Schedule C Lines 35 - 42 Figure your cost of goods sold by filling out lines 35-42 ofSchedule C. These lines are reproduced below and are explained in thediscussion that follows. 35 Inventory at beginning of year. If differentfrom last year's closing inventory, attach explanation            36 Purchases less cost of items withdrawn for personaluse            37 Cost of labor. Do not include any amounts paidto yourself            38 Arendal hotel roomsMaterials and supplies            39 Other costs            40 Add lines 35 through 39            41 Inventory at end of year            42 Cost of goods sold. Subtract line 41from line 40.Enter the result here and on page 1, line 4            Line 35Inventory at Beginning of Year If you are a merchant, beginning inventory is the cost ofmerchandise on hand at the beginning of the year that you will sell tocustomers. If you are a manufacturer or producer, it includes thetotal cost of raw materials, work in process, finished goods, andmaterials and supplies used in manufacturing the goods (seeInventories earlier in this chapter). Opening inventory usually will be identical with the closinginventory of the year before. You must explain any difference in aschedule attached to your return. Donation of inventory.If you donate any inventory item to a charitable organization, theamount of your deductible contribution is the fair market value of theitem minus the amount that would be ordinary income if you had soldthe item at its fair market value on the date of the gift. You must remove from opening inventory the costs and expenses forthe contributed property that you incurred in earlier years. They arenot a part of cost of goods sold for figuring gross income for theyear of the contribution. Costs and expenses for the contributedproperty that you incurred in the year of the contribution aredeductible as part of cost of goods sold for that year if thistreatment of costs and expenses is proper under your accountingmethod. If you take such a deduction, those costs and expenses thatyou incurred in the year of the contribution are not treated asresulting in a basis for the contributed property. Example 1.You are a calendar year taxpayer who uses an accrual method ofaccounting. In 1999, you contributed property from inventory to achurch. It had a fair market value of $600. The closing inventory atthe end of 1998 properly included $400 of costs due to the acquisitionof the property, and in 1998, you properly deducted $50 ofadministrative and other expenses attributable to the property asbusiness expenses. The amount of the charitable contribution allowedfor 1999 is $400 ($600 - $200). The $200 is the amount thatwould be ordinary income if you had sold the contributed inventory atfair market value on the date of the gift. The cost of goods sold youuse in determining gross income for 1999 must not include the $400.You remove that amount from opening inventory for 1999. Example 2.If, in Example 1, you acquired the contributed property in 1999 ata cost of $400, you would include the $400 cost of the property infiguring the cost of goods sold for 1999, and deduct the $50 ofadministrative and other expenses attributable to the property forthat year. You would not be allowed any charitable contributiondeduction for the contributed property. Line 36Purchases Less Cost of Items Withdrawn for Personal Use If you are a merchant, use the cost of all merchandise you boughtfor sale. If you are a manufacturer or producer, this includes thecost of all raw materials or parts purchased for manufacture into afinished product. Trade discounts.The differences between the stated prices of articles and theactual prices you pay for them are called trade discounts. You mustuse the prices you pay (not the stated prices) in figuring your costof purchases. Do not show the discount amount separately as an item ingross income. An automobile dealer must record the cost of a car in inventoryreduced by the amount of a manufacturer's rebate that represents atrade discount. Cash discounts.Cash discounts are amounts your suppliers let you deduct from yourpurchase invoices for prompt payments. There are two methods ofaccounting for cash discounts. You may either credit them to aseparate discount account or deduct them from total purchases for theyear. Whichever method you use, you must be consistent. If you want tochange your method of figuring inventory cost, you must get permissionfrom the IRS. See Publication 538for information on how to changeyour inventory method. If you credit cash discounts to a separate account, you mustinclude this credit balance in your business income at the end of thetax year. If you use this method, do not reduce your cost of goodssold by the cash discounts. Purchase returns and allowances.You must deduct all returns and allowances from your totalpurchases during the year. Merchandise withdrawn from sale.If you withdraw merchandise for your personal or family use, youmust exclude this cost from the total amount of merchandise you boughtfor sale. You do this by crediting the purchases or sales account withthe cost of merchandise you withdraw for personal use. You shouldcharge the amount to your drawing account. A drawing account is a separate account you shouldkeep to record the business income you withdraw to pay for personaland family expenses. As stated above, you also use it to recordwithdrawals of merchandise for personal or family use. This account isalso known as a withdrawals account or personalaccount. Line 37Cost of Labor Labor costs are usually an element of cost of goods sold only in amanufacturing or mining business. Small merchandisers (wholesalers,retailers, etc.) usually do not have labor costs that can properly becharged to cost of goods sold. In a manufacturing business, laborcosts that are properly allocable to the cost of goods sold includeboth the direct and indirect labor used in fabricating the rawmaterial into a finished, saleable product. Direct labor.Direct labor costs are the wages you pay to those employees whospend all their time working directly on the product beingmanufactured. They also include a part of the wages you pay toemployees who work directly on the product part time if you candetermine that part of their wages. Indirect labor.Indirect labor costs are the wages you pay to employees who performa general factory function that does not have any immediate or directconnection with making the saleable product, but that is a necessarypart of the manufacturing process. Other labor.Other labor costs that are not properly chargeable to the cost ofgoods sold may be deducted as selling or administrative expenses.Generally, the only kinds of labor costs that are properly chargeableto your cost of goods sold are the direct or indirect labor costs, andcertain other costs that are treated as overhead expenses properlycharged to the manufacturing process, as discussed later underLine 39 Other Costs. Line 38Materials and Supplies Materials and supplies, such as hardware and chemicals, used inmanufacturing goods are charged to cost of goods sold. Those that arenot used in the manufacturing process are treated as deferred charges.You deduct them as a business expense when you use them. Businessexpenses are discussed in chapter 8. Line 39Other Costs Examples of other costs incurred in a manufacturing or miningprocess that you charge to your cost of goods sold are as follows. Containers.Containers and packages that are an integral part of the productmanufactured are a part of your cost of goods sold. If they are not anintegral part of the manufactured product, their costs are shipping orselling expenses. Freight-in.Freight-in, express-in, and cartage-in on raw materials, suppliesthat you use in production, and merchandise that you purchase for saleare all part of cost of goods sold. Overhead expenses.Overhead expenses include expenses such as rent, heat, light,power, insurance, depreciation, taxes, maintenance, labor, andsupervision. The overhead expenses you have as direct and necessaryexpenses of the manufacturing operation are included in your cost ofgoods sold. Line 40Add Lines 35 through 39 The total of lines 35 through 39 equals the cost of the goodsavailable for sale during the year. Line 41Inventory at End of Year Subtract the value of your closing inventory (including, asappropriate, the allocable parts of the cost of raw materials andsupplies, direct labor, and overhead expenses) from line 40. Yourending inventory will usually become the beginning inventory of yournext tax year. Line 42Cost of Goods Sold When you subtract your closing inventory from the cost of goodsavailable for sale, the remainder is your cost of goods sold duringthe tax year. When you subtract your cost of goods sold from youradjusted gross receipts, the remainder is your gross profit fromsales.