What Does Cost of Goods Sold Mean?

Find out how cost of goods sold affects your tax return

The cost of goods sold (COGS) contains distinct expenses you attribute to the fabrication of your product or service. It’s a figure used to determine your gross profit.

Revenue — COGS = Gross Profit

Your business has direct and indirect costs — the direct costs are for building your product/service (labor and materials), while the indirect costs are for operating your business (advertising, trade memberships, business meals).

You’d label these expenses accordingly in your bookkeeping file for easier reference.

Direct expenses are part of COGS, while indirect costs are not.

Direct: Do you incur the cost only when you have an order to fill? Then these are probably direct expenses. Examples include buying or consuming inventory items to make the product, the employees’ labor costs who make the product, and freight.

Indirect: Would your business incur the cost even if you didn’t have a single order to fill? Then, these are likely indirect expenses. Examples include general overhead and administrative salaries, insurance premiums, and office supplies.

TIP: COGS varies by industry, which affects your cost of goods sold tax deduction. It’s best to talk with your accountant first.

DISCLAIMER: Please consult with your accountant, attorney, and financial advisor before implementing any information displayed on this website. DIY research does not replace the advice of a licensed professional who has thoroughly reviewed your file.

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