Should Server costs be classed as 'Cost of Sales' if resold to clients?

[Syranius Apostle]

I run a server that hosts the websites of my clients and my own company. I pay a monthly fee for the server, then divide this cost between my company and those of my clients. My clients pay upon receipt of a monthly invoice that includes their contribution towards the server costs as well as a small markup fee for the overall management of such a server.

In effect, I am both the customer and re-seller of this server.

With the above in mind, I am not sure what Expenses Category I should place the fees I pay towards the server provider.

Cost of Goods Sold
Initially, I thought I should place the fee within the 'Cost of Goods Sold', since my company is making some revenue from reselling the server to my clients.

Web Hosting
Alternatively, should I create a separate 'Web Hosting' Expenses Category and place such Fees within this Category?

Furthermore, would the server costs be classed as a Direct Cost or an Overhead?

Whilst on the topic, I am curious to understand how accurate Expenses Categories need to be? I have used a handful of Bookkeeping Software, where there seems to be a great deal of variation in how they handle the Categorisation of Expenses as well as associated terminologies. As such, suggesting there is room for interpretation rather than there being a strict guideline to follow alongside HMRC.

Ultimately, I have always thought that Bookkeeping should be done primarily for HMRC with Business Oversight being a secondary consideration. Is this not the case?

 

[gpietersz]

Ultimately, I have always thought that Bookkeeping should be done primarily for HMRC with Business Oversight being a secondary consideration. Is this not the case?

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Both are equally important, and both need to be done, and they have different rules (e.g. capital allowances vs depreciation). You have more discretion about financial reporting than tax.

Your particular question does not mater for tax (its a cost that reduces your taxable profits) .

If its just one server, I would say its an overhead. You cannot continue in (that line of) business without it, and you can probably put more clients on it so its not directly related to the volume of sales. Its not unlike the rent of a shop if you were a retailer.

 

[TheCyclingProgrammer]

I wouldn’t overthink it. I would treat it as an overhead and categorise your costs as “Web Hosting” and the money you receive from your customers is just sales.

 

[Syranius Apostle]

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Its not unlike the rent of a shop if you were a retailer.

Thank you for your analogy. I see what you are saying here.

Let's say in the future that I end up with clients who require servers that only host their website. In other words, offer dedicated servers.

Would the costs associated with these dedicated servers still be classed as overheads or would these be placed within the Cost of Sales category, since I would only be paying for the dedicated servers for the duration that I worked with the client(s).

Assuming such dedicated servers would be placed within the Cost of Sales category, would this have any future implications since I would have some servers within the Cost of Sales category with another server within the 'Web Hosting' category?

 

[Syranius Apostle]

I wouldn’t overthink it. I would treat it as an overhead and categorise your costs as “Web Hosting” and the money you receive from your customers is just sales.

I am often guilty of overthinking. :-S

Just trying to ensure the 'right' categories are selected as there seems to be many categories that overlap together with different Bookkeeping software using different categories. Just curious how strict HMRC would be on the such categories.

For example, 'Web Development' could fit both 'Website Services' and 'Marketing' categories. Is it a case of 'as long as it makes sense and is consistent' then HMRC are unlikely to query such categorisations?

 

[Syranius Apostle]

Sorry. I should had included this in the original question ...

I also offer some Clients (startups) a complete set up and management service for one set monthly fee. Among other aspects, part of this service can entail purchasing Domain names for the client and managing them on their behalf. How should these be Categorised? They are not Overheads and are not strictly part of the 'Web Hosting' Overheads. Would I be right in thinking these are 'Cost of Sales' or would 'Direct Expenses' be more fitting? I can also see 'General Expenses' being a category that is available within the Bookkeeping software too.

 

[NicoJ]

Technically the correct answer to your question is that the element of costs recharged to your customers is a cost of sale and the element of cost should be put to overheads. As you are splitting the cost anyway it shouldn't be too onerous to post correctly in your software.

To answer your second question cost of sales & direct expenses appear in the same place on your p&l (to calculate your gross profit) so it's up to you how you want to separate your postings. Either would be correct.

