What is Cost of Goods Sold (COGS)?
Cost of Goods Sold (COGS): sometimes called cost of revenue or cost of sales for services businesses: is the direct cost of producing the goods or delivering the services a company sells in a period. Under IFRS (IAS 2 for inventory) and US GAAP, COGS is deducted from revenue to arrive at gross profit on the income statement.
What goes into COGS
- Direct materials: raw materials and components consumed in production.
- Direct labour: wages of workers directly building or delivering the product.
- Manufacturing overhead: allocated factory costs (rent, utilities, depreciation of production equipment).
- For SaaS: hosting (AWS, GCP), customer support, payment processing, third-party APIs that scale with revenue, content delivery.
- For services businesses: billable employee cost, project travel, third-party contractor cost.
What does NOT go into COGS
- Sales and marketing.
- R&D and general engineering not tied to delivery.
- General and administrative: finance, HR, legal, executive payroll.
- Interest and tax.
The boundary matters: pulling support headcount into COGS deflates gross margin; pushing it into SG&A inflates the margin. Investors normalise to a fully-loaded COGS during diligence.
COGS vs. related concepts
- COGS vs. operating expenses: COGS is variable with output; opex includes both variable and fixed components.
- COGS vs. expenses: expenses is the broader income-statement term covering COGS, SG&A, R&D, interest and tax.
- COGS vs. capex: COGS hits the income statement; capex hits the balance sheet first (as fixed assets) and the income statement later via depreciation.
Inventory accounting
For product businesses, COGS depends on inventory accounting: FIFO (first-in-first-out), weighted-average, or specific identification. US GAAP also permits LIFO; IFRS does not. Method choice affects reported COGS and gross profit, particularly in periods of changing input prices.
Do: document the cost-classification policy and inventory method; apply both consistently across periods.
Don’t: exclude support, hosting or payment-processing from COGS to inflate the headline gross margin: investors will normalise it back in due diligence.
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