Explaining Cost of Goods Sold for Tax Returns

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The cost of goods sold is calculated by deducting purchases and closing inventory from the opening inventory. The cost of goods sold is usually subtracted from net sales to form a gross profit. Gross profit refers to the profit made by a business after the direct costs are deducted from sales. A gross profit is used in an income statement to estimate the net profit. A business should keep all of its statements and records safe for further use.

The Internal Revenue Service (IRS) allows for the cost of goods sold to be included in tax returns and can reduce your business’s taxable income. Calculating the cost of goods sold is important as it includes production costs that are not included anywhere else, and these costs reduce a business’ taxable income. Check out America's Best Bookkeepers

How is the cost of goods sold for tax returns calculated?

While it is recommended that you use a tax professional or a lawyer’s help to calculate the cost of goods sold for tax returns, the formula to calculate the cost of goods sold is: Starting inventory + purchases – ending inventory = cost of goods sold. There are also other methods to calculate it, but this is a basic formula.

What is included in the cost of goods sold?

Direct expenses such as purchases are included when calculating the cost of goods sold. The other direct costs include the cost of products for sale or raw materials, including freight, transportation expenses. It also includes costs of storage of products, raw materials, or parts used in production, direct labor costs for workers involved in producing the goods, and factory overhead and warehouse costs. Check out America's Best Bookkeepers

It does not include indirect expenses related to production and other overhead costs associated with managers and administrative employees.

What are the necessary needs to calculate the cost of goods sold for tax returns?

The first step to calculate the cost of goods sold is to determine the inventory value at the beginning of your fiscal year, the total inventory purchased for the year, and the value of inventory at the end of your business year. The next step is to differentiate between direct and indirect costs to make sure you only include direct expenses in the calculation.

Is an accountant necessary to calculate the cost of goods sold?

An accountant is helpful to calculate the cost of goods sold for tax returns as it includes complicated calculations. The inventory valuation method can also be difficult, and people with no accounting experience may find it hard to calculate it. Usually, the tax preparer is involved in inventory valuation.

What are the LIFO and FIFO methods?

LIFO (Last-In, First-Out) and FIFO (First-In, First-Out) are inventory valuation methods. The IRS keeps track of what method you are using to evaluate taxes accordingly.  LIFO assumes that only the recent inventory is being sold instead of the outdated or obsolete inventory. And FIFO assumes that the remaining inventory consists of items purchased last. LIFO is not as accurate as FIFO because it only includes new inventory. Check out America's Best Bookkeepers FIFO is more practical, and the valuation is performed according to the date of purchase.

Most business taxes include the cost of goods sold as businesses sell their products. The basic calculation of tax returns is the same for all corporate structures, including Corporations, S-corporations, partnerships, and LLCs (Limited Liability Company). Calculating the cost of goods sold is very important in a business as it determines the cost of manufacturing a good or service for sale to a client. The IRS asks businesses to keep a record of their cost of goods sold as it impacts calculating the tax returns. This specific rule by the IRS must be followed by all types of businesses.

Calculating the cost of goods sold is not only important for a business’s financial needs but is also used in the calculations of taxes and tax returns. Therefore, a business must calculate an accurate evaluation of the cost of goods sold.

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