How is cost of sales calculated?

In Sage 50, the Cost of Sales represents the known cost to your business for items or services when sold to customers. Cost of sales (also known as cost of goods sold) for inventory items are computed based on the inventory costing method you select (FIFO, LIFO, or Average Cost) and is only calculated on sales invoices and/or receipts.

Note: The costing method cannot be changed once the inventory item is saved.

Below is a description of each method along with an outline of how each works:

• FIFO (First In First Out)
  This method assumes that the oldest items are to be sold first (first in, first out) when calculating the cost of sales
• LIFO (Last In First Out)
  The method of determining the cost of inventory items that assumes the newest items are to be sold first
• AVERAGE
  A method of determining the cost of inventory items, which averages the price paid for all items

How each works:

The example below will be used to show how each Costing Method calculates cost.

Two Items were purchased in 2007 for $1.00 each.
Two of the same Item were purchased in 2008 for $1.50 each.
Two of the same Item were purchased in 2009 for $2.00 each.
None were sold. So, there are 6 On Hand.

A Sale of two was processed on a Sales Invoice on 1/1/2010.

Below, see how each Costing Method works:

• FIFO calculates Cost based on the Cost of the oldest Inventory Items on Hand. So, the cost of the two oldest items would be calculated. $1.00 X 2= $2.00
• LIFO calculates Cost based on the most recent purchases. Using the example above, the cost calculated would use the cost of the two most recently purchased Items, $2.00 each. $2.00 x 2=$4.00
• Average calculates based on the Items On Hand at the time of the sale, and the cost of all those Items divided by the number on hand. Using the example above, the calculated cost for two Items sold in 2009 would be $3.00
  The program adds $1.00 X 2 + $1.50 X 2 + $2.00 X 2 (2009)=
  $9.00/6 (Items on Hand))= 1.50 X 2 (the number being sold)= $3.00.  The rule to remember on Average Costing is that the average is calculated using the cost of each of the items On Hand at the time of the Sale and divided by the number On Hand

Setting up and managing inventory training