Merchandising and manufacturing companies generate revenue and earn profits by selling inventory. For such companies, inventory forms an important asset on their company balance sheet.
Merchandisers, including wholesalers and retailers, account for only one type of inventory, that is, finished goods as they purchase the ready for sale inventory from manufacturers.
On the other hand, manufacturers first purchase raw materials from suppliers and then transform these raw materials into finished goods. Therefore, manufacturers classify inventory into three categories: raw materials, work-in-progress, and finished goods Work-in-progress inventory is nothing but the inventory that is still under process and is not yet converted into finished goods to be sold to customers.
Now, in order to record the cost of inventories in the books of accounts, manufacturers can either record the amounts of raw materials, work-in-progress and finished goods separately on the balance sheet or simply showcase the total inventory amount.
Therefore, we can say that inventories and cost of goods sold form an important part of the basic financial statements of many companies.
International Financial Reporting Standards (IFRS) has stipulated three cost formulas to allow for inter-company comparisons. These include Specific Identification, First-In-First-Out (FIFO), and Weighted Average Cost Methods.
Thus, the type of method used by a company to value its inventory has an impact on its ending inventory and cost of sales. So in this article, let us try to understand what is the Cost of Goods Sold, COGS Formula, and different Inventory Valuation Methods.