How to calculate cost of sales

Step by step

1. Start with opening inventory. Begin with the value of unsold goods brought forward from last period.
2. Add net purchases. Add purchases, less returns outwards, plus carriage inwards.
3. Deduct closing inventory. Subtract the value of goods still unsold at the end of the period.
4. Read off the cost of sales. The result is the cost of the goods that were sold.
5. Use it to find gross profit. Revenue less cost of sales gives gross profit.

Worked example

Opening RM6,000 + purchases RM20,000 − closing RM7,000 = RM19,000 cost of sales.

Understanding the method

To know what the goods you sold cost, count only the goods that left the business. A trader starts the year with some inventory, buys more and ends with some unsold. The goods available to sell were the opening inventory plus purchases.

Whatever is left unsold at the year end is taken out. This is the matching concept: this year's sales are set against the cost of this year's sales only.

Each adjustment follows this idea. Carriage inwards (the cost of getting purchased goods to your premises) is added, because it is part of the cost of acquiring the goods.

Purchases returns are deducted, because goods sent back were never really bought. Goods the owner took for personal use are removed from purchases too, since they were not sold to customers.

Closing inventory is subtracted, and it then becomes next year's opening inventory. For each item, ask whether the cost belongs to goods the business sold to customers this year.

The figures can come in any order. Net purchases may be given already, or you may have to net off returns. Carriage inwards may be hidden in a list of expenses.

Closing inventory may need valuing from a stock sheet, or restating at the lower of cost and net realisable value if goods are damaged. If cost of sales is given and a purchases or closing inventory figure is missing, rearrange the same formula.

Here is an example for a retailer. Opening inventory is RM12,000. Purchases are RM70,000, of which RM4,000 was returned to suppliers.

Carriage inwards is RM3,000. The owner took goods costing RM2,000 for personal use. Closing inventory is RM15,000.

Net purchases are 70,000 − 4,000 = RM66,000. Add carriage inwards: RM69,000. Remove the own-use goods: RM67,000.

Add opening inventory: RM79,000 of goods available for sale. Subtract closing inventory: 79,000 − 15,000 = RM64,000 cost of sales.

To check, goods available for sale less closing inventory must equal your answer. If sales are given, work out gross profit.

A cost of sales larger than sales means selling below cost, which is unusual and worth re-checking. A closing inventory that is too high makes cost of sales too low and flatters profit.

Common mistakes include adding carriage outwards to purchases (it is a selling expense below gross profit). Others are adding closing inventory instead of subtracting it, and subtracting opening inventory instead of adding it. Others are leaving own-use goods in purchases, confusing purchases returns with sales returns, and using last year's closing inventory as this year's closing figure.

If your cost of sales keeps coming out wrong, we can help. One of our teachers can go through your last attempt with you line by line and find which item is on the wrong side. Book a trial class

Related skills

• How to calculate mark-up and margin
• How to value closing inventory
• How to prepare an income statement for a sole trader

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.