The 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 a reduction in business income. Therefore, the higher you can legitimately make the cost of the products sold, the less income you will have to pay taxes. The calculation process of the goods sold is the same for all businesses.
How to Calculate the 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.
- It would help if you were doing the calculation, which starts with beginning inventory, adding in the cost of materials, labor, and other expenses during the end, and then finally calculate the ending inventory.
The calculation of the cost of goods sold depends on tax returns. The cost of products sold is essential for every business as it is an allowable deduction on taxes. If a company 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 the market, or other. If you are using the cash accounting method, make sure that you value inventory at cost. Make sure that your tax preparer is under constant check, especially if you have changed your method of determining quantities, values, or expenses. It would help if you included 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 explain.
- Cost of Purchasing: You should be able to get a total of all the products you purchased during the year and those 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 you purchased during that 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 expenses for administrators or employees in sales, marketing, finance, or other business areas.
- Costs of Materials and Supplies: These costs should be directly concerning 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 inventory items at the end of the year.
This is everything that you need to calculate the cost of goods sold using a tax software program or to give to the 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.