Cost of goods sold (COGS) or cost of goods sold (COGS) is perhaps one of the most important accounting terms for business owners to know.
COGS includes all direct costs involved in manufacturing the product. Understanding HPP and how to manage its components can make it easier for you as a business owner to run your business.
Then, what is meant by cost of goods sold or COGS? Let’s thoroughly peel about HPP by listening to the article below!
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What is Cost of Goods Sold (HPP)?
If revenue represents the total sales of a company’s products and services, then COGS is the accumulated costs of making or obtaining those products.
HPP is an accounting term with a specific definition based on predetermined accounting principles.
In determining the HPP, the company must apply the principle of inventory cost.
These definitions provide a guide between which costs to include and the associated formula for calculating COGS.
Most importantly, cost of goods sold is a key component for determining two important business metrics, namely a company’s gross profit and its gross margin.
Gross profit is obtained by subtracting COGS from revenue, while gross margin is gross profit divided by revenue.
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The higher the company’s COGS, the lower its gross profit. So, HPP is an important concept to understand.
COGS, sometimes referred to as “cost of sales,” and are generally recorded on a company’s income statement , just below the revenue line.
COGS includes all costs incurred to make the products that the company offers.
Most are variable costs for making products, for example, raw materials, labor, machine maintenance costs and so on.
Examples of costs that are commonly included in COGS include:
- Raw material
- Items purchased for resale
- Cost of shipping goods
- Purchase returns and allowances
- Trade discount or cash
- Factory workers
- Parts used in production
- Storage fee
- Factory overhead costs
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Why Should You Calculate Cost of Goods Sold?
The reason companies have to calculate the COGS value is to benchmark how much profit the company wants.
Companies also need funds for employee salaries and various company operations. However, there are some items that are excluded from the COGS.
Starting from selling, general and administrative costs such as distribution costs to customers, office rent, advertising, accounting and legal costs, and management salaries.
Simply put, all non-operating costs, such as interest and capital expenditures, are also not included in HPP.
In addition, the COGS exemption includes fees for products that remain unsold at the end of a certain period. Rather, it is reflected in how much inventory is in the warehouse at the end of the period that is visible in the warehouse application used.
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Components of Cost of Goods Sold
1. Initial Inventory
Beginning inventory is inventory that exists at the beginning of the company’s accounting period.
The initial inventory balance of goods can be seen from the trial balance of the current period or at the beginning of the company the previous year.
2. Ending Inventory
Ending inventory is the inventory of goods at the end of a company’s accounting period or the end of the current accounting year.
3. Net Purchases
Net purchases are all purchases of goods made in cash and on credit.
There are several elements in net purchases, including gross purchases, price reductions, purchase returns, and purchase discounts.
4. Net Sales
Net purchases are one of the company’s income which consists of three components, such as purchase returns, gross purchases, and price reductions.
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How to Calculate Cost of Goods Sold (HPP)
Every accountant must know and understand the basic HPP formula in carrying out their duties and responsibilities.
The HPP formula consists of three variables, including initial inventory, purchases, and ending inventory. Then, how do you calculate the correct COGS? Try the following four steps:
- Identify the beginning inventory of raw materials, then work-in-progress and finished goods, based on the previous period’s ending inventory.
- Determine the cost of material purchases made during the period, taking into account freight, trade and cash discounts.
- Don’t forget to determine the ending inventory balance. Typically, this is based on the number of physical cycles and is performed according to the company’s preferred inventory valuation method.
- Ensure that other direct manufacturing costs are included in the inventory valuation.
The following is a general HPP formula that an accountant must know
1. The Net Sales Formula
Net Sales = Total Sales Value – Sales Returns
2. The Net Purchases Formula
Net Purchases = (Purchases + Purchase freight costs) – (Purchase returns + Purchase discounts)
3. Goods Inventory Formula
Goods inventory = Beginning Inventory – Ending Inventory
4. The formula for Cost of Goods Sold (HPP)
COGS= (Beginning Inventory + Purchases) – Ending Inventory
5. Example of Calculation Case Study
Look at the illustration of how to calculate the cost of goods sold below to make it easier for you to understand:
Company A sells high-end kitchen countertops to consumers. On January 1, 2019, he kept five tables in inventory, each worth Rp. 1,000,000. Then, throughout the period, Company A purchases an additional 10 tables from its supplier.
On December 31, 2019, Company A counts three unsold tables in its warehouse.
Here’s how a company calculates its COGS:
COGS = (Initial Inventory + Purchases) – Ending Inventory
= (Rp. 5,000,000 + Rp. 10,000,000) – Rp. 3,000,000
= Rp. 15,000,000 – Rp. 3,000,000
= Rp. 12,000,000
The example above is a simple way of calculating. The examples of HPP in the company’s accounting reports are as follows:
Based on the report table above, you can see that HPP UD. Tribhakti as of June 31 2022 is Rp. 58,750,000.
How to calculate the cost of goods sold can also be done with the application. Usually a good online accounting application has a feature to calculate financial reports and costs automatically.
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The Importance of Cost of Goods Sold
Now that we have discussed what HPP is, how to calculate it, along with examples, we will then discuss the reasons why you need to understand it.
The following explains some of the reasons why it is important for a company to have a HPP:
1. Calculating the Gross Profit Margin
To calculate what your gross profit margin is, you need to know your cost of goods sold.
Gross Profit Margin (gross profit margin) is a ratio used to measure a company’s financial health by expressing the amount of money left over from sales after deducting COGS.
The gross profit margin is calculated by subtracting the COGS from total revenue and then dividing that figure by total revenue.
2. Determining the Selling Price
Setting the selling price for your product is one of the most difficult things in business.
If it’s too high, then no one will be interested in the product you offer.
Conversely, if it is too low, it will be difficult for you to make a profit.
Finding the right price is possible if you have an accurately calculated cost of goods sold.
By knowing the COGS, you will know exactly how much you need to sell to cover your other expenses, such as employee salaries and marketing.
3. Your Product Efficiency
By calculating and seeing the overall picture of the HPP, your accounting report arrangement will be more detailed.
This can help you improve product production efficiency.
You can more easily determine how to save money on each product.
Besides ways to save money, you can also find ways to make the production process faster and more efficient.
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4. Distinguish between Direct and Indirect Costs
Understanding HPP and calculating it correctly can also help you to know the difference between direct and indirect costs.
Examples of direct costs in a company are production costs and raw material costs.
Meanwhile, indirect costs include factory overhead costs and operational costs.
In more detail, examples of indirect costs include the following:
- Rental costs
- Employee salary
- Marketing
- Legal and Accounting Costs
- Tax
So, that was an explanation regarding the Cost of Goods Sold (HPP) in the company.
Having an understanding of HPP is very important for the development of your business in the future. So, don’t be lazy to learn and understand it, OK?