Inventory Vaulation

[Snow White]

Client has a business whereby she premakes decorated scrap book pages. Such as for Valentines Day, she may put together 5 pages, all of which may include scrap-size pieces of paper, stickers, buttons, lace, etc. She is a new client and now she has to go back to 12/31/04 and figure out what her ending inventory was in order to complete schedule C. Not too difficult to count the raw materials and determine what their cost was. But now she has finished products with a little of this and a little of that. Does anyone have any good ideas about how she can cost this out without having a major cost accounting system for each piece of her raw materials. Are there valid percentage computations that she can use based on percentage of sales? 2004 was her first year doing this. Sales first year around $2500.

[BOB W]

Inventory

What were her purchases of inventory goods for 2004?

What was her ending inventory of raw materials?

What is the retail value of the finished unsold goods?

Of course all info must be as of 12/31/04

[Snaggletooth]

Wing It

I've been where you are numerous times. There are historical sales and purchases of materials which, given enough time, can allow you to "back into" an ending inventory. The easiest way of course is to simply COUNT raw materials, etc. but my guess is that this was the first year - the client didn't know to take an inventory -- and now she must "guess" at it.

Snow White, this is NOT the correct answer, but at this point it may be the ONLY answer. Take her Sales for 2004 and divide by three (for the kind of "put-together" operation she has). This would be about $833. Subtract this from her Purchases of inventoriable materials and supplies for 2004, and that would be your ending inventory. This will ONLY work in 2004 because it is the first year.

Tell her she will HAVE to take an inventory in December of 2005. If she doesn't then tell her you will have to estimate her inventory on the high side. Fortunately, in 2004, you don't have a lot of money involved that an error would involve a lot of money for an auditor.

In her kind of business, make SURE an allowance is made for personal usage.

Snow White, there will be further posts criticizing my process as outlined above. I know it is faulty, but if you want a textbook "pure" way to handle it, you don't have the information to assemble a good method.

Regards, Ron Jordan

[Snow White]

Snag

How did you determine this and why would it work only in the first year:

"Snow White, this is NOT the correct answer, but at this point it may be the ONLY answer. Take her Sales for 2004 and divide by three (for the kind of "put-together" operation she has). This would be about $833. Subtract this from her Purchases of inventoriable materials and supplies for 2004, and that would be your ending inventory. This will ONLY work in 2004 because it is the first year."

I appreciate your response even though others may not. At a minimum, it gives me something to think about or a direction or lead to follow. Thanks for responding.

One thing I do as a service for my clients, is that if there's ever a quick and dirty excel spreadsheet that helps them, I usually take 10 mintues to put one together and copy it off. I have an idea for this client that will help her during the year. A lot of what she has spent on inventory supplies is impulse buying and now she has a basement full of "raw materials".

[Bees Knees]

Snow

I assume your client averages less than $1 million in gross sales per year. That qualifies her for the cash method of accounting. The only thing you have to worry about as for inventory is the materials and supplies rule. That rule says you deduct the cost of your raw materials in the later of the year the materials and supplies are used, or the year they are paid for. No accrual of receipts or deductions are necessary.

That being said, it is almost still a cost of goods sold situation, since the raw materials and supplies at the end of the year still need to be included in ending inventory. If your client did not take an ending inventory of materials and supplies on hand, have your client estimate the cost of raw materials and supplies that go into each product sold. Then multiply that by the number of products sold (assuming each product sold uses about the same amount of materials and supplies). That will give you your cost of goods sold deduction. You can also throw in an estimate of materials and supplies damaged or discarded by the end of the year. But I would inform your client to take inventory of supplies on hand next December 31 so that you don’t need to do this estimation stuff again next year.

[Bees Knees]

more...

One more suggestion. Let’s say each product is not equal in cost or in the amount of raw materials and supplies used. Then, the best way to estimate cost of sale is to have her take a sample cost of products she is producing now. So lets say for a $40 sale price, it costs her $10 in raw materials. For an $80 sale price, it costs her $15 in raw materials. You then start making averages in various price ranges, so that your $40 price range products have a 25% of gross sale price cost, but your $80 price range products have a 18.75% of gross sale price cost.

Then you apply these percentages to each item sold per price range, and you have your cost of goods sold.

I think if you take sample sales estimates like these, any auditor would probably accept it as a reasonable method absent actual inventory counts.

[Snaggletooth]

Assuming the Conclusion..

...of course is something you should not do. But in my suggestion, and also assumption of a gross profit such as Beeswax above, we are assuming the conclusion.

Snow White, as I admitted before, my approach is full of holes, but given the situation was a suggestion to get the clients return filed for 2004 -- had better records been available or had the situation involved a substantial amount of money, there would have been many better ways to do this.

You must first have pounded into your mind the simple, classic calculation of Cost of Sales for accounting purposes. In its simplest form there are only four line items in the calculation, and understanding of the interaction of these four line items. The reason my suggestion works only in Year 1 is that there is no beginning inventory. Also it would not be recommended in future years because there will (presumably) be many more dollars involved and there should be inventories recorded in future years.

If you wade through the suggestion offered by Bees Knees, he is offering a more developed solution, but again all that shakes out of his calculation is a percentage-wise assumption of cost-of-sales, and then "backing in" to the ending inventory just as I did. His percentage-wise solution becomes a more and more realistic estimate as the amount of raw data becomes more and more abundant. For example, if you have 3-4 years worth of data, his estimate of cost-of-sales gives you a more realistic Schedule C than would be the case with only a portion of the first year.

[Snow White]

Thanks

Thank you Bees Knees and Snaggletooth. It is always good to get other's opinions and bounce these off of someone else. I'm glad this board is here!