This company legitimately spent $300,000 throughout the year (and has the lack of cash on hand to prove it) but is only getting $270,000 of expense when tallying taxable profits. But think about a scenario where a company started the year with $10,000 of inventory, had purchases throughout the year of $300,000, and ended with $40,000 in inventory: If your inventory stayed constant and level year to year this would be fine. Inventory is an asset and shouldn’t be expensed until used. Really, that makes sense if you think about it it is Cost of Goods SOLD after all. For tax purposes COGS is calculated in this way on an annual basis: The only issue with this is the tax calculation for COGS and how this can impact larger inventory purchases.
For small businesses, and in particular for small dollar and small quantity inventory items, there is the assumption that these will be used in short order and the purchase just goes straight to COGS. No one wants to put 100 $1.00 widgets into inventory as separate items and then reduce the inventory count one at a time each time you sell one for $2. And for a lot of small or incidental items, this can make practical sense. Unless you are a retail operation and keep up with specific items for reordering purposes or are a company that bills material costs back to the customer, many people just put the entirety of a purchase straight into Cost of Goods Sold (COGS). Year End Inventory and Cost of Goods SoldĬonstantly keeping track of inventory is a pain. For this article, we’re going to talk about inventory timing. Instead, these quick recaps will simply serve as an effective “heads-up” about certain important issues and will help you to see whether a more serious look into your business accounting practices are needed. Trust me, you probably wouldn’t want me to write anything that long or detailed (unless you happened to be suffering from insomnia, in which case an in-depth treatise on business accounting would probably be just what you needed). If you don’t have this basic understanding you can find yourself with unexpected pain come tax season.Īnd keep in mind, these are not comprehensive or exhaustive discussions of the intricacies of accounting. If you have at least a decent working knowledge of these matters, it becomes a relatively easy process for us together to plan around them accordingly. But based on some business tax returns I’ve seen recently I thought it might be good to write a few articles focused on some key accounting principles that can have a huge effect on a company’s profit and loss in a given year.
Normally I focus on the tax code, business strategy, and other things in that same vein. I don’t usually write “Accounting 101” type articles. But I do think that it’s healthy for you to have a general understanding of what problems can exist, and ultimately how an advisor can best solve them for you. Do you need to become an accounting expert? Of course not. But solving it “in a way you don’t understand”? I’m not sure that’s the wisest approach. So yeah, there can be “problems you didn’t know you had” and to be sure, that’s where a good accountant comes in. You’re not supposed to know the intricacies of accounting and taxes. You’re a business owner and you’re an expert in your particular field. OK, that old line, as with many jokes, contains a certain amount of truth. “An accountant is someone who solves a problem you didn’t know you had in a way you don’t understand.”
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