What is included in cost of sales, admin and distribution costs?

In my previous post (So what are financial statements anyway?), I mentioned that when you are presenting your P&L, make sure you classify your expenses consistently either by function or by nature.

• Expenses by nature: depreciation, purchases of materials, transport costs, marketing costs, etc.
• Expenses by function: cost of sales, distribution costs and administration costs.

Many accountants I know usually get slightly confused about how to group expenses by function. Especially what to include in cost of sales. So, I decided to help out those who are looking for guidance. Cost of sales / Cost of goods sold will usually consist of the following:

• Cost of inventories used in producing revenues. Cost of inventory would include direct costs related to purchase of materials, transportation from supplier to your production facility, and costs of production.
• Direct staff costs: such as production plant staff, but not staff costs of your, say marketing department.
• Direct depreciation charges: again, this would be depreciation of things like machinery, used for production, production floor, etc. Do not include depreciation of your office equipment.
• Any other relevant ad-hoc charges, such as external hire of equipment and staff.
• Include cash-backs or bulk discounts that you receive from your supplier. Do not include finance discounts though.

There may be certain overheads which are not directly related to generating revenues. However, if you can prove that they are indirectly linked, you could potentially allocate portion of those costs too. Distribution costs will usually consist of the following:

• Staff costs relating to sales and marketing departments.
• Marketing and advertising costs.
• Client entertainment.
• Storage costs for finished goods. This will include any rent and depreciation of your storage facilities. If storage facilities are shared for finished goods and goods in progress, you would need to allocate the cost between cost of sales and distribution costs proportionally.
• Costs of transporting inventory from production facility to sales floor, or to client.
• Fixed and variable costs relating to your sales floor. For example, your retail unit maintenance costs, fees paid for POS and CRM systems, etc.
• Agent fees and commission.
• Any other selling costs.

General and Administrative expenses include:

• Office expenses for admin staff, like HR, Finance, IT and general management. This will include both fixed costs such as rental and depreciation, as well as variables such as salaries, stationary and other consumables.

When you include any expenses as an accrual, you should record reversal of the over-accrued expense in the same line as the original expense. Some people treat reversal of expenses as other income, or within ‘other costs’. This would not be in accordance with the requirements of IFRS. IAS 2 (Inventories) paragraph 34, for example, specifically requires you to include reversal of write-down of inventories within cost of sales. Above relates to reversal of over-accrued expense as a result ‘changes in accounting estimates’, rather than ‘error or misstatement’. If over-accrual was a result of material ‘error or misstatement’, you would have to correct this retrospectively (i.e. by restating your previous financial statements). See more on IAS 8 – ‘Accounting Policies, Changes in Accounting Estimates and Errors’ (coming soon). Bonus – what to include within ‘Finance costs’:

• Interest expenses on loans and borrowings.
• Intrinsic interest cost included within rentals in finance lease agreements.
• Mandatory / non-discretionary payment of dividends on shares classified as liability (for example preference shares). Read more about debt or equity classification (coming soon).
• FX losses on loans and borrowings.
• Unwinding of discounts or premiums arising from fair valuation of financial liabilities on initial recognition.
• Unwinding of discounts on long-term provisions.