 

[Millerd]

General Expenses is not a good option as if it becomes a material amount HMRC may require these to be broken down.
With your concerns you are confronting the "art" part of bookkeeping/accounting as opposed to the science element.
HMRC wants as much profit as possible and are more concerned about expenses that are questionable (for example splits between personal and business expenses) - if it is a genuine business expense it makes little difference which line it occupies.
For you as a business owner I would be more concerned understanding the numbers in terms of the business (for example at the end of the year seeing which parts of the business are more or less profitable and if possible which customers, etc).

 

[gpietersz]

Would the costs associated with these dedicated servers still be classed as overheads or would these be placed within the Cost of Sales category, since I would only be paying for the dedicated servers for the duration that I worked with the client(s).

A cost of goods sold and deducted from gross profit - going back to a retail analogy its like the the cost of an item you sell in a shop. You cannot sell the item without buying it, so the cost of buying it a cost of goods sold.

I am not sure what the right wording is when its a service. Is it still cost of goods sold?

 

[Syranius Apostle]

Technically the correct answer to your question is that the element of costs recharged to your customers is a cost of sale and the element of cost should be put to overheads. As you are splitting the cost anyway it shouldn't be too onerous to post correctly in your software.

Thank you for your response, though I am still struggling to understand the answer. I am finding that so many people have different interpretations.

Maybe some figures would help me, with understanding the answer. Let's assume the following costs:

- Dedicated Server: £200 per month. (Paid by my business)
- My business pays £20 per month to host its website on the server.
- I have 9 other clients who pay my business £20 per month for a space on the server.

As such, I break even on the server, where the business makes its revenue from providing management services that are invoices separately.

Regarding this £200, would this be placed as a 'Cost of Goods', since it is used predominately by clients? You state the element of cost should be put as overheads but the Cost of Goods are classed as Direct Costs, not Overheads within the Bookkeeping software I am using.

Not sure if I am confusing myself or simply mixing up multiple people's ways of doing Bookkeeping.

 

[Syranius Apostle]

HMRC wants as much profit as possible and are more concerned about expenses that are questionable (for example splits between personal and business expenses) - if it is a genuine business expense it makes little difference which line it occupies.

Thank you for your response.

Are you saying that HMRC gives leeway for how Expenses are Categorised? Let's say there 2 businesses that pay for the monthly server fees and the annual domain renewal fees for its clients.

Company A categorises these expenses as 'Costs of Goods';
Company B categorises these expenses as 'Web Hosting'.

HMRC then decides to investigate both companies. Would HMRC pick up on either as being incorrect and thus request the company to change its approach to Expense Categorisation?

I have been doing my own Bookkeeping for several years, with no issues but since migrating to new Bookkeeping software, with different Expenses Categories, I am starting to wonder if there are mistakes in the way I am approaching Bookkeeping.

 

[Syranius Apostle]

You cannot sell the item without buying it, so the cost of buying it a cost of goods sold.

This is what I was initially thinking but I have come across others who say that such a Cost is an Overhead. The 'Cost of Goods' (Cost of Sale) Expenses Category is not an Overhead but a Direct Cost. This is adding to the confusion, my end.

 

[NicoJ]

The reason I put "technically" in my post is because there is nothing set in stone to show you where to post each and every transaction.

You can, to a certain extent, put your expenses wherever you want to. It's your bookkeeping! HMRC do not care as long as you can answer their questions should they ever investigate.

Do you have an accountant? It may be worth compiling your bookkeeping questions and going through them together. It will help with the year end accounts if you and your accountant are on the same page with the books.

 

[TheCyclingProgrammer]

You’re still massively overthinking this. Put it down as web hosting and move on.

 

[Millerd]

Thank you for your response.

Are you saying that HMRC gives leeway for how Expenses are Categorised? Let's say there 2 businesses that pay for the monthly server fees and the annual domain renewal fees for its clients.

Company A categorises these expenses as 'Costs of Goods';
Company B categorises these expenses as 'Web Hosting'.

HMRC then decides to investigate both companies. Would HMRC pick up on either as being incorrect and thus request the company to change its approach to Expense Categorisation?

