When a business spends money that’s an expense. Not all expenses are the same, but why is it important to properly allocate the expenses, and what is so special about COGS?
The answer to that question has multiple layers. First and foremost is tax reporting. Many business expenses are tax-deductible. They lower the amount of income tax that needs to be paid. However, not all expenses are created equal. Your GSuite subscription is likely 100% deductible. The meal you had with a potential new client is only 50% deductible. Both would be considered business expenses, but the IRS will not let you reduce the amount of income you pay taxes on by the entire cost of the meal. For this reason, they need to be put into different expense accounts when doing bookkeeping.
So then where does COGS come into play? COGS are the Cost of Goods Sold. These are the expenses directly related to the product you sell, or the service you provide. If you’re a landscaper, this would be the seasonal flowers you plant or weed killer you buy. For a computer manufacturer, the expense of the individual parts of the computer would be coded to the COGS account versus a general expense account. They are put in separate areas of the tax form, but this distinction is more likely to help you as a business owner analyze your company’s financial situation than it is to help the IRS properly tax you.
Properly categorizing money spent is important for both the IRS and the business owner, but for different reasons.
If you have any further questions about this, please contact me at Michelle@CareBookkeepingServices.com, or give me a call at 713-714-0264