How to Calculate Cost of Sales

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In order to calculate cost of sales, it's important to first understand the two categories of such calculations, which are direct costing and absorption costing. Discover the practical uses of calculating cost of sales with lessons from a math teacher in this free video on math calculations for daily life.

Part of the Video Series: Math in Daily Life
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Video Transcript

How do you calculate cost of sales? Hi, I'm Jimmy Chang. I've been teaching college math for almost a decade and we're here to talk about how to calculate cost of sales. There's actually two categories of how to calculate that. One is actually the more straightforward of the two -- direct costing, which basically just has you at...taking the cost of materials and adding it with the cost of labor, and those two are pretty much it. And so that's a pretty straightforward addition problem. But it's not as involved as what's probably more practical and commonplace, and that is what's called absorption costing. Now, it is used in areas such as accounting and agencies such as the Internal Revenue Service. The IRS uses absorption costing as well. And what that does is it takes the cost of materials, adds it with the cost of labor, but also adds it with the...any overhead expenses that are out there, which as you know, a lot of businesses have overhead. So it is a third major category of cost that's going to be involved. Now, if you take a look, it's a very straightforward addition problem as well, but it gives you a chance to kind of break down what's involved. So let's just say you have materials that cost you 6,000 dollars. You have labor that cost you 5,000 dollars, and any of the overhead expenses, whether it be...and they...and they can be lease expenses, how much utilities would cost, and any money you have to spend on office expenses. Suppose all that came to be about 3,000 dollars. What you basically do from there is just add the three cost expenses together and as you can see there, 6,000 plus 5,000 plus 3,000 is going to give you 14,000. That's going to give you the true cost of what your expenses are going to be. And once you figure that out, just gather your own revenue together and you can figure out what your total profit's going to be. But that's pretty much how you calculate the cost. I'm Jimmy Chang, and that's exactly how you calculate your cost of sales.


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