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Cost of Goods Sold (COGS): Calculation & Example

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

After reading this lesson, you'll be able to calculate the cost of goods sold for any business. You'll learn the formula to use as well as how this number benefits you tax-wise.

Cost of Goods Sold

Every business needs to know or be able to calculate its cost of goods sold come tax time. We define the cost of goods sold (COGS) as the cost to make all the products that sold. If a business is making the calculation at the end of the year for that particular tax year, then the cost of goods sold will be the cost to make all the products that sold that year.

It's important to know or be able to calculate this number because this number will actually give you a very useful tax benefit. The IRS lets you deduct your cost of goods sold from your gross receipts, thus decreasing the amount of taxable income your business has. This means that you'll have less tax to pay.

Formula

Because the IRS is giving you this benefit, it also has stipulated a certain way to calculate your cost of goods sold.

The formula the IRS uses is this one:

(beginning inventory) + (cost to make more products) - (ending inventory) = COGS

Using the Formula

To use this formula, you first add your beginning inventory and whatever costs you spent on making more products during the year. Then you subtract your ending inventory. The resulting number is your cost of goods sold. The IRS actually provides you a little table that helps you think about all the costs that go into the making of your products.

IRS COGS calculation
cogs

So, say for example your toy business has a beginning inventory of $5,000. During the year, you make more toys at a cost of $50,000. At the end of the year, you are left with $3,000 worth of inventory. Plugging these numbers into the formula, you get this:

$5,000 + $50,000 - $3,000

Evaluating this, you get a COGS of $5,000 + $50,000 - $3,000 = $52,000. This is the number you give to the IRS, and this is the number that the IRS lets you deduct from your gross receipts.

Example

Let's look at another example.

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