Description of how various transactions affect the "Cost of Goods Sold" (COGS) amount in Accounting Professional and in Accounting Express

INTRODUCTION

This article describes how various transactions affect the "Cost of Goods Sold" (COGS) amount in Microsoft Office Accounting Professional and in Microsoft Office Accounting Express.

More Information

Accounting Professional and Accounting Express use the first-in, first-out (FIFO) cost method. This cost method assumes that the oldest cost of an inventory item is used first when the item is sold. For more information about the FIFO cost method, see the "About inventory valuation" topic in Microsoft Office Accounting Help.

The standard transaction flow

Consider the following scenario:

On January 1, 2006, you receive 3 units of item A. Each item has a cost of $5.00.
On January 5, 2006, you receive 2 more units of item A. Each item has a cost of $5.50.
On February 2, 2006, you sell 2 units of item A. A transaction is posted to the COGS account for $10.00 because the system assumes that the items that you sold are two of the items that you received on January 1. Each of these items has a cost of $5.00.
On February 5, 2006, you sell 3 units of item A. A transaction is posted to the COGS account for $16.00 because the system assumes that the items that you sold included one of the items that you received on January 1 and two of the items that you received on January 5. One of these items has a cost of $5.00, and two of these items have a cost of $5.50 each.

Exceptions to the standard transaction flow

The following examples illustrate specific transactions that may affect the amounts in the COGS account. These examples show exceptions to the standard transaction flow. In each example, the recalculation process of the COGS account is described. Any combination of these transactions may result in a complex calculation and a large adjustment to the COGS account. To see the effect on the COGS account in the following examples, view the "Transaction Detail by Account" report. Use a filter set to display the voided transactions.

Example 1: You sell items without receiving the items into inventory

If you sell items without receiving the items into inventory, the purchase price from the item record is used to estimate the COGS amount. The COGS amount from all previous transactions is recalculated if the following conditions are true:

The purchase price is changed.
The item is sold again. However, you do not receive the item into inventory.

Consider the following scenario:

You create item A. Item A has a purchase price of $10.00. Item A has an on-hand quantity of 0 and a value of $0.00.
On January 1, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $10.00.
You open item A from the item list. Then, you change the purchase price from $10.00 to $20.00.
On January 5, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $30.00.

Because the purchase price in the item record was changed before this item was received into inventory, the system recalculates all the previous transactions by using the new purchase price. Therefore, the transaction from January 1, 2006 now uses a cost of $20.00 instead of a cost of $10.00. Additionally, the transaction from January 5, 2006 also uses a cost of $20.00. Therefore, the ending balance of the COGS account should now be $40.00. Because $10.00 has already been posted for the transaction from January 1, 2006, another transaction for $30.00 will be posted on January 5, 2006 so that the ending balance of $40.00 is displayed correctly.

Example 2: You save a sales document before you save a purchase document

If you save a sales document before you save a purchase document, the purchase price from the item record is used when the sales document is saved. Therefore, when the item is actually purchased, an adjustment is made to the COGS account if any cost differences occur.

Consider the following scenario:

You create item A. Item A has a purchase price of $5.00. Item A has an on-hand quantity of 0 and a value of $0.00.
On January 1, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $5.00.
On March 1, 2006, you receive 1 unit of item A that has a cost of $4.50. A transaction is posted to the COGS account for a negative amount of $.50 on January 1, 2006. This now causes the COGS account to accurately reflect an ending balance of $4.50.

Example 3: You void invoices from a previous date when documents exist that have a transaction date that is later than the transaction date of the voided invoices

When you void an invoice, the items in that invoice are returned to the inventory. The items are returned to the inventory on the date that is used in the voided invoice. When the item is returned to the inventory, the cost of goods that was associated with that sale is restored. That cost of goods will have the oldest date. That cost of goods will be used first for any later sales. The entries in the COGS account for later sales of the same item are recalculated if the following conditions are true:

You sold more of the same item after you created the invoice.
You sold more of the same item before you voided the invoice.

Therefore, the costs of the items on the voided invoice are consumed in the next recorded sale. All the sales after the date of the voided invoice have new amounts in the COGS account.

When you void an invoice, the program creates a set of transactions to offset the original sale so that the recalculation can occur. These transactions include the following:

A transaction that removes the original cost of goods.
Another transaction that adds the cost of the items on the voided invoice back to the inventory.

Both the transactions have the same date as the voided transaction. Therefore, the COGS account and the inventory have correct ending balances after the restatement. However, there is a large one-time adjustment for the recalculations of all the later sales.

Consider the following scenario:

You create item A. This item has an on-hand quantity of 0 and a value of $0.00.
On January 1, 2006, you receive 1 unit of item A. This item has a cost of $5.00.
On February 1, 2006, you receive 1 unit of item A. This item has a cost of $4.50.
On March 1, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $5.00.
On March 5, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $4.50.
You void the invoice from March 1, 2006.

