Is Labor Included in COGS for Restaurants?

A frequent question in the restaurant industry is whether labor costs should be part of the Cost of Goods Sold (COGS). For financial reporting under Generally Accepted Accounting Principles (GAAP), the answer is no. Labor costs are not included in a restaurant’s COGS because it is defined to include only the direct costs of food and beverage products sold to customers. Labor is instead treated as a separate operating expense on the income statement.

Defining Restaurant Cost of Goods Sold

The calculation of a restaurant’s Cost of Goods Sold measures the direct costs of inventory used to generate revenue. The standard formula is: Beginning Inventory + Purchases – Ending Inventory = COGS. This formula ensures that you are only accounting for the cost of the products sold during a specific accounting period.

The items that fall under the COGS calculation are specific and tangible. They include all food ingredients, from meat, poultry, and fish to produce, dairy products, and dry goods. This category also includes all beverage costs, both alcoholic, such as beer and wine, and non-alcoholic, like soda, juices, and coffee.

Beyond the edible components, COGS also includes certain supplies that are directly tied to delivering the final product to the customer. These are items consumed in the act of the sale. This includes disposable to-go containers, pizza boxes, paper napkins, and straws. If the item is a direct material cost of the product being sold, it belongs in the COGS calculation.

The Proper Classification of Labor Costs

In the restaurant industry, labor costs are accounted for differently than in a manufacturing setting where some labor can be directly capitalized into inventory. Under GAAP, all labor costs in a restaurant are classified as operating expenses, appearing on the income statement separately from COGS. This is because restaurant service is immediate, and the labor involved is not seen as creating a tangible asset that sits in inventory.

This category of labor costs includes all expenses related to employing staff. It includes the gross wages and salaries for every employee, from the back-of-house team to the front-of-house staff. The classification remains the same whether the employee is paid hourly or receives a fixed salary.

Beyond direct wages, labor costs also include related expenses. An operator must account for the employer’s share of payroll taxes, which includes Social Security, Medicare, and federal and state unemployment taxes. Any employee benefits provided by the restaurant are part of this total labor cost, including contributions to health insurance plans, retirement plan matches, and paid time off.

Understanding Prime Cost

While COGS and labor are kept separate for formal financial statements, they are often combined for internal management analysis using a metric called Prime Cost. This figure is calculated by adding the Total Cost of Goods Sold and the Total Labor Costs for a given period. The formula is: Prime Cost = COGS + Total Labor Costs. This metric provides a view into the two largest controllable expense categories for a restaurant.

Analyzing Prime Cost is a key performance indicator (KPI) for operational efficiency. For example, if a restaurant has a COGS of $30,000 and a total labor cost of $35,000 for a month, its Prime Cost is $65,000. If the total revenue for that same month was $110,000, the Prime Cost as a percentage of sales would be 59%.

Tracking this KPI is important for maintaining profitability. A healthy and sustainable Prime Cost should fall between 55% and 65% of total revenue. A figure above this range often signals inefficiencies such as high food waste, overstaffing, or menu prices that are too low. A number below this range might indicate high menu prices or efficient operations.