Start a business, Do your taxes, Save money

I have COGS! What now?

Cheer up. It’s not all that bad and I’m sure this post will make you feel a lot better.

When you have inventory in your business, chances are pretty good that at the end of the year you will not have sold everything. The goods (or the material you use to make goods) is what we call your “Ending Inventory“. In other words, this is the amount of unsold inventory on hand at the end of the year.

Let’s look at an example.

Bob is tired of rubbing people’s backs. He gives up his massage business (a service business) and becomes a coffee roaster (an inventory business). He spends $10,000 on an old coffee roasting machine, $1,500 on 500 pounds of green coffee beans, and starts a new business.  Because he is a regular reader of the Canuckbusiness blog (I’ll put in a link to that cool blog when I have time), he puts the receipt for his coffee roaster in the envelope in his shoe box that says “Capital Assets“. And if you read my last post, you will correctly assume he will put the $1,500 receipt for the “green” into the “Purchases” envelope. Nice. Time to roast some beans.

Bob’s first year of business comes to an end. And it was slow. He weighs his green beans and sees he has 200 pounds left! And now he has to file his tax return. This is where the COGS will be calculated.

So what exactly is COGS?

Here is one definition (I made it up):  “how much you paid for all the stuff it took to make (or buy) ONLY the products that you sold in the year”.

Here is another definition (by someone smarter than me): “The cost to the business of all the goods sold during the year”.

And here is the almighty Canada Revenue Agency’s take on it:
Opening Inventory + Purchases + Direct wages + Subcontracts – Closing Inventory = Cost of Goods Sold

Since only CRA’s opinion matters when it comes to filing your taxes, we’ll forget everything the first two bozos said and focus on the above formula. There are places on the “Statement of Business (Professional) Activities” form for each one of the elements in the above formula. In TurboTax you just plug your numbers in for each of these and PRESTO! The dreaded COGS is magically calculated for you. We just need to know what these elements are.

Opening Inventory: Total cost of all inventory on hand at the beginning of the year. This is identical to the previous year’s Closing Inventory.
Purchases: Total cost of all inventory (or materials used to make inventory) bought during the year.
Direct wages: Wages paid out to workers to manufacture the inventory.
Subcontracts: Amount paid to contract workers for work directly involved with manufacturing the inventory.
Closing Inventory: Total cost of all inventory on hand at the end of the year. This will be the Opening Inventory for the next year.

Depending on your business you may need to get another envelope for “Direct Wages” or “Subcontracts”, or possibly both. Most businesses just starting out probably won’t need either of these because the owner will be doing everything.

Back to Bob:

Let’s see how our Bob made out with his coffee roasting venture. Here are the numbers he would use on his tax return:

Opening Inventory: $0 (this is his first year so he started with nothing)
Purchases: $1,500
Direct wages: $0
Closing Inventory: $600 (200 pounds X $1500/500)

Bob’s COGS = $0 + $1,500 + $0 + $0 – $600 = $900
Opening Inventory + Purchases + Direct wages + Subcontracts – Closing Inventory = Cost of Goods Sold

But who cares?

Bob’s COGS for the year is $900. Whoopee–why bother? As I said before, we don’t even need to calculate COGS if we don’t feel like it because TurboTax will do it on the tax form for us. So what’s the point?


Total Revenue – COGS = Gross Profits

And Profits are sexy. So we’ll talk about them in another post.

July 4, 2011 - Posted by | Running Your Business, Starting Your Business | , , , , , ,


  1. I am currently using the 2010 Turbotax Home and Business edition and have gone through the entire business interview without being directed to a COGS entry section. Nor can I find one manually.
    Any ideas how/if I can find this? I’m on a Mac, so am using the online version; download is not available.

    Comment by J.R. Rardon | July 28, 2011 | Reply

    • Hi J.R.,
      I think I may be able to help. Try this first:
      -click “Forms” in the top menu
      -type “t2125” in the “Keyword to search for” box and hit enter
      Scroll down to “Part 4: Cost of Goods Sold” (pg 2 of 6)

      It’s possible that the section may be greyed out and you can’t enter anything. If that is the case:
      -click “Forms” in the top menu
      -type “t2124” in the “Keyword to search for” box (yes that’s “t2124” not “t2125”) and hit enter and scroll down to Part 4 again.

