Expenses That Can Be Included In COGS (That Might Surprise You)

Some Cost of Goods Sold (“COGS”) expenditures are obvious (eg. raw materials or subcontractors working on a customer’s job), while others that can count as COGS might be overlooked. In this article, our CFOs will go over a few lesser-known expense types that should be included in COGS. For each, we’ll explore why they can be included and whether they might be classified as direct or indirect Cost of Goods Sold.

Cost of Goods Sold
is defined as expenditures directly related to the production of revenue. COGS are also referred to as the “Cost of Revenue” or “Cost of Sales.” In a nutshell, COGS tracks how much a business is spending to generate their top line sales. COGS differ from overhead expenses in their direct connection to the production of revenue, while overhead expenses are related to the operation of the business as a whole.

Direct COGS
are costs associated directly with revenue generation that can be tied to a specific client, product or job, while Indirect COGS are costs necessary for revenue generation but cannot be or are too difficult to tie to a specific client, product or job (eg. fuel in trucks or shop supplies). These differ from overhead expenses, which support the overall business but can’t be tied to revenue generation. To get a deeper dive into COGS, read our article: Understanding Cost of Goods Sold.

Expenses that may be included in COGS:

Sales Commissions

Why it’s included in COGS: Sales commissions can be directly tied to generating revenue. When commissions are directly attributable to a specific sale or client, they are a direct COGS. However, when commissions are based on overall sales volume and cannot be directly linked to a particular sale, the classification becomes more complex.

Direct or indirect: Sales commissions may be classified as either direct or indirect COGS depending on the commission structure. If commissions are tied to specific sales, they are direct COGS. If they are based on overall sales volume, they might be considered indirect, although some businesses may opt to allocate them to specific products or services.

Worker’s Compensation

Why it’s included in COGS: While Workers’ Comp is more commonly considered an overhead expense, it is wholly dependent on wages, a significant portion of which are usually tied to revenue generating activities in certain industries like construction and manufacturing. In these industries, worker’s compensation costs are directly tied to the labor involved in production and should be considered a production cost.

In manufacturing, for example, worker’s compensation costs would be included in the costs of final manufactured goods. Once the goods are actually sold, this would then hit COGS.

Direct or indirect: In many cases, worker’s compensation costs can be allocated to specific projects or products based on the amount of labor and can be considered direct COGS. If they can be tied to revenue-generating activities, but not a specific project or job, then they may need to be classified as indirect COGS. At the same time, worker’s comp premiums for administrative or other office type salaries should be classified as overhead expenses.

Truck Repairs

Why it’s included in COGS: For businesses that rely on trucks for delivery or service, repair costs are directly linked to the ability to generate revenue and may thus be included in COGS. Without operational trucks, sales can be impacted. Note that if a truck is inoperable for an extended period and not generating revenue, its repair costs might need to be treated as operating expenses rather than COGS. If a truck is used for personal purposes, even partially, the repair costs may not be considered COGS, but rather personal expenses.

The classification of truck repair costs can be complex and depends on specific circumstances, so, when in doubt, make sure to consult with an accounting professional before classifying this expense as COGS.

Direct or indirect: Truck repair costs are typically indirect COGS due to the difficulty and minimal benefit of specifically allocating the repairs to jobs. While these costs still contribute to revenue generation, it’s too hard to link them specifically to a single sale, product or service. I mean, when did the engine really break? At ABC Job when it wouldn’t start or over the last 7 years’ worth? For this reason, we treat truck repairs as indirect COGS when the expense is incurred.

Note: We typically don’t differentiate truck repairs from regular servicing and preventative maintenance like oil changes, tire rotations and inspections since these expenses are required to keep the fleet operational which relates to producing revenue. At the same time, expenses on the owner’s truck or a shop truck could be considered Overhead.

Postage

Why it’s included in COGS: While postage might seem like a general overhead expense, costs associated with mailing essential sales documents or shipping sold products to customers can be directly linked to revenue generation.

For example, if a client is billed for a series of services, one of which is mailing or delivery, postage used to mail those products that were included as part of generating revenue would be considered COGS. Lucrum occasionally mails 1099’s for our clients; we charge a flat $15 plus postage for this service. Accordingly, the 1099’s used for filing client work and the related postage get coded to COGS but our own internal 1099’s and postage throughout the year end up in Overhead expense.

If the postage is used to ship products directly to customers after they are sold, then it can be counted as COGS (Amazon anyone?). Especially when postage is a significant component of the overall cost of delivering the product, it can be included in COGS.

Direct or indirect: Postage can be either direct or indirect depending on the purpose. If directly related to a specific large custom order with custom shipping for example, it could be classified as direct COGS. For businesses mailing higher volumes of products or documents, it may be too difficult to match each postage dollar to a specific sale or product, and it may need to be classified as indirect COGS. If mailing a quarterly company newsletter, on the other hand, postage may need to be counted as an overhead expense.

Fuel/Gas

Why it’s included in COGS: Businesses that rely on vehicles, such as delivery services, transportation companies, or field service providers, directly link fuel costs to their ability to generate revenue. Without fuel, these businesses cannot operate, and therefore, cannot generate sales. Fuel is a crucial input that is consumed in the process of producing or delivering goods or services. It’s similar to raw materials or supplies that are directly used in the creation of a product.

Direct or indirect: Whether fuel costs are direct or indirect COGS will depend on whether the fuel costs can be directly attributed to the delivery of a specific product or the fuel costs for a specific service. For high volume applications, it may be difficult to allocate every gallon of gas to a specific delivery, product or service.

Supplies

Why it’s included in COGS: Supplies are typically counted as Cost of Goods Sold (COGS) when they are used to create or deliver a product or service. This means that the supplies are consumed or depleted in the process of generating revenue.

Smaller consumable supplies can be challenging to track. One example highlights a creative approach to allocating these costs: An HVAC company for which Lucrum provided CFO services came up with a system in which once the last item out of a box of consumable supplies was used, the new replacement box was coded to the last job. Things would ‘even out’ for the most part in the end across jobs, and it would have been too tedious to code each supply item used for every job. So, one job is charged for a full box of screws, another for zip ties, a third for PVC fittings, etc., despite all three jobs using some screws, zip ties and fittings.

Direct or indirect: The classification of supplies depends on their use. If they are directly consumed in the production process (e.g. raw materials) for a specific custom product or sale, they are direct COGS. If they are directly consumed in the production process, but it is difficult to track to a specific job (e.g. think the HVAC scenario above if the company had not come up with the creative solution that they did), they may be classified as indirect COGS. If they are used for general office or administrative purposes (e.g. pens, paper and printer ink), they are overhead costs.

Get Confidence in the Numbers with Accurate COGS

COGS is a key metric in understanding margins. Misclassifying COGS as overhead or other expenses may distort the picture of the company’s financial health. We often see business owners proud of their Gross Margin % (Sales – COGS) but on further analysis, we find several expenditures in Overhead that should be in COGS. Once corrected, it’s a tough pill for these entrepreneurs to swallow.

By carefully considering these often-overlooked expenses, businesses can gain a more accurate picture of their COGS and make informed decisions about pricing, profitability, and overall financial performance.

The classification of expenses as COGS can vary depending on the specific industry, accounting standards, and internal policies. It’s essential to consult with an accountant or business financial advisor for guidance. Need help? Schedule a no-commitment consultation with our CFOs and accountants today.