The cost of goods sold is the calculation of the value of any company’s inventory that has been sold and the things that 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 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. 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, starting with the beginning inventory, adding in the cost of materials, labor, and other costs during the end, and 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 tax deduction. If a business fails to add this value, its 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 use the cash accounting method, ensure you value inventory at cost.
- Ensure that your tax preparer is constantly under check, especially if you have changed your method of determining quantities, values, or costs. You should include 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 explain.
Cost of Purchasing
You should get a total of all the products you purchased during the year and those items you placed in the inventory to sell. You should subtract any products that you took out for your personal use. If you are a manufacturer, you must 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 make products from raw materials and parts. It does not include costs for administrators or employees in sales, marketing, finance, or other business areas.
Costs of Materials and Supplies
These costs should be directly related to making the product. 
Other Costs
These include your shipping costs, freight-in on materials and 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 year’s end. It would be best if you had everything to calculate the cost of goods sold using a tax software program or to give to the tax preparer you have employed. Always ensure 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.
Conclusion
In conclusion, understanding and accurately calculating the Cost of Goods Sold (COGS) is crucial for every business for tax purposes. Companies can optimize their deductions and minimize tax liabilities by diligently gathering the necessary information and following the proper valuation methods. Attention to detail in accounting for inventory, labor, purchases, and other costs ensures compliance with tax regulations while maximizing financial efficiency. By mastering COGS calculation, businesses can effectively manage their tax obligations and maintain financial health.
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