Cost of Goods Sold

If you're in business you are already familiar with the words "cost of goods sold"; but, for the remaining readers, cost of goods sold refers to the materials needed to produce whatever it is you're selling. If you're in the service industry, your cost of goods sold is relatively small, since providing a service doesn't require you to purchase additional materials to produce the service. But, if you're actually making a product, you must purchase materials to manufacture a product in some way. There is a distinct difference between the cost of goods sold and business expense items, and in this article we're going to concentrate on cost of goods items, and differentiating them from business expense items. When you complete your Schedule C for sole proprietorships, or the S Corporation or C Corporation return known as 1120 or 1120S have an entire section devoted to cost of goods sold and determining that exact value. If your business maintains an inventory, it too will play a part in determining your cost of goods value; even contract labor will play a role in determining your cost of goods sold. Let's take a look now at the information that is normally included in your cost of goods sold. To begin, you need your inventory levels at the beginning of the year; technically, this should agree with your ending inventory value from the year prior. It should simply be a carryover of the total from the previous year's return. If you use a computer to calculate your tax, it will automatically carryover. The next piece of information you'll need is a record of your purchases for the preceding year. Your purchases will include any materials purchased direct consumption in the production of the materials you sell. Purchases in this section of the return have nothing to do with the indirect costs involved in preparing a product for sale, or in making the sale, such as the advertising or insurance that your purchase in order to operate a business or make buyers aware of your product for sale. Next in line is your cost of labor. The cost of labor does not include your wages and salaries paid. It does however include any costs associated with acquiring that labor, (such as workman's compensation insurance, recruiting fees, etc.) even the use of contract labor in the production of the goods for sale is included in this area. Additional 263A costs, unless you actually incur those kinds of costs, you won't even know what the form is asking for. Section 263A costs are costs associated with the production of property that are normally considered capital expenditures, that can be capitalized over a period of years and are directly allocable to the property production. Section 263A requires that the tax entity capitalize the direct and allocable portion of the indirect costs that benefit or are incurred by reason of a production or resale activity. Businesses that would normally incur these types of expenses that come to mind automatically are film producers, video companies, drilling companies involved in some research and development of a large area, and some manufacturing facilities. Other costs are any other costs that cannot be classified into any of the previous categories, but are directly related to the cost of producing goods for sale. Since we operate in such a diverse and complex business environment, many expenses may be considered just that, a business expense in one area, but are vital to the production of a product for another business, therefore, should be included in the cost of goods sold. This is the purpose of the "other" costs area. Finally, you must perform an inventory at year's end; this determines how much of your materials purchased are left on hand, and weren't actually used for the current year's cost of goods sold. If left unchecked, many business owners could stockpile inventory in years when there might be a tax due, in order to offset the calculation of the tax liability. This figure will also be used on the next year's return as your inventory for the beginning of the year. When you finish collecting this information, it's merely a process of adding and subtracting in order to determine exactly what figure is to be used for your cost of goods sold, and for what profit your business will attribute a tax liability.