Cost of Goods Sold

[Snaggletooth]

This is an outgrowth of an ongoing post, but that thread is fraught with many topics, so I'll start this one so the topic can be focused.

Can there be a "Cost of Goods Sold" if there are no "goods?" Most of you will recognize this as being a Part III to Sch. C or Schedule A on an 1120, etc.

This discussion may have a counterpart in GAAP reporting as well, and I mention this because IRS [may, may not] allow GAAP treatment.

[BOB W]

This is an outgrowth of an ongoing post, but that thread is fraught with many topics, so I'll start this one so the topic can be focused.

Can there be a "Cost of Goods Sold" if there are no "goods?" Most of you will recognize this as being a Part III to Sch. C or Schedule A on an 1120, etc.

This discussion may have a counterpart in GAAP reporting as well, and I mention this because IRS [may, may not] allow GAAP treatment.

I use COGS for reporting subcontractors as they directly effect sales volumn.

[ChEAr$]

I use COGS for reporting subcontractors as they directly effect sales volumn.

I've also done that in the past, but in pure theory, there ARE no "goods" being sold and
certainly no inventories for which to account.

I wonder if HRB uses COGS to reflect tax consultant labor on their 1120.

[joanmcq]

It depends if there are 'goods'. the sale of services is not the sale of goods. For example, my creating a tax return is not considered a sale of goods but a sale of services so I don't have to collect sales tax. No goods, no COGS.

Pretty simple, and I think hiding expenses in COGS could be considered preparing a false return?

[ChEAr$]

Pretty simple, and I think hiding expenses in COGS could be considered preparing a false return?

Misclassification of an otherwise deductible expense does not give rise to a false return.

[Snaggletooth]

GAAP Treatment

Thanks to all for responding thus far. Each response becomes a factor in formulating an opinion.

What I have not heard thus far is the addressing of GAAP in COGS. IRS allows that "Any consistent method for determining cost of goods sold is accepted as long it follows generally accepted methods of accounting." TTB 1040 ed. pp 5-20 and IRS §1.183-1(e). The IRS reference is clearly to GAAP, which is mostly in the province of the AICPA, but mostly honored by the IRS except in special instances.

The topic of COGS classification is surely addressed by GAAP, and most likely the classifications vary from one industry to the next. Any CPAs wanna tackle this one?

[ChEAr$]

The topic of COGS classification is surely addressed by GAAP, and most likely the classifications vary from one industry to the next. Any CPAs wanna tackle this one?

"Good sold" are those sold either at retail, wholesale, or by a manufacturer and the IRS "formula" in that section whether on schedule c or page 2 of 1120 IS GAAP. Inventory methods, whether FIFO, LIFO, or other may vary, but all are accepted by IRS if used consistently. There is opportunity for error however in determining which other costs are included, e.g. "labor", "supplies" and "other". These mean direct costs, in GAAP parlance of course, and not all "supplies" automatically go here. And not all labor costs go here, e..g a manufacturing concern includes only direct manufacturing labor here, whereas other salaries go elsewhere. The key is "direct" costs go into COGS, along with some, but not all, indirect costs. And this is why we have cost accountants and where they earn their keep.

Remember also that IRS has some rules concerning need for reflecting inventories, although I'm not familiar with them; something about "with sales under.. what? 1,000,000$? Anyway, I use GAAP for all clients, regardless of size.

[joanmcq]

On this issue when I said fraudulent return, I wasn't speaking of misclassification, but the intentional inclusion of expenses in COGS where the activity is a hobby and the expenses would not otherwise be deductible, which was discussed on the thread from which this thread is an offshoot. IMHO, burying contractors in COGS in a service biz (where you are less likely to be audited on the issue of contractors) is intentially preparing a false return. We are in a service biz; we don't sell tax returns, we sell the service of preparing tax returns. And if you want to argue, I don't collect sales tax because I am NOT selling a 'good'.

Therefore we are in agreement, that without 'goods', there is no COGS. Generally the classification of labor, supplies, etc under COGS rather than operation expenses depends on whether they are direct costs or indirect costs. direct costs, such as assembly line wages, would be COGS, whereas admin labor would be classed as operational expenses. Of course there are gray areas, but that is the gist of it.

On the issue of audits, however, I wonder how many of you who have COGS on your returns are opening yourself up to a possible sales tax audit with the tax starved states looking for that underpayment of anything they can find?

Joan McHugh, CPA

[Snaggletooth]

Joan Mc

Joan - I guess it's down to you and me still banging this issue around the ring -- maybe we should charge admission!

Whereas you are a CPA you are no doubt familiar with income statement classifications for presentation purposes under GAAP and their possible equivalency to COGS on a tax return.

