Concepts

Cost of sales

Cost of sales is the direct cost of producing or buying the goods or services you sold in a period, such as stock and direct labour, subtracted from sales to find gross profit.

Cost of sales, sometimes called cost of goods sold, is the direct cost of the products or services you sold during a period. For a retailer, it is mainly the price paid for the stock that was sold. For a manufacturer, it includes materials, direct labour and other production costs. For a service business, it may include direct labour and the materials used on jobs. It is separate from general overheads such as rent, insurance and office costs.

The usual calculation for a business that holds stock is to take the value of opening stock, add purchases made during the period, and subtract the value of closing stock. The result is the cost of the stock that was actually sold. A stocktake at the end of the period establishes closing stock, which is why accurate stocktakes matter for both your accounts and your tax return. Errors in stock values flow directly into profit.

Cost of sales matters for tax because it reduces your assessable profit. In income tax, the cost of trading stock is generally deductible as it is sold, and the way you value stock at year end affects how much deduction you receive. Some small businesses can use simplified trading stock rules and skip a stocktake if the change in stock value is below the level set by the rules, which should be checked on the ATO website.

For GST, purchases that make up your cost of sales are usually acquisitions made for your business, so if you are registered and the supplier charges GST, you can generally claim a credit with a valid tax invoice. In your accounts, cost of sales is normally recorded at the GST-exclusive amount, because the GST is recovered through the BAS. The GST on stock purchases appears in the credit labels, while the stock cost sits in your profit calculations.

Separating cost of sales from operating expenses gives a clearer view of how profitable each sale is. If your gross margin looks thin, the cause might be supplier prices, wastage, theft or under-pricing. Splitting costs into direct and indirect categories in your chart of accounts makes this analysis easy, and most accounting software supports it. It also helps when applying for finance, because lenders look at margins.

A common misunderstanding is including all expenses in cost of sales, which distorts gross profit. Another is forgetting that stock bought but not yet sold is not a cost of sales yet. It stays as an asset until it is sold. Freight-in on stock can be part of the stock cost, while freight-out to customers is usually a selling expense. This is general information only, so confirm your treatment with the ATO or a registered tax professional.

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