COGS is sometimes referred to as cost of sales and refers to the production costs for products manufactured and sold or purchased and re-sold by the company. These costs are an expense of the business, and they reduce the revenue the company makes from selling its products.
For example, say your business assembles a completed widget from various inventory parts and sells it online for $15. The parts of the widget and the direct labor required to assemble them cost $10.
The $10 cost is deducted from the widget's sale price to determine the gross profit it generates, and the taxes on that profit. The IRS allows you to include a variety of costs in this calculation.
Cost of goods sold is determined annually by showing changes in the company's balance of "goods" or inventory, from the beginning to the end of the company's fiscal (financial) year, and it is included in the company's income statement. The income statement information is included on the business tax return and used to calculate adjusted gross income as well as net income for tax purposes.
What's Included in Cost of Goods Sold
Cost of goods sold includes the direct cost of producing the product or the wholesale price of goods resold and the direct labor costs to produce the product. Specifically, it can include:
Cost of raw materials.
Cost of items purchased for resale.
Cost of parts used to construct a product.
COGS also includes other direct costs such as labor to produce the product, supplies used in manufacture or sale, shipping costs, costs of containers, freight in, and overhead costs directly related to the manufacture or production activity (like rent and utilities for the manufacturing facility).
Finally, COGS includes indirect costs such as distribution costs and sales force costs that are also directly related to the products the company sells.
