Cost of sales and cost of goods sold are two terms that are often used interchangeably. Both cost of sales and cost of goods sold records the cost incurred to produce goods, to purchase goods, to sell to the end customer or to offer a service. Both these amounts are reported in the income statement following sales revenue. The key difference between cost of sales and cost of goods sold is that cost of goods sold is tax deductible whereas cost of sales is not.
CONTENTS
1. Overview and Key Difference
2. What is Cost of Sales
3. What is Cost of Goods Sold
4. Side by Side Comparison – Cost of Sales vs Cost of Goods Sold
5. Summary
What is Cost of Sales
Cost of Sales is the term used to record the direct costs associated with offering a service; thus, this is recorded in service related organizations which do not offer a physical product as their main stream operation. Since service-only businesses cannot directly relate any operating expenses to something tangible, they cannot list any cost of goods sold on their income statements. Without any cost of goods sold on their income statements, they cannot claim any cost of goods sold deductions.
E.g: In a hospital, the direct cost incurred for labor, medical supplies and equipment to provide direct patient care is classified as cost of sales.
What is Cost of Goods Sold
The term cost of goods sold is applicable to manufacturing organizations that have stocks of physical products. Cost of goods sold is calculated using the below formula.
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
Unlike for cost of sales, a tax reduction is available for cost of goods sold, to compensate for a portion of expenses incurred. This is allowed by the Internal Revenue Service (IRS), the tax authority. IRS Publication 334: Tax Guide for Small Businesses and IRS Publication 550 provides more details regarding the same.
Expenses that are Tax Deductible for Cost of Goods Sold
- Raw materials
Resources that are unprocessed, that will be converted into finished goods
- Storage and handling costs
Costs of storing and moving raw materials and finished goods in and out of the production floor
- Shipping costs
Some companies import raw materials from other countries, thus shipping charges are involved.
- Direct labor costs
Wages and salaries cost to workers who are involved with processing the products.
- Factory overhead costs
Indirect costs and all other manufacturing support costs
Figure 1: Fluctuations in raw material prices directly affect Cost of Goods Sold
Only the costs incurred to bring the products into salable condition, i.e. finished goods, can be included in the Cost of Goods Sold. Expenses such as distribution, advertising and transportation of finished goods cannot be included here; they should be treated as operating expenses. For companies who purchase and sell products, the cost of purchasing the respective finished goods (purchase price) from the manufacturer will be considered as cost of sales.
What is the difference between Cost of Sales and Cost of Goods Sold?
Cost of Sales vs Cost of Goods Sold |
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| Cost of Sales is not tax deductible | Cost of Goods Sold is tax deductible. |
| Use | |
| Service organizations record Cost of Sales to account for direct costs related to delivering a service. | Manufacturing organizations record Cost of Goods Sold to account for direct cost related to producing goods. |
Summary – Cost of Sales vs Cost of Goods Sold
Generally accepted accounting principles do not provide any detailed guidelines on cost of goods sold or cost of sales, which is one of the reasons why the two terms are lumped together so frequently. The difference between cost of sales and cost of goods sold can be identified by the product or service offering. For both cost of goods sold and cost of sales, the companies should be careful only to include direct expenses with regard to either the product or service.
Reference:
1. Ross, Sean. “What’s the difference between cost of goods sold (COGS) and cost of sales?” Investopedia. N.p., 26 Nov. 2014. Web. 19 Feb. 2017.
2. “Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).” Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ). N.p., n.d. Web. 19 Feb. 2017.
3. “Direct costs.” The Free Dictionary. Farlex, n.d. Web. 19 Feb. 2017.
4. “Cost of Goods Sold and Gross Profit – Boundless Open Textbook.” Boundless. N.p., n.d. Web. 19 Feb. 2017.
5. “What is cost of sales? definition and meaning.” BusinessDictionary.com. N.p., n.d. Web. 19 Feb. 2017.
Image Courtesy:
1. “GlobalTrade wheat coarse grain soy 2008 usda”By Economic research unit of the USDA, us federal gov – (Public Domain) via Commons Wikimedia