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What are cost of goods sold?

Cost of goods sold represents the total amount of expenses that is incurred to produce the product or service that the company sells to its customers. There is a level of subjectivity involved when determining whether a cost is a cost of good sold or an operating expense.

Cost of goods sold generally includes direct materials, direct labors, and manufacturing overhead (factory costs, indirect labor, etc.). Cost of good sold is also commonly referred to as manufacturing costs.

Under U.S. GAAP, cost to produce the good or service are capitalized into inventory on the balance sheet until the product is sold. When the product is sold and revenue is recognized, the costs to produce the good or service are recognized on the income statement in cost of goods sold. As you can see below, cost of goods sold are subtracted from revenue to calculate gross profit.

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  • What is an operating expense?

    An operating expense can be phrased as an expense that is incurred in the normal course of business that are not related to the product or service the business is selling. Basically, these are costs that are necessary to run the business and support the sale of the product or service the business is providing to customers. Operating expenses are a period cost and not a product cost. As you can see in the visual below, operating expenses are subtracting from gross profit to calculate operating income: Operating expenses can be further broken down into three main types of expenses: Selling expenses, general expenses, and administrative expenses.

  • What is an income statement?

    An income statement measures how much money the company generates in the form of revenue and sales, and then how much actually turns into profit after subtracting cost of goods sold and operating expenses. Below is a very summarized income statement that illustrates the key components of any income statement. The goal is to maximize net income! Remember, the income statement is over a period of time while the balance sheet is a snapshot at a point in time.