Cost of goods sold is the calculation of the value of any company’s inventory which has been sold and the things which have not been sold or will be sold in the future. It is shown similarly on every type of business tax return. On each return, the cost of goods sold is considered as a reduction in business income. Therefore, the higher you can legitimately make the cost of the goods sold, the lesser income you will have to pay taxes on. The calculation process of the goods sold is the same for all businesses.
How to Calculate Cost of Goods Sold
- Gather the information needed for this calculation. Mostly, you will need to know the valuation method, beginning and ending inventory, and the cost of labor and purchases.
- You should be doing the calculation which starts with beginning inventory, adding in the cost of materials, labor and other costs during the end and then finally calculating the ending inventory.
The calculation of the cost of goods sold depends on the tax returns. The cost of goods sold is important for every business as it is an allowable deduction on taxes. If a business fails to add this value, their business income becomes higher than necessary which means higher taxes.
Consider the Following Information
- Valuation Method: Designate whether inventory is valued equally to the cost of the market, lower than the cost of market or other. If you are using the cash accounting method, make sure that you value inventory at cost. Also make sure that your tax preparer is under constant check especially if you have changed your method of determining quantities, values or costs. You should be including an explanation of any changes to make the tax preparer and your employees aware.
- Beginning Inventory: This is the total cost of all products in your inventory at the beginning of any year. Most of the time, this should be the same as the inventory at the end of the year. If it is not the same, you must provide an explanation.
- Cost of Purchasing: You should be able to get a total of all the products that you purchased during the year and those items that you placed in the inventory to sell. You should subtract any products that you took out for your personal use. In case you are a manufacturer, you will need to include the total cost of all the raw materials and parts that you purchased during the time of that one year. It does not matter if they were assembled or not.
- Cost of Labor: This is the cost of your business employees who directly work in making products from raw materials and parts. It does not include costs for administrators or employees in sales, marketing, finance or other areas that a business consists of.
- Costs of Materials and Supplies: These costs should be directly in relation to making the product.
- Other Costs: These include your shipping costs, freight-in on materials and the supplies, and the overhead expenses for rent, heat, light, etc. for the area where the products are being manufactured, produced, or assembled.
- Ending Inventory: Calculate and determine the total value of all items in inventory at the end of the year.
This is basically everything that you need in order to calculate the cost of goods sold using a tax software program or to give to your tax preparer that you have employed. Always make sure that you can provide records verifying the costs of goods sold.
Summary of How to Calculate the Cost of Goods Sold
- Add up beginning inventory, purchases and all the other costs.
- Getting costs of the goods sold.
- Subtract the inventory at the end of the year.
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