In a previous episode,
we studied the travel costs from one to the other account
and we ended up with the full schedule of
various T accounts with their ending billing balances.
And we also saw how raw materials and other costs they travel to work in progress,
how then from working progress we get some costs of finished goods.
Do they go to finished goods?
And then finally, that's all prepared for sale.
And then, we sell something,
and then we take into account the cost of goods sold.
Now in this episode,
we will talk a little bit more specifically about the cost of goods sold,
how it's actually structured,
and how we can calculate that.
Because in the previous episode,
we took these traveling costs out,
and then, calculated the ending balances.
Here, what we will do,
we'll start with beginning balances and ending balances and then,
the corresponding plug number will travel to the other account.
So, this is the cost of goods sold,
the extremely important parameter for inventories.
Now, so how that goes?
We have the beginning balance of the finished goods inventory then,
plus purchases of FGI.
So what is that? This is the total cost of inventory.
Now, so that is basically what is prepared for sale.
Now, here we have the ending balance of FGI,
so this is what is left, so
that is what's left. And then, this is the cost of goods sold.
So this is what's been sold.
Well, no rocket science here.
Now, sometimes, when people study inventories and in general,
well they talk about accounting,
certain things seem to be absolutely trivial.
And that, actually plays a trick.
Because people get used to the fact that this whole trivial,
and they believe well,
you don't have to know much you can think from plain common sense and this way,
you'll be able to arrive at the right answer.
And sometimes, it's much easier to do
when you keep in mind certain procedures. All right.
Let's now illustrate that on the example that we've had before,
and that was the cost of goods sold
for the manufacturing firm.
So we go back to the numbers from our previous episode.
And again, all that is summarized in our handout,
so I will not reproduce it once again,
I'll just use the numbers.
So here,we start
with materials cost.
So this is the beginning balance of raw materials inventory,
plus purchases of RMI and that here,
we arrive at the total cost of raw materials.
And now, we at the end of the period count,
the ending balance of RMI and that
is cost of materials.
Now that in itself,
that travels up here,
but before we have to,
let's say, stage II,
this is labor and other.
So here, we start with the beginning balance of the working in process inventory.
Here, I arrive this number cost of materials.
So we put here materials, and then,
plus factory labor, plus depreciation.
This is basically the quotably the cost of the use of equipment,
then plus other, whatever they are.
Then, from here we subtract the ending balance of WPI,
and all that is nothing less than cost of finished goods inventory.
Now, this is the cost of FGI.
In general, how we calculate that?
We start with the beginning balance of FGI,
from this number, it arrives here, cost of FGI.
Then us all, we subtract the ending balance of FGI,
and all that results in what we've been searching for,
the cost of goods sold.
And finally, we can write to the equation that which is in the board one,
that the gross margin is the revenue,
minus cost of goods sold.
Well in our example, it was $80.
Again, all the numbers are on previous pages of the flow chart in our handouts.
Well, at the first glance,
it seems to be absolutely trivial again and cuddle cumbersome,
but if we go back to the T accounts that we've had before,
we'll be able to properly recalculate all that once again.
And here, to give you an example that we'll be
calculating cost of goods sold.
Again, this is raw materials inventory,
we started with 75 was the beginning balance.
Now, we added 300.
And then, the ending balance was 185.
So this is 375, we subtract that, and from here,
we get the number 190 that goes to WPI.
Because WPI, the beginning balance was 95.
Now here, comes this amount 190.
And then, we had whatever was there,
it was 110, 35, and then 90,
so that was all together 520,
and the ending balance of WPI was 325 that was I put 520 here to make it easier.
And then, again, from these numbers,
we get the amount of 195 that now goes to finished goods inventory.
And then, finished goods inventory again,
we start with 60 is the beginning balance,
then here, arrives 195 and then,
the ending balance is 125,
and from these numbers,
we get 130, and this is the cost of goods sold.
So that is consistent with what we had on the previous page of the flip chart.
Again, like I said,
there's no rocket science here.
This is something very trivial,
somewhat cumbersome because it takes time, it takes accuracy,
but if we did that specifically in this way to really
go through these very simple moves one at a time,
slowly, to make sure that we really understand which number go somewhere.
Because like I said before,
the major challenge in accounting is to get bogged down within these numbers.
Because this is where numbers play an important role but you have to be able
to see the result or the bottom line behind these numbers.
Now in the next final episode of the first week,
we will say a few more words about the approaches to inventories.
And then, we'll be sort of almost all set with respect to current assets.
Konstantin KontorDirector and Professor of Finance and Strategy