We'll come back to the race car, perhaps. But if you were compiling or attesting to statements for Nobugs Pest Control, and they had a cost of sales section comprised of Technician labor, Heptochlor chemicals, supplies, and replacement lumber, would you tell them their classification was wrong? If they had these on their tax return under COGS would this be wrong? Assume also their P&L contained Operational Expenses below the gross income line such as receptionist salary, telephone, rent, etc. and they were not claiming these as COGS.

Keep in mind that Nobugs Pest Control does not sell "merchandise", but sells a "service."
Are they not entitled to a COGS section on their tax return? Would you agree that the abovementioned expenses are of a "direct" nature as opposed to operational expenses?

Pest Control is not the Racing Car? I agree this is hardly correlative. But one of the "direct" expenses I am deducting is Entry Fees. The Racetrack sent the 1099 for $2800, but did not deduct the client's entry fees payable every time he entered a race. These totalled some $1100. Are these not "direct" enough to deduct for presentation on line 21? In fact, on a GAAP statement they would probably appear ABOVE the COGS line, maybe on Sales Returns and Allowances or some reduction to Sales. Does this constitute a "fraudulent" claim?

Please respond - not for purposes of continuing this bantering, but because I'm sincerely interested in your opinion. I've followed your posts for a long time and have credited you with quite a bit of tax savvy.

Ron Jordan, Manchester, TN

[newbie]

not joan, not a CPA

but in my opinion a big difference is the pest control is doing service for others, the race car driver has no other customers, no service provided, no goods sold.

[ChEAr$]

but in my opinion a big difference is the pest control is doing service for others, the race car driver has no other customers, no service provided, no goods sold.

Right. A pest control service does not sell goods or merchandise, but uses supplies in the furnishing of its services, hence no COGS section needed on a tax return.

[joanmcq]

If the pest service also sold pest control products that the homeowner used between services (like my plumber sold me some stuff to help keep my drains clean), that would be in COGS, but otherwise it is a service. the race car entry fees are as much a below the line cost as my CPA license, or a pay-per-return fee you may pay.

If the financial statements prepared by the client came in misclassified, the reclassification to GAAP is part of the attestation services. If not presented according to GAAP, say cash basis or income tax basis, that is noted in the audit report. Just plain wrong is not allowable. Part of the process of attestation is the preparation of the financial statements.

[ChEAr$]

If the pest service also sold pest control products that the homeowner used between services (like my plumber sold me some stuff to help keep my drains clean), that would be in COGS, but otherwise it is a service. the race car entry fees are as much a below the line cost as my CPA license, or a pay-per-return fee you may pay.

If the financial statements prepared by the client came in misclassified, the reclassification to GAAP is part of the attestation services. If not presented according to GAAP, say cash basis or income tax basis, that is noted in the audit report. Just plain wrong is not allowable. Part of the process of attestation is the preparation of the financial statements.

Good point about items a pest control service might also sell.

However the items they may sell to general public are not the same chemicals that
the state allows only them to use. So purchases would have to be segregated, and
those hard chemicals put on the supplies line, while consumer usable chemicals be
(properly) accounted for as inventory, don't you think?

Contrast this with a beauty salon which uses supplies (not part of COGS) and sometimes
will sell to a customer. Those sales would be a credit to supplies instead of actual
sales reported on line 1 way up top.
I'm assuming beauty shop pays sales tax on all supplies it purchases of courses.

[AJsTax]

Very interesting

One of the things I enjoy most about this forum is the opportunity to hear about situations and differences in other parts of our country. Sales tax is a good example.

Here, I have a client that drives to his customer's home or business to mow the grass. That is all he does. Or the same person runs a snow plow in the winter. This is strictly a service, no goods involved, but he must charge sales tax on all the services he provides if he grosses more than a certain amount per year. At the present that is $5000.

Our hairdresser clients do not charge sales tax on haircuts, etc. They do not pay sales tax on the supplies the buy and use in the shop, but any that they sell to the customer for outside the shop must have sales tax charged, so we must keep track of that inventory separately. They do have to charge sales tax on other services such as nails.

Just a couple quick ones to point out the fact that sales tax being charged really does not have much to do with COGS around here.

[joanmcq]

The hairdresser is a good example. Cutting/dyeing/styling hair is a service, but most shops (at least the ones I've gone to) also sell shampoos & styling products. These are NOT supplies or from supplies; the shampoos they use are in big old bottles where the products they sell are in retail sizes. The retail products would be in inventory & in COGS, where the shampoo, conditioner, dye & styling products used on the customer are below the line supplies.