Tax & Business Services |
Cost of Goods Sold (COGS)
COGS & Inventory
While any kind of business will record revenue for its sales or services, COGS is an expense only to those businesses that sell inventory. Cost of Goods Sold (often referred to as "COGS") represents your business's cost of inventory that was sold during the accounting period.
Service-only businesses do not have COGS because they do not sell products (inventory). However, if your business sells both services and products, you will record COGS for the products you sell.
When a business buys inventory, the inventory is an asset until it is sold. In a sense, COGS represents the value of inventory that is "released" as an asset and converted into an expense. So, if product is purchased for resale, it is an asset and is listed on the balance sheet as inventory. The cost of the product does not become an expense until the product is sold.
The Matching Principle
The matching principle of accounting requires revenues and expenses to be matched. By matching an expense with the revenue generated as a result of that expense, a business will not distort its income statement.
When a product is sold, its cost (COGS) is recognized at the same time that its revenue is recognized from its sale. For example, the cost of the computer is an asset, but it does not become an expense until the asset is sold, at which time it is matched with the revenue generated by the sale.
Small business owners may not need to report inventory/COGS on their federal income tax returns. However, they still need to keep their "inventory" costs separate because they'll report the cost in supplies in the year they sell the inventory item(s). (See pages 15-16, Publication 334.)
COGS Calculation
The basic Cost of Goods Sold calculation is shown below and is similar to the calculation used in federal income tax returns.
The calculation for COGS is:
Value of inventory at beginning of accounting period
+ Purchases during accounting period
+ Cost of labor
+ Cost of freight in
= Total value of inventory available for sale during accounting period
- Value of inventory at end of accounting period
= Cost of Goods Sold (during accounting period)
COGS & Inventory
While any kind of business will record revenue for its sales or services, COGS is an expense only to those businesses that sell inventory. Cost of Goods Sold (often referred to as "COGS") represents your business's cost of inventory that was sold during the accounting period.
Service-only businesses do not have COGS because they do not sell products (inventory). However, if your business sells both services and products, you will record COGS for the products you sell.
When a business buys inventory, the inventory is an asset until it is sold. In a sense, COGS represents the value of inventory that is "released" as an asset and converted into an expense. So, if product is purchased for resale, it is an asset and is listed on the balance sheet as inventory. The cost of the product does not become an expense until the product is sold.
The Matching Principle
The matching principle of accounting requires revenues and expenses to be matched. By matching an expense with the revenue generated as a result of that expense, a business will not distort its income statement.
When a product is sold, its cost (COGS) is recognized at the same time that its revenue is recognized from its sale. For example, the cost of the computer is an asset, but it does not become an expense until the asset is sold, at which time it is matched with the revenue generated by the sale.
Small business owners may not need to report inventory/COGS on their federal income tax returns. However, they still need to keep their "inventory" costs separate because they'll report the cost in supplies in the year they sell the inventory item(s). (See pages 15-16, Publication 334.)
COGS Calculation
The basic Cost of Goods Sold calculation is shown below and is similar to the calculation used in federal income tax returns.
The calculation for COGS is:
Value of inventory at beginning of accounting period
+ Purchases during accounting period
+ Cost of labor
+ Cost of freight in
= Total value of inventory available for sale during accounting period
- Value of inventory at end of accounting period
= Cost of Goods Sold (during accounting period)