Cost of goods sold refers to the accumulated sum of all the costs that are used to produce a particular product or service that has been sold. There are three main categories for these costs, namely, materials, labor, and overhead. For businesses which render different types of services, the cost of goods sold is composed of the direct labor, benefits of the employees with billable hours, and the payroll taxes.
In an income statement, the cost of goods sold is deducted from the net sales of the business, in order to arrive at the gross margin. Under the periodic inventory system, the cost of goods sold is computed by adding the purchases to the beginning inventory, and then subtracting the ending inventory. It is assumed that the result derived from this computation, which indicates the costs that are no longer in the inventory, has a relationship with the goods that have already been sold. The derivation of costs through this process, also involves the items in the inventory that were considered scraps, obsolete goods, and stocks that were stolen. With this, this cost derivation tends to add too much expenses to the goods that were actually sold for the current period.
On the other hand, in a perpetual inventory system, the cost of goods sold is accumulated continuously as products and services are sold. In this process, separate recording of transactions, which include sales, obsolescence, scrap, among others, is performed. Compared to the computation of cost of goods sold under the periodic inventory system, making use of this approach yields more accurate results if cycle counting is conducted.
Some companies misdeclare their profit levels intentionally by altering the cost of goods sold. This can be done by inaccurately counting the inventory, declaring more overhead than the actual, changing the bill of materials and records of labor, as well as using wrong cutoff periods.