases for one product type and divide by the number of products purchased to get the average cost figure.
For example, IDR 10,000 + IDR 15,000 / 2 = average cost of IDR 12,500
Step 2. Find the average cost of the goods produced
If a company buys raw materials and then processes them, the process requires subjective decisions. Determine the time period and the amount of inventory produced during that period. Add the total (usually estimated) costs of raw materials and labor to produce the product. Now, divide the total inventory units produced in that period.
- Always comply with the laws and regulations governing the company's accounting practices, one of which is related to how to calculate inventory production costs.
- The cost of producing inventory will of course vary depending on the product, but the cost of the same product can vary over time.
Step 3. Perform a physical inventory check calculation
Pay attention to the amount of inventory you have on the start date as well as the end date. Multiply the average cost by the difference between starting inventory and ending inventory.
Step 4. Calculate COGS using average costs
The total cost for inventory is $1,250 x 20 units = $25,000. If 15 units are sold, the total COGS using this method is Rp. 18,750 (15 x Rp. 1,250).
- Companies use the average cost method because their products are easy to replace or physically indistinguishable from one another, such as mineral, oil and gas commodities.
- Most companies that use the average cost reporting method calculate COGS on a quarterly basis.
Method 2 of 3: Using the FIFO Inventory Reporting Method
Step 1. Select the starting and ending inventory dates
FIFO is an alternative method used to calculate inventory costs. To calculate COGS using the FIFO method, first count the physical inventory at the start date and also at the end date. Keep in mind, these inventory calculations must be 100% accurate.
It would be helpful if the company had a number on each type of raw material
Step 2. Find the price paid when buying the item
You can refer to the receipt sent by the supplier. These costs can vary even on the same type of inventory. Be sure to calculate the ending inventory value to make it easier to understand the effect of the costs incurred. The FIFO method assumes that the first goods purchased or produced will be the first goods sold.
- For example, you buy 10 units of goods at a price of IDR 1,000 per item on Monday and then buy another 10 items at a price of IDR 1,500 per unit on Friday.
- Then, assume that the ending inventory shows 15 units sold on Saturday.
Step 3. Calculate HPP
Subtract the number of sales by inventory starting at the earliest date. Then, multiply the item by the purchase price.
- Your HPP is 10 x IDR 1,000 = IDR 10,000 plus 5 x IDR 1,500 = IDR 7,500 for a total of IDR 17,500.
- Your COGS will be lower with the FIFO reporting method and your profits will be higher when the cost of inventory items increases. In this case, the initial inventory cost is less than the inventory acquired in the following week, assuming they are both sold at the same price.
- Use the FIFO method if inventory costs tend to increase over time AND you need to display a strong balance sheet to impress investors or to get a bank loan. This is because the value of the remaining (final) inventory will be higher.
Method 3 of 3: Using the FILO Inventory Reporting Method
Step 1. Sort inventory purchases starting with the most recent
The FILO method operates on the basis that the most recently purchased inventory is the first to be sold. You still need inventory calculations at the beginning and at the end of the period.
Step 2. Find out how much you paid when you bought the item
You can refer to invoices sent by vendors. Costs may vary even on the same type of inventory.
Again, suppose you buy 10 units of goods at a price of Rp. 1,000 per item on Monday and buy another 10 items at a price of Rp. 1,500 per item on Friday. On Saturday, you sell 15 units
Step 3. Calculate HPP
This time the HPP is calculated from 10 units purchased at a price of IDR 1,500 per item (first sold according to the FILO method) (10 x IDR 1,500 = IDR 15,000). Then add 5 more from the purchase of units purchased at a price of IDR 1,000 per item (5 x IDR 1,000 = IDR 5,000) the total value of HPP from sales of IDR 20,000. When the remaining 5 inventory has been sold, the COGS value will be IDR 5,000 (5 x IDR 1,000).
Companies use the FILO method when holding large amounts of inventory items whose costs are increasing. Therefore, the company's profit and tax expense decreased
Tips
- Small businesses and businesses related to non-public products are better off using the basic method of financing to calculate COGS.
- There is an accounting standard that applies in Indonesia, namely PSAK (short for Financial Accounting Standards Guide) to determine the reporting function relying on HPP calculations. Trading companies that have gone public must submit financial reports based on PSAK, so it is very important to choose the HPP calculation and reporting method that best suits your business. It is not recommended to change the inventory calculation method.
- There are other accounting transactions that can also affect COGS. For example, repurchases and inventory breakdowns will reduce or increase COGS. However, this change may not be accompanied by a change in the amount of inventory.
- HPP is an account on the company's income statement, which then reduces the company's revenue.
- The current value of inventory is an account on the company's balance sheet.
