What is Intermediate Consumption? And how is it different from COGS?

Do you know what I discussed in my last post - What is Cost of Goods Sold (COGS) and how is it calculated?

Come on! You can do it. At least venture a guess. 

No? 

I talked about COGS and how it’s calculated. 

I also cracked a lot of COGS jokes, just COgS I could. But COGS is just a COGs in the wheel. There’s much more to understand and explore. 

So, as promised in my last post, I’m now going to talk about Intermediate Consumption. 

Intermediate Consumption is the value of goods and services (which are used up in the process of production) purchased by a production unit from outsiders. 

The SNA says this about Intermediate Consumption:

“Intermediate consumption consists of the value of the goods and services consumed as inputs by a process of production, excluding fixed assets whose consumption is recorded as consumption of fixed capital. The goods or services may be either transformed or used up by the production process. Some inputs re-emerge after having been transformed and incorporated into the outputs; for example, grain may be transformed into flour which in turn may be transformed into bread. Other inputs are completely consumed or used up; for example, electricity and most services.” 

For a production unit that makes furniture for instance, the cost of wood, nails, adhesive, paint etc. is all part of Intermediate Consumption. So are the costs incurred on power, rent, insurance of the production facility, repair and maintenance of equipment etc. Basically, any good or service bought from outsiders (as opposed to being producing in-house) that is used in the production process (directly or indirectly) is included in Intermediate Consumption. Note: as mentioned above, capital investments such as building another room in the furniture production unit, or buying expensive machinery that helps in the furniture making process are not included in Intermediate Consumption. Neither is the depreciation charged to them. 

The reason the concept of Intermediate Consumption is important is because: Output - Intermediate Consumption = Valued Added. And, the sum of the value added by all the production units in a country gives us its GDP. 

Timing and Valuation of Intermediate Consumption

Per the SNA:

“The intermediate consumption of a good or service is recorded at the time when the good or service enters the process of production, as distinct from the time it was acquired by the producer. In practice, the two times coincide for inputs of services, but not for goods, which may be acquired some time in advance of their use in production. A good or service consumed as an intermediate input is normally valued at the purchaser’s price prevailing at the time it enters the process of production; that is, at the price the producer would have to pay to replace it at the time it is used. ” 

This of course is ideally how Intermediate Consumption should be valued for the purpose of estimating “Value Added”. That said, since value added is usually estimated from the financial statements of business enterprises, and the purchases made by them are valued at cost in these statements (Profit and Loss Account), this guideline is hard to implement.

How is Intermediate Consumption different from COGS? 

Now that we understand both concepts (read my post What is Cost of Goods Sold (COGS) and how is it calculated? for a detailed understanding of COGS), it is easier to differentiate between the two:

• While no wages/ salaries are included in Intermediate Consumption, COGS does include the wages of those working directly on the product or service. For example, wages of factory workers in a manufacturing enterprise are included in COGS. 

• Intermediate Consumption includes the value of all the goods or services used as inputs (purchased from outside the enterprise) into ancillary activities such as purchasing, sales, marketing, accounting, data processing, transportation, storage, maintenance, security, etc. In fact, any good or service bought from outside the enterprise (excluding capital goods) and utilized either directly for production or for any related ancillary activity is included in Intermediate Consumption. This is not the case for COGS. Only those purchased goods which are used directly in the production process are included in COGS. Also, only the overheads (power, water, rent etc.) for the manufacturing area can be included in COGS. 

• COGS is a financial concept, whereas Intermediate Consumption is an economic concept. 

• As is evident from our discussion above, Intermediate Consumption is a much broader concept as compared to COGS. 

I think this brief introduction to Intermediate Consumption, and its quick match-up with COGS is enough for now. I could go on.....but I feel like I should exercise restraint. 

Especially since in my next post, I’m going to convert a real-life (not living and breathing unfortunately, but a bonafide FY15 P&L statement of a company) Profit and Loss Statement into a Value Added Statement using the concepts we’ve learnt so far (Output, Intermediate Consumption, COGS).

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