What is Costs of Goods Sold (COGS) expense?
Cost of Goods Sold (COGS) represents the direct costs a business incurs to produce or deliver the products it sells. These costs include materials, labor, and other expenses directly tied to production. COGS is reported on the income statement and subtracted from revenue to calculate gross profit.
What is cost of goods sold?
COGS includes all costs directly related to making or acquiring the goods your business sells. This can include raw materials, manufacturing labor, and shipping costs tied to finished products. For service-based businesses, it may also include labor or expenses directly associated with delivering the service.
How to categorize cost of goods sold
- Record under Cost of Goods Sold (COGS) on the income statement.
- Include only direct costs that are essential to producing or delivering your goods or services.
- Exclude indirect expenses such as administrative salaries, rent, or utilities as these belong under operating expenses.
- Track COGS separately from other costs to measure gross profit and pricing efficiency.
- Adjust for beginning and ending inventory to calculate accurate COGS for each period.
Examples of cost of goods sold
- Raw materials or components used in manufacturing.
- Direct labor for production or service delivery.
- Packaging and shipping for finished goods.
- Freight or logistics for incoming materials.
- Equipment maintenance directly related to production.
- Merchant fees or platform costs tied to sales fulfillment.
Tax implications for cost of goods sold
- COGS is fully deductible from gross revenue, reducing taxable income.
- Businesses that produce, purchase, or sell goods must report COGS on their tax return.
- Inventory-based businesses must include beginning inventory, purchases, and ending inventory in their COGS calculation.
- Keep detailed records of materials, labor, and production costs to substantiate your COGS deduction.
- Service-only businesses may not have a traditional COGS line but can include direct labor and supplies as cost of sales.
