What is Cost of Goods Sold?
Cost of goods sold is an amount reflecting the costs associated with the goods sold by a company. Cost of goods sold includes cost of purchases during the year and materials, labor, and parts needed to produce these goods. The typical calculation for cost of goods sold is (a) inventory of goods available for sale at the beginning of the year, plus goods purchased or produced for sale during the year, minus inventory of goods available for sale at the end of the year.
Cost of goods sold is an important calculation because it is an allowable deduction for a business. If you don't include cost of goods sold, your business income will be higher than necessary.
Information needed to calculate cost of goods sold
In order for you or your tax preparer to calculate cost of goods sold, you will need the following information:
- Valuation method: Designate whether inventory is valued at cost, lower of cost or market, or other. If you use the cash accounting method, you must value inventory at cost. Check with your tax preparer if you have changed your method of determining quantities, costs, or valuations. You must include an explanation of any changes.
- Beginning inventory: The total cost of all the products in your inventory at the beginning of the year. This should be the same as the inventory at the end of last year. If it's not the same, you must provide an explanation.
- Cost of purchases: Next, get a total of all the products you purchased during the year and that you placed in inventory to sell. Subtract any products you took out for personal use. If you are a manufacturer, you'll need to include the total cost of all raw materials and parts purchased during the year. Don't worry about whether they are assembled or not.
- Cost of labor: This is your business's cost for employees who work directly making a product from raw materials and parts. It doesn't include costs for administrators or employees in sales, marketing, finance, or other areas.
- Cost of materials and supplies: These costs must be directly related to making the product.
- Other costs, including shipping containers, freight in on materials and supplies, and overhead expenses for rent, light, heat, etc. for the area where the products are being manufactured or assembled.
- Ending inventory.Determine the total value of all items in inventory at the end of the year.
Running the calculation for cost of goods sold
In case you want to see how the calculation is done, here it is:
- Add up beginning inventory, purchases, and all costs.
- Subtract inventory at the end of the year.
- To get cost of goods sold.
Read more about How to calculate cost of goods sold.
Cost of Goods Sold and Your Business Tax Return
If you are preparing your business taxes yourself using tax software, you will find the cost of goods sold calculation in the following business tax returns:
- For sole proprietors and single-member LLC owners, in Schedule C
- For partnerships and multiple-member LLCs, cost of goods sold is part of the partnership tax return (Form 1065)
- For corporations and S corporations, cost of goods sold is included in the corporate tax return (Form 1120) or the S corporation tax return (Form 1120-S).