Question - Does inventory count as income?

Answered by: Andrew Wright  |  Category: General  |  Last Updated: 23-06-2022  |  Views: 1036  |  Total Questions: 14

Inventory is a reduction of your gross receipts. This means that inventory will decrease your “income before calculating income taxes” or “taxable income. To make inventory profits hurt less, minimize them -- at least for tax purposes. Businesses normally report financial results differently from the numbers they use on their tax returns. By lowering the cost of ending inventory, you increase COGS and save on taxes. Impact on Your Taxes If you paid tax on your gross sales receipts, you would have a very high tax bill. By deducting the value-of-inventory figure, you reduce your taxable income by as much as 88 percent (assuming a 12 percent average markup for inventory). You only pay taxes on your profits. Inventory is not directly taxable as it is cannot be bought or sold. The business owner considers the inventory unsold at the end of the financial year, when calculating the tax to pay. Unsold inventory affects the tax bill, so it should be handled with care. When you purchase inventory, it is not an expense. Instead you are purchasing an asset. When you sell that inventory THEN it becomes an expense through the Cost of Goods Sold account. You will understate your assets because your inventory won't actually show up as inventory on the balance sheet.

Inventory Purchases You record the value of the inventory; the offsetting entry is either cash or accounts payable, depending on the method you used to purchase the goods. At this point, you have not affected your profit and loss or income statement.

Although you are not required to report inventory if your receipts are 1 million or less as a Qualifying Taxpayer, the costs for what would otherwise be inventoriable items are considered to be NON-incidental materials and supplies to be listed on line 36 (purchases on Sch C).

For example, say a company with $100, 000 worth of inventory decides to write-off $10, 000 in inventory at the end of the year. First, the firm will credit the inventory account with the value of the write-off to reduce the balance. The value of the gross inventory will be reduced as such: $100, 000 - $10, 000 = $90, 000.

Debit the cost of goods sold (COGS) account and credit the inventory write-off expense account. If you don't have frequently damaged inventory, you can choose to debit the cost of goods sold account and credit the inventory account to write off the loss.

In its most basic form you would determine your profits as follows: Your sales make your Total Revenue. Your beginning inventory plus the items you buy each year minus your ending inventory form your Cost of Goods Sold (“COGS”). What you have not sold by the end of the year valued at your cost, is your Inventory.

When It Comes to Taxes, Here Is How to Handle Inventory Your total revenue would equal your annual sales. Beginning inventory plus new inventory minus ending inventory would result in your annual cost of goods sold. Remaining unsold goods is your inventory at the end of a year, so your profits would equal total revenue minus COGS.

In periods of price decline, the best method for a lower net income, and therefore lower income taxes, is the method that renders the highest value for the cost of goods sold. As our example shows, FIFO renders a value of $1, 000 for cost of goods sold, and LIFO renders a value of $500.

Inventory is made up of all the items that a business has on hand to sell, as well as all of the goods that the company will use to manufacture income-producing goods. While inventory is not directly taxable, it is used to calculate a business's cost of goods sold, or COGS.

What happens when Inventory goes up by $10, assuming you pay for it with cash? No changes to the Income Statement. On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow from Operations - it goes down by $10, as does the Net Change in Cash at the bottom.

Inventory is written down when goods are lost or stolen, or their value has declined. This should be done at once, so that the financial statements immediately reflect the reduced value of the inventory.

Yes, you have to keep track of inventory. Your purchases that go into the product you sell are not deductible until sold. You don't need to track details, size, color, etc., unless that's meaningful to you, but you do need to track the dollars.

What about items you can't sell? If you can no longer sell a product, it's considered “worthless” and taken out of inventory. The loss will result in slightly higher COGS, which means a larger deduction and a lower profit. There's no tax advantage for keeping more inventory than you need, however.

The purchase of inventory doesn't impact the income statement at all. Therefore, neither Gross Profit or Net Income are affected.

When an ending inventory overstatement occurs, the cost of goods sold is stated too low, which means that net income before taxes is overstated by the amount of the inventory overstatement. However, you then have to pay income taxes on the amount of the overstatement.