What Should Not Be Included When Calculating the Costs of Goods Sold (COGS): A Comprehensive Guide

When calculating the costs of goods sold (COGS), it is essential to ensure that only directly related costs are included. Accurate COGS reporting helps businesses maintain financial health and make informed decisions. This guide will clarify what should not be included in your COGS to ensure compliance and accuracy.

Understanding COGS Principle

The traditional formula for calculating COGS is:

COGS Opening Inventory Purchases - Closing Inventory

This formula works for many businesses but is not all-encompassing. COGS must include all direct costs necessary to bring the goods to their current condition and location. This includes inbound logistics, material costs, labor costs, and shipping costs.

Common Exclusions from COGS

The following items should not be included in the COGS:

Selling, General, and Administrative (SGA) Costs: SGA costs, such as marketing, administrative costs, and office supplies, are not part of COGS. Income Taxes: Income tax expenses are recorded separately from COGS and are typically found in the income statement under the “Taxes” section. Financing Costs: Interest expenses, dividends, and other financing-related costs are not included in COGS but rather in the financing statement. Profit: Profit or loss is not a cost to be included in COGS; it is a net result of a business's operations and financial performance. Depreciation and Amortization: Depreciation and amortization costs related to assets are excluded since they are considered part of the asset's cost and not directly related to the sale of goods.

These expenses should not be overshadowed by the broader category of selling, which encompasses marketing, customer service, and sales staff salaries but should remain distinct from COGS.

Importance of Accurate COGS Reporting

Accurate COGS reporting is crucial for several reasons:

Profit Margins: Accurate COGS allows for the correct calculation of gross profit margins, which is essential for understanding and managing profitability. Inventory Management: Proper COGS reporting helps in inventory management, ensuring that businesses do not overvalue or undervalue their inventory, which can lead to financial discrepancies. Tax Planning: Correct COGS information is vital for tax purposes, as it impacts the calculation of taxable income. Decision-Making: Business owners and managers rely on accurate COGS for decision-making, such as setting prices, making cost-saving improvements, and forecasting future financial performance.

Conclusion

Calculating the costs of goods sold (COGS) requires a clear understanding of what should be included and excluded. Direct, necessary costs such as material costs, labor, and shipping are key, while SGA costs, income taxes, financing costs, and profit are to be excluded. Accurate COGS reporting ensures financial health, regulatory compliance, and informed business decision-making. If you have any doubts or additional questions, seek the guidance of a certified accountant or financial advisor.

Additional Resources:

Understanding COGS: A Beginner's Guide COGS Calculator Ways to Reduce COGS

Keywords: cost of goods sold, COGS, excluded costs