You finally took the plunge and are selling those balsa wood sculptures you carve so well. To do this, you need to purchase the materials to make the sculptures — like the wood, a little paint, and other miscellaneous items. You know that you can deduct the cost of making your crafts on your tax return to determine your profit for your business, but how do you figure out the costs of the goods you sold?
You calculate the cost of goods sold on your Schedule C. Use the worksheet on lines 35 – 42 of page two.
Let’s walk through each of the lines.
Line 35: Inventory at the Beginning of the Year
If you were just reselling merchandise you purchased from someone else, the amount on this line is the cost of the merchandise you had on hand at the beginning of the year.
However, if you make the items you sell, the amount on this line is the cost of any items you produced, plus the cost of the supplies you purchased in the prior year and still have on hand to make the items you will sell in the future. This is usually the ending inventory of the year before.
Note: If there is any difference between last year’s ending inventory and this year’s beginning inventory, you will need to explain why there is a difference.
Line 36: Purchases Less Cost of Items Withdrawn for Personal Use
If you buy merchandise to resell, the amount on this line is the items you bought during the year to sell.
If you make the items to sell, the amount is the materials and parts you purchased during the year. This is the amount you actually paid the vendor for the items, including any discounts they gave you. You need to back out the cost of any items you returned, as well as any items you pulled out of your inventory to use for your own personal use.
Line 37: Cost of Labor
The cost of labor consists of three elements:
- Direct labor: wages you pay to employees who work directly on making the products to be sold.
- Indirect labor: what you paid to employees who perform general factory functions, such as a foreman, and whose work does not have a direct connection with the making of the product.
- Other labor: wages for selling or administrative personnel.
The cost of indirect labor and other labor costs need to be allocated to each product produced during the period.
Line 38: Materials and Supplies
The cost of materials and supplies on this line is the cost of the items that are not the main materials used in the production of what you have for sale, but are still an important part of constructing the product. This might include things like glue and buttons.
Line 39: Other Costs
You use this line to record any additional costs of your product — such as packaging and shipping costs to bring in supplies and materials — as well as the overhead costs for utilities, rent and insurance. These costs might not be directly a part of your product, but are needed to make or sell your product.
Line 40: Cost of Goods Available for Sale
On this line, you add the amounts on lines 35 through 39 to get the cost of goods available for sale.
Line 41: Inventory at End of the Year
On this line, you will include the value of the items you have in your inventory that have not yet been sold as of year-end.
Like most businesses, you may need to take a physical count of what you have on hand on December 31, and determine the cost to produce the items in that count.
When valuing your ending inventory, be sure to use the cost to produce the items and not the price you charge customers for these items.
Now that you have all that information, you can calculate the cost of goods sold. On line 42, subtract the amount on line 41 from line 40. This will give you your CoGS, which goes on line 4 of page one of the Schedule C, Cost of Goods Sold.
The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Also published on Medium.