UNDERSTANDING Cost of Goods Sold (COGS) in the Manufacturing Industry

1.  Backdrop

      Good morning, everyone.

     Professor:  Today I don’t want you to write any formula , just a simple story about school bags.

Student 1:  Sir, no formula? That’s unusual for Costing!

Professor:  Exactly! Today, I want you to think like a business owner. Suppose you manufacture 1,000 school bags. You spend ₹2,00,000 manufacturing them. Now tell me — have you incurred a cost of ₹2,00,000?

Student 2:  Yes, sir. That’s the manufacturing cost.

Professor:  Good. Now suppose you sell only 800 bags during the year. What happened to the remaining 200?

Student 3:  They are still in our warehouse.

Professor:  Excellent. So, should the cost of all 1,000 bags be treated as the cost of goods sold?

Students:  No, sir. Only 800 bags sold.

Professor:  Exactly! And that is where COGS begins.

COGS = Cost of Finished Goods Actually Sold

Fig. 1 — Of the 1,000 bags manufactured, only the 800 sold flow into COGS; the 200 unsold stay in inventory.

2.  Does ‘Manufactured’ Mean ‘Sold’?

Professor:  So let me ask you something. If we manufactured goods worth ₹31,000, can I immediately say COGS is ₹31,000?

Student 1:  Not necessarily, sir. Some of those goods may still be unsold.

Professor:  Very good.

Student 2:  So we need to look at finished goods inventory.

Professor:  Correct.

3.  Let’s Solve a Business Problem

Professor:  Imagine our company starts the year with finished goods inventory of ₹6,000. During the year, we manufacture goods costing ₹31,000. At year-end, we still have finished goods worth ₹5,000 in the warehouse. Now, how much did we actually sell?

Student 3:  Sir, ₹31,000?

Professor:  Are you sure?

Student 3:  Hmm… because ₹5,000 is still unsold.

Professor:  Exactly. But remember — we also had ₹6,000 of finished goods at the beginning of the year. So let’s think about it.

On the Board
Opening Finished Goods	₹6,000
Add: Goods Manufactured	₹31,000
Less: Goods Still Unsold	(₹5,000)
COGS	₹32,000

Students:  ₹6,000 + ₹31,000 − ₹5,000 = ₹32,000

Professor:  Excellent! COGS = ₹32,000

4.  Wait — That Doesn’t Add Up… Or Does It?

Student 4:  Sir, something is confusing me.

Professor:  Good! Confusion is often the beginning of learning. Ask.

Student 4:  If we manufactured goods worth ₹31,000, how can COGS become ₹32,000?

Professor:  Excellent question. Who wants to answer?

Student 2:  Because we had ₹6,000 of finished goods already available at the beginning.

Professor:  Exactly!

Student 2:  So we had goods available for sale of ₹37,000.

Professor:  Perfect!

Goods Available for Sale = Opening Finished Goods + COGM = ₹6,000 + ₹31,000  =  ₹37,000 Goods Available for Sale − Closing Finished Goods = ₹37,000 − ₹5,000  =  ₹32,000 COGS

5.  Connecting COGS with Gross Profit

Professor:  One final question. Suppose our company sold these goods for ₹50,000. What is our gross profit?

Student 1:  ₹50,000 − ₹32,000 = ₹18,000.

Professor:  Exactly!

Particulars	₹
Sales	50,000
Less: COGS	(32,000)
Gross Profit	18,000

Fig. 2 — How Opening Stock, COGM and Closing Stock combine into COGS, and how COGS drives Gross Profit.

Professor:  Now you understand why COGS is important.

Student 3:  Because if we calculate COGS incorrectly, gross profit will also be wrong.

Professor:  Absolutely!

6.  Can We ‘Manage’ Profit by Inflating Inventory?

Professor:  Now suppose closing finished goods inventory increases from ₹5,000 to ₹10,000. What happens to COGS?

Student 4:  COGS will decrease.

Professor:  And what happens to gross profit, assuming sales remain unchanged?

Students:  Gross profit will increase!

Professor:  Good. But should we simply increase inventory to show higher profit?

Students:  No, sir!

Professor:  Why?

Student 2:  Because inventory must be properly counted and valued. We cannot manipulate closing stock just to increase profit.

Professor:  So what does accounting require?

Ind AS 2 — Inventories Inventories are generally measured at: Lower of Cost and Net Realisable Value (NRV). AS 2 — Valuation of Inventories Inventory is generally valued at: Lower of Cost and Net Realisable Value.

Student:  Sir, so we cannot deliberately increase inventory just because we want higher profit?

Professor:  Exactly. The inventory must be properly measured according to the applicable accounting framework.

Professor:  Exactly. Now you are thinking like accountants — and managers.

7.  The Key Distinction — COGM vs. COGS

COGM “What did we complete?”

COGS “What did we sell?”

Memory Formula COGS = Opening Finished Goods + COGM − Closing Finished Goods