      Let me know if this works!

      Comment by jkswift | July 28, 2011 | Reply

      • Thanks for the prompt reply, jk …

        Unfortunately, the ‘forms’ option is not available in the online version. And because I’m on a Mac, I am not able to get the download version.
        But thanks, again, for your input. If you stumble across anything in the online product, I’m all ears.

        Comment by J.R. Rardon | July 28, 2011

      • Well, I went and looked at the online version and followed it through a bit. When you started entering in Business stuff it asks you to choose what type of business you have: Professional, Commission,…., Other. It could be that if you choose “Professional” it won’t give you access to COGS. I chose “Other” and it asked me about Opening Inventory and all that stuff.
        Do you think that might be it?

        Comment by jkswift | July 29, 2011

      • Thanks once again …

        I considered that when I was battling through this yesterday. I tried my business as “professional”, “services” and “sales”, and could not get the COGS screen to show up under any of them.

        When I enter the business profile, there are three “tiers” … the first one does not have an “other” option (professions, services, sales, wholesales, construction, manufacturing, natural resources). I have tried selecting professions, services and sales, then selected “other” in the following tier each time, and still do not get the COGS screen.

        Your assistance is appreciated, but I don’t expect you to tie up more of your time with it … I’ve contacted Turbo Tax (and gotten an initial, unhelpful reply), and will continue with that avenue. If I’m able to break through, I’ll pass along what I’ve learned.

        Best wishes,

        Comment by J.R. Rardon | July 29, 2011

      • Sorry I couldn’t be of more help J.R. When you do hear back from TurboTax I’d love to hear what you figure out. I’m sure lots of people have had the same problem with the software.

        Comment by jkswift | July 29, 2011

  2. Hi J.K.,

    Cool blog. Thank you for sharing so much info.

    I have a question about the formula in this post. Shouldn’t it be like this:
    Opening Inventory + Purchases + Direct wages + Subcontracts – Closing Inventory = Cost of Goods Sold? This is how I understand it by looking at Part 4 of T2125, edition 2012.

    Thank you.


    Comment by C.P. | February 24, 2013 | Reply

    • Yikes! Good catch C.P.! I`ll edit that right now. Thanks very much for stopping by.

      Comment by -- | February 24, 2013 | Reply

      • Thank you!

        Comment by C.P. | February 25, 2013

  3. Looking at the guide above this should cover the cost of lost/broken/giveaway items? Also the one thing I’m not clear on is how to calculate the exact cost of an item as I doubt approximate costs are accepted. I pay for items from china and they want USD, so I do the exchange at time of payment. There is shipping costs, and duty. I was previously going to factor it all in to get a price per item but I don’t think that will be accepted. Little confused on how to find the cost on let’s say 10 different items at varying costs and quantities on one invoice.

    Comment by Matt | May 27, 2013 | Reply

    • Hi Matt,

      The cost of lost/broken/etc. items will be reflected in the Cost of Goods Sold calculated on the Statement of Business Activities at year-end because the formula subtracts the final inventory that you count at that time. If it is no longer in inventory that means it has been sold, stolen, broken, wasted, or whatever, and you get credit for the expense.

      When it comes to shipping, exchange, etc., you would be surprised at how often approximate costs ARE accepted! To the best of your ability and information, add in shipping and exchange costs and average them over the number of items in your invoice. If the items are completely different sizes (like when one thing weights 100 grams and another weighs 2 kilos) pro-rate the shipping for those items by ESTIMATING. Often, common sense dictates you must do this. In the event of an audit, if CRA doesn’t like what you’ve done they’ll tell you, and as long as it’s reasonable there will be no penalty.

      Remember that the cost of your inventory is everything it takes to get that inventory to your “door” ready to sell.

      Good luck and thanks for stopping by Canuckbusiness!

      Comment by jkswift | May 28, 2013 | Reply

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s