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Cost of Goods Sold Explained

How to Calculate COGS, How to Keep Records on COGS, COGS and Business Taxes


Cost of goods sold (sometimes called cost of sales) is a calculation that affects the price of goods you sell, and so it is an important concept to understand and manage to keep your business taxes low.

In this article, we will look at the concept of cost of goods sold, how it is calculated, and how cost of goods sold affects your inventory, business financial records, and, most important, your business tax return.

1. What is Cost of Goods Sold?

Cost of goods sold (COGS) is a calculated amount showing the value of goods used to produce products for sale. Cost of goods sold is turned into inventory and then into sales. Cost of goods sold includes value of products, of labor, and production facilities. Cost of goods sold is included in all business tax returns, no matter what type of business you have. It's an important calculation because these costs are deductible, reducing the taxable income of your business.

2. What Information is Needed to Calculate Cost of Goods Sold?

In order to calculate cost of goods sold for a business tax return, you will need to gather some information. Start with the cost of beginning inventory (usually ending inventory from the previous year), then add information on purchases and costs to make products, and the cost of ending inventory. Be sure you have good records to substantiate these figures, in case of an audit. You can do the calculation for cost of goods sold yourself, using tax software, or give the information to your tax preparer.

3. How Do I Calculate Cost of Goods Sold?

This "how to" takes you through the calculation for one product, so you can see how it is done and what information you will need to provide your tax preparer or include in your business tax calculations using tax software.

Start with the basic calculation for cost of goods sold:

Beginning Inventory Cost
Plus Cost of Additional Inventory Manufactured or Purchased during the year
Minus Cost of Ending Inventory
Equals Cost of Goods Sold

4. How Do I Include Cost of Goods Sold in My Business Taxes?

In all types of business tax returns, cost of goods sold is calculated in a separate schedule and then included as a reduction to gross income in the Income section of the tax return.  For sole proprietors and single-member LLC owners, cost of goods sold is part of Schedule C. Partnerships and multiple-member LLCs calculate cost of goods sold on a partnership tax return (Form 1065). Corporations calculate cost of goods sold on Form 1120 and S corporations calculate on Form 1120-S. This article provides details on how to find the calculations for cost of goods sold, and where to include the calculation on the tax return.

5. What Records Do I Keep on Cost of Goods Sold?

This article discusses the types of records you need to keep to substantiate your cost of goods sold calculations. Be sure to keep specific records showing the purchase of inventory or supplies to be used in production. You will also need to take inventory (count items in inventory) at the beginning and the end of the year.

6. How is Cost of Goods Included in Business Financial Records?

Rosemary Peavler, Guide to Business Finance, shows how an item moves from cost of goods sold (an expense) to an inventory item (an asset), and then how the sale of the item is accounted for.

Cost of goods sold is shown on a company's profit & loss (income statement) as a deduction from income.

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