Cost of goods sold (COGS) refer to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out (FIFO), or average cost. Costs include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of goods made by the business include material, labor, and allocated overhead. The costs of those goods not yet sold are deferred as costs of inventory until the inventory is sold or written down in value.

Many businesses sell goods that they have bought or produced. When the goods are bought or produced, the costs associated with such goods are capitalized as part of inventory (or stock) of goods. These costs are treated as an expense in the period the business recognizes income from sale of the goods.

Determining costs requires keeping records of goods or materials purchased and any discounts on such purchase. In addition, if the goods are modified, the business must determine the costs incurred in modifying the goods. Such modification costs include labor, supplies or additional material, supervision, quality control, use of equipment, and other overhead costs. Principles for determining costs may be easily stated, but application in practice is often difficult due to a variety of considerations in the allocation of costs.