Form 1125-A: Calculating Cost of Goods Sold
Properly calculating the Cost of Goods Sold on Form 1125-A is a critical step in determining a corporation's taxable income and overall profitability.
Form 1125-A, Cost of Goods Sold, is a supplemental form used by corporations and partnerships to calculate the direct costs associated with producing or acquiring the goods they sell. This calculation determines a company’s gross profit. The resulting Cost of Goods Sold (COGS) figure is deducted from gross receipts on the primary tax return, which reduces the business’s overall taxable income.
Determining if Form 1125-A is Required
A business must file Form 1125-A if it produces, purchases, or sells merchandise. This applies to manufacturers, wholesalers, and retailers that maintain an inventory of physical goods. The form is an attachment to a main business income tax return, such as Form 1120 for C corporations, Form 1120-S for S corporations, or Form 1065 for partnerships.
Businesses that provide services and do not sell goods do not need to file Form 1125-A. An exception exists for small business taxpayers with average annual gross receipts of $30 million or less for the three prior tax years. These businesses may be exempt from keeping formal inventories and filing this form. This exemption also relieves qualifying businesses from applying the Uniform Capitalization (UNICAP) rules, though businesses should confirm the inflation-adjusted threshold with the IRS.
Information Needed to Complete Form 1125-A
Before filling out the form, a business must choose an inventory valuation method, as it dictates how costs are assigned to goods. Common methods include valuing inventory at cost, the lower of cost or market, First-In, First-Out (FIFO), or Last-In, First-Out (LIFO). This method must be used consistently from year to year.
The first piece of data required is the beginning inventory. This figure is the value of all finished goods, raw materials, and supplies on hand at the start of the tax year. It must match the ending inventory value reported on the prior year’s Form 1125-A.
Next, you must calculate the total cost of purchases made during the year. This includes the cost of all raw materials or merchandise bought for resale and freight-in charges. It is important to subtract the cost of any items withdrawn from inventory for personal use.
The form also requires detailing the cost of labor. This line item is for the wages of employees directly involved in the manufacturing or mining process. It should not include salaries for administrative staff, salespeople, or other employees whose work does not directly contribute to the production of the goods.
A particularly complex area involves additional costs under the Uniform Capitalization (UNICAP) rules. These rules require certain direct and indirect costs associated with production or resale activities to be capitalized into inventory. Examples include factory rent, depreciation of manufacturing equipment, and utilities for the production facility.
Other costs that are directly related to getting inventory ready for sale but do not fit into the previous categories are reported separately. This can include expenses for shipping supplies and freight-out for delivering goods to customers. Finally, the ending inventory must be determined through a physical count of all goods on hand at the close of the tax year and valued using the consistently applied inventory method.
Step-by-Step Guide to Calculating COGS on Form 1125-A
Once all necessary figures have been compiled, completing Form 1125-A is a matter of transferring those numbers to the correct lines. The process follows a logical formula to arrive at the final COGS amount and relies on the accuracy of the data gathered beforehand.
The calculation begins on Line 1, where you enter the inventory at the beginning of the year. On Line 2, you will input the total amount for purchases made during the tax year, less any goods taken for personal use. Line 3 is designated for the cost of labor for those wages directly tied to production or mining operations.
Next, Line 4 is where you report the additional costs that were capitalized under the UNICAP rules. Line 5 is used to report any other direct costs not included on the preceding lines. Line 6 represents the total of these costs, calculated by adding the amounts from Lines 1 through 5, which is the total cost of all goods available for sale.
The value of your inventory at the end of the year is entered on Line 7. The final calculation is on Line 8, which is the Cost of Goods Sold. This is determined by subtracting the ending inventory on Line 7 from the total cost of goods available for sale on Line 6. This final COGS figure is then transferred to the main corporate tax return.