Calculating COGS for a service company

There is no beginning or ending inventory - but, you are on the right track. If I buy a part for a specific job I link that purchase directly to a sub account of my COGS account called "COGS - materials job specific". (I do not carry inventories.)

We also have technicians who 100% of the time work out in the field. Rather than link thier payroll to an expense account I link it to a sub account of my COGS account called "COGS - Technicians".

My boss wants COGS to represent the cost of the technicians and and direct purchase of parts for specific jobs. That is his preference.

As far as office and sales people their salaries are linked to an expense account for salaries.

If you are not sure how to handle your specific company talk to your CPA. The CPA is the one who will be filing the IRS paperwork at the end of the year and will want to know how you categorize various expenses.

I do agree with you that it makes more sense to put the technicians salaries in a cogs account.

Mary

I'm on the other side of things and offer this view for consideration. I am not a CPA nor an EA with the IRS.

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This quote from the IRS fact sheet on COGS

http://www.taxact.com/referenc...

"Generally, businesses that make or buy goods to sell may deduct the cost of goods sold from their gross receipts in computing business income. This information applies if the business is a manufacturer, wholesaler or retailer, or if engaged in any business that makes, buys or sells goods to produce income.

This information generally does not apply to personal service businesses, such as doctors, lawyers, carpenters or painters except for personal service businesses that sell or charge for the materials and supplies normally used in the course of business.

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."

and from this IRS fact sheet

http://www.cbia.com/cbianews/2...

"Determine cost of goods sold

If your business makes or buys goods to sell, you may deduct the cost of goods sold (COGS) from your gross receipts. There are several factors that go into determining COGS, including:

* Inventory at the beginning of the year

* Purchases less cost of items withdrawn for personal use

* Labor costs (generally applies to manufacturing and mining operations)

* Materials and supplies (generally a manufacturing cost)

* Other costs (generally applies to manufacturing and mining operations)

* Inventory at the end of the year

To determine COGS, first add the beginning inventory; net purchases; cost of labor, materials and supplies; and other costs. Then subtract inventory at the end of the year from this total."

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This quote from the Texas Comptroller regarding the filing of what Texas calls franchise taxes

http://www.window.state.tx.us/...

"Generally a taxable entity in the service industry will not have COGS as they do not sell tangible personal property or real property in the ordinary course of business.

... only taxable entities that are eligible to use COGS in computing margin are those entities that sell real or tangible personal property in the ordinary course of business. This section of the code goes on to confirm that the performance of a service is not considered the sale of tangible personal property. However, we did include a provision in Rule 3.588(c)(6) that reads as follows:

"Mixed transactions. If a transaction contains elements of both a sale of tangible personal property and a service, a taxable entity may only subtract as cost of goods sold the costs otherwise allowed by this section in relation to the tangible personal property sold."

Examples:

1. Oil Change Services - a taxable entity providing an oil change may include in its COGS computation only the cost of the oil filter and oil that is that is included in the performance of the service. No labor costs would be included as part of COGS.

2. Crop Duster - a taxable entity that provides crop dusting services may include in COGS the cost of chemicals used in the performance of the service as part of COGS. Aviation fuel, labor, airplane rental, etc. would not be allowed as part of COGS.

3. Veterinary Service - a taxable entity that performs veterinary services may include in COGS the pharmaceuticals and other medical (vet) supplies. No labor costs or fees would be included."

Russler,

Great information. It also highlights that different states may have different rules. I go back to my suggestion that the original poster go back to his CPA and ask the best way to handle his particular business. The type of service he provides may influence where he fits under the IRS guidelines.

Mary

Mary, Rustler,

Thank you both for your input. From a brief discussion with the CPA at the accounting firm we use, it seems like how we track COGS will not directly impact how our taxes are filed. We are a I.T. (computer) consulting firm, so similar to a doctor or carpenter, our time is our product--but just like a doctor may also charge a patient for a medical device, or a carpenter may charge a client for materials, we also sell tangible goods (servers, computers, routers, etc.) to a lesser extent. Mary's approach to having two different COGS accounts (one for tangible "materials" and one for technicians' labor), makes sense to me--without the labor expenses in COGS, it just seems like the COGS number in our P&L is missleading at best. We have been doing it as a "Mixed transaction" (similar to how the Texas Comptroller describes), but with the majority of our "product" being our technician's time, this way of recording COGS seems meaningless. I'm assuming that IRS rullings would trump, and individual states would not conflict.

Hello All

Thank you for taping into this very interesting subject

I have an online marketing agency , so basically we simply render services such as consultancy for advertisers

I don’t buy any inventory ( such as advertising banners  ahead of time to sell them later at a higher cost) therefore I don’t have inventory per say

Can you kindly help me on how to calculate my COGS

Thanks in advanced