The popularity of online marketplaces such as eBay and Etsy has led to the expansion of businesses transacting through these marketplaces. Some businesses operate entirely through online retail, taking advantage of global target markets and low operating expenses. Although unconventional, these businesses still need to pay taxes and prepare financial documents like any other company. They should also consider their inventory and take advantage of tax breaks like other retailers, including listing cost of sales (COGS) on the income statement.
Cost of Goods Sold (COGS)
Cost of goods sold is an accounting term used to describe the expenses a company incurs in producing goods or services. These are direct costs only, and only businesses with products or services to sell can list COGS on the income statement. When deducted from revenue, cost of goods sold helps determine a company’s gross profit. The most common way to calculate COGS is to take the annual inventory at the beginning of the year, add all purchases, and subtract the ending inventory from this total.
Examples that can be listed as COGS include material costs, labor, wholesale prices for resale items such as grocery stores, overhead, and storage. Any commercial supplies that are not directly used to manufacture the product are not included in COGS.
Cost of Goods Sold (COGS) and Online Retailers
Although operating differently than traditional retail companies, online businesses can reimburse most of the same costs. For example, a business that builds and sells widgets through eBay (EBAY) may list any raw materials used to create the widgets as COGS. When these raw materials are shipped to a business location, or even to a home, the transportation cost is included in the cost of goods sold.
If a business has no actual production costs and is only engaged in buying and reselling goods over the Internet, it may still list the amount spent on purchases as cost of goods sold. Packaging can even be included, but only if the packaging is unique and similar to what appears on the shelf at the actual location. Bubble wrap, tape and cardboard used to deliver small parts to customers are not COGS. The cost of shipping to the customer is also not included in COGS.
The Internal Revenue Service (IRS) allows companies to deduct the cost of goods sold for any product they manufacture or buy themselves and intend to resell. This deduction is available to any business that lists COGS on its income statement, including manufacturers, wholesalers and retailers—whether they operate in brick-and-mortar stores or only online.
Consider a retail business that operates through Etsy (ETSY) and has less than $1 million in annual sales. It tracks inventory such as unused materials, unsold items, etc. In this case, IRS Publication 334: Small Business Tax Guide details how businesses can use the cash accounting method to deduct inventory expenses. If supplies are imported for Etsy sellers, any taxes, commissions, duties, or other related charges may be counted as COGS for IRS purposes. However, fees associated with online services such as PayPal may not count towards COGS. Additionally, time spent marketing merchandise online does not count toward COGS.
Cost of Goods Sold (COGS) is an important item on the income statement. It reflects the cost of producing a good or service for sale to customers. The IRS allows cost of goods sold to be included on tax returns and can reduce your business’ taxable income. The same rules apply whether you are a traditional retailer or an online retailer.