Are Merchant Fees Considered Cost of Goods Sold?
Gain clarity on how payment processing expenses are accounted for, distinguishing them from direct production costs for accurate financial insights.
Merchant fees are charges businesses incur for processing electronic payments, such as credit or debit card transactions. These fees are a cost of doing business, separate from the direct costs of producing goods. Understanding their classification is important for accurate financial analysis. This article clarifies whether merchant fees are considered Cost of Goods Sold (COGS) and explains their typical accounting treatment.
What Are Merchant Fees
Merchant fees encompass a range of charges businesses pay to accept electronic payments from customers. These fees arise from transactions made via credit cards, debit cards, or online payment systems. They cover the costs associated with the payment processing infrastructure and the various parties involved in a transaction.
A significant component of these charges includes interchange fees, which are paid to the card-issuing bank. Card networks like Visa, Mastercard, and American Express also levy assessment fees, typically a small percentage of the transaction value. Payment processors, who facilitate transactions for businesses, charge their own markup or fees, which can be structured as a percentage of each transaction, a flat fee, or a combination.
Additional fees can include gateway fees for online transactions, PCI compliance fees, and monthly minimums. Businesses may also encounter authorization fees, and situational fees, such as chargeback or refund fees.
What is Cost of Goods Sold
Cost of Goods Sold (COGS) represents the direct costs of producing the goods or services sold by a company during a specific accounting period. It is a crucial metric for businesses as it directly impacts gross profit. COGS is typically the second line item on an income statement, appearing directly after sales revenue.
The primary components that constitute COGS include direct materials, direct labor costs, such such as wages paid to employees directly involved in the manufacturing or production process, and manufacturing overhead. Overhead encompasses indirect costs related to production, such as factory rent, utilities for the production facility, and depreciation of manufacturing equipment.
COGS is deducted from revenue to calculate a company’s gross profit, which indicates the profitability of its core operations before considering other expenses. This calculation is fundamental for financial reporting and analysis, providing insight into how efficiently a company produces its goods. These direct production costs are distinct from the costs associated with selling or administrative activities.
How Merchant Fees Are Classified
Merchant fees are generally not classified as Cost of Goods Sold. This is because COGS includes direct costs related to the production or acquisition of goods for sale. Merchant fees, conversely, are incurred after the goods have been produced and are associated with the act of selling and collecting payment. They are considered a cost of facilitating the sale rather than a cost of creating the product itself.
Instead, merchant fees are typically categorized as Operating Expenses on a company’s income statement. They often fall under Selling, General & Administrative (SG&A) expenses. Businesses may list them under accounts such as “Payment Processing Fees,” “Bank Charges,” or a broader category like “Other Operating Expenses.” This classification aligns with accounting principles, which aim to match expenses with the revenue they help generate, while clearly distinguishing between production costs and operational costs.
The rationale is that these fees are a necessary cost of doing business in a modern economy where electronic payments are prevalent. However, they do not contribute to the transformation of raw materials into finished goods or the direct acquisition of inventory for resale. Therefore, their placement within operating expenses provides a clearer picture of the costs associated with running the business and selling its products, separate from the cost of manufacturing them.
Why Classification Matters
Proper classification of merchant fees carries significant implications for a business’s financial reporting and strategic decision-making. Incorrectly categorizing these fees can distort key financial metrics, leading to misinterpretations of a company’s performance. For instance, if merchant fees were erroneously included in COGS, it would result in an understatement of gross profit. This misrepresentation could lead management to believe the core production process is less profitable than it truly is, potentially influencing pricing strategies or production efficiency assessments.
While the ultimate impact on net income might be the same regardless of classification, the intermediate profit metrics are affected. Financial statement users, including investors, creditors, and internal management, rely on accurate expense classification to analyze a company’s cost structure and operational efficiency. Misclassification can lead to misleading financial ratios, which are often used to compare a company’s performance over time or against industry benchmarks.
Accurate expense classification also plays a role in tax compliance and identifying eligible deductions. Although both COGS and operating expenses are generally deductible for tax purposes, their categorization affects how they appear on tax forms and can influence specific tax calculations. Maintaining precise financial records through correct classification is therefore important for both internal financial management and external reporting obligations.