I have been doing my own Bookkeeping for several years, with no issues but since migrating to new Bookkeeping software, with different Expenses Categories, I am starting to wonder if there are mistakes in the way I am approaching Bookkeeping.

The main concern of HRMC is getting what they think is owed to them! In both cases it makes no difference and any query would probably be more related to the opinion of the individual looking at the transaction than the substance of the issue.

Also remember that most bookkeeping packages are created by computer geeks who probably know less about accounting than you do!

As I mentioned I would be more concerned about what the numbers mean to me as a business owner than the technical interpretation of HRMC.

 

[gpietersz]

HMRC then decides to investigate both companies. Would HMRC pick up on either as being incorrect and thus request the company to change its approach to Expense Categorisation?

They do not care. They only care if your classification affects tax. For example if you classify capital expenditure as a cost, they will care.

 

[gpietersz]

- Dedicated Server: £200 per month. (Paid by my business)
- My business pays £20 per month to host its website on the server.
- I have 9 other clients who pay my business £20 per month for a space on the server.

if your business paid for the server, who is it paying £20 a month to?

 

[Syranius Apostle]

You’re still massively overthinking this. Put it down as web hosting and move on.

It was not just the naming of the Category but whether the Expense would be classed as 'Overheads' or 'Cost of Sales'.

As a Business, I have Web Hosting Fees that would be classed as 'Overheads'. Primarily, covering the cost of the Business' Website and Emails server.

As a reseller of various Web Hosting resources, the Business also has Web Hosting fees that are directly related to client sales. Therefore, could be classed as 'Cost of Sales', in my view.

In the end, I have gone with Web Hosting as an Overhead; which I hope would be satisfactory should HMRC query anything.

 

[Syranius Apostle]

The main concern of HRMC is getting what they think is owed to them! In both cases it makes no difference and any query would probably be more related to the opinion of the individual looking at the transaction than the substance of the issue.

Also remember that most bookkeeping packages are created by computer geeks who probably know less about accounting than you do!

As I mentioned I would be more concerned about what the numbers mean to me as a business owner than the technical interpretation of HRMC.

Thank you for your patience and continued guidance.

I guess I should just look at Bookkeeping in a way that makes sense to me, from an organisational perspective, as well as in a way that accurately organises financial data in a way that makes sense and would allow me to answer any HMRC questions, should they arise.

Not to mention, in a way that allows me to peruse the data to review the financial performance of the business as well of course! ;-)

I just have it stuck in my head that there is a Black & White approach to Bookkeeping that has very little leeway, and if you are a penny out, HMRC will seek to issue penalties etc if the Bookkeeping does not follow rigid guidelines.

Not that I have had any issues over the past 5 years but as a self taught individual, I always like to double check these things.

Once again, thank you for the reassurances.

 

[Syranius Apostle]

if your business paid for the server, who is it paying £20 a month to?

Sorry. Let me clarify the example ...

Costs:

• Dedicated Server: £200 per month. (Paid by my business);
• I have 9 clients who pay my business £20 per month for a space on the server. This equates to £180 that goes towards the cost of the £200 per month for the Dedicated Server;
• The remaining £20 is covered by my Business.

Obviously, the cost of the Dedicated Server would be placed into the Web Hosting Expense Category. I am just not sure if this Category should be classed as an 'Overhead', since it is covering my Business' Website and Email needs or whether the Expense Category should be classed as 'Cost of Sales' since the the Dedicated Server cost would be directly proportionate to the amount of clients on board.

With regards to the new Bookkeeping Software I am using, I can see that I can split transactions, during reconciliation.

Using the above example, would there be any harm in splitting the transaction, with £180 being assigned to the 'Web Hosting (Clients) - Direct Costs' Expense Category and £20 to the 'Web Hosting (Business) - Overheads' Expense Category? My only issue would then be that the incoming invoice would reflect £200 with both transactions being under this £200.

 

[Alan]

I have 3 things in my Cost of Sales

1. Online Service costs - this includes hosting and any additional SaaS services (e.g. backup storage ) needed to service my clients
2. Purchases on behalf of clients - this includes domain names, themes, plugins etc
3. Outsourced services - this includes for instance copywriting services or design services

Been doing it like that for years and my accountant is perfectly happy with it