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.