Fundamentals of Accounting – Cost of goods Sold or Purchased

Cost of goods sold. Income determination requires in case of both manufacturing and trading concerns, the cost of goods sold. In case of trading concerns, the job is comparatively easy since the cost of goods sold can be easily found out be taking into account the cost at which the goods have been purchased. However, in case of manufacturing concerns, the cost of goods sold is to be found out taking into consideration the cost involved in their manufacture. Manufacturing costs can be both direct as well as indirect. Direct costs are those costs which can be directly, conveniently and wholly identified with specific products, jobs or manufacturing processes, e.g., cost of raw materials used for manufacturing the products, cost of factory labour etc. Indirect manufacturing costs are those costs which cannot be directly be identified with specific jobs products or processes, e.g., salary paid to the factory manager, rent, rates, lighting, depreciation of factory machines, etc. These cost are to be apportioned on different products on some reasonable basis e.g., the salary paid to the factory manager may be charged to different products on the basis of direct wages for each product. Similarly, rent paid for the factory may be charged to different products on the basis of departmental area occupied by each of the production departments. Apportionment of the indirect costs so made cannot be fairly accurate and, therefore, the cost of the products so computed cannot also be very accurate. Moreover, some costs such as depreciation of plant and machinery or depreciation of factory buildings cannot themselves be determined accurately. Depreciation depends on the cost of the assets, its scrap value and the estimated life of the assets. It is very difficult to make a fair estimate about the scrap value and life of the asset. The amount of depreciation charged may not, therefore, be very correct. Thus, when estimation of the various elements which constitute cost cannot correctly by made, the measurement of income on the basis of such estimates cannot also be very accurate.