In this scenario, when you void the invoice from March 1, 2006, the item is returned to inventory. The item is assigned the original cost of goods that was used on January 1, 2006. This means that the invoice from March 5, 2006 would actually have a COGS amount of $5.00 instead of a COGS amount of $4.50. A negative amount of $4.50 is posted to the COGS account on March 1, 2006.

This process will affect all the saved invoices that contain item A because a large single adjustment will be posted. This adjustment will use the date of the voided invoice.

Example 4: You create an inventory adjustment transaction

When you create an inventory adjustment transaction in the Adjust Quantity window or in the "Adjust Quantity and Value" window, you must enter the new value instead of the value of the adjustment that you want to make. The difference between the new value that you entered and the value of the COGS account on the specified date is used to determine the inventory adjustment amount.

Consider the following scenario:

You create item A. Item A has an on-hand quantity of 10 and a value of $2,000.00 as of January 1, 2006. This means that each item costs $200.00.
On February 1, 2006, you sell 5 units of item A. A transaction is posted to the COGS account for $1,000.
On February 5, 2006, you sell 5 units of item A. A transaction is posted to the COGS account for $1,000.
You realize that the value on January 1, 2006 should have been $1,500 instead of $2,000. To create this adjustment, you open the "Adjust Inventory Quantity and Value" window. You set the date to January 1, 2006. You enter a new quantity of 10, and you enter a new value of $1,500.

In this scenario, a transaction is posted to the COGS account for a negative amount of $500.00 on January 1, 2006.

If you generate the Inventory Valuation report for item A, the report contains the following information:

On January 1, 2006, the original transaction that is displayed is for $2,000.
On January 1, 2006, a transaction for a negative amount of $500.00 is displayed. This transaction for a negative amount reflects the difference between the original value of $2,000 and the new value of $1,500. This changes the individual item cost from $200 to $150.
On February 1, 2006, a transaction for a negative amount of $750.00 is displayed. This transaction for a negative amount reflects the 5 items that were sold and that had a cost of $150.00 each.
On February 5, 2006, a transaction for a negative amount of $750.00 is displayed. This transaction for a negative amount reflects the 5 items that were sold and that had a cost of $150.00 each.

Example 5: You change the items in a saved document

When you change the items in a saved document, the effect on the COGS amount resembles example 3. When you change the items in a saved document, the cost of any removed items is restored by using the date of the edited document. The COGS amount is recalculated for documents that were created after the date of the edited document.

Consider the following scenario:

On January 1, 2006, you purchase 1 unit of item A. This item has a cost of $5.00.
On January 5, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $5.00.
On February 1, 2006, you purchase 1 unit of item A. This item has a cost of $6.00.
On February 5, 2006, you sell 1 unit of item A. A transaction is posted to the COGS account for $6.00.
You edit the invoice from February 5, 2006. You replace item A with item B.

In this scenario, a transaction is posted to the COGS account for $6.00 on January 5, 2006. This date is the date of the edited invoice. Therefore, the invoice that was created on February 5, 2006 used a cost of $5.00 instead of $6.00.

Example 6: The unit of measure that you used to purchase an item differs from the unit of measure that you used to sell the item.

Sometimes, when you purchase an item from a vendor, you separate the item into smaller units to sell as individual items. For the COGS amount to be accurate, we recommend that you use the same unit of measure when you purchase the items and when you sell the items.

Consider the following scenario:

You create item A. This item has a purchase price of $10.00, an on-hand quantity of 0, and a value of $0.00.
On January 1, 2006, you purchase 5 units of item A. This item has a cost of $10.00 each. You add a memo on the bill that indicates that there are 5 bushels. Each bushel contains 20 ears of corn.
On January 5, 2006, you sell 10 units of item A. You add a note in the invoice description field that this sale is for 10 ears of corn.

In this scenario, a transaction is posted to the COGS account for $100.00. This transaction reflects the 10 items that were sold and that had a cost of $10.00 each. However, this amount should really be $5.00. Therefore, the amount in the COGS account is overstated by $95.00.

Additionally, if you generate the Inventory Valuation report, the report will display an inventory quantity of -5 and a negative value of $50.00 for item A. However, there are still 90 ears of corn left to sell. If you continue to sell the items in increments of 10 ears of corn, the following issues occur:

After all the ears of corn are sold, the Inventory Valuation report will display an inventory quantity of -95.
The inventory will have a negative value of $950.00.

Example 7: You change the COGS account that is associated with an item

When a COGS account that is associated with an item is changed, previous transactions are not affected. The new COGS account is used for any new documents that contain this item.

Example 8: A vendor bill is edited when an invoice already exists for one or more items included on the bill

When the vendor bill is edited it becomes voided and a new bill is created. Once the edit is saved, the bill is no longer associated to the items on the invoice. The COGS amount from all previous transactions is then recalculated.