Cost of sales or expenses? Where purchases go

Cost of sales is what it cost to make or buy the things you sold. Expenses are the costs of running the business. Getting the split right gives you a gross profit you can trust, but moving a cost between the two doesn’t change your total profit or your tax.

Last checked against GOV.UK on 2 November 2026.

A4O Accounts files your accounts and CT600 from the same figures. Get started free, no card required.

A quick test

Ask: if you’d sold nothing this year, would you still have paid this? If the cost would have fallen away, it’s probably cost of sales. If you’d still have paid it, it’s probably an expense. There’s no single statutory list, so use this as a guide and apply it the same way each year.

Where it shows in the accounts

The most common profit and loss format for a small company runs in this order:

Figures are invented. Turnover, cost of sales, gross profit, distribution costs and administrative expenses are headings in Format 1 of the 2008 regulations. A second format groups costs by type instead, such as raw materials and staff costs, with no cost of sales line.

Micro-entity accounts use a shorter format that also groups costs by type, so there’s no cost of sales line and no gross profit.

Why the split matters

Your gross margin is the first thing you, a lender or a buyer will look at. In the example it’s 31,000 out of 60,000, or about 52%. If some direct costs sit in expenses this year and in cost of sales next year, the margin moves when nothing about the business has changed.

What’s bought isn’t always cost of sales this year

Cost of sales is the cost of what you sold, not what you bought. Goods still on the shelf at the year end go on the balance sheet as stock, and they become a cost when they’re sold.

See counting, valuing and writing down stock.

Equipment and capital items

Something the company keeps and uses goes on the balance sheet as a fixed asset and is depreciated over its life. A repair or small replacement part is usually an expense. Tax treats the two differently: depreciation is added back and capital allowances are given instead. See what goes in a Corporation Tax computation.

What it changes for tax

Moving a cost between cost of sales and expenses doesn’t change the profit, so it doesn’t change the Corporation Tax. Three things do affect the tax:

• Whether the cost was for the trade. Expenses aren’t deductible unless they’re incurred wholly and exclusively for the trade, wherever they appear in the accounts. If a cost has more than one purpose, an identifiable business part may still be deductible.
• Whether it’s stock. Unsold goods at the year end don’t reduce this year’s profit. See closing stock and Corporation Tax.
• Whether it’s capital. Equipment goes through capital allowances rather than as an expense. For most small companies the Annual Investment Allowance still gives full relief in the year it’s bought.

Getting it right at the year end

Read down the accounts in the trial balance before you prepare anything from it. Check that the same kind of cost sits in the same place as last year, that any large purchase isn’t really equipment, and that the margin looks sensible against last year. The year-end checklist gives the full order.

In A4O Accounts

Each purchase goes to the account you choose. Accounts of the cost of goods sold type appear under cost of sales in the accounts, and other expense accounts appear under administrative expenses unless the account is set to another line. See entering and paying a bill and what you can file.