Publication 334 |
2001 Tax Year |
Figuring Cost of Goods Sold Schedule C Lines 35 42
Figure your cost of goods sold by filling out lines 35-42 of
Schedule C. These lines are reproduced below and are explained in the
discussion that follows.
35 |
Inventory at beginning of
year. If different from last year's closing inventory, attach
explanation |
|
36 |
Purchases less cost of
items withdrawn for personal use |
|
37 |
Cost of labor. Do not
include any amounts paid to yourself |
|
38 |
Materials and supplies |
|
39 |
Other costs |
|
40 |
Add lines 35 through 39 |
|
41 |
Inventory at end of year |
|
42 |
Cost of goods sold.
Subtract line 41 from line 40.
Enter the result here and on page 1, line 4 |
|
Line 35
Inventory at Beginning of Year
If you are a merchant, beginning inventory is the cost of
merchandise on hand at the beginning of the year that you will sell to
customers. If you are a manufacturer or producer, it includes the
total cost of raw materials, work in process, finished goods, and
materials and supplies used in manufacturing the goods (see
Inventories in chapter 2).
Opening inventory usually will be identical to the closing
inventory of the year before. You must explain any difference in a
schedule attached to your return.
Donation of inventory.
If you donate any inventory item to a charitable organization, the
amount of your deductible contribution is the fair market value of the
item minus the amount that would be ordinary income if you had sold
the item at its fair market value on the date of the gift.
You must remove from opening inventory the costs and expenses for
the contributed property that you incurred in earlier years. They are
not a part of cost of goods sold for figuring gross income for the
year of the contribution. Costs and expenses for the contributed
property incurred in the year of the contribution are deductible as
part of cost of goods sold for that year if this treatment of costs
and expenses is proper under your accounting method. If you take such
a deduction, those costs and expenses are not treated as resulting in
a basis for the contributed property.
Example 1.
You are a calendar year taxpayer who uses an accrual method of
accounting. In 2001, you contributed property from inventory to a
church. It had a fair market value of $600. The closing inventory at
the end of 2000 properly included $400 of costs due to the acquisition
of the property, and in 2000, you properly deducted $50 of
administrative and other expenses attributable to the property as
business expenses. The charitable contribution allowed for 2001 is
$400 ($600 - $200). The $200 is the amount that would be
ordinary income if you had sold the contributed inventory at fair
market value on the date of the gift. The cost of goods sold you use
in determining gross income for 2001 must not include the $400. You
remove that amount from opening inventory for 2001.
Example 2.
If, in Example 1, you acquired the contributed property in 2001 at
a cost of $400, you would include the $400 cost of the property in
figuring the cost of goods sold for 2001 and deduct the $50 of
administrative and other expenses attributable to the property for
that year. You would not be allowed any charitable contribution
deduction for the contributed property.
Line 36
Purchases Less Cost of Items Withdrawn for Personal Use
If you are a merchant, use the cost of all merchandise you bought
for sale. If you are a manufacturer or producer, this includes the
cost of all raw materials or parts purchased for manufacture into a
finished product.
Trade discounts.
The differences between the stated prices of articles and the
actual prices you pay for them are called trade discounts. You must
use the prices you pay (not the stated prices) in figuring your cost
of purchases. Do not show the discount amount separately as an item in
gross income.
An automobile dealer must record the cost of a car in inventory
reduced by a manufacturer's rebate that represents a trade discount.
Cash discounts.
Cash discounts are amounts your suppliers let you deduct from your
purchase invoices for prompt payments. There are two methods of
accounting for cash discounts. You may either credit them to a
separate discount account or deduct them from total purchases for the
year. Whichever method you use, you must be consistent. If you want to
change your method of figuring inventory cost, you must file Form
3115, Application for Change in Accounting Method.
For more information, see Change in Accounting Method
in chapter 2.
If you credit cash discounts to a separate account, you must
include this credit balance in your business income at the end of the
tax year. If you use this method, do not reduce your cost of goods
sold by the cash discounts.
Purchase returns and allowances.
You must deduct all returns and allowances from your total
purchases during the year.
Merchandise withdrawn from sale.
If you withdraw merchandise for your personal or family use, you
must exclude this cost from the total amount of merchandise you bought
for sale. Do this by crediting the purchases or sales account with the
cost of merchandise you withdraw for personal use. You should charge
the amount to your drawing account.
A drawing account is a separate account you should keep
to record the business income you withdraw to pay for personal and
family expenses. As stated above, you also use it to record
withdrawals of merchandise for personal or family use. This account is
also known as a "withdrawals account" or "personal account."
Line 37
Cost of Labor
Labor costs are usually an element of cost of goods sold only in a
manufacturing or mining business. Small merchandisers (wholesalers,
retailers, etc.) usually do not have labor costs that can properly be
charged to cost of goods sold. In a manufacturing business, labor
costs properly allocable to the cost of goods sold include both the
direct and indirect labor used in fabricating the raw material into a
finished, saleable product.
Direct labor.
Direct labor costs are the wages you pay to those employees who
spend all their time working directly on the product being
manufactured. They also include a part of the wages you pay to
employees who work directly on the product part time if you can
determine that part of their wages.
Indirect labor.
Indirect labor costs are the wages you pay to employees who perform
a general factory function that does not have any immediate or direct
connection with making the saleable product, but that is a necessary
part of the manufacturing process.
Other labor.
Other labor costs not properly chargeable to the cost of goods sold
may be deducted as selling or administrative expenses. Generally, the
only kinds of labor costs properly chargeable to your cost of goods
sold are the direct or indirect labor costs and certain other costs
treated as overhead expenses properly charged to the manufacturing
process, as discussed later under Line 39 Other Costs.
Line 38
Materials and Supplies
Materials and supplies, such as hardware and chemicals, used in
manufacturing goods are charged to cost of goods sold. Those that are
not used in the manufacturing process are treated as deferred charges.
You deduct them as a business expense when you use them. Business
expenses are discussed in chapter 8.
Line 39
Other Costs
Examples of other costs incurred in a manufacturing or mining
process that you charge to your cost of goods sold are as follows.
Containers.
Containers and packages that are an integral part of the product
manufactured are a part of your cost of goods sold. If they are not an
integral part of the manufactured product, their costs are shipping or
selling expenses.
Freight-in.
Freight-in, express-in, and cartage-in on raw materials, supplies
you use in production, and merchandise you purchase for sale are all
part of cost of goods sold.
Overhead expenses.
Overhead expenses include expenses such as rent, heat, light,
power, insurance, depreciation, taxes, maintenance, labor, and
supervision. The overhead expenses you have as direct and necessary
expenses of the manufacturing operation are included in your cost of
goods sold.
Line 40
Add Lines 35 through 39
The total of lines 35 through 39 equals the cost of the goods
available for sale during the year.
Line 41
Inventory at End of Year
Subtract the value of your closing inventory (including, as
appropriate, the allocable parts of the cost of raw materials and
supplies, direct labor, and overhead expenses) from line 40. Inventory
at the end of the year is also known as closing or ending inventory.
Your ending inventory will usually become the beginning inventory of
your next tax year.
Line 42
Cost of Goods Sold
When you subtract your closing inventory (inventory at the end of
the year) from the cost of goods available for sale, the remainder is
your cost of goods sold during the tax year.
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